Contingent liabilities – can security endure after the loan has been repaid?

Briefing

In Kendall v Morley, Anderson J controversially found that a borrower's security continued to secure a lender's future litigation costs, despite the principal and interest having been repaid in full. This was based on the "contingent liability" wording found in the Security Agreement.

Facts

Industrial North West LLP (INW) was a property developer, set up to acquire and develop interests in Merseyside. On 19 April 2018, it entered into a £61.25 million Facility Agreement with Fairfield (F) as lender to purchase five plots of land. This contained the following Clause 14.5:

"The Borrower shall…pay to each Secured Party the amount of all costs and expenses (including legal fees) incurred by that Secured Party in connection with…any proceedings instituted…against that Secured Party as a consequence of it entering into a Finance Document".

The loan was secured by a Security Agreement. This contained the following standard 'market' terms:

Secured Liabilities were defined as "all present and future obligations and liabilities (whether actual or contingent… of the Chargor to any Secured Party under or pursuant to any Finance Document…"
a covenant to pay
a provision that the security would "extend to the ultimate balance of the Secured Liabilities regardless of any …discharge in whole or in part"
the end of the Security Period was defined as the date on which "all of the Secured Liabilities have been unconditionally and irrevocably paid and discharged in full".

The Facility Agreement contained a condition that INW had to prove (by 2 May 2019) to F's satisfaction that it had obtained a commitment from a third-party lender to refinance the loan. The long-stop date passed, and F accelerated the loan on 8 May.

Administrators were appointed. Three of the five plots of land were sold by them and the sale proceeds repaid the loan in full.

The owner of INW, Mr Morley (M), contended that it had not been in breach of the Facility Agreement. He threatened to take F to court. His solicitors separately reserved his rights to dispute the issue, but no proceedings had yet been issued.

F took the view that M was "likely to deliver" on his threat to litigate. It was then at risk of incurring significant costs in defending any claim and stated that it was entitled to recover these costs under the costs and expenses clause of the Facility Agreement. Furthermore, this was a contingent liability under the Security Agreement. F refused to consent to the sale of the two remaining properties. M was also not prepared to particularise the claim, even though F was willing to consider a partial release of the security.

Application

INW's administrators then sought directions from the Court regarding whether they should continue to treat F as a secured creditor of INW.

The questions before the Judge were whether:

Did INW have a contingent liability for F's costs of the threatened litigation within the meaning of the Agreements?
Did the Agreements continue to provide security for that liability?

M's case

M submitted that:

the costs and expenses clause only extended to the costs of proceedings that had already been issued
there could be no contingent liability for costs until proceedings had been issued
there needed to be a trigger for a contingent liability, otherwise the security would be perpetual – there would always be a risk of future litigation
if the clause was construed in a way that meant the contingent liability provided security for costs after the loan was repaid, this would give F an objectionable collateral advantage in being able to demand that threatened claims be renounced
the continuation of the Security Agreement after enforcement and repayment of the principal and interest had been made would lack mutuality and would not be permitted in equity.

F's response

F responded as follows:

It was obvious, in the context of a large loan facility, that the parties intended for F to be secured for all the costs and expenses incurred in connection with the transaction.
This case could be distinguished from the body of case law relating to clogs on the equity of redemption. M could have achieved the release of the remaining assets from F's security, if it was prepared to detail its claims. F could then have taken a view on potential costs.
M's submissions that the clause was unconscionable in equity would not arise given that there was no suggestion F had acted oppressively or unconscionably.

Judgment

INW did have a contingent liability for F's costs of the threatened litigation within the meaning of the Agreements. The Agreements continued to provide security for that liability.

The Judge considered whether there was a real prospect of F incurring costs in dealing with M's application, and found that there was. M was a litigious character who was happy to bring even the most difficult claims. He had also expressed his intention to bring some form of claim against F and had reserved his rights in this regard.

Clause 14.5 was clearly drafted not only to include litigation that had already commenced, but also to cover the costs of threatened proceedings – even though they could not become a present liability until the proceedings were issued and determined. The Judge also considered the commercial context of the loan, finding that there was equality of bargaining power.

The Judge also found nothing about the contracts that were unfair or unconscionable in equity. There was nothing offensive against any equitable principle that a contingent liability could remain secured for an indefinite period.

Key takeaways

Security continued to attach to a loan in circumstances where principal and interest had been paid in full. This seems surprising, but the particular facts and the context were important in understanding the outcome of this decision:

The Judge took the view that in a commercial loan, both parties expect the lender to be reimbursed by the borrower for all costs and expenses relating to the loan.
M's arguments that F's refusal to release the security represented a clog on the equity of redemption were not persuasive either. M was given a chance to partially redeem the security by stating his case to allow the lender to work out a reasonable estimate of the costs of its defence. He refused to do so.
The prospect of litigation was not too speculative, given M's character and track record.

Lenders can take comfort from the fact that market-standard wording in loan and security documentation proved robust enough to cover the costs of borrower litigation in circumstances where proceedings had not even been issued.