Sub-participation or loan?

The Court of Appeal recently handed down judgment in Yieldpoint Stable Value Fund, LP v Kimura Commodity Trade Finance Fund Limited [2024] EWCA Civ 639, on Kimura's appeal from the High Court's decision¹ that a participation agreement between Yieldpoint and Kimura should be properly construed as a loan. The Court of Appeal allowed the appeal and found that the participation agreement should be construed as a sub-participation and not a loan.

Brief facts:

• Kimura in its capacity as a lender had provided a loan facility (the "Facility") to Minera Tre Valles SPA ("MTV").
• Kimura and Yieldpoint entered into a master participation agreement (the "MPA") based on the Bankers Association for Finance and Trade (BAFT)'s standard form of master participation agreement for trade transactions. The MPA was a framework agreement that allowed the parties from time to time to enter into sub-participations in respect of specific trade transactions by exchange of an "Offer" and "Acceptance". The terms of the MPA stated that the "Participations" concluded between the parties were sub-participations such that the "Participant" (i.e. Yieldpoint in this case) would only receive its share of recoveries and income if such amounts have been received by the "Seller" (i.e. Kimura in this case). The MPA also included an equitable assignment (expressed as a sale and not as a security) by Kimura to Yieldpoint of its rights, title and interests against the "Recourse Parties" (i.e. MTV in this case).
• Kimura and Yieldpoint entered into a funded sub-participation in respect of the Facility, where Yieldpoint paid to Kimura a participation amount in respect of a portion of the Facility.
• However the standard form "Offer" was amended to include (i) a "Maturity Date of the Participation", which was set as 1 year from the start of the sub-participation, and (ii) certain special conditions setting out a process for Yieldpoint to renew the sub-participation prior to the expiry of the maturity date.
• MTV defaulted on the Facility prior to the maturity date of the sub-participation.
• Yieldpoint demanded repayment of the participation amount from Kimura, arguing that the arrangement was in fact a fixed term loan from Yieldpoint to Kimura and that Yieldpoint was not intending to accept credit risk in respect of MTV or the Facility, save in respect of the income payments (i.e. interest payments from MTV to Kimura).

Decision of the High Court in the first instance:

The High Court found (although to some extent reluctantly) that the inclusion of the maturity date in the Offer, and the absence of any mechanism in the Offer or the MPA to unwind the sub-participation at such maturity date, were sufficient features for the Court to determine that the parties had intended to depart from the pre-ordained sub-participation structure set out in the MPA and that, rather, the arrangement should be properly construed as a fixed term loan. The Court instructed Kimura to repay the participation amount to Yieldpoint.

Overturned by the Court of Appeal:

The Court of Appeal found that the High Court had made a number of errors in coming to its conclusion, including relying on certain likely inadmissible pre-contract negotiation evidence that did not add anything to the written documentation and by dismissing Kimura's argument that Yieldpoint's interpretation was highly uncommercial. The Court of Appeal instead found that it "seem[ed] permissible and appropriate to interpret the inclusion of the [maturity date in the Offer] as entitling Yieldpoint to be repaid on that date at par, absent an [MTV] default in the preceding 12 months"².

Takeaway points:

• The inclusion of provisions which result in a sub-participation terminating prior to the relevant participated transaction will not in, and of themselves, result in a sub-participation being recharacterised as a fixed term loan, and an interpretation that would involve "overturn[ing] the entire structure and effect of the umbrella agreement stated to govern" the transaction will not be permitted, absent a clear intention of the parties to such effect³. However, market participants drafting such provisions or other loan-like features and terms should do so with care and with sufficient clarity as to their purpose and how they should be construed.
• When interpreting contracts that may contain countervailing provisions, you should "seek to read all the contractual provisions together, in order to reach a coherent interpretation of the entire contract which conforms with commercial sense"⁴.
• Although not a legal term of art like an "assignment" or a "trust", the English courts recognise the concept of a sub-participation as being a debtor-creditor relationship between a grantor and a participant, where the participant accepts certain pre-agreed credit risks in respect of a transaction originated by the grantor with a counterparty, and the participant does not obtain any direct rights against the counterparty. However, as is the case in the BAFT master participation agreement for trade transactions, there is no reason why the grantor cannot agree to transfer to the participant certain of its rights against the counterparty so that the participant does have direct rights against the counterparty.
• The importance of considering a proposed deal not only from the perspective of all going to plan but also expressly addressing how the transaction documentation will respond to any default or non-performance.