A feature of all bond transactions is the ability of creditors on the occurrence of certain events which give them cause for concern that their investments may be unsafe (usually referred to as Events of Default) to accelerate their right to be repaid and, on a secured transaction, take control of the underlying security until the borrower’s payment obligations have been discharged. Clearly, this would be a disproportionate remedy to a minor breach of obligation with little or no impact on the investors (for example, a quickly-cured late provision by the borrower of accounting information which does not reveal any financial distress, or a change in the prescribed location of a service provider, for example due to a change in the regulatory landscape). On a public bond issuance with many thousands of creditors, to launch a consent solicitation request over such an inconsequential default would be costly, time-consuming and impractical.

A trustee is typically appointed to a bond transaction to act as a single point of reference for the issuer and to represent the interests of the bondholders (to whom the trustee owes fiduciary duties). Since only the trustee can enforce the bonds, it follows that the issuer generally only requires the consent of the trustee to such matters as amendments and waivers in order to bind all the bondholders. This arrangement will be reflected in the bond documents, although there will be many instances in which the trustee will need to obtain bondholder authorisation before providing such consent, either because it is unable or unwilling to exercise discretion in the matter. The advantages of this system are manifest, particularly where bonds are publicly traded, and the investor community is unfixed and relatively anonymous.

The duties and liabilities of an English-law trustee are extensively regulated under common law and statute, but the power of a bond trustee to unilaterally waive breaches of bond documents in the name of bondholders will be governed by its appointing trust instrument, and to-date has been the subject of curiously little judicial scrutiny. As a consequence, the trustee’s discretionary powers of waiver and modification in bond trust deeds are fairly consistently formulated across the market, and a number of conventions have been established to assist both issuers and trustees in their approach to waiver consent requests.

Knowing the ropes

A bond trustee’s power to waive breaches is always strictly limited to circumstances where the trustee has determined that such waiver would not cause material prejudice to the investors. Typically, a trustee will also be prohibited from overruling a decision made by the investors on the issue underpinning the waiver request (generally in the form of a bondholder resolution), and from waiving a breach which would impact a fundamental condition of the transaction (usually referred to as a Basic Terms Modification or Reserved Matter). A trustee can grant a waiver on any terms it sees fit, and, once granted, a waiver will be binding on all creditors.

As a preliminary practical step, most issuers will approach a bond trustee on an informal basis to discuss a proposed waiver, with a view to agreeing the more formal consent request process to be undertaken. The consent request letter should include (among other things) confirmation from the issuer that the proposed waiver will not cause material prejudice to the interests of the investors, and will often be accompanied by an explanation as to why with, potentially, supporting evidence. The trustee is able to rely on such statements under its standard entitlement in the trust instrument to call for and rely on certifications from the issuer. Trustees will also expect issuers to certify that a proposed waiver will not constitute a Basic Terms Modification, that no Event of Default has occurred or will occur as a result of the waiver, and no further consents are required (or that such additional consents have been obtained). Trustees will then conduct their own analysis of the documents in order to reach an independent conclusion as to whether or not it can grant the waiver, often with the support of external legal advice obtained at the cost of the issuer.

Getting underway

When approached with any waiver consent request, a bond trustee will first consider the background to the breach which is proposed to be waived. A trustee will need to be satisfied, firstly, that it is empowered by the terms of the trust instrument to consent to the waiver and, secondly, that it would be appropriate to exercise discretion to waive the breach, having regard to all the circumstances. The degree of permanence of any proposed waiver will likely influence a trustee’s assessment of whether an amendment to the terms of the bond documents is necessary; trustees will be wary of issuers attempting to short-circuit an amendment process where a waiver appears to be a quicker fix. On the other hand, there may in some instances be an element of urgency which would warrant the granting of an immediate waiver with a view to formalising an amendment to the documents at a later stage.

Once comfortable that consenting to a particular waiver would amount to a proper exercise of its discretionary powers under the terms of the relevant documents, a trustee will turn to the certification by the issuer that the investors will not be materially prejudiced by the proposed waiver.

Fathoming out material prejudice

It is generally accepted among lawyers that the test of material prejudice applies to the contractual rights of investors to receive payments in full when due, and to contractual rights ancillary to such payment entitlements. Bond documents will almost always specify that, in reaching a determination of no material prejudice, the trustee should have regard to the interests of the investors as a class, rather than as individuals, whatever their number. Occasionally, investors may be actively looking out for breaches by the issuer in order to trigger an early acceleration and enforcement process, for example when they suspect a more serious financial default is coming down the tracks. A trustee is entitled to ignore such commercial objectives, and to consider the facts and supporting documents at face value when assessing whether a waiver would materially prejudice investors. Nonetheless, trustees are wary of the risk of being dragged into disputes between competing creditor groups and would be unlikely to exercise discretion on an issue over which it was aware investors were split.

Similarly, it would be unusual for a trustee to come to an independent conclusion as to the materiality of a breach of an essentially commercial term of the documents without seeking input from investors. By way of example, at the outset of most private placement bond issuances, trustees will insist on an express exemption from unilaterally waiving conditions precedent or subsequent to a drawdown, which drives to the economics of the deal and can be a controversial issue among creditors. Transaction parties are not always sympathetic to a bond trustee’s reluctance to intervene in commercial matters, and often point to its exculpatory provisions in the documents, which generally exonerate the trustee from all liability save for losses arising from its own negligence, wilful default or fraud. However, exoneration clauses cannot assist a trustee which knowingly acts contrary to beneficiaries’ interests or is recklessly indifferent towards their interests (Armitage v Nurse [1997] EWCA Civ 1279). As a rule of thumb, trustees will only agree to a waiver on the basis of no material prejudice where they are in no doubt that the entirety (or vast majority) of the investor group would support such a determination.

Plotting a course

On receipt of a waiver consent request, there are a number of options available to a bond trustee:

• If the trustee is satisfied it can properly consent to the request, it can countersign the request letter and enter into any amending documentation (as applicable), and the breach will be waived, subject to the fulfilment of any conditions and obtaining any further consents.
• The trustee may conclude the issue should be referred to the investors. It may be influenced by the size and circumstances of the particular creditor pool; for example, if the bonds were held by two known investors, it would be reasonable for a trustee to seek their views, even on an informal basis, before consenting to a waiver of any breach of the bond documents. On the other hand, on a public bond deal with a large and fluctuating investor group, it would be expensive and time-consuming to formally solicit the investors’ views, and almost impossible to seek informal guidance, and the trustee would likely come under intense pressure to make an independent determination as to the materiality of a breach.
• The trustee might seek the views of an expert, perhaps in the form of a legal opinion, relying on its entitlement to consult advisors under the terms of the trust instrument (at the cost of the issuer).
• As a final resort, the trustee may apply to the court for directions, eg under Pt 64 of the Civil Procedure Rules. It was affirmed by the Privy Council in Marley and others v Mutual Security Merchant Bank and Trust Co Ltd. [1991] 3 All E.R. 198 that any trustee “who is in genuine doubt about the propriety of any contemplated course of action in the exercise of his fiduciary duties and discretions is always entitled to ... protect his position by seeking the guidance of the court”. However, in the case of UBS Ag, London Branch v GLAS Trust Corporation Ltd & Anor [2017] EWHC 1788, the High Court made clear that exercises of trustee discretion “may contain a substantial measure of judgment, may be controversial, and may have to be carried out speedily to enable resolution of the transaction”. To gain the sympathy of the court, a bond trustee must have exhausted all other options and should have formed a preliminary view for the court to bless.

This article first appeared in the October 2020 issue of Butterworths Journal of International Banking and Financial Law

Authored by Izzy Bull