Since the start of the financial crisis in 2007, there have been many public accusations of mismanagement and dishonesty made against those involved in the running of the UK’s banks and financial institutions. Over the past several months, concerns have been expressed about the sale of interest rate swap products to small and medium-sized companies (SMEs). Similar allegations have been considered in a number of high-profile litigations in other jurisdictions, such as Germany and Hong Kong.
Pressure for action to be taken resulted in an initial review being undertaken by the Financial Services Authority (FSA), following which a number of UK-based banks including Barclays, HSBC, Lloyds, NatWest and the Royal Bank of Scotland plc (‘RBS’ or ‘the Bank’) reached agreement with the FSA to provide appropriate redress where mis-selling had occurred. However, a number of claims by SMEs had already been brought in the courts, with substantial damages being sought against banks for alleged mis-selling of these products. Guidance has been sought from the courts as to how the contractual arrangements entered into between the banks and their customers fitted with obligations under UK statute and European Directives.
In Scotland, in an action raised in the Commercial Court of the Court of Session, Lord Hodge recently delivered his opinion in the much anticipated case of Grant Estates Ltd (In Administration) v The Royal Bank of Scotland plc .
In its written case, Grant Estates Ltd (In Administration) (‘GEL’ or ‘the Company’) made assertions that RBS and its employees had either negligently or knowingly mis-sold an Interest Rate Swap Agreement (IRSA) to the Company and sought orders to set aside not only the Company’s obligations under the IRSA itself, but its obligations under all the related contracts, including the standard security granted by the Company over its heritable properties and the principal loan agreement, in respect of which the IRSA was provided. Finally, the Company sought an undisclosed award of damages against the Bank in respect of the loss it was said to have incurred as a result of the IRSA being put in place. Essentially, GEL was looking for the Court to write off the principal debt owed to the Bank and for compensation with an award of damages.
Following a lengthy legal debate, the Court dismissed the action against the Bank, confirming that the contractual arrangements entered into could not be disregarded and remained binding on both parties. The legal implications of this decision are far reaching for any company or business that has entered into an IRSA with its bank and in this article we examine the key points addressed in the judgment.
GEL was a property development company which experienced financial difficulties during the economic downturn and was unable to meet its ongoing obligations to its lender, RBS. The Bank appointed administrators to the Company, with a view to recovering monies owed to it.
Initially, the Company raised proceedings in the Court of Session in Edinburgh, seeking to challenge the Bank’s right to appoint the administrators to the Company. Through its directors, it claimed that the Company had been mis-sold an IRSA, in that RBS had wrongly advised that the IRSA would offer the Company protection against adverse movements in interest rates. By entering into the IRSA in December 2007, the Company had effectively fixed the interest rate on its borrowings from RBS for a five-year period and was therefore unable to benefit from a reduction in interest payments when much lower interest rates became available in the market, following the economic downturn in late 2008.
The directors claimed that they had relied on advice given by RBS employees, which was not only wrong but which the RBS employees knew to be wrong, and had therefore been induced by negligence and fraud to enter into the IRSA. The Company argued that the Bank had breached the Conduct of Business Rules (COBs), the regulatory rules introduced by the FSA to implement the European Directive 2004/39/EC governing financial instruments such as IRSAs, and that it had therefore breached an implied term of the contract with the Company, entitling it to set aside the IRSA and the related contracts. It was also claimed by the Company that, as a direct result of entering into the IRSA, it had found itself in a position that it could not afford to repay its borrowings to RBS. This caused it to default on its obligations to the Bank, ultimately resulting in administrators being appointed.
The Bank denied all of the allegations made against it by the Company. It contended that the IRSA had not been mis-sold and the Bank was entitled to enforce the Company’s obligations under the contracts entered into and appoint administrators.
The Court dismissed GEL’s case against RBS in its entirety. It did so on the basis that the Company’s claims against the Bank were irrelevant as a matter of law and should not be allowed to proceed any further. It seems clear that, had the Company been successful in persuading the Court to grant such remedies, the implications, not only for RBS but for other high-street banks who offered IRSAs on similar contractual terms, would have been enormous.
MATTERS CONSIDERED BY THE COURT
The Court did not hear evidence on any of the matters raised. Rather, it tested the parties’ respective arguments in a legal debate, on the theoretical assumption that the Company would be able to establish the facts alleged against RBS in due course, should a hearing of evidence be allowed to proceed. In the course of the debate, the Court considered written arguments, contractual documents lodged by the parties and oral arguments in support of each party’s case.
Lord Hodge identified five principal issues to be determined, namely:
- whether the alleged breaches of COBs could properly be relied on and made the subject of a claim in a civil action in court;
- what contractual obligations were incumbent on the Bank and whether it had failed to comply with these obligations;
- whether the Company had made out a relevant case of negligent misrepresentation;
- whether the Company had made out a relevant case of fraudulent misrepresentation; and
- whether compliance with COBs was implied as a term of the contract entered into between RBS and the Company or was included within a Bank’s common law duty of care.
The Court answered all of these questions in the negative, thereby allowing it to dismiss or strike out the Company’s entire case against the Bank.
In addition, the Court considered specific allegations made by the Company, although not insisted upon at the hearing, to the effect that the Bank and its employees had acted fraudulently (ie had deliberately set out to mislead the Company in making representations about the IRSA) when it sold the product to the Company.
THE CONTRACT AND COBS
A key feature of the Company’s case was that its directors were not familiar with interest rate hedging or swap products and that when considering whether to enter into the IRSA they relied upon, what they considered to be, advice and recommendations from the Bank and its employees.
The Bank argued that the nature of the contract between the parties protected it comprehensively from the arguments advanced by the Company, whatever the level of experience of the directors and it was not open to the Company to seek to open up or expand the terms of the contract, or to imply that RBS owed the Company any additional duty of care, given the very clear terms of the contract.
Lord Hodge considered the history of the relationship closely and the agreed terms of the contract between the parties and, in short, determined, on the basis of the largely uncontested documents and history, that RBS had given the Company clear and repeated warnings that it would not be providing the Company with any advice and that it should take its own independent advice before entering into the IRSA.
The Company also sought to argue that any breach of the COBs on the part of the Bank would give the Company a direct right of action against RBS, with a right to recover damages for any losses sustained as a result of such a breach.
Lord Hodge determined that, while the obligations on the Bank under the COBs were not excluded by the terms of the contract, this did not provide the Company with a direct right to bring a claim against RBS for any alleged breach of these rules in court. The COBs provided a route to make a complaint to the FSA only, and accordingly it would be for the FSA, and not the Court, to determine if there had been any contravention of the COBs, should such a complaint be made.
NEGLIGENT MISREPRESENTATION AND NEGLIGENT ADVICE
A central proposition of the Company’s case was that the Bank negligently had failed to advise it of all of the risks associated with the IRSA. It claimed that when the Bank’s employees explained the IRSA to the Company’s directors, they had given advice that was negligent and had induced the directors to enter into the IRSA.
However, the Court found that it need not look beyond the clear terms of the contract between the parties when considering whether the Bank or its employees had given advice negligently. The Court explained that if there had been no written contract between the parties, it would have required to hear evidence before it could determine whether what was said by RBS employees amounted to negligent misrepresentations or negligent advice. However, because the terms of the written contract were so clear, there was no need for such inquiry. Prior to entering into the IRSA with the Company, RBS clearly had stated that it would not provide advice in relation to the merits of a particular transaction and that it would make no representation or warranty and that it would give no investment advice.
While recognising the inequality in bargaining powers between the Company and RBS, the Court considered that RBS had made clear that there were risks in entering into an IRSA, had warned the Company of that and had given it the opportunity to take independent legal advice. At the hearing, it had been argued that the directors were young and inexperienced and that the Court should take this into consideration when determining whether it was appropriate for RBS to proceed with the sale of an IRSA to the Company. Lord Hodge did not think that this was a relevant consideration. He noted that the directors had been afforded the privilege of limited liability and, in return for that privilege, the law expected them to achieve an objective standard of competence and knowledge. If they had entered into the IRSA without understanding fully the legal effects of it, they were still bound by it.
Having made allegations of fraudulent misrepresentation against the Bank in the course of the written pleadings and in the written arguments, a matter which was, of course, of considerable concern to the Bank’s employees against whom they had been made, senior counsel for the Company sought to indicate to the Court, in the course of the legal debate, that they would not be insisted upon. However, given the gravity of the allegations, Lord Hodge did take time to analyse the Company’s pleadings, notwithstanding the concession, and to examine whether there were any facts that could properly have formed the basis for such a case being put forward. He concluded that there was no such justification in this case.
An allegation of fraudulent misrepresentation can generally only be justified in circumstances where one party has facts to aver which justify an allegation of deliberate deceit on the part of the other party. In this case, these allegations were made against two individuals employed by the Bank. Given the potential for serious harm to be caused to individuals against whom such allegations are made, particularly where the individuals are in regulated professions, Lord Hodge expressed concern that the allegations had been made when there was nothing before the Court to show that the Company could even infer that the Bank or its employees had acted dishonestly. Although the Company had not insisted in the allegation, Lord Hodge took the opportunity, in his Opinion, to set out in some detail the reasons for his conclusion that its entire case in relation to fraudulent misrepresentation failed.
This case was clearly an emphatic victory for RBS and will undoubtedly be a decision relied upon by other banks faced with claims of mis-selling of IRSAs by SMEs. However, it is unlikely to end complaints being made by disgruntled customers seeking to challenge the conduct of banks and their employees undertaking sales of IRSAs to SMEs during the period leading up to the financial crisis, which was followed by the substantial and sustained reduction in interest rates. Though it is now clear that a customer seeking to challenge such a sale is unable to seek redress through the courts, as long as the contract is in terms similar to that between RBS and the Company in this case, it remains open to those seeking to challenge such a sale to follow the review process set up by agreement between the major banks and the FSA. This provides for scrutiny by an independent reviewer and oversight by the FSA. It is hoped that the comments made in Lord Hodge’s Opinion about the responsibilities of those conducting litigation in the courts, where allegations of fraudulent misrepresentation arise, will be heeded, whatever the forum.