In this brief, BSR partner Andy Bates explores the issue of transferability and the meaning of the phrase 'financial institution'
It is not uncommon for loan agreements to permit assignment by the lender to a 'bank or other financial institution'. With the significant activity in the secondary debt market over recent years, the meaning of 'financial institution' has been frequently considered by practitioners. There has, though, been relatively little judicial consideration of the same.
In Grant & Ors v WDW 3 Investments Ltd & Anor  EWHC 2807 (Ch) (Re Olympia) the Court considered the meaning of the expression 'financial institution' and adopted the same (wide) test as the Court of Appeal in Argo Fund Limited v. Essar Steel Limited  1 CLC 546 (Argo), finding that to be a 'financial institution' an institution must be:
"a legally recognised form or being, which carries on its business in accordance with the laws of its place of creation and whose business concerns commercial finance".
Background to the issue
Irish Bank Resolution Corporation Limited (IBRC) (formerly known as Anglo Irish Bank Corporation Limited) had provided loan facilities to Olympia Securities Commercial Plc (Olympia) under a loan agreement which contained the following transferability wording:
"The Lender may… at any time transfer, assign or novate all or any part of the Lender’s rights, benefits or obligations under this agreement to any one or more banks or other financial institutions."
The relevant loan was assigned by IBRC to WDW3 Investments Limited (WDW) on 16 May 2014. WDW was incorporated in England and Wales with share capital of £1 on 2 May 2014, two weeks prior to the loan transfer. WDW was a non-trading company without any employees, and held the loan as nominee for a third party.
Olympia went into administration after the transfer of the loan and an unsecured creditor challenged the validity of the assignment of the loan from IBRC to WDW, asserting that WDW was not a 'financial institution'.
The only judicial guidance on the meaning of 'financial institution' prior to Re Olympia could be found in Argo, where similar wording in the relevant loan agreement was considered. In Argo, the first instance judge concluded that a transferee had to share at least some of the characteristics of a bank if it was to be a 'financial institution' and that to satisfy that requirement it had to have at least the following characteristics:
"(1) be a lender of money, though not necessarily in the primary lending market, since ‘institutions who buy debt in the secondary market thereby become lenders by definition’;
(2) have a lending office, though the Agreement did not specify any particular form for it;
(3) maintain accounts of money lent to, and of amounts, in capital and interest due from, borrowers, which, by clause 20.5 of the Agreement, were to be ‘in accordance with its usual practice’;
(4) have the ‘capabilities, financial, technical and capacity of lending money during the draw-down period, as ‘quasi-primary lenders’ in accordance with the terms of the Agreement’; and
(5) be a ‘financial institution’ in the sense of having ‘a legally recognised form or being, which carries on its business in accordance with the laws of its place of creation and whose business concerns commercial finance’."
The Court of Appeal in Argo upheld the first instance judge's decision that Argo was a 'financial institution' as that phrase was used in the relevant loan agreement, but did so having adopted a significantly wider test than the first instance judge. Auld LJ concluded that:
- it was not a necessary characteristic for the transferee to carry on bank-like activities (such as lending of money), nor that it should exhibit any particular standard of suitability or probity as a financial institution; and
- meeting the criteria set out at paragraph 5 above would be sufficient to qualify a transferee as a 'financial institution'.
In Re Olympia it was argued by an unsecured creditor that WDW could not be a 'financial institution' as it was a 'shell' £1 company and it was non-trading, holding the loan as nominee for a third party.
HHJ Pelling QC was not persuaded by either of the above arguments. The judge considered that the lack of capitalisation was not relevant as:
- a qualification based on capitalisation finds no justification in the formulation of the majority in Argo which requires that it merely be “ … a legally recognised form or being, which carries on its business in accordance with the laws of its place of creation …”;
- no test is immediately apparent to distinguish between those entities which are capable of being institutions by reason of their capitalisation and those that are not;
- there is no necessary connection between the capitalisation of a company or other incorporated entity and its trading volumes or commercial reputation;
- it would have been simple for parties who wished to limit the scope of the "financial institutions" phrase to corporations with a minimum capitalisation to do so by express provision, but the parties had chosen not to do so; and
- the point assumes that only a company or corporation is capable of being a 'financial institution', which is contrary to commercial sense as many internationally recognised financial institutions adopt partnership models.
In relation to the argument that WDW was a non-trading entity, the judge considered the argument to lack reality – the effect of such argument would be that no institution could become a financial institution until it had entered into its first transaction.
Points to note
The Court adopted a purposive approach in following the widely drawn approach set out in Argo, making it clear that it was free for the parties when negotiating the underlying document to include any restrictions or requirements in respect of transferability that were desired. In Re Olympia, and in Argo, there were no such restrictions.
Absent such restrictions, the 'financial institution' concept is widely drawn and, in the view of HHJ Pelling QC, will include for example commercial trust corporations, primary and secondary lenders and those who act as agents, trustees or fiduciaries either for buyers or borrowers on one side of a transaction or for the providers of services on the other; it would also include those who provide managerial services on behalf of the providers or users of financial products and services.