Declaring an event of default: termination tips

A recent case involving the repossession of an aircraft by a secured lender considered whether a loan agreement had been validly terminated so as to permit enforcement of security. The issues raised are a useful reminder of best practice when working through a default scenario and the risks that can arise.

Background

Lombard North Central plc v European Skyjets Ltd (in liquidation) [2022] EWHC 728 (QB) is a High Court decision arising out of a dispute between a secured lender, Lombard (the claimant), and the owner of the aircraft, European Skyjets Ltd (the defendant).

The lender provided a secured loan of USD8.8 million to the owner, to be repaid in 120 monthly instalments, with the lender being granted a mortgage over the aircraft. The owner subsequently defaulted on several payment instalments due under the loan agreement. While these defaults continued throughout 2010 and 2011, payments were made on occasion throughout this period, such that the owner was not continuously in arrears.

In 2012, the owner was said to be insolvent on a cashflow basis. The lender terminated the loan agreement, exercised its power of sale as mortgagee under the aircraft mortgage, and demanded that the owner pay the outstanding sum of USD5.9 million.

The only event of default specified in the termination notice was the failure to make payments due. However, evidence adduced at trial suggested that other events of default had occurred, including a breach of the warranty regarding the maintenance arrangements for the aircraft; a material adverse change in the financial health of the owner; and a failure to make a payment as requested by the lender to maintain the loan to value ratio (being the value of the aircraft divided by the outstanding balance of the loan expressed as a percentage from time to time).

The owner brought a counterclaim for GBP26m in damages, contending that the lender was not entitled to terminate the loan agreement and that, in selling the aircraft, the lender had breached its duties as a mortgagee.

Judgment

Mr Justice Foxton held that the lender had been entitled to terminate the loan agreement, and that it was justified in selling the aircraft. In doing so, he considered the following issues, which offer some helpful reminders of key points to think about when considering your position following a potential breach:

Must any default be continuing as at the date of termination?

Clause 9.1(a) of the loan agreement provided that an event of default would occur if the owner defaulted in the payment of principal, interest or any other sum payable under any transaction document.

Clause 9.2 of the loan agreement provided that at any time after the occurrence of an event of default, the lender could by notice to the owner cancel the facility and require the immediate repayment of the outstanding loan together with accrued interest and all other sums payable under the loan agreement.

There was no doubt that the owner had repeatedly failed to pay the monthly instalments when due, but the question arose as to whether there had to be an amount outstanding as at the date of termination, i.e. notwithstanding that interim (late) payments had been made. As a matter of construction of the words of the loan agreement, the judge concluded that (i) there was a breach of clause 9.1(a) whenever an amount was not paid when it was due to be paid; and (ii) clause 9.2 did not require the event of default to be continuing at the date the notice of cancellation is served, but rather entitled the lender to declare an event of default “at any time” after the occurrence of the event of default in question.

Has the right to declare an event of default been waived?

The owner then argued that the lender had waived its right to treat late payments as events of default, and therefore lost its right to terminate the loan agreement. This argument was made on the basis that the lender had accepted late payment and had given the owner additional time to clear outstanding arrears.

The lender sought to rely on a “no waiver” clause in the loan agreement, which prevented any failure or delay on the part of the lender in exercising any right, power or privilege under the loan agreement from operating as a waiver. The lender also relied on a general reservation of rights statement made repeatedly in e-mail correspondence to the owner. However, the court found that neither the clause nor the statement was sufficient to override an explicit communication sent from the lender to the owner giving the owner the opportunity to regularise the position by a specific date. In this case, the waiver did not result solely from a failure to exercise or delay in exercising a right (as provided in the relevant clause), but rather from positive statements made, which implicitly accepted that if payment were made, the lender would not seek to claim an event of default for past delays in payment.

What if the breach is de minimis?

The owner sought to argue in the alternative that any breach was too small to be meaningful, such that the exercise of the lender’s contractual rights was inequitable. The judge rejected this argument on the basis that it is well-established in English law that where parties have made a breach of a particular obligation a condition of the contract, giving the right to terminate, that right is available without regard to the magnitude of the breach. The judge confirmed there was no scope for a de minimis obligation so far as the failure to pay instalments under a loan is concerned.

What does the termination notice have to say?

The Judge also considered whether the lender’s termination notice was compliant with the relevant contractual provisions. Specifically, he considered whether it had to identify the events of default being relied upon, and whether it needed to accurately specify the sums due. In this case, the lender had mentioned only one ground of default (which had not, in fact, arisen) and had inaccurately included claims for accrued late payment charges which it subsequently accepted were not due. On the precise wording of the relevant clauses in the loan agreement and the mortgage, the judge found that there was no provision requiring the event of default to be identified, or for the amount due to be accurately stated. The judge decided that the owner was “no worse off by reason of the inclusion of an invalid ground than if nothing had been said at all”. Provided the lender could establish an event of default had occurred, its notice was effective.

Is the relevant clause a penalty?

The owner also argued that clause 9.2 of the loan agreement was void as a penalty, because it entitled the lender to render the full amount of the outstanding balance immediately payable and to take possession of the aircraft following an event of default which might, of itself, have little or no significant consequences. The judge rejected this argument as hopeless. There was nothing inherently penal in requiring repayment of the full outstanding balance following a failure to make an instalment payment on the due date, or in a mortgagee being able to enforce its security when there is a default under a secured loan.

Is there an obligation to act in good faith when terminating?

The judge noted that previous case law has established that rights of termination are not contractual discretions to which implied duties to act rationally and in good faith should apply. Rather, the lender had a so-called “absolute contractual right” to exercise for its own purposes, as it saw fit. It was not prevented from terminating by any duty of good faith.

Comment

This judgment gives some comfort to lenders seeking to enforce their rights under loan agreements and corresponding security, but also highlights some of the potential pitfalls that may arise for both lenders and borrowers. A party who wishes to exercise a contractual right of termination by notice must strictly comply with any conditions set out in the contract for the exercise of that right. Working out what those conditions are is an exercise in the construction of the relevant contract, and so will differ from case to case. The notice provisions of your contract deserve close scrutiny, in addition to those dealing with events of default, cure periods (if any), and termination rights and remedies.

Careful consideration also needs to be given to avoid accidental waivers of rights that may already be existing under the relevant contract or at law. If offers or concessions are made to allow borrowers to regularise circumstances that might otherwise constitute an event of default, these should be carefully drafted so as to make clear what the defaulting party is required to do; by when; and what the consequences are if it does not comply. As the Judge noted in this case, “ritual incantation” of reservation of rights language cannot prevent anything said or done in previous communications from having its objective effect – in other words, reserving your rights cannot save you if you have already waived such rights.

Article co-authored by Emilija Lazarevic, trainee solicitor at CMS

To see our other law-nows on related topics, please click on the links below:

Are good faith arguments in the aviation industry really taking off? (cms-lawnow.com)

Come and get it! The meaning of “give possession” under the Cape Town Convention (cms-lawnow.com)

Impact of Russian sanctions on the aviation industry – update on UK Sanctions (cms-lawnow.com)