Gemini (Eclipse 2006-3) Plc & Anor v Danske Bank AS & Anor

Contractual documents must be construed together to ascertain what a reasonable person, with the relevant background knowledge, would have understood the parties to mean. Where rival constructions are available, the court may test them against the other provisions and the commercial consequences, adopting the construction most consistent with business common sense. Clear subordination wording can make a debt contingent: an amount is not due and payable until funds remain after higher-ranking liabilities have been discharged. A facility drawing cannot be required by relying on the very liability whose due status depends on that drawing. Transaction documents governing a structured finance arrangement must therefore be read as an integrated scheme, with particular regard to the principal facility agreement and the agreed priorities of payment.

The claim concerned the proper construction of documentation governing a commercial mortgage-backed securities transaction. The liquidity facility provider claimed increased regulatory capital costs under the Liquidity Facility Agreement. The parties agreed that part of those costs was payable, but disputed whether the subordinated balance was due and payable on the relevant interest payment date.

The central issues were whether the subordination provisions made payment contingent on funds remaining after higher-ranking payments, and whether an Expenses Drawing had to be made in calculating those funds. The court determined the meaning and combined effect of the Liquidity Facility Agreement, the Cash Management Agreement and the Issuer Deed of Charge.

1. The claim was determined in favour of the Issuer and Cash Manager. The construction advanced by them was correct.

2. The court applied the contractual construction principles discussed in Investors Compensation Scheme Limited v West Bromwich Building Society [1998] 1 WLR 896 and Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900. The documents were to be construed by identifying the meaning which a reasonable person with the relevant background knowledge would have understood, testing rival meanings against the other provisions and their commercial consequences.

3. Clause 23(a) of the Liquidity Facility Agreement prevailed over other provisions of that agreement. Its words “if and to the extent that” created contingent debt subordination. Liquidity Subordinated Amounts, and other amounts caught by the clause, were not due and payable unless funds remained after all higher-priority payments under the Cash Management Agreement and Issuer Deed of Charge had been discharged.

4. The same conclusion followed from the waterfall in Schedule 1 to the Cash Management Agreement and clauses 7.4 and 20.1 of the Issuer Deed of Charge. The Liquidity Facility Provider had agreed not to demand or receive payment until higher-ranking creditors had been paid.

5. An Expenses Drawing could not be included in the available funds calculation where the drawing was said to be required only because the subordinated amount was payable. That would be a circular or “bootstraps” construction. The shortfall had to be assessed using funds already available before any such drawing. Otherwise the Expenses Drawing would be used primarily to pay higher-ranking noteholders, contrary to its contractual purpose.

6. The Liquidity Subordinated Amounts therefore remained unpaid and accrued interest until sufficient cash became available under the agreed priorities. The court accepted that this construction could make an Expenses Drawing for those amounts practically unnecessary, but held that this was the consequence of the parties’ chosen subordination scheme.