An Ideal Standard for drafting?

INTRODUCTION

The recent High Court decision in Strategic Value Master Fund Ltd v Ideal Standard International Acquisition S.A.R.L &ORS [2011] EWHC 171 (Ch) (the “Ideal Standard case”), brought to light the importance for lenders to ensure that ‘equity cure’ provisions in syndicated facilities agreements are drafted with care to safeguard lenders’ interests. An equity cure provision provides that in the case of a breach of certain financial covenants or, potentially other limited events of default, a borrower or other obligor may inject additional equity in order to remedy the breach. In addition, the case provided that meticulous construction of the terms of the provision would make certain that there are no loopholes to allow borrowers to comply with the provisions without in fact injecting any new monies; in circumstances where the commercial intention may be that fresh capital is required to satisfy the equity cure provision.

FACTS

Ideal Standard International Acquisition SARL (“Ideal Standard“) had breached its interest cover ratio covenants under a syndicated facilities agreement. However, the facilities agreement contained an equity cure provision which enabled Ideal Standard to remedy the breach. If the breach were remedied in accordance with the equity cure mechanism it would not be deemed to be an event of default.

Ideal Standard claimed to have cured the breach by the use of the equity cure provision. A subsidiary of Ideal Standard withdrew cash from the group’s cash pool and used this money to prepay an outstanding loan owed to Ideal Standard. Ideal Standard then used the funds received in prepayment to redeem certain shares it had issued to its parent company. The parent company immediately lent money back to Ideal Standard (which Ideal Standard subsequently on- lent to its subsidiary to replenish the cash pool). Arguably there was no injection of fresh capital into Ideal Standard as the funds utilised in the equity cure mechanism had been ’round-tripped’ i.e. the provisions of the equity cure were mechanically complied with by re-circulating existing monies.

The majority lenders considered the equity cure mechanism utilised by Ideal Standard to be ineffective as no new monies had been injected into Ideal Standard. As the majority lenders did not consider the breach of the financial covenant to have been remedied they served an acceleration notice on Ideal Standard. Essentially, the notice stipulated that the equity cure had been ineffective to cure the event of default and declared that all outstanding sums under the facilities agreement were immediately payable on demand.

Subsequent to the acceleration of the outstanding debt, the majority lenders sold their interests to other companies. The new majority lenders then sought to waive the acceleration notice and the events of default.

KEY LEGAL ISSUES

Equity cure

The case was brought by Strategic Value Master Fund Ltd (“Strategic Value“), a minority lender under the senior facilities agreement. The argument advanced by Strategic Value was that the equity cure mechanism utilised by Ideal Standard was ineffective as the commercial purpose of the equity cure provision had not been complied with. It further asserted that the equity cure provision in the syndicated facilities agreement entailed new money being injected into the group to improve its financial health. As no new funds had been put in the company the commercial purpose of the financial covenants and the safety value had not been complied with.

The court held that the equity cure mechanism was effective as Ideal Standard had injected additional funds into the company which had effectively remedied the breach of contract.  The court stated that it was not necessary to consider the commercial purpose of the agreement as the paramount issue was to determine whether the terms of the agreement had been complied with. In particular, on the basis of the construction of the equity cure clause only the provision of additional funds were required to remedy the event of default. Hence, the borrower had remedied the breach of the interest cover covenant under the equity cure provision by ’round-tripping’ money as the equity cure provision only required additional funds not new money.

Waiver of a term

The court also considered whether the majority lenders had the right to withdraw a notice on the acceleration of facilities and whether this decision required the consent of all lenders (given that all lenders’ consent is required to amend certain terms of the facilities agreement).  The court reached its decision by analysing the distinction between the waiver of a term and a right in a syndicated facilities agreement. The court held that the right of the majority lenders to accelerate the facilities after a notice had been served was not a waiver of a term but a waiver of a right.  Accordingly, only the consent of majority lenders not all lenders were required to withdraw the notice of acceleration.

CONCLUSIONS

In conclusion, this case illustrates that the interpretation of wording of a syndicated facilities agreement would take precedence over any commercial purpose that may exist between the parties to an agreement. It is therefore essential that lenders ensure that contractual provisions in a syndicated facilities agreement are carefully constructed to safeguard their interests and/or the commercial purpose they wish to achieve. Furthermore, if the intention of the lenders is to prevent ’round-tripping’ by the borrowers the equity cure provision should be carefully drafted to prevent loopholes that could lead to the recycling of capital.

Finally, in the judgment, the phrase “waiver of a term” was construed narrowly.  It seems that if only one particular right or remedy is waived, this will not fall within the ambit of a clause referring specifically to variation and waiver of terms of the finance documents if the term remains in place and is available for use on future occasions.