High Court strikes out claim against banks in their capacity as lenders to investors of a tax deferral scheme

The High Court has struck out claims brought by former investors in the Ingenious Media tax deferral schemes against lending banks who advanced sums to the investors for the purpose of investing in the scheme: Mr Anthony Barness & Ors v Ingenious Media Limited & Ors [2019] EWHC 3299 (Ch).

In the context of the current wave of tax deferral scheme litigation (including in respect of the film financing schemes Samarkand, Proteus, Imagine and Timeless Releasing), the interlocutory decision in Barness provides reassurance to banks which acted as lenders to the investors in those schemes. This is particularly welcome in circumstances where investors are increasingly pursuing claims against such lenders where the independent financial advisers (“IFA”) and promoters who provided advice to investors directly have either collapsed or do not have sufficiently deep pockets.

The most important aspects of the case which are likely to be of relevance to similar claims, and more generally to financial institutions selling products on an execution-only basis, are as follows:

  1. The claimant investors in Barness sought to establish that their relationship with the banks went above and beyond a standard lending relationship, and that they were owed duties (both in contract and in tort) by their lenders relating to the suitability of the investment for which the loan was advanced. The court firmly rejected this avenue of reasoning, referring to the decision of the Court of Appeal in Green v The Royal Bank of Scotland plc [2013] EWCA Civ 1197 and of the High Court in Carney v N M Rothschild & Sons Ltd [2018] EWHC 958 (Comm) that there is no general obligation on a lending bank to give advice about the prudence or otherwise of the transaction which the loan is intended to fund.
  2. For claims based on implied contractual terms or duties of care to succeed, it remains paramount for claimants to point to very specific words or conduct. In this case, it was asserted by the investors that the lending banks had agreed (or acquiesced) to the investors’ IFA “packaging” together the investment proposition with available financing. The court found that – even if this assertion was accepted – it was insufficient to establish an implied term as to the suitability of the investment, or to find that the banks had assumed a similar duty of care in tort or had otherwise endorsed the investment.
  3. The court was unconvinced by the argument that there existed an implied “umbrella contract” based on the “private banking and wealth management relationship” between the claimants and the lenders. We have previously considered a similar (unsuccessful) attempt at such an argument advanced in Standish v RBS [2018] EWHC 1829 (Ch) in our blog post. There has been a noticeable uptick in claimants asserting the existence of an implied umbrella or overarching agreement as a vehicle by which to advance arguments based on implied contractual terms. The court’s robust rejection of such claims in this case and Standish will be welcomed by financial institutions.
  4. The court also rejected a claim that the IFA promoting the scheme had acted as the lending banks’ agent, and that the banks were therefore vicariously liable for its negligent advice. The court held that the IFA and the banks had conducted their separate businesses throughout (of providing financial advice and financing respectively), such that the activities of the financial adviser could not be said to have been an integral part of the banks’ business. Evidence regarding the close relationship between the financial adviser and the banks was submitted to no avail. Again, the court’s robust rejection of this line of argument is helpful not only in the context of other tax deferral scheme litigation, but more generally where banks act on an execution-only basis alongside an IFA.

We consider the decision in more detail below.

Background

From 2002 to 2007 a number of tax schemes were promoted under the name “Ingenious” as tax-efficient vehicles through which investors could contribute funds to a limited liability partnership (“LLP”) for investing in films/video games and set off their share of the LLP’s losses against other taxable income. HMRC did not accept that the schemes worked as intended and, following a series of appeals, the outcome for the individual investors was that they lost both the sums invested in the schemes and the anticipated tax relief (and may be exposed to claims by HMRC for arrears of tax with interest and penalties). A number of the investors have issued claims to seek to recover their losses from a range of defendants, including claims against the banks which advanced the funds to cover some (or all) of the investors’ capital contribution to the relevant LLP.

The present claims were brought by investors who borrowed sums from Coutts & Co and National Westminster Bank plc (the “Banks”). All of the claimants received independent advice on their investments in the Ingenious schemes from the same IFA.

The claims against the Banks are part of a much larger litigation brought against financial and tax advisers, the promoters of the scheme and lenders. In relation to their claims against the lender Banks, the claimants relied on three separate causes of action:

  1. Claims for breach of contract, based on terms said to be implied into contracts between the claimants and the relevant Bank. In particular, an implied term relating to the suitability of the loans (i.e. that the Banks would not provide loan finance, introduce products or allow a loan to be packaged with an investment product, unless they were suitable for the claimants having regard to their financial position, needs, objectives and attitude to risk).
  2. Claims for negligence, predicated on duties of care of a similar nature to the (alleged) implied suitability terms, owed both (a) concurrently with the implied contractual duties; and (b) in tort arising from a non-contractual assumption of responsibility.
  3. Claims alleging that the Banks were vicariously liable for breaches of duty by the IFA, on the basis that the IFA acted as the Banks’ agent.

Decision

The court struck out the contractual and tortious claims pursuant to CPR 3.4(2)(a) and granted reverse summary judgment on the vicarious liability claims pursuant to CPR 24.2. The court’s analysis is considered in further detail below.

1. Breach of contract

The claimants asserted that the term relating to the suitability of the loan (and a number of other terms) were implied into either: (a) an unwritten umbrella or overarching contract on the basis that the claimants and the relevant Bank had entered into a “private banking and wealth management relationship”; or (b) the existing loan documentation.

Umbrella contract

As to whether there was a wider umbrella agreement, the Banks submitted that the claimants had failed to comply with CPR Practice Direction 16, which requires that claims based on oral agreements and conduct must specify the words spoken and conduct in sufficient detail. The court agreed that no facts had been pleaded which supported the existence of an umbrella contract between the claimants and either of the Banks.

Having noted that not every breach of Practice Direction 16 would lead to a claim being struck out, the court considered the claimants’ argument that the umbrella contract arose on the basis of the Banks’ conduct, specifically in offering the “package” presentation of the investment and loans. In the court’s view, this did not provide the requisite support for the umbrella contract. It said there was no logical connection between the alleged “packaging” of the loans and investments, and the suggestion that the Banks offered to undertake an overarching responsibility for management of the claimants’ wealth which was over and above the particular services provided by the Banks (loans and current accounts etc.). The court likewise held that statements in one of the Bank’s internal documents that the claimants had a “full banking relationship” did not suggest that the Bank had entered into an umbrella contract to provide not only banking but also wealth management services.

The court concluded that there was no pleaded basis for the suitability terms to be implied into an umbrella contract and this was sufficient to justify strike out in the circumstances, noting that it would have alternatively granted reverse summary judgment.

Loan documentation

The court paraphrased the test for implying terms into a contract (clarified in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Limited and another [2015] UKSC 72, although without citation in the judgment). It found that the alleged contractual duty on the Banks not to package loans with an unsuitable investment was neither so obvious as to go without saying, nor necessary to give business efficacy to the contract.

The court accepted that it was well established that a bank which sells a product to its customer is not under a (tortious) duty to advise as to the nature of the risks inherent in the transaction (Green v RBS). In those circumstances, the court could not see any sustainable case pleaded (or that could realistically be pleaded) that the suitability terms were to be implied into the contracts of loans between the Banks and the claimants.

The court therefore struck out the claims (and noted it would have alternatively awarded reverse summary judgment).

2. Negligence

As noted above, the allegation that the Banks owed the claimants a duty of care in tort was argued firstly on the basis that it was concurrent with a like duty in contract. This duty was not considered further, given the court’s rejection of the contractual claims.

Accordingly, the court proceeded to consider whether the relevant Bank assumed responsibility towards each of the claimants giving rise to a duty of care in tort of a similar nature to the (alleged) implied suitability terms. The court accepted that to find a duty of care in tort required some communication between the Banks and the claimants to the effect that the Banks were assuming responsibility for the tasks in question; and reliance by the claimants.

The claimants could not point to anything in terms of advice that crossed the line between the Banks and the claimants, but relied – once again – on the “packaging” of the loans with the investments to give rise to the duty of care. Without more, the court found this was insufficient to give rise to a duty of care. The court noted that a bank does not “assume an advisory role simply because it agrees to lend to the customer for a particular purpose” (Carney) and could not, therefore, be said to have assumed an advisory role simply because it agreed to its loans being “packaged” together with an investment. This was particularly so where there was an IFA advising the customer.

The court rejected the claimants’ attempts to draw comparisons with cases in which a duty of care had been found and reliance was not required, such as White v Jones [1995] 2 AC 207 (where a solicitor instructed by a testator was held to have owed duties of care in tort to the intended legatees). The court distinguished such cases on the basis that they related to whether an established contractual duty of reasonable skill and care can be said to be owed not only to a client of the defendant, but also to the person intended to benefit from the defendant’s advice. That was different to the present case, in which the question was whether there was a relevant duty of care at all, rather than widening the class of people who can sue for breach of duty.

The court therefore found that there were no reasonable grounds for bringing the claims and ordered strike out, noting that it would equally have granted reverse summary judgment.

3. Vicarious liability

The claimants alleged that the IFA had acted as the Banks’ agent in “introducing, explaining and advising upon the packaged investment”. The court said that the relevant question was whether the IFA was acting on behalf of the Banks, which required them to have either:

  1. told the claimants that the IFA was advising on their behalf, or otherwise held the IFA out as doing so (which was not the case, due to the fact that the loan documentation explicitly stated that the claimants were not relying on advice provided by the Banks); or
  2. used the IFA to discharge a duty to advise owed to the claimants (and the court found that there was no such duty to advise). In relation to the final claim based on vicarious liability, the court therefore granted reverse summary judgment in favour of the Banks.

An argument based on the rule in Cox v Ministry of Justice [2016] UKSC 10 which was advanced by the claimants also failed. This test expands the scope of agency to situations in which a person carries on activities as an integral part of the business activities of the principal and for its benefit. The court found that the business activities of the IFA in providing financial advice were neither an integral part of the business of the Banks, nor were they for their benefit. Despite the close commercial relationship between the IFA and the Banks, the commission paid by the former to the latter and the “packaged” presentation of the investment and the loan, each party was carrying out its own business, namely that of providing financial advice and providing banking and lending services respectively.

In relation to the final claim based on vicarious liability, the court therefore granted reverse summary judgment in favour of the Banks.

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High Court finds in favour of Lehman administrator in respect of US $7 million trade error and implies term into otherwise “unworkable” debt security trade agreement

A recent High Court decision has found that it was necessary to imply a term into an otherwise unworkable debt security trade agreement: Lehman Brothers International (Europe) (In Administration) v Exotix Partners LLP [2019] EWHC 2380 (Ch). The approach of the court towards implying terms into a contract is highly restrictive (see our litigation blog post) and implied terms are particularly unusual in the securities market, so this decision will likely be of interest to financial institutions.

In the present case, following a “colloquial” and “imprecise” oral agreement, both parties were mistaken as to the nature and value of the securities being traded. Having considered the contractual interpretation of the trade agreement, the court found that the correct interpretation required an implied term in order for performance to take place. Without this implied term, the trade would have been impossible to fulfil.

The court found that the implied term was not “obvious, because the implication of the term would have alerted the parties to their mutual misunderstanding. The term was instead implied solely on the basis that, without the term, the contract would lack commercial or practical coherence. In the court’s view, this included “workability”. This conclusion was not reached without some (understandable) hesitation from the court, in particular because – if the parties had been asked at the time of the transaction – they would likely have realised the shared misapprehension and dissolved the trade.

One of the most interesting points arising from the judgment is the legal gymnastics undertaken by the court in order to reach an ostensibly fair decision. The court notably criticised the defendant’s failure to notify its counterparty when it discovered the significant trading error. Indeed, the court found the defendant’s “commercial morality” to be “frail” at best. Against this backdrop, the court appears to have been motivated to claw back the defendant’s windfall gain of circa US $7 million.

It is worth noting that, had the agreement been made in writing as opposed to orally over a recorded line, the difficulties experienced by the court could have been avoided because rectification would have been a possible remedy. The Court of Appeal’s recent decision in FSHC Group Holdings Ltd v GLAS Trust Corporation Ltd [2019] EWCA Civ 1361 sets out the test for rectifying terms following common mistake and further consideration of the case can be found in our banking litigation blog post. However, rectification is not possible for oral agreements and therefore was not available here.

Background

In early 2014, Lehman Brothers International (Europe) (In Administration) (“LBIE”) entered into a trade of Peruvian Government Global Depository Notes (“GDN”) with Exotix Partners LLP via an oral trade agreement. A GDN is a debt instrument created and issued by a depository bank evidencing ownership of a local currency-dominated debt security (in this case, Peruvian government-issued bonds). Each GDN provided for payment of principal and interest in US dollars (unlike the underlying bonds, which were issued in Peruvian Nuevo Sol, or “PEN”).

The oral agreement was colloquial and imprecise. Both parties were mistaken as to the value of the trade. Indeed, each party was under the misapprehension that they were trading “scraps” worth approximately US $7,000 when in fact LBIE’s holding was worth over US $7 million. LBIE delivered its holding to Exotix which, upon the receipt of a larger than expected coupon payment, identified the error and, following some internal discussions, sold on the GDNs and pocketed the windfall without notifying LBIE.

Decision

The principal dispute was the true meaning and effect of the bargain struck further to the oral agreement, focusing on the contractual construction of that oral agreement and whether or not it contained an implied term.

Contractual construction

Applying the now well-established principles of contractual construction, the court considered the objective intention of the parties as to the subject of the trade and price. The key question was whether the parties had agreed to the sale and delivery of: (a) a specific number of GDNs (Exotix’s case); or (b) the number of GDNs equating to a face value in PEN (LBIE’s case).

The court found that the most likely meaning was (b) above, with the face value in PEN equating to approximately US $7,000. Accordingly, the performance (namely transferring a holding worth approximately US $7 million as opposed to US $7,000) was not in accordance with the objective interpretation of the trade agreement given the facts known at the time and the words used in the trade.

However, this interpretation presented a problem, because it required LBIE to deliver a non-integer quantity of GDNs. LBIE sought to cure this by way of an implied term.

Implied term

LBIE argued that as (i) fractions of the GDNs could not be transferred in practice and (ii) both parties were aware of the approximate trade value of US $7,000, the agreement must include an implied term which provided for and enabled delivery of a fraction of a GDN.

Finding in favour of LBIE, the High Court held that in order for the contract to be workable, a term must be implied into the trade agreement in respect of transferring fractions of GDNs.

In doing so, the court made the following key observations:

  • The court noted that the case of Crema v Cenkos Securities plc [2011] 1 WLR 2066 is the leading modern authority on the implication of terms based on clear trade practice. However, it held that there was not enough evidential basis to establish an “invariable, certain and notorious” practice relating to the delivery of a non-integer number of GDNs, and therefore this test was not satisfied. Even equating GDNs with bonds (for which it was accepted by both sides’ experts that trades might give rise to a fractional entitlement), the court could not properly extrapolate an implied term from the evidence when the issue of fractions of bonds is not common.
  • The court referred to the leading authority of Marks & Spencer plc v BNP Paribas [2015] UKSC 72 on the question of whether the pleaded implied term should be read into the trade on some other basis, in particular that it was obvious and necessary to provide commercial and practical coherence to the agreement and (in other words) to give the trade business efficacy.
  • The court noted that the difficulty in this case with saying that the term was so obvious as to go without saying, was the likelihood that knowledge of the term at the time of entering into the trade would have “jolted [the parties] into recognising the real problem”. So the implication of the term would have saved the contract from a misunderstanding rather than an obvious omission.
  • However, the court held that did not exclude the possibility of implying a term to ensure the workability of the agreement, i.e. that the implied term was necessary. The court emphasised that terms may be implied on the alternative bases of being obvious or necessary, and that although the outcome of either approach will usually be the same, that is not invariably the case. On this point, the court relied upon Nazir Ali v Petroleum Company of Trinidad and Tobago [2017] UKPC 2, which confirmed that a term may be implied if, without the term, the contract would lack commercial or practical coherence. In the court’s view, this included workability: a term may be implied if it is necessary to ensure that an agreement is workable.
  • Given the court’s conclusions on contractual construction, and the obligation to deliver a fraction of a GDN, the court stated that the only way in which the trade agreement could then be made to work was by implying a term for settlement of the fractional entitlement in cash, which was the implied term sought by LBIE.
  • The court acknowledged its hesitation in reaching this conclusion. It noted that, if the parties had been asked at the time, they likely would have made enquiries that revealed a shared misapprehension as to the nature of GDNs and dissolved the trade (this was intended to be a deal for scraps). However, the court stated that the law usually stops short of dissolving an agreement, preferring instead to give effect to what the parties appear ostensibly to have agreed (although the court considered LBIE’s argument that the contract was impossible to perform in the absence of the implied term, discussed further below).

Relief

The parties agreed that if LBIE succeeded in its primary case in respect of the contractual interpretation of the trade agreement and the implied term on fractions of GDNs, it would be entitled to restitutionary relief on the basis that Exotix would have been unjustly enriched by the over delivery of GDNs and coupon payments made on that amount.

The court held that the appropriate remedy for LBIE was monetary and this was the correct means of restitution (reference was made to Menelaou v Bank of Cyprus UK Ltd [2016] AC 176 (SC)).

In the event an implied term was not found, the court stated that the natural consequence would be that the contract was impossible to perform. It held that, in this event, LBIE would have been entitled to restitutionary relief on the basis there was a failure of consideration which would make the agreement void and unenforceable.

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High Court Strikes out claim alleging an implied overarching ‘customer agreement’ requiring the parties to “cooperate with each other and act in good faith”.

Standish & Ors v The Royal Bank of Scotland plc & Anor [2018] EWHC 1829 (Ch) will be of interest to financial institutions seeking to enforce rights or exercise powers under facility agreements. In particular, where counterparties allege the existence of implied duties which they allege restrict the exercise of express rights and powers in facility agreements, this decision provides a helpful example of the circumstances in which the court is prepared to strike out such claims.

In the instant case, the claimant (a borrower in default) alleged the existence of an implied overarching ‘Customer Agreement’, which was said to contain implied duties of good faith that restricted the defendant bank’s ability to enforce its express rights under the loan agreement. The Customer Agreement was referred to by the court as a “mysterious creature“, with no particulars given as to how it came into being; rather its function was to provide a vehicle into which terms could be implied. Unsurprisingly, the court rejected the existence of both the implied contract and the implied terms.

While the decision arose from an interlocutory application and turned on the specific facts of the case, it restates the leading authorities and provides an interesting application of what are now well-established principles of contractual interpretation. It was common ground that no general duty of good faith exists in English contract law and a high threshold must be met before the court is willing to imply the existence of a contract or term. The case should dampen some of the enthusiasm with which claimants may have viewed Mr Justice Leggatt’s (as he then was) ‘Relational Agreement’ formulation in Yam Seng Pte Ltd v International Trade Corp Ltd [2013] EWHC 111 (QB); a party seeking to argue that a ‘Relational Agreement’ falls to be implied must still be able to show that implying the ‘Relational Agreement’ is necessary to give business efficacy to the parties’ arrangements (Yam Seng at [142]). Finally, Standish should also serve as a timely reminder to parties to be more confident in applying for strike out where statements of case clearly provide no reasonable grounds for bringing a claim.

It is understood that the claimants have applied for permission to appeal the decision.

Factual Background

The claimants were shareholders in a company named Bowlplex Ltd (the “Company“), which owned and operated bowling sites across the UK. National Westminster Bank plc, which is a brand of the Royal Bank of Scotland plc (the “Bank“), provided the Company with banking facilities from 2004. The Company’s business suffered from both the introduction of the smoking ban and the global financial crisis, causing it significant financial challenges. This precipitated the Bank’s referral in June 2010 of the Company to the Bank’s Global Restructuring Group (“GRG“), following the Company’s breach of financial covenants.

The key points of the chronology thereafter are as follows. In August 2010, the Bank’s subsidiary and equity investment vehicle, West Register Number 2 Ltd (“West Register“), was introduced to the Company and a West Register employee began attending meetings between the Company and the Bank. The Company’s financial difficulties continued and two refinancing deals were struck with the Bank through which (among other things) the Company agreed to transfer 60% of the equity and 45% of the voting rights to West Register (together, the “Refinancing“). Shortly after the second refinancing, in 2012, Mr Standish was dismissed from his position as managing director of the Company on what he claimed to be spurious grounds.

Importantly, throughout the relevant period the Bank and the Company were party to a series of standard banking agreements, none of which included an entire agreement clause.

Against the factual background set out above, the claimants alleged that the Bank and West Register were party to an unlawful means conspiracy to force the Company to transfer shares to West Register. The unlawful means were alleged to fall into three categories:

  1. the Bank acted in breach of a duty of good faith;
  2. the Bank acted in breach of certain equitable duties; and
  3. West Register (alternatively the West Register employee) acted in breach of its fiduciary duties as a shadow director.

The focus of this e-bulletin is the alleged breach of a duty of good faith, as in relation to this issue the court made a number of points which will be of general application in similar cases.

Decision

The Bank applied for the claim to be struck out under CPR 3.4(2)(a), submitting that the particulars of claim showed no reasonable grounds for it being brought. The parties accepted that for the purposes of the application, the claimants’ version of events should be taken as accepted. It was common ground that for the claim to be struck out, the court had to be certain that the claim was bound to fail.

The court began by highlighting the current public interest in West Register and GRG. However, it emphasised that the question for the court was not whether GRG had behaved in commercial terms which were unsatisfactory, but whether, as a matter of law, the claim showed reasonable grounds.

The claimants argued that a duty of good faith should be implied into an overarching ‘Customer Agreement’ and that the formal facility agreements were to be regarded as sub-agreements for particular purposes. The particulars of claim, however, provided no insight as to how or when the Customer Agreement was to have come into being. The court considered separately the alleged implied Customer Agreement, and the duty of good faith alleged to be implied into that contract.

Implied Customer Agreement

In reaching its decision that no Customer Agreement existed, the court restated the current law on implying contracts into existence as per Baird Textile Holdings Ltd v Marks & Spencer plc [2001] CLC 999:

  1. for a contract to come into existence, there must be both (a) an agreement on essentials with sufficient certainty to be enforceable; and (b) an intention to create legal relations;
  2. no contract should be implied on the facts unless it is necessary to do so in order to give business reality to a transaction and to create enforceable obligations between the parties;
  3. it would be fatal to the implication of a contract if the parties would or might have acted exactly as they did in the absence of a contract.

The court relied on the comprehensive framework of standard banking agreements to conclude that there was no obvious reason why it should recognise an additional overarching agreement, without express terms, that was said to have come into being at some unspecified point in time. The claimants’ case on the Customer Agreement (and therefore the alleged duty of good faith implied into that contract) failed on the following bases: (1) the alleged overarching Customer Agreement failed the “necessity test” for introducing an implied contract; and (2) the circumstances of its creation were wholly unparticularised in the claimants’ pleadings. It was held that the Customer Agreement was a completely artificial construct that was divorced from the commercial realities of the dealings between the parties; its function was to provide the claimant with a vehicle into which the alleged terms could be implied.

Implied terms as to good faith

The court cited the leading authority on implied terms, Marks & Spencer v BNP Paribas Securities Services Trust Co [2015] 3 WLR 1843Marks & Spencer made clear inter alia a number of key principles. First, the default position is that nothing is to be implied into a contract; the more detailed the contract, the stronger that presumption will be. Second, it is impossible to imply into a contract any term or condition inconsistent with the express provisions of an agreement. Third, the implied term must be necessary to give business efficacy to the contract; a term can only be implied if, without the term, the contract would lack commercial or practical coherence.

Having found that there was no Customer Agreement in existence, the court noted that it was unnecessary to consider the Company’s case based on terms to be implied in that agreement and therefore declined to do so. The Company did not allege (“realistically“, in the court’s view) that terms were to be implied into the facility agreements themselves.

It is interesting to note that having determined that there was no Customer Agreement, the court also deemed it unnecessary to consider in any detail whether the types of duties envisaged in Mr Justice Leggatt’s (as he then was) ‘Relational Agreement’ in Al Nehayan v Kent [2018] EWHC 333 (Comm) and Yam Seng Pte Ltd v International Trade Corp [2013] EWHC 111 (QB) could be implied. Commentators are likely to watch with interest the next case where such arguments are raised, to see whether these authorities will be followed or distinguished.

Conclusion

The court therefore struck out the Company’s claims based on the Customer Agreement and implied terms of good faith. It also struck out the Company’s claims based on alleged breach of equitable and fiduciary duties.

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WW Property Investments Limited v National Westminster Bank Plc: Court of Appeal refuses permission for addition of claims regarding LIBOR manipulation

The case concerned an application by the claimant for permission to appeal a decision of the High Court to strike out the entirety of the claim concerning the claimant’s interest rate hedging products (IRHPs”) and its refusal to grant permission to add a new claim. Although not a substantive appeal as such, the case nevertheless illustrates some useful headline points in mis-selling claims.

The Court of Appeal held that the claimant had no real prospect of success in its claims: (1) based on alleged implied contractual terms and misrepresentations regarding the manipulation of LIBOR benchmarks (due to deficiencies in how those claims had been pleaded in this particular case); and (2) that the relevant IRHPs constituted wagering contracts and were invalid at common law. It did, however, grant leave to appeal a third limb of the claim (concerning conduct of the FCA Review).

Importantly, the Court of Appeal found that the claimant had through its conduct affirmed its interest rate swap, which would preclude any claim for rescission. The Court appeared to set a low standard for affirmation, finding that the claimant had affirmed the swap contract by: (1) making payments under the swap until its termination; (2) participating in the industry wide review of sales of IRHPs; and (3) claiming repayment of net swap payments and consequential losses in the proceedings.

Although the Court of Appeal’s decision is technically not binding precedent (as the judgment relates to permission to appeal), this point may have wider significance for LIBOR manipulation claims if other courts decide to follow the Court’s reasoning.

Background

The claimant entered into four IRHPs with NatWest, hedging loans made by that bank: three enhanced interest rate collars in 2004, 2005 and 2007, and an interest rate swap in 2010. In June 2012, the FCA announced that it had agreed with a number of banks (including NatWest) that a redress scheme would be set up to review and compensate certain customers to whom IRHPs had been mis-sold (the “FCA Review“). In this case, the FCA Review provided redress in respect of the three enhanced collars, but found that the swap had not been mis-sold.

The claimant advanced three main claims:

  1. LIBOR Claims: It was an implied term of the swap that NatWest had not previously, and would not in future, seek to manipulate any LIBOR index. Alternatively, there was an implied misrepresentation that NatWest would not manipulate any LIBOR index. This claim was not included in the initial pleading and the claimant had sought permission at first instance for its claim to be amended to include this claim.
  2. Wager Claim: The IRHPs constituted wagering contracts, as contracts for differences are in essence bets on the movement of the underlying rate/asset. It was claimed that such contracts are invalid under common law if the parties have unequal knowledge of the prospects of succeeding in the wager. The claimant argued that the parties had unequal knowledge as only NatWest knew that the IRHPs each had a mark-to-market value in favour of NatWest on the date of sale.
  3. Review Claim: NatWest had breached a duty of care owed to the claimant to carry out the Review diligently and to take proper account of all the evidence. The Review should have offered redress for the swap and offered additional consequential losses in relation to the three enhanced collars.

At first instance, HH Judge Roger Kaye QC in the Leeds District Registry struck out the entirety of the claim as having no real prospect of success and refused permission for the addition of the LIBOR Claims. The claimant sought permission to appeal.

Decision

The Court of Appeal refused leave to appeal the strike out of the Wager Claim and refusal to allow the amendment to include the LIBOR Claims. However, it granted permission to appeal the judge’s decision to strike out the Review Claim.

LIBOR Claim

The Court of Appeal found that the LIBOR Claims had no real prospect of success and accordingly refused permission to appeal. Whilst the Court found (following Deutsche Bank AG v Unitech Ltd and Graiseley Properties Ltd v Barclays Bank plc [2013] EWCA Civ 1372) that the existence of both the alleged implied term and implied representation was arguable, it was highly critical of how the claims had been pleaded in this case and found that several essential elements of the causes of action had not been pleaded. For example, in respect of the implied term claim, the claimant failed to allege that NatWest manipulated the relevant LIBOR rates at any relevant time. In respect of the implied misrepresentation claim, the claimant failed to claim that it had relied on the alleged misrepresentation.

Notably, both the High Court and the Court of Appeal found it “plain” that the claimant would not have been able to claim rescission (for breach of the alleged implied misrepresentation) as it had affirmed the swap contract by: (1) making payments under the swap until its termination; (2) participating in the Review and pursuing the Review Claim in the proceedings; and (3) claiming for repayment of all net swap payments and consequential losses in the proceedings.

Wager Claim

The Court of Appeal firmly rejected the Wager Claim, finding:

  1. The alleged common law rule that wagering contracts are invalid if the parties have unequal knowledge (if it had ever existed), would have been abolished by the Gambling Act 2005. In any event, the regime established by the Financial Services Act 1986 and the Financial Services and Markets Act 2000 would have excluded the rule from applying to the IRHPs or any financial instrument which they regulated.
  2. Even had the alleged rule applied, the IRHPs would not have constituted wagering contracts as they had a genuine commercial purpose. The IRHPs protected the claimant from changes in interest rates.
  3. Even had the alleged rule applied, the parties would not have had unequal knowledge, as neither side knew the future course of interest rates during the term of the IRHPs. The fact that the mark-to-market value was in favour of NatWest on the date of sale merely represented the expectations of the market, but ultimately neither party knew what would happen.

The Court also rejected an argument by the claimant, linked to point 3 above, that it is unlawful for a bank to enter into a swap contract with a customer that has a mark-to-market value in the bank’s favour on the date of sale, unless it discloses that fact to the customer. The Court firmly found that there was no realistic basis for claiming an implied term or representation that the mark-to-market is zero at the date of sale.

Review Claim

The Court of Appeal noted that it had recently granted permission to appeal a similar decision of the High Court in CGL Group Ltd v Royal Bank of Scotland [2016] EWHC 281 (QB). Accordingly, it accepted that the Review Claim was arguable and granted permission to appeal. The Court recommended that consideration should be given to listing the two appeals together (CGL is due to be heard in June 2017).

Comment

As the Court noted, it is unusual for the Court of Appeal to issue such a lengthy and detailed judgment in respect of an application for permission to appeal. This was primarily due to the judgment going into considerable depth to explain why the Wager Claim was fundamentally flawed. The Court suggested that it wanted to ensure similar claims were not advanced in future.

Perhaps the most significant part of the judgment is the Courts’ dismissal of the LIBOR Claim and its comments around affirmation. Much of the Court’s reasoning is limited to the particular facts of the case and, in particular, the claimant’s failure to plead its case properly. However, it is notable that the Court found that the claimant affirmed the swap contract (and therefore could not rescind) due to participating in the Review and also initiating proceedings to recover the net swap payments. The findings on affirmation were dealt with briefly in the judgment and the Court’s reasoning was not set out in detail. In addition, the judgment is technically not binding precedent, as it relates to the narrow question of permission to appeal. Nevertheless, if this approach is followed in other LIBOR manipulation cases (and in particular, in the upcoming judgment in Property Alliance Group v Royal Bank of Scotland plc, expected by January 2017), then claimants may struggle to establish rescission for implied misrepresentations regarding LIBOR manipulation. This could deal a severe blow to such claims, as it is likely that the amount of damages in any LIBOR manipulation claim (as distinct from rescission) would be minimal, given that the effect of alleged manipulation on any one product is likely to be negligible.

John Corrie
John Corrie
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Dan Eziefula
Dan Eziefula
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Windermere VII: Financial List provides guidance of wider market significance on the rights attaching to class X notes in a CMBS structure

A recent decision (heard in the Financial List) in Hayfin Opal Luxco 3 S.A.R.L. & Anor v Windermere VII CMBS plc & Ors [2016] EWHC 782 (Ch), relating to the interpretation of commercial mortgage backed securitisation (“CMBS“) documentation, will be of interest to finance lawyers and banking litigators alike.

The decision concerns the calculation of interest payable on certain ‘Class X’ notes. Whilst the findings relate to the specific documentation in question, they may well be of wider market significance given that such instruments are commonly used in CMBS structures and have (particularly in respect of those issued prior to the global financial crisis) been somewhat controversial. In particular, the Court confirmed that:

  1. interest payable to the Class X noteholder did not increase to include any default interest payable by the borrower under one of the underlying loans;
  2. interest payable to the Class X noteholder did not include interest on an underlying loan that had been capitalised;
  3. unpaid interest on the Class X note itself did not accrue interest (although this element of the decision was obiter).

Indeed, the first point above on default interest has also recently been considered in Credit Suisse Asset Management LLC v Titan Europe 2006-1 plc & Ors[2016] EWHC 969 (Ch), in which the Chancellor of the High Court reached the same conclusion in respect of a different set of Class X notes and underlying loan documentation. Whilst the specific analysis of the contractual wording was therefore also different, the same outcome was reached on the basis of an interpretation that was most likely to carry the commercial outcome intended by the parties given the overall scheme of the notes.

This judgment also provides guidance as to the approach to interpreting contracts governing complex financial instruments more generally. The case confirms (in line with previous Court of Appeal authority), that the Court will be reluctant to depart from the plain language used in an agreement unless the provision is ambiguous.

Permission to appeal has been granted and the appeal is due to be heard in early 2017.

Background

The case concerned the rights attaching to a Class X note, issued as part of a CMBS structure arranged by Lehman Brothers International (Europe) called ‘Windermere VII’ (the “Class X Note”).

As is common in a CMBS structure, a special purpose vehicle was established to issue notes of various classes, in this case Windermere VII CMBS plc (the “Issuer”). The payment of interest and principal on the notes was funded through payments of interest and principal on a portfolio of underlying loans secured against commercial real estate.

Interest on the notes was – in respect of all but the Class X Note – calculated by reference to EURIBOR (with an additional margin reflecting the seniority of the relevant note). In respect of the Class X Note, the Issuer did not pay a conventional rate of interest. Rather, the noteholder would receive any excess interest which the Issuer could expect to earn from the underlying loans, over and above the amounts that the Issuer was obliged to pay in respect of (a) the other notes; and (b) certain other fees and costs associated with the CMBS structure (the “Class X Interest Rate”).

Among the mortgage loans acquired by the Issuer was part of a loan made by Lehman Brothers Bankhaus AG (the “Nordostpark Loan”). The principal due on this loan was not repaid on the loan maturity date in 2012, constituting an ‘Event of Default’. The claimants, two related companies collectively referred to as “Hayfin” or the “Class X Noteholder”, subsequently acquired the Class X Note (and the Class B Notes) in 2015. Since acquiring its interest, Hayfin advanced a number of arguments as to how the amounts payable on the Class X Note should have been calculated and contended that the amounts paid by the Issuer were inadequate.

Decision

Hayfin issued a Part 8 Claim in the Financial List to determine a number of issues as to the rights attaching to the Class X Note. Four of these issues are of particular interest and are described in more detail below.

(1) Was interest paid to the Class X Noteholder improperly calculated by reference to EURIBOR?

The first issue was whether interest payable on the Class X Note ought, as a matter of construction, to have been calculated by reference to EURIBOR, or to a fixed rate of interest. As explained above, because the rate of interest payable by the Issuer was dependent upon interest earned on underlying loans, it was necessary for the Court to consider a number of defined terms in the loan documentation and this issue therefore turned on the facts of the case. The Court followed the most recent authority of the higher courts on contractual interpretation and rejected Hayfin’s submission that the relevant definitions could be corrected by construction or by necessary implication by the addition of further words.

There was an interesting discussion as to whether the proposed additional words would amount to implication of terms into the agreement (the strict requirements for which are set out in the recent Supreme Court judgment in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd [2015] UKSC 72, see blog post) or be characterised as the process of correction of mistakes by construction referred to in Chartbrook Ltd v Persimmon Homes Ltd & Ors [2009] UKHL 38. The Court held that there were certain features common to both lines of authority and, on either view, the test that must be satisfied is a strict one. The Court will “only add words to the express terms of an agreement if it is necessary to do so because the agreement is incomplete or commercially incoherent without them”.

The Court further held that there was considerable force in the Issuer’s argument that the relevant definitions were not mere boilerplate, but carefully drafted and central to the commercial deal. It therefore accepted that the definitions were likely to have been given careful attention by the contracting parties: Arnold v Britton & Ors [2015] UKSC 36. Accordingly, the Court did not consider that there was any reason to alter the plain language used by the parties. Interestingly, the Court observed that there was a “premium” to be placed on the language used in commercial documents forming the basis of tradeable financial instruments, although the Court did not rely upon this premium in its decision.

(2) Should the interest paid to the Class X Noteholder have included default interest payable on the Nordostpark Loan?

The second issue was whether interest payable to Hayfin in respect of the Class X Note ought to include any default interest payable by the borrower under one of the underlying loans, the Nordostpark Loan (notwithstanding the fact that the borrower could not pay that default interest). This issue arose because the definition of ‘Expected Available Interest Collections’ in the conditions to the Class X Note, which determined the Class X Interest Rate, included an assumption that interest payable on the underlying loans had been paid in full. Accordingly, Hayfin argued that the Class X Interest Rate ought to have included any default interest payable on the Nordostpark Loan.

The Court accepted that the definition of Expected Available Interest Collections required an assumption that the borrower of the Nordostpark Loan had paid default interest. However, it was necessary to ask whether any such monies would actually become available to the Issuer under the loan documentation. Pursuant to this documentation, the clear intention and effect of the waterfall provisions was to subordinate the payment of default interest to the Issuer until any unpaid interest and principal was paid. Interest payable to the Class X Noteholder therefore did not include default interest, as such monies would not become available to the Issuer until the waterfall was paid in full.

(3) Should the interest payable to the Class X Noteholder have included interest on an underlying loan that had been capitalised?

The Court was asked to determine the effect of capitalising interest paid on an underlying loan (the “Adductor Loan”) on the calculation of interest payable to the Class X Noteholder. The loan agreement governing the Adductor Loan provided that interest would be capitalised where it had been due for at least one year. After capitalisation, this amount was not included by the Issuer in the cumulative interest due and payable under the Class X Note. Hayfin argued that this capitalisation of interest could not have been intended to adversely affect the Class X Noteholder.

The Court concluded that the Issuer was correct to reduce the interest payable to the Class X Noteholder because the capitalisation of interest was specifically allowed for in the loan agreement. The Court held that if it had been intended that the capitalisation of interest ought not to reduce the amount of interest payable to the Class X Noteholder, then that could have been spelt out in the documentation. This finding was notwithstanding the fact that the offering circular in relation to the Class X Note made no mention of the possibility that the Class X Interest Amount might be affected by any capitalisation of interest owing on an underlying loan.

(4) Did unpaid interest on the Class X Note itself attract interest?

The fourth issue of interest was whether unpaid interest on the Class X Note itself accrued interest, either at the same rate as the Class X Interest Rate, or at some lower rate. Hayfin relied upon a condition of the Class X Notes entitled ‘Deferral of Interest’. It contended that any failure to pay the correct Class X interest amount would give rise to a shortfall as defined in that condition, which would itself accrue interest at the Class X Interest Rate.

Given the Court’s conclusion that there had been no underpayment of interest, this issue did not fall strictly to be determined. However, the Court nevertheless expressed the view that unpaid interest did not attract interest at the Class X Interest Rate because:

  • The relevant provision of the Class X Note conditions did not provide a remedy for miscalculation and resultant underpayment of amounts due under the Notes. Rather, it provided a mechanism to address a situation where the Issuer suffered a cash-flow shortage and could not meet its obligations under the Notes. Only in the latter case would the unpaid amounts accrue interest under the provision.
  • Under the Note conditions, no money was payable until the cash manager had determined the amount of interest payable on the Class X Notes. Accordingly, until the cash manager had made such a determination, interest was not payable and could not itself accrue interest.

The Court also expressed its view on two alternative arguments raised by the Issuer. It rejected the Issuer’s argument that the parties could not have intended for unpaid interest on the Class X Note to accrue interest at the Class X Interest Rate (which was much higher than any normal commercial interest rate). On the other hand, the Court – while not finally determining the point – was minded to accept the Issuer’s argument that a requirement to pay interest at the Class X Interest Rate for unpaid interest on the Class X Note would be an unenforceable penalty.

Comment

This judgment represents a detailed and considered decision from the Financial List, further illustrating the current approach of the Court to contractual interpretation and providing guidance of wider market significance for the use of Class X notes in CMBS structures, as noted in the introduction.

Over and above the key takeaway points on the interpretation of Class X notes, the Court’s comments in relation to the penalty clause argument are noteworthy. The Supreme Court recently considered penalty clauses in detail in Cavendish Square Holding BV v Talal El Makdessi; ParkingEye Limited v Beavis [2015] UKSC 67 (see blog post). Under the new more flexible test as to whether or not a clause will be found to be penal (and therefore unenforceable), it is generally expected that there will be less interference in contracts by the Courts. Against this background, it is perhaps surprising that a Financial List judge was willing (albeit on an obiter basis) to find that the requirement to pay interest at the Class X Interest Rate would amount to an unenforceable penalty. Whilst the Court commented that the interest payable otherwise would have been “exorbitant (if not extortionate)”, it is a high bar for a clause to be found to be out of all proportion to the legitimate interest in enforcing the obligation under the contract, particularly where the contract has been carefully drafted and negotiated. It may be that the issue would have been treated differently if it had been determinative.

Harry Edwards
Harry Edwards
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Hannah Bain
Hannah Bain
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Ceri Morgan
Ceri Morgan
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Bank exercising a right of forced sale did not have a duty to obtain the best price reasonably obtainable

(1) Rosserlane Consultants Ltd, (2) Swinbrook Developments Ltd v Credit Suisse International [2015] EWHC 384 (Ch)

The High Court has found that a Bank which had exercised a right of forced sale over an asset was not under a duty by way of an implied term to take reasonable steps to obtain the best price reasonably obtainable.

The Claimants had sought to establish that there was a general duty imposed by law on a party selling property belonging to another to obtain the best price. Their case was that the Bank had a duty of care akin to that which a mortgagee would have when exercising power of sale over its security.

However, the Judge found that the Bank was exercising its right to effect a sale in the owners’ name granted to it under a self-standing commercial agreement freely negotiated between the parties and therefore no term should be implied into that contract to impose such a duty on the Bank.

Summary of decision

The Defendant Bank provided a $127m loan to the Claimants, which were ultimately owned by Dr Zaur Leshkasheli. The purposes of the loan were to re-finance existing debt and for future expenditure for Caspian Energy Group (“CEG“), a partnership between the Claimants, whose main asset was an interest in an oil field in Azerbaijan. The loan was to be repaid by the Claimants upon a sale of CEG following an M&A sale process to be conducted by Credit Suisse Securities (Europe) Limited (“CSS“), an affiliate of the Defendant. As part of that transaction, the parties entered into a suite of contractual documentation including a Security Agreement and a Participation Agreement. Under the latter agreement, the Bank was entitled to a share in the proceeds of any sale and, in order to protect that right, had the right to force a sale of CEG if a sale had not been achieved by a certain date.

Following two sales processes over a period lasting more than 12 months, a consensual sale of CEG had not been achieved. On the date that the loan was due to expire, the Bank forced a sale of CEG. The Claimants argued that the price obtained was considerably less than the value of CEG and brought a claim for the loss of a chance of procuring a sale at a greater price.

In relation to whether the Bank had a duty of care in relation to the price, the Claimants argued that, had the Bank been exercising its powers of sale under the Security Agreement, it would have been subject to the well-established duty imposed on mortgagees to take reasonable steps to obtain the best price reasonably obtainable. However, because the Bank was exercising its right of forced sale under a separate agreement, the Claimants needed to establish an implied term to the effect of the mortgagees’ duty.

The Claimants put their case in two ways: firstly, they argued that the Bank was selling CEG as the Claimants’ agent (and agents are subject to such a duty of care); and secondly, that there is a general principle that where a party has the power to sell property belonging to another, the law imposes a duty to take reasonable care to obtain the best price.

In a lengthy passage of the judgment regarding the case law in this area, the Judge rejected the Claimants’ arguments. The Judge found that the Participation Agreement was carefully designed to avoid the Bank being under a mortagee’s duty if it forced a sale under this agreement. This was a commercial agreement between a sophisticated party and the Bank. The fact that the agreement was silent as to a duty on the Bank in relation to the price of a forced sale has to be the starting point for any consideration of an implied term. By contrast, the Claimants were under an express duty under the Participation Agreement to use all of their reasonable endeavours to procure a sale at the best price obtainable. The lack of a reciprocal duty was an important consideration in the Judge rejecting the implied term sought. Instead, the Court held that the Bank was only subject to an implied duty of good faith, which it discharged.

On the facts, the Judge also held that the claim would have failed on causation in any event.

Comment

This decision reiterates the difficulty Claimants have in implying terms into sophisticated agreements where they are properly advised. It also demonstrates the approach of the English Courts to reject arguments that terms should be implied to redress the balance between parties after the event.

Herbert Smith Freehills LLP advised the Defendant Bank, Credit Suisse International in relation to the claim. The team was led by Damien Byrne Hill and Ajay Malhotra assisted by Nihar Lovell and Hannah Pickworth. Helen Davies QC and Alec Haydon of Brick Court Chambers appeared as counsel for the Defendant.

Damien Byrne-Hill
Damien Byrne-Hill
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Ajay Malhotra
Ajay Malhotra
Associate
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Nihar Lovell
Nihar Lovell
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Hannah Pickworth
Hannah Pickworth
Associate
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Private LIBOR claims – an uphill battle for claimants

The ongoing regulatory investigations into the manipulation of LIBOR have prompted much speculation about the possibility of claimants bringing private law actions against banks based on the regulators’ findings. In the first cases to come before the UK courts, the Court of Appeal has recently granted permission to appeal two High Court decisions as to whether LIBOR-based claims could be introduced into existing actions alleging mis-selling of interest rate hedging products.

In light of those decisions, this briefing considers the prospects of such LIBOR claims in the mis-selling context and identifies substantial obstacles claimants will face in seeking to ‘piggyback’ off the regulatory actions.

A copy of our Banking Litigation Briefing is available here.

Interest rate hedging product claims – the current landscape

1.  The FSA review

In 2012, the Financial Services Authority (FSA) announced the findings of its review into interest rate hedging products (IRHPs) sold to small and medium sized firms and in June and July 2012, the FSA agreed with eleven banks that they would conduct a proactive redress exercise and past business review in relation to their sales of IRHPs on or after 1 December 2001.

Specifically, the FSA has agreed with the banks that, for sales to customers categorised under the FSA’s rules as either ‘private customers’ (in respect of sales before 31 October 2007) or ‘retail clients’ (in respect of sales from 1 November 2007), the banks will:

  • Provide appropriate redress to non-sophisticated customers sold structured collars;
  • Review sales of other IRHPs (except caps and structured collars) to non-sophisticated customers and provide redress where appropriate; and
  • Review the sale of caps to non-sophisticated customers in cases where a complaint is made by the customer and provide redress where appropriate.

In each case, a customer will be regarded as ‘non-sophisticated’ if it does not meet the FSA’s ‘sophistication test’ and any redress provided is to be by reference to what is fair and reasonable in all the circumstances. The exercise for each bank will be scrutinised by an independent reviewer and overseen by the FSA.

Each bank was asked to undertake a pilot review of a small sample of more complex cases before beginning the full review.  On 31 January 2013, the FSA published a report on its findings from its review of the pilot exercise conducted by Barclays, HSBC, Lloyds and RBS and confirmed that those banks would commence their full reviews in accordance with the approach set out in that report. The FSA has said that it expects those banks to aim to complete their full reviews within 6 months, although the FSA accepts that for banks with larger review populations this may take up to 12 months.

On 14 February 2013, the FSA also confirmed that the remaining banks (apart from the Irish Bank Resolution Corporation, which went into special liquidation on 7 February 2013)  had also agreed to proceed with their full reviews in line with the same approach set out in the  FSA’s 31 January 2013 report.

2.  FOS decisions

Although the FSA initially considered the establishment of a scheme effectively extending the FOS’s jurisdiction to deal with IRHP complaints, it has recently been confirmed that this will not be put in place.  However, customers meeting the existing FOS eligibility criteria will remain able to refer their complaint to the FOS if they are not satisfied with the redress offered within the review process.

It appears that a number of customers have already complained to the FOS. Indeed, during 2012 two provisional FOS decisions involving the sale of IRHPs were issued –  W Family v Bank E and Business H v Bank S.  The relevant parties in each case were requested to submit further representations before the FOS finalises its determinations. We set out further detail below.

The W Family v Bank E

In July 2007, the W Family took out a variable rate 14 year loan in order to expand their business. At the same time, the family took out a multi-callable swap for a period of 15 years, with an initial two year discounted rate. After two years, a higher fixed rate was payable for the remaining period of the swap. The interest rate payments under the swap were tied to LIBOR, as opposed to Bank E’s base rate, on which the loan was based (i.e. there was an element of mismatch).

The Ombudsman found that:

  • although the documentation was “unclear and contradictory about whether or not advice was given“, the actions of  the bank did in all the circumstances amount to professional investment advice in respect of the swap;
  • the bank recommended a swap that was not suitable to the W Family. The Ombudsman described the swap as being “a one-sided deal”, which allowed the bank to terminate the swap after two years if rates rose at any time, thereby leaving the customer unhedged against rising rates (although he did not directly consider the impact of including the call feature on the discounted rate offered on the transaction). The swap also did not amortise, even though it was expected that the W Family would start making capital repayments against the loan after the first two years, and the swap also lasted a year longer than the loan itself;
  • the bank also failed to explain the potentially onerous cancellation costs associated with the swap.

Business H v Bank S

Business H took out a variable interest rate loan and also bought a “base rate collar” in connection with the loan. (The bank later said that the hedging was a condition of the loan and the lending would not have been granted unless a hedging transaction arrangement had been agreed). The collar was set to cover a sum of £356,000, had a 20 year term and was set to amortise.

The Ombudsman found that:

  • the bank’s actions in connection with the swap amounted to investment advice;
  • the notion of a collar was not inherently unsuitable for Business H in its circumstances, given its desire to minimise the premium for this arrangement. However, a floor of 20 years with the possibility of significant cancellation charges was not suitable overall for the needs of Business H, which was a small operation; and
  • the bank also failed to highlight adequately or to explain the potential cancellation charges.

It is interesting to note that in both cases the Ombudsman did not make any formal findings on redress. Instead, he invited both parties to discuss how best an award could be agreed and, to facilitate those discussions,  set out the principles he would take into account if he were to make a formal award.

3.  Court decisions

Grant Estates Limited v Royal Bank of Scotland2

This is a Scottish case and the first reported judgment on the subject of IRHP mis-selling. In 2007, Grant Estates and RBS entered into a 5 year loan agreement for £775,000 and a swap transaction for the same notional amount. Grant Estates alleged that RBS mis-sold the swap agreement and that, instead of protecting Grant Estates from a rise in interest rates, the swap fixed rates too high and became such a burden on the company that it defaulted on the loan agreement with RBS and fell into administration. The Court rejected the claim on the following grounds:

  • Grant Estates was not a “private person” for the purposes of s.150 of the Financial Services and Markets Act 2000 (“FSMA”) and therefore had no direct remedy under that provision;
  • there was no implied collateral agreement for the bank to advise Grant Estates and consequently no breach of such a contract. This finding was based heavily on the Court’s conclusion that there was a written contract setting out what RBS was to undertake and expressly warning Grant Estates that it should obtain its own independent, legal and tax advice; and
  • the acts of the bank employees were consistent with a contractual regime in which the customer had agreed that it would not treat any views that the bank expressed in bringing about the derivative transaction as advice on which it was entitled to rely.

Green & Rowley v RBS3

In this first reported English IRHP case, the customers alleged that in May 2005, RBS mis-sold to them an interest rate swap as a form of hedge against their existing loan liabilities to the bank. They alleged that:

  • the bank had made various negligent misstatements regarding the operation of the swap, including understating the costs if they chose to break the swap early and inaccurately indicating that the swap transaction fixed not only the base rate but also the margin; and
  • the bank owed them advisory duties in respect of the swap because it had positively recommended the transactions and that those duties had been breached because the swaps were not suitable for them (principally because they allegedly required a transaction that fixed not only the base rate but also the margin).

Originally there were also claims for breach of statutory duty under s.150 of FSMA but it was accepted that those claims were time-barred.  Nevertheless, the customers alleged that at least some of the relevant FSA Conduct of Business Rules (the ‘COB Rules’) informed the scope of the bank’s common law duties for the purposes of both the negligent misstatement and the negligent advice claims.

The claims failed in their entirety, with the Court finding that there was no negligent misstatement and that no advisory duty had arisen (and that, in any event, there had been no breach of any such advisory duty).

This case was highly fact-sensitive and the Court’s findings turned largely on what was said at a meeting between the claimants and employees of the bank at which information regarding the swap and other similar products was provided. However, as in Grant Estates(above), the contractual documents contained helpful provisions clearly confirming that no advice was being given and the judge cited Grant Estates in finding that such provisions can be invoked to negate or delineate the ambit of any duty of care.

The judge also noted, with respect to the relevance of the COB Rules, that the scope of the duty in a common law action for negligent misstatement (as distinct from an advisory duty) is narrower than and does not necessarily encompass the COB Rules to the extent that the COB Rules include (i) duties to take reasonable steps to communicate clearly or fairly (COB 2.1.3) and (ii) duties to take reasonable steps to ensure that a counterparty understands the nature of its risks (COB 5.4.3).

Whilst future decisions could of course take a different approach depending on the specific facts (including particularly the content of a bank’s written terms), these first two IRHP judgments have been welcomed by the financial services industry.

4.  Potential for ‘top up’ of FOS decisions through court action

The manner in which IRHP claims are pursued may also potentially be influenced by a recent  High Court decision holding that a party who had accepted a favourable FOS decision and been paid the statutory maximum award (then £100,000, now £150,000) by the firm could nevertheless subsequently bring a damages claim for the balance of the full loss they had allegedly suffered, over and above the FOS award: Clark & anor v In Focus Asset Management & Tax Solutions Ltd [2012] EWHC 3669.

The decision departs from previous authority on this issue and, unsurprisingly, permission to appeal has been sought.  If the High Court’s decision is upheld, this may have the effect of encouraging potential litigants to seek to fund subsequent court action through a FOS award.  Complainants may also seek to adduce the FOS judgment in support of their court case, particularly given that it is quite common for the FOS to recommend a higher award than its statutory limit (albeit that the test for liability applied by the courts is of course materially different from the test adopted by the FOS).

Read our full briefing on the decision.

5.  LIBOR allegations in IRHP claims

A claim currently pending in the High Court has also raised the possibility of the IRHP claims landscape being overlaid with claims in respect of LIBOR (London interbank offered rate).

The claimants in that action have brought a claim in relation to loans made to them with an associated interest rate swap and interest rate collar agreement, payments under which were set by reference to 3 month Sterling LIBOR.  In a judgment delivered on 29 October 2012, the Court permitted the claimants to amend their pleadings to add claims based on alleged implied representations by the defendant bank (and/or implied contractual terms) as to the integrity of the LIBOR rates. The allegations in this respect rely heavily on regulatory findings against the relevant bank in respect of LIBOR:  Graiseley Properties Limited & ors  v Barclays Bank Plc [2012] EWHC 3093

It is important to note that the Court did not make any considered determination of the LIBOR allegations and was only required to consider whether the points raised reached the threshold of being sufficiently arguable to proceed to trial and be tested. However, this is now an important test case and the trial (listed in October 2013) will be watched closely both by claimants considering bringing similar claims and defendant banks.

 

1 Grant Estates Ltd v The Royal Bank of Scotland Plc [2012] CSOH 133.
2 John Green and Paul Rowley v The Royal Bank of Scotland [2012] EWHC 3661.

Damien Byrne-Hill
Damien Byrne-Hill
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Simon Clarke
Simon Clarke
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Rupert Lewis
Rupert Lewis
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Harry Edwards
Harry Edwards
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Jan O'Neill
Jan O'Neill
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Clearing brokers’ duties when exercising close out powers

In the current economic climate, brokers will find the decision of the High Court (UK) in Euroption of considerable interest, since it considers the duties of a broker which is conducting a close-out and liquidating the position of a client who is in a state of default.

Euroption Strategic Fund Limited v Skandinaviska Enskilda Banken AB [2012] EWHC 584 (Comm).

The facts

The claimant (Euroption) was a BVI-domiciled investment fund which primarily conducted options trading on the London International Financial Futures Exchange (LIFFE). As a non-member of LIFFE, it could only do so through engaging one of the clearing members of the exchange and accordingly entered into a contract with Skandinaviska Enskilda Banken (SEB).

Pursuant to that contract, Euroption was obliged to meet margin calls when requested by SEB in order to provide SEB with protection against adverse market movements on the fund’s positions, failing which SEB was entitled to close out Euroption’s open contracts “at any time without reference to” the fund and to do so having made reasonable efforts to contact Euroption if “at any time SEB deems it necessary for its own protection.”

Basis of Euroption’s claim

It was common ground that SEB had a contractual right to close out Euroption’s open positions and could choose the moment in which it did so. However, the claim involved allegations regarding SEB’s conduct of the forced close out of the portfolio in the extraordinary market conditions which prevailed in early October 2008. Euroption claimed for loss that was suffered as a result of the use of a trading strategy which involved the purchase of additional option positions together with their sale (so-called combination trades), as well as the delay in the close out of certain positions (during which the extent of losses increased). Euroption said that SEB’s conduct was in breach of:

  • a duty not to conduct the close out in an capricious, arbitrary or irrational manner;
  • an implied contractual duty of care to perform the close out with reasonable care and skill; and/or
  • a tortious duty of care brought about by an assumption of responsibility to act with reasonable, care and skill.

Basis of SEB’s defence

SEB countered that the mandate between SEB and Euroption provided a broad and unfettered discretion in relation to the conduct of any close out process and that, having taken the decision to liquidate the portfolio, SEB could effect that liquidation in a number of ways which were not limited by the express terms of the contract. Accordingly, the only limitation on what it could do to bring about the liquidation of the portfolio was that it must not act capriciously, arbitrarily or irrationally.

Regarding the specific trading strategies adopted during the close-out, SEB pointed to the fact that Euroption’s own expert had accepted that the ‘combination’ trades which were entered into by SEB were a legitimate means of closing out an options portfolio (and were in any event authorised by Euroption’s primary trader responsible for management of the portfolio) and that the delay in the sale of the short call positions was reasonable in the circumstances (even if not, with hindsight, the optimal strategy).

The Court’s findings

In relation to the argument that a contractual duty to take reasonable care was owed by SEB in exercising its close out rights, the Court held that no such duty could be implied into the broking agreement, either by the terms of section 13 of the Supply of Goods and Services Act 1982 or otherwise. The Court held that the implied term imposed by section 13 (requiring services to be carried out with reasonable care and skill) applies only to services which it is agreed will be provided under a contract; it does not extend the obligations under the contract. Certain advisory services and the settlement and exchange services were the services which the Broker had contracted to provide, not the close out of the portfolio which was a consequence of the client’s breach. Accordingly, absent express provisions in the contract, there was no basis on which to imply a requirement of reasonable care and skill into how the close-out was conducted.

Equally, there was no assumption of responsibility by the broker to the client to take reasonable care in exercising its right of close-out, in view of the nature of the role which a clearing broker undertakes and the modest commission which it receives for that role.

Moreover, the Court determined that, following a default, the broker was entitled to put its own interests first in order to protect itself against the exposure which had been brought about by its client’s breach (the failure to post margin). It was therefore the broker’s decision, which can be made in its own interests, how the close out should be conducted, subject only to the requirement that it did not step outside the bounds of a duty to act in good faith, honestly and not arbitrarily or irrationally.

On the experts’ evidence, SEB’s method of closing out the options positions was found to have been reasonable, both in entering new ‘combination’ trades as part of the close out and the delay in closing out some of the short call positions. In those circumstances, SEB was found not to have acted arbitrarily or irrationally.

Furthermore, the judge found that, even if she was wrong in rejecting the existence of a duty to take reasonable care in conducting the close out, SEB did not breach any such a duty. It was emphasised that looking back critically at each trading decision with the benefit of hindsight, as Euroption (and its expert) had sought to do, was not a permissible way to assess the trading strategy adopted by SEB:

The issue for the court is not the relative strengths and weaknesses of another strategy compared with the strategy in fact adopted but whether the decisions actually taken were within the bounds of reasonableness.”

Accordingly, Euroption’s claim was rejected in full.

Damien Byrne-Hill
Damien Byrne-Hill
Partner
+44 20 7466 2114
Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Rupert Lewis
Rupert Lewis
Partner
+44 20 7466 2517
Harry Edwards
Harry Edwards
Partner
+44 20 7466 2221
Jan O'Neill
Jan O'Neill
Professional Support Lawyer
+44 20 7466 2202