Cheyne Finance Plc, Re

MR. JUSTICE BRIGGS:

1 This is an urgent application for directions by Messrs. Nicholas Edwards, Neville Kahn and Nicholas Dargan, all of Deloitte & Touche LLP, as Receivers of the business and assets of Cheyne Finance Plc, having been appointed on 4^th September of this year pursuant to the terms of a Security Trust Deed dated 3^rd August 2005, and made between Cheyne and the Bank of New York. The Receivers seek directions as to how to apply monies coming into their hands on the basis that, on advice, they consider that they need the Court’s answer to an underlying difficult issue of the construction of the Security Trust Deed.

2 For that purpose the Receivers have identified two beneficiaries of the Security Trust Deed with interests served by the only two alternative constructions which have been identified, both of whom, or which, wish for commercial reasons to remain anonymous. They have each indicated through counsel that they are only prepared to participate in this hearing on that basis. Their identity is of no relevance to the issues and it appears that the preservation of their anonymity is the only way in which the adversarial argument on the issues can be arranged at the necessarily short notice. I am satisfied that the two alternative constructions have, despite the shortness of time, been fully argued. Preserving the anonymity of the two beneficiaries has enabled both the argument and this judgment to be heard and given in open court. I shall refer to the proponents of the rival arguments as Parties A and B. Another interested party initially appeared, also anonymously, to support Party B, but on reading the skeleton argument prepared on Party B’s behalf by leading and junior counsel decided that there was nothing that could usefully be added.

3 The urgency of the matter, it being recognised on all sides that the Receivers need directions today after a hearing yesterday afternoon, means that this judgment has had to be both extempore and in a relatively abbreviated form without the full explanation to the uninitiated of the relevant and complex contractual and commercial background which I would have preferred to provide. Since both the relevant facts and the contractual framework are common ground I can confine myself to a judgment which identifies the construction which I have decided is to be preferred and which provides brief reasons.

4 The Bank of New York, as Security Trustee, became obliged to appoint the Receivers pursuant to clause 10 of the Security Trust Deed because of the occurrence and notification by the Trustee of an Enforcement Event. As with most defined terms, the meaning of this phrase is to be found in Clause 2 of a Common Terms Agreement of even date. The Enforcement Event in the present case consisted of the breach by Cheyne of a Major Capital Loss test, also as defined, which I am told is itself the consequence of the fact that a significant part of Cheyne’s assets consisted of securities backed by assets consisting in part of United States of America home equity loans, some of which have suffered recently as a result of the USA sub-prime mortgage crisis.

Nonetheless, it is not the present view of the Receivers, after a brief initiation into the affairs of the company, that it is at present insolvent in the sense either than it is unable to pay its debts as they fall due or in the sense that its assets are exceeded in value by its liabilities.

5 More specifically, it is common ground that there has not yet occurred an Insolvency Event within the meaning of the Security Trust Deed or the Common Terms Agreement, which is defined as follows:

“Insolvency Event means a determination by the Manager or any Receiver that the Issuer is, or is about to become, unable to pay its debts as they fall due to Senior Creditors and any other persons whose claims against the Issuer are required to be paid in priority thereto, as contemplated by Section 123(1) of the United Kingdom Insolvency Act 1986 (such subsection being applied for this purpose only as if the Issuer’s only liabilities were those to Senior Creditors and any other persons whose claims against the Issuer are required under the Security Trust Deed to be paid in priority thereto).”

6 In order for that definition to be intelligible I must explain that the Issuer is Cheyne. The Senior Creditors are defined as persons to whom Senior Obligations are owing, and Senior Obligations are defined so as to include secured, but limited recourse Loan Notes issued by Cheyne to raise finance for its investment activities.

7 The reference to Section 123(1) of the Insolvency Act necessarily excludes balance sheet insolvency as defined by Section 123(2) of the Act. Thus, it is submitted by Party A and not seriously challenged by Party B, that if the Receivers were hypothetically to determine that Cheyne is able to pay its debts as they fall due now and in the near future, but not in the more distant future because of a balance sheet deficit, that would not constitute an Insolvency Event. I am prepared for present purposes to assume, without deciding, that the definition of Insolvency Event in the Common Terms Agreement does operate in that rather narrow and unusual way. I make it clear that the Receivers have not concluded that Cheyne is balance sheet insolvent at present.

8 The Receivers recognise a real risk that the present volatility and illiquidity in the market for some of Cheyne’s investments may lead to an Insolvency Event occurring in the future such that, although the present value of Cheyne’s assets is believed to be sufficient to pay all its creditors, that may change to an extent that even Senior Creditors will not be paid in full on the maturity of their Notes, which will occur on a rolling series of dates during the next two years.

9 The Receivers have cash available to pay maturing Senior Obligations through to early November 2007, but payments thereafter require asset realisations, the amount and speed of which are hard to predict having regard to the state of the relevant market.

10 During the period between appointment due to an Enforcement Event and the happening of an Insolvency Event the Receivers’ obligations are defined mainly by Clauses 10 to 12 of the Security Trust Deed. The relevant parts of Clause 10 are as follows:

“10.2 It shall be a term of any appointment of a Receiver under subclause 10.1 that such Receiver shall, unless and until an Insolvency Event Notice is delivered by the Security Trustee in accordance with Clause 9:

(a) manage the Security Assets and the business of the Chargor with the objective of arranging for timely payment in full of the Chargor’s obligations to the Senior Creditors and any creditors ranking in priority to the Senior Creditors in the Payment Priority and, unless in the opinion of such Receiver the interests of the Senior Creditors and any creditors ranking in priority to the Senior Creditors in the Payment Priority would be adversely affected thereby, the other Secured Creditors, in each case as and when they fall due for payment in accordance with Clause 12 below and, in so doing, shall ensure that the business of the Chargor is managed in accordance with the Restricted Funding Restrictions and Guidelines contained in subclause 6.2 of the Management Agreement …”

Clause 10.2(c) provides that the Receivers must, during the same period, also:

“determine, as often as it, acting in good faith, thinks fit, whether the Chargor is or is about to become unable to pay its debts to Senior Creditors and any other persons whose claims against the Chargor are required to be paid in priority thereto in accordance with the definition of Insolvency Event, and forthwith upon determining that the Chargor is or is about to become so unable, notify the Security Trustee accordingly.”

11 Clause 11 confers wide powers on the Receivers, the precise ambit of which is not relevant for the present issue. Clause 11.12 provides that those powers are available to the Receivers during the period from their appointment until the happening of an Insolvency Event.

12 Clause 12 sets out a detailed table of priorities which must be applied by the Receivers in paying creditors out of monies coming into their hands. Ten successive priorities are identified. The present issue arises not, as it were, as between any of those ten priorities but internally in relation to the second of them. The relevant parts of Clause 12 are as follows:

“Any moneys received by the Security Trustee or a Receiver after the occurrence of an Enforcement Event shall, subject to the payment of any claims having priority to the security constituted by the Security Trust Deed and to subclause 11.11, be applied in the following order of priority (the ‘Payment Priority’) …”

Subclause (a) provides for first priority for certain expenses and remuneration; and subclause (b) provides as follows:

“secondly, in satisfaction of or provision for all Senior Obligations as and when the same become payable and, if more than one such Senior Obligation is payable at the relevant time, pari passu and in proportion to the amounts payable in respect thereof;”

There then follow the remaining priorities, and after all ten have been listed the clause continues as follows:

“… and, for the avoidance of doubt, no such moneys shall be applied at any point in the Payment Priority unless and until payment for all amounts at a more senior position in the Payment Priority have been discharged, except to the extent that the Security Trustee or, as the case may be, the Receiver considers that sufficient cash has been realised from the disposal or maturity of the Security Assets to enable all such obligations at a more senior position in the Payment Priority which are not then due and payable to be discharged as and when they fall due for payment …”

13 The issue arises from two rival interpretations of clause 12.1(b). I shall describe them in the form into which they had developed by the end of the hearing. Under the first, referred in argument as the “pay as you go” construction, the Receivers are, on any particular day, obliged to use available moneys after compliance with Clause 12.1(a) in paying in full Senior Obligations by then due and payable, then in using any surplus as a cash provision for Senior Obligations not yet due and payable and only if a full cash provision leaves a surplus moving down to the third and subsequent priorities set out in Clause 12.1. This construction was advanced by Mr. Trower QC and Mr. Goldring for Party A.

14 Under the second construction, referred to in argument as the “pari passu” construction, the Receivers are obliged to apply moneys left after compliance with Clause 12.1(a), first, in making provision for payment of all Senior Obligations whether or not immediately due and payable, and making full payment in satisfaction of presently payable obligations only if the available moneys are sufficient to do so after making full provision and, if not sufficient, paying a reduced sum pari passu to all Senior Creditors. This construction was advanced by Mr. Mortimore QC and Miss Stonefrost for Party B.

15 On analysis the issue is therefore whether, prior to the happening of an Insolvency Event, Clause 12.1(b) sets up an internal priority between on the one hand payment of debts due and payable in full, and on the other hand provision for all relevant debts whether or not due and payable.

16 Before expressing my conclusion on this issue it is material to note certain aspects of the relevant provisions and certain consequences of the rival constructions. First, Clause 12 regulates the priority of payments by the Receivers not merely prior to an Insolvency Event but after it. This is because, for example, the definition of an Enforcement Event includes an Insolvency Event and because, by contrast with Clause 10.2, Clause 12 applies throughout the period of office of Receivers, who must be appointed under Clause 10.1 upon both an Enforcement Event and an Insolvency Event. Accordingly, it is not to be supposed that the numerous references in Clause 12.1 to pari passu distribution are meaningless unless they applied prior to the happening of Insolvency Event. It may be that they are intended to apply only after the happening of an Insolvency Event.

17 Secondly, if the operation of Clause 12.1 ever leads to any Senior Creditor being paid less than the full amount of a debt immediately due and payable, that will of itself automatically constitute an Insolvency Event. Thus, on the pari passu construction the inability of the Receivers to satisfy themselves that all future liabilities to Senior Creditors are fully provided for will itself trigger an Insolvency Event due to their inability to pay in full those Senior Obligations which are already due and payable.

18 Thirdly, once there has been an Insolvency Event, the rival constructions produce the same result, since by Clause 9.2 of the Security Trust Deed all Secured Obligations, which include most if not all Senior Obligations, are immediately due and payable and the distinction between Obligations payable now and Obligations payable only in the future therefore disappears.

19 Fourthly, it is therefore difficult to see how the second part of Clause 12.1(b) calling for pari passu payment between Senior Obligations with the same maturity dates could ever arise during the only period – i.e. after an Enforcement Event but prior to an Insolvency Event – when this issue of construction actually matters. If the Senior Obligations cannot be paid in full at any relevant time Cheyne is unable to pay its debts to its Senior Creditors as they fall due. It follows that the second part of Clause 12.1(b) is, in my judgment, of little weight in understanding how Clause 12 is intended to operate prior to an Insolvency Event.

20 I have concluded that Clause 12.1(b) is to be construed in accordance with the pay as you go construction. My reasons follow. The provision of the Security Trust which is most clearly expressed to be applicable to the relevant period – i.e. between the happening of an Enforcement Event and the happening of Insolvency Event – is clause 10.2, which requires the Receivers to manage the Company’s assets with the express objective of achieving the timely payment in full of debts to Senior Creditors as and when they fall due for payment.

21 The pay as you go construction of Clause 12.1(b) operates in complete harmony with that objective. By contrast, that objective, designed to produce cash-flow from realisations aligned with the amounts and maturity dates of the Senior Obligations, is at complete variance with the pari passu construction of 12.1(b). As Mr. Trower and Mr. Goldring put it in their skeleton argument:

“It would be illogical for the Receivers to be obliged to manage the Security Assets in a way aimed at allowing timely payment of the Company’s debts as they fall due but for the moneys received from such management to be distributed to Senior Noteholders in a different way.”

22 There is nothing in the language of Clause 12.1(b) itself which either points to or requires the Receivers to treat full provision for future Senior Obligations as a necessary condition precedent to payment of Senior Obligations already due and payable, nor, it is fair to say, does the language of Clause 12.1(b), viewed on its own, unambiguously require the opposite – i.e. payment of due debts in full before provisioning. In my judgment, the whole of Clause 12 is concerned with the order of priorities – that is the ten priorities identified – rather than with the internal administration of a particular priority, such as that identified compendiously in favour of Senior Obligations in Clause 12.1(b).

23 Nonetheless, the payment requirement in Clause 12.1(b) precedes the provision requirement and, although not as clear as it might have been, the language is, in my judgment, more easily reconciled with an obligation first to pay what is due and then to use as much as is necessary of the balance of the moneys as a cash provision against Senior Obligations due in the future.

24 The analysis is fortified by the avoidance of doubt section of Clause 12, which I have read, which forbids the Receivers from paying debts of lesser priority until full cash provision has been made for future more senior obligations. Implicit in that language is the contemplation that after payment of present Senior Obligations there may be some, but not enough, cash for provision against future Senior Obligations with the result that more junior debts, even though immediately payable, do not get paid. This will not, of itself, cause an Insolvency Event because that definition refers only to debts due to Senior Creditors.

25 Mr. Mortimore sought to avoid that interpretation by submitting that provision in Clause 12.1(b), although out of moneys in the Receivers’ hands, could nonetheless be made having regard to the other non-cash assets of Cheyne, whereas cash provision under the avoidance of doubt section of Clause 12 could not. Although ingenious, I am not persuaded by that argument. In my judgment, all references to “provision” in Clause 12 are about cash provision, as the avoidance of doubt section makes clear.

26 In reaching that conclusion I have not ignored Mr. Mortimore’s other submissions to the contrary. His main point was that the pay as you go construction involved the real risk that creditors of equivalent – that is senior – priority might get paid unequally to the prejudice of those with later maturity dates, who might get little or nothing if an Insolvency Event followed a significant period of pay as you go – i.e. in full – distribution by the Receivers after an Enforcement Event.

27 The pay as you go construction clearly does involve that risk, and on the assumption about the narrowness of the definition of Insolvency Event which I have been invited to make, even a probability of such unfairness where the Company’s balance sheet shows a likely inability to pay debts in full but only later rather than sooner. But the unfairness in question arises primarily from the narrowness of the definition of Insolvency Event deliberately chosen by the parties so as exclude balance sheet insolvency.

28 It would, in my judgment, be wrong to adopt a strained construction of Clause 12 merely to remedy, as I accept it would do, a potential for what some would regard as unfairness where the risk appears to have been deliberately undertaken in a detailed regime designed, as is common ground, entirely to replace the statutory insolvency scheme as between the parties, who include the Senior Creditors.

29 Furthermore, there is, prior to an Insolvency Event, an equal and opposite chance that an orderly run-off of Cheyne’s business pursuant to the objectives set out in Clause 10 will lead to the payment on time and in full of all Senior Creditors, even though the Receivers could not be sure at the outset that full provision could be made. The pari passu construction would prevent that objective from being achieved in such cases and would appear, therefore, to risk defeating an expressly stated commercial purpose of the contractual structure. In short, the structure appears to be the product of a deliberate decision by its participants to maximise the prospects of an orderly run-off at some risk to strict pari passu fairness if insolvency as defined later ensues. Whatever the general public policy enshrined in the insolvency legislation, there is no reason, in my judgment, why the court should seek to defeat that commercial objective freely agreed, as it was, between Cheyne and its no doubt highly sophisticated secured creditors.

30 Mr. Mortimore submitted that such an outcome would also be inconsistent with passages in the information memoranda relating to some of the Senior Obligations which describe the relevant Loan Notes as ranking pari passu amongst themselves. I do not agree. There are, on any construction of Clause 12.1(b), powerful pari passu elements built into the structure, both in the priority provisions and in the acceleration provisions triggered by the happening of an Insolvency Event. In any case, the true construction of the contractual provisions must prevail.

31 It seems to me at least possible that by reference to Section 123(1)(e) of the Insolvency Act 1986 incorporated into the definition of an Insolvency Event in the Common Terms Agreement, the definition might not be quite as narrow as that which I am invited to assume. For example, if the Receivers were to become certain after realising all Cheyne’s assets for cash that it will default in payment of Senior Creditors’ debts as they fall due in the distant rather than the near future, that certainty of future default may arguably constitute a present status of inability to pay debts as they fall due within the definition. The present circumstances do not require me to decide that question, nor do I, but it may arise for decision in the future. If that slightly broader definition were to prevail, it would, for present purposes, merely reduce the scope for alleged unfairness of the pay as you go construction.

32 It follows that I resolve the construction issue underlying this application in favour of the pay as you go construction, and I will hear submissions as to an appropriate form of order.

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