A brave new world of noteholder litigation

Publication July 2016


Noteholder litigation in the context of Commercial Mortgage-Backed Securitisation (“CMBS”) transactions is nothing new, whether brought directly by noteholders or via the note trustee. However, there has been a recent spate of cases brought by CMBS Class X noteholders alleging a miscalculation of the interest due under their notes and claiming all historical underpayments of such interest. These holders have often purchased their instruments relatively recently and at distressed prices and, in many cases, the issue of construction before the court is one that had not previously been apparent to any participant in the structure. In some cases, the relevant events are also so old that a claim for breach of contract would be outside the relevant limitation period. But this limitation period does not apply since the ultimate remedy sought is a  declaration of an event of default.

The approach taken by junior noteholders follows a familiar pattern: First, they undertake a forensic analysis of offering circulars and other transaction documents in order to identify potential past errors by transaction parties which could be used as potential triggers for an event of default. Secondly, the noteholder seeks to compel the note trustee to call an event of default, which would cause the transaction to make payments under a post-enforcement waterfall (which is generally considerably more advantageous for the particular class of notes held by that noteholder). This process is  made possible in part because the offering circular and transaction documents are generally available for inspection at the offices of the issuer or note trustee.

Historical entitlements and standing

In the recent case of Hayfin Opal Luxco 3 SARL v Windermere VII CMBS Plc  [2016] EWHC 782 (Ch), the claimant (“Hayfin”), a holder of Class X notes in a CMBS, brought a claim against the issuer essentially alleging that there had been a miscalculation of the interest due under its notes and claiming all historical underpayments of such interest. Hayfin ultimately lost the case but, had Hayfin been right, the underpayment of Class X interest (which Hayfin claimed accrued at the Class X Interest Rate) could have potentially amounted to several million euros.

Hayfin acquired its Class X notes in July 2015, and commenced proceedings five months later, in November 2015, claiming backdated interest to July 2007 (i.e. long before it had acquired the notes). Hayfin expressly stated that its ultimate objective was to trigger an event of default so that the post-enforcement waterfall would apply (under which payments of interest due under the Class X notes were near the top).

A threshold issue that arises in this context is one of standing. CMBS and similar structures typically contain a “no-action” clause against the issuer. This clause prevents any transaction party and any noteholder from instituting proceedings directly against the issuer for non-payment or any other breach of the transaction documents. The aim of this clause is to ensure that it is only the note trustee who may enforce the terms of the notes on behalf of all holders. Typically, these clauses state that a written direction must be given to enforce by a certain percentage by value of noteholders. Even then, the note trustee will usually have no obligation to act unless and until it is indemnified to its satisfaction.

In the Hayfin case, in view of the “no action” clause, the issuer initially challenged Hayfin’s right to bring the claim. In response, Hayfin argued that it had brought a claim seeking a declaration as to the operation of its rights under the notes rather than an action for the recovery of sums. An action for declaratory relief, Hayfin argued, fell outside the ambit of the “no action” clause. As the note trustee subsequently confirmed that it would bring an identical claim on Hayfin’s instructions, were Hayfin wrong on this point, the issuer agreed to not take the argument further and it was not therefore considered by the Court. However, the question of standing may arise in a more controversial form where the noteholder bringing a claim and the noteholders best placed to direct the note trustee have diverging economic interests.

Hayfin’s right to bring the claim was also challenged as it concerned a question of interpretation of an agreement to which neither Hayfin nor the note trustee was a party. Interestingly, Snowden J accepted that Hayfin’s claim could legitimately arise in this context albeit with the proviso that the effect of the judgment would not be binding on the parties to that agreement who were not also party to the litigation.

When does an event of default occur?

At the heart of these claims is an attempt to bring a structure into default and invoke the post-enforcement waterfall. Therefore, even if a noteholder can successfully establish a breach of the transaction documents, that breach has to be translated into an event of default - which is incapable of remedy - before the post-enforcement waterfall can be applied. Whether that effect can be achieved is, again, a matter of construction of the transaction documents.

In an important passage in Hayfin, Snowden J remarked that “The [terms and conditions of the Notes] provide an elaborate mechanism for the determination and publication of the amounts which will become due and payable on the Notes. Important consequences (such as the occurrence of events of default) attach to timely and precise compliance with payment obligations under the Notes, and hence it is consistent with the overall CMBS structure that the payment obligations of the Issuer in respect of the Notes should be defined by those determinations”.

While the Court ultimately found against Hayfin on the point of whether there had been a miscalculation and underpayment of Class X interest, it nevertheless ruled that, even if Hayfin had been correct, this would not have constituted an event of default. Hayfin had argued that, if there had been an underpayment on the October 2015 Interest Payment Date, the five day “cure” period would already have expired and so it would be too late for the event of default to be cured. The Court disagreed. Snowden J took a step back to consider the purpose of a CMBS structure as a whole and expressed that he could not see why the parties would have intended to create a concealed “hair trigger” under which an event of default could accidentally occur because of a simple miscalculation of interest payable, not noticed at the relevant time and yet incapable of cure at a later date, no matter how solvent the structure still was.

The Courts are not necessarily reluctant to declare that an event of default has occurred in the right circumstances. In another recent case, Citicorp Trustee Company Limited v Taberna Europe CDO II Plc [2016] EWHC 781 (Ch), in which judgment was handed down on the same day as Hayfin, the Court granted summary judgment on a claim by a senior noteholder that, on construction of the transaction documents, the issuer had breached its obligations thereunder; and, once it had been given notice of such breaches, the noteholder was entitled to accelerate payment of the notes because an event of default had occurred.  


The penalty doctrine briefly reared its head in Hayfin on an alternative argument by the issuer that any Class X interest on miscalculations would have been a penalty (the Class X interest rate would have been several thousand per cent). In considering this question, Snowden J applied the principles recently set down by the Supreme Court in Cavendish Square Holdings B.V. v El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67.

According to Cavendish Square, an obligation may be a penalty only if it is a secondary and not a primary obligation. Snowden J did not decide whether the accrual and payment of Class X interest in the event of an underpayment was properly categorised as a conditional primary or secondary obligation, although he considered the point was certainly arguable. Moreover, he did state that the Class X rate was potentially so exorbitant that it could have been out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. There is a reasonable chance, therefore, that, had the judge been compelled to decide the point, he would have ruled that the applicability of Class X interest to any historical underpayments of interest would have amounted to a penalty. This will be of note to transaction parties and those drafting the corresponding transaction documents.


Hayfin has provided some answers on the specific facts as to the court’s approach to claims brought by the most junior noteholders alleging miscalculation of the interest due under its notes and claiming all historical underpayments of such interest. However, the decision has been appealed (permission to appeal having been granted) and Hayfin has applied for that appeal to be heard on an expedited basis. In a very similar case (Titan Europe 2006-1 P.L.C, Titan Europe 2006-2 P.L.C. Cornerstone Titan 2007-1 P.L.C, and Titan Europe 2007-2 Limited) the court also concluded that there had been no miscalculation of Class X interest (albeit the issues and the wording of the contract were slightly different) and permission to appeal was refused by the trial Judge (although it can still be sought from the Court of Appeal). It remains to be seen as to whether these decisions will act as a deterrent for noteholders from pursuing further similar litigation.

It is heartening that the Courts are paying close attention to the mechanics and purpose of the transaction as a whole when applying principles of contractual construction. This recognises the important distinctions between cases involving traded financial instruments with the corresponding complex documentation and those that involve bilateral contracts. The commercial purpose of these transactions remains an important line of defence in these claims.

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