Deutsche Trustee Company Ltd v Cheyne Capital (Management) UK (LLP) & Anor

This is a Part 8 claim for the determination of an issue of interpretation of clause 26.4(b) of a servicing agreement which is part of the documentation relating to a commercial mortgage-backed securitisation transaction (“the Transaction”). The Claimant (“the Trustee”) is the Note Trustee and Issuer Security Trustee in relation to certain notes (“the Notes”) issued by the Second Defendant (“the Issuer”) as part of the Transaction. The Trustee has no commercial interest in the outcome, but seeks the assistance of the Court. The First Defendant (“Cheyne”) acts as Operating Advisor for the Class G Noteholders. Cheyne advances one interpretation of clause 26.4(b). The Trustee has agreed to advance an alternative interpretation. The Issuer also has no commercial interest in the outcome, and has stayed neutral.

Sensibly, the parties prepared a Statement of Agreed Facts before the claim was issued, and subsequently a Statement of Further Agreed Facts. The only evidence filed was two brief, formal witness statements. My account is substantially based on the agreed Statements, supplemented by additional references to the Transaction documents from the parties’ skeleton arguments.

CMBS transactions are securitisations which, in broad terms, involve the acquisition of one or more loans secured upon income-generating commercial real estate, by a special purpose vehicle (in these proceedings, the Issuer), which funds the acquisition of the loan(s) through the issuance of notes to debt capital market investors.

Payments of interest on, and repayments of principal in respect of, the notes are typically funded through payments of interest on and repayments of principal in respect of the loan(s). Such payments are typically funded by the cash-flow generated by the relevant commercial real estate.

Notes in CMBS transactions are typically issued in multiple classes. The allocation of principal receipts on the loan(s) towards payments of principal on the notes is typically governed by complex rules that, in a pre-loan default situation, allocate loan principal receipts to the various classes of notes partly on a sequential basis and partly on a pro-rata basis but, following a loan default, on a fully sequential basis, with the most senior class of notes being paid first in priority and the most subordinate class of notes being paid last in priority. “Sequential” means that the relevant amount is allocated to the most senior class of notes first until it has been redeemed in full, then to the next most senior class of notes until it has been redeemed in full and so on until the relevant amount has been fully allocated. “Pro-rata” means that the relevant amount is allocated among all classes proportionally (based on their principal amount outstanding as a proportion of the aggregate principal amount outstanding of all classes of notes) meaning that each class of notes will receive a proportionate share of the relevant amount. Principal losses on the loan(s) are therefore allocated reverse-sequentially, with the most senior class of notes being the least risky and the subordinated class of notes being the most risky from a credit perspective. “Reverse-sequentially” means that the relevant losses are allocated to the outstanding principal amount of most subordinate class of notes first until it has been reduced to zero, then to the next most subordinated class of notes until its principal amount outstanding has been reduced to zero and so on until the relevant loss has been fully allocated.

The issuer in a CMBS transaction (such as the Issuer) is typically an orphan special purpose vehicle without employees to manage the loan exposures. The management of the loans is therefore outsourced to a third party service provider (in the Transaction, the “Issuer Servicer”) pursuant to a loan servicing agreement (in the Transaction, the “Issuer Servicing Agreement”). So long as the loans perform in the manner that they are expected to (i.e. there is no default), the management of the loans is relatively limited, typically only involving cash collections, information gathering and reporting and responding to borrower requests for waivers and consents in a pre-default scenario.

When a loan in a CMBS transaction suffers a default which constitutes a trigger event for the purposes of the loan servicing arrangements (identified in the Transaction documents as a “Special Servicing Transfer Event”), however, the responsibility for the active management of such loan, and the resolution of that default, passes into the hands of a specialist loan work-out/resolution service provider known as a special servicer (in the Transaction, the “Issuer Special Servicer”).

The special servicer is required to determine the options available to it for resolving such default and, from those options, select and implement the one that maximises recoveries in respect of the defaulted loan. Such resolution strategy may involve agreeing a consensual restructuring of the loan with the relevant borrower so that the loan becomes a performing loan once again. If a consensual restructuring is not possible or appropriate, however, the special servicer would need to consider loan security enforcement strategies with a view to maximising recoveries.

The rights and obligations of the parties involved in the Transaction are set out in a suite of interlocking documents entered into on 28 June 2007 (“the Transaction Documents”). The principal Transaction Documents for present purposes are as follows:

Each of the Transaction Documents is expressly governed by English law and contains a jurisdiction clause in favour of the courts of England and Wales.

The Notes were part of a financing structure relating to ten Euro-denominated loans made to borrowers in Germany, Switzerland and Austria (“the Loans”). The Loans provided an income stream to pay principal and interest on the Notes. The originator in respect of the Loans was Deutsche Bank AG, London Branch (“the Originator”).

At the time of issue of the Notes in June 2007, a portion of the Originator’s interest in certain of the Loans was sold to the Issuer by way of loan sale agreements. The sale incorporated a transfer of the Originator’s corresponding interest in the assets securing these Loans. The interest in the remaining portion of certain of the Loans and the corresponding interest in the related security were retained by the relevant original lender and the Originator.

The Issuer granted security over, amongst other assets, the Loans, for its obligations in respect of the Notes. Security was granted pursuant to the Deed of Charge.

The Notes are Euro-denominated commercial mortgage floating rate notes (except that Class X bears interest at a variable rate) in the total sum of €1,445,342,232, with a final maturity date of April 2018. As set out in the following table, the Notes fell into ten classes, from Class A1 to Class G in descending order of priority:

Each class was rated by one or more of three rating agencies (the “Rating Agencies” as defined in the Master Definitions Schedule): Moody’s Investors Services Ltd (“Moody’s”), Standard & Poor’s Rating Services, a division of the McGraw-Hill Companies, Inc (“S&P”) and Fitch Ratings Ltd (“Fitch”). “NR” in the table above means not rated.

As would be expected, the more junior notes, with lower ratings, paid a higher margin over the applicable base interest rate (EURIBOR), than the more senior notes. So the Class A1 Notes paid a margin of 0.16% over EURIBOR, while the more speculative Class G Notes paid a margin of 3.25% over EURIBOR.

The relative priority of the more senior classes of Notes over the more junior classes is reflected, in the usual way, in various provisions of the Transaction Documents. For example:

The Transaction Documents contain a concept of the “Controlling Class” of Notes, being, in short, the holders of the most junior ranking class of Notes with at least 25% of its original principal amount outstanding. The holders of the Class G Notes, as the most junior class of notes, were the Controlling Class as at the Closing Date, and are still the Controlling Class. Condition 19 of the Notes provides, in short, that, if an Event of Default occurs in respect of the payment of principal or interest on any Relevant Whole Loan, some or all of the holders of the Class of Notes which is then the Controlling Class may elect to acquire the Relevant Whole Loan at par plus accrued interest (and see also clause 25.1 of the Issuer Servicing Agreement).

Condition 19 of the Notes provides that in certain circumstances the Controlling Class is entitled to appoint a Noteholder to be their representative, referred to as the “Operating Adviser”. The Issuer Servicing Agreement gives the Operating Adviser certain rights. In particular, clause 12 requires the Issuer Servicer or Issuer Special Servicer to consult with the Operating Adviser before agreeing to certain waivers or amendments to any Loan Document relevant to a Loan. The Operating Adviser has the right to suggest alternative courses of action to the Issuer Servicer or Issuer Special Servicer and to require the Issuer Servicer or Issuer Special Servicer to submit revised proposals which incorporate the alternatives suggested by the Operating Adviser to the extent that the Issuer Servicer or Issuer Special Servicer considers that such proposals are not inconsistent with the Servicing Standard. Absent agreement, at the end of 45 days, the Issuer Servicer or Issuer Special Servicer is required to decide on the course of action which it thinks should be taken in accordance with the Servicing Standard. Clause 12.8 provides that, notwithstanding any other provision, in no event is the Issuer Servicer or Issuer Special Servicer required to take any action which in its good faith and reasonable judgment would cause it to violate the Servicing Standard.

The Issuer Servicing Agreement provides for the Issuer Servicer to be appointed to manage and administer the relevant loans on behalf of, amongst others, the Issuer, the Issuer Security Trustee and the Note Trustee. The loans are to be managed by the Issuer Servicer in accordance with a prescribed standard referred to as the “Servicing Standard” (clause 3). The Issuer Servicing Agreement also provides that, in certain circumstances, the Issuer Servicer will be replaced by the Issuer Special Servicer, which will take over responsibility for managing the relevant loans (clause 10). The relevant circumstances are defined as a Special Servicer Transfer Event and include, amongst other things, a payment default on a loan or the Borrower becoming the subject of insolvency proceedings (Master Definitions Schedule).

Under the Issuer Servicing Agreement, the Originator was appointed as the Issuer Servicer and HPI as the Issuer Special Servicer.

Clause 26 of the Issuer Servicing Agreement sets out a code dealing with the termination of the appointment of each of the Issuer Servicer and the Issuer Special Servicer, and the appointment of successors. There are three broad bases for termination, set out in clauses 26.1, 26.2 and 26.3, each of which can only take effect if the requirements in clause 26.4 are also met:

So far as relevant, clause 26.3 provides:

“Subject to the requirements of Clause 26.4, the appointment of the person then acting as Issuer Special Servicer in relation to a particular Loan and, if applicable, a Senior Loan and its related Subordinated Loan may also be terminated (a) upon the relevant Operating Advisor notifying the Issuer that it requires a replacement Issuer Special Servicer to be appointed or (b) ... or (c)... , provided always that any such termination or replacement does not cause the then current rating of the Notes to be downgraded, withdrawn or qualified. …”

So far as relevant, clause 26.4 provides:

“No termination of the appointment of the Issuer Servicer or the Issuer Special Servicer under Clauses 26.1, 26.2 or 26.3 will take effect unless:

…

(b)

the Issuer Servicer or, as the case may be, the Issuer Special Servicer will have notified each of the Rating Agencies in writing of the identity of the successor Issuer Servicer or successor Issuer Special Servicer and the Rating Agencies have confirmed to the Issuer Security Trustee and the Note Trustee that the appointment of the successor Issuer Servicer or Issuer Special Servicer will not result in an Adverse Rating Event, unless each class of Noteholders have approved the successor Issuer Servicer or successor Issuer Special Servicer, as applicable, by Extraordinary Resolution;

…”

An “Adverse Rating Event” is defined in the Master Definitions Schedule as meaning “with respect to any Rating Agency, an event that would cause the downgrade, qualification or withdrawal of the then current ratings by such Rating Agency of any class of Notes”.

Clause 29.10 requires the Issuer Servicer promptly to notify each Rating Agency of any of various events of which it has actual knowledge, including “(d) the appointment of any replacement Issuer Servicer or Issuer Special Servicer …”.

Clause 29.13 provides:

“If this Agreement requires Rating Agency confirmation to be obtained in relation to a particular matter, the Issuer Servicer (or, in the case of matters pertaining to a Specially Serviced Loan, the Issuer Special Servicer) will, as soon as is practicable following a request therefor, provide each Rating Agency with all information as is reasonably necessary and available to it to enable such Rating Agency to determine whether, and on what basis, confirmation should be given. In the event that Moody’s fails to respond to such request for confirmation within 30 days (or such earlier date as the Issuer Servicer or the Issuer Special Servicer, as applicable, has determined is appropriate under the circumstances in accordance with the Servicing Standard), the Issuer Servicer or the Issuer Special Servicer will not be required to obtain such confirmation from Moody’s.”

The Rating Agencies are not parties to any of the Transaction Documents. Nevertheless, those documents contain various provisions which require information to be given to the Rating Agencies or permit or require their confirmation to be obtained, often in slightly different terms depending on the context. In addition to clause 26.4(b) of the Issuer Servicing Agreement, other such provisions include, for example:

In this connection, two points should be noted with regard to the definitions contained in the Master Definitions Schedule. The first is that the Master Definitions Schedule provides that “any two Rating Agencies” or “two Rating Agencies” “shall be construed to include S&P and Fitch”.

The second is that the Master Definitions Schedule contains a definition of “Rating Agency Confirmation” as “a confirmation from Fitch and S&P that their current ratings of the Notes will not be qualified, suspended or downgraded”. This defined expression is not used in clause 26.3 or clause 26.4(b). Indeed, the defined expression appears to be barely used in the Transaction Documents: apart from Condition 12(p) of the Notes referred to above, the only use which was drawn to my attention is in clause 11.3 of the Deed of Charge. The expression is re-defined in Condition 12(l) of the Notes referred to above in a manner that is almost, but not quite, consistent with the definition in the Master Definitions Schedule (Condition 12(l) refers to withdrawal rather than suspension).

It is agreed that, in about 2007, Moody’s generally stopped providing written confirmations in relation to CMBS transactions.

On 10 December 2012 Fitch issued a press release stating:

“In EMEA CMBS, Fitch is periodically asked to confirm that the appointment of a special servicer would not, in itself, cause the downgrade of any notes. As outlined more fully below, Fitch will not provide such ratings confirmations in EMEA CMBS. This stance formalises concerns previously expressed by Fitch regarding proposals originating from individual creditor classes whose interests may not be aligned with those of other affected noteholders.

Replacing a special servicer is one source of influence over rating-sensitive outcomes that may or may not be in the wider interests of holders of all rated notes. In general terms, there is potential for conflicts of interests to arise from, inter alia:

-

a connection between the controlling class (or its representative) and the prospective special servicer;

-

conflicting preferences between the controlling class (or its representative) and other (in particular senior) noteholders.

… Fitch expects to continue to receive notification of all changes in transaction parties, including those governed by the servicing agreement. If warranted by such a change, Fitch will take rating action as appropriate.”

Cheyne was appointed as Operating Adviser for the Class G Noteholders, as the Controlling Class, by Extraordinary Resolution dated 8 December 2011. On 22 May 2014 Cheyne in its capacity as Operating Adviser requested the Issuer and the Trustee to terminate the appointment of the Issuer Special Servicer of two of the smaller Loans within the Transaction and to appoint a replacement Issuer Special Servicer, namely Solutus Advisors Ltd.

As noted above, the Rating Agencies are not parties to the Transaction. Accordingly, they are under no obligation to say whether or not the appointment of the successor Issuer Special Servicer will result in an Adverse Rating Event.

All three Rating Agencies have been notified of Cheyne’s request. A confirmation of the kind required by clause 26.4(b) has been received from S&P. Moody’s has said that it will be able to provide a confirmation contemporaneously with the Issuer Special Servicer being replaced. Unsurprisingly, given its announcement on 10 December 2012, Fitch has stated that it will not respond to any request to provide a confirmation. Accordingly, no confirmation has been received from Fitch. Nor has Fitch indicated that replacement will result in an Adverse Rating Event.

The issue is whether clause 26.4(b) permits the replacement of the Issuer Special Servicer in circumstances where a Rating Agency declines to say whether or not the appointment of the proposed successor Issuer Special Servicer would result in an Adverse Rating Event. The issue arises because of the stance adopted by Fitch since 10 December 2012.

In short, Cheyne contends that clause 26.4(b) should be interpreted as requiring confirmation that replacement will not result in an Adverse Rating Event from such of the Rating Agencies as are willing in principle to give such confirmations. Accordingly, since Fitch is not willing to give such confirmations as a matter of principle, the absence of a confirmation from Fitch does not prevent the replacement of the Issuer Special Servicer. The Trustee contends that clause 26.4(b) should be interpreted as requiring confirmation from all three Rating Agencies. Accordingly, the absence of a confirmation from Fitch does prevent the replacement of the Issuer Special Servicer (unless another step is taken, as explained below).

I was referred by the parties to a number of the well-known authorities on interpretation of commercial documents, including in particular Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, [2009] 1 AC 1101, Re Sigma Finance Corp [2000] UKSC 2 [2010] 1 All ER 571, Rainy Sky SA v Kookmin Bank [2011] UKSC 50 [2011] 1 WLR 2900, Aberdeen City Council v Stewart Milne Group Ltd [2011] UKSC 56 and Arnold v Britton [2015] UKSC 36. I adopt the convenient summary of the basic principles set out by Richard Snowden QC (as he was), sitting as a Deputy High Court Judge, in US Bank Trustees Ltd v Titan Europe 2007-1 (NHP) Ltd [2014] EWHC 1189 (Ch) as follows:

“i)

The interpretation of a contract is an objective exercise in which the court's task is to ascertain the meaning that the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.

ii)

This exercise of interpretation was described by Lord Clarke in Rainy Sky as a ‘unitary’ process. The starting point of that process must be the ordinary, natural and grammatical sense of the language used by the parties. The court should not, however, confine itself to a consideration of such language in isolation, but should carry out an iterative process, checking each of the rival meanings of the provision in question against the other provisions of the document and its overall scheme, and investigating their commercial consequences.

iii)

If as a consequence of this exercise the court concludes that the language used is unambiguous, then the court must apply it, even though some other result might be thought more commercially reasonable, and even if it gives a result that is commercially disadvantageous to one of the parties. The court's function is to interpret the contract, not to rewrite it.

iv)

In cases where the language used is ambiguous, in the sense that it is capable of bearing more than one ordinary and natural meaning, the court is entitled to prefer the interpretation that is most consistent with business common sense having regard to the commercial purpose of the transaction.

v)

There may be cases where, even though the language used is unambiguous, it is clear that something must have gone wrong, because the resultant meaning is one that would require the court to attribute to the parties an intention that they plainly could not have had. In such a case, if it is clear both that a mistake has been made in the language used and what a reasonable person would have understood the parties to have meant, the contractual provision must be interpreted in accordance with that meaning.”

As Lord Clarke of Stone-cum-Ebony pointed out in Rainy Sky, interpretation is an iterative process. In the present case it is convenient to divide the analysis into stages.

A general consideration relied upon by Cheyne is that the right of the Controlling Class, acting by the Operating Advisor, to replace the Issuer Special Servicer is a valuable right, since it enables the appointment of an Issuer Special Servicer with different skills and a different approach to the existing Issuer Special Servicer with a view to enhancing recoveries for all Noteholders, and in particular the more junior Classes. I accept that this is so. As is common ground, however, by the same token, there is the potential for a conflict of interest between the Controlling Class and other Classes, as Fitch recognised in its announcement on 10 December 2012.

The first limb of clause 26.4(b) provides that termination of the appointment of the Issuer Servicer or Issuer Special Servicer cannot take effect unless “the Rating Agencies have confirmed to the Issuer Security Trustee and the Note Trustee that the appointment of the successor Issuer Servicer or Issuer Special Servicer will not result in an Adverse Rating Event”.

The Trustee contends that the meaning of the first limb of clause 26.4(b) is perfectly clear: the Rating Agencies must all have confirmed to the Trustee that the replacement of the Servicer will not result in an Adverse Rating Event. Thus there must be a communication from each Rating Agency and it must contain the requisite confirmation.

I did not understand counsel for Cheyne to contend that this language was ambiguous. Rather, he submitted that it did not address the problem that had arisen in this case, since the draftsman had failed to anticipate the possibility that one of the Rating Agencies might adopt a policy of refusing to provide such confirmations. Accordingly, he argued, the language had to be interpreted in a manner which made sense in such circumstances. Where a Rating Agency had adopted a policy of not providing such confirmations, it did not make sense to require a confirmation from that Rating Agency. Thus the first limb should be interpreted as requiring confirmation from those Rating Agencies that were willing in principle to give such confirmations.

Counsel for the Trustee argued that Cheyne’s interpretation would be uncertain in its effect, but I do not accept that. Nor do I accept that it is a point against Cheyne’s interpretation that it would apply to all three Rating Agencies if Moody’s and S&P were to adopt the same policy as Fitch. Nevertheless, viewed purely as a matter of language, it seems to me that the Trustee’s interpretation is the natural one. The problem with Cheyne’s interpretation is that this is not what the words actually say.

On the other hand, I agree with Cheyne that it does not appear sensible to require confirmation to be obtained from a Rating Agency which has adopted a policy of not providing such confirmations. Counsel for the Trustee argued that it was rational for clause 26.4(b) to require confirmation by the Rating Agencies, because otherwise there was the risk that one or more Ratings Agencies might downgrade the Notes when notified of the replacement Issuer Servicer/Issuer Special Servicer. As discussed below, I agree that that risk needs to be taken into account; but I do not regard it as an answer to the point that it is fruitless to seek confirmations from an agency that has a policy of not providing them.

The second limb of clause 26.4(b) provides an exception to the need to obtain confirmations from the Rating Agencies where “each class of Noteholders have approved the successor Issuer Servicer or successor Issuer Special Servicer, as applicable, by Extraordinary Resolution”. It is common ground that this does not mean that confirmations do not have to be requested from the Rating Agencies, but only that a failure by one or more Rating Agencies to provide a confirmation can be overridden. There is disagreement, however, as to the implications of this.

The Trustee contends that this provides an answer to the problem which Cheyne says arises with respect to the first limb. Cheyne contends, first, that this cannot have been intended to provide an alternative route to that of attempting to obtain confirmations from Rating Agencies that are willing in principle to give them; and secondly, that it is not a satisfactory answer to the problem of Rating Agencies not being willing to give confirmations.

I do not consider that Cheyne’s first contention really advances the debate. If a Rating Agency is in principle willing to give confirmations, then no difficulty arises. The difficulty only arises if a Rating Agency has a policy of not giving confirmations. Then the question which arises is whether the second limb provides an answer to that problem. Thus it is Cheyne’s second contention which matters.

As to that, one might think just from reading clause 26.4(b) that an Extraordinary Resolution must be passed by each Class of Noteholders. On that hypothesis, counsel for Cheyne submitted that it would be very unlikely that all Classes of Noteholders would agree to take such a step.

As counsel for the Trustee pointed out, however, this is not the case. The Master Definitions Schedule defines “Extraordinary Resolution” as having the meaning set out in Schedule 4 of the Note Trust Deed. Paragraph 18 of Schedule 4 contains a complex provision dealing with Extraordinary Resolutions, which includes a proviso that begins:

“An Extraordinary Resolution of the Class Al Noteholders shall be binding on all the Class A2 Noteholders, the Class A3 Noteholders, the Class B Noteholders, the Class C Noteholders, the Class D Noteholders, the Class E Noteholders, the Class F Noteholders and the Class G Noteholders irrespective of the effect upon them, except that no Extraordinary Resolution to sanction a modification (including a Basic Terms Modification) of, or a waiver or authorisation of any breach or proposed breach of any of the provisions of, the Note Trust Deed, the Conditions or any of the other Transaction Documents passed at any meeting of the Class Al Noteholders shall not take effect unless such modification, waiver or authorisation shall have been sanctioned by an Extraordinary Resolution of each of the Class A2 Noteholders, the Class A3 Noteholders, the Class B Noteholders, the Class C Noteholders, the Class D Noteholders, the Class E Noteholders, the Class F Noteholders and the Class C Noteholders or it shall not, in the opinion of the Note Trustee, in its sole discretion, be materially prejudicial to the respective interests of the Class A2 Noteholders, the Class A3 Noteholders, Class B Noteholders, the Class C Noteholders, the Class D Noteholders, the Class E Noteholders, the Class F Noteholders and the Class G Noteholders.”

Counsel for the Trustee submitted that this enabled the Class A1 Noteholders to pass an Extraordinary Resolution which was binding on the junior Noteholders except for (putting it shortly) modifications, waivers and authorisations. An Extraordinary Resolution in respect of a modification, waiver or authorisation is not effective unless either the junior Noteholders also pass Extraordinary Resolutions or the Trustee concludes in its sole discretion that it is not materially prejudicial to their interests. This appears to me to be correct.

Furthermore, the proviso continues with successive sub-paragraphs which enable Class A2 to bind those below them and so on, with the exception of the Class G Noteholders (being the bottom of the pile), but these sub-paragraphs are not effective unless either the senior Noteholders also pass Extraordinary Resolutions or the Trustee is of the opinion that the Extraordinary Resolution would not be materially prejudicial to the interests of the senior Noteholders or none of the senior Notes remains outstanding.

Thus, as counsel for the Trustee submitted, it would in principle be possible for one Class of Noteholders (except for Class G) to pass an Extraordinary Resolution under the second limb of paragraph 26.4(b) which binds other Noteholders. Thus it would not necessarily be the case that all Classes of Noteholders had to pass such an Extraordinary Resolution.

In any event, even if an Extraordinary Resolution must be passed by all Classes of Noteholders, I do not consider that it is improbable that there are any circumstances in which all Classes would agree to replace an Issuer Servicer or Issuer Special Servicer. I shall return to this point below.

Accordingly, I conclude that the second limb does provide at least a partial answer to the problem which has arisen with respect to the first limb.

Cheyne relies on the fact that clause 29.10 requires each Rating Agency to be notified of the resignation, termination or replacement of the Issuer Servicer or Issuer Special Servicer. Cheyne argues that this shows that the Rating Agencies cannot be by-passed: they must be notified and will have an opportunity to take rating action. I accept this, but I do not consider this point advances Cheyne’s case on the interpretation of clause 26.4(b).

The Trustee relies on the second sentence of clause 29.13 as being inconsistent with Cheyne’s interpretation of clause 26.4(b). This provides that, if Moody’s fails to respond to a request for a confirmation, then no confirmation need be obtained from Moody’s. Thus the draftsman of the Issuer Servicing Agreement addressed his mind to the possibility of a Rating Agency not responding to a request for confirmation and made provision for that eventuality which was specific to Moody’s.

Counsel for Cheyne submitted, first, that clause 29.13 only applied where the Issuer Servicing Agreement “required” a Rating Agency confirmation, which was not the case with clause 26.4(b); and secondly, that clause 29.13 was designed to address the known problem with Moody’s, that it did not address the possibility that Fitch or S&P might adopt a policy of not providing confirmations and that it nevertheless indicated how the parties contemplated that such a problem should be addressed.

I do not accept the first submission. In my judgment clause 26.4(b) does require Rating Agency confirmation to be obtained if the Issuer Servicer or Issuer Special Servicer is to be replaced (although, as discussed above, it also provides for an override if this is not obtained).

Turning to the second submission, it is not clear to me that clause 29.13 does address the known problem with Moody’s. The known problem with Moody’s was that it did not generally issue written confirmations. Thus obtaining confirmation from Moody’s does not appear to be a problem in the present case. The problem to which clause 29.13 is addressed is a failure to respond at all. On the other hand, it is fair to say that, in addition to clause 29.13, the Transaction Documents contain a number of other provisions which appear to be predicated on the basis that it may not be possible to obtain a confirmation from Moody’s (see paragraphs 28-30 above).

Furthermore, counsel for the Trustee pointed out that there was another possible reason why the draftsman might have differentiated between Moody’s and the other two Rating Agencies in clause 29.13, namely that Moody’s only rates the A1 and A2 Notes, whereas Fitch rates the A1 to F Notes and S&P rates all of the Notes. Thus it might have been felt that it was less important to obtain confirmations from Moody’s.

More importantly, I agree that clause 29.13 does not in terms address the possibility that Fitch or S&P might adopt a policy of not providing confirmations. I also agree that the approach prescribed by clause 29.13 to a failure by Moody’s to respond commends itself as a logical solution to the problem of another Rating Agency failing to respond to a request for confirmation. My difficulty with this argument is that clause 29.13 could easily have said “In the event that any Rating Agency fails to respond”, but it does not. Thus Cheyne’s interpretation of the Issuer Servicing Agreement amounts to re-writing this clause.

Cheyne relies on the proviso to clause 26.3 as supporting its interpretation of clause 26.4(b). Cheyne points out that the effect of this proviso is that the replacement of the Issuer Special Servicer will be ineffective if there is in fact an Adverse Rating Event i.e. there is what appears to be a condition subsequent. Counsel for Cheyne submitted that this meant that the more senior Classes of Noteholders were always protected, and accordingly there was no need to insist on a confirmation in advance.

I do not accept this argument, for the following reasons. First, the proviso to clause 26.3 applies whether or not confirmations have been provided in accordance with clause 26.4(b). Secondly, if this was sufficient protection for the more senior Classes, there would be no point in the requirement for advance confirmations in clause 26.4(b). I infer that the reason for this requirement is to attempt to avoid, so far as possible, the possibility of an Adverse Rating Event occurring and hence the replacement being ineffective. Thirdly, it seems to me that an Adverse Rating Event may be prejudicial to Noteholders even if the trigger for the Adverse Rating Event ceases to operate (because the replacement is ineffective). Fourthly, it is not clear how the proviso is supposed to operate on Cheyne’s interpretation. What if it takes a Rating Agency two weeks to respond to notification of the replacement? Who services the Loans during that period? This is rather less of a problem if the Rating Agency has given advance confirmation, although I accept that that does not entirely remove the difficulty.

Accordingly, I consider that the proviso to clause 26.3 is neutral with respect to the present issue of interpretation.

Cheyne also relies on the fact that clause 26.2, which provides for voluntary termination by the Issuer Servicer and Issuer Special Servicer, is also subject to clause 26.4(b). Cheyne argues that it cannot have been intended that such a termination was ineffective merely because a Rating Agency had adopted a policy of not providing confirmations.

In my view this argument adds little to Cheyne’s case. It is simply another consequence of the difficulty which arises on the Trustee’s interpretation of the first limb of clause 26.4(b).

On the other hand, it seems to me that this point supports the Trustee’s case with respect to the second limb of clause 26.4(b). Even if an Extraordinary Resolution must be passed by all Classes of Noteholders, all Classes of Noteholders are likely to agree that it is better to have an Issuer Servicer/ Issuer Special Servicer which is not the preferred candidate of some Classes than not to have one at all.

This reasoning also applies to other scenarios relied on by Cheyne, such as a winding up order being made in respect of the Issuer Servicer or Issuer Special Servicer (clause 26.1(d)).

Certain other provisions in the Transaction Documents were drawn to my attention, but in my view none of them really assists with the resolution of the present issue. My attention was also drawn to certain passages in the Prospectus for the Transaction, but in my view none of these adds significantly to the arguments I have already considered.

Both Cheyne and the Trustee contend that the other’s interpretation of clause 26.4(b) produces a commercially absurd result.

Cheyne contends that it is absurd to interpret clause 26.4(b) as requiring confirmation to be obtained from a Rating Agency that has adopted a policy of not giving such confirmations. As indicated above, I agree that this does not appear sensible. If it were not for the get-out provided by the second limb of clause 26.4(b) and the presence of clause 29.13, I might have taken the view that this could not have been intended, and therefore the first limb should be interpreted in the manner contended for by Cheyne. As it is, however, I am not persuaded by this argument. The get-out provided by the second limb provides at least a partial answer to the problem, and clause 29.13 shows that the draftsman addressed his mind to the problem, but did not solve it in the manner contended for by Cheyne. In any event, I do not consider that the argument on absurdity is all one way.

The Trustee contends that it is absurd to construe clause 26.4(b) such that it operates solely where one or more Rating Agencies responds by saying the appointment would result in an Adverse Rating Event. In that event, the Noteholders would be unlikely to want to proceed. If the first limb of clause 26.4(b) does not bite where a Rating Agency fails to respond, there is a risk that that Rating Agency will downgrade the Notes, which would be undesirable for the reasons discussed above. In my view this does not demonstrate that Cheyne’s interpretation of clause 26.4(b) is absurd, but as I have just said it does show that the argument is not all one way.

My overall assessment is that I consider that the interpretation of clause 26.4(b) advanced by the Trustee is the correct one. It corresponds with the natural meaning of the words of the first limb; the second limb provides at least a partial answer to the problem which arises as a result of Fitch’s policy; Cheyne’s interpretation is also inconsistent with clause 29.13; and the argument on commercial absurdity does not persuade me that clause 26.4(b) should be construed in the manner contended for by Cheyne.

Cheyne relies upon the decision of Mr Snowden with respect to a similar issue in US Bank v Titan as supporting its interpretation. The Trustee submits that the present case is distinguishable from US Bank v Titan because there are material differences in the relevant documents, and hence Mr Snowden’s reasoning is inapplicable. I agree with the Trustee on this point. Importantly, in that case, the clause corresponding to clause 26.4(b) did not include the second limb, and the clause corresponding to clause 29.13 did not differentiate between Moody’s and the other two Rating Agencies. There were also other less significant differences, such as the fact that the clause corresponding to clause 26.3 did not include the proviso. As I read Mr Snowden’s judgment at [99], his reasoning was driven by two key points: first, the wording of the clause corresponding to clause 29.13; and secondly the commercial absurdity of the contrary interpretation. Neither point applies here. Clause 29.13 is limited to Moody’s, and the argument on commercial absurdity is much less compelling due to the presence of the second limb in clause 26.4(b).

Clause 26.4(b) is to be interpreted in the manner contended for by the Trustee.