Litigation Update: Some Comfort and Words of Caution to Lenders Using Standard Loan Documents

Introduction

In the recent case of African Export-Import Bank & Ors v Shebah Exploration & Production Company Limited & Ors [2017] EWCA Civ 845, the Court of Appeal considered the question of whether the use of model form agreements (in this case, Loan Market Association (LMA) form of syndicated facility agreement) by lending banks could constitute dealing “on written standard terms of business”, which would be subject to the Unfair Contract Terms Act 1977 (UCTA) reasonableness requirement.

As amended by Consumer Rights Act 2015, Section 3 of UCTA provides:

(1) This section applies as between contracting parties where one of them deals on the other’s written standard terms of business.

(2) As against that party, the other cannot by reference to any contract term—

(a) when himself in breach of contract, exclude or restrict any liability of his in respect of the breach; or

(b) claim to be entitled—

(i) to render a contractual performance substantially different from that which was reasonably expected of him, or

(ii) in respect of the whole or any part of his contractual obligation, to render no performance at all, except in so far as (in any of the cases mentioned above in this subsection) the contract term satisfies the requirement of reasonableness.

The decision of the Court of Appeal signals that it would not be easy for a defaulting party to assert as a defence that it was dealing on its counterparty’s standard terms where a) substantial negotiations preceded the conclusion of the agreement, and b) the defaulting party was able to introduce meaningful changes to the terms of the other party. While it provides useful judicial guidance, the decision does not change the law relating to exclusion clauses.

The Court of Appeal, perhaps unsurprisingly, rejected the proposition that a contract based on an LMA form could never be made on standard business terms. Whether or not it is would depend on the extent of the negotiations and amendments made to the form of agreement. This is one of the unusual situations where evidence of pre-contractual negotiations is admissible under English law.

This decision will give comfort to lenders who use precedents or model form agreements, making it more difficult for borrowers to argue that they contract on the lenders’ standard terms in circumstances where extensive negotiations preceded the conclusion of an agreement and substantive changes suggested by borrowers.

Background facts

Shebah Exploration & Production Company Limited (Shebah) entered into a pre-export finance facility agreement with three banks (the Lending Banks), to refinance its pre-existing debt and obtain working capital to fund an oil production programme. Shebah’s obligations were guaranteed by two other parties (together with Shebah, the Defendants). The Lending Banks advanced US$50 million each to Shebah. The facility agreement was based on the LMA form of syndicated facility agreement, which was used as a starting point for negotiation.

Shebah defaulted on its capital repayment obligations, and the Lending Banks accelerated Shebah’s entire debt, as was their right under the facility agreement. When no payment was made by Shebah, the Lending Banks started proceedings to recover the debt.

The Defendants advanced counterclaims in the sum of US$1 billion and argued that they were entitled to set off the alleged counterclaims against their accepted liabilities under the facility agreement.

The Lending Banks relied on the following “no set off” clause in the facility agreement:

All payments to be made by an Obligor under the Finance Documents shall be calculated and be made without (and free and clear of any deduction for) set-off or counterclaim.

The Defendants argued that they were dealing on the Lending Banks’ “written standard terms of business” under section 3 of UCTA, so that the Lending Banks could only rely on the no set-off clause if it were “reasonable”.

At first instance, Phillips J granted summary judgment against the Defendants. The Defendants appealed.

Court of Appeal

The Court of Appeal agreed with the first instance judge and held that the Defendants did not deal on the Lending Banks’ “written standard terms of business”, and made the following observations:

Model form agreements. The party alleging that it was dealing on another party’s standard terms must show “that the other party habitually uses those terms of business”. Showing only that terms are sometimes used and sometimes not used is not enough.

Insofar as model forms are concerned, for UCTA to apply, it is essential that such form be “invariably, or at least usually” used by the party in question, and that a party has adopted a model form as its standard terms of business “either by practice or by express statement”. Demonstrating that a model form has been used “on the particular occasion” would not suffice.

The Shebah decision confirms that the Court will look at all the circumstances of the transaction. Here, the Defendants were dealing with three different lending banks (one Egyptian, two Nigerian) in a syndicated loan transaction, and could not have believed that they were doing so on “standard terms”. The Court stressed that the Defendants had to evidence their assertion that they were contracting on the Lending Banks’ standard business terms: “It cannot be right that any defaulting borrower can just assert that business is being done on standard terms and that the lender then has to disclose the terms of other (how many other?) transactions he has entered into […]”.

Pre-contractual negotiations. Consistently with the previous authorities, the Court of Appeal rejected the proposition that any negotiations of any kind would automatically bar UCTA from applying. The relevant question was “whether there have been more than insubstantial variations to the terms which may otherwise have been habitually used by the other party to the transaction”. Substantial variations would be less likely to engage UCTA.

In Shebah, detailed negotiations preceded the entry into the facility agreement, and substantial amendments (evidenced by copious “redlines”) were made by the Defendants. This made hopeless the Defendants’ argument that the LMA model form was, or the terms ultimately agreed were, the Lending Banks’ standard terms of business.

The Court of Appeal stressed that it is not necessary for the negotiations to relate to the exclusion terms in order to displace the application of UCTA: the Court will look at all the surrounding circumstances to determine whether the terms ultimately agreed were or were not standard terms.