Vol 8 (2011) - Issue 2

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BNY Corporate Trustee Services Ltd v Eurosail UK 2007-3BL and others [2010] EWHC 2005 (Ch): The High Court Clarifies the Balance Sheet Insolvency Test

Introduction

The recent High Court judgment of Sir Andrew Morritt in BNY Corporate Trustee Services Ltd v Eurosail UK 2007-3BL and others1 considered the scope and application of the 'balance sheet test' set out in s. 123(2) of the Insolvency Act 1986 (as amended) (the 'Act').

The court stated that the balance sheet test under s. 123(2) of the Act, is a legal test requiring the consideration of all the relevant facts of the case when deciding on what value to attribute to the prospective and contingent liabilities of a company, and did not involve simply considering the accounting treatment of the assets and liabilities of a company.



Facts

The securitisation

In July 2007, Eurosail (the 'Issuer') entered into a securitisation of UK sub-prime residential mortgage loans. As part of the transaction, Eurosail issued notes with an aggregate value of GBP 660 million and used the proceeds of the issue to purchase sub-prime mortgage loans with a face value of GBP 650 million. These underlying mortgage loans were charged to BNY Corporate Trustee (the 'Trustee') to be held as security to guarantee the Issuer’s payment obligations under the notes. The notes issued were of five classes (A to E) denominated in different currencies with the A1 notes maturing in 2027, and the remaining notes maturing in 2045. In order to hedge its exposure to changes in exchange rates and interest rates, the Issuer had entered into currency and interest rate swaps with Lehman Brothers Special Financing Inc. ('LBSF') whose obligations under the swaps were guaranteed by Lehman Brothers Holdings Inc ('LBHI').

The terms and conditions of the notes (the 'Conditions') provided that the notes were to become repayable upon the occurrence of certain events of default and the subsequent enforcement of security by the Trustee. Condition 9(a)(iii) included the following event of default:

'the Issuer being unable to pay its debts as they fall due or, within the meaning of s123(1) or (2) … of the Insolvency Act 1986 (as that section may be amended from time to time), being deemed unable to pay its debts … provided that … the Trustee shall have certified to the Issuer that such event is, in its sole opinion, materially prejudicial to the interests of the Noteholders.'

It is an important aspect, for credit rating purposes, for the Issuer in a securitisation to be considered insolvency remote. In order to achieve this, the parties to the transaction are only able to proceed against the assets and cannot proceed directly against the Issuer. Such limited recourse structures have historically had uncertain tax consequences in the UK market and in this case issuer insolvency remoteness was achieved by the inclusion of a post-enforcement call option ('PECO') in the structure. The PECO entitles an independent company to purchase outstanding notes from the Issuer. Following such purchase, the holders of the outstanding notes bring proceedings against the independent company and no insolvency proceedings are brought against the Issuer directly.