A recent decision issued by Lord Hodge in the Court of Session in Scotland (on 21 August 2012) suggests that the circumstances in which corporate borrowers will be able to claim damages for allegedly mis-sold interest rate hedging products will be limited and, for those customers, recourse to the FSA may be the only course of action. As Banks look to stay litigations pending the outcome of the recently announced FSA review, this decision may encourage customers to agree to that approach.

In his opinion Lord Hodge dismissed the case brought by a property development company which sought the reduction of an interest rate swap agreement entered into with a bank so that it would be unenforceable against the development company. The company further sought damages against the bank. 

The bank’s customer was a property development company which acquired various properties for development in Fife.  In order to finance the development, the customer obtained a loan facility from the bank and entered into a five year interest rate hedging arrangement. This swap agreement had the effect of fixing the customer’s interest rate on the loan facility within a particular range with the consequence that when interest rates fell in 2008, the customer was unable to benefit from that fall. 

Following the economic downturn, the customer fell into default on the loan facility and went into administration in 2011. It was asserted that, but for the obligations incurred under the swap agreement, the company would not have defaulted on the facility and would not have gone into administration. 

In bringing the proceedings to challenge the validity of the swap, the bank’s customer sought three remedies:

  • To have the swap agreement reduced (i.e. treated as null and void);
  • To have any sums paid to the bank under the swap agreement returned; and
  • An award of damages in relation to (i) an alleged breach of the Markets in Financial Instruments Directive 2004/39/EC (“MiFID”) and also the Conduct of Business Sourcebook (“COBS”) issued by the Financial Service Authority (“FSA”) which implemented MiFiD into national law (ii) an alleged breach of contract, (iii) alleged negligent advice and (iv) alleged misrepresentations by the bank’s employees.

Large parts of the case turn on their particular facts and on the terms of the agreements between the parties. However, Lord Hodge’s decision in relation to the remedies available for customers where a financial institution breaches the terms of COBS or MIFID is of universal application.

The Court determined that, in order for a customer to be able to raise a court action for damages against a financial institution for a breach of COBS, which implemented MiFiD into UK law, the customer had to come within section 150 of the Financial Services and Markets Act 2000 (“FSMA”). This requires a customer to show that they meet the definition of “private individual” as defined by regulations.

The Court gave the definition of “private person” for the purposes of section 150 of FSMA a narrow interpretation.  Lord Hodge determined that a company would only have a claim under section 150 of FSMA where the transaction had not been entered into in the course of the company’s business. He gave the term “in the course of business” a wide meaning to include anything done in the course of business rather than requiring the actions to be an integral part of the business. Further he found that, even if he were wrong on that point, he would have determined that entering into agreements of this type was an integral part of the business of a property development company which sought to develop residential properties using in large measure borrowed funds. In the circumstances, the company had no right of action under section 150 of FSMA. In reaching this decision, the Scottish Court has made the same decision as the English Courts reached in Titan Steel Wheels Ltd v RBS [2010] 2 Lloyds Law Reports 92. 

Following on from this decision, it appears that there will be very few corporate customers who are in a position to raise Court actions for damages for breaches of COBS or MiFiD.  However, the decision does not whether there has been mis-selling of interest rate heading products or what if any redress may be available if there has been. The current FSA review into the mis-selling of interest rate hedging products does not contain the “private person” test found in section 150 of FSMA. The big four banks have already agreed with the FSA that they will not take enforcement action against customers affected by these issues until after the review into their case has concluded.  Accordingly, some customers may determine that they are better submitting to the FSA review than seeking to raise court proceedings at least at this stage.