Sending a notice of default: termination tips

A recent case involving the repossession of an aircraft by a secured lender examined whether a loan agreement was validly terminated to allow a security to be enforced. The issues addressed are a useful reminder of best practices when working through a failure scenario and the risks that can arise.

background

Lombard North Central plc v European Skyjets Ltd (in liquidation) [2022] EWHC 728 (QB) is a High Court decision arising from litigation between a secured lender, Lombard (the plaintiff) and the owner of the aircraft, European Skyjets Ltd (the defendant).

The lender provided the owner with an $8.8 million secured loan, repayable in 120 monthly installments, with the lender providing a mortgage on the aircraft. The owner then defaulted on several installments due under the loan agreement. While these defaults continued in 2010 and 2011, payments were occasionally made during this period so the owner was not constantly in arrears.

In 2012, the owner is said to have been insolvent on a cash flow basis. The lender terminated the loan agreement, exercised its selling powers as mortgagee on the aircraft mortgage, and required the owner to pay the outstanding balance of $5.9 million.

The only default mentioned in the notice of termination was failure to make payments due. However, evidence presented at the hearing indicated that other defaulting events had occurred, including a breach of warranty relating to the aircraft’s maintenance agreements; a material adverse change in the owner’s financial health; and a failure to make any payment required by the lender to maintain the loan to value ratio (which is the value of the aircraft divided by the outstanding balance of the loan, expressed as a percentage from time to time).

The owner counterclaimed for damages of £26m, alleging that the lender had no right to terminate the loan agreement and that the lender breached its obligations as a mortgagee in selling the aircraft.

judgement

Mr Justice Foxton considered that the lender was entitled to terminate the loan agreement and that the aircraft was justified in selling. In doing so, he considered the following points, which provide some helpful reminders of important points to keep in mind when considering your position after a potential breach:

Does a default have to be ongoing at the time of termination?

Clause 9.1(a) of the Loan Agreement provides that an Event of Default would occur if the Owner defaults on any principal, interest or other sums payable under any Transaction Document.

Clause 9.2 of the Loan Agreement provides that at any time after an Event of Default has occurred the Lender may terminate the Facility by notice to the Owner and require immediate repayment of the outstanding Loan together with any accrued interest and any other amounts payable under the Loan Agreement.

There was no doubt that the owner had repeatedly failed to pay the monthly installments due, but the question arose as to whether an amount was still outstanding at the time of termination, i.e. regardless of interim (later) payments. As a matter of construction of the loan agreement, the judge concluded that (i) there was a breach of Clause 9.1(a) if any amount was not paid when it was due; and (ii) Clause 9.2 did not require the Event of Default to persist at the time the notice of termination was served, but rather entitled the Lender to declare an Event of Default “at any time” after the occurrence of the Event of Default in question.

Has the right to establish default been waived?

The owner then argued that the lender had waived its right to treat late payments as defaults and therefore lost its right to terminate the loan agreement. This argument was made on the basis that the lender had accepted a late payment and given the owner additional time to settle any outstanding arrears.

The lender attempted to invoke a “no waiver” clause in the loan agreement that prevented any failure or delay on the part of the lender in exercising any right, power or privilege under the loan agreement from functioning as a waiver. The lender also referred to a general declaration of retention of title repeatedly submitted to the owner in e-mail correspondence. However, the court found that neither the clause nor the statement was sufficient to overrule an express notice given by the lender to the owner that gave the owner the ability to regulate the position by a specific date. In this case, the waiver resulted not solely from failure to exercise or delay in exercising a right (as provided for in the relevant clause), but from affirmative statements implicitly accepting that the lender would not make any payment in the event of an event of default for want to claim past payment delays.

What if it’s a minor violation?

In the alternative, the owner attempted to argue that any breach was too minor to be significant, making the exercise of the lender’s contractual rights unreasonable. The judge rejected this argument on the grounds that it is generally accepted in English law that where parties have declared breach of a specific obligation of a term of the contract, that right is available without regard to the amount of the breach. The judge confirmed that there was no margin for a de minimis Obligation as far as non-payment of installments for a loan is concerned.

What must the termination contain?

The judge also examined whether the lender’s termination was consistent with the relevant contract provisions. In particular, he checked whether it needed to identify the events of default it was claiming and accurately state the amounts due. In this case, the lender had only stated a reason for default (which in fact had not occurred) and erroneously included claims for accrued default interest which it later recognized as not due. As to the exact wording of the relevant clauses in the loan agreement and the mortgage, the judge found that there was no provision requiring a determination of default or an exact statement of the amount owed. The judge ruled that the owner “not put in a worse position by the inclusion of an ineffective reason than if nothing had been said at all“. If the lender could prove that a default had occurred, its termination was effective.

Is the relevant clause a penalty?

The owner also argued that Clause 9.2 of the loan agreement was void as a penalty because it entitled the lender to call in the full amount of the outstanding balance immediately and take possession of the aircraft after an event of default which might come of its own accord little or no impact. The judge dismissed this argument as futile. It was not inherently criminal to demand repayment of the entire outstanding balance after an installment payment was not made by the due date, or if a mortgagee was able to enforce their security when a secured loan defaults.

Is there a good faith duty in termination?

The judge noted that previous case law has held that termination rights are not contractual discretions that should be subject to implicit duties of reasonable and good faith. Rather, the lender had a so-called “absolute contractual right” that he could exercise for his own purposes at his own discretion. There was no good faith duty to prevent their termination.

comment

While this ruling offers some comfort to lenders seeking to enforce their rights under loan agreements and related collateral, it also highlights some of the potential pitfalls that can arise for both lenders and borrowers. A party wishing to exercise a contractual right of termination must strictly comply with the terms of the contract for exercising that right. The drafting of these conditions is an exercise in the construction of the contract in question and will therefore vary from case to case. The termination provisions of your contract deserve close scrutiny, in addition to those dealing with cases of default, cure periods (if any), and termination rights and remedies.

Careful consideration must also be given to avoid inadvertently waiving rights that may already exist under the relevant contract or the law. If offers or concessions are made to allow borrowers to settle circumstances that might otherwise constitute default, they should be carefully drafted to clarify what the defaulting party must do; by when; and what the consequences are if she doesn’t comply. As the judge observed in this case, the “ritual invocation” of the language of reservation of rights cannot prevent something said or done in previous communications from having its objective effect – in other words, reserving your rights cannot save you if you have already waived those rights.

Article co-authored by Emilija Lazarevic, Associate at CMS

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