Dan Antoun - PhotoOn 21 March 2016 the Supreme Court heard the appeal of BNY Mellon Corporate Trustee Services Ltd v LBG Capital No. 1 plc & Anor. It concerned the Court of Appeal’s interpretation of contractual provisions relating to a series of capital notes issued by Lloyd’s Banking Group shortly after the financial crisis in 2008.


Following the global financial crisis in 2008, financial institutions were made subject to capital adequacy requirements. Banks were to be stress tested by regulators to predict whether they had adequate capital to cope in extreme but plausible economic events, such as another financial crisis. Capital was divided into tiers with the highest tier known as core tier 1 (“CT1”). Financial institutions were required to maintain a certain level of CT1 capital compared to risk-weighted assets – the CT1 ratio.


In March 2009, the Financial Services Authority stress tested LBG and found that LBG’s CT1 ratio was inadequate. LBG responded in December 2009 by issuing a series of enhanced capital notes (“ECNs”) via a trust deed. The ECNs would initially form part of LBG’s tier 2 capital but could convert to CT1 capital (in the form of ordinary shares) if LBG’s CT1 ratio deteriorated below a prescribed threshold. At the time of issue, therefore, the ECNs were classed as tier 2 capital, but due to their ability to convert, they could be counted as CT1 capital in an FSA stress test if, in the hypothetical ‘stress scenario’, LBG’s CT1 ratio was predicted to fall below that threshold.

A high level of interest was payable on the ECNs. However, the ECNs could be redeemed early if a capital disqualification event (“CDE”) occurred. Under the trust deed, a CDE would occur if, as a result of changes to regulatory requirements, the ECNs ceased to be taken into account for the purposes of an FSA stress test in respect of LBG’s CT1 ratio. CT1 capital was defined as “[CT1] capital as defined by the FSA as in effect and applied … as at 1 May 2009”.

In December 2014 the Prudential Regulatory Authority (“PRA”), successor to the FSA, carried out a further stress test on LBG. Following several regulatory changes between 2009 and 2014, CT1 capital had been replaced by another type of capital (common equity tier 1 (“CET1”) capital) for the purposes of stress testing. Financial institutions had to show that even under stress they would have an adequate CET1 ratio; additionally, the minimum acceptable CET1 ratio was set at a higher level than the minimum CT1 ratio had been.

LBG’s actual CET1 ratio was significantly higher than the threshold at which the ECNs would convert into CT1 capital. The ECNs were therefore not taken into account in the December 2014 stress test.

Legal Issues

In early 2015 LBG sought a declaration from the High Court that a CDE had occurred entitling it to redeem the ECNs. It argued that, as the conversion trigger for the ECNs was far below the new minimum CET1 ratio, the conversion trigger could never be reached before LBG had already ‘failed’ the stress test. The ECNs, therefore, could not be taken into account for the purposes of any stress test.

The fact that the ECNs had not been taken into account in this particular stress test was not contested. However, the trustee of various holders of ECNs (“BNY Mellon”) contended that no such event had occurred and that the stress test was not relevant to the definition of a CDE, as it was a CET1 stress test and not a CT1 stress test. Even if it was a relevant test, the ECNs had not ceased to be taken into account for the purposes of calculating the CT1 ratio.


The High Court found that the definition of a CDE in the trust deed should not be read literally because there had been “an obvious mistake” in its drafting. Therefore the trust deed and ECNs were interpreted so as to give effect to their objective commercial purpose in light of the facts. The High Court held that the definition of a CDE “connotes a disallowance in principle of the ECNs on stress testing with continuing effect in the foreseeable future”. The High Court concluded that the PRA had not disallowed the ECNs in principle and therefore a CDE had not occurred.

LBG appealed against the High Court’s decision. The Court of Appeal agreed that there had been an obvious mistake in using the definition of CT1 capital within the definition of a CDE. However, the Court of Appeal adopted a different interpretation of the provisions and found that once the ECNs ceased to “be capable of contributing to LBG’s ability to meet the relevant ratio in the stress test in question (ie ‘any’ stress test), they cease[d] to be taken into account for the purposes of the clause and a CDE [had] occurred”. The Court of Appeal allowed LBG’s appeal and granted a declaration that a CDE had occurred and that LBG was entitled to redeem the ECNs.

Appeal to the Supreme Court

The Court of Appeal’s decision saved LBG an estimated £1 billion, but meant that the noteholders (on whose behalf BNY Mellon are litigating) would be denied the high interest they were expecting on the ECNs.

BNY Mellon was granted leave to appeal to the Supreme Court. The issue before the Supreme Court is whether the Court of Appeal erred in law in its construction of the terms of the ECNs by relying on technical and specialist information as part of the factual matrix.