LB Re Financing No. 3 Ltd v Excalibur Funding No.1 Plc & Ors

In construing complex commercial instruments, the court must identify the meaning conveyed to the reasonable audience in light of reasonably available background knowledge. Commercial absurdity may justify departing from apparently natural language, but perceived unfairness or one-sidedness is insufficient. Where genuinely alternative meanings exist, commercial common sense may assist in choosing between them.

An Inadequate Par Coverage default arose when the contractual ratio fell below 100 per cent on a Measurement Date. However, where the shortfall was certain on that date to be automatically cured by redemption three business days later, the default did not continue beyond the payment date.

The administrators of LB Re Financing No. 3 Ltd brought a Part 8 claim concerning the construction of Conditions in a securitisation Trust Deed. The claimant held the Class B Notes. The defendants included the issuer, the principal Class A Noteholder and the trustee.

The dispute concerned whether an Event of Default under Condition 10(a)(iv), based on Inadequate Par Coverage, had occurred on 25 January 2011 and remained continuing when the trustee served a Notice of Acceleration on 8 February 2011. The issues were matters of contractual construction, with no dispute of fact.

1. The court applied the ordinary principles of contractual construction. The relevant audience included persons considering purchasing or lending against the Class A Notes. The factual matrix was limited to background reasonably available to that audience, and the parties’ previous negotiations were excluded: ICS Limited v West Bromwich Building Society [1998] 1 WLR 896; Re Sigma Finance Corp [2009] UKSC 2.

2. Commercial absurdity can justify departure from apparently unambiguous language where the language cannot represent an intention the parties could have had. That principle must be distinguished from mere unfairness or one-sidedness. Commercial common sense may also help select between genuinely alternative meanings: Antaios Compania Naviera v Salen Rederierna AB [1985] AC 191; Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101; Ing Bank NV v Ros Roca [2011] EWCA Civ 353; Barclays Bank plc v HHY Luxembourg SARL [2010] EWCA Civ 1248.

3. The deliberate exclusion of Principal Account Balances from the Par Coverage Numerator was not commercially absurd. Those balances might be required for interest shortfalls, expenses or hedging liabilities rather than redemption. The drafting errors referring to “clauses (c)” and nonexistent provisos did not justify ignoring the entire parenthetical phrase. Nor could drafting history from earlier securitisations properly control construction.

4. An Event of Default occurred on 25 January 2011 because the Par Coverage Numerator, excluding the Principal Account Balances, was below 100 per cent of the Principal Amount Outstanding, which had not yet been reduced by the redemption payment.

5. The phrase “and is continuing” was sufficiently open-textured to permit a commercially realistic construction. Where the required calculations showed on the Measurement Date that the shortfall would automatically be cured by redemption three business days later, the default did not continue beyond the payment date. Accordingly, there was no continuing Event of Default on 8 February 2011 and the Notice of Acceleration was invalid.