Tue 18 Aug 2020

Pathway Finance Sarl v London Hanger Lane Centre Ltd

 English High Court corrects a drafting error so as to make security accession deeds effective

It is common for loan and security documents to contain lender and creditor protections in the event that an existing borrower or borrowing group of companies acquires further subsidiary companies or otherwise wants to bring other group companies into its finance arrangements.  Generally speaking, those protections are likely to require the parent company to procure that each new subsidiary becomes a party to the facility agreement as a borrower and/or a guarantor and grants security over some or all of its assets in favour of the lender(s) in respect of the obligations of the borrower and guarantor companies under the facility documentation.  That is often dealt with by way of a deed of accession to (i) the facility agreement and (ii) to the relevant security documentation.  By way of each deed of accession the subsidiary company will confirm that it intends to be bound by the terms of the facility agreement as a new borrower and/or guarantor and that it intends to be bound by the terms of the existing security agreement(s) and to grant security over its assets in the same terms as that original security agreement respectively.  Each deed of accession will refer to the original facility or security agreement so as to identify the agreement(s) which are being acceded to.  From the lender's perspective, it is clearly vital that the accession documentation works so as to bind the new companies to the original documentation.  But what happens if the description of original documentation is wrong?  Does such an error invalidate the accession and does it render any purported security interest over the assets of the acceding subsidiary ineffective or can the errors in the documents be construed differently, so as to make them effective?  These are some of the issues the English High Court recently had to consider in the case of Pathway Finance Sàrl v London Hanger Lane Centre Ltd [2020] EWHC 1191 (Ch) ("Pathway").

The facts of the Pathway case can be summarised as follows:

  • on 16 September 2011, Pathway had entered into a facility agreement with several borrowing group companies for the provision of loan facilities to those companies;
  • each of those companies entered into a security agreement which included floating charges over substantially the whole of their assets in favour of Pathway on the same day;
  • as is common in group financings of this nature, both the facility agreement and the security agreement contained provision for additional group companies to become borrowers and chargors at a later date on the same terms by way of accession to those agreements;
  • the original security agreement dated 16 September 2011 had attached to it a form of deed of accession which was to be used in the event that any additional chargors acceded to it and which cross referred to the original security agreement;
  • 87 additional group companies acceded to the facility agreement and security agreement at various times between 24 February 2017 and 12 April 2019, each executing deeds of accession;
  • each of the 87 deeds of accession incorrectly referred to the original security agreement as being dated 17 November 2016;
  • the error was subsequently discovered and the companies wanted clarity on the effectiveness of the 87 deeds of accession which had already been registered at Companies House pursuant to s859A of the Companies Act 2006;
  • in particular, Pathway sought confirmation that each of the deeds of accession remained effective particularly as they purported to create security interests over the assets of the acceding companies.  Pathway therefore asked the court to find that each incorrect reference to the date of the original security in the deeds of accession be construed as a reference to the correct date of 16 September 2011;
  • the High Court agreed and found as Pathway had requested and, in doing so, confirmed that the fact the deeds of accession had already been registered at Companies House complicated matters somewhat because copies of the documents, containing the wrong date, were available for inspection by the public at large;
  • however, the court took the view that anyone who reviewed one of the deeds of accession would either have noticed the discrepancy or would have asked for a copy of the security agreement dated 17 November 2016 and would have been told that no such agreement existed and that the only existing security agreement was that which was dated 16 September 2011.  The court gave full weight to the evidence that there was no document dated 17 November 2016 and decided that the deeds of accession should be construed as if they referred to the correct security agreement, dated 16 September 2011.  The court added that if it had not been able to make a declaration on the construction of the deeds of accession in those terms, it would have been content to grant an order for rectification of the documents.

Would this case have been decided differently in Scotland? 

It is important to note that this is an English High Court case which is not binding on the Scottish courts so no Scottish court would require to follow the English High Court's findings.  However, in recent years there have been a number of English cases which have gone to the Supreme Court on questions of contractual interpretation which would be persuasive in Scotland and which might result in similar principles of contractual interpretation being applied.  Despite that, the Scottish approach to contractual interpretation remains in a state of flux with a number of Scottish judges taking different views on contractual interpretation and how it should be approached in Scotland, including recently in several cases decided in 2019.  For example:

  • in British Overseas Bank Nominees Limited v Stewart Milne Group Limited [2019] CSIH 47 the court highlighted that a purposive and contextual approach to contractual interpretation should be adopted with a commercial common sense being central to that exercise;
  • in Burnett v International Insurance Company of Hanover Limited [2019] CSIH 9 the Inner House of the Court of Session suggestive that a purposive approach should be taken: "the construction given to the contractual wording should reflect the intention of the parties and the commercial sense of the agreement…";
  • in Our Generation Limited v Aberdeen City Council [2019] CSIH 42 the Inner House said that "a purposive construction was appropriate and commercial common sense should be applied";
  • however in Scanmudring AS v James Fisher MFE the majority of the Inner House found that a sub-sea excavator which had become stuck on the seabed had not suffered a "breakdown" for the purpose of the contract, meaning James Fisher had to pay for its use even though he was unable to make use of it whilst it was stuck on the seabed.  Lord Menzies and Lord Brodie prioritised the ordinary meaning of the language used in the contract - i.e they took the view the excavator was merely stuck on the seabed but was otherwise still operational and therefore could not have broken down.  The Lord President disagreed and applied commercial common sense, concluding that the excavator could not do what it was supposed to if it had become stuck on the seabed and therefore it had to be deemed to have broken down; and
  • some Outer House commercial judges have indicated that commercial common sense might play a more restricted role in contractual interpretation.  For example, in EOP v Carpetright Lord Bannatyne took the view that the defender in that case could not rely on commercial common sense because the language in the contract under dispute was unambiguous.  Similarly, in Drum v Buchanan Lord Ericht said that "questions of which of two possible constructions best accords with commercial common sense do not arise" because there was "no room for the defender's alternative construction".  These views therefore suggest that, for some Scottish judges at least, there may be no role for commercial common sense if the language used in a contract is clear.

It is clear therefore that, whilst there are a number of long and well established principles which apply to the interpretation of contracts, the Scottish judiciary does not always take a consistent approach or view as to how those principles are to be applied to the facts of any given case.  In any event, the matter still falls to the discretion of the court considering the dispute.  In this particular case the question arising was not one of what the language used in the deeds of accession meant but instead reference had been made to a date which was obviously wrong.  The parties did not dispute that the date was incorrect nor that there was only one original security agreement to which the companies could accede so one would hope that a commercial common sense approach would be applied in the circumstances and the same outcome would be reached in Scotland.

It is worth noting that the risk of this type of mistake happening in Scotland is generally lower than is the case south of the border because, in Scotland, chargors typically grant standalone Scots law security documents and do not tend to accede to existing security agreements by way of deeds of accession so any Scottish risk is, in many respects, limited to cross border transactions on which Scottish companies might be party to English law governed documents which are more likely to be granted and entered into on a composite basis and subsequently acceded to. 

Further, in the Pathway case the court considered the fact that none of the 87 companies involved had granted subsequent security in favour of third parties.  If any of them had done so, or any similar future case before the Scottish courts involved other creditors, the interests of those creditors and the implications of finding as the English High Court did, may be relevant for consideration particularly if applying a common sense approach might prejudice those creditors and any such prejudice to those creditors might well sway a court to reach a different conclusion.  At the very least one would expect any such creditor to have something to say about the matter.

Practical considerations

Whilst the court’s decision may provide reassurance to lenders holding securities containing incorrect cross-references to existing documents, or other errors, that nothing may need to be done in the circumstances, it goes without saying that if the effectiveness of a poorly drafted document lies at the discretion of the court, it is vital that any drafting errors (however innocuous) are avoided in the first place.  It is easy to see how this happened - a document was re-used whenever a new accession was required and so any mistakes in the first document were copied across into each subsequent deed of accession.  One should never assume that a template attached to another document is correct and lawyers should always avoid simply re-using a previous document, even if they think that previous document is correct.  Always start again from scratch when a new accession is required.  And, if all else fails, check, check and check again!

If mistakes do come to light, lenders can also consider whether supplemental security documents should be granted to provide certainty as to the lender's rights but that does take time and expense to sort out and, if the mistake is the fault of the lender or its lawyers, the borrower is unlikely to be willing to indemnify the lender for any costs incurred.  Whilst that approach might prove costly for a lender (or the lawyers who may have caused the mistake and may have to prepare supplemental security documents free of charge), a court might look favourably on a lender willing to bear the cost of correcting the mistake should that lender later need the court's assistance in the matter if the lender can demonstrate that all appropriate steps were taken to avoid use of the court's already limited time.

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