Banking and finance legal update: Q4 2024

Sole directors’ decision making

The High Court has once again considered the ability of sole directors to make decisions on behalf of a company in accordance with the provisions of the model articles for private companies limited by shares (the Model Articles), following the earlier cases of Re Fore Fitness and Re Active Wear.

Re KRF Services (UK) Ltd [2024] EWHC 2978 (KRF Services) focused on whether an order should be allowed for the appointment of administrators for an insolvent company (the Company). One of the issues arising from the case was whether the Company validly brought the administration application made by the Company’s sole director on its behalf. The Company had previously had multiple directors but at the relevant time only had a sole director. The Company had adopted the Model Articles in full without modification.

The two relevant provisions of the Model Articles considered in the case were Article 7(2), which provides that if the company only has one director and no provision of the articles requires it to have more than one director, a sole director may act alone to make decisions for the company, and Article 11(2), which provides that the quorum for directors’ meetings may be fixed from time to time by a decision of the directors but must never be less than two and unless otherwise fixed is two.

Questions over the interaction between these provisions of the Model Articles had been raised previously in the High Court in Re Fore Fitness and Re Active Wear. In Re Fore Fitness, departing from the view of many practitioners, the judge said that an amendment to the Model Articles would be required to delete Model Article 11(2) to give a single director the power to take decisions on behalf of a company. In the latter case of Re Active Wear, the judge came to a different conclusion: that Model Article 7(2) prevails over Model Article 11(2) when a company has only one director and when there was no provision of the articles requiring it to have more than one director, as was the case under the unamended Model Articles. However, the judge went on to comment obiter that Model Article 7(2) would not apply in a situation where the company has in the past had more than one director.

In KRF Services, the judge agreed that Model Article 11(2) should not be read as a requirement for the company to have more than one director whereby Model Article 7(2) could never take effect. Where a company has unamended Model Articles, the sole director has authority to act under Model Article 7(2). However, departing from the comments in Re Active Wear, the judge said that the fact the Company had more than one director in the past was irrelevant. The judge reasoned that the conditions for Model Article 7(2) to apply are first that the company “only has” one director (in the present tense) and second that “no provision of the articles requires it to have” more than one director, and both conditions were satisfied in this case.

This decision adds weight to an argument that where a sole director company has adopted the Model Articles without amendments to the provisions on numbers of directors or quorum for board meetings, no amendments are required to the articles to allow the sole director to run the company, and the fact that the company has in the past had more than one director is not relevant to this point.

What are the key takeaway points?

• Where a company has bespoke articles or has adopted an amended form of the Model Articles and the amendments impact the requirement for a certain number of directors and/ or the quorum requirements for board meetings, companies with sole directors will need to amend the articles to disapply any term that requires more than one director or appoint a second director.
• Lenders entering into finance documents with borrower companies with sole directors (including loan agreements, security documents and intercreditor agreements) will want such companies’ articles to be reviewed and amended to address this point where relevant, to ensure that the company can validly resolve to enter into those documents.

Read more about this topic in our article here.

A reasonable alternative rate to be used on LIBOR cessation

The High Court has ruled on a recent case brought under the Financial Markets Test Case Scheme, which sought to determine the appropriate calculation mechanism to be used following the discontinuation of the London Interbank Offered Rate (LIBOR) and the cessation of the publication of the three-month US dollar LIBOR setting at the end of September 2024.

The facts of the case centred on how to calculate dividends on preference shares where the dividends were payable by reference to “Three-Month LIBOR” with three fallback calculations. The issuer of the shares attempted to amend the definition of Three-Month LIBOR in its articles to an alternative calculation when LIBOR was discontinued, however the amendment did not receive sufficient shareholder approval and failed. As such, when publication of LIBOR ceased in September 2024, the issuer bank brought proceedings so that the correct rate to be used could be determined. The issuer argued that the third fallback definition of Three-Month LIBOR’s reference to “three-month US dollar in effect” ought to be interpreted as a “rate that effectively replicates or replaces three-month USD LIBOR” and, alternatively, that a term should be implied allowing the bank to use a reasonable alternative rate. The defendants, being those with legal title as nominee and those with an economic interest in the shares, argued that a term ought to be implied allowing redemption of the shares given the cessation of LIBOR.

In its judgment, the Court, applying the test set out in previous case law, decided that a term should be implied into the contract allowing for the use of a reasonable alternative rate to LIBOR. The implied term was deemed necessary for the contract to remain effective and was considered an obvious, unspoken agreement between the parties given the long-term nature of the contract and the reasonable expectation of the parties that it would survive changing circumstances and unforeseen events. The Court reasoned that LIBOR was to be viewed as a calculation mechanism to determine the parties’ rights, not as a core entitlement itself and so the contract should be interpreted in a way that best serves the essential purpose of the bargain.

The issuer’s interpretation of the third fallback definition was rejected by the Court on the basis that the fallback definition was intended as a last resort when there were occasional operational problems, not where there was a permanent cessation of LIBOR. The defendants’ argument that the preference shares should be redeemed was also rejected as the Court found it was clear the parties had not intended for the contract to be frustrated by the discontinuation of LIBOR.

The Court determined that the reasonable alternative rate should be CME Term SOFR plus the spread adjustment recommended by the International Swaps and Derivatives Association. This rate was selected because it is widely used and is the closest available alternative to three-month US dollar LIBOR. The Court also clarified that the identification of the reasonable rate is an objective question for the Court to decide, and that available alternatives may change over time.

Although this ruling was specifically in the context of preference shares, the Court indicated that the same reasoning is likely to be applicable to debt instruments that reference LIBOR but do not specify what should happen should LIBOR cease to exist. In such debt instruments, LIBOR is likely to be viewed as a measure of the wholesale cost of borrowing, and its inoperability should not invalidate the continuation of the contract.

What are the key takeaway points?

• Where LIBOR has been used as a contract’s calculation mechanism and no alternative rate is allowed for within the terms of the contract, it appears that the courts may be willing to allow a term to be implied into the contract to allow for CME Term SOFR to be used instead.
• It is preferable for legacy contracts referencing LIBOR to be amended to provide certainty over the rate to be substituted, however many parties will be reassured to see that where this was not possible, the courts intervened to allow the contract to continue.

Find out more on the Standard Chartered Plc v Guaranty Nominees Limited and others [2024] EWHC 2605 (Comm) case.

Lender’s right to demand loan repayment “on demand” without reason is reaffirmed

The High Court has considered an appeal by two individuals acting as guarantors relating to the implication of a term into a loan agreement that contained a provision allowing the lenders to demand repayment at any time without reason. 

The borrower secured two loans from two different lenders, both of which were guaranteed by personal guarantors. Both agreements contained a clause (7.2) which stated that the loans were “repayable on demand”. The lenders became concerned that the borrower’s development project was not progressing as anticipated, so in order to mitigate potential losses, the lenders called in the loans and issued statutory demands against the guarantors under their respective guarantees.

The guarantors argued that clause 7.2 was subject to a Braganza duty, meaning that it had to be used in a reasonable and proportionate manner. The guarantors relied on an earlier case where the Court of Appeal had found an implied term in a consumer mortgage contract to the effect that in exercising its discretion to vary interest rates, the mortgage lender was bound to make its judgment “fairly, honestly and in good faith, and not arbitrarily, capriciously or unreasonably”. 

However, the judge here doubted that a similar implied term would apply in relation to a power to call in a loan. The Court held that the “repayable on demand” clause gave the lenders the right to demand full repayment without providing any reason. The judge considered the judgment in UBS AG v Rose Capital Ventures Limited [2019] 2 BCLC 47, in which the Court said that a Braganza duty was more likely to apply to contractual decisions where one party has a role in the ongoing performance of the contract and therefore has a clear conflict of interest, rather than a unilateral right given to a lender in a mortgage. The judge did comment that the power to demand repayment was not completely unconstrained and was at least required to be exercised in pursuit of legitimate commercial aims.

The guarantors also sought to rely on section 3 of the Unfair Contract Terms Act 1977 (UCTA), which prevents a party from (amongst other things) relying on a standard contract term to render a performance of the contract “substantially different from that which was reasonably expected” where the term is deemed unreasonable under UCTA. The Court rejected this argument on the basis that the term was “front and centre” in the contract and the borrower should have known about it, that the Court would be reluctant to invoke UCTA between two commercial parties except where a term was clearly abusive (which was not the case here), that it was doubtful that the clause was unreasonable, that there was no evidence of an imbalance of bargaining powers between the parties, and that the parties were not contracting on standard terms.

What are the key takeaway points?

• This case supports an argument that financial institutions are able to rely on “repayable on demand” clauses without having to justify their decisions, provided this is what the loan agreement specifies, and the clause is deployed for legitimate commercial aims.
• The courts will be reluctant to invoke UCTA in commercial disputes unless a term is clearly abusive, even where such a term is unfavourable to one party.

Find out more about the Murfet & Anor v Property Lending LLP & Anor [2024] EWHC 2787 (Ch) case.