The global slowdown in economic activity as a result of the COVID-19 lockdown in countries across the globe has sent financial markets into a sharp descent. To counter the impacts of this downturn, companies, including those who are regular issuers of debt securities, are developing strategies to ensure they have enough liquidity to allow their businesses to survive the downturn, to service their debt levels and to perform their contractual obligations.
Note trustees for debt capital market (DCM) issuances (Trustees) need to be aware of the challenges that issuers are facing, and understand the options available to both issuers and noteholders to protect their respective interests. Trustees also need to consider their responses and obligations in different scenarios and be prepared for opportunities to demonstrate how they can add value.
Trustees that are commercial and responsive and have a depth of knowledge of debt structures and the practices in the financial markets they operate in, will be at a premium.
We summarise below some key considerations Trustees should bear in mind as they confront the expected challenges and additional demands of the upcoming months.
The most important element of preparation for any Trustee is to have sufficient resources to service any additional work. This means that adequately briefed and prepared operational and back-office teams should be on standby to deal with the increased volume of work.
Ensure compliance with trustee duties
Trustees need to be mindful that especially in the current market conditions, noteholders will closely scrutinise their actions to ensure Trustees have properly discharged their duties to noteholders.
One of the fundamental duties of a trustee is the duty to use due diligence and care in the administration of a trust. This is an equitable duty, not a common law duty, and arises out of the trust relationship. Australian courts have held that a trustee’s duty to use due diligence and care is, generally speaking, a standard of care that an ordinary, prudent person would exercise in the conduct of a business as if it were his or her own business. At the same time, the courts have not excluded the possibility that a higher standard of care could be applied to a professional trustee, commensurate with its greater expertise.
Do trustee duties extend to monitoring?
A trustee’s equitable duty to use due diligence and care in the administration of a trust has not been extended by Australian courts to require a Trustee to investigate, monitor or police the performance of any party under the note documents.
It is nevertheless common practice for Trustees in Australia to expressly disclaim monitoring duties with respect to the financial performance of the issuer and compliance by the issuer with its covenants by including such provisions (so-called “anti-Bartlett” provisions) in note trust deeds. The anti-Bartlett provisions usually also exclude a Trustee's responsibility to interfere in the running of the company if it has no knowledge of any wrongdoing, and provide that a Trustee is entitled to assume that the parties will comply with their obligations and may assume that no event of default or potential event of default has occurred until a trustee has “actual knowledge or written notice” to the contrary.
It would be prudent for Trustees to review the note trust deeds under which they have been appointed to ensure they include provisions along the above lines.
Chapter 2L considerations
In Australia, Trustees appointed under Chapter 2L of the Corporations Act 2001 (Cth) (Act) must comply with certain statutory duties.
Chapter 2L was enacted to apply predominately to retail bond issues and issues of debentures within the meaning of the Act.
The duties of Trustees subject to Chapter 2L include a duty to monitor the financial position and performance of the issuer, to exercise reasonable diligence to ascertain whether the property of the issuer will be sufficient to repay the notes, to identify whether a breach of the trust deed and the terms of the notes has occurred and to take steps to ensure that the issuer remedies any breach.
Trustees appointed to these types of issuances should review their Chapter 2L duties carefully to ensure those duties are being discharged in accordance with the required standards.
Knowledge or notice of default
Note trust deeds typically state that a Trustee’s duty to act following an event of default or a potential event of default arises where it has knowledge or notice of these events and not before. Note trust deeds will also often state there is no requirement for the Trustee to actively seek any notice or information about a potential event of default or an event of default. However, in the present circumstances, Trustees should be prepared for the possibility of receiving notifications from issuers about such events and be on the alert to process and circulate this information to noteholders.
The type of knowledge required and what constitutes “knowledge” can vary depending on the formulation in the note documents and its interpretation by the courts. For example, language referring to the Trustee having “any knowledge” or “constructive knowledge” is very broad and may result in the Trustee being deemed to have notice without having actual notice – this may be problematic. The ideal position is for Trustees not to be required to act until they receive “written notice” of default.
Use of certificates
Trustees typically have powers under the note documents to request a formal certificate from the issuer or other transaction parties (such as guarantors) in relation to a range of matters, which the trustee can then rely on absolutely and without any liability.
Where a Trustee receives any request, direction, confirmation or information from the issuer or another transaction party, it would be prudent for the Trustee to insist that this be provided in the form of a "certificate” so that the Trustee can rely on that document without liability. The certificate should include a statement of any relevant facts or circumstances with sufficient details to allow the Trustee to consider the matter in question and make a decision based on those facts.
Where an issuer has an obligation to deliver an annual compliance certificate, it is usually required to certify that no event of default or potential event of default has occurred and that the issuer has complied with its contractual obligations under the note documents as at the date of the certificate.
If a compliance certificate is overdue, this may trigger a potential event of default or even an event of default. If a compliance certificate is overdue, and the Trustee suspects that an event has occurred which may be a potential event of default or an event of default, the Trustee usually has the power to request a formal certificate from the issuer confirming the position. Often the issuer will have covenanted to notify the Trustee of the occurrence of a potential event of default or an event of default, and therefore a failure to provide the formal certificate could amount to a breach of the issuer’s obligations.
Receiving a certificate from an issuer that confirms the occurrence of an event of default will allow the Trustee to accelerate the notes (on the instructions of the noteholders). Where a certificate confirms the occurrence of a potential event of default only, although this would not allow a Trustee to immediately accelerate, it may allow the Trustee to take certain steps to protect the interests of noteholders - these might include a right to take control of agents to secure any funds before the deal goes into default and enforcement and inspection of the issuer’s books to assist in developing a recovery or work-out strategy.
Following the introduction of strict lockdown measures in most countries to contain the spread of COVID-19, the holding of physical noteholder meetings is now problematic. Trustees will need to consider whether they can hold a meeting of noteholders by telephone or virtual conference call whether, if such a meeting takes place, its validity could be challenged.
Trustees will need to consider whether the holding of a non-physical noteholders’ meeting is permitted under the note documents and if so, whether the meeting’s rules and procedures can be complied with if the meeting proceeds in this manner. If there is doubt Trustees may need to consider delaying the holding of the meeting altogether or at least while legal advice is sought.
A Trustee often has a power, subject to its sole discretion, to prescribe further regulations regarding the holding of, the attendance and voting at, a noteholders’ meeting. This power does not usually require consent from the issuer or noteholders. Depending on the drafting of the meeting provisions, Trustees who agree to a non-physical noteholders’ meeting have two options in regard to meeting procedures: first, to closely adhere to the formula prescribed in the note documents and use the same meeting documents; or secondly, where it is not appropriate to apply the same procedures, to amend those procedures, or at least some aspects of them to enable more express communication to ensure the proper functioning of the meeting. Any changes to the procedure will require a Trustee to positively exercise its discretion to do so and it would be prudent for the Trustee to notify noteholders accordingly.
The verification of the identity of attending noteholders and other parties is another matter which a Trustee should consider and address before the meeting is held. If inadequately resolved, this could impact whether the required quorum was present or whether the relevant majority vote was achieved.
Although notice provisions can be overlooked during commercial negotiations, they can be critical when there is no time to waste in a distressed or enforcement scenario. To avoid any possible dispute in respect of the valid delivery of a notice, the notice provisions in the note documents should be strictly followed. Boilerplate notice provisions do not usually factor in any delay in the actual receipt of notices caused by travel restrictions, office closures or other COVID-19 imposed measures. It may therefore be prudent for Trustees to request additional written or electronic acknowledgements of receipt where this is practicable, rather than relying solely on deemed receipt provisions.
Issuers who are in financial distress as a result of the global slowdown will already be reviewing their obligations under note documents and will need to seek solutions where compliance is a concern. Therefore, we expect that Trustees will see an increase in requests to consider certain note provisions and make determinations where this is required. Inevitably, there will be disagreements as to interpretation. Simple cases may be resolved by a Trustee taking legal advice, while the more complex may require the advice of a leading counsel or, in a serious case, the making of an application to Court for directions as to how to proceed.
Trustees should ensure their note documents give them the ability to rely on advice from legal counsel and other professional advisors when making determinations under the note documents and also provide for a right to be reimbursed or indemnified for any associated costs that they incur.
We can expect to see an increase in disputes as issuers become subject to financial stress and this may extend to Trustee determinations under note documents. If the parties are unable to reach agreement in relation to a Trustee’s determination, an application may need to be made to the courts for, amongst other things, a declaration as to the validity of the Trustee’s determination as a way to resolve such dispute conclusively between those parties. Social distancing will make it increasingly challenging to run an expedited court process, with any delay potentially exacerbating existing difficulties.