LBG Capital No. 1 Plc & Anor v BNY Mellon Corporate Trustee Services Ltd

A contractual term may be corrected by interpretation where it is clear that the language has gone wrong and clear what a reasonable reader would understand the parties to have meant. That exercise must give effect to the instrument’s commercial purpose.

A capital-disqualification redemption condition was engaged where regulatory changes meant that contingent convertible notes could no longer assist the issuer to meet the relevant capital-ratio threshold in a regulatory stress test. The condition did not require an express regulatory disqualification. It was insufficient that the notes might remain relevant to a wider supervisory assessment or might convert only after the stress-test threshold had been breached.

The issuers appealed from the Chancellor’s decision in an expedited Part 8 claim, [2015] EWHC 1560 (Ch). The claim concerned their right to redeem enhanced capital notes before maturity under the trust deed.

Redemption depended on a Capital Disqualification Event under condition 19. The notes converted into ordinary shares if the group’s fixed historic core tier 1 ratio fell below 5%. Following the move to a common equity tier 1 stress-test threshold, the contractual conversion trigger could not be reached before the new threshold was breached.

The Chancellor held that no event had occurred because the notes had not been disallowed in principle from stress testing. The central question was whether the notes had ceased to be taken into account for the purposes of the relevant stress test.

1. Appeal allowed. Gloster LJ, with whom Briggs and Sales LJJ agreed, held that a Capital Disqualification Event had occurred. The court granted a declaration that the issuers were entitled to redeem the notes in accordance with their terms.

2. The Trustee’s cross-appeal on the preliminary construction issue was dismissed. The reference in the redemption definition to the consolidated core tier 1 ratio incorporated a historic 2009 definition which was deliberately fixed for the separate conversion trigger. Its incorporation into the redemption condition was an obvious drafting error. A reasonable reader would understand the condition to refer dynamically to a stress test of the ratio between the regulator’s then highest-grade loss-absorbing capital and risk-weighted assets.

3. The second limb of condition 19 did not require a regulatory declaration that the notes were disqualified. Its language differed materially from the first limb, which concerned eligibility for lower tier 2 capital. The relevant question was whether the notes remained capable of helping the group meet the applicable stress-test capital-ratio threshold.

4. The change to the common equity tier 1 regime and its 4% and then 4.5% threshold placed the threshold above the notes’ contractual conversion trigger. The notes could therefore not assist the group to pass the December 2014 stress test, or foreseeable tests under that regime. Their possible relevance to a wider regulatory response did not mean that they were taken into account for the specified stress-test purpose.

5. The court rejected the issuers’ separate argument that a Capital Disqualification Event arose merely because regulatory requirements had strengthened the group’s actual capital position, so that conversion was not needed in that particular test. That was distinct from the successful ground: the regulatory change had made the notes incapable of assisting compliance with the relevant threshold.

Briggs LJ added that the decisive words were those tying the stress test to the relevant ratio. They showed that the notes had to assist in passing the test, rather than merely feature somewhere within it.

• Court of Appeal (Civil Division): Allowed the issuers’ appeal, dismissed the Trustee’s cross-appeal, and declared that a Capital Disqualification Event had occurred: [2015] EWCA Civ 1257.
• High Court, Chancery Division: The Chancellor held that no Capital Disqualification Event had occurred and that the issuers could not redeem the notes: [2015] EWHC 1560 (Ch).