Lloyds TSB Bank plc v Clarke & Anor (Bahamas) [2002] UKPC 27 (29 May 2002)

	Privy Council Appeal No. 41 of 2001

Lloyds TSB Bank plc	Appellant
	v.
(1) Paul Frederick Clarke (Liquidator of Socimer 
      International Bank Limited) and
(2) Chase Manhattan Bank Luxembourg S.A.	Respondents

	FROM

	THE COURT OF APPEAL OF THE BAHAMAS
	---------------

	REASONS FOR REPORT OF THE LORDS OF THE JUDICIAL
	COMMITTEE OF THE PRIVY COUNCIL, OF THE 
	13th May 2002, Delivered the 29th May 2002
	------------------

	Present at the hearing:-
			Lord Bingham of Cornhill
			Lord Nicholls of Birkenhead
			Lord Hoffmann
			Lord Hobhouse of Woodborough
			The Rt. Hon. Justice Tipping
		  	[Delivered by Lord Hoffmann]
	------------------

1. 	At the conclusion of the hearing on 13 May 2002 their Lordships agreed humbly to advise Her Majesty that the appeal ought to be dismissed and that they would give their reasons later. This they now do.

2. 	The question in this appeal is whether a sub-participation agreement, entered into between two banks in respect of part of a eurobond issue, conferred upon the sub-participating bank any proprietary interest in the underlying bonds or their proceeds. The question has arisen because the bank which granted the sub-participation has gone insolvent.  If the agreement amounted to an assignment of a proprietary interest in the proceeds, the money belongs to the sub-participant.  If not, it forms part of the insolvent estate and the sub-participant is an unsecured creditor.
3. 	The eurobond issue consisted of US$150m 5 year 8% loan notes issued on 26 August 1993 by a Brazilian company called Bombril SA.  $36.1m of these notes were acquired by a Panamanian company called Woodchuck Investments Inc (“Woodchuck”).  In 1996 it appears that Woodchuck wished to dispose of the notes in such a way that the voting rights remained in friendly hands.  The reasons are obscure and do not matter; the evidence hints at some apprehended proxy battle. The scheme adopted was to transfer that part of the issue held by Woodchuck to a friendly bank and then create transferable derivatives which carried the right to capital and interest but not to votes or custody of the bonds.  The derivatives (called “depositary receipts”) were then marketed and sold.  The bank retained the voting rights.

4. 	The detailed machinery was as follows.  Woodchuck transferred title to the bonds to Socimer International Bank Ltd (“SIBL”) in exchange for payment in cash.  SIBL entered into a pair of interlocking agreements with Chase Manhattan Bank Luxembourg SA (“Chase”).  (In fact there were two pairs of agreements, each dealing with a separate tranche of bonds, but they were in the same terms and it is sufficient to refer to one.)  The first was called a Short-Form Sub-Participation Agreement (“the sub-participation agreement”) and the second a Deposit Agreement.

5. 	The sub-participation agreement was expressed to be governed by English law.  It referred to Chase as “the Participant” and began with a preamble:
“We [SIBL] ... hereby confirm the proposed 100 per cent participation by the Participant (the ‘Participation’) in the principal and interest (the ‘Payment Rights’) with respect to [US$20.5m] of the Notes (the ‘Subject Notes’) ...”

6. 	The main operative clause was 2.  Subclause 2.1 was largely concerned with stating what a sub-participation did not mean:
“On and subject to the terms and conditions of this letter agreement, and in consideration of the transfer by the Participant to SIBL of US$20,500,000 face value bearer depositary receipts (‘the Receipts’) issued pursuant to a deposit agreement dated as of the date hereof (‘the Effective Date’), SIBL grants the Participant a participation in the Payment Rights in respect of the Subject Notes.  The relationship between SIBL and the Participant thus arising shall be a debtor-creditor relationship.  The Participant shall have no rights of ownership in the Subject Notes nor does SIBL act as agent or trustee for the Participant in relation to the Subject Notes; provided that SIBL shall not be entitled to sell or otherwise dispose of the Subject Notes, without the prior written consent of the Participant.”

7. 	The actual rights of the Participant were stated in subclause 2.2:
“Upon receipt or recovery by SIBL of any amount (whether of principal, interest or otherwise) in respect of the Subject Notes which becomes due during the term of the Participation, SIBL shall remit to the Participant such amount … such amount being equal to the amount so received or recovered by SIBL ...”

8. 	The Deposit Agreement was expressed to be governed by the law of Luxembourg, where Chase was incorporated.  It referred to SIBL as “the Arranger” and to Chase as “the Depositary” and also began with a recital:
“The Depositary has been requested by the Arranger to accept a 100 per cent participation (which participation is documented by [the sub-participation agreement] ... in the principal and interest (‘the Payment Rights’) in respect of [US$20.5m of the notes] and to issue upon and subject to the terms of this Agreement transferable depositary receipts (‘Receipts’), each  evidencing the existence of a fiduciary contract (contrat fiduciaire) in respect of the Payment Rights between the Depositary as fiduciary and the holder of the relevant Receipt.”

9. 	Clause 3 provided that the Arranger should enter into the sub-participation agreement and repeated that –
“The relationship between the Arranger and the Depositary shall be a debtor-creditor relationship.  The Depositary shall have no rights of Ownership in the Notes nor will the Arranger act as agent or trustee for the Depositary in relation to the Notes.”

10. 	Clause 4 provided that Chase as depositary was to issue a “Global Receipt” against “transfer to it of the Payment Rights” and that the Global Receipt would “represent an amount of [US$20.5m] in Receipts”.  The notional Receipts thus represented could be dealt in through the Cedel and Euroclear clearing systems.  A Schedule set out the form of the Global Receipt.  It certified that Chase constituted the fiduciary contracts evidenced by the Global Receipt and that –
“the Payment Rights and any amounts of principal and interest received by the Depositary thereunder constitute fiduciary assets of the Depositary.”

11. 	Thus Chase held its rights under the sub-participation agreement in trust (under Luxembourg law) for the receipt holders in proportion to their holdings.  In accordance with the provisions of the sub-participation agreement, it transferred all rights to the receipts to SIBL as consideration for the sub-participation.  The transaction as between SIBL and Chase was therefore, in economic terms, essentially circular. SIBL granted Chase a sub-participation which required SIBL to pay to Chase the whole of its financial entitlement under the bonds and Chase gave SIBL receipts which entitled it, by way of fiduciary contract, to all the rights it had granted by way of sub-participation.  Having set up this machinery, SIBL then sold the receipts in the market for real money.  It thereby reimbursed itself for the money it had paid Woodchuck for the bonds. One of the purchasers of receipts was the appellant, Lloyds TSB Bank (“Lloyds”). 

12. 	The two pairs of agreements were executed on 19 November 1996 and 6 February 1997 respectively.  Until February 1998 SIBL paid over to Chase the interest received from Bombril under the bonds.  But on 3 March 1998, before Chase had distributed the interest payment to the receipt holders, SIBL resolved upon a creditors' voluntary winding up.  The last interest payment and a single bullet repayment of capital was made in August 1998. Both interest payments and the capital payment have been held by Chase in a special interest bearing account pending a decision of the court as to whether they belonged to the receipt holders or the general creditors of SIBL.

13. 	The liquidator of SIBL took out an originating summons seeking directions as to whether the payments held by Chase formed part of the general assets of SIBL or fiduciary assets held by SIBL on behalf of Chase.  Sawyer CJ decided that they were held in trust for the receipt holders.  The Court of Appeal, by a majority (Zacca P and Churaman JA, Ganpatsingh JA dissenting) reversed the decision of the Chief Justice and held that the money formed part of the general estate of SIBL.
14. 	It is agreed that the rights of the receipt holders under their fiduciary contracts with Chase are no greater than the rights Chase acquired under the sub-participation agreement.  It is those rights, and those only, which Chase holds as fiduciary.  The question therefore involves ascertaining precisely what rights Chase acquired under the sub-participation agreement.  Again, it is agreed that this depends upon the construction of the agreement.

15. 	The term “sub-participation agreement” is not a legal term of art like “assignment” or “trust”.  It is however a term commonly used in the market and there was before the courts in The Bahamas a good deal of evidence about what it meant.  Such evidence, showing what certain words would have been understood to mean in the relevant trade at the time of the agreement, is in their Lordships' opinion admissible as part of the background against which the agreement should be construed.   

16. 	A sub-participation appears to be a transaction generally used by banks in connection with loans rather than bonds, for the purpose of enabling a lending bank to pass on all or part of the debtor risk in a loan it has made.  Mr Philip Wood, in his standard work on International Loans, Bonds and Securities Regulation, published in 1995, describes (at p. 104) various ways in which a lender (“the lead bank") may grant another bank “participations” in “a loan or other credit facility already entered into”. They include novations, assignments and “sub-participations”.  A “sub-participation” is described (at p. 110-111) as a transaction in which –
“the participant places a deposit with the lead bank in the amount of its participation and the lead bank agrees to pay to the participant amounts equal to the participant's share of the receipts by the lead bank from the borrower if and when received ... The lead bank does not assign or declare a trust of any part of the original loan in favour of the participant.  The participant is a creditor only of the lead bank and not the borrower.  If the lead bank becomes insolvent, the participant is an unsecured creditor of the lead bank ... Therefore the participant has a double risk - the risk of the borrower and the risk of the lead bank.” (Italics in original).

17. 	There is a similar description of a “sub-participation” in a paper (BSD/1989/1) published by the Banking Supervision Division of the Bank of England in 1989 for the guidance of banks subject to supervision.  It describes “sub-participation” as a “back-to-back non-recourse funding arrangement” which creates a debtor-creditor relationship without giving the participator any interest in the underlying loan. 

18. 	Mr Milligan QC, who appeared for Lloyds, rightly pointed out that the fact that the parties labelled their agreement a “sub-participation agreement” did not necessarily mean that it had to have the legal consequences described by Mr Wood and the Bank of England.  The legal rights and duties created by the contract were a matter of construction for the court.  Whether those legal rights and duties, as ascertained by construction, should be regarded as having a particular legal character was a question of law: see Street v Mountford [1985]  AC 809 (lease) and Agnew v Commissioner of Inland Revenue [2001] 2 AC 710 (floating charge).  The label was not conclusive.  Nor was it conclusive as to whether a transaction fell within a particular market category.

19. 	Mr Milligan referred to a number of cases which showed that an agreement for consideration to make a payment out of money receivable at a future date will be construed as an equitable assignment, either absolute or by way of charge, transferring a proprietary interest to the assignee as soon as the money is received.  Cotton v Heyl [1930] 1 Ch. 510 provides a simple illustration of this principle.  Mr Milligan said that if upon its true construction the sub-participation agreement was an agreement requiring SIBL to pay Chase the interest and capital received under the bonds as and when it was received, it constituted such an assignment. The fact that the parties chose to call it a sub-participation or described their relationship as debtor and creditor was irrelevant.

20. 	Their Lordships do not find it necessary to pursue this argument to its conclusion (which may well be right) because its fundamental premise is that, as a matter of construction, SIBL was obliged to pay Chase the money which it received from Bombril.  The first question is whether this premise is right. Does the sub-participation agreement show an intention that the money received from Bombril should be the source of the payments to Chase or only the measure of those payments?  

21. 	The evidence of market practice shows that various methods exist by which banks which have granted credit facilities (or acquired rights under credit facilities originally granted by others) can reduce or eliminate their exposure by passing on the risk to others. In some cases these involve giving the participator a proprietary interest in the debt and in other cases they do not. One would therefore expect the instrument to be drafted with a view to making it clear which method had been chosen.

22. 	In the present case, the main operative clause (2.1) states immediately after the grant of “a participation in the Payment Rights” that “the relationship between SIBL and the Participant thus arising” (ie. from the grant of the sub-participation) “shall be a debtor-creditor relationship”.  It goes on to say that the Participants “shall have no rights of ownership in the Subject Notes” and that SIBL does not “act as agent or trustee for the Participant”.  This may be contrasted with the position of Chase, which is expressly declared by the Deposit Agreement to be a fiduciary.  Furthermore, the sub-participation is defined in clause 2.2 as being the right to “such amount being equal to the amount so received or recovered by SIBL” (Italics added).

23. 	Their Lordships think that it would be hard for the draftsman to have made it clearer that he was intending the sub-participation to have precisely the effect described by Mr Wood and the Bank of England.  The agreement contains no words declaring a trust or assignment.  And the words “equal to” are calculated, as Churaman JA emphasised in the Court of Appeal, to make it clear that the payments received are only the measure of SIBL’s obligation to Chase. 

24. 	Mr Milligan drew attention to various turns of phrase which were consistent with an assignment of a beneficial interest in the proceeds of the bonds: for example, clause 3 of the deposit agreement provided that on receipt of payments from Bombril, SIBL should instruct the transfer of “such funds”, rather than “an amount equal to such funds”, to Chase.  The same clause provided that SIBL should retain “all rights as a Noteholder (other than the Payment Rights)”.  The Payment Rights were defined as the right to receive the interest and capital due under the bonds.  So this language suggested that SIBL was not retaining the Payment Rights and had  therefore assigned them to Chase.

25. 	Their Lordships agree that these and other linguistic inconsistencies can be found in the documents.  But they cannot detract from the clear and uncompromising language of clause 2 of the participation agreement, the operative clause, which firmly identifies the arrangement as being a sub-participation as commonly understood.

26. 	It is also true that the arrangement appears to have been used in  a somewhat unusual context: as part of the machinery for refinancing part of a bond issue rather than for passing on the economic benefit of an existing bank loan.  Both the Chief Justice and the Court of Appeal appear to have attached some importance to whether SIBL first acquired the bonds with its own money and then reimbursed itself by selling the derivatives, or whether it used the proceeds of the derivatives to pay Woodchuck for the bonds.  But their Lordships do not think it matters.  It appears clear that although SIBL provided bridging finance, the object of the transaction was to refinance the bonds with money paid by purchasers of the derivative receipts.  The provision of bridging finance cannot affect the meaning of the sub-participation agreement, which is entirely a matter of construction and, in their Lordships' opinion, admits only of the meaning it was given by the majority in the Court of Appeal.  

27. 	Mr Milligan advanced a subsidiary argument that even if the relationship between SIBL and Chase was debtor and creditor, it would be unconscionable for SIBL in liquidation to retain money which was intended for Chase: compare Re Japan Leasing (Europe) plc [1999] BPIR 911. But their Lordships consider (and they think Mr Milligan really accepted) that if upon the true construction of the agreement the money was not intended to be the source of the payment to Chase, there is nothing unconscionable about requiring Chase to share pari passu in the distribution of SIBL's assets like any other unsecured creditor. Their Lordships will therefore humbly advise Her Majesty that the appeal should be dismissed.  The appellants must pay the costs before their Lordships' Board.