Citibank NA & Anor v QVT Financial LP

The scope of a security trustee’s powers before enforcement depends on the contractual security documents. Parties may confer a power to require the exercise of a charged option before default, even where preservation of the security is not established.

A court-approved restructuring plan may be a document replacing or supplementing the underlying finance agreement. Where the trust and charge documents require the trustee to act on the note controlling party’s directions in relation to rights arising from that agreement, the trustee must implement a direction to exercise the option. Negative pledges must be construed in their contractual context and did not prevent an election made at the direction of the very parties whose consent the clauses required.

Fixed-Link Finance BV held Eurotunnel tier 3 junior debt as the principal asset supporting seven tranches of securitisation notes. Citibank NA was security trustee. MBIA Assurance SA, as note controlling party, guaranteed certain senior notes. QVT Financial LP held unenhanced junior notes.

Under a French court-approved Safeguard Plan, the debt was replaced by rights to cash and hybrid notes, with a 15-day option to elect further cash rather than the hybrid notes. MBIA instructed Citibank to cause Fixed-Link Finance to exercise that option. Citibank sought directions because QVT objected.

Mann J declared that Citibank had power, and was obliged, to act on MBIA’s instruction: [2006] EWHC 3215 (Ch). QVT appealed. The central issues were whether the trustee could require exercise of the option before enforcement and whether MBIA’s direction bound the trustee.

1. Appeal dismissed. The Court upheld the declarations made by Mann J. Citibank had power to require Fixed-Link Finance to exercise the tier 3 cash option and was bound to do so on MBIA’s direction.

2. The ordinary expectation that a mortgagee will not intervene before enforcement unless the security is threatened can be varied by contract. Nelson v Hannam [1943] 1 Ch 59 showed that a mortgagee may exercise an option forming part of the security during the mortgage where the parties’ arrangements so provide. The controlling question was therefore the proper construction of the trust deed and deed of charge.

3. Clauses 4 and 8.1.3 of the deed of charge authorised Citibank to require Fixed-Link Finance to enforce rights under the Participation Documents. The Safeguard Plan was a document replacing or supplementing the Credit Agreement. Clause 8.1.3 therefore covered exercise of the cash option. Arden LJ rejected the wider proposition that the option could be exercised merely because it formed part of the charged property, but Dyson LJ considered that conclusion available.

4. Clause 12.2 and Schedule 4 of the trust deed also required Citibank to exercise Fixed-Link Finance’s rights in respect of the Financing Agreements in accordance with MBIA’s instructions. The right to elect cash was such a right. Clause 8.1 independently produced the same result.

5. The negative pledges did not apply where Fixed-Link Finance acted at the direction of Citibank and MBIA. Their purpose was to prevent transactions undertaken without those parties’ consent. In any event, Arden LJ’s alternative analysis was that the entitlement to hybrid notes was inherently defeasible on election for cash, so the election was not a disposal.

6. The direction regime did not offend the irreducible core of a trust. Citibank remained obliged to act in good faith and retained real discretionary functions in other respects.

• Court of Appeal (Civil Division): QVT’s appeal was dismissed: [2007] EWCA Civ 11.
• High Court, Chancery Division (Mann J): Declared that Citibank had power, and was obliged on MBIA’s instruction, to exercise or require exercise of the tier 3 cash option; the negative pledges did not require separate consent: [2006] EWHC 3215 (Ch).