Myers & Anor v Kestrel Acquisitions Ltd & Ors

This is the trial of two closely related Part 8 claims. The first was issued on 12 August 2013, the second on 9 April 2014. It is not necessary to distinguish between them. They arise out of the issue on 12 May 2004 to the claimants, Dennis and Patricia Myers, by the first defendant (“Kestrel”) of £5,264,798 Fixed Rate Unsecured Loan Notes 2010 (“the Vendor Loan Notes” or, more simply, “the VLNs”). The VLNs were issued as part of the consideration for the sale by the Myers of their sub-prime lending business which they conducted through a company called Swift Advances plc (“Swift”). The Myers hold the VLNs as trustees of a family settlement. Claiming to exercise powers contained in the terms of the VLNs, Kestrel has purported to make unilateral amendments to those terms. The amendments are of two kinds. The first relates to amendments designed to subordinate the VLNs to further loan notes which Kestrel has issued. This has happened on 2 November 2007, 15 July 2008 and 6 July 2009. In all the VLNs have been subordinated to £102m of further loans, together with the interest that those further loans have earned and continue to earn. The second relates to amendments designed to postpone the redemption date of the VLNs. This has happened on 15 July 2008, 1 September 2010, 21 December 2011 and 26 March 2014. If the postponements are valid the VLNs now mature for payment, failing an earlier event of default, on 31 March 2018. The original maturity date was 12 May 2010. The subordinations and postponements were effected to enable Kestrel to raise the further funding it needed so that it could weather the global recession.

By these claims the Myers, who appear by Paul Downes QC and Stewart Chirnside, seek relief intended to establish the invalidity of the amendments. They contend that, without their consent (which was not forthcoming), Kestrel had no power to subordinate the VLNs to the further loans. They contend that all of the postponements were likewise invalid although they accept that the first of them (made on 15 July 2008 whereby redemption was postponed from 12 May 2010 to 30 September 2012) was arguably valid. I call this “the invalidity issue”. They say that as a result of the subordinations and postponements the VLNs are now worthless. They seek declaratory relief to reflect these contentions. They also contend that in the events that have happened Kestrel and the second defendant (“Kestrel Holdings”), which is Kestrel’s parent company, are unable to pay their debts within the meaning of section 123 of the Insolvency Act 1986 (“section 123”) and that accordingly there has been an event of default under the terms of the VLNs. They seek a declaration to that effect. I call this “the insolvency issue”.

The defendants, appearing by Guy Morpuss QC and Patricia Edwards, deny that Mr and Mrs Myers are entitled to any of the relief they seek. They contend that the amendments were validly made and that, in any event, the Myers are estopped from contending otherwise. They also contend that Kestrel and its parent are not insolvent within the meaning of section 123.

The Myers have also issued a Part 7 claim. It arises out of the same facts. Whether it proceeds to any extent will depend on the outcome of this hearing. It has been stayed by consent in the meantime.

I should add that one of the two issues raised by the later of the Part 8 claims (the so-called “lapse” issue) was abandoned by the Myers in late October by the service of a notice of discontinuance. I will mention it in more detail a little later.

Although these are Part 8 proceedings and therefore the Myers are obliged to assert, and do assert, that the resolution of the issues raised is unlikely to involve any substantial dispute of fact, to which end there was an agreed statements of facts, a great deal of evidence has been filed and neither side has quite been able to resist the temptation to refer to matters which do give rise to disputes of fact. That has been done either to describe the “wider picture” or in the hope that I will take the view that the factual position is so overwhelmingly in that side’s favour on some issue that I should not hesitate to find accordingly. Or it has been to show that what at first sight looks to be unchallengeable factually, in truth conceals complex issues fit only for trial under Part 7. Nevertheless, both sides have been anxious that so far as possible I should determine the issues raised by the two Part 8 claims.

The agreed statement of facts and the undisputed evidence disclose that the Myers built up a highly successful business in the field of non-conforming sub-prime secured lending. They did so through the medium of Swift. Swift is the eighth defendant. All of the shares in Swift were held on Myers family trusts. Among them was the P Myers Interest in Possession Settlement. The Myers bring these proceedings as trustees of that settlement. Nothing turns on its provisions.

On 8 May 2004 the Myers entered into an agreement (“the Sale and Purchase Agreement”) with Kestrel and Kestrel Holdings for the sale of the whole of Swift’s issued share capital to Kestrel. That company had been specially incorporated for the purpose. The sale was effectively to a private equity firm called Alchemy Partners LLP. The purchase consideration amounted in the event to £85m. Of that sum £4,661,173 was paid on (but as to £1m within six months of) completion. The balance of £80,338,827 was satisfied by the issue by Kestrel to the Myers on completion of (i) guaranteed loan notes in the sum of £75m, (ii) 74,029 shares in Kestrel, and (iii) the Vendor Loan Notes in the sum of £5,264,798. Completion was on 12 May 2004. (There was also a provision whereby up to a further £5m would become payable in certain events but those events did not and cannot now occur.) Effectively, as I understood it, the Myers received £79.67m in cash, 74,000 odd shares in Kestrel Holdings and the VLNs. It is with the latter, and only with the latter, that this hearing is concerned.

The VLNs were created by an instrument dated 12 May 2004 (“the Vendor Loan Note Instrument” or, more simply, “the VLNI”). They carry interest at 12% compounded annually, with the interest so earned being paid on the loan redemption date, i.e. initially 12 May 2010 and, if they were validly extended, the postponed dates and not before. Kestrel has the right in defined circumstances to redeem all of the Notes prior to that date with interest accrued up to the date of redemption. It can also purchase any of the Notes at any time and there is provision for the holders of the Notes to call for earlier repayment (together with accrued interest) upon the occurrence of specified events of default.

The consideration for the shares in Swift was funded in large part by Kestrel issuing unsecured discounted loan notes (“the Discounted Loan Notes” or more simply “the DLNs”) with a nominal value of £103,086,443 to the sixth defendant (“Alchemy”) and the fifth defendant (“Indigo”). The DLNs were created by Kestrel by an instrument dated 12 May 2004 (“the Discounted Loan Note Instrument” or, more simply, “the DLNI”). The discounted price paid was £55,185,201. Of that amount Alchemy agreed to subscribe £52,226,800 and Indigo the £2,958,401 balance. In addition, Alchemy subscribed for 734,272 ordinary shares in Kestrel Holdings and Indigo for 41,599 further such shares. The shares were issued at par.

Those loan notes, like the VLNs, had the same maturity date (12 May 2010). They were issued at a discount but this, I was told, was on the footing that, once interest up to redemption is included, the amount repayable on redemption would be their nominal amount, namely £108,925,803. I understood, but have not done the calculation, that this was on the footing that interest was also at the rate of 12% compounded annually. The DLNs provided for earlier redemption at Kestrel’s option and, for this purpose, set out how interest was to be calculated up to the date of such earlier redemption. It was also open to Kestrel to purchase any of the Notes and there was provision for earlier redemption in various defined circumstances.

It is convenient at this point to return to the abandoned lapse issue. It arose from the fact that on 31 March 2008 the DLNs were replaced by fresh notes (“the Replacement Notes”) constituting £85,766,963 Fixed Rate Unsecured Loan Notes 2010. They were issued to Alchemy and Indigo in the sums of £81,169,116 and £4,597,847 respectively and were in all material respects the same as the DLNs which they replaced. (Rather than refer to them in what follows it is simpler to continue to refer to the DLNs as if they had continued in being.) The gist of the lapse issue (which was one of the two issues raised by the later of the two Part 8 claims) was that, as a matter of construction, after 31 March 2008 when the DLNs were replaced by Replacement Notes, Kestrel’s right unilaterally to modify the VLNI lapsed. For a time this was the Myers’s only and later their primary contention. However, by notice dated 29 October 2014, they abandoned the point. They sought to discontinue that claim when the matter came on for hearing before me. There remained a dispute on the costs arising out of it. At the end of the hearing I determined that dispute. It resulted in my ordering the Myers to make of payment of £30,000 on account of the defendants’ costs of the issue.

Alchemy is a nominee for the seventh defendant (“Alchemy Guernsey”). These two companies are, together with Alchemy Partners LLP, part of a wider group of companies (“the Alchemy Group”). It was Alchemy Partners LLP which had initially offered to buy the entire issued share capital of Swift. It caused Kestrel to be incorporated as a wholly owned subsidiary of Kestrel Holdings for the purpose of the acquisition. As a result of the acquisition Alchemy now holds a majority of the shares in Kestrel Holdings. It does so for investors in what was described as the Alchemy Investment Plan. This in turn is managed by Alchemy Guernsey.

Indigo is part of a group of companies (“the Indigo Group”) which carries on business, I was told, as providers of mezzanine finance and venture capital. The Indigo Group includes the third defendant (“Indigo Capital”) and the fourth defendant (“Indigo SARL”). The latter, which is a Luxembourg entity, is a wholly-owned subsidiary of Indigo. Up to the beginning of July 2007 Indigo Capital managed Indigo. There was then, it seems, a transfer of Indigo Capital’s business to Indigo Capital LLP. I do not think that the details of this matter although, according to the evidence filed on behalf of the third defendant, the point is made (and it features in a submission made by Mr Downes in connection with the insolvency issue) that Indigo SARL has its own board of directors based in Luxembourg and it is they who are ultimately responsible for making its investment and divestment decisions.

A shareholders’ agreement, dated 8 May 2004, to which, among others, the relevant Alchemy and Indigo companies, together with Kestrel and Kestrel Holdings were parties set out the terms on which the Alchemy and Indigo parties were willing to invest in Kestrel and its parent company. I do not need to refer to any of its terms. They have not featured in counsels’ submissions. But it is necessary to set out some of the terms of the VLNI. Of particular importance to the current dispute are the following terms of that instrument (in which the expressions “Notes” and “Loan Notes” refer to the VLNs):

“2.3

The Notes shall rank equally with the Discounted Loan Notes so as to provide the same pre-tax return to the respective holders thereof and the Company undertakes to treat the Discounted Loan Notes in the same manner as if they constituted a single class of securities.

2.4

Without prejudice to the generality of Clause 2.3 above, the Company undertakes:-

2.4.1

not to redeem, repay or purchase any of the Discounted Loan Notes unless at the same time the Company redeems, repays or purchases a proportionate amount of the Loan Notes based on the respective total amounts of Discounted Loan Notes and the Loan Notes outstanding prior to such event; and

2.4.2

not to amend the Discounted Loan Note Instrument or the terms and conditions of the Discounted Loan Notes unless at the same time it makes appropriate amendments to this Instrument and the terms and conditions of the Loan Notes in order to give effect to clause 2.3 above.”

Clause 6.1 deals with events of default and their consequences. Among the events of default is, by clause 6.1.4, if “any Group Company shall be unable to pay its debts within the meaning of Section 123 of the Insolvency Act 1986”. The clause goes on to state that if an event of default occurs and in the case of, among others, clause 6.1.4, the event is continuing, the note holder is entitled by written notice to the Company to declare its holding of VLNs to be immediately due and payable whereupon they become immediately due and payable on the note holder’s demand. Clause 6.2 goes on to state that where, pursuant to clause 6.1, a note holder has validly declared the VLNs to be due and payable “then, provided that the holders of Discounted Loan Notes have declared their notes to be due and payable, the Noteholder may by written notice to the Company call for repayment of its holding of Notes on such date as it may specify in such notice…” It is only therefore if the holders of the DLNs (or now the Replacement Notes) have declared their notes to be due and payable that the holders of the VLNs can actually demand payment of what is due to them.

Clause 9, headed “Modification” is as follows:

“9.1

The Company may make any modification to this instrument (including, for the avoidance of doubt, to the Conditions) either:-

9.1.1

with the sanction of an Extraordinary Resolution of the Noteholders; or

9.1.2

without the sanction of an Extraordinary Resolution but unilaterally if the modification is consistent in all material respects with any modification being made to the Discounted Loan Note Instrument.”

It is not necessary to refer to the Conditions or to any other provision in the VLNI.

On completion of the sale to the Alchemy and Indigo parties, the Myers, Kestrel, Swift and others entered into an intercreditor agreement (“the ICA”). Its aims included regulating the ranking of various debts owed by Kestrel. Having regard to the submissions made to me it is material to refer to just one of its terms and some of the definitions set out in it. The material term is clause 3, headed “Ranking of Debt”, which so far as material is as follows:

“3.1

The Debt will rank for all purposes and at all times in the following order: 3.1.1 first the Lender Debt; 3.1.2 second the Investor Debt; and 3.1.3 third the Intra-Group Debt.

3.2

This Intercreditor Agreement does not purport to rank: 3.2.1 any of the Investor Debt as between the Investors; and 3.2.2 any of the Intra-Group Debt as between the Intra-Group Creditors. ”

“Debt” is defined as the Lender, Investor and Intra-Group Debts. “Lender Debt” is what was owed or incurred by any Obligor to the Investors under certain finance documents. This dispute is not concerned with “Lender Debt” or “Intra-Group Debt” but, so far as the argument went, simply with “Investor Debt”. That is defined by clause 1.1 to mean “the aggregate amount from time to time outstanding of all monies, obligations and liabilities (whether actual or contingent) due owing or incurred by any Obligor to the Investors under the terms of the Investment Documents (or any of them)”. Kestrel was the material Obligor. The Investors were the Myers and the fifth, sixth and seventh defendants who were all parties to the ICA. At the time the ICA was entered into the Investor Documents were, so far as material, the VLNI and the DLNI. I was not referred to any other provision in the ICA.

This brings me to the further advances made to Kestrel, each secured by separate loan notes (referred to as Follow On Notes or “FONs” for short), and the steps taken by Kestrel to subordinate the VLNs to those further advances and also to postpone their maturity date.

On 2 November 2007 Kestrel issued £15m of Fixed Rate Unsecured Loan Notes 2011 (“the 2007 FONs”). They were issued to Alchemy as to £13.5m and to Indigo SARL as to the remaining £1.5m. According to the evidence (an Alchemy Guernsey so-called final investment recommendation paper) this borrowing was “to meet Swift’s lending and growth targets, to manage a period of tight cash headroom and to preserve Swift’s optionality.” I was also told that the persons who supplied the cash under the so-called Alchemy Investment Plan to enable this further investment to be made by Alchemy were not the same as those who had supplied the £52,226,800 to enable Alchemy to purchase its share of the DLNs in May 2004. I was given to understand that this was also the case in relation to Alchemy’s participation in the various FONs.

On the same date, 2 November 2007, Kestrel, by a deed of variation executed in purported exercise of the power conferred by clause 9.1.2 of the VLNI, sought to vary the terms of the VLNs so as to insert a new clause (clause 11). This new clause subordinated the rights of the holders of the VLNs to the rights of the holders of the 2007 FONs. The Myers challenge the validity of that deed. At the same time a similar amendment was made to the DLNI.

On 15 July 2008 Kestrel purported by deed executed on that date to amend the terms of the VLNs so as to (i) postpone their redemption date from 12 May 2010 to 30 September 2012 and (ii) subordinate the rights of the holders of the VLNs to the rights of the holders of (a) the 2007 FONS and (b) the (as yet to be issued) 2008 FONS. At the same time (and by separate instruments) similar amendments were made to the Replacement Notes and the redemption date of the 2007 FONs was postponed to 30 September 2012.

On 25 July 2008 Kestrel issued £64 million Fixed Rate Unsecured Loan Notes 2012 (“the 2008 FONS”). Of this amount £60 million was issued to Alchemy and £4 million to another company, Ares Capital Europe Limited (“Ares”).

On 6 July 2009 Kestrel issued £23 million Fixed Rate Unsecured Loan Notes 2013 (“the 2009 FONs”). These were issued to Alchemy alone and were expressed to rank pari passu with the 2008 FONS issued to Ares but in priority to the remaining 2008 FONS and the 2007 FONS. The 2008 FONS and the 2009 FONS were expressed to be issued “to preserve Swift’s optionality by paying off the debts of the banks in an orderly exit”. By a deed executed on the same date Kestrel purported to amend the VLNs so as to subordinate the rights of the holders of them to the rights of the holders of (i) the 2007 FONs (ii) the 2008 FONs and (iii) the 2009 FONs and to make similar amendments to the Replacement Notes. At the same time the 2007 FONs and the 2008 FONs were amended so as to be subordinated to the 2009 FONs.

By a deed dated 1 September 2010 Kestrel purported to amend the VLNs so as once again to postpone the redemption date, this time from 30 September 2012 to 31 October 2013. A similar amendment was made to the Replacement Notes. At the same time the redemption dates of the 2007, 2008 and 2009 FONs were rescheduled to the same date.

By a deed dated 21 December 2011 Kestrel purported to amend the VLNs a yet further time by postponing the redemption date from 31 October 2013 to 31 March 2015. Once more, similar amendments were made to the Replacement Notes and to the redemption dates of the 2007, 2008 and 2009 FONs.

Finally, on 26 March 2014, which was shortly after the first Part 8 claim had been issued, Kestrel purported to amend the redemption date of the VLNs once more, this time from 31 March 2015 to 31 March 2018. I was told that similar amendments were made to the redemption date of the Replacement Notes and the various FONs.

Some play was made before me by Mr Downes of the circumstances in which this final postponement occurred, coming as it did after a first hearing of the first Part 8 claim. Nothing turns on this, or at least nothing which I can deal with on the hearing of Part 8 claims.

The effect, said Mr Downes, of subordinating the VLNs and the Replacement Notes to the further loans and postponing their (and the FONs’) redemption dates, coupled with the high rates of interest that the FONs carried and the return that Swift was making on its trading, was that by July 2008, when the 2008 FONs were issued, this further borrowing could at best be no more than a short term measure. He submitted that if the further £64 million was not repaid by the end of 2011 at the latest (the 2008 FONs had a redemption date at that time of 30 September 2012) there was no real prospect of the Myers (as holders of the VLNs) receiving any repayment if the subordinations and redemption postponements purportedly effected at that time took effect according to their terms. Effectively, he submitted, the VLNs were thereby being made irredeemable and insolvency rendered inevitable. He described this as Kestrel’s financial tipping point. The further loan secured by the 2009 FONs, the subordination of the VLNs to this further borrowing and the further postponements of the redemption dates, coupled with the continuing high interest rates and lack of an improvement in Swift’s level of trading meant, he said, that the position for the Myers as holders of the VLNs could only get worse, indeed exponentially worse.

It is against that background of steadily mounting indebtedness and the lack of any prospect of repaying it, at least from late 2008, that Mr Downes invited me to consider the validity of the deeds purporting to subordinate the VLNs and postpone their redemption, and the issue of Kestrel’s (and Kestrel Holdings’) insolvency.

Mr Downes advanced two separate arguments. The first was that the power to modify the terms of the VLNI was subject to an implied term. This was that the modification had to be in good faith and for the benefit of the holders of the DLNs and VLNs as a whole, viewing them for this purpose as a single class. Good faith meant something broader than simply the absence of dishonesty. I refer to this as the good faith term. He submitted that this result is reached in one or other of three ways. First, such a term is always implied into what Mr Downes described as “these sorts of arrangements.” On analysis this meant that either by clause 2.3 or by clause 9.1.2 (or by a combination of the two) Kestrel is obliged to treat the Myers (as holders of the VLNs) as a minority within a larger single class of noteholders comprising the VLNs and the DLNs and that, for their protection, it was appropriate to imply the good faith term which is commonly implied where a majority has the right to bind a minority. Second, he submitted, there is a gap in the VLNI since, read literally (i.e. without implying some additional term), there is nothing in that instrument to prevent Kestrel from amending it in a way that amounts to a fraud on the holders of the VLNs such that, on accepted principles for implying terms into a contract, it is appropriate to place a curb on that possibility. This is achieved by implying the good faith term. Third, the VLNI gives to Kestrel a discretion whether or not to modify the terms of those two instruments such that, in accordance with well established authority, when exercising the discretion Kestrel must act in good faith and rationally. The second argument was that the changes made (on the occasions and in the manner set out above) to the terms of the VLNI so as to subordinate the VLNs to other indebtedness and to postpone their redemption date went beyond the scope of modification allowed by clause 9.1. No change which altered the essential nature of the VLNs was permissible. In particular, he submitted that to be within the scope of what was permissible under clause 9.1.2 the modification must, viewing the position objectively at the time that it is to be made, improve the VLNs’ prospect of repayment. A change which, so viewed, had the effect of diminishing that prospect, and necessarily one which eliminated that prospect altogether, was therefore beyond the scope of what was permissible and for that reason invalid. I refer to this as the threshold requirement. Additionally, and quite separately, Mr Downes submitted that, having regard to the terms of clause 3.1 of the ICA, subordination is simply not available as a permissible modification.

Mr Morpuss submitted that there was no basis for implying the good faith term. He submitted that, giving the power to modify its proper construction, all of the subordinations and postponements were permissible and validly effected and there was no justification for importing any kind of threshold requirement. He submitted that if, contrary to his submission, the power to modify was subject to the good faith term or must satisfy the threshold requirement then whether on any occasion the amendment to effect the subordination or postponement in question was valid involved an issue of fact which was not appropriate for determination on a Part 8 claim. He submitted that the ICA is irrelevant to the question of subordination or to any question of good faith.

It is appropriate to refer, briefly, to the relevant legal principles. I was taken to a great many cases. It is sufficient to mention only a very few of them.

Dealing first with the power in the court to imply a term into a contract or other instrument, the most recent authoritative statements of the permissible limits of the power are to be found in the following two decisions. In Attorney General of Belize v Belize Telecom Ltd [2009] UKSC 10; [2009] 1 WLR 1988 Lord Hoffmann, delivering the judgment of the Privy Council, set out (at [16] to [18] and [21]) some general observations (equally applicable to this country) about what he described as the “process of implication”:

“16…The court has no power to improve upon the instrument which it is called upon to construe, whether it be a contract, a statute or articles of association. It cannot introduce terms to make it fairer or more reasonable. It is concerned only to discover what the instrument means. However, that meaning is not necessarily or always what the authors or parties to the document would have intended. It is the meaning which the instrument would convey to a reasonable person having all the background knowledge which would reasonably be available to the audience to whom the instrument is addressed: see Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, 912-913. It is this objective meaning which is conventionally called the intention of the parties, or the intention of Parliament, or the intention of whatever person or body was or is deemed to have been the author of the instrument.

17 The question of implication arises when the instrument does not expressly provide for what is to happen when some event occurs. The most usual inference in such a case is that nothing is to happen. If the parties had intended something to happen, the instrument would have said so. Otherwise, the express provisions of the instrument are to continue to operate undisturbed. If the event has caused loss to one or the other of the parties, the loss lies where it falls.

18 In some cases, however, the reasonable addressee would understand the instrument to mean something else. He would consider that the only meaning consistent with the other provisions of the instrument, read against the relevant background, is that something is to happen. The event in question is to affect the rights of the parties. The instrument may not have expressly said so, but this is what it must mean. In such a case, it is said that the court implies a term as to what will happen if the event in question occurs. But the implication of the term is not an addition to the instrument. It only spells out what the instrument means.

21 …in every case in which it is said that some provision ought to be implied in an instrument, the question for the court is whether such a provision would spell out in express words what the instrument, read against the relevant background, would reasonably be understood to mean…There is only one question: is that what the instrument, read as a whole against the relevant background, would reasonably be understood to mean?”

In the subsequent case of Geys v Societe Generale, London Branch [2012] UKSC 63; [2013] 1 AC 523 Baroness Hale JSC provided (at [55]) a succinct summary of the circumstances in which a term might be implied into a contract:

“…it is important to distinguish between two different kinds of implied terms. First, there are those terms which are implied into a particular contract because, on its proper construction, the parties must have intended to include them: see Attorney General of Belize v Belize Telecom Ltd [2009] 1 WLR 1988. Such terms are only implied where it is necessary to give business efficacy to the particular contract in question. Second, there are those terms which are implied into a class of contractual relationship, such as between landlord and tenant or between employer and employee, where the parties may have left a good deal unsaid, but the courts have implied the term as a necessary incident of the relationship concerned, unless the parties have expressly excluded it: see Lister v Romford Ice and Cold Storage Co Ltd [1957] AC 555, Liverpool City Council v Irwin [1977] AC 239.”

On the obligation of a majority to act bona fide and for the benefit of the class as a whole, the classic exposition of the principle is to be found in the judgment of Sir Nathaniel Lindley MR in Allen v Gold Reefs of West Africa [1900] 1 Ch 656 at 671:

“Wide, however, as the language is of s.50 [Companies Act 1862: the power to alter a company’s articles by special resolution], the power conferred must, like all other powers, be exercised subject to those general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must be exercised, not only in the manner required by law, but also bona fide for the benefit of the company as a whole, and it must not be exceeded. These conditions are always implied, and are seldom, if ever, expressed.”

See also British America Nickel Corporation v M J O’Brien Ltd [1923] AC 369, concerned with a power contained in a trust deed securing an issue of mortgage bonds where a majority of the bond holders had the power to modify the bondholders’ rights. Viscount Haldane, delivering the judgment of the Privy Council, said (at p 371) that:

“To give a power to modify the terms on which debentures in a company are secured is not uncommon in practice. The business interests of the company may render such a power expedient, even in the interests of the class of debenture holders as a whole. The provision is usually made in the form of a power, conferred by the instrument constituting the debenture security, upon the majority of the class of holders. It often enables them to modify, by resolution properly passed, the security itself. The provisions of such a power to a majority bears some analogy to such a power as that conferred by s.13 of the English Companies Act of 1908, which enables a majority of the shareholders by special resolution to alter the articles of association. There is, however, a restriction of such powers, when conferred on a majority of a special class in order to enable that majority to bind a minority. They must be exercised subject to a general principle, which is applicable to all authorities conferred on majorities to bind minorities; namely, that the power given must be exercised for the purpose of benefiting the class as a whole, and not merely individual members only.”

As to good faith more generally, it was common ground that there is no general duty of good faith in commercial contracts but such a duty may be implied where it is in accordance with the presumed intention of the parties. I was referred in this context to the decision of Leggatt J in Yam Seng Pte Ltd v International Trade Corporation [2013] EWHC 111 (QB); (2013) 146 Con LR 39. Particularly illuminating in this context was the following passage from the judgment of Andrews J in Greenclose Ltd v National Westminster Bank plc [2014] EWHC 1156 (Ch) at [150]:

“So far as the “Good Faith” condition is concerned, there is no general doctrine of good faith in English contract law and such a term is unlikely to arise by way of necessary implication in a contract between two sophisticated commercial parties negotiating at arms’ length. Leggatt J’s judgment in Yam Seng Pte Ltd v International Trade Corporation Ltd …, on which Greenclose heavily relies, is not to be regarded as laying down any general principle applicable to all commercial contracts. As Leggatt J expressly recognized at [147] of that judgment, the implication of an obligation of good faith is heavily dependent on the context. Thus in some situations where a contracting party is given a discretion, the Court will more readily imply an obligation that the discretion should not be exercised in bad faith or in an arbitrary or capricious manner, but the context is vital. A discretion given to the board of directors of a company to award bonuses to its employees may be more readily susceptible to such implied restrictions on its exercise than a discretion given to a commercial party to act in its own commercial interests. ”

This brings me conveniently to the line of cases which culminated in Socimer International Bank v Standard Bank London [2008] EWCH Civ 116; [2008] 1 Lloyd’s Rep 558 concerned with the exercise of a contractual discretion where the contract gives to one side a power to make decisions under the contract which might have an effect on both parties. In that case Rix LJ, after reviewing a number of authorities, said this (at [66]):

“It is plain from these authorities that a decision-maker’s discretion will be limited, as a matter of necessary implication, by concepts of honesty, good faith, and genuineness, and the need for the absence of arbitrariness, capriciousness, perversity and irrationality. The concern is that the discretion should not be abused. Reasonableness and unreasonableness are also concepts deployed in this context, but only in a sense analogous to Wednesbury unreasonableness, not in the sense in which that expression is used when speaking of the duty to take reasonable care, or when otherwise deploying entirely objective criteria: as for instance when there might be an implication of a term requiring the fixing of a reasonable price, or a reasonable time.”

None of this was a matter of dispute between the parties.

Accepting that, as the cases made clear, there was no general duty of good faith in commercial contracts Mr Downes nevertheless submitted that, in the instant case, given the nature of the contract constituted by the VLNI and the discretion given to Alchemy (under the DLNI) and to Kestrel (both in the DLNI and in the VLNI) to vary those instruments, there had to be some limitation on the power to amend or modify the VLNI. The key to this was clause 2.3 which in terms states that the DLNs and the VLNs are to treated as a single class. He submitted that the reasonable expectation of any lender under the terms of the VLNI in May 2004 was that his rights would not be eroded by the majority loan note holders other than where the majority were acting in their own self interest as loan note holders and in good faith. Such a loan note holder would not reasonably have expected that the majority should be free to commit an act of economic self-harm to further what Mr Downes described as “some other conflicting agenda”.

This potential for abuse was to be avoided, he submitted, by the implication of the good faith term, either because, given the position of Alchemy (and Indigo) as holders of the DLNs (numerically far greater in number and value than the VLNs) and the terms of clause 2.3 of the VLNI, it was appropriate to imply such an obligation so that any modification of the VLNI had to be in good faith and for the benefit of the loan note holders as a whole, or because without such an implied term there would exist a “gap” in the contract which would expose the holders of the VLNs to the risk that the majority could take steps to deprive them of their rights. The same result, he submitted, was to be reached by applying the Socimer line of cases and making Kestrel’s unilateral power under clause 9.1.2 to modify the VLNI subject to the good faith requirement. He submitted as clear beyond argument that if the DLN and VLN notes had been constituted as a single class with the result that the majority could bind the minority, the VLNs could not have been changed unless the amendment was effected bona fide and for the benefit of the loan notes as a class. He submitted that it is against that background that clause 2.3 falls to be construed. It was to be understood as limiting the ability of Kestrel to make variations under clause 9.1.2 to reflect a modification being made to the DLNI to those which were being in good faith and for the benefit of the class as a whole. It mattered not that the amendment was being imposed by Kestrel rather than by Alchemy as the majority note holder in the enlarged class. Kestrel, when so acting, was seeking to match an equivalent modification made to the DLNI. In effect, it was acting for the holders of the DLNs.

I hope I have accurately captured the essence of what Mr Downes submitted to me on this part of the case.

Moving next to the scope of the modifications that clause 9.1.2 permits, Mr Downes submitted that the expression, as used in clause 9.1.2, should be given its natural and ordinary meaning, namely a change which does not alter the essential nature and characteristics of the VLNs. He supported this reference to the Oxford English Dictionary definition of “modification”, namely “the act of making changes in an object without altering its essential nature or character; the state of being thus changed…” He submitted that the purported amendments to the VLNI amounted, either individually or collectively, to fundamental changes to the essential characteristics of the VLNs which could not be considered “modifications” on a true construction of the VLNI. He drew a distinction between a redeemable and an irredeemable (or perpetual) debenture. He drew my attention to the decision in Southern Brazilian Rio Grande Do Sul Railway Company Limited [1905] 2 Ch 78 where Buckley J held that the grant by the company of irredeemable debenture stock was unauthorised by the company’s memorandum in that, although the company had power to borrow by the issue of debenture stock, borrowing necessarily implied the obligation at some time to repay whereas the irredeemable stock was equivalent to a perpetual annuity which was beyond the scope of the power. Drawing on those remarks, Mr Downes submitted that the various amendments, if valid, effectively meant that the VLNs ceased to be debts to be paid by a specified date (originally 8 March 2010) but instead would only be repayable if and when Kestrel chose. That, he said, was a change to their essential nature. He submitted that the fact that it may not be possible to identify at what precise point, and with which amendment to the VLNI, this became so did not matter. He summarised the figures, comparing Kestrel’s aggregate loan note indebtedness with its available assets, at or about the time of each amendment and, as I have mentioned, identified July 2008 or thereabouts as the approximate date when, unless repaid reasonably promptly, the additional indebtedness represented by the 2007 (and subsequent) FONs and the interest that they were earning, taken together with the repeated postponements of their redemption date, meant that (if the amendments were valid) the VLNs became effectively irredeemable. He accepted that a postponement per se would not necessarily be outside the scope of the clause if it improved the prospect of repayment but submitted that at the point where that ceased to be the case any further postponement would be beyond the scope of the clause. He submitted that that was very likely to be so in the case of any subordination of the VLNs to another category of debt. From all of this he derived what I have referred to as the threshold requirement, namely that implicit in the power to modify was that it was exercisable only if, objectively viewed, it improved the prospect of repayment.

Mr Downes sought to support this result by recourse to an alternative route. He referred to what he described as the “general purview” of the clause. He cited Trade Indemnity Company Limited v Workington Harbour and Dock Board [1927] AC 1. In that case there was a power in a performance bond (procured in relation to a contract to enlarge a dock in Workington) to make alterations to the contract works without thereby releasing the performance guarantors. Lord Atkin (at page 15) stated that the words allowing alterations “would have to be cut down so as not to include such changes as have been suggested as substituting a cathedral for a dock, or the construction of a dock elsewhere, or possibly such an enlargement of the works as would double the financial liability…” Lord Atkin later referred (at page 21) to Rowlatt on Principal and Surety (1926 edition) to the effect that such words only relate to alterations “‘within the general purview of the original guarantee.’” Mr Downes also referred to Triodosbank NV v Dobbs [2005] 2 Lloyd’s Rep 588 where, again in the context of a guarantor’s liability, the Court of Appeal stated that a variation to the contract between the creditor and the principal debtor in that case, permitted by the contract of guarantee, had to be within the ‘purview’ of the guarantee. In the course of his judgment Longmore LJ stated (at paragraph 16) that “…it is important to distinguish between a true variation of an existing obligation and the entering of what is in fact a different obligation even though it may purport to be no more than a variation. In that sense it is perfectly possible (and, indeed, right) to put a ‘limit on the power to vary’…” In the instant case, said Mr Downes, the effect of the amendments (if valid), whether looked at individually or cumulatively, is such that the VLNI (as purportedly amended) falls outside the general purview of the original instrument so rendering the amended version an entirely different and new instrument which has effectively replaced the original instrument.

Coming to an authority in a context much closer to the present case, Mr Downes referred me to the decision of the Court of Appeal in Mercantile Investment and General Trust Company v International Company of Mexico, decided in 1891 and reported as a footnote to Sneath v Valley Gold Limited [1893] 1 Ch 477 at 484 and following. In that case a group of debenture-holders challenged a resolution (and its subsequent implementation) of the defendant company (the issuer of the debentures in question) to exchange the debentures for paid-up preference shares in another company which had taken over the assets and liabilities of the defendant company. The complainants had voted against. One of the grounds of challenge was that the transaction embodied in the resolution was beyond the power of the clause in the debenture trust deed pursuant to which it was purportedly authorised. The clause in question was a power to “sanction any modification or compromise of the rights of the debenture-holders against the company or against its property…” The objects of the defendant company, which had been incorporated in Connecticut, were to buy and sell land in Mexico. The objects of the other company (a UK company), for whose preference shares in exchange for the debentures the resolution provided, were enough to encompass just about any kind of business. The Court of Appeal allowed an appeal from an order holding that the resolution was binding on the dissenting debenture-holders. In his judgment Lindley LJ stated that “the power to modify the rights of the debenture-holders against the defendant company does not include the power to relinquish all their rights.” He said that a power to compromise their rights presupposed some dispute about them or difficulty in enforcing them and did not include a power to exchange their debentures for shares in another company where there was no such dispute or difficulty. Fry LJ, after stating that the debenture-holders were entitled under the debenture to the personal obligation of the defendant company to pay the principal and interest and to the benefit of a mortgage of certain land in Mexico, said this:

“The result of the resolution in question, if valid, is to extinguish both these rights, and in fact all rights against the American company and its property, and to substitute for them the rights of a preference shareholder in an English company which had been formed. The holders of the debentures would cease to have any security or any right to recover principal or interest, and would in exchange become entitled to share in the divisible profits of the new company. That new company had acquired, not only the property subjected to the mortgage of the American company, but other properties of that company not charged to the debenture-holders; and the right of the preference shareholders would be confined to share in the profits of the entire company and to an interest, in case of dissolution, in its surplus assets.

….

In my opinion, the transaction embodied in the resolution is not a modification of the rights of the debenture-holders against the defendant company or their property; it is the extinction of all their rights against the company or its property. A right to share in profits produced by a business in which the mortgaged property may be used as a part, and part only, of the profit-producing undertaking, is not a right against that property. ”

From this Mr Downes extracted the proposition that a modification of rights cannot extend to an extinction of those rights. Coming to the facts of the instant case he submitted that the repeated postponement of the redemption date and subrogation of the VLNs to the various FONs, if valid, were equivalent to an extinction of the rights under the VLNI and their replacement with entirely new rights which amounted effectively to a form of preference share. Such a substitution of rights was, he submitted, beyond the scope of clause 9.1.12.

In assessing whether to imply the good faith term I remind myself that, as Lord Hoffmann said in Belize (at [16]), the court has no power to introduce terms to make the instrument it is asked to construe fairer or more reasonable and that the most usual inference, if the instrument does not expressly provide for what is to happen when some event occurs, is that nothing is to happen and that where the event causes loss, the loss lies where it falls. I remind myself also that the overall documentation entered into when the Myers sold control of Swift to Alchemy and Indigo is extensive and detailed. In inviting me to imply the good faith requirement for the protection of the Myers (as holders of the VLNs) I am being asked to conclude that the parties omitted to insert an important term. The omission is all the more striking given that the authors of the documentation gave attention to the protection of the Myers’ interests: any changes to the terms of the VLNs which Kestrel wishes unilaterally to make have to be within the scope of clause 9.1.2 of the VLNI; clause 2.3 requires that the VLNS are to rank equally with the DLNs as regards pre-tax returns; and clause 2.4 prohibits Kestrel from redeeming or repaying the DLNs or making any amendments to their terms without securing for the VLNs equivalent returns, redemptions and amendments.

It is important also to bear in mind that the impetus for the implied term has been Kestrel’s need for additional borrowing and that the terms upon which such additional borrowing was likely to be available were likely to impact on the rights of the holders of the DLNs and VLNs. One may be forgiven for thinking that this is precisely the sort of issue that would have been in the minds of those asked to agree the terms of the VLNI. To an extent it was: the Myers as holders of the VLNs had the right under clause 15.1.3 of the Sale and Purchase Agreement to invest further when Kestrel was looking for further financial support. That clause (“the co-investment clause”) provides that when in the future Kestrel proposes to issue any shares, securities or further loan notes to Alchemy, it will offer to the Myers (for so long as they hold shares in Kestrel or VLNs) the opportunity to make a further investment pro rata to Alchemy’s and their own existing respective investments in Kestrel. This opportunity was offered to them in 2007 but they declined to take it up. It is difficult, to put it no higher, to see why there is a need to imply an additional term into the VLNI to give them further protection merely because, as the co-investment clause plainly envisaged, they declined to invest further resources while others were willing to do so. If they had decided to exercise their co-investment right on each occasion that Kestrel looked for further financial support it is hard to suppose that the Myers would be looking for further protection; it is difficult therefore to see why, having decided not to exercise that right, it is appropriate, in order to mitigate the consequences of that decision, to imply some term into their agreement with Kestrel which constrains the circumstances in which Kestrel should be able to obtain further investment from another source, whether it is by subjecting Kestrel (or indirectly) Alchemy to the suggested good faith term, or by preventing Kestrel from giving priority to the new lending or by postponing the redemption date of the loan notes.

I mention these matters because they are the context for considering whether it is right to imply any additional term into the VLNI or to construe the power to modify given by clause 9.1.2 as if it were subject to the threshold requirement. For, as all the authorities make clear – I do not need to refer to them by name – the temptation to imply an additional term or to add a gloss to the meaning of a straightforward word like “modification” must yield to any contrary intention demonstrated by the existing terms of the instrument in question and to the relevant background.

the good faith term

With those considerations in mind I come to the three ways in which Mr Downes suggested that it was appropriate to imply any additional term into the VLNI. The first concerns the power of a majority to bind a minority, a circumstance which carries with it, either as a matter of implication (whether because it satisfies the requirements set out in Belize or because it is a term generally implied by the law in an instrument of this nature) or by imposition of equity, a requirement that the majority should exercise its power bona fide for the benefit of the class as a whole. I have referred already to the relevant authorities.

I do not accept that it is permissible to imply such a term into the VLNI, much less, as Mr Downes suggested by way of a further possibility, into the ICA. There are several reasons why I reach this conclusion.

First, the assumption which underlies implying such a term into the VLNI is that the DLNs (now the Replacement Notes) and the VLNs constitute a single class. They do not. The DLNs are a class separate from the VLNs. They are created by different instruments. The DLNI makes no reference to the VLNI. There is nothing in the former to suggest that the DLNs form part of some wider class. The Myers, as holders of the VLNs are not parties to it and Alchemy and Indigo (as holders of the DLNs) are not parties to the VLNI. Schedule 3 of the DLNI sets out detailed provisions for the summoning and conduct of meetings of note holders. There is nothing in those provisions entitling the holders of the VLNs to be invited or heard or stating that their interests are to be considered in any way. The same is true in the case of the equivalent provisions in the VLNI in respect of the summoning and conduct of meetings of holders of the VLNs as regards the interests of holders of the DLNs. The importance of this is that if, as Mr Downes suggested, clause 9.1.2 is to be read as if it contained the good faith term it is difficult to see how it can assist the Myers. As non-parties to the VLNI there is nothing to require Alchemy or Indigo to have regard to the interests of holders of the VLNs when exercising their powers under the DLNI.

In any event, clause 2.3 of the VLNI proceeds on the footing that the DLNs and the VLNs are not one class. It requires Kestrel to treat the DLNs “in the same manner as if they constituted a single class”. Two things are to be noted. First, the clause is directed at Kestrel’s conduct, not that of the holders of the DLNs. Second, the clause does not say that the DLNs and the VLNs are a single class, merely that Kestrel is required to treat the DLNs in the same manner as if they constituted a single class. I read that to mean that Kestrel is to treat the DLNs as if they constituted a single class for the purposes set out in it, namely with regard to pre-tax returns and, to that end (as further explained in clause 2.4), with regard to redemption, repayment and purchase of the DLNs (being matters which all pertain to the return to the holders) and the making of any amendments to the DLNI (without doing the same to the VLNI) “in order to give effect to clause 2.3…” Mr Downes submitted that if that had been the purpose of the clause, it could easily have ended after the word “manner”. The fact, he said, that the words “as if they constituted a single class of securities” are added can only mean that the two sets of notes (the DLNs and VLNs) are indeed to form a single class and that they do so for all purposes and, in so doing, import the requirement that the majority must act bona fide and in the interests of the whole class. I do not agree. If it was intended that they were a single class for all purposes clauses 2.3 and 2.4 would not be needed. Instead, there would have been a clause in each instrument making clear that the loan notes created by that instrument formed part of a larger class which included the notes created by the other instrument. Neither does so.

Next, it is to be noted that by clause 4 of the DLNI the DLNs (like the VLNs) are freely transferable. The condition of any transfer is that the transferee shall have complied with any provisions relating to the transfer of the DLNs set out in the ICA. The only requirement in the ICA is that a transferee becomes a party to the ICA: see clauses 21.2 and 21.3 of the ICA. (The transferee is required to enter into a so-called Intercreditor Novation Deed making that person a party to the ICA.) There is nothing in either the DLNI or the ICA to indicate to the transferee that his rights under the DLNI are constrained by any duty to have regard to the interests of those holding VLNs, as part of some larger class which includes the DLNs. Mr Downes had no real answer to this point. He submitted that the duty is a “low” one. He submitted that an assignee of the DLNs who only became aware of the VLNs after he had paid his money and taken his assignment would have no problem in fulfilling the duty. But this did not answer the point.

Nor does the ICA itself assist in identifying the existence of a wider class comprising the DLNs and the VLNs. Mr Downes submitted that the good faith term was to be implied into it but was unable to identify any provision of that agreement, other I suppose than clause 3, where it would be appropriate to do so. If in truth the ICA was intended to be understood as if it contained the good faith term it would surely have said so. It does not do so. Significantly, it is the only one of the many agreements and other documents executed at the time of the sale by the Myers of their sub-prime lending business to which Alchemy, Indigo and the Myers are parties. This surely would have been the agreement in which to set out the duties of good faith to be owed by those entities (“the Investors” as they are described in it) to one another if it had been intended that such duties were to exist. It does not.

In short, it is impossible to see by what process, contractual or otherwise, the freedom of the holders of the DLNs to exercise their powers under the DLNI is constrained by any obligation to have regard to the interests of the holders of the VLNs.

If Alchemy and Indigo as the holders of the DLNs are not subject to any duties to the Myers as holders of the VLNs, it would, as Mr Morpuss submitted, be extremely odd if Kestrel were somehow bound by an obligation of good faith. On the contrary, Kestrel’s contractual obligation is to ensure that the VLNs are treated no differently (as regards the matters mentioned in clauses 2.3 and 2.4.1 of the VLNI) from the DLNs and, by clause 2.4.2, that no amendment is made to the DLNI or to the terms and conditions of the DLNs without at the same time making appropriate amendments to the VLNI and to the terms and conditions of the VLNs. The only limitation is that the amendments must be within the scope of clause 9.1.2 which is the only power to amend conferred on Kestrel if the VLNI is to be amended without the approval of the holders of the VLNs.

Once the holders of the DLNs have resolved to amend the DLNI, Kestrel has no choice: under clauses 2.3 and 2.4 it is obliged to modify the DLNI. It does so, if the holders of the VLNs do not themselves agree to make an equivalent amendment pursuant to clause 9.1.1, under clause 9.1.2. Although clause 9.1 is drafted as a power to modify (“the Company [ie Kestrel] may make any modification …”) the power under 9.1.2 is not a discretion which involves a choice from a range of options. It is the exercise of a contractual right whether or not to modify the VLNI without the consent of the holders of the VLNs. It is constrained by the requirement that it should be a modification and that the modification in question should be consistent in all respects with any modification being made to the DLNI. It harks back to clause 2.4.2. The power is akin to the discretion vested in the claimant Trust in Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd (t/a Medirest) [2013] EWCA Civ 200. In that case Medirest was under a duty to monitor monthly its own performance and record instances where it fell short. A formula existed for calculating how many so-called “failure points” Medirest had incurred and what deductions fell to be made to the Trust’s monthly payments to Medirest as a result. Once the correct figure for the failure points and deductions had been established the Trust had a contractual discretion: it was empowered to “award” Medirest the failure points or it might choose not to do so. Likewise, it might levy a deduction against its monthly payment to Medirest or it might choose not to do so. Jackson LJ (with whom Lewison and Beatson LJJ agreed) noted (at [91]) that the discretion entrusted to the Trust in relation to service failure points and deductions was very different from those cases where the discretion did not involve a simple decision whether or not to exercise an absolute contractual right but where the discretion involved making an assessment or choosing from a range of options taking into account various interests. He observed that the discretion in that case permitted the Trust to decide whether or not to exercise an absolute contractual right. Mr Morpuss described this as a binary choice. He submitted that under clause 9.1.2 Kestrel has a similar choice provided only that the amendment to be made to the VLNI, if it is to be imposed by Kestrel, is a modification in the sense discussed above. In my judgment, he is right in that analysis. The fact that Kestrel had that contractual choice does not justify subjecting it to some kind of good faith obligation. The decision in Socimer upon which Mr Downes relied is not in point.

What then of Kestrel’s obligations under clauses 2.3 and 2.4? Mr Downes submitted that clause 2.4.2 (at the least) should be read as if it were subject to a duty to have regard to the interests of holders of the VLNs at the point where Kestrel and the holders of the DLNs are contemplating an amendment to the DLNI. It is to be noted that although by clause 8 of the DLNI Kestrel has the power with the sanction of an extraordinary resolution of the holders of the DLNs to make any modification to the DLNI (see also condition 6 of the conditions endorsed on each DLN) so that Kestrel has the power to initiate the modification, under clause 19.4 of the second schedule to the DLNI, holders of DLNs have the power themselves to initiate and sanction any modification of their rights against Kestrel. The power is exercisable by the holders of the DLNs without Kestrel’s agreement. Given those terms and the fact (if I am right) that the holders of the DLNs owe no duty of any kind to the holders of the VLNs when exercising their rights and powers under the DLNI, I find it very difficult indeed to see why Kestrel should itself be subject to any implied good faith (or similar) obligation towards the holders of the VLNs when deciding whether to initiate or agree to an amendment of the DLNI. Not the least of the reasons why, in my judgment, Kestrel should not be under any such obligation is that, at the end of the day, Kestrel and the holders of the VLNs are at arms’ length with one another. Where a commercial party (here Kestrel) has a discretion which impinges directly on its own commercial and economic interests, exceptional circumstances are needed to imply a term requiring that party to subject those interests to those with whom it is dealing, not least when the instrument in which the term is to be implied is one where, as here, the terms are to be found in a detailed and professionally prepared commercial document.

For these reasons, which largely followed the submissions made to me by Mr Morpuss, I am not willing to imply the good faith (or any like) term.

the threshold requirement

I come next to the supposed threshold requirement. There was some debate between Mr Downes and the court before Mr Downes settled upon the formulation for which he now contends. Material to this is that although the good faith condition featured in the first of the Myers’ two Part 8 claims there is no reference to the threshold requirement in either claim form, notwithstanding that the later claim pleads how the word “modification” in clause 9.1.2 should be construed. The first appearance that the revised formulation makes is in paragraph 59 of Mr Downes’s and Mr Chirnside’s skeleton argument. Mr Morpuss drew my attention to this delayed appearance. It is not entirely without significance in that if it had not occurred to those propounding it until so late in the day, the case for saying that that is what the clause must obviously mean is made more difficult.

That point aside, I am not persuaded that the meaning of the VLNI, as it would be reasonably understood by anyone with the relevant background knowledge who was invited to invest in the VLNs, is that clause 9.1.2 operates as if it contains a condition precedent that it can only be exercised if the modification in question improves the prospect of repayment of the VLNs. For that is the effect of the threshold requirement. I say that for three reasons. First, this is a carefully drawn instrument and it is very unlikely that so important a requirement would have been omitted on the footing that, although the instrument does not say so, this is what it must mean. Second, the requirement is silent on how one is to assess, at the time that the modification is proposed, whether it would improve the prospect of repayment and who it is who is to undertake the assessment. It seems scarcely likely that Kestrel and those investing in the VLNs, if they had intended to make the power of modification subject to this important qualification would have omitted this important aspect of its operation. Third, what is or is not a modification would probably change from time to time depending on what Mr Morpuss described as the “vagaries” of Kestrel’s performance and what could be predicted for its future. This would give rise to uncertainty and, not least, to an uncommercial result which Kestrel and those investing in the VLNs are very unlikely to have intended.

were the amendments “modifications” within the scope of clause 9.1.2?

It only remains to consider whether the amendments to the VLNI providing for the redemption date to be postponed and for the subordination of the VLNs to later indebtedness were “modifications” within the scope of clause 9.1.2.

Reference to the dictionary definition of “modification” and to statements on general purview are all very well at a high level of abstraction but of little assistance in determining where the line is to be drawn between what is and is not a modification and therefore on which side of the line the various amendments are which Kestrel has purported to make. No-one would quarrel with the proposition that a right under a contract for the delivery of an enlarged dock to modify the terms of that contract would not enable the supplier to substitute a cathedral. But that scarcely assists. Much closer to the challenged amendments is the assistance to be derived from the clutch of authorities dating to the end of the 19^th century and early years of the 20^th century to which I was referred. Principal among them was Mercantile Investment upon which, as I have mentioned, Mr Downes placed considerable reliance. But that was a case where an attempt was made to subject the debenture-holders to a wholly different risk from the risk which they assumed when they invested in the debenture. Their rights against the company in which they had invested were to be replaced by rights, and then only as shareholders, in a quite different company with different objects and incorporated in a different jurisdiction. That involved, as Mr Downes submitted, an extinction of rights and their replacement by wholly new rights.

In Follitt v Eddystone Granite Quarries [1892] 3 Ch 75 the debenture trust deed which constituted a first charge over the undertaking and property of the company (the issuer of the debentures) contained the same power to sanction modifications and compromises as in Mercantile Investment. Resolutions of the debenture-holders and the shareholders were passed sanctioning a further loan to the company when it fell into financial difficulty. The further loan was to have priority over the debentures and be a first charge on the company’s properties. The further charge was entered into and the trustees postponed the security given to the debenture-holders in favour of the further charge. Some of the debenture-holders challenged the validity of the steps taken to sanction and give effect to these matters. Stirling J held that the debenture-holders’ resolution and the subordination of their security to the further charge were valid. In so doing he referred to and followed the decision in 1886 of Chitty J in Re Dominion of Canada Freehold Estate and Timber Company (reported only at 55 LT (NS) 347). There one of the questions was the validity of a resolution passed by the requisite majority at a duly-convened meeting of debenture-holders which authorised the company (the issuer of the debentures) to allow persons, willing to advance money, to receive security standing in priority to the debentures. Chitty J was of the view that the postponement of the debenture-holders’ security to the new security was within the scope of a power in the debenture trust deed authorising the debenture-holders by a stated majority at a meeting duly convened to “assent to any modification” of its provisions. Mr Downes sought to distinguish the decision in Follitt (and, I think, the decision of Chitty J) on the basis that they concerned the placing of new security ahead of existing security. I do not consider that this is a relevant distinction. The fact is that in both cases the debenture-holders were losing priority to a new class of creditor.

In Northern Assurance Company Limited v Farnham United Breweries Limited [1912] 2 Ch 125 the debenture trust deed conferred upon a general meeting of the debenture-holders a power similar to the power to sanction compromises and modifications contained in the trust deed considered in Mercantile Investment. The question which arose was whether resolutions passed by the requisite majority at a duly-convened meeting of the debenture-holders could validly sanction the conversion of redeemable debentures into irredeemable or perpetual debentures under a power in the debenture trust deed to sanction any modification or compromise of the rights of the debenture-holders against the company (the issuer of the debentures) or its property (the same power as in Mercantile Investment). The debenture trust deed was entered into in 1890 and provided for payment of the principal thereby secured on 30 September 1909 with interest payable half-yearly at just over 4% per annum in the meantime. By a supplemental trust deed dated 1 May 1907, executed in pursuance of a resolution of the debenture-holders at a duly convened meeting and with the requisite majority the redemption date was put back ten years to 30 September 1919. In December 1910 a duly-convened meeting of the debenture-holders resolved (by the required majority) to convert the debentures into perpetual debentures and authorised the trustees to concur with the company in giving effect to the change. A small number of debenture-holders challenged the validity of the resolution. It was argued that the alteration sanctioned did not amount to a modification of the rights of the debenture-holders but to something much more extensive. Joyce J rejected this, holding that the alteration in question did not amount to anything more than the modification of the rights of the debenture-holders against the company and its property (i.e. was within the sanctioning power). Interestingly, it was also argued by the plaintiffs that the power to modify or compromise pursuant to which the resolution had been passed was subject to an implied condition precedent that it could not be exercised until some serious occasion should arise which rendered it necessary or plainly expedient that the power in question should be exercised. Joyce J rejected this too, saying that he was unable to find any such condition expressed or necessarily implied anywhere in the deed.

It would appear, because the case is referred to in the judgment, that Joyce J was influenced in reaching this decision by what Eve J had said in October 1909 in a case reported as a footnote to the decision in Northern Assurance (and otherwise referred to briefly only at 54 Sol J 31), namely Re Joseph Stocks & Co Limited, Willey v Joseph Stocks & Co Limited. In that case too there was, for all practical purposes, the same power to modify or compromise contained in a debenture trust deed as there was in Mercantile Investment and also in Northern Assurance. The principal secured by the debentures was repayable at the latest on 1 October 1907. The company (the issuer of the debentures) found itself in debt to its bankers and, with a view to meeting the bankers’ requirements if the overdraft was not to be called, passed a resolution passed by the requisite majority at a duly-convened meeting of the debenture-holders to do away altogether with the date of repayment of the principal secured by the debentures. The plaintiffs who had voted against the resolution challenged its validity, arguing, among other points, that it was not within the scope of that power. In dismissing that contention Eve J, adopting the approach taken by Fry LJ in Mercantile Investment, held that it was competent for the debenture-holders at a properly convened meeting and by the required majority to modify the rights of the holders by releasing the right to repayment on 1 October 1907. In so doing he reasoned as follows:

“The right of the stockholder…was to receive his principal moneys if the company went into liquidation or if the company committed any breach of the covenants on its part contained in the deed, and the right, whatever happened, on October 1, 1907, to be paid off. Those three rights the stockholders enjoyed down to September 6, 1904, and the effect of this resolution was so far to modify their rights against the company as to eliminate from those three rights the absolute right to repayment on October 1, 1907.”

Although those cases do not bind me in any way – each is inevitably a decision on its own facts and none seeks to lay down any hard and fast principle – they show how the courts have approached the issue of a “modification” to the terms of corporate loan stock deeds, in particular amendments postponing redemption or, as the case may be, subordinating the issue to other indebtedness, and help point the way. Mr Downes submitted that some of them, Northern Assurance in particular, took too generous a view of a modification and demonstrated a judicial reaction against the ability of a small minority of stockholders to block, or to seek to block, an amendment to the governing trust deed. He referred to the remarks of Joyce J in Northern Assurance (at page 133) quoting Mellish LJ in another case describing such a minority as a few “cantankerous” debenture-holders. He submitted that Northern Assurance was wrongly decided as being inconsistent with what was said in Mercantile Investment, or at least that it would be decided differently today, and that I should ignore it. Time has moved on, he said; the courts should look with more circumspection at what is claimed to be a modification and, at the very least, be wary of attaching much, if any, weight to those authorities.

I do not agree that those early decisions take too generous a view of what is a modification. I do not consider that the decision in Northern Assurance was wrong and very much doubt that it would be decided differently today. I am unaware of any appeals from those decisions or adverse criticism of them in later cases or in academic writings. Equally, however, I do not consider that they are determinative of the questions which I have to decide. But they do illustrate how in the past the courts have approached amendments to a debenture trust deed postponing redemption or, as the case may be, subordinating the issue to other indebtedness. In each case amendments providing for a subordination of the indebtedness to other indebtedness (secured or unsecured) or a postponement of its redemption have been held to be a permissible modification of rights.

How then should I view the amendments in the present case? Each postponement of the redemption date, of which there have been four, has been for a relatively short period (the shortest was for no more than eleven months, the longest for forty-eight months). The cumulative effect of them, if all are valid, has been to extend the redemption date from 12 May 2010 to 31 March 2018. As for the amendments made to the VLNI subordinating the VLNs to the 2007, 2008 and 2009 FONs, it was rightly not contended that the VLNI imposed any restriction on further borrowings by Kestrel and the interest that might be charged for them, notwithstanding that further borrowings, if at a higher rate of interest than was being charged under the VLNI, might well have the effect of reducing the return achievable by the VLNs on redemption. Relevant to this is that the VLNs have at all times been unsecured: subject to the terms of the ICA, holders of the VLNs rank pari passu with Kestrel’s other creditors. Subordination puts them in an inferior position as regards higher-ranked indebtedness.

The conclusion I have reached is that, subject only to an argument based on the ICA (which relates only to subordination), each amendment made postponing redemption and each amendment made subordinating the VLNs to some other class of creditor was a modification of rights within the scope of clause 9.1.2. In reaching this conclusion it is to be noted that all of the other detailed rights and obligations, set out in what was clearly a carefully worded instrument, have remained unchanged. In particular, Kestrel’s right at any time to redeem or repurchase the VLNs has remained unaltered. Also unchanged are the many events of default, the power to declare the VLNs repayable on the occurrence of an event of default and the circumstances in which the right to call for their repayment arises. The VLNs have continued to rank equally with the Replacement Notes. There was no suggestion that the various postponements should for some reason be viewed as if they had been made on the same occasion, rather than when each was made. In my judgment it is right to view each amendment separately at the time it was made. But, even if it were appropriate to consider the matter as if there had been one single postponement, from 12 May 2010 to 31 March 2018, I reach the same conclusion: the postponement was within the scope of clause 9.1.2. I should add, for what it is worth, that the amendments made are far removed in effect from the situation in Mercantile Investment. There is no extinction of rights of the scale and nature considered in that case.

the ICA argument on subordinations

That brings me finally to Mr Downes’ submission based on the ICA concerning the validity of the subordination amendments. I understood him to submit that clause 3.1 of the ICA has the effect of preventing any alteration in priorities as between various classes of Kestrel’s creditors which might operate to the detriment of the VLNs. In my judgment the ranking of the three types of debt mentioned in clause 3.1 is confined to those three. Clause 3.2 makes clear that the ICA does not seek even to rank any of its Investor Debt or Intra-Group Debt as between the Investors and Intra-Group creditors. The ranking dealt with by the clause is limited in its effect and is irrelevant to other debt. It does not prevent other debt from enjoying priority over the three classes of debt referred to in it. I cannot therefore see that it prevents Kestrel from specifying by appropriate amendment to the VLNI that the VLNs should be subordinated to it. It is not as though the parties to the ICA did not contemplate the possibility of further investment by Alchemy. This, in my judgment, is because there was never any intention that such further debt would be affected by clause 3 (or any other clause) of the ICA. I have also drawn attention to the co-investment right (clause 15.1.3 of the Sale and Purchase Agreement). Its significance in the present context is that if the intention had been that any further investment by Alchemy (or anyone else) should be ranked with the other Investor Debt, or at any rate not given priority, it could and presumably would have said so. It does not.

For these reasons I conclude that each of the challenged amendments to the VLNI was a “modification” within the scope of clause 9.1.2.

One of the events of default under the VLNI is, as I have earlier mentioned, if “any Group Company” (an expression which includes Kestrel and Kestrel Holdings) shall be unable to pay its debts within the meaning of Section 123 of the Insolvency Act 1986”: see clause 6.1.4. The Myers contend that Kestrel (and therefore Kestrel Holdings which depends entirely on the solvency and continued trading of its group subsidiaries, in particular Kestrel, to remain afloat) is insolvent within the meaning of that section. They contend (and if necessary will do so in their Part 7 claim) that the practical consequence of establishing a default is, as I understood it, that they will be entitled to call for the immediate repayment of the VLNs.

A lot of evidence, much of it contested, was filed which related to whether Kestrel was insolvent and, if so, by what date. I do not need to consider that evidence, and on a Part 8 claim it would not be appropriate to do so, because the defendants accept that from 2012 onwards, while there may be argument over the detailed numbers, Kestrel’s liabilities have far exceeded its assets and that some form of restructuring of Kestrel’s debt will be necessary to ensure that its liabilities do not exceed the funds available to meet them when the VLNs (and other notes) mature for payment, assuming that their redemption date has been validly postponed from time to time. (The Myers, as I have made clear earlier, allege that Kestrel has been insolvent since appreciably before 2012 but I do not need to explore whether they are right about that.)

The material provisions of section 123 of the Insolvency Act 1986 are to be found in sections 123(1)(e) and 123(2). Section 123(1)(e) provides that “[a] company is deemed unable to pay its debts…(e) if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due.” And section 123(2) provides that “[a] company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.” Those are well known to practitioners as the cash-flow and assets (or balance-sheet) bases of insolvency respectively.

It was not, however, until the decision of the Supreme Court in BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28; [2013] 1 BCLC 613 (“Eurosail”) that there was discussion of the expression “debts as they fall due” (critical to an understanding of the cash-flow basis) and the precise relationship between the two bases was explored. Lord Walker SCJ, in whose judgment Lords Mance, Sumption and Carnwath SCJJ concurred and with whom Lord Hope, who delivered a separate judgment on the so-called PECO agreement, also agreed, said this (at [37]) on those issues:

“…the ‘cash-flow’ test is concerned, not simply with the petitioner’s own presently-due debt, nor only with other presently-due debt owed by the company, but also with debts falling due from time to time in the reasonably near future. What is the reasonably near future, for this purpose, will depend on all the circumstances, but especially the nature of the company’s business…The express reference to assets and liabilities is in my view a practical recognition that once the court has to move beyond the reasonably near future (the length of which depends, again, on all the circumstances) any attempt to apply a cash-flow test will become completely speculative, and a comparison of present assets with present and future liabilities (discounted for contingencies and deferment) becomes the only sensible test. But it is still very far from an exact test, and the burden of proof must be on the party which asserts balance-sheet insolvency…”

I am satisfied that, provided (as I have found them to be) the postponements of redemption were validly effected, the Myers have not shown that Kestrel was at any material time and is now cash-flow insolvent. There was no evidence that Kestrel has been unable to pay its presently-due debts at any time or is likely to be unable to pay debts falling due within the reasonably near future. Amanda Brooks, finance director since May 2007 of Kestrel, Holdings and Swift, asserted in evidence that Kestrel and Kestrel Holdings had always met their liabilities as they had fallen due. This was not really disputed. The question rather was whether the Myers demonstrate – the burden of proof being on them to do so - that Kestrel is balance-sheet insolvent (and Kestrel Holdings too). This in turn focused on the position when the VLNs (and other notes) mature for payment. Currently, that will be 31 March 2018. The defendants contend, and their evidence sought to suggest, that in the light of the increasing deficiency going forward Kestrel and Kestrel Holdings will, if necessary, effect a reconstruction to ensure that their liabilities do not exceed the funds available to them when they mature in 2018. I will come to their evidence on this a little later.

In the event, therefore, the only issue in relation to balance sheet solvency, and thus in relation to the issue of insolvency as a whole, is whether and in what manner the court may take account of a future restructuring of Kestrel’s liabilities. For without it there can be no doubt, as the evidence showed, that Kestrel is balance-sheet insolvent and so too is Kestrel Holdings.

It is convenient to consider first the decision in Eurosail to which Mr Downes referred me. In that case there were, so far as material, two classes of debt (represented by differently-denoted interest-bearing notes of the issuing company). One of the specified events of default under the notes was whether the issuer was “unable to pay its debts as and when due” or “was deemed unable to pay its debts” within the meaning of section 123(2) because “the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities”. In order to bring about the practical impossibility of the issuer being subjected to an insolvency process and thus to attract a higher credit rating the trustee of the noteholders’ rights entered into a so-called post-enforcement call option agreement (or “PECO”) on behalf of the noteholders which limited the issuer’s liability to creditors to the value of the assets backing the notes. The PECO gave an associate company of the issuer a call option to acquire all the notes at a nominal price together with the noteholders’ claims if the security for the notes was found to be insufficient to pay all of the amounts due in the event of the security being enforced. The two classes of debt were not repayable until 2045 at the latest. The issue for decision by the court was whether the issuer was unable to pay its debts within the meaning of section 123(2) and, if so, whether the PECO had the effect that the issuer was nevertheless deemed able to pay its debts in the event of the call option under the PECO being exercised on the ground that the assignment of the noteholders’ claims to the option holder would in practice extinguish their claims and they would have no further claim against the issuer. The Chancellor held that the value of the issuer’s assets exceeded its liabilities so that the effect of the PECO did not arise but that, if it had, it would not have affected the issuer’s liabilities since they would remain the same whether or not there was a PECO and whether or not the call option under it was called. He considered that while a PECO might affect the practical possibility of the issuer being subjected to an insolvency process it was irrelevant to the issuer’s liabilities. The Court of Appeal dismissed an appeal against the solvency finding by affected noteholders. It also dismissed a cross-appeal by the issuer against the PECO ruling and did so for essentially the same reasons that the Chancellor had given. The matter went to the Supreme Court which dismissed the noteholders’ appeal on the solvency issue, although for reasons which differed from those given in the Court of Appeal. I have already referred to what Lord Walker said on the correct approach to the operation of section 123(1) and (2). I do not need to deal further with that aspect of the appeal. The Court also dismissed the issuer’s cross-appeal. They did so (at [50] and [51]) by stating that they agreed with the reasons for doing so that had been given by the Chancellor and the Court of Appeal.

It was what Lord Hope went on to say about the relevance to balance-sheet solvency of the PECO agreement that was the subject of debate before me. It was argued on behalf of the issuer that, although as a matter of contract its liabilities were unlimited in recourse, the commercial reality was that liabilities which it would be unable to pay were liabilities which, by the operation of the PECO, it would never have to pay. Lord Hope did not accept that it was possible to distinguish the intended commercial effect of the PECO from their legal effect in this way. At [63] he said that:

“…It [the PECO] has no effect…on the amount of the issuer’s liabilities. To limit those liabilities as the issuer contends would contradict the parties’ clearly expressed commercial intention as found in the contractual documents. The fact that the economic result of the PECO may be the same as if the noteholders’ right of recourse had been limited to the issuer’s assets is beside the point. ”

I agree with Mr Morpuss that Eurosail is not really of any assistance in the instant case. There is no PECO or equivalent provision in the VLNI or, so far as I am aware, in any of the other loan note instruments. Either the contractual liability of Kestrel under the various loan notes continues to subsist when the time comes to assess what its liabilities are and whether they exceed the assets available to meet them so that it is possible to determine whether at that time Kestrel is balance-sheet insolvent or it does not. The question therefore is whether, although Kestrel’s liabilities currently far exceed its assets and are likely to increase in amount and the gap between them and available assets likely to widen as time passes, it is permissible for the court to take into account Kestrel’s intention to effect a restructuring when the liabilities fall due for payment (currently at the end of March 2018) either by recourse to a modification of the rights of the holders of the various classes of loan notes (including therefore the Myers as holders of the VLNs if they so remain by that date) pursuant to the right of modification (where it exists) under the various classes of loan note (clause 9.1.2 in the case of the VLNs) or, failing that, by recourse to a statutory scheme of arrangement under Part 26 of the Companies Act 2006. He submitted that it was so open to the court. He submitted that this was essentially a matter of evidence and that on a balance of probabilities the evidence justified the conclusion that such a restructuring would occur such that when its liabilities fall due for payment the available assets will suffice in value to discharge them in full.

Mr Downes advanced three points. First, the evidence relied upon to say that the necessary restructuring will occur falls far short of what is needed if the court is to be persuaded that it will happen and that Kestrel will not be balance-sheet insolvent when the VLNs fall due for payment. He submitted that, so far from being a commercial certainty, in truth there are good commercial reasons why a restructuring will not happen. He submitted that the evidence relied upon by the defendants to say that it will happen is carefully qualified. Second, he submitted that any attempt to achieve a restructuring by recourse to a contractual right to do so under clause 9.1.2 is not open to Kestrel since the power of modification of the VLNs under that clause does not permit the sort of restructuring that Ms Brooks envisages. Third, he submitted that a statutory scheme of arrangement will require the court’s sanction and this will hardly be granted if the Part 7 claim is unresolved when the need for the scheme arises.

As to the first of those points, the evidence in question was to be found in the witness statements of Amanda Brooks for Kestrel and Kestrel Holdings, Kevin Murphy for Indigo and Dominic Slade for Alchemy. In paragraph 76 of her statement Ms Brooks said that “I consider that some form of restructuring will ultimately be required to ensure that each of [Kestrel’s] and [Kestrel Holdings’] liabilities do not exceed the funds available to meet them as and when they mature.” She enlarged on this, emphasising the support that the business had had from Alchemy and Indigo and how such support could be expected in the event of a restructuring. She explained the kind of restructuring that might be possible. They were of two types. One of them, she said, could be a contractual restructuring pursuant to clause 9.1.2 of the VLNI and its equivalent in the Replacement Notes, for example by amending the notes to give the holders the right to receive shares for their debt and, as a default position to be exercised only to the extent that any of the note holders chose not to take up this right, to make the debt redeemable by Kestrel at a sum which represented an appropriate percentage of the debt then outstanding under the notes in question. The other possibility canvassed by Ms Brooks was a statutory scheme of arrangement under Part 26, for example one whereby the loan terms of the VLNs and the Replacement Notes would be altered so that they would be redeemable by Kestrel at a sum which represented “an appropriate percentage of the debt then outstanding under those notes.” Her evidence also explored how Holdings too might be restructured to ensure balance sheet solvency. I understood that the restructuring which Ms Brooks has in mind would be not be effected until at or near to the time for payment of the liabilities as until then it would not be known quite how much of the liabilities would need to be written down to ensure that they did not exceed the then available funds. She concluded that “By reason of their ability, with the support of sufficient of their stakeholders, to restructure their respective liabilities before those liabilities fall due for payment, and by reason of the fact that those stakeholders have unequivocally confirmed the availability of that support, neither [Kestrel] nor [Kestrel Holdings] is balance sheet insolvent.”

Mr Slade is the managing partner of Alchemy Partners LLP (“Alchemy Partners”) and is a director of Kestrel Holdings. He stated that Alchemy Partners is the investment adviser to the seventh defendant and that the sixth defendant, which is under the control of the seventh defendant, holds the Replacement Notes as nominee on behalf of the groups of investors who together make up the so-called Alchemy Investment Plan (“the Plan”) of which the seventh defendant is the manager and general partner. His evidence was to the effect that Alchemy Partners makes recommendations to the seventh defendant which has full discretionary management in relation to the Plan’s investments. Nonetheless, he said, the seventh defendant will consider those recommendations as part of its decision-making process “and, if it thinks fit, follow those recommendations.” He stated that, in relation to each of the decisions needed in respect of its investment in the Kestrel Group, the sixth defendant had so far carried out the seventh defendant’s recommendations. He went on to say that he believed that “any further recommendations by Alchemy in connection with the Plan’s investment in the Kestrel Group would also be followed.” Against that background he stated that “as investment adviser, Alchemy [i.e. Alchemy Partners] can envisage no benefit to the Plan in maintaining a higher level of loan note debt than [Kestrel] would be able to repay on maturity. At an appropriate point in time, but prior to the ultimate maturity date of the loan notes, Alchemy will recommend to [the seventh defendant] that the loan note debt is restructured in a manner which will ensure that [Kestrel’s] liabilities do not exceed the cash or other assets available to meet those liabilities…Ideally…any restructuring would take place only when there was some degree of certainty as to the level of debt that needed to be restructured.” He expressed a similar view in relation to Kestrel Holdings regarding the need to reduce the level of intercompany debt owed by it to Kestrel so that its cash and assets are sufficient to meet its liabilities. He concluded by saying that the fact that Alchemy had not yet recommended a specific restructuring should not be taken as calling into question Alchemy’s commitments in this regard and that at the relevant time, once approved by Alchemy’s investment committee, Alchemy will recommend the Plan to compromise Kestrel’s debt “in accordance with the most appropriate restructuring option outlined in the first witness statement of Amanda Brooks [i.e. as summarised above] in order to ensure that the liabilities of [Kestrel] do not exceed the value of [Kestrel’s] assets as at the time those liabilities ultimately fall to be repaid.” He said that a similar recommendation would be made with respect to Kestrel Holdings’ liabilities.

Mr Murphy is one of the managing partners of Indigo Capital LLP. That entity, according to Mr Murphy, is able to make investment decisions directly in relation to the various assets held by the fifth defendant, including the Replacement Notes. He stated that the fourth defendant holds and has full discretionary management in relation to the 2007 FONs but that in practice that entity has chosen to follow each of the recommendations made to it by Indigo Capital LLP in relation to the Kestrel Group. He said that he believed that it would follow any further such recommendations. He then repeated, almost word for word but with suitable alterations to refer to Indigo and not Alchemy, what Mr Slade had stated with regard to Alchemy’s support for restructuring the debt owed by Kestrel.

Mr Downes criticised these statements as not going far enough. All there was, he said, were recommendations to approve a restructuring. There were no undertakings to do so. Moreover, he submitted, the restructuring proposals, in so far as both Alchemy and Indigo held debt which had priority over the VLNs, made little or no commercial sense: they might be better advised to take what was available towards discharge of the debts which had priority and ignore the claims of those like the VLNs which were lower down the repayment scale.

I have no reason to doubt the willingness of both Alchemy and Indigo to assist Kestrel and Kestrel Holdings to effect whatever restructuring is eventually proposed with a view to ensuring that the cash and other assts available are sufficient to meet their liabilities at the time the loan notes mature for payment. My difficulty is slightly different. It is that the nature of any scheme of arrangement, if one is needed, is at best no more than an aspiration. The most that Ms Brooks could say about it was that Kestrel “might propose to amend the terms of both the Investor Loan Notes and the Vendor Loan Notes to make these redeemable by [Kestrel] at a sum which…represented an appropriate percentage of the debt then outstanding under those notes.” She could scarcely have been more tentative. She is really saying no more than that a scheme will be proposed to restore Kestrel to solvency and that it will command the requisite support of the principal creditors. How the scheme will actually provide for each class of creditor (as there will almost certainly be more than one), what those classes will be and how in other respects the scheme will operate are all matters which have yet to be worked out. In effect I am asked to accept on trust that a scheme will be promulgated which the necessary classes of creditor will vote to support by the required majorities and that it will receive the court’s sanction. In Eurosail Lord Walker approved (at [42]) what Toulson LJ (as he then was) had stated when the case was before the Court of Appeal as the appropriate approach to balance-sheet insolvency:

“Essentially, s 123(2) requires the court to make a judgment whether it has been established that, looking at the company’s assets and making proper allowances for its prospective and contingent liabilities, it cannot reasonably be expected to be able to meet those liabilities. If so, it will be deemed insolvent although it is currently able to pay its debts as they fall due. The more distant the liabilities, the harder this will be to establish. ”

Kestrel’s liabilities currently greatly exceed its assets. On the evidence the likelihood is that the deficiency will increase as each month passes up to the maturity date of the VLNs. It is conceded that a restructuring of some kind will be needed to restore Kestrel to solvency. The form and details of the restructuring are unknown. All that seems likely is the readiness of the main creditors to support it. I am not willing on that evidence to say that Kestrel is solvent. Similarly with Kestrel Holdings. In my judgment the Myers have discharged the onus which is upon them to demonstrate balance-sheet insolvency.

In view of my conclusions on his first and second points Mr Downes’ third point does not arise. This was to the effect that in any event the Part 7 claim will not have been concluded by the time the VLNs mature for payment and that it is scarcely likely that any court would exercise its power to sanction a scheme of arrangement if this were then the position. The Part 7 claim is concerned, among other issues, with claims in damages against the defendants for breach of contract, procuring breach of contract, negligence, breach of duty and injunctive relief against the fourth and fifth defendants. It is currently stayed pending determination of the two Part 8 claims. I have no idea whether the Part 7 claim will have been tried or otherwise resolved by the time that Kestrel has need for a scheme under Part 26. I have no means of saying that it will not. There is certainly much time for it to be disposed of between now and March 2018. Nor is it apparent whether even if it has not been disposed of by then what remains for trial would be relevant to the sanctioning of a scheme under Part 26. All I need say is that if this had remained a live point I would have felt unable to attach any weight to it.

Is this conclusion affected by the power to make modifications to the terms of the VLNs under clause 9.1.2? Even if I cannot assume that an acceptable scheme will be proposed which will receive the necessary creditor support and the court’s sanction when the time for it comes, might it be open to Kestrel to have recourse to clause 9.1.2 so as to ensure that the VLNs are paid in full on maturity. And if it is open to Kestrel to have recourse to its power under clause 9.1.2 when the time is ripe to do so, is it any more appropriate for me now to assume that it will be effected in the future at or shortly before the VLNs are due to be repaid? Mr Downes submitted that the restructuring described by Ms Brooks (already summarised above) would be beyond the permissible scope of that clause. This is because in so far as it involved a reduction in the nominal value of the VLNs it would involve an extinction of rights and that would offend what was said in Mercantile Investment, namely that an extinction of rights is not a modification of rights. For the same reason, he submitted, any restructuring that involves the substitution of shares in Kestrel in place of the VLNs would involve an extinction of rights. In reply, Mr Morpuss submitted that by the time the need for a contractual restructuring arises the VLNs would be so far without value in view of the debts having priority over them and the inadequacy of Kestrel’s assets to meet even those prior claims that whether the nominal value of the VLNs is written down to any extent or the VLNs are exchanged for shares the position of the holders of the VLNs can only be improved. In short, the restructuring would be giving the holders of the VLNs some value (at a time when they would otherwise have none) and would therefore be improving their position. This, as I understood the submission, would not be an extinction of rights but a conferment of rights where immediately prior to restructuring none existed or none which had any value.

In my judgment Mr Morpuss’ argument must be rejected. I have discussed earlier in this judgment the scope of a permissible modification under clause 9.1.2. I am of the view that a writing-down of the nominal value of the notes from say £1 to say 10p or their replacement by shares constituting a very small minority holding, carrying no right to redemption by any given date and carrying no entitlement to any particular income rights (Ms Brooks does not say what species of share would be offered and therefore what rights it would carry) is not a ‘modification’ within the scope of clause 9.1.2. I do not consider that the answer to this question would be affected by postulating that at the time of the alteration of rights the VLNs have no value. Moreover even if the power to modify were arguably wide enough I would need stronger evidence than I have been shown setting out what precisely the restructuring is that Kestrel intends, in particular the degree of write-down. This is because there must come a point, even giving clause 9.1.2 a wide and generous interpretation, when the proposed write-down in rights goes beyond what is permissible.

Mr Morpuss had a final string to his bow. He submitted that even if the Myers could establish that Kestrel or Kestrel Holdings was insolvent within the meaning of section 123 it would not be of any practical assistance to them. This was because, pursuant to an order earlier in these proceedings, they are now fully secured by reason of a deposit of £14.5m in a trust account and also because any petition to wind up Kestrel or Holdings would probably be opposed by Alchemy and Indigo who are the only significant creditors and who have both indicated that they support the companies. Moreover, he submitted, under clause 6.2 of the VLNI, the Myers are only entitled to demand payment of what is due to them on the occurrence of an event of a default if the holders of the DLNs (now the Replacement Notes) have declared their notes to be due and payable. Alchemy and Indigo have not done so. (There is, I should mention, a claim by the Myers in their Part 7 claim that a term is to be implied in the ICA that, in the event of the insolvency (within the meaning of section 123) of Kestrel or of Kestrel Holdings or of a declaration to that effect, Alchemy and Indigo would declare their Replacement Notes to be immediately due and payable and would not do anything to prevent the Myers from being entitled to call for the immediate payment of the VLNs.)

I am not minded to deny the declaratory relief which the Myers seek simply because, without more, they would appear unable presently to demand payment or pursue winding up proceedings. I consider that they are entitled to a declaration to reflect my finding that insolvency is established. It will be for decision in the Part 7 claim whether, insolvency having been established, Alchemy and Indigo are obliged to declare their Replacement Notes to be immediately due and payable. The fact that the precise extent of the balance-sheet deficiency is or may be a matter of dispute does not matter.

The defendants have advanced two estoppels. The first was in defence to the lapse claim (see paragraph 12 above). That claim has now been abandoned and there is no longer any need to pursue the defence to it. The second was in defence to the modification claim. This was to the effect that if each of the six amendments to the VLNI, providing for the successive postponements of the redemption date of the VLNs and for their subordination to the various FONs, was beyond the scope of the power to modify given by clause 9.1.2, the Myers are, by reason of their conduct, estopped from so contending. The species of estoppel relied upon is either estoppel by convention or estoppel by acquiescence. As I am of the view that these six amendments are all within the scope of clause 9.1.2 the point does not arise. I should nevertheless make it clear that if I had to any extent been of a contrary view regarding the amendments I would not have thought it right to reach a decision on the estoppel defence on a Part 8 claim on the limited material before the court.

I do not need to refer to the authorities to which I was taken where the relevant principles relating to these estoppels are set out. It is sufficient to say that the defendants focus on an email sent by Kestrel’s solicitor to Mr Myers and his solicitor in late October 2007 setting out the resolution which was to be passed by Kestrel to amend the terms of the Vendor Loan Note Instrument to subordinate the VLNs to the 2007 FONs, an email from Mr Myers to Mr Slade in March 2008 in connection with the replacement of the DLNs by the Replacement Notes and email exchanges which took place in July 2008 in connection with amendments needed to the VLNI to cater for the postponement of the redemption date of the VLNs from May 2010 to September 2012 and their subordination to the 2008 FONs. The gist of the contention was that the Myers’ conduct on those occasions was consistent only with an acceptance that the modifications were permissible under clause 9.1.2 and that it would be unconscionable of them subsequently (in the current proceedings) to seek to say that they were not. I was persuaded that despite the contents of those emails there are serious arguments to suggest that the necessary requirements of an estoppel (whether it is by convention or by acquiescence) are not satisfied to enable the defences to each of the six amendments to run. Over and above that I am alive to the warning by Stanley Burnton LJ (at [77]) in ING Bank NV v Ros Roca SA [2011] EWCA Civ 353; [2012] 1 WLR 472 (and to which Mr Morpuss very properly referred me) that “[i]n general Part 8 proceedings are wholly unsuitable for the trial of an issue of estoppel. Once such a claim is disputed, save in exceptional cases, the proceedings will cease to comply with CPR r 8.1(2)(a), since they will cease to be proceedings in which the parties do not seek the court’s decision only on questions which are ‘unlikely to involve a substantial dispute of fact’. A disputed claim of estoppel should be carefully pleaded.” The estoppel claim is disputed. There are disputes of fact. Those disputes are ones of substance as regards the availability of the estoppel defence. There is nothing exceptional in the case to justify their determination as part of the current Part 8 claims.

I am willing to make declarations reflecting my conclusions on the matters that were argued before me.