I'm afraid to say that the economic outlook for borrowers and lenders alike looks rather bleak at the present time.
The Bank of England has an inflation rate target of 2% per annum, whereas inflation currently sits at 10% to 12% per annum (depending on which index one prefers). That is not sustainable - the Bank of England Bank Rate will have to go up further still, having increased already by 175 basis points to 2.25% since February 2022. Indeed, markets are pricing-in a Bank Rate of 6% by next year. In the meantime, the price of just about everything is going up (including, most importantly, energy costs, albeit subject to the UK Government's Energy Price Guarantee). There is also the war in Ukraine and ongoing international supply chain issues to factor-in to the equation. And all of this as economies endeavour to reawaken and recover from Covid-19 pandemic lockdowns whilst, from a UK perspective, GBP is tanking in international FX markets, increasing the cost of imports for UK businesses.
Many borrowers will find their ongoing liquidity under serious pressure in these circumstances. Suppliers will increase prices whilst borrowing costs rise to reflect underlying lender cost of funds. It's not difficult to envisage non-payment and financial covenant breach defaults following-on in a great many cases. Many lenders will have difficult decisions to make as to whether to accelerate and bring enforcement action or provide ongoing forbearance to their borrowers (and if so, for how long).
It is difficult to say whether this will give rise to an increase in corporate insolvencies and restructurings in the UK. Whilst logic might suggest that this would be an inevitable consequence of the circumstances specified above, on the other hand, we've been in similar territory before - specifically at the outset of the Covid-19 lockdown when many commentators predicted an economic firestorm for UK corporates. Back then, massive UK Government financial and legal intervention staved-off the corporate insolvencies which would almost inevitably otherwise have followed. And it may well be the case that this trend repeats itself on this occasion (see, for example, the UK Government's Energy Price Guarantee referred to above). However, it's difficult to see financial markets supporting the levels of public borrowing that would be necessary to provide the UK Government with the financial means required in order to ameliorate this "perfect storm" of economic headwinds, and quantitative easing would not appear to be an option either since this would likely stoke inflation still further. Indeed, financial markets have taken an exceedingly dim view of the UK's fiscal and monetary policies appearing to be pulling in opposite directions, causing the value of Sterling to plummet and UK gilt yields to rise (the latter of which prompted the Bank of England to stage an enormous intervention into gilt markets buying-up excess supply which institutional investors were dumping). Combined with an almighty political backlash, this has forced the new Chancellor of the Exchequer to perform a screeching "u-turn" on the flagship policy of his "mini-budget", being the abolition of the 45p top rate of income tax. These are almost unprecedented circumstances.
So, on balance, I suspect that we may very well see an uptick in UK corporate insolvencies over the course of the next 6 to 18 months.
In these circumstances, the law pertaining to enforcement of creditor's rights will come into sharp focus, as lenders and borrowers each look to protect their positions. The recent case of Lombard North Central plc v European Skyjets Limited (in liquidation)  EWHC 728 (QB) is perhaps therefore timely since it involves the enforcement of an aircraft mortgage in contentious circumstances in which the aircraft owner brought several challenges to the conduct of the enforcing secured creditor.
The facts of the case are convoluted and the judgment of Mr Justice Foxton is lengthy. Skyjets threw everything they could by way of legal challenge at the enforcement actions of Lombard in an attempt to counter-claim for damages for the losses it alleged it suffered as a result. The case is therefore a cornucopia of legal principles involved in the acceleration and enforcement of secured debt facilities. However, a comprehensive analysis of the case would result in something approaching a post-graduate degree thesis, and so this piece is intended only as a high-level exploration of some of the most interesting "take-aways" from the case as I see them.
Facts of the Case
The Lombard Mortgage
The case involved a financing arrangement concluded in 2008 for the acquisition of a Learjet aircraft (the "Aircraft") by Skyjets from Learjet Inc. The financing comprised a US$ 8.771mn loan provided by Lombard secured by an aircraft mortgage on the Aircraft. The Skyjets business was organised into what one might describe as an "opco / propco" structure in which Skyjets owned the Aircraft, and an affiliated company, Skytime, offered private jet charter services which the Aircraft was utilised to fulfil.
The Asset Maintenance Plan
The Aircraft was subject to an ongoing servicing and maintenance arrangement as required by UK Civil Aviation Authority rules, but Skyjets terminated this servicing arrangement with effect from November 2009, which Lombard alleged gave rise to a misrepresentation under the terms of its loan agreement.
The Non-payment Defaults
There then followed a number of payment defaults throughout 2009, 2010 and 2011 which gave rise to Lombard applying default interest on unpaid sums at a default rate of contractual interest + 5% (as it was contractually entitled to do) and also demanding payment of a "default fee" of 15% on all arrears (as it was not contractually entitled to do). Not surprisingly, Skyjets objected to the imposition of the 15% "default fee".
The Change of Control
In 2012, a new investor - Danesmoor Group - acquired a 50% stake in Skytime. Skyjets represented to Lombard that the monies from the equity injection would be partly retained in the Skyjets group and partly applied in payment of outstanding sums due under the Lombard Mortgage. The numbers talked about in terms of the equity injection fluctuated from £2.25mn to £650k, but in any event none of the money was seen by Lombard and it was instead paid out to other equity holders. This despite the fact that the transaction gave rise to a "change of control" mandatory prepayment event under the Lombard Mortgage.
The Asset Cover Percentage
There were also issues with an asset cover percentage clause in the Lombard Mortgage, under which, if the value of the Aircraft fell to less than 133% of the outstanding balance of the loan (the "ACP"), then Lombard could call for the loan to be prepaid so that the ACP was brought into compliance (i.e. ≥133%). The Aircraft fell in value triggering the ACP clause, which gave rise to Lombard calling for prepayment or additional collateral, but this demand was not complied with by Skyjets. Lombard's view was that this gave rise to an additional non-payment event of default.
The Appointment of Duff & Phelps
Given the above circumstances, Lombard appointed Duff & Phelps as independent accountants to assess the viability of Skyjets' business. After some difficulties in obtaining relevant information and delay in agreeing their fees (which Skyjets was responsible for), Duff & Phelps produced an interim update to Lombard in which they opined that:
"[Skyjets was] not in a position to repay its debts as and when they fall due and is insolvent on a cash flow basis."
It appears that at this stage Lombard resolved to terminate the loan agreement and bring enforcement action under the Lombard Mortgage against the Aircraft.
The Termination Notice
In November 2012, representatives of Lombard, Skyjets and Danesmoor met to discuss matters further. At that meeting, the Lombard representative served a termination notice on Skyjets, the broad terms of which were as follows:
- That Skyjets was in arrears in a sum of circa US$ 294.3k.
- That accordingly there was a non-payment Event of Default giving rise to Lombard having the right to terminate the loan agreement and demand payment of all sums due thereunder.
- That the loan was therefore accelerated and a sum due for immediate payment of circa US$ 5.8mn was demanded.
- That the Lombard Mortgage had become enforceable and that therefore Lombard was exercising its powers thereunder to take possession of the Aircraft and exercise a power of sale thereover via its appointed agents of sale.
The Sale of the Aircraft
Thereafter, and following a lengthy marketing process, the Aircraft was sold by Lombard's sale agents, Colibri, for around US$ 3.3mn, leaving an unsecured balance outstanding of circa US$ 3.5mn.
Lombard therefore brought proceedings for recovery from Skyjets (now in liquidation) of the outstanding balance of the Lombard Mortgage.
Skyjets defended the action by arguing that Lombard had no entitlement to terminate the loan agreement or enforce the Lombard Mortgage to sell the Aircraft, that in any event Lombard had breached its duties as mortgagee when selling the Aircraft; and Skyjets therefore counterclaimed for damages in the sum of £26mn for breach of contract and/or conversion.
The Issues in Contention
As I mentioned above, the judgment is lengthy and Skyjets brought an enormous number of legal challenges to Lombard's conduct of the enforcement action. I don't propose to cover each and every one of those challenges in this article, but will instead focus on those which I believe to be the most important or interesting. Specific commentary is set out in separate boxes for those who wish to "speed read"!
Was Lombard entitled to rely on a non-payment Event of Default?
It wasn't in dispute that there had been a number of failures to pay under the terms of the loan agreement in respect of scheduled principal repayments and interest. However, Skyjets brought two arguments that this Event of Default could not be relied upon by Lombard:
1. The Event of Default relied upon had to be "continuing"
Skyjets argued that the Event of Default had to be continuing at the time the notice of termination was served. Foxton J held that it was not necessary that an Event of Default be continuing in this specific case, and this was based on a literal interpretation of the acceleration clause in the loan agreement, which stated expressly that Lombard may terminate and accelerate payment "[a]t any time after the occurrence of an Event of Default."
Nevertheless, Skyjets argued that equity dictated that a requirement that the Event of Default relied upon should be continuing at the point of notice should be implied into the contract by the court. Foxton J analysed the case law (including the judgment of Lord Wilberforce in Empresa Cubana de Fletes v Lagonisi Shipping Co Ltd (The Georgios C)  1 QB 488) and held that no such term could be implied into the contract.
This aspect of the judgment shows the crucial importance for borrowers of ensuring that the acceleration and enforcement clauses in loan and security documents are drafted in line with Loan Market Association ("LMA") terms to include the optional "continuing" language as follows:
"On and at any time after the occurrence of an Event of Default [which is continuing], the Agent may……"
It is also important to ensure that the LMA interpretative provision which deals with the meaning of the word "continuing" in the context of an Event of Default is carefully drafted to ensure that Events of Default can be remedied or waived in order to no longer be continuing. If Events of Default can only be waived and if an express or implied waiver cannot be established, then the simple fact is that any objective remedy will not stay the lender's hand. It may proceed to accelerate and enforce regardless.
2. The non-payment Events of Default had been waived by the conduct of Lombard
There was a great deal of dispute as to whether sums that Lombard had charged were actually due and payable. Lombard had sent a number of statements of account which were in fact inaccurate, and there was an enormous dispute as to whether Lombard was entitled to charge the 15% "default fee". There was a degree of obfuscation from Lombard on that latter point, largely because there was no contractual entitlement to charge the "default fee" under the terms of the loan agreement and it was being used as a means through which to encourage Skyjets to make payment of the arrears of principal and interest.
It seems the "default fee" payments were later put on to a stronger contractual footing when Lombard wrote to Skyjets saying that, as a condition of its ongoing forbearance, a "default fee" would be charged on future unpaid sums.
Nevertheless, the net effect of all of this was that, if there had been an outstanding balance due from Skyjets to Lombard on the date of delivery of the Termination Notice, then that balance was US$ 179.99 and not circa US$ 294,300 as stated in the Termination Notice.
Further, on 10 October 2022 Lombard wrote by email to Skyjets acknowledging receipt of further payments on account of arrears in the sum of around £165.6k, but noting that there remained an outstanding balance of circa US$ 154.7k. The email went on to state that "… as a gesture of goodwill we will allow more time to bring the balance of arrears up to date", before stating that the next payment instalment fell due on 28 October 2012. Skyjets argued, and Foxton J agreed with them in the judgment, that this correspondence constituted a waiver of the right to accelerate and enforce based upon the non-payment defaults to date and made clear that it was the position post-28 October 2012 that was relevant to whether acceleration and enforcement action could be taken thereafter.
In response to this, Lombard pointed to the standard "no waivers" clause in its Loan Agreement and also the reservation of rights language it included in the email sent on 10 October 2012 and in other correspondence with Skyjets.
The "no waivers" clause was in fairly typical form and was in the following terms:
“No failure and no delay in exercising on the part of the Lender …. of any right, power or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power or privilege preclude the further exercise of such one or any other right, power or privilege whether hereunder or otherwise”.
Foxton J held that the clause was not applicable here because there had not been a failure or a delay on the part of Lombard in terms of exercising any rights or powers. Instead, Lombard had taken a positive step to extend more time for payment and in so doing waive its entitlement to rely on the existing non-payment defaults at least until 28 October 2012.
The reservation of rights language in the 10 October email was in the following terms:
"This correspondence is without prejudice and Lombard fully reserves its rights in respect of the identified breaches being arrears on the Loan Agreement and an insufficient Asset Cover ratio”.
On a first glance, this does appear to make clear that rights arising due to arrears of payments are not prejudiced and are reserved by Lombard. However, Foxton J held as follows (my emphasis):
"I do not accept, however, that the ritual incantation of this language can prevent anything said or done in the preceding letter from having its objective effect. I considered a similar issue in SK Shipping Europe Plc v Capital VLCC 3 Corp  EWHC 3448 (Comm), -, and concluded that it was not invariably the case that acting under a reservation of rights would prevent an affirmatory act (and I am satisfied that this is also the case for waiver, which is also a species of election)."
Accordingly, the 10 October 2012 email was held to take effect as a waiver of entitlement to rely on any pre-existing non-payment Event of Default at least until 28 October 2012.
Where all of this left Lombard was that, in order to establish it had a non-payment Event of Default to rely upon, it had to prove that it was owed the sum of US$ 179.99 by Skyjets. The difficulty Lombard had was that its account systems and ledgers were not clear on what payments were actually due and what payments had been received. Foxton J held that the burden of proof fell on Lombard to establish that the sum of US$ 179.99 was due and payable and that it had failed to do so. Accordingly, there was no non-payment Event of Default on which Lombard could rely.
Lenders should really sit-up and take notice of this aspect of the judgment. Non-payment defaults are generally considered to be a "slam dunk" in terms of allowing lenders to move to acceleration and enforcement, being objectively verifiable and a clear indicator that the borrower is not able to service its debt liabilities. It is not at all unusual for lenders to give forbearance to allow borrowers more time to pay, but lenders need to be extremely careful in the language they use and the approach they take in this regard.
The judge's use of the phrase "ritual incantation" of reservation of rights language amused me since lawyers regularly add such language to correspondence in restructuring and workout scenarios and I have often wondered about the extent to which it actually worked. It seems clear following this judgment that this language will not operate to obviate an affirmatory act such as an express or implied waiver of acceleration or enforcement rights. As always, the devil is in the detail and legal advice should be taken at an early stage in order to avoid missteps which can be attacked in the future.
The importance of keeping accurate and up to date ledgers and accounts is also highlighted here. Foxton J held that, if Lombard had been able to establish that the relatively de minimis sum of US$ 179.99 had in fact been due and payable to it, then the fact that it was such a trifling sum which Skyjets could easily have paid had it been aware of it was irrelevant. Lombard could still have relied upon the non-payment of this de minimis amount by Skyjets to accelerate and enforce.
Had Lombard established a "material adverse change" Event of Default?
Lombard's failure to establish a non-payment default meant that it had to rely on the other Event of Default provisions in the loan agreement. Lombard was able to establish that the following Events of Default had in fact occurred:
- A misrepresentation default had occurred since Skyjets had terminated the Maintenance Agreement in place in respect of the Aircraft whereas it did not disclose this to Lombard and went on to represent in the warranties clause in the Loan Agreement that the Maintenance Agreement was in full force and effect.
- That there had been a material adverse change such that the applicable MAC provision in the Events of Default clause had been triggered.
It is this latter MAC Event of Default that I find most interesting. The MAC clause was in the following terms (my emphasis):
"[There shall be a default if]… in the opinion of the Lender, a material adverse change occurs in the business, assets, condition, operations or prospects of any Group Company or any Credit Support Provider."
It will be seen that a contractual discretion is given to Lombard in this clause in the sense that the question of whether a MAC has occurred or not fell to be determined by Lombard. The MAC clause was therefore similar in terms to that at issue in the leading case on such clauses, being Cukurova Finance International Ltd v Alfa Telecom Turkey Ltd  AC 923. Following that case, all that Lombard had to establish in this case was that it formed the requisite opinion that a MAC had occurred (and that this opinion was honest and rational). Specifically, there was no requirement for Lombard to establish objectively that the event or circumstance relied upon had actually had an adverse effect. The result is that the decision is an entirely subjective one, tempered only by so-called Wednesbury standards of unreasonableness (as apply in respect of public sector decisions per Associated Provincial Picture Houses Ltd. v Wednesbury Corporation  1 KB 223) and as have been held to apply to commercial contracts under cases such as Socimer International Bank Ltd v Standard Bank London Ltd  EWCA Civ 116 and Braganza v BP Shipping  UKSC 17.
In other words, the decision must be honest and rational, but otherwise there is no good faith requirement or requirement to act reasonably in making the determination.
Foxton J was satisfied that Lombard had reached an honest and rational conclusion that a material adverse change had occurred. He need not have gone any further for the Event of Default to have been established, but he did in any event opine that the decision reached in this regard was reasonable given the obvious deterioration in Skyjets' business.
There is no doubt that Foxton J's decision here was correct and in line with the case law. The result is that, where a MAC clause is drafted as set out above (i.e. it is to be determined "in the opinion of the lender") then the lender becomes, in effect, the judge and jury in its own cause with only very basic legal protections afforded to borrowers in respect of the honesty and rationality of the decision.
Properly advised borrowers should not allow MAC clauses to be drafted in this manner. It is in my view vital that they seek at least one of the following revisals:
A. "[There shall be a default if]…
in the opinion of the Lender, a material adverse change occurs …….."
B. "[There shall be a default if]… in the reasonable opinion of the Lender, a material adverse change occurs ……..."
Option A is the gold standard for borrowers and will result in the MAC determination being an entirely objective one such that the court becomes the ultimate arbiter of whether a MAC has in fact occurred and the burden of proof lies on the lender and is very onerous - see, for example, Grupo Hotelero Urvasco SA v Carey Value Added SL  EWHC 1039 (Comm).
For that reason, lenders will resist Option A, but borrowers should try to compromise at least to the Option B language. This introduces a degree of objectivity to the analysis in the sense that the lender is required to form a reasonable opinion, and the ultimate arbiter of whether the opinion is reasonable will be the court.
Must Lombard be in good faith when exercising its right to accelerate and enforce?
So, Lombard successfully founded Events of Default based on a misrepresentation and a material adverse change. Having done so, was it tempered by any requirement to act in good faith when exercising its acceleration and enforcement rights, as alleged by Skyjets? Or put another way, was the decision to enforce subject to so-called "Braganza duties" per the Braganza case referred to above. Were that to be the case, then if the decision to enforce was capricious or so unreasonable that no reasonable person would have proceeded in that manner, then the court could strike it down and damages claims would follow for unlawful enforcement.
Foxton J pointed out that a termination / acceleration right falls to be considered as an "absolute contractual right" and it is not therefore subject to any Braganza duties. There was therefore no requirement for Lombard to be in good faith in this regard.
Again, there is no doubt that Foxton J's decision in this regard was correct. To have held otherwise and to have introduced Braganza duties to termination and acceleration rights would have created a large degree of uncertainty in markets with enforcing parties being at risk of their actions being held unlawful by a court possibly after many years of litigation.
There is a "floodgates" angle to this as well in the sense that many borrowers who have been subjected to enforcement action on their mortgaged assets would bring legal challenges based on a perceived lack of good faith, which would ultimately cause enormous disruption in markets.
Was the Termination Notice defective due to its inaccuracies?
Skyjets sought to attack the viability of the Termination Notice on a number of grounds, including the following:
- That the sum specified as being overdue for payment therein was inaccurate and inflated since it was for circa US$ 294,300 whereas, if any payment was overdue, then it was for a sum of only US$ 179.99. Foxton J held that an error in the overdue sum did not vitiate the notice, and in so doing relied on the Australian case of Bunbury Foods Pty Ltd v National Bank of Australasia (1984) 51 ALR 609 as followed in English cases such as Tridos Bank v Dobbs  EWHC 845 (Ch).
- Alternatively, Skyjets argued the Termination Notice was invalid because it (a) erroneously stated that a non-payment Event of Default was outstanding, and (b) did not thereafter accurately state the Events of Default which had occurred upon which Lombard could have relied (in this case being the misrepresentation and MAC Events of Default). Foxton J held that it was not necessary for the Termination Notice to accurately state the Event of Default upon which Lombard was relying, but this appears to be as a result of a specific clause in the loan agreement which provided that all that was required for a termination notice to be validly served was that it was served after the occurrence of an Event of Default and that it expressly cancelled the facility and accelerated payment of the loan. It was therefore unnecessary for Lombard to set out accurately the Events of Default upon which it relied in the Termination Notice.
The decision in this respect cannot be regarded as establishing a general rule that it is not necessary to accurately state the Event of Default which is relied upon in a default or termination notice. Standard practice amongst finance lawyers is to narrate the Events of Default relied upon at length and this remains good practice. The decision reached by Foxton J does appear to have been predicated on the specific terms of the loan agreement. What is clear, however, is the importance that all applicable contractual terms are analysed and considered when serving demand / termination notices. Mistakes may not be fatal, but it is obviously better that the notice is entirely accurate and establishes a clear contractual basis for taking the acceleration, termination or enforcement action.
Did Lombard satisfy its duties as a secured creditor when disposing of the Aircraft?
When a mortgagee is exercising a power of sale in respect of a mortgaged asset, it owes the mortgagor an equitable duty to obtain the best price reasonably obtainable. This involves the exercise of an informed judgment and, provided the mortgagee goes about the exercise of this judgment in a reasonable way, then there will be no breach of duty. See: Silven Properties v Royal Bank of Scotland  1 WLR 997 and Cuckmere Brick Co Ltd v Mutual Finance Ltd  Ch 949.
Skyjets claimed that Lombard had not handled the sales process in compliance with this duty, arguing that (amongst other things):
- Lombard should have stored the Aircraft in a cheaper location in order to save money and, had it been stored in the location preferred by Skyjets then there then would have been less risk of corrosion.
- Lombard delayed in appointing a sales agent.
- Lombard delayed in commissioning an external valuation.
- The appointed sales agent - Colibri - was inappropriate as it was a one person business and did not have significant contacts in the United States, which is the world's largest market for Learjet aircraft.
- Calibri should have advertised the Aircraft for sale in various aviation industry sales journals.
- The price eventually realised was too low.
None of these lines of attack were successful. Lombard had not dallied unduly and had acted appropriately in appointing a sales agent and commissioning valuations. The Aircraft was eventually sold under "mortgagee in possession" circumstances and after a significant time on the market. Ultimately, the price realised was not substantially at odds with market valuations given all the circumstances.
The importance of a properly held marketing and sales process backed-up by robust valuations comes into sharp relief here. Secured creditors must tread carefully when exercising powers of sale if the sale is not to be subsequently challenged.
I'm afraid this is a lengthy piece and I apologise for that. However, it remains only a cursory examination of the case and all the multitude of challenges brought by Skyjets. The punchline conclusion to be taken, as I see it, is that accelerating debt facilities and realising mortgaged assets is a fraught process which is subject to complex legal principles at almost every turn. There are many bear traps into which unsuspecting secured creditors may fall and which well advised borrowers might take advantage of.
The importance of sound legal advice in this context cannot be overstated.
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