Interest rate hedging products are sold in a variety of forms – swaps, caps, collars and structured collars, to name but a few. Their objective is to protect the counterparty (customer) against the risk of interest rate movements where, for example, it has entered into a loan with a floating rate of interest.
In June 2012 the Financial Services Authority (FSA) reported(1) on a two-month review into the products, finding that there had been "serious failings" in their sale to small and medium enterprises and requiring a number of banks to carry out a review of past business and provide redress to customers where appropriate.
A number of customers have brought legal proceedings against banks but until Green v Royal Bank of Scotland(2) there were no reported decisions of the English courts on this issue, although it had already come before the Scottish courts in another claim against the Royal Bank of Scotland (RBS), Grant Estates.(3) This lack of reported cases is ostensibly due to the fact that many have settled before the matter reached trial.
In this case, the claim brought by the claimants was robustly dismissed by the Manchester Mercantile Court.
The case revolved around a relatively straightforward interest rate swap. At the time that the swap was entered into on May 25 2005, the claimants had a pre-existing loan liability to RBS. This was in the form of multiple loans, but can be summarised for these purposes as a liability repayable in 15 years on an interest-only basis, with interest charged at 1.5% (the margin) above base rate.
The swap was a separate instrument to the loan, for a matching notional amount of £1.5 million, but with a fixed rate of 4.83% and a shorter period of 10 years. The base rate at the time of inception was 4.75%. Under the terms of the swap, quarterly payments were made on a net basis between the claimants and the bank on the following bases:
- If the base rate exceeded 4.83%, the bank would pay the claimants an amount representing the difference between the interest which would have accrued in the period on the notional £1.5 million at the base rate and that which would have accrued at 4.83%.
- If the base rate was below 4.83%, the difference in the amount notionally accrued would be payable by the claimants to the bank.
As the judge commented, assuming the margin on the loan remained the same, the swap was "the same as converting the variable rate loan to a fixed rate loan with all the potential advantages and disadvantages that has, depending on the state of the market".
While the base rate initially remained relatively stable, from June 2006 it rose sharply. During this time, the claimants did well out of the swap, because it provided effective protection against the rise in interest rates. However, by March 2009 interest rates hit an all-time low of 0.5%. While this meant that the interest payments on the loan went down, the claimants had to keep making payments under the swap, negating the difference.
The origins of the claim came in early 2009, when the claimants sought to restructure their partnership. When they enquired about the costs of breaking the swap early, they were told that the cost would be up to £138,650 – prompting their allegation that they would not have entered into the swap if they had anticipated such costs.
Two categories of claim were put before the court. The first of these – the information claims – alleged that the bank was liable for negligent misstatement in relation to various details of the swap and its functionality, namely:
- the break costs of the swap – either that the claimants were told that these were "modest" or the bank should have told them that they were not;
- the swap being separate from the loans – when in fact it was linked by an 'all monies' clause and a 'cross-default' clause;
- that the swap would fix the rate of the margin on the loans, as well as the base rate, when it did not; and
- that the swap was portable and could be moved to a different lender along with the loans, when in reality this was unlikely.
The second category – the advice claim – alleged that the bank's representatives, rather than merely providing information, had advised the claimants to enter into the arrangement. This advice carried with it a duty of care, which was purportedly breached on the basis that the swap was not suitable for the claimants.
The judge noted that this was a "highly fact-sensitive case", turning on what was said at, and shortly before, a meeting on May 19 2005 attended by:
- the claimants – namely, Mr Rowley, a hotelier and "sometime property developer", who had banked with the bank for many years; and Mr Green, who had partnered up with Rowley in 2001 for the purpose of making property investments;
- Mrs Gill, by then a senior commercial manager with the bank, who knew the claimants well, both socially and in business; and
- Mrs Holdsworth, an area manager with the bank specialising in interest rate hedging products.
The judge found Holdsworth to be an "impressive witness", and she was the only attendee of the meeting with contemporaneous documents, including a typed-up version of a manuscript note that she had taken in the meeting itself, together with illustrative diagrams and figures used at the meeting. She had "a clear understanding of how she structured her meetings".
Gill was left in the difficult position of having been a friend of the claimants, only to discover that – in the early stages of the dispute in November 2009 – she had been covertly recorded by them making "unguarded remarks about certain other individuals at the Bank…and how [the claimants] might complain most effectively".
In contrast, the claimants' evidence was found to be "not always consistent with each other on significant matters or internally, nor was it always plausible". The judge opined that they had been "hampered by the lengthy lapse of time…the absence of any documents to help them, and the fact that they have probably by now persuaded themselves that the Bank is to blame".
Where their evidence conflicted, the judge therefore generally preferred the evidence of the bank to that of the claimants.
In addition to Holdsworth's note, there existed a series of transactional documents – some forming the contract itself and others post-contractual, but nevertheless of evidential significance. The claimants disputed that they had seen all of these documents, but the judge found that they had. This is significant, because the documents contained a number of statements that were helpful to the bank's case in both making clear the terms of the swap and resisting the bank's adoption of any duty of care.
The court considered when a statement – true in part – should properly be regarded as a misstatement. The court found that "the context in which the statement is made and understood is, as ever, important", and that only rarely will a statement true on its face be regarded as an implied misstatement.
To succeed in a claim for negligent misstatement, Hedley Byrne(4) sets out that a claimant must show that the defendant owed it a duty of care, which was breached by the defendant carelessly making a false statement to it which they relied upon, thus suffering loss.
Section 150 of the Financial Service and Markets Act 2000 can provide a remedy in the form of damages for loss suffered as a result of the breach of an FSA rule, but this was unavailable to the claimants due to being time-barred. Instead, the claimants pleaded that the relevant (then in force) FSA Conduct of Business (COB) Rules and Guidance should provide evidence of the duty of care required under Hedley Byrne. Specifically, they sought to rely on:
- COB Rule 2.1.3 – "When a firm communicates information to a customer, the firm must take reasonable steps to communicate in a way which is clear, fair and not misleading"; and
- COB Rule 5.4.3 – "A firm must not: (1) make a personal recommendation of a transaction; or…(3) arrange (bring about or execute a deal in a…derivative to or for a private customer unless it has taken reasonable steps to ensure that the private customer understands the nature of the risk involved".
There was authority for such a proposition in an advisory context, but the judge here held that the "duty to take care not to mis-state is much narrower than the advisory duty where one would expect that relevant professional standards would form part of the assessment as to whether it has been broken". Hedley Byrne did not encompass a duty to give information unless without it a statement becomes misleading.
On the information claims pleaded, the judge found as follows:
- In terms of the break costs, Holdsworth's statements were not misleading, unclear or unfair. There would not have been a breach under COB Rule 5.4.3.
- Regarding statements as to the separate nature of the swap, this was found to refer only to them being two separate contracts, not that they were not in any way linked. While the judge could see no Hedley Byrne breach, he said that even if he had, causation had not been established.
- The crux of the claim regarding the fixing of the margin rate was that the claimants alleged that they had been told that by entering the swap, they would effectively fix the base rate payable under the loan and also fix the margin. Gill had made statements which supported the proposition that the margin would not be changed from 1.5%. As a matter of fact, despite some effort by the bank, the claimants had effectively resisted any significant change to the margin during the period of the loan. The judge suggested that Gill's comments might estop the bank from making such an increase in the future, but on the claim before him rejected any notion that they had been told that the swap would fix the margin rate.
- As to the alleged misstatements concerning the portability of the swap, the judge found that "Mrs Holdsworth could not possibly be saying that in all events the other bank would be obliged to take the Swap". While it was theoretically possible for the bank to refuse consent to moving the swap, it was "extremely difficult to see why it should do so". Again, even if the COB Rules applied here, he did not think that they would make any difference, and even if a duty and breach had been made out, this claim would again probably have failed on causation.
On whether a duty existed
It was accepted by the bank that if a duty of care existed (which it denied), in considering a breach regard should be had to COB Rule 5.4.3 (above) and Rule 5.3.5:
"(1) A firm must take reasonable steps to ensure that, if in the course of a designated investment business: (a) it makes any personal recommendation to a private customer to: (i) buy, sell, subscribe for…a designated investment…the advice on investments or transaction is suitable for the client."
The claimants alleged that because they were "positively recommended the Swap at the Meeting, the Bank's advisory duty came into play". Their main allegation of breach of this duty was that the swap was unsuitable because it did not fix the claimants' position with regard to base rates and margin.
The judge agreed with the comments of the judge at first instance in Rubenstein(5) – namely, that for the purpose of considering whether advice was given, it was enough if the product in question was recommended. In support of the point, the claimants relied on the final sentence of Holdsworth's note of the meeting, which read: "Transaction suitable as they didn't really want to pay a premium and they were looking for a fixed rate for 10 years less than 5.00%."
However, the judge in this case was not satisfied on the facts that any recommendation or advice as to suitability was given before or at the meeting. While Gill had suggested the product, this initial recommendation before the meeting was provisional to the information to be provided by Holdsworth. The judge was under the "very clear impression" that "the person in charge of speaking about the products on offer was Mrs Holdsworth". Although she had received no formal training, she "had considerable experience of selling products". The standard way in which she carried out her meetings included her saying that she was "not there to give advice about the products" and that she could "appreciate the difference between giving information and advice".
Of the documents which followed the meeting, as noted above, these "emphasise the non-advisory nature of what took place at the Meeting". The extent to which the bank could rely on these clauses was argued before the judge, given that COB Rule 2.5.3 bars firms from seeking "to exclude or restrict, or to rely on any exclusion or restriction of any duty or liability it may have to a customer". Given his other findings, the judge found it unnecessary to determine the matter, but did note that, in his view, the pre-contractual documents were "untouched by this debate".
Breach of duty
If he had been wrong and there was a duty, the judge would nevertheless have found that it was not breached, even accounting for the COB Rules. Given his conclusions on the evidence, the claimants understood that the swap did not itself fix the margin and they were not told otherwise. Any complaint on assurances regarding the margin was in the context of what they were told by Gill, not in relation to them entering into the swap.
Further, "as for the objective of base rate fixing, the Swap was entirely suitable…and it is not suggested otherwise". That the drop in interest rates left them paying large sums under the swap did not mean that "the Swap was an unsuitable product back in May 2005".
This decision is illustrative of the difficulties that claimants will face if they pursue mis-selling litigation rather than relying on the FSA or the Financial Ombudsman Service. Although there is little in the way of new law, it highlights the importance of documentary evidence.
It was apparent from the judgment that much of the decision turned on the strength of Holdsworth's evidence, which was bolstered by the contemporaneous documentary evidence that was available to her.
In many respects, the evidence provided by Holdsworth was typical of the evidence that might be expected to be produced by the bank in mis-selling cases. It seems that much of the strength of Holdsworth's evidence stemmed from her describing what was routine for her. When set against the recollection of the claimants of a single meeting many years prior, it may come as no surprise which version of events the court preferred. Although the judge found that the claimants were "doing their best to help the Court", he also noted that the passage of time and lack of documents hindered their evidence, leaving them in the unfortunate position "that many banking customers found themselves in the wake of the catastrophic failures of the banking system in 2008 and beyond".
In any event, this case is unlikely to be both the first and final word on the mis-selling of interest hedging products. If nothing else, solicitors acting for the claimants recently indicated(6) that they have been instructed to appeal the decision, so it appears that another instalment to this particular story may be forthcoming.
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