Transaction documents may not give mezzanine lenders a de facto seat with seniors at the negotiating table.

A recent Commercial Court case examined the nature of the duties owed by a security trustee in an enforcement situation involving a syndicate of senior and mezzanine lenders.

In 2008, the Stabilus group was acquired by a private equity fund and the group assumed substantial indebtedness to various senior and mezzanine lenders, which entered into a typical form of inter-creditor agreement for a syndicated financing which, among other things, postponed and subordinated the claims of the mezzanine lenders to those of the senior lenders.

In April 2010, following financial difficulty, the senior facility agent (acting on the unanimous instructions of the senior lenders) issued an enforcement notice to itself, as security trustee, to transfer the business of the Stabilus Group to third parties.

The restructuring agreement essentially resulted in the mezzanine lenders being left without any significant assets and the senior lenders taking a 36% ‘haircut’. The mezzanine lenders claimed, among other things, that the security trustee owed fiduciary duties to them to avoid conflicts of interest between the lenders and to act in the interests of all the lenders, including the mezzanine lenders.

The court dismissed these claims and noted:

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– The duties owed by the security trustee to the mezzanine lenders were no greater than those of a mortgagee to a mortgagor and did not equate to fiduciary duties. Pursuant to the terms of the inter-creditor agreement, such duties were limited to:
– taking reasonable care to obtain the true market value of and/or the best price reasonably obtainable for the security at the time of the sale/disposal; and
– exercising the power of sale bona fide and for its proper purpose.

– The security trustee was not obliged to consider and act in the interests of all the lenders when deciding how and when to exercise the powers of enforcement of security. Indeed security could be released and a non-consensual restructuring of the Stabilus Group as instructed by the senior lenders effected, notwithstanding such actions resulted in a zero return for the mezzanine lenders.

– The inter-creditor agreement clearly stated the scope and nature of the security trustee’s duties in respect of enforcement of security. The general approach of the court in cases involving complicated financial transactional documents made between sophisticated parties is to give effect to the contractual terms agreed by such parties. Here the mezzanine lenders agreed:
– to subordinate their interests to those of the senior lenders; and
– the senior lenders had the right to control the timing and manner of enforcement, even though this may be detrimental to the interests of the junior lenders.

This shows the risk mezzanine lenders take in syndicated loans. The transaction documents may not give them a de facto seat at the table when it comes to enforcement/restructuring negotiations and the decisions taken by senior lenders depending on where the value of collateral sits at the time of enforcement.

Keith Wilson is a partner with Berwin Leighton Paisner’s asset finance department