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

A contractual capital-disqualification clause must be interpreted in its commercial and regulatory context. A one-off stress test in which contingent convertible notes are not counted because the bank already has sufficient capital does not, without more, establish a continuing disqualification. The relevant question is whether regulatory change has caused the instruments to cease, in principle and with continuing effect, to perform their intended capital role in stress testing. The clause therefore referred to the ratio of top-grade loss-absorbing capital, as defined by the regulator from time to time, to risk-weighted assets. The notes remained relevant to assessing any capital shortfall and remedial measures after a stress-test failure. No capital disqualification event had occurred.

BNY Mellon Corporate Trustee Services Ltd, as trustee of 33 series of enhanced capital notes issued by LBG Capital No. 1 Plc and LBG Capital No. 2 Plc, sought a declaration concerning the issuers’ proposed early redemption of approximately £3.3 billion of notes.

The notes permitted redemption following a Capital Disqualification Event. The issuers relied on the fact that the Prudential Regulation Authority had not taken the notes into account in its December 2014 stress test, which used CET1 capital requirements. The central issue was the proper interpretation of the contractual definition of a Capital Disqualification Event and whether the December 2014 stress test satisfied it.

1. Declaration. A Capital Disqualification Event had not occurred. The issuers were therefore not entitled to redeem the enhanced capital notes on that basis.
2. The literal interpretation advanced by the trustee, under which any stress test using a definition differing from the 1 May 2009 definition of Core Tier 1 Capital would make the notes irredeemable, produced an extraordinary commercial result. The reference to the historic definition was apt for the conversion trigger, but inapt for the Capital Disqualification Event clause.
3. The second limb of the clause was interpreted purposively as referring to a stress test concerning the ratio of top-grade loss-absorbing capital, as defined from time to time by the regulator for stress-testing purposes, to risk-weighted assets. The words requiring the notes to cease to be taken into account connoted a disallowance in principle with continuing effect, rather than their omission from a particular test because the bank’s capital was already strong enough.
4. The December 2014 stress test did not produce that result. The notes were omitted because LBG remained above the relevant threshold without relying on them. They would nevertheless remain relevant, following any stress-test failure, to determining the extent of a capital shortfall and the remedial action required. The notes continued to be treated as converted if the hypothetical stressed ratio reached their conversion trigger, and there had been no regulatory change causing them to cease to count in stress tests.
5. The contractual provision was directed to regulatory change preventing the notes from fulfilling their intended role in stress testing. The declaration was accordingly granted in favour of the trustee.