Rethinking of the No Action Clause

During the last few decades, the volume of the usage of the trust in financial transactions has increased considerably because of the globalisation of investment and the development of financial structures in which the trust is used, such as securitisation [1] . Recently, investors are likely to seek to recover their losses through claim against other parties including trustees [2] and thus have become more concerned about whether the relevant parties have performed properly or not, particularly after the credit crisis in 2007. On the other hand, in trust instruments used in financial transactions, the clauses which may influence the liabilities, rights and powers of the settlor, beneficiary and trustee are often set out. For example, there are the so-called ‘no action clause’ which restrict the right of bondholders to take their enforcement action [3] and the ‘trustee exemption clause’ which excludes or limits the trustee’s duty and liability for breach of trust [4] . As a result of the existence of these clauses, investors as beneficiaries may face the difficulty in exercising their rights against the trustee or issuer which they would have if these clauses do not exist. Thus, when we consider current law in relation to the commercial trusts, it would be useful to consider the role of these clauses and to what extent they are effective.

The purpose of this dissertation is to examine the role of these clauses in financial transactions and how effective they are, and whether current law in relation to these clauses is fair between the interests of the relevant parties such as settlor, beneficiary and trustee. I suggest that these clauses promote the use of trust in financial transactions and work effectively on the whole, however, that current law in relation to these clauses is not fair because these clauses are somewhat too protective of professional trustees, although there are restrictions by some statutory or case law. These clauses are so trustee-friendly that there is at risk that professional trustees become reluctant to be active for beneficiaries.

[This dissertation will focus on the matters relating to the ‘no-action clause’ and ‘trustee exemption clause’ and will not examine the other clauses usually set out in trust instruments in financial markets.]

The rest of this dissertation is as follows. Part II and Part III provide the explanation and analysis of recent cases of the ‘no-action clause’ and ‘trustee exemption clause’ respectively. Then in Part IV, I will describe statutory restrictions on limitation of the trustee’s liability and discuss to what extent the trustee’s liability can be excluded or limited. Finally, in Part V, I will consider whether current law in relation to these clauses is fair or not and how these clauses should be regulated in the future. Part VI concludes.

Part II: No action clause

What is the no-action clause?

The no-action clause is usually found in the terms and conditions of the bonds or the trust deed. The clause gives the trustee the power to take enforcement action against the issuer in accordance with the instruction by a certain percentage of bondholders or a third person. Its purpose is to prevent bondholders from taking their own enforcement action directly and to force them to do so through the trustee [5] . It also provides that, if the trustee is obliged to take enforcement action against the issuer in accordance with the terms and conditions of trust instruments but fails to do so within a given period, then the bondholders can do so directly. [6]

The typical example of the no-action clause is as follows (which is taken from the case of In the Matter of Colt Telecom Group plc [7] ):

‘Limitation on suits.

A holder may not pursue any remedy with respect to this Indenture or the Notes unless:

a. The Holder gives to the Trustee written notice of a continuing Event of Default;

b. The Holders of at least 25% in aggregate principal amount at maturity of Outstanding Notes make a written request to the Trustee to pursue the remedy;

c. Such Holder or Holders offer the Trustee indemnity satisfactory to the Trustee against any costs, liability or expense (including the reasonable fees and expenses of its Council);

d. The Trustee does not comply with the request within 60-days after receipt of the request and the offer of indemnity;

e. During such 60-day period the Holders of a majority in principal amount at maturity of the Outstanding Notes do not give the Trustee a direction that is inconsistent with the request.

A Holder may not use this Indenture to prejudice the rights of another Holder or to obtain a preference or priority over such Holder.’

The above percentage of bondholders which can request the trustee to pursue the remedy differs depending on cases and, where the bond/note has several tranches, the junior or subordinated classes are usually not allowed to give instructions to the trustee against the will of the senior bondholders. [8]

The effectiveness and scope of the no-action clause

As to the construction of the no-action clause, there are three recent cases under English law; In the Matter of Colt Telecom Group plc [9] , Elektrim SA v Vivendi Holdings 1 Corp [10] and Elliott International LP v Law Debenture Trustees Ltd [11] .

　In the Matter of Colt Telecom Group plc [12]

The issues in In the Matter of Colt Telecom Group plc are related to the construction of the no-action clause set out in the terms of the notes and their associated indenture [13] . Although the terms of the relevant trust instruments including no action clause were governed by the laws of the State of New York, the English court judged on the basis that the same principles apply under English law and New York law [14] . The clause prevented an individual bondholder from pursuing any remedy with respect to the trust instrument or the bonds in case of an event of default unless the trustee was obliged, and failed, to do so. One of the issues is whether the no-action clause applies to all remedies not only after, but also before, an event of default has occurred. The other is whether it applies to non-contractual claims like an application for an administration order in question, as well as contractual claims. It was also considered whether public policy overrides the no-action clause.

In this case, Jacob J took a purposive approach to the construction of the no-action clause. [15] Because of no direct New York authority in point, he considered by expert evidence what the principle to be applied under New York law is. He concluded that the no-action clause was effective for commercially pragmatic reasons and applied to claims for administration before an event of default had occurred; despite the literal wording of the clause which referred only to the restriction of the bondholders’ right to pursue a remedy in the case where an event of default had occurred [16] . The judge stated that there was ‘no rational purpose in limiting the bar to “contractual claims”’ [17] . It was also held that the no-action clause which provided the contractual restrictions on bondholders was not contrary to public policy.

A broad purposive approach to the construction of the no-action clause has been criticised by Professor Kahan [18] . He argues that such broad approach excessively prevents the minority of individual bondholders from bringing non-contractual claims and that the balance with respect to enforcement should be tilted more towards individual rights [19] . He insists that the (U.S.) courts have denied the trustees standing to assert non-contractual rights of bondholders and, if a breach of a non-contractual right of the minority of bondholders does not meet the requirement that the trustee become obliged to take actions under the terms of bonds, it will result in the effect that neither the trustee nor bondholders cannot take actions as to non-contractual rights [20] . He also points out that the courts have given the no-action clause too broader meaning in the pursuit of collectivity, compared to the fact that typically there are clauses which require a unanimous consent for the amendment of certain terms of bonds [21] .

Although part of his opinion would be right, in this case the court’s decision would be accepted. As to the effectiveness of the no-action clause, I support the court’s decision because bondholders have bought the bonds with knowledge of the terms of the bonds including the no-action clause. 　It can be said that there is a deal between the issuer of bonds and respective bondholders [22] to the effect that bondholders’ rights to take actions against the issuer are restricted by the terms of bonds, i.e., the no-action clause. Bondholders can choose to buy, or not to buy, the bonds which contain restrictions on their rights of taking actions against the issuer. It should be considered that bondholders agreed to such restrictions on their rights. In addition, compared with the restrictions on shareholder’s right to petition, it is considered that the principle in Peveril Gold Mines Ltd, Re [23] , which provides that a shareholder’s right to bring winding-up proceedings against his company cannot be excluded by the articles of associations, applies only about the restrictions on the internal regulation of the company, and so it will not extend to similar agreement in a contract, i.e., the no-action clause in the terms of the bonds [24] .

As to the construction of the broad scope of the no-action clause, it would be forced to be accepted by the pragmatic reason. The no-action clause has been commonly used in bond markets for many years [25] on the basis that it is valid and has a wider meaning. On the other hand, if the clause does not apply to non contractual claims or claims before an event of default, the no-action clause will become almost meaningless. Thus if the clause were interpreted more narrowly than people commonly understand in bond markets, there might be a serious impact on the practice in bond markets [26] . The market impact should not be underestimated, although it cannot be said that the market practice is always right and fair. Moreover, such broad construction would be welcome for most of market players in order to continue their market practice.

However, the discrepancy between the construction and its literal wording would not be desirable. It should not be ignored that a broad approach to the no-action clause leaves the minority of bondholders at a disadvantage. In this case the literal wording of the clause referred to the restrictions on actions only after event of default has occurred [27] . The relevant parties should have considered more appropriate wording of the no-action clause. The scope of the clause should have been made clearer because it would not be fair if bondholders cannot understand or expect the scope of the restrictions on their rights under the no-action clause before buying the bonds.

　Elektrim SA v Vivendi Holdings 1 Corp [28]

Another case which a similar approach to the above was taken is Elektrim SA v Vivendi Holdings 1 Corp. [29] In this case the following clauses are set out in the trust deed and the bond conditions:

‘10.1 The Trustee shall not be bound to take any proceedings mentioned in Clause 9 or any other action in relation to these presents unless respectively directed or requested to do so (i) by an Extraordinary Resolution of the holders of the Bonds or (ii) in writing by the holders of at least thirty percent in principal amount outstanding of the Bonds and in either (i) or (ii) then only if it shall be indemnified to its satisfaction against all Liabilities to which it may thereby render itself liable or which it may incur by so doing.

10.2 Only the Trustee may enforce (i) [against the security provided by Elektrim] or (ii) the provisions of these presents. No Bondholder shall be entitled to proceed directly against [Elektrim Finance] or [Elektrim] to enforce the performance of any of the provisions of these presents unless the Trustee having become bound as aforesaid to take proceedings fails to do so within a reasonable time and such failure is continuing.’ ( taken from Clause 10 of the Trust Deed) [30]

‘13. Enforcement of Rights

At any time after the Bonds become due and repayable, the Bond Trustee may, at its discretion and without further notice, institute such proceedings against [Elektrim Finance] or [Elektrim] as it may think fit to enforce the Bonds and the provisions of the [Trust Deed], but it need not take any such proceedings unless (i) it shall have been so directed by an Extraordinary Resolution of the Bondholders or so requested in writing by holders of at least thirty percent in principal amount outstanding of the Bonds and (ii) it shall have been indemnified to its satisfaction. No Bondholder may proceed directly against [Elektrim Finance] or [Elektrim] unless the Bond Trustee, having become bound to proceed, fails to do so within a reasonable time and such failure is continuing.’ (taken from Condition 13 of the Bond Conditions) [31]

The fact of this case is complex. The background of this case is the dispute which lasted since 1990 between Elektrim and a French media company, Vivendi Universal SA (Vivendi) over the Elektrim’s stake in a Polish mobile telephone service provider, Polska Telefonia Cyfrowa. Vivendi Holdings 1 Corp (VH1), a subsidiary of Vivendi, acquired from Everest Capital (Everest) a substantial holding in the bonds issued by a special purpose vehicle and guaranteed by Elektrim in order for Vivendi to pursue a battle with Elektrim by indirect means. [32] VH1 sued Elektrim and the trustee of the bonds in the Florida court, as transferee of Everest’s rights as bondholder, alleging that Elektrim induced Everest to buy the bonds and that the trustee was in breach of fiduciary duty. [33] Elektrim issued proceedings against VH1 for a declaration that VH1 was in breach of the no-action clause by issuing the Florida proceedings and for an injunction restraining VH1 from continuing the Florida proceedings. The High Court granted the final anti-suit injunction prohibiting VH1 from continuing the Florida proceedings in favour of Elektrim, which enforced the no-action clause. VH1 appealed.

The question which arose was the construction of the no-action clause in a bond issue. The no-action clause provided that only the trustee was entitled to take enforcement action against the issuer, and bondholders could not proceed directly against the issuer unless the trustee failed to do so in accordance with the trust deed and terms and conditions of the bonds. [34]

The judge took a broad purposive approach to the construction and the no-action clause was construed to have a wider meaning as to the scope of the clause than its literal wording. [35] He said that the phrase ‘enforcement performance of’ the bond conditions prescribed in Clause 10.2 of the trust deed in question was not limited to claims for specific performance and should extend at least to a claim for damages for compensation for non-performance of the bond conditions, even if the cause of action was in tort, not for breach of contract [36] . Therefore, the anti-suit injunction which prohibited VH1 from continuing the Florida proceedings was upheld by the Court of Appeal and VH1’s appeal was dismissed. Furthermore, it was held that there is no duties of the trustee, whose main function is administrative and ministerial, to advise bondholders on the risks of accepting the funds provided by the issuer to repay the bonds [37] .

I consider that the no-action clause generally should not prevent a personal claim in tort and unrelated to the bonds against the issuer. As mentioned above, the trustee would not be entitled to take actions for such non contractual claim on behalf of a particular bondholder under the terms of bonds [38] . Such claim in tort deserves to protect, unless it results in a particular bondholder’s cunning means to go ahead to other bondholders.

In light of preventing a particular bondholder from going ahead to other bondholders, I support the conclusion of the decision which states that the no-action clause applies to a claim for damages for compensation for non-performance of the bond conditions, regardless of whether the cause of action is in tort or breach of contract. VH1 asserted that the claim in Florida court was a personal claim purely in fraud, and unrelated to the contract, i.e., the trust deed or bonds [39] .　Despite such assertion, the purpose of the claim of VH1 was to make up for the loss of a contractual right or entitlement under the bonds conditions which it had by virtue of being as a bondholder [40] . If this type of claim were permitted, the no-action clause would be watered down. In addition, as the judge pointed out, it was the same loss which the trustee was seeking to recover from Elektrim in the Chancery Division [41] , and the allegations made in the Florida proceedings were about breaches by Elektrim of the trust deed, i.e., claims related to the bonds [42] . Going ahead by using a loophole in the terms of bonds would not be fair to other bondholders because it is contrary to the concept of a pari passu distribution through the trustee to all bondholders.

Elliott International LP v Law Debenture Trustees Ltd

The judge in this case took a narrower approach to the construction of the no-action clause. [43] The claimants were holders of some 70 per cent of the bonds issued by Eurotunnel Finance Limited and governed by English law, and the defendant was the bond trustee.

In the trust deed of the bonds in question, there was the following no-action clause:

‘(b) No action by bondholders.

(i) Subject condition 14(b)(ii), each Bondholder and Couponholder acknowledges that the right to enforce the obligations of the Issuer and the Guarantors under the Bonds, the Coupons and the Bond-related Agreements is vested in the Bond Trustee and, accordingly, without limitation, no Bondholder or Couponholder shall have the right to

(A) commence, either alone or in conjunction with any other Bondholder or Couponholder, or take any action against any member of the Owning Group for the enforcement of any of the provisions of the Bonds, the Coupons or Bond-related Agreements, or

(B) take any step with a view to, or which may reasonably be expected to result in, the dissolution of any member of the Owning Group, or

(C) take any other action which by virtue of the AAL, the Bond Trustee is prohibited from taking in relation to the Bonds, the Coupons and Bond-related Agreements.’ [44]

The Paris Commercial Court had issued a series of judgments opening safeguard proceedings in respect of a number of companies including the issuer. The safeguard proceedings are a form of court-sanctioned restructuring for solvent debtors [45] . The claimants challenged the opening of the safeguard proceedings in respect of English companies including the issuer by commencing the opposition proceedings known as a ‘tierce opposition’ under French law [46] . As they thought that their standing might be attacked on the ground that the no-action clause in the trust deed, they sought a declaration that the relevant clauses did not prevent them from taking the opposition proceedings. [47]

The judge held that the opposition proceedings were not proceedings within the no-action clause. In this case there was no challenge to the validity of the no-action clause. [48] In construing the no-action clause, he stated that the restrictions on bondholders by the no-action clause covered only the proceedings that would be contradictory to proceedings which the trustee could take to enforce the terms of the bonds [49] . Both safeguard and opposition proceedings were not proceedings to enforce the terms of the bonds but rather the proceedings the purpose of which was to achieve a restructuring of the issuer’s debt [50] . Therefore, it was held that the claimants were not prevented by the no-action clause from pursuing the opposition proceedings.

I support the decision. According to wording of the no-action clause, the opposition proceedings can be said to be neither proceedings to enforce the provisions of the bonds ((A) in the clause above), nor those to dissolve the issuer ((B) in the clause above), nor those to take an action which the trustee is prohibited from taking in relation to the bonds ((C) in the clause above). I think that the court’s approach which does not (or need not) extend the scope of the no-action clause is a desirable attitude towards the construction of the no-action clause.

Cases in U.S., Canada, etc.

The effectiveness of the no-action clause has been admitted in other countries. In the U.S., as described above in the case of In the Matter of Colt Telecom Group plc, there is no direct New York authority in point. However, there have been many cases such as the case of Feldbaum v McCrory Corp [51] , which admit the effectiveness of the no-action clause, although there are some statutory limitations (as described below). Professor Kahan stated:

‘The scope of the no-action clause is rather broad. It includes suits for breach of an implied covenant of good faith and fair dealing, as well as for breach of express rights (including redemption and sinking fund provisions, bondholder put rights upon a change in control, collection of principal after the maturity of bonds has been accelerated, and miscalculation of the conversion ratio). As interpreted by courts, the no-action clause also applies to most noncontractual claims (such as fraudulent conveyance claims, certain fraudulent misrepresentation claims, RICO violations, and actions to appoint a receiver or to impose a constructive trust); to suits brought by former bondholders; and to suits against defendants other than the company. Suits against the trustee itself and claims under the federal securities laws have been held not to be subject to the clause.’ [52]

In Canada, the courts have been unwilling to allow restraint of the fundamental right to sue to recover one’s money [53] . In Millgate Financial Corp. v B.F. Realty Holdings Ltd. [54] , it was held that the debenture holders were not prevented from commencing a proceeding for an oppression remedy [55] . However, recently the Ontario Court of Appeal admitted in Casurina Limited Partnership v Rio Algom Limited [56] that the no-action clause is effective and adopted a broad approach to the contraction of the no-action clause [57] .

In France, the courts in Kerr v Societe Pyrennees Minerals [58] affirmed that the no-action clause was not contrary to public policy [59] .

Analysis

The no-action clause has been commonly used in trust instruments in connection with bond issues governed by English law since the 19th century [60] . It aims primarily to protect bond issuers from the burden of a number of bothersome claims and lawsuits, which undermine the economic interests of the bond issuer and its creditors [61] . In addition, it protects the interests of the whole bondholders by blocking claims against the bond issuer from a particular bondholder or a small group of bondholders [62] . By forcing all the bondholders to exercise their collective rights under the bonds through the trustee, they can be treated equally or pari passu in the distribution of the principal, interests and other payments under the bonds [63] . As the economic interests of all the bondholders are theoretically same, it can be said that centralising the bondholders’ enforcement power to the trustee by the no-action clause would not generally undermine their interests and can be justified. Thus, I agree with the court’s decision that the no-action clause is effective and not contradictory to public policy.

Although a broad construction of the meaning of the no-action clause has been generally accepted by the courts except for some cases, it can be said that the court’s construction depends highly upon the meaning of the literal wording of the no-action clause. It seems that the courts expect, as financial market practice, a reasonable construction and agreement by bondholders of the terms of bonds including the no-action clause by buying bonds. If the literal wording of the no-action clause is unclear, there is a considerable risk that the courts might take a strict approach [64] due to unfairness or inconsequence. For example, it was pointed out that the di