An unusual case involving a negative pledge might be of interest to lenders. Two secured facility agreements (between the same borrower and lender) contained a negative pledge (an undertaking not to dispose of and/or grant any security over any of its assets during the life of the loan). The negative pledge is an important term of loan and security documentation – it ensures the value of the assets held by the borrower are preserved while the loan is outstanding, and can also ensure that the priority of the lender is preserved as the only creditor holding security over assets (as ‘unsecured’ creditors rank behind ‘secured’ creditors in an insolvency scenario).

In this case, the borrower had approached the lender to ask for consent to be able to grant security over some of its assets to another lender, and the existing lender had refused to consent.

The borrower claimed that refusal was a breach of an implied term of a facility agreement that the lender, in deciding whether to consent, had to (a) act in good faith and should not act capriciously (a principal that had been determined in a previous case, Braganza v BP Shipping Ltd [2015] UKSC 17); (b) take into account all relevant considerations and not take into account any irrelevant considerations; and (c) would not use the discretion for an improper purpose.

The lender claimed that it had an unqualified right to refuse consent, and along with the protections provided by the general law for those who secure debt against property, means that the alleged implied terms cannot or should not be implied into facility agreements.

The court found that a term was implied to the effect that the lender was not entitled to refuse its consent “for a reason or reasons unconnected with what it perceived to be its own commercial best interests or … when no reasonable entity in the position of [the lender] could have refused consent”.

By way of background, the initial financing took place before the global financial crisis, following which the lender changed its strategy in terms of volume of lending and acceptable parameters of ratio of loan to value against EBITDA, with witnesses of the lender stating that they had to “react to..[a] changed goalpost” and admitting “there was a very severe tightening in credit conditions”. The lender wanted the borrower to sell assets as a means to reduce its debt, with the borrower claiming it was unduly pressured to do so. While the judge confirmed “none of this would excuse action being taken otherwise than in accordance with the agreements that governed the relationship between [the borrower] and [the lender]”, he was clear that a lender could act it its commercial best interests and “it difficult to see how, in such circumstances, such otherwise lawful action could be sensibly characterised as …. acting in a manner that was dishonest, capricious or unconscionable, or as… acting in bad faith”.

Negotiations between the borrower and the lender continued for some time - the proposals from the borrower had included an attempt to refinance the facilities, but as the debt due to the lender was between 12x and 13x EBITDA, the other lenders that had been approached had made it clear that it only made commercial sense for them to lend up to 10x EBITDA. The borrower had also requested a significant debt write off, which was refused by the lender (and the judge confirmed that the lender was entitled to refuse such a request). Finally, the borrower approached the lender with a refinancing proposal with Barclays, which involved securing a loan to Barclays against a hotel in Manchester (which was already secured to the existing lender). The existing lender rejected this on the basis that it would not reduce its overall debt and would adversely affect the loan to EBITDA ratio.

The court found:

• the decision of the lender was rational and based on legitimate commercial interests.
• the lender was entitled to prioritise its security interests and overall financial health of the lending relationship.
• the lender had a duty to act in good faith, but this did not require it to act against its own commercial interests or balance its interests against those of the borrower.
• the refusal to consent to the Barclays refinance proposal and its insistence on asset sales were consistent with its contractual rights and objectives.

What does this mean for lenders?

Be aware that the negative pledge in loan and security document is not an unqualified right as it is drafted – it must be exercised using good faith; but be reassured that a lender is entitled to make decisions based on its own commercial interests.