Judging by the number of insolvency practitioners (IPs) who attended a recent R3 breakfast briefing on the thorny subject of how to deal with interest rate hedging product (IRHP) mis-selling claims held by insolvent companies, IPs are at last trying to get to grips with this issue. The FCA estimates that of 19,082 swap claimants in the FCA review, around 2,000 companies were insolvent or dissolved. That does not include other potential claimants who do not fall within the terms of the review and could still make claims in Court. However, IPs may need to act fast since in many cases the statutory limitation period for bringing claims may shortly be expiring.
It became common practice in recent years for banks to offer IRHPs to companies and individuals taking out loans. The idea, sensible at face value, was to offer hedging protection against rises in interest rates. Various products were available, ranging from:
- caps, which provided a maximum limit on the interest rate payable;
- swaps, which would, for example, replace a variable interest rate with a fixed one;
- simple collars which provided both a ceiling and a floor to interest rates; and
- structured collars, which were similar to simple collars but under which the borrower may have been subject to increased interest rates where base rates fell below the floor.
In many cases, companies were required to enter into such products as a condition of the loan and the duration of the IRHPs often far exceeded that of the loan itself.
While interest rates remained relatively stable, the detailed provision of IRHPs did not give rise for concern. However, with the dramatic fall in interest rates in 2008/9 from 5% to 0.5%, thousands of borrowers found themselves required to pay interest rates which might be ten times the market rate. They then may have discovered that they were over-hedged or required to pay very substantial break costs in order to terminate the IRHPs.
Attention quickly turned to the question of whether the banks had adequately explained the risks and costs inherent in such products and the matter was taken up by the FCA which subsequently found that over 90% of IRHPs had been mis-sold. Following this finding, the banks concerned agreed to set up a review supervised by the FCA to determine whether compensation should be available to customers.
The scope of the review has been criticised in some quarters as unduly unrestrictive since it has excluded claimants whom the banks categorised as “sophisticated”. The definition of sophistication for these purposes means either:
- the customer’s actual experience and knowledge indicated that they were sophisticated;
- the company was not a small company as defined under section 383 of the Companies Act 2006; or
- claimants with an IRHP notional value of more than £10 million.
For those excluded from the review, they still had the option of bringing legal proceedings against the banks.
The issue of whether IPs can bring litigation claims in respect of IRHPs has now reached an urgent phase. As mentioned before, most of the loss-making IRHPs were sold in the period around 2008 when the financial crisis was at its height. That means that many claims are reaching the normal six year statutory period beyond which legal claims cannot normally be brought. Many IPs recognise that, if they have not done so already, they need to investigate whether a protective claim should be issued in the Courts to prevent the limitation expiry date being missed. Having said that, it is possible that the limitation period may be extended in some cases. The start of the limitation period may be delayed by up to 3 years if it can be shown that the claimant was not put on enquiry as to the facts which would allow it to bring a legal claim until some time after it entered into the contract. The case of Re Kays Hotel Limited  is an example of that possibility. In that case, the borrower had agreed a collar with Barclays Bank in 2005 but did not issue proceedings until 2012. The bank applied to strike out the claim as time-barred but the Court refused to do so on the grounds that it was open to the borrower to argue at trial that it was not alerted to a possible claim against the bank until the full financial consequences of the collar became apparent.
Resolving potential conflicts of Interest
The whole issue of IRHPs obviously puts IPs into a position of potential conflict of interest against the bank which may have appointed them. This concern that there is a perceived or actual conflict has led many IPs to appoint a separate independent IP to deal solely with the IRHP claim.
In addition, IPs have the usual issues to consider when investigating potential legal claims, such as whether funding is available and whether they have sufficient evidence to mount a legal challenge. Even if those obstacles may be overcome, for example, through ATE insurance or litigation funding, there is also the question of to whom the proceeds of such a claim would belong.
In most cases, there will be a shortfall in the insolvency in the amount owed to the bank. The question therefore arises as to why the bank should not receive those proceeds where it has a floating charge. Alternatively, there are arguments that the bank could simply set off the amount of such claim against the amount due to the bank or that it would be subject to automatic insolvency set off. Some have even argued that proceeds of such a legal claim are not floating charge assets and would fall outside the scope of the bank’s security. However, these are issues which have remained largely untested.
In other situations, however, the proceeds might benefit parties other than the bank. For example, where:
- the amount of the IRHP claim exceeded the shortfall to the bank and created a surplus in the insolvency which would be repayable to the shareholders;
- proceeds could be made available to unsecured creditors under the ring-fenced fund out of floating charge assets; or
- they could benefit a personal guarantor by reducing his or her personal liability.
For these reasons, other parties may be putting pressure on IPs to consider bringing IRHP claims. For example, in the case of Hocking v Marsden , an IP had decided not to bring an IRHP claim but had refused to assign it to one of the directors who was also a creditor. The director applied to the Court, claiming that the administrator’s actions had caused the creditor unfair harm . The Court agreed that the claim should be assigned, subject to the creditor providing the administrator with a personal indemnity against any adverse costs order.
IPs who are in a position to bring IRHP claims will still need to overcome a number of legal hurdles in order to succeed.
The first issue to consider is whether the claimant can claim damages for breach of FCA regulations which protect investors dealing with regulated financial firms. Under the Conduct of Business rules (COBs), regulated firms are under an obligation to ensure that they provide adequate advice in relation to financial products and to ensure that those products are suitable for the customer.
However, damages for breach of the COBs rules are only available if claims are brought by a “private person”. The definition of a private person is either an individual or a company not acting in the course of its business. As a result, almost all companies find themselves without this damages remedy. They have to try to establish liability of the banks through general principles of contract and tort. A number of cases have established the following principles over the last few years:
as a general principle, a bank does not owe its customer a duty to advise as to the merits of any proposed transaction;
if, however, the bank “crosses the line” and provides advice then it owes the customer a duty to exercise reasonable skill and care in providing that advice;
the banks may state in their terms of business that they are not providing advice. The courts have so far upheld such “basis” clauses; and
where a clause is held to be an exclusion clause rather than a basis clause, it is open to the test of reasonableness under the Unfair Contract Terms Act 1977.
Crestsign v RBS
These principles have been most recently considered by the High Court in the case of Crestsign v RBS . The conclusions of the Court were:
- The bank had given the customer advice and that advice had been negligent.
- However, the bank’s terms of business had disclaimed any liability for providing advice and as a result the Court accepted that the bank was not liable for the advice which had been given.
- The Court did not accept that the “basis” clause was an attempt to rewrite history after the event.
- Although the customer could not rely directly on the COBs rules for damages, as it was a company, there was no reason why the common law rules should not overlap with COBs.
- The bank was not under a duty to ensure that the customer had understood all other available options in order to take an informed decision, but the bank was nevertheless subject to a duty to provide full information in relation to the products it was selling.
- However, the Court considered that the bank had satisfied its duty to provide that information to the customer and so was not liable.
As a consequence, the customer in this case failed to achieve any compensation from the bank (subject to any appeal). However, the result is not a conclusive win for banks and the door has still been left open for other cases where different facts and different terms and conditions might result in banks being found liable.