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• 07 May 2024

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From the Stephenson Harwood book (2024):

4.3 DISCRETION TO AGREE MODIFICATIONS

4.3.1 Introduction
A bond trustee will usually be given limited power to agree modifications to the terms of the trust deed (or the terms and conditions of the bonds), without seeking the consent of the bondholders. This limited power will ordinarily extend only to modifications that fall into one or more of the following categories:
• Modifications of a 'formal, minor or technical nature'.
• Modifications to correct a manifest error.
• Modifications where the bond trustee is of the opinion that the modification is not materially prejudicial to the interests of the bondholders. Any such power to determine no material prejudice will often be further limited so that it is not capable of extending to the modification of important commercial terms which require a higher quorum at meetings of bondholders (entrenched terms which are commonly referred to and defined as 'Reserved Matters" or 'Basic Terms Modifications' in the trust deed). 

If the bond trustee is not able or willing to exercise this power, it will be necessary for the bondholders to pass a resolution approving the modification. Under the terms of the bond trust deed, this will typically require: (i) the convening of a bondholder meeting to consider and vote on the modification; or (ii) the passing of a written resolution (if the trust deed provides for this - some older trust deeds may not and, where they do, the participation thresholds tend to be high).

Achieving bondholder consent to a modification can be an expensive and time consuming process. Consequently, it will be tempting for an issuer to seek to persuade a bond trustee that a proposed modification fits within the discretionary categories specified above. However, to ensure that it will not be held liable for acting outside the authority conferred by the trust deed, a bond trustee must be satisfied that any consent it gives is firmly within the four corners of its discretionary power.
 

4.3.2  Relevant Law
What constitutes a modification of a ‘formal, minor or technical nature’?
It is difficult co point to any hard and fast rules on exactly what is meant by these terms. One view (https://www.lexisnexis.co.uk/store/products/fuller-the-law-and-practice-of-international-capital-markets-third-edition-skuLPIC3) which seems to us to be sound and sensible, is as follows:

• A formal modification is a modification that does not change the substan­tive legal effect of a document.

• A minor modification is a modification that may change the substantive legal effect of a document, but only in such a way that its effect on the rights of the parties is unimportant.

• It is not altogether dear how a technical modification differs from a for­ mal or a minor modification, but arguably could include, for example, the modification of a reference to a data source or a technical term (such as a statutory provision that has been modified or superseded).

'When can an amendment be made to correct a 'manifest error'?

A manifest error is one which is so obviously wrong to the reader, applying reason, that there is no room for a credible argument to the contrary. Judicial reference is often made to the definition of manifest error given by Lord Lindley “oversights and blunders so obvious as to admit of no difference of opinion”. Recently, the judge in Flowgroup Plc (In Liquidation) v Co-operative Energy Ltd [2021] EWHC 344 (Comm) (19 February 2021) (while applying the phrase in a slightly different context) agreed that a manifest error must be more than just a wrong answer, it must be a 'howler'. It is, however, important to note that a manifest error does not always have to be immediately obvious. For complex transactions, it might be necessary to perform a detailed analysis so as to ascertain whether there is indeed manifest error in the relevant document. However, the test will then be if, when that analysis has been done, the error is sufficiently obvious as to count as a 'manifest error'. The following concepts are now also generally accepted:

• It is possible to rake account of related (and substantially contemporaneous) documents (and not just the document containing the potential manifest error) to form a view as to whether there is indeed a manifest error.

• Any solution to 'fix' a manifest error should also be obvious.

Some trust deeds now include the ability for a bond trustee to agree to modification which, in its opinion, is necessary to correct a 'proven error' (or similar drafting). It seems to us that it would be reasonable for a bond trustee to apply similar considerations to those set out above when forming its opinion as to whether there is a 'proven error'.

When can a trustee determine that a modification is ‘not materially prejudicial to the interests of the bondholders’?
Often it will not be straightforward for a bond trustee to form the opinion that a proposed modification is not materially prejudicial to the interests of the bondholders. The bond trustee will need to consider the following:

• Whose interests are relevant? The starting point should always be that the bond trustee should consider the interests of the holders as a class (and should not consider the position of any particular bondholder or group of bondholders). However, a careful check of the transaction document will be essential. It is not always a straightforward matter for the trustee to determine whose interests it needs to consider. Depending on the type of transaction and the drafting of the particular transaction documents and the trust deed could dictate that the interests of only certain classes of bondholders (such as the most senior class) should be considered by the trustee in certain circumstances.


• What is the nature of the proposed discretion? 

If the bond trustee's power to determine no material prejudice has been limited so that it does not apply to reserved matters or basic terms 
modifications (which will usually be the case), it will be important to assess the nature of the modification.

• What is meant by 'material prejudice' in this context? 

It is generally consid­ered that 'material' prejudice in this context means prejudice that is more than de minimis. A bond trustee is also likely to need to consider potential (as well as actual) prejudice when it is exercising this discretion, which can introduce a broad range of potential considerations. This contrasts with the bond trustee certifying material prejudice in relation to certain events of default, for instance when the bond trustee needs to confirm that the relevant event has caused actual (and not potential) material prejudice.

4.3.3  Practical Considerations
(1) The bond trustee is not under any obligation to exercise its discretion to modify- as it is a power. Furthermore, under most trust deeds, the bond trustee will usually be entitled to decline to take any form of action unless it is indemnified to its satisfaction.

(2) The circumstances in which a modification counts as being of a 'formal, minor or technical nature' or being required to correct a 'manifest error' are likely to be relatively rare.

(3) Bond trustees will ordinarily not wish to make a determination as to the absence of material prejudice, other than with the benefit of expert advice on which they can rely without liability. For example, under most trust deeds a bond trustee can usually rely (without liability for doing so) on one or both of the following:

• Expert legal, financial, or other professional advice.
• Certificates issued by one or more directors of an issuer, confirming certain factual matters.

(4) Where an issuer is seeking to persuade a bond trustee to exercise it discretion, it may present the bond trustee with a so-called 'Consent Letter'. Among other things, this letter may seek to do the following:

• Explain the background for the request.
• Provide an analysis of why the trustee should be able to exercise discretion (by reference to facts, not opinions, which are confirmed by the person providing the Consent Letter to be accurate and complete).
• Signpost provisions of the trust deed which the bond trustee should reference (including those which empower the bond trustee to exercise a discretion).
• Confirm that no event of default has occurred, nor will one arise as result of the consent being given.

The bond trustee should ensure that any Consent Letter is drafted in such a way that it dovetails into the protections available to the bond trustee under the trust deed. So, if the trust deed provides that the trustee can rely on a certificate as to matters of fact or expediency, duly signed by two directors of the issuer, the Consent Letter should be signed in that way and contain information consistent with those requirements. However, if there are legal or financial issues to consider, a bond trustee will probably also wish to seek its own expert advice.

(5) Trustees have sometimes looked to use so-called 'negative consent' procedures. Under a negative consent process, the bond trustee informs bondholders that it is intending to exercise its discretion unless the bondholders provide objections to the bond trustee within a particular timeframe. While this might be useful to indicate to the bond trustee any strong bondholder feeling about certain changes, the trust deed will not usually provide for this type of process. Further, under English contract law, silence does not constitute acceptance. Therefore, the bond trustee will not be fully protected when relying on such a process and it must still always form its own carefully considered opinion when exercising a discretion in these circumstances.

(6) While a trustee can rely on various protective provisions in the trust deed, and this can be informed by relevant and appropriate advice and confirmations of fact, it will ultimately still have to form its own view when exercising a discretion and should document its decision process.

(7) It remains possible for the trustee to seek the assistance of the court where there are mistakes or ambiguities in trust documents and the bond trustee is concerned about its own potential liability in agreeing or pursuing a particular course of action. Depending on the issue to be resolved and the attitude of the relevant parties, this would ordinarily be dealt with by way of a construction hearing or by way of rectification of the trust deed. As with many court-based processes, these tend to be time-consuming and expensive.

(8) It will always remain open to an issuer to seek bondholder consent to a proposed modification via the normal mechanisms in the trust deed (e.g. a resolution passed by the appropriate majority at a quorate meeting of holders or, if the trust deed provides for it, a written resolution).

 See also the question on inherent discretion: >Can you explain who instructs a security trustee and how? 

RA

Rachel Amos

07 May 2024

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