In the recent case of Yieldpoint Stable Value Fund, LP v Kimura Commodity Trade Finance Fund Ltd  EWHC 1212 (Comm), the High Court found, as a matter of contractual construction, that the terms of a supplemental agreement between the parties trumped the terms of their master framework participation agreement. The result was an unusual hybrid agreement that left the lender of record liable to repay the participant’s capital investment on the maturity date.
What is a sub-participation?
Sub-participation enables a lender to transfer its economic risk in a loan to another party. It does not involve the legal transfer of the underlying loan itself, but instead creates a new arrangement between the lender of record and the new party (the participant) that is separate to, and distinct from, the underlying loan. In a typical funded sub-participation, the participant buys a derivative interest in the underlying loan from the lender, and in turn the lender agrees that it will make payments (mirroring the underlying payments of principal and interest) to the participant only if, and to the extent, it receives the same from the borrower. The participant therefore takes credit-risk on both the borrower and the lender. (For the purpose of this article, we put to one side the alternative concept of risk participation – perhaps a topic for another day!) For many loans, sub-participation by the lenders of record does not require consent from the borrower or even disclosure, enabling the lenders of record to maintain their relationships with their borrowers whilst mitigating the economic risk.
Kimura Commodity Trade Finance Fund Ltd (Kimura) was a joint senior lender under an existing US$45 four-year structured finance facility (the MTV Facility).
In February 2021, Kimura entered into a Master Participation Agreement (MPA) with Yieldpoint Stable Value Fund, LP (Yieldpoint). The MPA included a template supplemental sub-participation agreement which was to be used to document the terms of a particular transaction. The MPA (including the template form of sub-participation agreement) envisaged that any future funded participation agreement between the parties would be on a conventional sub-participation basis: Yieldpoint would take risk on the underlying borrower, with payment of both capital and return dependant on the equivalent payments of principal and interest being made by the underlying borrower to Kimura as lender of record. The MPA provided that with respect to any particular transaction under the MPA the parties could agree any amendments to the template sub-participation agreement in writing, that the express terms of any sub-participation agreement agreed for a particular transaction would override or modify any conflicting or inconsistent terms of the MPA, and that in the event of a conflict between the MPA and an agreed sub-participation agreement the terms of the agreed sub-participation agreement would prevail.
In March 2021, the parties entered into a sub-participation agreement (MTV Participation Agreement) in respect of the MTV Facility, but the MTV Participation was modified from the form of template scheduled to the MPA and, unfortunately for those later tasked with interpreting it, was largely inconsistent with the terms of the MPA. The MTV Participation Agreement provided for Yieldpoint to pay Kimura USD 5m for an interest in the MTV Facility; crucially, it also provided for a fixed 12-month term for the participation, with the option for Yieldpoint to extend the term by providing notice to Kimura at least 45 days prior to the "maturity date" of 31 March 2022. The concept of a maturity date for the arrangements between a lender of record and a participant is inherently at odds with the nature of a participation and so was the subject of much focus by the court.
The borrower under the MTV Facility ceased operations in January 2022, and failed to make subsequent payments due under the MTV Facility on 31 March 2022. In February 2022 Yieldpoint provided notice of its intention not to renew the deal but Kimura did not repay the claimed USD 5m of capital to Yieldpoint.
The key question for the court was whether the arrangement between the parties under the MTV Participation Agreement and the MPA was:
- A typical sub-participation such that Yieldpoint was exposed to the underlying default risk of the borrower under the MTV Facility, as occurred when the borrower defaulted, such that no payment was due from Kimura to Yieldpoint, or
- Akin to a fixed-term loan of 12 months, such that in the absence of a notified extension the capital sum of USD 5m became repayable by Kimura to Yieldpoint on 31 March 2022?
The court was faced with a complex interpretation exercise, noting that each side’s analysis suffered “heavy linguistic casualties” and that “making sense of what they objectively agreed is not easy”. The court noted:
- There is no fixed concept of sub-participation under English law, and the analysis turns on the language used.
- The starting point contemplated by the MPA was a proportionate sharing of both risk and reward in the relevant underlying finance transaction (such as the MTV Financing), and that this entailed exposure for Yieldpoint of both capital and income stream to the default risk of the underlying borrower.
- Given that starting point, clear language was needed to alter the default structure in a significant way, and that the more significant the departure, the stronger the wording needed to be.
- The terms of the MPA did allow for the default structure to be modified.
On balance, the court preferred Yieldpoint’s analysis, finding that notwithstanding the terms of the MPA, the result of the MTV Participation Agreement was a hybrid agreement containing both a fixed-term loan (as to capital) and a participation (as to the interest received on the underlying loan). Kimura was therefore liable in debt (alternatively in damages) for USD 5m plus interest.
Yieldpoint’s interpretation of the arrangements was preferred for the following key reasons:
- Maturity date – the court took the view that the concept of a maturity date was in itself “alien” to a sub-participation agreement but was appropriate for a fixed-term loan agreement where the lender takes the default risk of the borrower. On the maturity date, the loan becomes repayable without demand, and
- Assurance by Kimura to repay the capital amount to Yieldpoint after 12 months – on the evidence, the court found that Yieldpoint was promised that its capital would be returned after 12 months.
This case reinforces the courts’ position that simply labelling an agreement as a sub-participation agreement does not necessarily make it one. And it serves as a useful reminder for all parties to ensure that regardless of any labels used, the terms of your agreements (including any structured by way of a master agreement plus supplement) properly and clearly reflect their commercial understanding.