In a dramatic vindication of bondholder rights, a judgment of the English High Court has thrown into doubt the legality of a central plank of the restructuring of Irish banks carried out by the Irish government in around 2010. The judgement could have repercussions throughout the Eurozone.

In Assenagon Asset Management S.A. v Irish Bank Resolution Corporation Limited (formerly Anglo Irish Bank), Mr. Justice Briggs in the Chancery Division of the English High Court has ruled that the “exit consent” technique used by Anglo Irish (and a number of other Irish banks) in order to enforce losses on subordinated bondholders is not permitted as a matter of English law, which is the governing law of many of the bonds issued by the banks. Briggs J acknowledged that this was the first time that the legality of “exit consents” had been tested by the English Courts. He considered the US case of Katz v Oak Industries (1986), in which “exit consents” were upheld in Delaware, but expressly chose not to follow that case.

Many bondholders who suffered losses from the use of “exit consents” by the Irish banks may now seek compensation.

The judgment may also have an effect on the legality of “exit consents” in other jurisdictions, including in respect of the recent Greek sovereign debt exchange.

The Anglo Irish Case

Mr. Justice Briggs considered the legality under English law of a technique used by the issuers of corporate bonds, which he described as “exit consent”. It has also been described (notably by Brown Rudnick, which has handled many of the bondholder cases arising out of the Irish banking crisis) as a “coercive tender”. The technique was summarised by Briggs J as follows:

The issuer wishes to persuade all the holders of a particular bond issue to accept an exchange of their bonds for replacement bonds on different (less advantageous) terms. The holders are all invited to offer their bonds for exchange, but on terms that they are required to commit themselves irrevocably to vote at a bondholders’ meeting for a resolution amending the terms of the existing bonds so as to devalue the rights arising from those existing bonds. A holder who does not offer his bonds for exchange and either votes against the resolution or abstains takes the risk, if the resolution is passed, that his bonds will be devalued by the resolution. As is clear, the purpose of the attachment of the exit consent to the exchange proposal is to dissuade bondholders from opposing the exchange.

Exit consents of this type have been upheld in the United States. In Katz v Oak Industries Inc. (1986) 508 A.2d 873 the attachment of an exit consent designed to devalue the existing bonds in the hands of dissenting holders who declined an associated exchange offer was challenged in the Delaware Chancery Court as amounting to a breach of the contractual obligation of good faith by the issuer, as against the bondholders. Chancellor Allen concluded that the particular exit consent in that case, (which included the removal of significant negotiated protections to the bondholders, and the deletion of all financial covenants), did not despite its coercive effect amount to a breach of the contractual obligation of good faith between issuer and bondholders in what he evidently regarded as an ordinary commercial arms-length contract.

By contrast, the challenge made against the Anglo Irish tender in the English High Court was mainly based upon an alleged abuse by the majority bondholders of their power to bind the minority, albeit at the invitation of the issuer. The challenge was based upon the well recognised constraint upon the exercise of that power by a majority, namely that it must be exercised bona fide in the best interests of the class of bondholders as a whole, and not in a manner which is oppressive or otherwise unfair to the minority sought to be bound.

The bond issue to which the Anglo Irish case relates consists of the Bank’s subordinated floating rate notes due 2017 (“the 2017 Notes”) issued by the Bank on 15 June 2007 pursuant to the terms of a trust deed dated 15 August 2001 between the Bank and Deutsche Bank Trustee Co. Limited (“the Trustee”). The commercial terms of the 2017 Notes were summarised by Briggs J as follows:

(i) They were to mature in 2017, for redemption at par, unless redeemed earlier at the Bank’s election (also at par) on any interest payment date after 19 June 2012.

(ii) In the meantime they carried a floating rate of interest at 0.25% above three months Euribor until 2012 and 0.75% above three months Euribor thereafter.

(iii) The Notes were subordinated, so as to be prioritised for payment in an insolvency after all secured and unsecured creditors (including the Bank’s depositors) and ahead only of equity shareholders. They were wholly unsecured.

As is common with these types of bonds, the Trust Deed was governed by English law and subject to the jurisdiction of the English courts. It was provided that an Extraordinary Resolution could be passed by a three-fourths majority of persons voting, and would then be binding upon all.

By September 2008, Anglo Irish Bank had become the third largest bank in the Irish domestic market with €101 billion of gross assets on its balance-sheet, representing about 50% of Irish GDP. It had a particular focus on commercial property lending, and as a result of the 2008 financial crisis, with a linked rapid decline in commercial property values, the Bank faced a liquidity crisis which, unless it was rescued by the Irish Government, would have forced it into insolvent liquidation. On 21 January 2009 the Bank was nationalised.

On 30 September 2010, the Irish Minister of Finance made a statement on the banking system in Ireland which, while stating an intention to respect all senior debt obligations in the Bank, continued:

“The principle of appropriate burden sharing by holders of subordinated debt, however, is one with which I agree…[I]t is right that the holders of Anglo’s subordinated debt should share the costs which have arisen.

I expect the subordinated debt holders to make a significant contribution towards meeting the costs of Anglo.”

On 21 October 2010, the Bank proposed to Noteholders an exchange of (inter alia) the 2017 Notes for new Notes (“the New Notes”) at a 20% exchange. The proposal contained the following provisions.

“By offering to exchange its Existing Notes, a holder will be deemed to … vote in favour of the relevant Extraordinary Resolution in respect of all Existing Notes of the relevant series offered for exchange by such holder and which are accepted by the Bank at the…2017 Notes Meeting…

…If an Extraordinary Resolution is passed in respect of any Series of Existing Notes…the amendments shall be binding on all Holders of Existing Notes of such Series, whether or not those Holders attended or were otherwise represented at the relevant Meeting and/or voted in favour of the relevant Proposal.

If the Bank chooses to exercise such call right (which the Bank currently intends to do shortly after the relevant Settlement Date, although the Bank is under no obligation to do so), the redemption amounts payable to a Holder of Existing Notes (being €0.01 per €1000 in principle amount of Existing Notes) will be significantly less than the principal amount of the New Notes such Holder would have received had such Existing Notes been exchanged pursuant to the relevant Exchange Offer.”

The Bank notified acceptance of all notes offered for exchange on 22 November 2010 and the Resolution was therefore duly passed. On 30 November 2010, the Bank exercised its newly acquired right to redeem the remaining 2017 Notes at the nominal price of €0.01 per €1000 face value pursuant to which the claimant received €170 for its €17 million face value of 2017 Notes.

The claimant did not attend, or vote by proxy at, the 2017 Noteholders’ meeting. It first complained about what had occurred on 30 November 2010. This claim was issued on 15 April 2011.

The claimant sought a declaration that the resolution purportedly passed at the 2017 Noteholders’ meeting on 24 November 2010 was invalid on three independent but related grounds:

  1. The Resolution constituted, in substance, the conferral of a power on the Bank to expropriate the 2017 Notes for no more than a nominal consideration. It was therefore ultra vires the power of the majority under the Trust Deed.
  2. At the time of the Noteholders’ meeting on 23 November, all those noteholders whose votes were counted in support of the Resolution held their Notes beneficially, or for the account of, the Bank. Accordingly, all those votes are to be disregarded pursuant to provisions in the Trust Deed which prohibit the issue from voting in an EGM.
  3. Even if ultra vires, the Resolution constituted an abuse of the power of the voting majority because:
    • (i) It conferred no conceivable benefit or advantage upon the 2017 Noteholders as a class; and,
    • (ii) It was both oppressive and unfair as against that minority.

Briggs J found against the claimant on the first argument (ultra vires), but found in favour of the claimant on the second (the issuer being prohibited from voting in the EGM) and third (oppression of the minority). In short, the tender process carried out by Anglo Irish Bank was unlawful.

The repercussions of this judgment are potentially huge, and could affect all bond restructurings carried out by the Irish banks in the period 2009 to 2011, as well as restructurings in other jurisdictions.

It remains to be seen whether Anglo Irish Bank will pursue an appeal. Brown Rudnick continues to advise investors in Irish and other Eurozone jurisdictions, including Greece and Spain, on bonds and sovereign restructurings.