Bluebird Bank Loan

International Banking Law

Bluebird Ltd, owners of a football team, the Bluebirds, is in need of loan finance to provide the seating and other fittings in a shortly to be completed new football stadium. It negotiates a revolving credit facility with Popular Bank. The term sheet that forms part of a commitment letter prior to signing the agreement states that, because there will be a very short time in which to install the seating, work can begin on this prior to completion of the stadium.

Bluebird and Popular Bank sign the loan agreement. However, in July, when Bluebird seeks to draw the loan funds down to begin the job of installing seating, Popular Bank point to a clause in the loan agreement headed ‘Condition Precedent’. This states that no funding can be drawn down until a ‘Certificate of Health and Safety’ from the appropriate regulatory agency is granted to Bluebird.

After some delay, in August, Bluebird produce a certificate from the engineers building the stadium and the Bank allows a portion of the funds to be drawn down. In fact under the Safety of Sports Grounds Act 1975, as a designated sports ground, the stadium requires a safety certificate issued by the local authority. The delay in drawing down the money and beginning work on the seating causes the first two football games of the season to be cancelled with a loss of £50,000. Moreover, for failing to play these games, the Bluebirds has ten points deducted, making it likely that they will be relegated from the league causing even greater losses.

The problems with the local authority’s certificate are widely reported in the national press. The local authority initially refused to issue a certificate until some seating was in place so that it could judge how easy the stadium would be to evacuate. Popular Bank is likely to have known of these reports and that the certificate issued by the engineers was not sufficient to meet the condition precedent but they allowed the funding to be drawn down given the impasse with the local authority.

One of the warranties in the loan agreement is that the furnishing funded by the loan is in good working order and well maintained. In fact in only the second game held in the stadium in September, after a particularly heavy defeat to a local rival team, the Swans, many Bluebird supporters riot, tearing up seats and wrecking the Directors’ boxes that had been installed. Bluebird Ltd does not report this to Popular Bank but seek to draw down more funding to pay for the repairs to the damaged seating and boxes. The loan agreement states that warranties are taken to be repeated on draw down of further funding and that compliance with warranties is itself a condition precedent of further funding being made available.

For the next sixth months, the stadium functions well but Bluebird have a poor season and are unable to make up the gap of ten points deducted at the beginning of the season. Relegation from the league will prove very costly and may threaten the financial viability of the Bluebirds. Popular Bank is worried that it will not recover its money. In March it points to the inadequate safety certificate and states that the original funding paid in the previous August must be repaid, together with all interest. Popular Bank seek neither to cancel the agreement as a whole nor to recover any other funding.

The only way that Bluebird could repay the loan is to borrow from another source. Another bank, Bob Bank, is willing to lend in principle but would require security. Bluebird has ample security to offer, but there is a negative pledge prohibiting the creation of security interests over its assets in the agreement with Popular Bank.

Discuss.

A loan agreement is a contract like any other and requires the usual elements of a contract, namely an offer, acceptance and consideration, plus an intention to create legal relations. If all these conditions are met then there will be a binding agreement. Chitty on Contracts defines a loan as:

“…a contract whereby one person lends or agrees to lend a sum of money to another, in consideration of a promise express or implied to repay that sum on demand, or at a fixed or determinable future time, or conditionally upon an event which is bound to happen, with or without interest.”

We shall consider here the contract between Bluebird Ltd and Popular Bank and the problems that they have.

Firstly we should consider whether there is a contract between the two parties. Popular Bank have made an offer to Bluebird Ltd when they put together their loan agreement, together with term sheet and commitment letter. Bluebird Ltd accepted that agreement when they signed the loan agreement, the consideration being the loan money and the promise of reimbursement, their intent to create legal relations being clear. All the basic legal requirements of a contract are present and there are no untoward circumstances such as duress, therefore we must conclude that the loan agreement is a valid contract at this stage.

Bluebird Ltd have chosen to set up a revolving credit facility with Popular Bank. A revolving credit facility is similar to an overdraft in that there is a set amount of capital available, over a specified period. Each tranche is usually borrowed for a reasonably short period of time before it will need to be repaid. However, as long as the borrower has not defaulted on the loan, the tranche can be withdrawn again. A revolving credit facility does differ from an overdraft in that it is for a fixed term, unlike an overdraft which can be demanded to be repaid at any time. We have no information regarding the specifics of the arranged credit facility between Bluebird Ltd and Popular Bank and have no indication when the first instalment that Bluebird Ltd drew down is due to be paid. We can therefore only presume that they have made all their repayments on time as scheduled and are not in arrears at all.

The term sheet that Bluebirds Ltd sign is essentially a summary of the terms of the loan. Normally a term sheet should set out the principal terms of the transaction and will not contain substantive detail. Bluebird Ltd should have checked the full terms and conditions of the loan before signing the agreement, specifically for any conditions precedent that Popular Bank might include. The term sheet and commitment letter may have been badly drawn up as usually the salient points of the agreement, especially the conditions precedent would have been listed on this document. Nevertheless, this will not negate the fact that the complete loan agreement should have been checked prior to agreement by Bluebirds Ltd.

It is generally thought that a terms sheet is not legally binding (this is of importance when considering fees or when the full loan agreement is not agreed). If the commitment letter contains so few of the terms found in the full agreement, it could be said that the parties did not intend to be bound by the commitment letter. Nevertheless, in this case the full loan agreement has been signed and agreed so any discussion on whether the terms letter would have been binding are moot as the loan is agreed in any event.

Whilst the loan agreement is binding, until the conditions precedent have been met, the bank does not need to make the funds available; the term will need to be fulfilled before the loan agreement can take effect. In this case the condition precedent that Popular Bank have included states that before they can draw down on the loan Bluebird need to possess a valid health and safety certificate regarding the stadium seating from the appropriate regulatory body.

As Bluebird Ltd were apparently not aware of the condition precedent that they needed to obtain the appropriate health and safety certificate there was some delay in them receiving one from the engineer’s and therefore before they were able to draw down on the loan. They state that this caused the building of the seating to be delayed, causing them to cancel two games and losing them £50,000 as well as a ten point reduction.

These losses are not likely to be attributable to Popular Bank as Bluebird Ltd should have thoroughly read the complete loan agreement as the term sheet will only contain a summary of the key points. As we have discussed, a term sheet may not even be binding on its own and accompanied by a signed loan agreement, it would seem unlikely that Bluebird Ltd can rely on the term sheet over and above the main loan agreement. Even if Popular Bank were in breach of contract in not advancing the money, Bluebird Ltd could not sue for failure to advance the loan money as specific performance orders would not normally be granted for loans. However, Bluebird would possibly be able to sue for damages, if only nominal. Any expenses or profit lost must be in the reasonable contemplation of the parties. In this case there would be little doubt that there would be financial losses from cancelled games due to no seating, maybe less so foreseeable that there would be a points deduction for failure to play, resulting in relegation. It must be remembered though, that in commercial transactions the parties should understand the nature and practices of their businesses. It is therefore very unlikely that Popular Bank would be responsible for damages at this stage. The issue of remoteness of damages will be considered below.

The situation is further complicated when we learn that the health and safety certificate needs to be provided by the local authority. As we have seen, Popular Bank accepted a certificate from the engineer’s, probably knowing that this was insufficient to meet the condition precedent, and yet they released funding anyway. With regard to the fact that Popular Bank were likely to have known of the problems in obtaining a certificate of health and safety certificate from the local authority, there is little evidence that this is relevant. It perhaps would have been honourable of them to mention this to Bluebird Ltd but failure to will in no way make them liable for the delay in obtaining the same. There is nothing that Popular Bank could have done to assist Bluebird Ltd in meeting the condition precedent as it was in the hands of the third party local authority, and usually it is solely down to the borrower to satisfy the condition precedent.

The situation becomes tricky when we come to the issue of the certificate provided by the engineers. We are led to believe that Popular Bank know that this certificate is insufficient to meet the terms of the condition precedent but accept the certificate anyway and allow Bluebird Ltd to drawn down on the loan. In doing this Popular Bank have effectively assented to a new contract whereby the terms are different to the previously agreed one. This is a well known rule dating back to the case of Brogden v Metropolitan Rail Co (1877)where it was held that a contract became binding when the parties acted upon it.Popular Bank have acted as if the certificate provided satisfied the condition precedent, and in so doing effectively changed the terms of the contract. Should Popular Bank have wanted to rely on this condition precedent, they should have relied on it from the start, refusing to let any money be drawn down until the appropriate health and safety certificate was received. Instead, now the engineer’s report has been treated as sufficient to meet the condition precedent, and Popular Bank cannot reverse this decision as it pleases them. Popular Bank therefore has no basis or just cause to demand early repayment of the original funding paid in August on these grounds.

The second main issue is regarding the warranty that the furnishing funded by the loan being in good working order and well maintained. This is another condition precedent of the agreement and usually a loan agreement will specify that it is an event of default to make a representation or warranty that is not correct. A written loan agreement such as this will invariably contain a default clause, which means that if certain events that may occur could cause the lender to claim a default event and therefore accelerate payment of the loan and terminate any future commitments that they had. Bluebird Ltd should have informed Popular Bank of the damaged seating but instead they have deceived them and drawn further funds in breach of the warranty and condition precedent.

The warranty here is a repeating warranty and therefore it would have been necessary for Bluebird Ltd to have complied with this warranty before they drew down their second stage of funding (which was for repair to the seating). A breach of a warranty does not usually entitle a party to end the contract as a warranty is not usually a vital term. However, in this case the warranty is a condition precedent of further funding and therefore as the warranty could not be met, Bluebird Ltd should not have received additional funding.

This is known as an event of default and Popular Bank, had they known about it would be well within their rights to demand accelerated payment and cancel their commitments under the agreement. However, we presume that Popular Bank never actually knew about this breach of warranty and they did not seek to demand repayment because of this breach, which had they of, they may well have been successful. Since Popular Bank was completely unaware, the breach clearly has had no impact upon them and therefore it is very unlikely that a Court would now decide that this breach entitles Popular Bank to terminate the contract.

An important thing to consider is the negative pledge which effectively prevents Bluebird Ltd from obtaining a loan with another bank. The purpose of this negative pledge is to protect Popular Bank’s interests as the negative pledge will prevent Bluebird Ltd from granting security to another lender. They are perfectly entitled to impose a negative pledge and this would have also been in the original loan agreement. In actual fact, If Bob Bank induces Bluebird Ltd to break the negative pledge this could give rise to an action in tort and Bob Bank could be found to hold any securities obtained on trust for the negative pledge holder (in this case Popular Bank).

However, there are different varieties of negative pledge that would allow Bluebird Ltd to grant security to Bob Bank as well as Popular Bank. Bluebird could promise to grant “equal and rateable security” to the bank which is known as the ‘equivalent security negative pledge’. There is also the ‘automatic security negative pledge’ where security is automatically conferred in the same asset should breach occur. We do not know what type of negative pledge we are concerned with in this situation but if Popular Bank are seriously worried about getting their money back and they currently have a basic negative pledge term then they could consider agreeing to a different form of negative pledge which would enable Bluebird Ltd to obtain another loan to reimburse them, whilst still ensuring that they have ample security for other aspects of the loan.

However, should Popular Bank want to stick with a basic negative pledge cause and deny Bluebird Ltd the opportunity of obtaining further credit there are remedies available to them should Bluebird breach the negative pledge. Firstly, a breach of the negative pledge cause will default the loan agreement and if any loss is caused by the breach there may be an action for damages. However, these options are impractical and unattractive to lenders.

Popular Bank could apply to the Court for an injunction preventing Bluebird Ltd from breaching the negative pledge clause. Of course, if they did that, we are led to believe that Bluebird Ltd have no other way of paying back the loan advancement and therefore this course of action would seem to be fruitless for Popular Bank. Ideally Popular Bank would aim to succeed in an order for specific performance, compelling Bluebird Ltd to give them an equal and rateable security in the assets which Bob Bank will use as security for the new loan. This way Popular Bank retain their security and also are able to receive repayment from Bluebird Ltd.

Should Bob Bank take security from Bluebird Ltd in breach of the negative pledge clause, they will also be opening themselves up to liability for damages. Again, Popular Bank could obtain an injunction against them, as per the rule in De Mattos v Gibson. Popular Bank would then be put back into the position they had been in had there not been a breach meaning that Bob Bank would be treated as an unsecured creditor. This is of course presuming that Bob Bank has knowledge of the negative pledge clause binding Bluebird Ltd. However, in practice this principle is used in only very limited situations in the Courts of England and Wales.

As we have seen, a negative pledge clause is difficult and unlikely to be enforced and as Chitty on Contracts states, “the clause may be of doubtful practical utility because of the lack of mechanisms for its enforcement”. If Popular Bank desperately wanted their money back then there is little point in trying to enforce the clause.

Lastly, we shall turn to consider the precise demand made by Popular Bank. They are demanding repayment of the monies loaned in August and also all interest, which brings the issue of penalty clauses into play.

If, in the event of a breach of contract the parties agree that a sum shall be paid by one party to another, then it will either be classified as liquidated damages (recoverable) or as a penalty (non-recoverable). The clause must be a genuine attempt to estimate the extent of the loss suffered by the claimant in the event of a breach, albeit the actual losses incurred from such an event are irrelevant. The purpose of such a clause is to agree an element of damages in advance without the cost of proving the actual losses suffered, which can be expensive. The operation of this rule has been controversial;

“…the power to strike down a penalty clause is a blatant interference with freedom of contract and is designed for the sole purpose of providing relief against oppression for the party having to pay the stipulated sum. It has no place where there is no oppression.”

If the agreed term is confirmed to be a penalty clause, then that in itself will not preclude the claimant from recovering damages. In the event that a penalty clause is deemed unenforceable, then the Court will award the aggrieved party such damages that would compensate him for the actual loss. The limitation of this rule applies to ensure that the claimant will not recover more than his actual losses i.e. he will not be over compensated.

The issue of whether a term of the contract allowing for damages upon breach constitutes a penalty clause is a question of law, per Lord Dunedin in Dunlop Pneumatic Tyre Co v. New Garage and Motor Co Ltd (1915). He set out a number of criteria to consider when assessing whether such a term amounted to a penalty clause or liquidated damages. While it is not necessary to repeat the full list here, there are certain points of law (and fact) that need to be considered before advising Bluebirds Ltd as to the potential enforceability of the right of Popular Bank to recover all of the interest payable under the loan based upon the initial payment made in August.

Where the effect of a clause has the intent of in terrorem (Latin – intimidating) against the defendant, then it may be considered to be a penalty clause. The specific application of this rule in a situation similar to that in our scenario was considered in the matter of The Angelic Star (1988). It was decided that “a clause which provided that in the event of any breach of contract a long term loan would immediately become payable and that interest thereon for the full term would not only be payable but would be payable at once would constitute a penalty as being a payment of money stipulated as in terrorem of the offending party.” More recently the case of County Leasing Ltd (2007) where the claimant sought to enforce a clause that entitled them in the event of a breach of contract, to recover not only the full capital amount under the loan, but also the total amount of interest for the term of the loan. The amount claimed exceeded £1.2 million whereas the claimant eventually recovered less that £450,000. It was once again held by the Court that despite the clause being agreed between the parties, it was nevertheless unenforceable.

A line of argument put forward by Counsel for the claimant (Mr. Deegan) was that the oppression referred to above was not present in the case of County Leasing Ltd. Considered by Judge Richard Seymour QC sitting in the High Court this reasoning was dismissed as, notwithstanding that the defendant has a history of dealings in the business and in entering into agreement of this nature, these factors were irrelevant for considering whether the term amounted to a penalty clause. Consequently such considerations of oppression and bargaining positions do not appear to be so relevant to modern considerations of what amount to a penalty clause as opposed to liquidated damages.

We would have to conclude that the clause that Popular Bank are seeking to enforce is purely a penalty clause regardless of any terminology gifted to it within the loan agreement. It is the effect of such a term not its title that defines it;

“The agreed sum, though described in the contract as liquidated damages, is held to be a penalty if it is extravagant or unconscionable in relation to any possible amount of damages that could have been within the contemplation of the parties at the time when the contract was made.”

Recent case law has given some cause for concern as in Alfred McAlpine Capital Projects Ltd v. Tilebox Ltd (2005) it was stated that the Court’s are predisposed to consider contentious clauses as liquidated damages rather than penalty clauses. This inclination is even stronger when cases involving commercial contracts are considered given that the parties are usually on an equal footing. However this should be contrasted with the case Jeancharm Ltd v. Barnet Football Club Ltd (2003) where an interest rate of 5% for late payment was held to be a penalty clause.

Notwithstanding the status of Bluebirds Ltd as a limited company, the operation of the clause to permit Popular Bank to recover the amount of interest payable under the duration of the loan upon breach of the contract would arguably amount to a penalty clause and therefore be unenforceable. While the figures are not clear as to what the amount of the loan was provided in August, or what the amount of “all interest” would be for the duration of the loan, it cannot be considered reasonable that Bluebirds Ltd would have contemplated such a penalty in the event of a breach. The operation of the penalty clause was appropriately summarised in Dunlop Pneumatic Tyre Co v. New Garage and Motor Co Ltd (1915), particularly with regard to our problem.

“If the Court, after looking at the language of the contract, the character of the transaction, and the circumstances under which it was entered into, comes to the conclusion that the parties have made a mistake in calling the agreed sum liquidated damages, and that such sum is not really a pactional pre-estimate of loss within the contemplation of the parties at the time when the arrangement was made, but a penal sum inserted as a punishment on the defaulter irrespective of the amount of any loss which could at the time have been in contemplation of the parties, then such sum is a penalty, and the defaulter is only liable in respect of damages which can be proved against him.”

Consequently, while Bluebirds Ltd may well be liable to repay the capital sum advanced in August, any additional penalty will have to be proportionate so as to achieve an “equitable” result.

Finally, the issue of damages, if any needs to be considered. In addition to the damages/repayment of the loan to be claimed by Popular Bank, Bluebirds Ltd may intend to seek damages from breach of contract themselves. The general principle of recovery of damages under breach of contract is that the claimant should be placed in the position as if the contract had been fulfilled. However in circumstances where, as a result of that breach, the claimant has suffered additional losses, consequential to the contractual losses, recoverability will depend upon the question of remoteness. It is irrelevant to assess damages upon how remote they are to the breach of contract if such losses are expressly provided for. In contrast, losses secondary to the breach that were not discussed between the parties can be considered implied within the contract providing they are not too remote.

The principle of remoteness was provided in the case of Hadley v. Baxendale (1854) where loss of profits were sought to be recovered as a result of a failure to deliver parts to a machine (in breach of contract). The same were held to be too remote and beyond the contemplation of the parties at the time of foundation of the contract. More recently the Court have confirmed that damages would not be too remote where it can be proven that the kind of loss was within the contemplation of the parties as being a likely result of the breach. There was also guidance provided in the matter of Victoria Laundry (Windsor) Ltd v. Newman Industries Ltd (1949). The Court stated that for damages to be recoverable as a result of a breach they needed to be reasonably foreseeable, that this needed to be within the knowledge of the parties as a possibility at the formation of the contract and the losses must be in the ordinary course of things. However, it was also stated that in special situations, the ordinary course of things may include particular knowledge given that parties relationship that would make losses foreseeable where otherwise they might not be. Each case will turn on its facts and it is for the Court to extrapolate a finding of foreseeability coupled with what would have been within the contemplation of the parties should a breach occur.

The issue of the kind of damage that was reasonably foreseeable needs to be addressed. The losses that have been incurred by Bluebirds Ltd are purely financial however the manners in which they have been brought about are quite unique. Strictly speaking, the losses incurred are in the first instance pecuniary, yet the initial consequence was the deduction in points due to the first two matches being cancelled. It could be argued that breach of contract by Popular Bank would lead to financial losses by the Bluebirds Ltd in the form of lost ticket sales, advertising and sponsorship amongst other things. This is within the contemplation of the parties as the creation of a new stadium is the fundamental basis for the loan and breach would naturally lead to financial losses.

The points deducted are a kind of damage that could be considered within the actual knowledge of the parties given the special circumstances i.e. the business of Bluebirds Ltd. The recent case of Jackson v. Royal Bank of Scotland (2005) confirmed that “Where knowledge of special circumstances is relied on, the assumption is that the defendant undertook to bear any special loss which was referable to those special circumstances.” However it is important to consider the situation as a whole rather than piecemeal as was considered in the Victoria Laundry Case (1949). In that matter the defendant failed to deliver a boiler in accordance with the contract and the claimant sued for loss of profits. The Court of Appeal confirmed that while the defendant was aware of the claimant’s business and could therefore foresee an element of lost profit, the loss of several specialist contracts was considered to be too remote. Similarly we could consider that the initial lost profits would be recovered yet the further losses relating to the deducted points and consequential losses would be too remote.

There is in any event the issue of the uncertainty of the football season and the poor performance of Bluebirds Ltd leading to their ultimate relegation. It cannot be considered foreseeable that an initial breach resulting in financial losses and a deduction in points would have resulted in Bluebirds Ltd being relegated with the consequence of them suffering further losses from reduced revenue in the lower leagues. While Popular Bank will have some amount of liability and responsibility for damages regarding the initial breach, even the application of the judgment in Jackson v. Royal Bank of Scotland would not extend the application of this rule so as to consider such extreme losses are not being too remote.

Popular Bank is obviously concerned about the financial security of Bluebird Ltd after the events of the season and looks to secure its own position by asking for repayment of some of the loaned monies. However, the way in which they ask for repayment is fatally flawed and they are unlikely to be able to recover any immediate payment from Bluebird Ltd at this stage. They seek to demand repayment due to a breach of contract when Bluebird Ltd provided the incorrect documentation to satisfy the condition precedent, but as they allowed funding to be drawn down as a result of the provision of another certificate, they can now no longer rely on that breach as an event of default.

They could have relied upon the breach of contract which occurred when Bluebird Ltd failed to inform them of the damaged seating which breached a warranty and therefore also a condition precedent, but because this event happened and resolved itself without their knowledge, it is unlikely that a court would hold that they suffered any detriment as a result. Therefore, the issue of the negative pledge is academic as Bluebird Ltd will likely not require the additional loan, however, as discussed, the negative pledge term is difficult to enforce and the damages that Popular Bank would receive for breach would be negligible. Also if they managed to enforce the negative pledge agreement, they are arguably still not in a good position as Bluebird Ltd have no other way of paying off the demanded debt.

It is highly unlikely that Popular Bank Ltd will be able to enforce the clause relating to the recovery of “all the interest” under the loan insofar as it relates to that portion of the loan drawn down in August. The same will in all likelihood be considered a penalty clause and therefore unenforceable as it seeks to enrich Popular Bank Ltd beyond that reasonably expected in the event of breach of contract. There are arguments relating to the bargaining position of Bluebirds Ltd in that, as a business, they agreed to the terms and the Court should not interfere. However, it more probable that the amount of any damages payable by Bluebirds Ltd will be limited to interest and charges for the period overdue.

In contrast, the damages sought by Bluebirds Ltd will be curtailed by the principle of remoteness. While the initial financial losses from the first two games of the season being cancelled are recoverable, the ultimate relegation cannot be considered foreseeable by any means. The poor run of form is something intangible that cannot be measured when the contract was created, and hindsight will not make good a loss that is otherwise too remote.

Bibliography

• Adams, David, Corporate Finance: Banking and Capital Market, Bristol: Jordan Publishing Ltd, 2003

• Chitty on Contracts, including 4^th Cumulative Supplement, London: Sweet & Maxwell, 2004

• Cranston, Ross, Principles of Banking Law, Oxford: Oxford University Press, 2002

• Ellinger, E.P, Lomnicka & Hooley, Modern Banking Law, Oxford: Oxford University