9 March 2009
In restructuring property finance, enforcement is not your only option, says Nicholas Crocker.
In the current economic climate the most commonly cited cause of borrower default is breach of loan to value (LTV) covenants. It has recently been said that anyone who in the last few years bought at above 70 per cent LTV is now probably in default.
The scarcity of new debt means that borrowers will also find it difficult to refinance debt reaching maturity. Financial institutions are constrained to shrink their balance sheets, and this is part of the overall reduction of the place of the financial sector in the economy: will borrowers find banks calling in debts in order to reduce their exposure?
In the commercial property sector this is not the majority option being pursued, with lenders showing a preference for restructuring, or renegotiating terms, rather than requiring the borrower to sell, or selling by way of enforcement.
One way that a lender may look to improve its position is to widen the scope of the security package, whether by taking additional security from the debtor, and/or by (further) cross-collateralising across a group. Lenders can perceive a group of single property-owning entities as one aggregate risk, but the questions arising from separate corporate personalities have to be examined and, if this can be done, resolved.
If the granting of additional security is the price or part of the price of a loan not being accelerated and security realised, an argument can readily be made that the directors of a borrower company are acting with a view to the best interests of the company.
That directors are acting in accordance with their duties to the company, or are not in breach of them, does not mean that there has not been a “transaction at an undervalue”, but it can mean that a given act or disposition – such as giving additional security - cannot be challenged as such, given relatively recent amendments to Jersey law.
The court cannot make an order setting aside a transaction at an undervalue if the court “is satisfied (a) that the company entered into the transaction in good faith for the purpose of carrying on its business; and (b) that, at the time it entered into the transaction, there were reasonable grounds for believing that the transaction would be of benefit to the company”.
This combines subjective and objective elements.
But the single most important factor is the company’s solvency before and after the “transaction at an undervalue”.
Things can become more difficult where cross-security is introduced, where it was not originally part of the transaction. Other assets within the group are pressed into service to reduce the lender’s exposure. Group benefit arguments can be insufficiently loadbearing in circumstances of this kind, and a guarantee fee at an appropriate rate may be needed.
Alternatively this may need to be analysed as a distribution of value, and treated and authorised as such, with a full statement of solvency.
In Jersey, a particular feature is that much property is held through property unit trusts. Trusts and companies cannot be assimilated to a common treatment: trustees and directors are both fiduciaries, but subject to differing analysis.
Unlike the Companies Law, the Trusts Law does not have a provision that a breach of duty can be cured by unanimous authorisation of all the shareholders, assuming ongoing solvency.
A beneficiary can in defined circumstances relieve a trustee of liability to the beneficiary for a breach of trust, and indemnify a trustee against liability for a breach of trust. But the statute does not say that the breach of trust is erased, nor, consistently, does it make any reference to solvency.
How the Jersey insolvency legislation can be applied to trustees is problematic, but at least the principles underlying that legislation must be applicable, for example where there are competing creditors.
Jersey can be expected to follow the recent English decision of In the Matter of Cheyne Finance PLC (in receivership) (2007), that the test of cash flow or ‘commercial’ insolvency includes consideration of prospective or contingent debts, the standard of proof for proving inability to pay debts being the balance of probabilities.
Another English case which will be persuasive in the Jersey courts is Hill v Spread Trustee (2005), tactfully cutting across the earlier case of MC Bacon, to the effect that it is clear that the granting of security can amount to a “transaction at an undervalue”.
We see no automatic preference of lenders for enforcement: restructuring and enhanced terms are often preferred. While both parties can freely agree to this, there can be legal risks to assess and address as far as this can reasonably be done; and things can be more difficult where there are multiple parties, and in particular trustees.
Nicholas Crocker is a partner in corporate and finance practice at Carey Olsen.