Tael One Partners Limited had a $32 million participation in a $100 million syndicated loan to Finspace SA. The facility agreement provided for Finspace to pay interest and, on prepayment or repayment of the loan, a payment premium. The payment premium was to be calculated at the time of the repayment as a percentage return per annum, varying according to the circumstances of the repayment.

At Finspace's request, Tael transferred $11 million of its participation to Morgan Stanley & Co International Plc. The transfer was documented by a transfer certificate, an LMA trade confirmation and a purchase price letter. Payment premium was not mentioned in any of these three documents.

The trade confirmation incorporated the LMA standard terms and conditions for par trade transactions. Although the particular LMA terms discussed in the case have been superseded by the LMA's combined terms and conditions for par and distressed trading, the issues and clauses discussed are similar to those in the latest LMA trading documents.

Conditions 11.3 and 11.9(a) of the LMA terms provided that Morgan Stanley should account to Tael for any payments of interest and fees accrued up to, but excluding, the date of the transfer. Condition 11.9(a) specified the interest and fees as those "which are expressed to accrue by reference to the lapse of time".

After Finspace repaid the loan in full, Tael contacted Morgan Stanley claiming that Tael was entitled to receive $729,791, reflecting the payment premium that had been accumulating for the period during which it advanced the $11 million before that part of the loan was transferred to Morgan Stanley. Morgan Stanley refused to pay, saying that it had sold its participation in the loan to a third party and had not received any payment premium from Finspace.

The High Court held that Tael was entitled to the proportion of the payment premium that corresponded to the period for which it held the loan, as the payment premium formed part of the consideration for that portion of the loan. The court based this decision on its conclusion that the payment premium fell within condition 11.9(a) as it accrued by reference to the lapse of time.

Morgan Stanley appealed to the Court of Appeal, which overturned the High Court's decision, finding that condition 11.9(a) did not impose an extra entitlement to payment beyond that which was payable under condition 11.3 (www.practicallaw.com/9-532-4066).

The Court of Appeal pointed to the fact that, contrary to the wording used in other conditions within section 11 of the LMA terms, there was no reference to any requirement to "pay" or "payment" under condition 11.9. Also, there was no mechanism within the LMA terms to allow for the buyer to pay anything back to the seller after the date of the transfer, which the court saw as problematic in a situation where there could be multiple transfers of the participation during the life of the loan. In the absence of any notification or payment obligations between the parties, this would create difficulties in terms of accountability between the various lenders in the chain.

It was also unclear what the position would be if Finspace never paid the payment premium; that is, would Morgan Stanley be accountable to Tael for money it had never received? Ultimately, the court concluded that if the parties had intended Tael to recover any part of the payment premium from Morgan Stanley, the court would expect it to have been mentioned in the purchase price letter.

The Supreme Court dismissed Tael's appeal, although its reasoning differed from that of the Court of Appeal. The court considered the wording of condition 11.9(a) and the reference to fees "which are expressed to accrue by reference to the lapse of time" and concluded that payment premium did not fall within this definition. While it was true that the payment premium was calculated by reference to the lapse of time, this was not sufficient to make the payment premium come within the scope of condition 11.9(a). The use of the word "accrue" in condition 11.9(a) referred to the coming into being of a right or obligation. In this case, the entitlement to the payment premium accrued on a defined event; that is, the repayment or prepayment of the loan, and so did not fall within condition 11.9(a).

The court also referred to the same difficulties raised by the Court of Appeal regarding the ongoing accountability between various traders of the loan participation. It remarked that it is significant that the LMA terms do not contain any mechanism that would enable the holder of the putative right to a payment premium, following the sale of its interest in the loan, to know when, or in what amount, its right has vested. The court also felt that the natural time to attribute value to any payment premium to which the seller felt it was entitled would be at the time of the sale.

This decision leaves both buyers and sellers in the secondary loan market in a quandary when it comes to attributing a price to any loans where a payment premium is involved. The parties in this case agreed that, at the date of the transfer, it was not possible to calculate the amount of payment premium to which Tael would be entitled on prepayment or repayment of the loan. So any value attributed to it on the sale of the loan would have to involve an element of guesswork by the parties.

This clearly opens the door to much more complex negotiation of the purchase price than would normally be required in these circumstances, with both parties concerned about making a bad bargain. This risk becomes even more pronounced when considering the concern raised by both the Court of Appeal and the Supreme Court that the payment premium might not be paid out, as the buyer is unlikely to want to increase the purchase price to cover a sum for which it might never be compensated.

Following this decision, parties are left with no option but to embark on a guessing game. If they do not do so then, in a scenario where a four-year loan is traded once just a few weeks before the end of the loan, the buyer would be rewarded for the risk of providing the financing for the full four years when in reality it was not exposed to any risk at all for the majority of that time, and the seller would receive no recognition of the risk that it has taken. The query raised by both the Court of Appeal and the Supreme Court as to why the parties cannot simply account for the payment premium when negotiating the trade gives inadequate consideration to the ambiguity over the likely sum to be payable and the concerns of both parties of striking a bad bargain.

Unfortunately, in terms of providing certainty, this judgment does not appear to do any favours to the LMA's key objective of improving liquidity, efficiency and transparency to primary and secondary loan trading. It is most likely already too late for all those who had traded under the LMA terms in reliance on them properly apportioning risk and payment between lenders.