BNY Mellon Corporate Trustee Services Ltd v LBG Capital No 1 Plc and another
| Jurisdiction | England & Wales |
| Judge | Lord Sumption,Lord Mance,Lord Toulson,Lord Clarke,Lord Neuberger |
| Judgment Date | 16 June 2016 |
| Neutral Citation | [2016] UKSC 29 |
| Date | 16 June 2016 |
| Court | Supreme Court |
[2016] UKSC 29
Lord Neuberger, President
Lord Mance
Lord Clarke
Lord Sumption
Lord Toulson
Appellant
Robin Dicker QC Stephen Robins
(Instructed by Allen & Overy LLP)
Respondents
Mark Howard QC Robert Miles QC Andrew De Mestre Gregory Denton-Cox
(Instructed by Norton Rose Fulbright LLP)
Heard on 21 March 2016
(with whom Lord Mance and Lord Toulson agree)
The issue in this case is whether Lloyds Banking Group ("LBG") is entitled to redeem £3.3 billion of loan notes which would otherwise carry a relatively high rate of interest, namely over 10% per annum. The loan notes are contingent convertible securities (perhaps inevitably known as "Cocos"), and are formally described as enhanced capital notes, or the ECNs. The ECNs are potentially convertible into fully paid up shares in LBG, and they were issued in November 2009, at a time when LBG, like many other banks, was in dire need of recapitalisation in order to protect its capital position and to comply with regulatory requirements.
Before turning to the terms on which the ECNs were issued, it is necessary to understand a little about the Regulations as at that time, and, in order to understand the issues on this appeal, it is necessary to set out some of those terms and then explain a few of the changes effected to the Regulations in 2013 and the way in which they were applied.
As at the time that the ECNs were issued, the capital requirements of financial institutions in the EU were governed by a 2006 Directive known as CRD I. This Directive was inevitably based on the current international banking accord, at that time the so-called Basel II. The relevant regulatory authority in the United Kingdom at the time was the Financial Services Authority, the FSA.
Under CRD I, the capital of financial institutions was arranged in tiers. The highest tier of capital was Core Tier 1, known as CT1; the next tier was divided into Upper Tier 2 Capital and Lower Tier 2 Capital. CT1 included, inter alia, paid up shares and retained earnings. Lower Tier 2 Capital included dated subordinated debt. The FSA's practice was to require a financial institution to maintain a minimum ratio of CT1 assets and in addition to pass certain "stress tests", which involved subjecting the bank's balance sheet to hypothetical challenging market situations.
In November 2008, the FSA issued a Statement which described a "Capital Framework" which it intended to apply to all financial institutions. The November 2008 Statement explained that the FSA "used as common benchmarks within this framework ratios of capital to risk weighted assets of total Tier 1 Capital of at least 8% and Core Tier 1 Capital, as defined by the FSA, of at least 4% after the stressed scenario". The November 2008 Statement also stated that the FSA "will be addressing the longer term capital regime for deposit takers in a discussion paper in the first quarter of 2009, the expectation being that this document will form part of the wider review of the global regulatory environment, which the FSA along with the other regulatory authorities, will be participating in".
From time to time, the FSA issued further Statements and Guidance. Thus, in May 2009, it issued a Statement indicating that it had "[g]reatly increased the use of stress tests as an integral element of our ongoing supervisory approach". The May 2009 Statement also stated that the FSA "expected UK banks to maintain Core Tier 1 Capital, as defined by the FSA, of at least 4% of Risk Weighted Assets after applying an FSA defined stress test". The Statement added that "[t]his current framework will remain in place until the Basel accord, which is implemented through EU capital requirement directives, has been modified to reflect the lessons learned from recent events". The May 2009 Statement also explained that the stress tests "look forward over five years but with greater detail over the first three" and that the tests "are used to identify if at any time in the next five years there is a danger that under the stress scenario the level of capital will fall below the 4% Core Tier 1 minimum".
In September 2009, in response to transitional legislation issued by the EU to control the use by financial institutions of hybrid securities as capital, the FSA issued another Statement making it "clear that the FSA will work to ensure the timing of the introduction of a new long-term capital regime …". The September 2009 Statement also stated that "hybrid capital instruments must be capable of supporting Core Tier 1 by means of a conversion or write-down mechanism at an appropriate trigger. Instruments with these characteristics could be seen as a form of contingent Core Tier 1 Capital".
Meanwhile, in March 2009, the FSA had stress-tested LBG, and had found that it had a shortfall in its CT1 Capital, in the light of the 4% minimum requirement referred to in the November 2008 Statement. As a result, the FSA required LBG to demonstrate that it had raised at least £21 billion which could qualify as CT1 Capital. After considering alternative options, LBG decided to raise £13.5 billion by issuing new fully paid-up shares through a rights issue, and £8.3 billion through the medium of the ECNs, to be issued in exchange for existing securities. These ECNs were intended to be Cocos which would satisfy what was said in the passage in the September 2009 Statement quoted at the end of para 7 above.
This decision was duly implemented. The terms of the £8.3 billion ECNs were described in a so-called Exchange Offer Memorandum. The exchange invited in that Memorandum was taken up, and the ECNs were issued and subscribed in a number of different series in December 2009.
The ECNs were loan notes whose terms were contained in a Trust Deed, which included in Schedule 4 detailed Terms and Conditions ("T&Cs"). In very broad terms, the ECNs (i) carried interest at varying rates depending on the series, but averaging about 10.33% per annum, (ii) subject to points (iii) and (iv), were redeemable only at certain specified dates under clause 8(a) of the T&Cs, which, depending on the series, varied between 2019 and 2032, but (iii) could be redeemed early by LBG, albeit only on a so-called "Capital Disqualification Event" under clauses 8(e) and 19 of the T&Cs, and (iv) were in the meantime potentially convertible into paid up shares in certain specified circumstances described in clause 7(a) of the T&Cs.
Clause 7 of the T&Cs was concerned with "Conversion" of the ECNs. Clause 7(a) was headed "Conversion upon Conversion Trigger", and clause 7(a)(i) provided that "[i]f the Conversion Trigger occurs at any time, each ECN shall … be converted … into … Ordinary Shares credited as fully paid". The "Conversion Trigger" was defined as occurring at any time when "LBG's Consolidated [CT1] Ratio is less than 5 per cent". The 5% figure was 1% above the minimum 4% ratio required at the time by the FSA, as explained in the Statements cited in paras 5 and 6 above. The remainder of clause 7 was concerned with consequential machinery.
Clause 8 of the T&Cs was headed "Redemption and Purchase". Clause 8(a) provided for the ECNs to be redeemed on the relevant "Maturity Date" (which was a date which varied between 2019 and 2032 depending on the particular series of the ECN) "[u]nless previously converted, redeemed or purchased and cancelled as provided in these Conditions". Clause 8(e) provided that "[i]f … a Capital Disqualification Event has occurred and is continuing, then [LBG] may … redeem … all, but not some only, of the ECNs at [a specified price]".
Clause 19 of the T&Cs was headed "Definitions". It provided that "a 'Capital Disqualification Event' is deemed to have occurred":
"(1) if at any time LBG … is required under Regulatory Capital Requirements to have regulatory capital, the ECNs would no longer be eligible to qualify in whole or in part (save where such non-qualification is only as a result of any applicable limitation on the amount of such capital) for inclusion in the Lower Tier 2 Capital of LBG … on a consolidated basis; or
(2) if as a result of any changes to the Regulatory Capital Requirements or any change in the interpretation or application thereof by the FSA, the ECNs shall cease to be taken into account in whole or in part (save where this is only as a result of any applicable limitation on the amount that may be so taken into account) for the purposes of any 'stress test' applied by the FSA in respect of the Consolidated Core Tier 1 Ratio."
Certain other definitions in clause 19 of the T&Cs are also of some relevance. "Core Tier 1 Capital" was defined as "core tier one capital as defined by the FSA as in effect and applied (as supplemented by any published statement or guidance given by the FSA) as at 1 May 2009". "Tier 1 Capital" and "Lower Tier 2 Capital" were each defined as having the "meaning given to it by the FSA from time to time". "Regulatory Capital Requirements" was defined as meaning "any applicable requirement specified by the FSA in relation to minimum margin of solvency or minimum capital resources or capital". The "FSA" was defined elsewhere in the Trust Deed as including any "governmental authority in the United Kingdom … having primary supervisory authority with respect to LBG".
The effect of this arrangement was that (a) the ECNs counted as Lower Tier 2 Capital so long as they were neither redeemed under clause 8 nor converted under clause 7, and (b) if the ECNs were converted under clause 7 they would count towards the CT1 Capital. That is because, as explained in para 4...
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