To what extent should borrowers be liable for hedging break costs that a financier has put in place "behind the scenes" to make funding available to such borrower?

This question has been considered recently by Justice Warren in Barnett Waddington Trustees (1980) Limited v The Royal Bank of Scotland plc [2015] EWHC 2435 (Ch) (Barnett Case). In that case it was held that the financier could not recover such costs from the borrower.

The same question was also considered in an earlier case, being Bank of Scotland v Dunedin Property Investment Co Ltd (1998) IH (1 Div) (Dunedin Case). In that case it was held that such costs were recoverable from the borrower.

So why was there a difference in the outcome of these two cases? The answer lies in the facts specific to each case.

Barnett Case


Briefly, the facts in the Barnett Case were as follows:

  • Merchant Place Property Syndicate 35 (MPPS) received a loan from The Royal Bank of Scotland (RBS) for a period of 30 years at a fixed rate of interest.
  • After five years, MPPS decided to consider redeeming the whole loan. In response to this suggestion, RBS notified MPPS that as a condition of such redemption, MPPS would need to pay to RBS an interest rate swap termination cost under Clause 12.1 of the relevant loan agreement as it would need to unravel its hedging arrangements that it put in place to make the funding available to MPPS at the fixed rate of interest.
  • In this case, the relevant hedging arrangement referred to by RBS was made internally at RBS between RBS Corporate Banking division and RBS Markets, being the interest rates desk responsible for hedging RBS' interest rate risk (Internal Swap).
  • Clause 12.1 of the loan agreement between RBS and MPPS provided that MPPS shall indemnify RBS in respect of any "Loss" sustained as a result of any "cost to the Bank incurred in the unwinding of funding transactions undertaken in connection with the Facility …"

RBS contended that the Internal Swap was a "funding transaction" without which RBS could not have made the loan available to MPPS and accordingly, MPPS should pay for the costs to RBS of unravelling such transaction.


In this case, it was held that the costs associated with unravelling the Internal Swap were not subject to the indemnity in Clause 12.1. The rationale for this was that:

  • the arrangement between the two divisions of RBS constituting the Internal Swap was not a "transaction", merely an internal arrangement within RBS, effected for its own purposes; and
  • even if it were a "transaction" it gave rise to no "Loss" to the RBS.

Dunedin Case


Briefly, the facts in the Dunedin Case were as follows:

  • Dunedin Property Investment Co Ltd (Dunedin) approached Bank of Scotland (BOS) and requested that BOS make available funding of £10,000,000 for a fixed interest rate for 10 years.
  • At that time, BOS had an internal policy not to enter into a fixed rate arrangement for such a long period of time.
  • Accordingly, BOS sought to hedge its position by:
    • borrowing £10,000,000 from the London interbank market; and
    • entering into a swap arrangement with Security Pacific (later to be known as Bank of America) under which BOS obtained a fixed interest rate.
  • The combination of these two steps were that BOS would ensure that throughout the term of the loan to Dunedin it would receive a fixed profit.
  • Part way through the term of the loan, Dunedin sought to prepay the loan in full to BOS. As a result of this, BOS took steps to break its hedging arrangements with Security Pacific.
  • BOS then sought to pass through the costs it incurred in breaking its arrangement with South Pacific to Dunedin.

Dunedin claimed that the costs incurred by BOS were not a cost, charge or expense incurred by BOS in connection with the funding arrangements made available to Dunedin.


It was held, in this case, that the costs did amount to a cost, charge or expense incurred by BOS in connection with the funding arrangements made available to Dunedin and therefore, Dunedin was liable to reimburse BOS for such costs.


Both cases raise a couple of points for further consideration by financiers, being the nature of the swap arrangement itself (eg internal vs external) and the drafting of the costs and/or indemnity clauses.

Internal swap vs external swap

As noted above, one of the key differences between the Barnett Case and the Dunedin Case was that in the Barnett Case, the relevant swap counterparty was a separate division of the same entity, whereas in the Dunedin Case, the relevant swap was with a third party, namely Security Pacific.

A further relevant point arising from the Barnett case was that the reason that RBS entered into the Internal Swap was so that RBS Market could hedge its risk externally on a portfolio basis. It was not a question posed to the court to decide as to whether this external arrangement could constitute a "funding transaction" for the purpose of the indemnity in Clause 12.1 and how losses associated with external portfolio-based funding could, in fact, be quantified. The court left it open for the question to be raised by the parties (should they wish) in further proceedings and whether the outcome of such case would be different if that question were answered by the court remains to be seen.

Justice Warren also suggested that a different outcome may have ensued had the indemnity clause been drafted so as to specifically refer to an internal hedging arrangement.

Drafting of relevant costs clauses/indemnity clauses

A key consideration in both cases was the manner in which the relevant clause under which the costs associated with the termination of the swap arrangements were claimed to fall for the account of the borrower had been drafted.

In the Dunedin Case, the relevant phrase being considered was "cost, charge or expenses incurred in connection with" the financial accommodation provided to the borrower.

In the Barnett Case, the relevant phrase being considered was "Loss … which the Bank has sustained as a consequence of … (f) any cost to the Bank incurred in the unwinding of funding transactions undertaken in connection with the Facility".

In the Barnett Case, it was noted by Justice Warren that the fact that the indemnity regarding funding transactions was expressed to be a sub-clause of an opening preamble referring to "Loss" meant that the clause was unnecessarily constrained (the reason being that in order for a cost to qualify as a cost for the purposes of Clause 12.2, it also had to be a "Loss"). As noted above, had the clause been drafted more broadly so as to specifically refer to internal hedging arrangements and costs associated with breaking these, the outcome may have been different.


The key take-away for any financier from the above cases is to ensure that costs clauses and indemnity clauses are drafted in a sufficiently broad manner so as to capture all costs and losses that the financier would seek to recover from a borrower in the event of early prepayment.

In particular, if the financier intends to seek reimbursement for internal swap break costs, these should be expressly referred to in such clauses. If such costs are not acceptable to the borrower, then the negotiation between bank and borrower can be had at the outset, leaving both parties clear as to the costs for which they would be liable in the event of early repayment.