Dealmakers take note: the High Court offers guidance on interpreting finance documents

In Re Arboretum Devon, the junior creditor's claim - that the senior security did not secure the borrower's obligations to repay the beneficiaries of the senior security – was unsuccessful. HHJ Cooke held that the junior creditor was prevented from challenging the agreed order of priority. 

Facts

Arboretum Devon Limited (AD) required capital to buy land in Devon and develop holiday chalets. Lendy Limited (L) operated a peer-to-peer lending platform under the trading name of Saving Stream Security Holding Limited (SS). On 5 September 2016, AD entered into two loan agreements with L acting as Agent for the lenders, unspecified investors drawn from its lending platform; the amount of the advance was also unspecified (the L Loan Agreements). On the same date, AD granted a debenture to SS.

Separately but also on 5 September 2016, Shoby Investments Limited (SH) agreed to lend AD approximately £4.23 million. This too was secured by a debenture of the same date.  

In March 2018, further security on after-acquired property was granted to SS and SH. Both entities and L entered into an intercreditor deed which held that SS's security would rank in priority to that of SH up to an amount of £7.85 million plus interest. 

Administrators were appointed over AD in May 2019. Its business was sold for £902,500.  

SH's application to the court

On the face of it, the sale proceeds were caught by the security net and flowed to SS under the terms of the intercreditor deed. However, SH now sought the court's intervention. It asked the court to confirm that SH was entitled to challenge the validity/enforceability of loans made by L to AD and the security held by SS.

Intercreditor terms

The intercreditor deed contained the following Clause 2.9: "Neither Lender shall challenge or question:

• 2.9.1 the validity or enforceability of any Security constituted by a Security Document
• 2.9.2. the nature of any Security constituted by a Security Document or
• 2.9.3 without prejudice to the generality of the foregoing, whether any Security constituted by a Security Document is fixed or floating." 

Security was widely defined as including any mortgage, charge or other security interest.

Security Document was equally widely construed and included a definition of "Senior Debt Document" which included the Senior Debenture. 

Within that debenture, "Secured Liabilities" were defined as "all present and future monies obligations and liabilities of the Borrower to the Beneficiaries whether actual or contingent and whether owed jointly or severally, as principal or surety or in any other capacity together with all interest (including without limitation default interest) accruing in respect of those monies obligations or liabilities pursuant to any Finance Document."

Finance Document was defined as "the Loan Agreement the Security Documents and all other agreements entered into between [L] (directly or as agent) or [SS] and [AD]."

SH's case

SH contended that it had the right to challenge SS's entitlement to the monies flowing from the sale of AD's business i.e. the £902, 500 for the following reasons:

• L was only acting as agent for the lenders and was therefore warranting the existence of a defined group of lenders. L had not in fact secured the agreement of a defined group of lenders. This could be inferred from delays in responding to drawdown requests. Therefore, the basis of the loan agreements entered into by L as agent had failed. SH accepted that AD was under an obligation to repay monies advanced by L, but this obligation did not arise under the written loan agreements. Rather, they arose by way of an implied contract or by restitution.  
• "Secured Liabilities" were liabilities which arose "pursuant to any Finance Document'. However, AD's obligations to repay did not arise under the loan agreements (see 1 above) and so were not Secured Liabilities. The obligation was not, therefore, secured by the SS security documents.  
• SH could feasibly bring its challenge under clause 2.9 of the Intercreditor Deed on the basis that the "validity" in its context only referred to questions of execution, and so wider questions about the enforceability of the security were valid.

Judgment

The court held that SH was prevented from challenging SS's entitlement to the sale proceeds by Clause 2.9:

• the Judge pointed out the £6.8 million had been lent by L and a breach of warranty did not make the L Loan Agreements void ab initio, only voidable. It was therefore difficult to see how the L Loan Agreements had "failed"
• the term "Finance Document" did not encapsulate oral agreements. However, the Judge took the view that AD's obligations to repay were obligations arising "pursuant to" the Finance Documents. They therefore fell within SS's security. "It would be a nonsense" for the parties to have intended that the security would be available if a claim was made relying on express written agreement but not if a claim was made on another legal basis, such as restitution or implied contract
• the prohibition on "challenging the validity...of any Security" barred a challenge from SH. "Validity", despite SH's arguments, was not confined to matters of due execution, but the effectiveness of the Security generally.

Comment

The terms and definitions of the intercreditor deed are market standard.  

Senior lenders can take comfort from this judgment, which demonstrates that these provisions are fit for purpose, fending off the junior creditor's challenge at an early stage.