• Rewards and Penalties in Bond Covenant Consent Solicitations Under English Law
  • August 21, 2012
  • Law Firm: Skadden Arps Slate Meagher Flom LLP - New York Office
  • Two recent cases decided in the English High Court provide contrasting views about rewards offered to holders who vote in favor of amendments to the terms of bonds or loan notes (we will refer to “loan notes” to cover both bonds and loan notes) and penalties imposed on those who vote against. These are the decisions of Mr. Justice Hamblen, in Sergio Barreiros Azevedo & Vera Cintia Alvarez v. (1) Imcopa Importacao, Exportaacao e Industria de Oleaos Ltda; (2) Imcopa International SA and (3) Imcopa International Cayman Limited [2012] EWHC 1849, and of Mr. Justice Briggs in Assénagon Asset Management S.A. v. Irish Bank Resolution Corporation Limited (formerly Anglo Irish Bank Corporation Limited) [2012] EWHC 2090. We will refer to these respectively as the Azevedo and the Anglo Irish cases.

    Both of these cases arose in the context of corporate restructurings and are of some importance in this context. In both cases a central issue is what rewards can be given to, or penalties inflicted on, noteholders who do not support a resolution proposed in relation to the restructuring or exchange of loan notes. Such arrangements are historically unusual in England (or indeed Europe generally), if common in the United States, although as Mr. Justice Briggs noted, they have become more common in Europe since 2008. It was interesting (and also unusual) to see both judges quoting U.S. cases as part of their judgments.


    Under English law, a loan note is a debt instrument of a company typically issued under a trust deed (which has some similarities to a U.S. style indenture). The trust deed normally provides that amendments (which normally includes compromises, arrangements and even cancellation) to the loan notes can be proposed by the company and, if approved by a specified majority of the noteholders (normally 75 percent), such amendments can be binding on all noteholders. Over the years the English courts have developed a principle that the power of a majority of the noteholders to so bind all the holders must be exercised bona fide and for the purpose of benefiting the class of noteholders to which they belong as a whole.

    This broad principle is challenged when a proposal is made that has elements which benefit not all noteholders, but only those who support the proposal in some way, or which penalizes those noteholders who do not support the proposal.


    In Azevedo, the judge had to consider whether payments made to noteholders who voted in favor of three resolutions proposed over 12 months as part of a restructuring of a company were illegal, invalid or ineffective under English law.

    The argument that the payments were illegal was that they were to be regarded as bribes to those who accepted the payments, or at least conferred a special personal advantage to such bondholders outside the proposals to be voted on at the bondholder meeting.

    Mr. Justice Hamblen had no difficulty in considering the payments were not bribes as they were openly provided and available to all bondholders. After quoting Kass v. Eastern Airlines Inc. [1986] WC 13008 (Del Ch), he went on to say that the payments were “consideration to those voting in return for their agreement to the consent solicitation.” He upheld the effectiveness of the resolutions. Insofar as the decision is contrasted with that in Anglo Irish it is worth stressing that the payments involved were relatively small.

    This was not in any way an unexpected decision. Most practitioners in the area would analyze the problem in the same way and agree with the judgment.

    Anglo Irish

    The same cannot be said about the decision in Anglo Irish which likely surprised many practitioners in the area.

    The Anglo Irish case arose out of the near collapse of the Irish banking system early in the global financial crisis. Anglo Irish Bank, a major Irish financial institution, was rescued by the Irish government and brought into state ownership. The Irish government believed that there was no or little value (or perhaps that there should be no or little value) in the debt of the Irish banks, and various write-downs were proposed. For Anglo Irish Bank, the proposal was to exchange the subordinated loan notes of a particular class for unsubordinated loan notes issued by the bank with a principal amount of 20 percent of the exchange notes, but critically with a guarantee by the Irish government. To incentivize holders to tender their notes into the exchange offer, those whose offers of loan notes were accepted were required to agree to vote in support of a resolution to amend the original notes (which of course would only be held by those who did not support the bank’s proposal) to allow the bank to redeem them at €0.01 per €1000 nominal. The resolution was duly carried.

    Assénagon did not tender its notes into the exchange offer. Its €17 million of notes were therefore liable to acquired for a nominal €170. Not surprisingly, it decided to take legal action to attack the validity of the resolution.

    One ground for the challenge was that the resolution was ultra vires (beyond the powers) of what could be achieved by a resolution. The judge found this difficult (he was persuaded by a “narrow margin”), but accepted that the express power in the trust deed to permit a resolution to authorize a reduction or cancellation of the principal payable on the notes was sufficient.

    The second challenge was against the validity of the votes of the noteholders who had accepted the exchange offer, on the grounds that on its acceptance of the notes tendered under the exchange offer, the notes were (as a matter of English law) beneficially owned by the bank and could not be voted under the trust deed. The judge accepted this view. This part of the case demonstrates that care needs to be taken in how such offers are structured in future, but does not demonstrate any fundamental conceptual problem with the approach adopted to exit consents.

    It follows that the judge’s analysis of the third point, that the exercise of the power of the majority at the loan note holders meeting was an abuse of their power and not in the interests of the holders of the loan notes as a whole, were dicta. Nonetheless, Mr. Justice Briggs is a well-regarded judge and it is likely that other judges will follow him on this point, at least pending the result of the anticipated appeal.

    It was obvious from the judgment that Mr. Justice Briggs was hostile to the whole concept of different outcomes for different holders of the notes of the same class (indeed his comment quoted above on the ultra vires point was odd, given the clear provisions of the trust deed). This may reflect the fact that he is a judge in the Chancery Division of the High Court (Mr. Justice Hamblen is in the Commercial Court). While there are no longer big divisions between the courts of equity and common law, it remains the case that judges in the former area sometimes have an advanced sense of “fairness.” It was perhaps not surprising to see the judge praying in aid of his views principles law out in the “Institutes” of Justinian promulgated in the 6th Century CE.

    Mr. Justice Briggs regarded the overall proposal as “quite simply a coercive threat which the issuer invites the majority to levy against the minority, nothing more or less. Its only function is the intimidation of a potential minority, based on the fear of any individual number of the class that, by rejecting the exchange and voting against the resolution he (or it) will be left out in the cold.” He went on to say “Putting it as succinctly as I can, oppression of the minority is of the essence of exit consents, and it is precisely that at which the principles restraining the abusive exercise of powers to bind minorities are aimed.”

    Put in such robust terms, this is a complete bar against consent solicitations which penalize noteholders who do not vote in favor or otherwise support a restructuring compared to those who do, and as such has caused a considerable degree of concern. However, the following points arise:

    1. Mr. Justice Briggs distinguished Azevedo so it should not be assumed that rewards, such as payments for voting in favor, are ruled out (although for some holders this is not tax-efficient). But care may be needed with relatively large incentives;

    2. While nothing that Mr. Justice Briggs acknowledges that this was key to his decision, this was an extreme case in that those who did not accept the exchange offer were left with virtually no value. This has led at least one commentator to suggest that the outcome might have been different if those who voted against were left with a holding equivalent to, say, 15 percent of their initial entitlement (those who accepted having got 20 percent), particularly as the judge used strong language in parts of his judgment about the effect of what the bank proposed (the “complete expropriation” of the holdings of dissentients); and

    3. In fact, the precedent cases which Mr. Justice Briggs cites do not necessarily support the broad proposition he advances. They are about rewards available to some but not all of noteholders or (to the extent Mr. Justice Briggs looked at cases about shareholder votes) shareholders, even if not all noteholders accepted them. The dissentients in Anglo Irish could have avoided the disadvantage they suffered. So there are realistic grounds to appeal on this point, although the result would be uncertain. One is reminded of the ancient judicial pronouncement: “hard cases make bad law.”


    We are left in an interesting position. There is still a great deal of corporate reorganization to be done in Europe even if the Euro crisis does not get worse. Many major companies and financial institutions have English law governed debt instruments, some of which will be included in restructuring proposals. It is perhaps not a good time for the market to be feeling such a degree of uncertainty about the techniques available to deal with recalcitrant minorities.