In debt capital markets and structured finance transactions, a trustee is often appointed to represent the interests of noteholders in the transaction and hold the benefit of, for example, the covenant to pay and security. The trust deed appointing the trustee typically provides it with an express discretion, on prescribed grounds, to consent to a modification without the consent or sanction of noteholders. This discretion is important for the efficient running of the debt transaction as it reduces the need to obtain costly or time consuming resolutions/directions from the noteholders in respect of a requested modification.
One of the prescribed grounds on which a trustee can exercise this discretion is if the modification is not materially prejudicial to the interests of the noteholders. This ground is popular among both trustees and the parties requesting amendments because it is flexible. In addition, the documentation usually also allows a trustee agree to a waiver/consent on the same grounds, without reverting to the noteholders. However, for a trustee, deciding what is, and is not, materially prejudicial can be difficult and involves some risk.
Our corporate trust and agency team regularly advises trustees and issuers on the exercise of this discretion, and its limitations. To do so, we set out a decision making framework that indicates the factors to be considered and tools which can be employed to help reach a decision. This allows trustees to considerately and thoroughly discharge their legal and fiduciary duties to the noteholders, while balancing their risk with the need to be practical and add value to the transaction. We discuss some key aspects below.
The typical trust deed provides that the trustee has the discretion to consent to modifications to the transaction documentation without needing noteholder consent if, in the opinion of the trustee, the modifications are:
To correct a manifest error
Formal, minor or technical in nature, or
Not materially prejudicial to the interests of the noteholders
Depending on the transaction, there may be other/additional grounds set out in the trust deed but these would be the most common. Our experience, and market trends, would suggest that the first two grounds are of limited scope and applicability and do not apply to waivers/consents. In contrast, the third ground is more flexible in scope and applies to modifications and waivers/consents. This makes it more useful, even if determining what is, or is not materially prejudicial can be a difficult task for trustees.
It is worth noting as a preliminary point that the trustee’s use of this discretion is a matter for the trustee to decide upon. It is certainly not bound to use the discretion, to agree to a request. That said, in order to fully discharge its fiduciary duty to noteholders, the trustee must actively consider the request, even if it ultimately decides not to consent. This means that a trustee cannot really deal with these requests passively through inaction.
What is “not materially prejudicial”?
First it is necessary to decide whether the requested modification/waiver/consent is “not materially prejudicial”. This generally involves a factual determination by the trustee as to what the impact on noteholders may be if it agrees to the request. Relevant matters to consider include:
Who could be affected if the request is granted. This is usually the noteholders, but this can be complicated if, for example, there are different classes of noteholders, where one is affected and another is not
What rights/interests of the noteholders could be affected for example, what covenant, clause or provision benefitting the noteholder is at question, and
How could the noteholders be affected for example, what would the practical effects be for the noteholders if the trustee agrees?
Decision-making framework for the trustee
An important tool in assisting a trustee is a certificate, also known as a trustee consent letter, from the party requesting the modification. This is often the issuer or, if there is one, the originator or servicer. The purpose of this certificate is to establish the facts upon which the trustee can base its assessment and determination as to whether the modification/waiver/consent is materially prejudicial. The content will differ from transaction to transaction, but our experience is that they will usually address four main areas:
The factual background to the request and why the trustee’s consent is required
A clear request to the trustee to exercise its discretion to agree to the modification/waiver/consent, and on which ground i.e. it is “not materially prejudicial”
Confirmation of the specific powers the trustee is being requested to use. If relevant, it should also confirm that the decision does not relate to ‘reserved’ or ‘entrenched’ matters, which always require noteholder approval, and
Confirmation that the modification/waiver/consent would not be materially prejudicial to the noteholders, and detail as to how this conclusion has been reached
The trustee must still form its own opinion, but such certificates can be very useful in ensuring the trustee is aware of all relevant facts.
In addition, a trustee will usually have the right to request to be further or specifically indemnified, secured and/or prefunded to its satisfaction before consenting. This can be useful in circumstances where, regardless of the steps taken above, there may be some noteholders that are dissatisfied if the trustee agrees to the request. In that context, a trustee should examine the transaction documentation to establish if it is possible to obtain a further or specific indemnity in respect of its exercise of discretion. This could give the trustee a financial back stop and support its legal and factual analysis as to exercise of this discretion.
The exercise of discretions by a trustee can be one of the key ways it demonstrates its value and flexibility on a transaction, considering the often lengthy and time-consuming alternative of obtaining noteholder resolutions or directions. Noteholder apathy in respect of such requests could also be challenging. The question of what is, or is not, materially prejudicial to noteholders is by no means an easy one. However, we believe the above framework can be of assistance to trustees in working through what can be a very thorny area.
For more information on this development, contact a member of our Debt Capital Markets & Listing team.
The content of this article is provided for information purposes only and does not constitute legal or other advice.