Reservation of Rights Letters following Lombard North Central plc v European Skyjets Ltd (in liquidation)
With signs of distress in the market increasing, lenders are likely to see more defaults occurring under facilities they have advanced. In turn, this makes it more likely that lenders will be considering their options and issuing reservation of rights letters while they do so.
Earlier this year, the High Court handed down its judgment in the case of Lombard North Central Plc v European Skyjets Ltd (in liquidation)1 ("Lombard v Skyjets"). This case provides a useful reminder that a lender (or an agent acting on behalf of a syndicate of lenders) must consider carefully what rights it has following a breach by the borrower and decide how to respond, and that its conduct and its reservation of rights letter must be consistent with that decision. If it is not, a lender could inadvertently waive rights that it may have consequent on such a breach, on which it may have wished to rely.
1. What is a reservation of rights letter, and when and why should one be sent?
If an obligor is in default under any finance documents but the lender does not wish to enforce its rights immediately, a lender will commonly issue a reservation of rights letter.
It is now well recognised that when a right to terminate (or, in the context of a loan agreement, accelerate/cancel a facility) arises, the non-defaulting party has to make an active choice whether to exercise its contractual rights. Case law suggests that the non-defaulting party is permitted some time to make up its mind about what to do. However, failure to act for any significant period of time, or acting inconsistently with its rights, could result in a court determining that the non-defaulting party has waived the breach or affirmed the contract.
Following the occurrence of an event of default, a reservation of rights letter is commonly issued by a lender to its defaulting borrower. A reservation of rights letter will usually specify the default that has occurred under the relevant finance document (usually the facility agreement). It will also usually go on to state that the lender is reserving its rights and remedies under the relevant finance document and state that the lender's failure to act will not constitute a waiver of the relevant default.
A reservation of rights letter is intended to give the lender breathing space to gather background information on the default that has occurred and take expert advice on the options available to it, while seeking to ensure that the lender is not prevented from taking action against the borrower or its assets at a later stage.
2. Limitations to reservations of rights letters
The recent case of Lombard v Skyjets is a timely reminder that the issue of a reservation of rights letter by a lender is not a guaranteed method of preventing a waiver of rights.
In Lombard, the court considered the effect of both a "no waiver" clause in the relevant loan agreement and a so-called "no waiver statement", which appeared repeatedly in email correspondence between the parties, and which purported to reserve Lombard's rights in relation to defaults which had occurred under the finance documents.
The court held that the "no waiver statement" constituted merely a general reservation of rights and that "the ritual incantation of this language" could not prevent an affirmatory act from having its "objective effect" (i.e. affirming the contract and thereby waiving the non-defaulting party's rights in relation to any breach).
The court found in Lombard that the lender had waived its right to rely on the event of default through its conduct, which included agreeing extra time to make payments, accepting late payments, claiming interest on unpaid payments and agreeing a late payment fee that appeared to be in return for not terminating. Because of that conduct, the court held that neither the "no waiver" clause in the loan agreement, nor the "no waiver statement" had any effect.
This follows the Court of Appeal decision in SK Shipping Europe Plc v Capital VLCC 3 Corp2 (handed down a matter of weeks before the Lombard v Skyjets judgment), which similarly held that a reservation of rights is not effective in all circumstances:
"While a reservation of rights will often have the effect of preventing subsequent conduct constituting an election, this is not an invariable rule. The court must have regard to all the circumstances, including the nature and terms of any reservation of rights which has been communicated and the nature and consequences of any demand for future performance."
3. Practical tips for lenders when sending reservation of rights letters
- Lenders should review the relevant contractual documentation as soon as it is aware of an event of default or potential event of default, and consider carefully what rights it may have, and what restrictions, formalities and/or time limits might apply to the exercise of those rights.
- Unless the lender intends to enforce immediately, the safest course is to send a reservation of rights letter without delay. This will reduce the risk that delay in taking enforcement action constitutes waiver of the relevant default.
- Once a lender has issued a reservation of rights letter, it should keep the situation (and the time elapsed since the occurrence of the relevant default) under continual review, and in the meantime investigate the situation and decide without delay whether it wishes to exercise the rights it has following a breach. A lender should include reservation of rights language in any further communications with the obligors exchanged after the relevant breach but before the lender has decided what action it wishes to take in respect of the breach.
- A lender must always ensure that any actions it takes, including its communications with obligors (whether written or oral) and its acceptance of any further payments from the borrower, are consistent with the reservation of rights letter. If the lender does not do this, it may inadvertently waive the breach and the reservation of rights letter will be deemed to be of no effect. To do this, it must obtain clear advice on the nature of the breach, the rights available to it, and how those rights can be exercised. This will involve a careful review of the express contractual terms, and advice as to what conduct and what demands would be consistent with preserving its rights.
- In Lombard v Skyjets the lender allowed the borrower additional time to make late payments and accepted late payments. However, a less obvious action which (depending on the circumstances, the conduct of the parties, and the wording used) may defeat a reservation of rights letter, is issuing a demand for payment of any default interest (as distinct from merely asserting that default interest is accruing). While a lender may contractually be entitled to such sums in a default scenario, a demand for payment of default sums may indicate that the lender is affirming the contract, which may be inconsistent with asserting other contractual remedies, such as acceleration or the ability to enforce its security. Legal advice should therefore be sought before any such demand is made. As the name suggests, a reservation of rights letter usually does nothing more than reserve the rights of the lender. It is possible that after a default the lender may decide that it is willing to waive a breach, renegotiate the terms of the facility agreement or embark on some form of restructuring. These would, of course, need to take place following the issue of a reservation of rights letter and be documented separately.
4. Practical tips for borrowers upon receipt of a reservation of rights letter
- If you receive a reservation of rights letter, this does not always mean that termination, acceleration and/or enforcement action is inevitable:
- while a breach may have occurred, it may not necessarily be a breach which gives rise to termination rights, and even if it does then there may be restrictions on when and how the lender can exercise them; and
- the issue of a reservation of rights letter is often standard procedure for lenders where they become aware of a default.
- Check whether the alleged breach has in fact occurred, including whether there may be factual uncertainty over what has occurred and/or legal uncertainty over whether the factual circumstances fall within the meaning of relevant contractual provisions.
- Wherever appropriate, keep channels of communication with the lender open. This is often the best way to allay a lender's concerns about a business' solvency and may result in the lender choosing not to take enforcement action, or to delay any further action while you remedy the breach. Lenders are key stakeholders in consensual restructurings or refinancings, so maintaining a good relationship and open channels of communication with them can assist with future plans.
- The issue of a reservation of rights letter is not guaranteed to have its stated effect – the lender may waive its rights at a later stage, either expressly or inadvertently by inconsistent conduct.
- If you are unsure of your rights and options, or if you may require restructuring, refinancing or reorganisation advice, consider seeking legal and/or financial advice.
1  EWHC 728 (QB)
2  EWCA Civ 231