Source: https://hsfnotes1.com/bankinglitigation/tag/loans/
Timestamp: 2020-07-03 11:29:05
Document Index: 519458081

Matched Legal Cases: ['EWCA ', 'UKSC ', 'UKSC ', 'EWCA ', 'EWCA ', 'EWCA ', 'EWCA ', 'EWCA ', 'EWCA ', 'UKSC ', 'EWCA ', 'EWCA ']

Loans | Banking Litigation notes
Proposed insolvency reforms: impact on secured and unsecured bank debt
The new Corporate Insolvency and Governance Bill, currently expected to be enacted in mid-June 2020, is likely significantly to impact secured and unsecured bank debt.
Most fundamentally, the Bill introduces a debtor-in-possession insolvency procedure for the first time in English law. This appears to grant super-priority to certain pre-moratorium unsecured debts (likely including unsecured banking and finance arrangements) which means that they will rank above other debts (including potentially financial debts secured by a floating charge) where a company enters into administration or insolvent liquidation within 12 weeks of a new moratorium ending. These changes could upset the delicate balance between debtors and creditors under UK insolvency law and, potentially, the balance between secured and unsecured financial creditors.
Our Restructuring, Turnaround and Insolvency team has analysed the likely impact on secured and unsecured bank debt in this note on our website. For an analysis of the effect on other key groups, see the team’s notes on the impact on supply chains and their customers and on landlords’ recoveries in an insolvency process.
LIBOR transition: The risks of interim milestone delay for the cash market due to COVID-19
The Working Group on Sterling Risk-Free Reference Rates (RFRWG) has published a further statement on the impact of COVID-19 for firms’ LIBOR transition plans.
The latest statement follows the earlier joint statement made by the FCA, Bank of England and RFRWG on 25 March 2020, in which the regulators set out their initial response to the impact of COVID-19 on transition plans.
In this blog post we consider the specific delays to interim LIBOR transition milestones that have been announced, the likely effect such delay is likely to have on loan market LIBOR transition and how this may impact the profile of the associated litigation risks.
Overarching theme of the regulators’ COVID-19 impact statements
Both of the statements published by the regulators/working group, emphasise that the deadline for LIBOR cessation remains fixed for end-2021 and firms cannot rely on LIBOR being published after that date, notwithstanding the impact of COVID-19 on firms’ steps to prepare for that event. The regulators are working with the RFRWG and its sub-groups and task forces to consider how all firms’ LIBOR transition plans may be impacted.
However, recognising the reality at least in the short term, it is clear that some interim transition milestones may be delayed. The most recent communication announces the first key date to be affected.
Delay to key interim milestone in the loan market
The first key interim LIBOR transition milestone to be affected by COVID-19 is the deadline by which the cash market is recommended to stop issuing LIBOR linked loans. That deadline was originally the end of Q3 2020 but has now been pushed back to the end of Q1 2021.
The RFRWG’s current timetable as to the use of LIBOR-linked loan products is now as follows:
After the end of Q3 2020 lenders, working with their borrowers, should include clear contractual arrangements in all new and re-financed LIBOR-referencing loan products to facilitate conversion ahead of end-2021, through pre-agreed conversion terms or an agreed process for renegotiation, to SONIA or other alternatives; and
All new issuance of sterling LIBOR-referencing loan products that expire after the end of 2021 should cease by the end of Q1 2021.
The regulators have repeatedly acknowledged that the loan market has made less progress in transitioning away from LIBOR than other markets. This led to various initiatives earlier this year to accelerate change, with an emphasis on steps to alleviate some of the difficulties which were faced in the cash markets: The Bank of England’s attempts to “turbo-charge” LIBOR transition in the cash markets: will these increase or decrease the litigation risks? In particular, the Bank of England announced the publication of a SONIA-linked index from July 2020 to support market participants to cease issuing LIBOR-based cash products (maturing beyond 2021). It is therefore perhaps not surprising that the first interim milestone to be relaxed is in that market.
Impact on loan market LIBOR transition
Given that one of the most important drivers to move the cash market to new risk free rates (RFRs) is to stop writing new loans linked to LIBOR, the RFRWG’s decision to delay this particular milestone is significant, though not surprising given the pressures that both lenders and corporates find themselves under as a result of COVID-19.
While there was significant impetus from both lenders and corporates behind a movement to RFRs in the loan markets in Q1 of 2020 (for example British American Tobacco signed a USD 6bn revolving credit facility linked to both SONIA and SOFR in March – see this press release), which will be further boosted by the publication of central bank indices, there has been an understandable hiatus as the impact of COVID-19 has been felt. The issues around market conventions for compounding, and the development of new loan and treasury management systems to support RFR loans, have not yet been resolved, nor has the calculation been fully settled of the credit spread above the RFRs to ensure that the transfer is value neutral. Once the immediate impact of COVID-19 has abated, attention will need to be turned to these once again.
During the extension period (i.e. the six-month period from the original deadline of end-Q3 2020 to end-Q1 2021), the RFRWG’s guidelines state that all new and re-financed LIBOR-linked loans should include a robust fallback mechanisms to enable transition to SONIA (or other alternatives) when LIBOR ceases. For example, through pre-agreed conversion terms or an agreed process for renegotiation.
Profile of litigation risks: impact of delay
Most loans currently being issued include more robust fallbacks of the kind envisaged by the RFRWG’s guidelines (i.e. including an agreed process for renegotiation when LIBOR ceases). However – importantly – the deadline relaxation will mean a further six months’ worth of facilities being written in LIBOR, which will increase the overall volume of LIBOR-linked loans in the market when the benchmark ceases.
The particular risks associated with fallbacks based on a requirement to renegotiate at the time of LIBOR cessation fall broadly within two categories:
Commercial difficulties. An agreed process for renegotiation will only take participants so far: each transaction will still need to be amended on a deal-by-deal basis, though the LMA hopes that its exposure draft form of reference rate selection agreement will smooth this process in some cases. Accordingly, the way in which negotiations unfold on a loan by loan basis will reflect the relative bargaining strengths of the parties at that time.
Practical difficulties. Continuing to increase the volume of loans which will subsequently require renegotiation upon the cessation of LIBOR (on top of legacy loans) will increase the practical challenges firms will face, and the time and cost burden, particularly for those with large books of bilateral loan facilities.
In summary, while pushing this interim milestone back by six months may provide some welcome breathing space in the cash market in the short term, it is not without cost. It will almost certainly increase the challenges firms face in the next stage of the process to achieve LIBOR transition in this market by the fixed deadline of end-2021. It is unlikely that this is the last adjustment to that timetable which will need to be made.
The past week has been important for developments in LIBOR transition, particularly for the cash markets where progress has hitherto been less advanced than other markets.
On 26 February 2020, the International Swaps and Derivatives Association (ISDA) and Securities Industry and Financial Markets Association (SIFMA) hosted a joint conference on benchmark reform in London. One of the most important speeches at this event was given on behalf of the Bank of England (BoE) by Andrew Hauser: Turbo-charging sterling LIBOR transition: why 2020 is the year for action – and what the Bank of England is doing to help.
So what is the BoE doing to accelerate the transition? It seems the answer is to offer both “carrots” and “sticks” to encourage the transition of financial products from LIBOR to SONIA. In a nutshell, the BoE has announced measures:
Supporting the adoption of SONIA in cash products by simplifying the calculation of compounded interest rates by agents through the publication of a SONIA-linked index from July 2020;
Acknowledging the market’s desire to go a step further by agreeing to consult the potential publication of daily “screen rates” for specific period averages of compounded SONIA which would avoid agents having to perform any calculation at all; and
Penalising firms which continue to hold LIBOR assets by October 2020, by increasing haircuts on LIBOR linked collateral when using the BoE’s funding window, if that collateral remains LIBOR-linked.
These measures are explained further below, together with a discussion as to how these developments are likely to be received by the market, and how they might alter the profile of the litigation risk faced by financial institutions and other corporates given the impact on ease, certainty and necessity of transition.
1. BoE to publish compounded SONIA-linked index from July 2020
The BoE intends to publish a compounded SONIA-linked index from July 2020. It has said that this will complement its existing publication of the overnight SONIA rate and the index will provide a flexible tool to help market participants construct compounded SONIA rates in an easy, consistent and flexible way. The stated intention of the BoE is to support market participants to cease issuing GBP LIBOR-based cash products (maturing beyond 2021) by Q3 of 2020. This is the deadline set by the UK Risk Free Rate (RFR) Working Group in its roadmap for 2020 – see our banking litigation blog post for further discussion of the 2020 roadmap and the accompanying suite of documents published by the regulators and working groups at the beginning of this year.
The BoE has celebrated the speed with which SONIA has become the default reference rate of choice for floating-rate notes and securitisations (which are predominantly wholesale transactions), but recognises that replicating this success in the bilateral and syndicated loan market is a different challenge. It is understood that one of the challenges to widespread adoption is the practical difficulty of calculating compounded SONIA rates in a simple and consistent way that can easily reconcile with the overnight SONIA rate published by the BoE. For example, to calculate the compounded interest rate for a three month period requires approximately 60 data inputs (the overnight SONIA rates for each working day of the interest period) and there are a number of different ways in which the precise calculation can be performed that might create difficulties without universal acceptance of established conventions.
It is to overcome this (primarily operational) challenge, that the BoE plans to publish a “golden source” SONIA-linked index from which bespoke rates can more readily be calculated.
2. BoE consultation on publication of daily “screen rates” for specific period averages of compounded SONIA rates
The BoE recognises that some market participants are calling for it to go a step further and publish daily “screen rates” for one or more specific period averages – for example 6-month, 3-month or 1-month compounded SONIA rates – so that the agent need perform no calculation at all; it can simply use the relevant screen rate. It is therefore consulting on whether there is sufficient market consensus on which set of period averages it should publish as screen rates, or whether the number of different screen rates which would need to be published to meet the market’s needs would create the risk of confusion and undermine the very certainty which the BoE is seeking to achieve.
In our view, while the index is helpful, it is the BoE’s second initiative to consult on publishing a daily “screen rates” for specific period averages which is what the market really wants and needs. The need for a term replacement remains as strong in the market as ever, and the comments from the BoE underline the regulatory commitment to force the transition, irrespective of the state of market readiness, and so the development of a term replacement will continue to rest with the market.
Even if ultimately the BoE decides only to publish a SONIA-linked index, this represents a step forward in terms of helping the bilateral and syndicated loans market move to using RFRs. A number of the barriers to the Loan Market Association (LMA) producing a RFR facility agreement, or even a hard-wired fallback to RFR document, stem from the fact that the market has not yet agreed on the method of calculation of the compounded average RFR. This proposal from the BoE largely dispenses with these concerns, aids standardisation and provides a screen rate for agents to use, assuming the market is willing to accept a single standardised source calculated on this basis.
In terms of litigation risk, the simple point is that if publication of the SONIA-linked index (or daily screen rates for specific period averages) reduce the volume of new cash products written in LIBOR, then that will mean a reduction in the volume of risky LIBOR-linked products in existence on cessation of LIBOR.
However, a number of questions still remain. In particular, even if the operational challenges are removed by publication of a SONIA-linked index (or daily screen rate) in order for parties to transition legacy LIBOR-linked contracts to SONIA, they will have to agree the quantum of the spread adjustment which mitigates or eliminates the value transfer between them. As discussed in our article in the Journal of International Banking Law and Regulation on the types of litigation which may arise on LIBOR discontinuation, there is no procedure to amend legacy loan facilities on an industry-wide basis and there are clear obstacles for achieving effective adoption of revised fallbacks on a bilateral basis. As such there still remains a risk of significant volumes of legacy loan facilities which are not amended before LIBOR cessation takes place, notwithstanding this development.
3. BoE to increase haircuts on LIBOR-linked collateral it lends against from October 2020
And so to the stick. The BoE currently makes funding available to firms as part of its normal market operations against a wide set of eligible collateral, but applies a “haircut” to that collateral to protect against possible falls in its value in the period between a counterparty default and collateral sale.
The current average haircut is just under 25%, but from Q3 2020 the BoE will progressively increase the haircuts on LIBOR-linked collateral – increasing to 35% in October 2020, to 65% in June 2021 and, at the end of 2021, to 100% (i.e. effectively rendering such collateral ineligible). In addition, LIBOR-linked collateral issued after October 2020 will be ineligible for use.
The BoE says this graduated approach will give firms the time they need to replace that collateral with RFR alternatives, ensuring their borrowing capacity is maintained while also protecting public funds. The intended effect is clear, the higher the haircuts the less attractive the collateral, and so this step is likely to further wean firms from holding stocks of LIBOR linked assets and continue the evolution towards RFRs.
This development presents an interesting and novel litigation risk in relation to LIBOR discontinuation for market participants. If firms are unable to transition a sufficient amount of their book of LIBOR-linked products to SONIA in time, then it will affect their borrowing capacity at the BoE. Given that the BoE’s lending operations are designed to provide liquidity support to market participants experiencing either a predictable liquidity need or responding to an idiosyncratic or market wide liquidity shock, impairing the availability of effective liquidity at a possibly critical moment for firms could be significant.
The High Court has struck out claims brought by former investors in the Ingenious Media tax deferral schemes against lending banks who advanced sums to the investors for the purpose of investing in the scheme: Mr Anthony Barness & Ors v Ingenious Media Limited & Ors [2019] EWHC 3299 (Ch).
In the context of the current wave of tax deferral scheme litigation (including in respect of the film financing schemes Samarkand, Proteus, Imagine and Timeless Releasing), the interlocutory decision in Barness provides reassurance to banks which acted as lenders to the investors in those schemes. This is particularly welcome in circumstances where investors are increasingly pursuing claims against such lenders where the independent financial advisers (“IFA”) and promoters who provided advice to investors directly have either collapsed or do not have sufficiently deep pockets.
The most important aspects of the case which are likely to be of relevance to similar claims, and more generally to financial institutions selling products on an execution-only basis, are as follows:
The claimant investors in Barness sought to establish that their relationship with the banks went above and beyond a standard lending relationship, and that they were owed duties (both in contract and in tort) by their lenders relating to the suitability of the investment for which the loan was advanced. The court firmly rejected this avenue of reasoning, referring to the decision of the Court of Appeal in Green v The Royal Bank of Scotland plc [2013] EWCA Civ 1197 and of the High Court in Carney v N M Rothschild & Sons Ltd [2018] EWHC 958 (Comm) that there is no general obligation on a lending bank to give advice about the prudence or otherwise of the transaction which the loan is intended to fund.
For claims based on implied contractual terms or duties of care to succeed, it remains paramount for claimants to point to very specific words or conduct. In this case, it was asserted by the investors that the lending banks had agreed (or acquiesced) to the investors’ IFA “packaging” together the investment proposition with available financing. The court found that – even if this assertion was accepted – it was insufficient to establish an implied term as to the suitability of the investment, or to find that the banks had assumed a similar duty of care in tort or had otherwise endorsed the investment.
The court was unconvinced by the argument that there existed an implied “umbrella contract” based on the “private banking and wealth management relationship” between the claimants and the lenders. We have previously considered a similar (unsuccessful) attempt at such an argument advanced in Standish v RBS [2018] EWHC 1829 (Ch) in our blog post. There has been a noticeable uptick in claimants asserting the existence of an implied umbrella or overarching agreement as a vehicle by which to advance arguments based on implied contractual terms. The court’s robust rejection of such claims in this case and Standish will be welcomed by financial institutions.
The court also rejected a claim that the IFA promoting the scheme had acted as the lending banks’ agent, and that the banks were therefore vicariously liable for its negligent advice. The court held that the IFA and the banks had conducted their separate businesses throughout (of providing financial advice and financing respectively), such that the activities of the financial adviser could not be said to have been an integral part of the banks’ business. Evidence regarding the close relationship between the financial adviser and the banks was submitted to no avail. Again, the court’s robust rejection of this line of argument is helpful not only in the context of other tax deferral scheme litigation, but more generally where banks act on an execution-only basis alongside an IFA.
We consider the decision in more detail below.
From 2002 to 2007 a number of tax schemes were promoted under the name “Ingenious” as tax-efficient vehicles through which investors could contribute funds to a limited liability partnership (“LLP”) for investing in films/video games and set off their share of the LLP’s losses against other taxable income. HMRC did not accept that the schemes worked as intended and, following a series of appeals, the outcome for the individual investors was that they lost both the sums invested in the schemes and the anticipated tax relief (and may be exposed to claims by HMRC for arrears of tax with interest and penalties). A number of the investors have issued claims to seek to recover their losses from a range of defendants, including claims against the banks which advanced the funds to cover some (or all) of the investors’ capital contribution to the relevant LLP.
The present claims were brought by investors who borrowed sums from Coutts & Co and National Westminster Bank plc (the “Banks”). All of the claimants received independent advice on their investments in the Ingenious schemes from the same IFA.
The claims against the Banks are part of a much larger litigation brought against financial and tax advisers, the promoters of the scheme and lenders. In relation to their claims against the lender Banks, the claimants relied on three separate causes of action:
Claims for breach of contract, based on terms said to be implied into contracts between the claimants and the relevant Bank. In particular, an implied term relating to the suitability of the loans (i.e. that the Banks would not provide loan finance, introduce products or allow a loan to be packaged with an investment product, unless they were suitable for the claimants having regard to their financial position, needs, objectives and attitude to risk).
Claims for negligence, predicated on duties of care of a similar nature to the (alleged) implied suitability terms, owed both (a) concurrently with the implied contractual duties; and (b) in tort arising from a non-contractual assumption of responsibility.
Claims alleging that the Banks were vicariously liable for breaches of duty by the IFA, on the basis that the IFA acted as the Banks’ agent.
The court struck out the contractual and tortious claims pursuant to CPR 3.4(2)(a) and granted reverse summary judgment on the vicarious liability claims pursuant to CPR 24.2. The court’s analysis is considered in further detail below.
The claimants asserted that the term relating to the suitability of the loan (and a number of other terms) were implied into either: (a) an unwritten umbrella or overarching contract on the basis that the claimants and the relevant Bank had entered into a “private banking and wealth management relationship”; or (b) the existing loan documentation.
As to whether there was a wider umbrella agreement, the Banks submitted that the claimants had failed to comply with CPR Practice Direction 16, which requires that claims based on oral agreements and conduct must specify the words spoken and conduct in sufficient detail. The court agreed that no facts had been pleaded which supported the existence of an umbrella contract between the claimants and either of the Banks.
Having noted that not every breach of Practice Direction 16 would lead to a claim being struck out, the court considered the claimants’ argument that the umbrella contract arose on the basis of the Banks’ conduct, specifically in offering the “package” presentation of the investment and loans. In the court’s view, this did not provide the requisite support for the umbrella contract. It said there was no logical connection between the alleged “packaging” of the loans and investments, and the suggestion that the Banks offered to undertake an overarching responsibility for management of the claimants’ wealth which was over and above the particular services provided by the Banks (loans and current accounts etc.). The court likewise held that statements in one of the Bank’s internal documents that the claimants had a “full banking relationship” did not suggest that the Bank had entered into an umbrella contract to provide not only banking but also wealth management services.
The court concluded that there was no pleaded basis for the suitability terms to be implied into an umbrella contract and this was sufficient to justify strike out in the circumstances, noting that it would have alternatively granted reverse summary judgment.
The court paraphrased the test for implying terms into a contract (clarified in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Limited and another [2015] UKSC 72, although without citation in the judgment). It found that the alleged contractual duty on the Banks not to package loans with an unsuitable investment was neither so obvious as to go without saying, nor necessary to give business efficacy to the contract.
The court accepted that it was well established that a bank which sells a product to its customer is not under a (tortious) duty to advise as to the nature of the risks inherent in the transaction (Green v RBS). In those circumstances, the court could not see any sustainable case pleaded (or that could realistically be pleaded) that the suitability terms were to be implied into the contracts of loans between the Banks and the claimants.
The court therefore struck out the claims (and noted it would have alternatively awarded reverse summary judgment).
As noted above, the allegation that the Banks owed the claimants a duty of care in tort was argued firstly on the basis that it was concurrent with a like duty in contract. This duty was not considered further, given the court’s rejection of the contractual claims.
Accordingly, the court proceeded to consider whether the relevant Bank assumed responsibility towards each of the claimants giving rise to a duty of care in tort of a similar nature to the (alleged) implied suitability terms. The court accepted that to find a duty of care in tort required some communication between the Banks and the claimants to the effect that the Banks were assuming responsibility for the tasks in question; and reliance by the claimants.
The claimants could not point to anything in terms of advice that crossed the line between the Banks and the claimants, but relied – once again – on the “packaging” of the loans with the investments to give rise to the duty of care. Without more, the court found this was insufficient to give rise to a duty of care. The court noted that a bank does not “assume an advisory role simply because it agrees to lend to the customer for a particular purpose” (Carney) and could not, therefore, be said to have assumed an advisory role simply because it agreed to its loans being “packaged” together with an investment. This was particularly so where there was an IFA advising the customer.
The court rejected the claimants’ attempts to draw comparisons with cases in which a duty of care had been found and reliance was not required, such as White v Jones [1995] 2 AC 207 (where a solicitor instructed by a testator was held to have owed duties of care in tort to the intended legatees). The court distinguished such cases on the basis that they related to whether an established contractual duty of reasonable skill and care can be said to be owed not only to a client of the defendant, but also to the person intended to benefit from the defendant’s advice. That was different to the present case, in which the question was whether there was a relevant duty of care at all, rather than widening the class of people who can sue for breach of duty.
The court therefore found that there were no reasonable grounds for bringing the claims and ordered strike out, noting that it would equally have granted reverse summary judgment.
The claimants alleged that the IFA had acted as the Banks’ agent in “introducing, explaining and advising upon the packaged investment”. The court said that the relevant question was whether the IFA was acting on behalf of the Banks, which required them to have either:
told the claimants that the IFA was advising on their behalf, or otherwise held the IFA out as doing so (which was not the case, due to the fact that the loan documentation explicitly stated that the claimants were not relying on advice provided by the Banks); or
used the IFA to discharge a duty to advise owed to the claimants (and the court found that there was no such duty to advise). In relation to the final claim based on vicarious liability, the court therefore granted reverse summary judgment in favour of the Banks.
An argument based on the rule in Cox v Ministry of Justice [2016] UKSC 10 which was advanced by the claimants also failed. This test expands the scope of agency to situations in which a person carries on activities as an integral part of the business activities of the principal and for its benefit. The court found that the business activities of the IFA in providing financial advice were neither an integral part of the business of the Banks, nor were they for their benefit. Despite the close commercial relationship between the IFA and the Banks, the commission paid by the former to the latter and the “packaged” presentation of the investment and the loan, each party was carrying out its own business, namely that of providing financial advice and providing banking and lending services respectively.
In relation to the final claim based on vicarious liability, the court therefore granted reverse summary judgment in favour of the Banks.
The phrase “mandatory provision of law” had no territorial qualification, it included the laws of any country (not just English law).
The word “mandatory” in this context meant a provision of law that the parties could not vary or dis-apply.
The effect of the words “in order to comply” with a mandatory provision of law, applied whenever a party refrained from acting in a manner that would otherwise attract the possible imposition of a sanction or penalty by operation of a statute.
The most striking aspect of the judgment is the approach to interpretation of the phrase “in order to comply”. The conclusion reached by the court accords with the ‘in practice’ position of parties faced with secondary sanctions risk (i.e. that, in effect, they have to ‘comply’ with non-applicable US law). However, it is not an obvious construction of the phrase given the legal nature of secondary sanctions.
The drafting of the clause in this case was not entirely clear and the parties had to rely on the court to determine the correct interpretation. In order to avoid uncertainty, in many cases it will be prudent for parties to include a detailed definition of terms such as “comply” and “mandatory provision of law” which expressly state whether such terms are: (a) intended to be limited to the laws of any particular jurisdiction; and (b) intended to include laws which do not expressly require a party to refuse to make payment (or otherwise perform its obligations) but which may result in the party being subjected to secondary sanctions if it does so. However, where the risk being mitigated includes secondary sanctions risk arising under US laws which are subject to the so-called Blocking Regulation (EU Regulation 2271/96) (in particular in relation to Iran and Cuba), parties who are EU persons will also need to consider whether the language they wish to use would itself give rise to risk under the Blocking Regulation.
The claimant, Lamesa Investments Limited, is a Cypriot company whose ultimate beneficial owner is Mr Viktor Vekselberg. On 19 December 2017, the claimant entered into a Facility Agreement with the defendant, Cynergy Bank Limited, an English company.
Under the Facility Agreement, the claimant lent £30 million to the defendant, which was required to make interest payments on 21 June and 21 December of each year throughout the term of the loan. Clause 9.1 of the Facility Agreement provided that the borrower would not be in default if sums due were not paid “in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction”. The Facility Agreement was governed by English law.
On 6 April 2018, the US placed Mr Vekselberg on the list of “Specially Designated Nationals” (“SDNs“), pursuant to Executive Order 13662 (made under the International Emergency Economic Powers Act). As a result, the lender became a “Blocked Person” by reason of its indirect ownership by Mr Vekselberg.
The US sanctions on Russia (in common with a small number of other US sanctions regimes, including for example the regime applicable to Iran), contain so-called ‘secondary sanctions’ provisions. By contrast to traditional ‘primary sanctions’, which apply to US persons and conduct within the territorial jurisdiction of the US, secondary sanctions seek to target non-US persons who engage in certain specified activities that have no US jurisdictional nexus. A non-US party that engages in the specified activities can itself be subjected to retaliatory measures by the US government. For example, pursuant to US/Russian sanctions, knowingly facilitating a “significant” transaction with a SDN is secondarily sanctionable.
This meant that if the borrower knowingly facilitated a significant financial transaction on behalf of the lender, then the borrower could be subjected to secondary sanctions. In particular, under Section 5 of the Ukraine Freedom Support Act 2014 the borrower could be blocked from opening or maintaining a correspondent account in the US or have strict conditions imposed on the maintaining of such an account.
A significant part of the borrower’s business was denominated in US dollars, and US dollars deposited by its retail customers were deposited in a correspondent account maintained by the borrower with JP Morgan in the US. As a result of the significant risk to its business, the borrower relied on clause 9.1 of the Facility Agreement to withhold payment of £3.6 million of interest instalments that had fallen due (although it had ring-fenced the funds).
The lender sought a declaration that the borrower was obliged to continue making the payments under the Facility Agreement notwithstanding the risk that it would be subjected to secondary sanctions.
The court held that the borrower was entitled to rely on clause 9.1 of the Facility Agreement for as long as Mr Vekselberg remained a SDN and the lender remained a Blocked Person by reason of it being owned by Mr Vekselberg.
The court re-iterated the general position that, unless the contract provides otherwise, English law will not excuse contractual performance by reference to foreign law, unless that law is the law of the contract or the law of the place of performance. The Facility Agreement was not governed by US law and the US was not the place of performance. The sole issue was therefore whether, on its true construction, clause 9.1 of the Facility Agreement excused performance by reference to the relevant provisions of US law. There were three key battlegrounds on contractual construction, each of which is considered further below.
The court rejected the lender’s argument that the phrase “mandatory provision of law” should be construed to include a territorial qualification. It based its decision on the relevant documentary context. In particular:
Clause 9.1 also referred to regulations and orders of any court of competent jurisdiction. The definition of the term “regulation” was not subject to any territorial qualification.
The reference to “any court of competent jurisdiction” suggested that the parties did not intend to impose a territorial qualification.
In the court’s view, it would therefore be inconsistent to construe the term “mandatory provision of law” as being confined to English law. The court also noted that if the parties had intended to include a territorial qualification then they could have done so easily enough, but they chose not to do so.
Meaning of “mandatory” provision of law
The court did not accept that the natural understanding of English lawyers at the date of the Facility Agreement would have been that a “mandatory” rule of law was one that expressly required compliance. It said that all provisions of the law by definition have to be complied with unless the parties dis-apply them to the extent possible. Accordingly, the court found that the word “mandatory” in this context meant a provision of law that the parties cannot vary or dis-apply.
Meaning of “in order to comply”
The court considered that the real issue concerned the effect of the words “in order to comply”.
This is an interesting phrase in the context of secondary sanctions. On the one hand, there is an argument that technically such provisions do not require non-US persons to take or refrain from taking any particular steps; they do not ‘apply’ outside the US, and non-US parties are not required to ‘comply’ with them. Rather, they specify conduct which, if taken, could on a discretionary basis give rise to various forms of retaliatory action. On the other hand, in practice their effect is that non-US persons consider themselves required to ‘comply’, given the severe repercussions if secondary sanctions are imposed.
The court noted three possible permutations of the phrase “in order to comply”:
The first was that it only applied to a statute that expressly prohibits payment on pain of the imposition of a sanction or penalty.
The second was that it applied whenever a party refrains from acting in a manner that would otherwise attract a sanction or penalty imposed by statute.
The third was that it applied whenever a party refrains from acting in a manner that would otherwise attract the possible imposition of a sanction or penalty by operation of a statute.
The court found that there was no reason why clause 9.1 should be confined to the first of these permutations (express prohibition). It emphasised that it has long been recognised in context of whether a contract is void for illegality that if a statute imposes a penalty that will be treated as an implied prohibition (see Phoenix General Insurance Co of Greece SA v Halvanon Insurance Company Limited [1988] 1 QB 216). In the court’s view, a party who acts so as to avoid the imposition of a penalty is complying with the implied prohibition just as much as a party who acts so as to comply with an express prohibition. (The court did not address the point that the imposition of secondary sanctions is not per se a ‘penalty’ imposed for breach of an applicable law).
The court further found that the factual and commercial context suggested that it was highly unlikely that the parties intended the clause to be limited to the first and second but not the third permutations. In particular:
The parties were aware in December 2017 that it was possible that US sanctions would be imposed on the lender, albeit this was not considered likely. It was known to the parties that the risk was that the borrower would be exposed to secondary sanctions, not primary sanctions. Neither party could have thought that there was any question of primary sanctions arising if the lender became a Blocked Person because there was nothing in the Facility Agreement that required payment to be made in US dollars or to a US bank account, neither of the parties were US entities, and the agreement did not involve any conduct in the US.
The way that clause 9.1 addressed the risk was by prospectively excusing payment by the borrower. It did not provide any recourse after the event if the borrower made a payment and a sanction was then imposed after an unsuccessful attempt by the borrower to persuade the US authorities not to impose a sanction. If clause 9.1 were limited to the first and second permutations this would not adequately address the risk because the borrower would be required to make the payment and would have no recourse if a sanction was then imposed.
It was all the more unlikely that the parties intended to exclude the third permutation (possible imposition of a sanction/penalty) because even though the imposition of sanctions was theoretically only ‘possible’ if the borrower made payment to a Blocked Person, in reality sanctions were the default position. As such the clause would have no effect if limited in this way. The court took that view in light of guidance from the relevant US authorities, and the limited exceptions in the US legislation itself; the fact that secondary sanctions have in practice been imposed only infrequently did not feature in the judgment.
Accordingly, the court found that the borrower was entitled to rely upon clause 9.1 of the Finance Agreement for as long as Mr Vekselberg remained a SDN and the lender remained a Blocked Party, and was entitled to a declaration to that effect.
Blocking Regulation
One final point of interest to sanctions practitioners is a brief appearance in the judgment of reference to the so-called Blocking Regulation (EU Regulation 2271/96). Cynergy had argued that relieving Lamesa of its obligation to perform the contract would be contrary to the UK’s policy of not giving extra-territorial effect to US secondary sanctions programmes. The court rejected that argument, on the basis that its ruling was based on contractual construction, and “[u]nless there is a mandatory rule of English law that precludes parties to a contract from including a provision to the effect alleged I do not consider the alleged policy is material”. The court found that since the Appendix to the Blocking Regulation did not include the US/Russia secondary sanctions, the parties were free, through the terms of their agreement, to manage secondary sanctions risk.
This leaves open the possibility (albeit this was not relevant on the facts of the case), that the same approach would not pertain if the secondary sanctions in question were the blocked laws which appear in the Appendix to the Blocking Regulation (relating principally to Iran and Cuba). Set against this, but in a slightly different context, there are obiter comments in Mamancochet Mining Limited v Aegis Managing Agency Limited & Ors [2018] EWHC 2643 to the effect that there was “considerable force” in an argument that the EU Blocking Regulation was not engaged where an insurer’s liability to pay an Iran-related claim was suspended under a sanctions clause in an insurance policy (see our insurance blog post).
In short, the impact of the Blocking Regulation in these sorts of claims has yet to be fully explored, but it is interesting to see the courts begin to grapple with its potential impact; and as the US turns more often to secondary sanctions as a policy tool, it seems reasonable to anticipate more cases in which it will feature.
On a recent summary judgment application, the High Court has given effect to an anti set-off clause on standard Loan Market Association (“LMA“) terms to prevent the defendant from relying on equitable set-off, as a defence to claims to recover interest and principal under a loan agreement: AMC III Purple B.V. v Amethyst Radiotherapy Limited [2019] EWHC 1503 (Comm).
The commercial aim of such anti set-off provisions in loan agreements is for the lender to secure payment free from potential cross-claims. Whereas legal set-off is only available where the two claims are for liquidated damages which can be readily ascertained, equitable set off is available for unliquidated damages (e.g. damages payable pursuant to a claim in negligence). Equitable set-off may arise where there is a close connection between the claim and cross-claim, such that it would be manifestly unjust to allow a party to enforce payment without taking into account the cross-claim (Geldof Metaalconstructie NV v Simon Carves Ltd [2010] EWCA Civ 667). While previous authority has suggested that the standard form LMA anti set-off clause would be effective in relation to both legal and equitable set-off, this decision is likely to be welcomed by financial institutions as demonstrating the court’s willingness (in appropriate cases) to grant summary judgment to give effect to such clauses.
This decision is in line with other recent authority giving certainty to the effect of anti set-off provisions, such as the Court of Appeal’s decision in Woodeson & Anor v Credit Suisse (UK) Ltd [2018] EWCA Civ 1103 (see our banking litigation blog post).
In 2014, the claimant provided a €21 million mezzanine facility to the defendant (the “First Loan Agreement“). In 2015, under a separate agreement (the “Second Loan Agreement“), the claimant provided a further €4 million loan to the defendant. The defendant failed to make certain interest payments under both loan agreements, and also to repay principal under the Second Loan Agreement.
The claimant applied for summary judgment in the High Court seeking:
a declaration that an Event of Default had occurred under the First and Second Loan Agreements; and
an order that the defendant pay outstanding interest under the First Loan Agreement and outstanding principal and interest under the Second Loan Agreement.
The defendant contested the summary judgment application on a number of bases. One of the defences, which is likely to be of broader interest to the sector, was an argument that the defendant was not obliged to make interest payments under either of the loan agreements (or principal under the Second Loan Agreement) because it was entitled to set off, by way of equitable set off, various claims against the claimant (the details of those alleged claims are not relevant for the purposes of this post).
In response, the claimant relied on the anti-set-off clauses in the First and Second Loan Agreements which provided respectively: “All payments to be made by the Borrower under the Finance Documents shall be calculated and be made without (and free and clear of any deduction for) set-off or counterclaim“; and “Each payment to be made by the [Defendant] under this Agreement will be made in full, without any set-off or deduction“.
The judgment does not expressly state whether the loan agreements were on standard terms, but the anti set-off provision in the First Loan Agreement was in identical form to the LMA standard form version of that clause.
The High Court held that the claimant was entitled to summary judgment as sought.
In particular, it found that a defence based on equitable set-off was not arguable, highlighting the following key points:
In respect of the First Loan Agreement (taking standard LMA form), the court had previously considered a clause in identical terms and found it to preclude the application of both an equitable set-off as well as a legal set-off (Credit Suisse International v Ramot Plana ODD [2010] EWHC 2759 (Comm).
In respect of both clauses, this outcome was further supported by the Court of Appeal decision in Caterpillar (NI) Ltd v John Holt & Co. (Liverpool) Ltd [2013] EWCA Civ 1232 where it was held that “the average businessman who was told that a clause of this kind applied to legal set-offs but not equitable set-offs would hardly be able to contain his disbelief“.
The reference in the more detailed anti-set-off clause in the First Loan Agreement to “payments” being “calculated” without set-off prevented the defendant from arguing that the clause only applied to sums which were “due“, and that there could thus be an equitable set-off where no sums were due.
The reference to “any” in the anti-set-off clause in the Second Loan Agreement (there shall not be “any set-off or deduction“) must mean what it says and therefore prevent both equitable and legal set off (as per Caterpillar).
James Leadill
+44 7 495 78 37587
A borrower’s right of set-off may be excluded in loan and security documentation (subject to limited exceptions), with the commercial aim of the lender to secure payment, free from potential cross-claims. The recent Court of Appeal decision in Woodeson & Anor v Credit Suisse (UK) Ltd [2018] EWCA Civ 1103 provides helpful guidance as to the operation of such anti-set off provisions in the context of secured property. This decision is likely to be welcomed by both financial institutions and finance lawyers. It should contribute to the certainty of anti-set off provisions in mortgage documentation, thereby enhancing the security position of secured lenders.
Firstly, the Court of Appeal confirmed that the requirement to draw to the attention of a counterparty any “particularly onerous or unusual” provisions would not ordinarily apply to anti-set off clauses included in mortgage documentation. Distinguishing Interfoto Picture Library v Stiletto [1989] QB 433, the Court of Appeal commented that anti-set off clauses were “by no means unusual in mortgage transactions” and the contractual documentation containing the set-off clauses was signed by the claimants in the instant case. Where the contractual documentation is signed, the Interfoto principle will have no (or at least extremely limited) application as per Peekay v Australia and New Zealand Bank [2006] EWCA Civ 386.
Secondly, the Court of Appeal made significant obiter remarks on the application of the principle in Spencer Day v Tiuta International Ltd & Anor[2014] EWCA Civ 1246. The Court of Appeal confirmed that a mortgagor cannot – by asserting an equitable right of set-off – prevent a mortgagee from enforcing its security by taking possession of and selling the mortgaged property and recovering the mortgage debt (without giving credit for the mortgagor’s claim) from the proceeds of sale. It said this was so, even if the cross-claim asserted by the mortgagor was sufficiently connected with the mortgage debt to satisfy the general test for an equitable set-off. The commercial reasoning behind this principle is that such mortgagor claims can only be pursued as freestanding claims for damages, as they are not claims which are secured on the mortgaged properties or the proceeds of sale thereof. To allow otherwise would in effect give the mortgagor a secured position (Samuel Keller (Holdings) Ltd v Martins Bank Ltd [1971] 1 WLR 43 (a first instance decision affirmed by the Court of Appeal)).
While obiter remarks do not have precedent value and are not binding, they may be persuasive in future cases. The obiter dicta here is likely to carry weight given that the comments were made by a Court of Appeal judge whose express and sole intention was to clarify the law in this area – the judgment of Leggatt LJ (concurring with the leading judgment given by Longmore LJ) was entirely devoted to clarifying the law in this area. Further, the court did not technically make any new finding of law, but rather consolidated previous decisions of the High Court and Court of Appeal.
It should be noted that one important limitation in relation to anti-set off provisions, is that parties are not permitted to contract out of the mandatory rules of insolvency set-off. Notwithstanding the anti-set off provisions in this case, the insolvency set-off rules would have applied if the claimants in these proceedings (who were individuals) had been declared bankrupt.
In addition to its findings on the anti-set off provisions, the Court of Appeal confirmed the position in relation to extending a time-barred claim where a declaration, rather than damages, is sought. In such cases, the court will look at the basis on which the declaration is sought and consider whether that base action is time-barred. As such, a claimant cannot seek a declaration, instead of damages, to improve its position if it would otherwise be time barred from bringing the cause of action.
The claimants (who were individuals) owned a property, which they re-mortgaged with Credit Suisse (UK) Limited (the “Bank“) in 2008, pursuant to an interest only Swiss franc loan for a term of five years. The sum borrowed was far greater than necessary to repay the previous mortgage. The surplus funds were used to invest in sterling deposits (i.e. a carry trade).
The claimants’ intention was to benefit from the interest rate difference by receiving a higher interest from the sterling deposits while paying lower interest on the Swiss franc mortgage. However, this deal proved to be “disastrous” when the Bank of England base rate fell sharply from October 2008 and the exchange rate of the Swiss franc to sterling declined significantly. When the loan matured, the claimants failed to repay it and the Bank subsequently appointed Receivers over the mortgaged property. The Receivers commenced proceedings seeking possession of the mortgaged property. The claimants commenced the present action as a form of “counter-attack” to dissuade the court from granting possession of the property (see details of this claim below). The claimants were not successful and an order granting the Receivers possession of the mortgaged property was granted.
In the instant proceedings, the claimants sought a number of declarations. These included a declaration that the claimants were entitled to set off (against sums due to the Bank under the mortgage) a cross-claim for damages. The cross-claim for damages allegedly arose from the Bank’s mis-selling of the Swiss franc facility pursuant to s.138D of the Financial Services and Markets Act 2000 (“FSMA“), in the tort of negligence and/or deceit.
The Bank applied for summary judgment on the basis: (1) that the claims on which the declarations were founded were statute-barred; and (2) that the claimants had contracted out of the right of set-off, and therefore the claims did not provide any defence to the Bank’s claim to recover the debt through the possession proceedings.
The High Court granted summary judgment in respect of all claims (except for the deceit claim), finding that the claims were time-barred. The first instance decision is not publicly available, but it appears that the High Court held that the anti-set off provisions arguably operated in relation to the claims based on negligence and breach of statutory duty. As to the deceit claim, the High Court held that it was arguable that the time for a deceit claim was extended pursuant to s.32 of the Limitation Act 1980 and that it was arguably unreasonable pursuant to the Unfair Contract Terms Act 1977 to seek to apply the anti-set off provisions to a deceit claim.
The result of the High Court judgment was that the claimants could only pursue their claim in deceit. The claimants appealed this decision.
The claimants appealed on the following grounds:
Their claims for equitable relief in the form of declarations were not time-barred (and could be granted and then used as defences as and when the need arose);
That the Bank deliberately concealed the facts relevant to the claims in negligence and breach of s.138D FSMA (as well as deceit); and
That because the Bank did not draw the claimants’ attention to the no-set off clauses and explain their effect, the clauses could not be relied on by virtue of the application of Interfoto.
The Court of Appeal dismissed the three grounds of the claimants’ appeal and refused a stay of the order that the Receivers take possession of the mortgaged property. The key issue which is likely to be of interest to financial institutions is the Court of Appeal’s decision in relation to the anti-set off clauses, which is dealt with first below (followed by a very brief summary of the other issues).
1. Anti-set off provisions
The claimants relied on the principle established in Interfoto, namely that any “particularly onerous or unusual” provisions must be drawn to the attention of the other party. They argued that, unless the presence of the anti-set off clauses were specifically brought to the attention of the claimants, they could not be relied upon by the Bank.
The Court of Appeal distinguished Interfoto, where the clause in question: (a) was considered by the court to be unreasonable on its face; and (b) was contained in a document which had not been signed by the party whose rights were affected by the clause. The Court of Appeal noted that the anti-set off clauses were “by no means unusual in mortgage transactions” and the contractual documentation containing the set-off clauses was signed by the claimants in the instant case. It referred to Peekay, as authority for the principle that where the contractual documentation is signed, the Interfoto principle will have no (or at least extremely limited) application. Accordingly, the Court of Appeal held that the anti-set off clauses could (in principle) be relied on by the Bank.
In addition to its main finding on this issue, the Court of Appeal also made significant obiter remarks on the application of the “Spencer Day principle“. This was reference to the Court of Appeal decision in Spencer Day v Tiuta International and “a long line of binding decisions of the Court of Appeal” which confirmed that claims asserted by a mortgagor could not – as a matter of law – be set off against a mortgage debt (irrespective of any anti-set off clause). Such mortgagor claims could only be pursued as freestanding claims for damages.
The claimants submitted that the Spencer Day principle was confined to claims for possession of the mortgaged property and did not extend to cases where the bank had a money claim or to cases where the mortgagor sought an account of what was truly due to the bank after considering any cross-claims. The Court of Appeal rejected this proposition, finding it was inconsistent with Spencer Day and the cases cited therein. The Court of Appeal confirmed that a mortgagor cannot – by asserting an equitable right of set-off – prevent a mortgagee from enforcing its security by taking possession of and selling the mortgaged property and recovering the mortgage debt (without giving credit for the mortgagor’s claim) from the proceeds of sale. This was so, even if the claim asserted by the mortgagor was sufficiently connected with the mortgage debt to satisfy the general test for an equitable set-off.
Applying the Spencer Day principle, the Court of Appeal’s view was that the claimants had no right to prevent the property from being sold and the proceeds used to repay their debt to the Bank, without giving credit for any cross-claim for damages. However, these conclusions did not form part of the Court of Appeal’s binding decision, because the Spencer Day point was not pursued by the Bank at first instance, nor before the Court of Appeal. The Court of Appeal noted that this was “unfortunate“, as significant time and cost might have been saved in relation to the anti-set off clause issue.
2. Limitation and concealment
The Court of Appeal affirmed the first instance decision that the claims for declaratory relief (based on claims for negligent advice and breach of statutory duty) were time-barred.
The Court of Appeal applied P&O Nedlloyd BV v Arab Metals Co [2005] 1 WLR 3733 and held that it was necessary to look at the basis upon which a declaration is sought to consider whether a claim is time barred. In this case, the claimants’ cross-claims were based on actions in tort and breach of statutory duty, which had a six-year time period in which to be commenced (unless time could be extended by deliberate concealment – see below). As the basis of the claimants’ action was time barred, the claimants could not improve their position by seeking the remedy of a declaration rather than damages. The Court of Appeal said the fact that a claim was time-barred would not normally preclude it being used to establish a defence of equitable set-off (as opposed to a free standing claim), but this would be inconsistent with the Spencer Day principle discussed above.
The Court of Appeal went on to consider the claimants’ argument that their declaratory relief claims in tort and breach of duty should not be time barred, pursuant to s.32 of the Limitation Act 1980, on the basis that the Bank concealed the relevant facts giving rise to those causes of action. However, the Court of Appeal found that the relevant facts for the claimants’ right of action were apparent more than six years before the claim was commenced and so s.32 of the Limitation Act would not assist.
High Court rejects unfair relationship claim concerning allegations of breach of an advisory duty, misrepresentation and efficacy of basis clauses
Carney & Ors v NM Rothschild & Sons Limited [2018] EWHC 958 (Comm) is a recent case where the High Court rejected claims of an unfair relationship arising between a lender and two borrowers under s.140A of the Consumer Credit Act 1974 (the “Act“).
This decision will be of interest to financial institutions which (unusually) bear the reverse-burden of proving that a relationship is not unfair under the Act. The decision shows the forensic approach the courts will take to assess whether the particular relationship is unfair, which involves consideration of the elements of the causes of action which are alleged to have contributed to the unfairness. It highlights the numerous and specific elements of an unfair relationship claim which may be challenged by a lender. It also adds further weight to the growing body of case law which illustrates the difficulties claimants face in trying to establish the existence of an advisory relationship in an ordinary financial institution – customer relationship (see our recent banking litigation e-bulletin).
This was the first case (so far as the court was aware) to consider the efficacy of so-called “basis clauses” (under which parties agree the basis of their relationship, typically about whether it is advised/non-advised) in relation to an unfair relationship claim. The court gave guidance as to how clauses of this kind should be assessed under the unfair relationship provisions by reference to other regimes (such as the Unfair Contract Terms Act 1977, “UCTA“). The court noted that the assessment under the Act was not the same as that which would be conducted under other such regimes because of the “different and wider exercise” set out in the unfair relationship provisions of the Act. However, it said that a clause found to fall outside of the UCTA regime (i.e. a true basis clause) should have “much less” impact on the issue of the unfair relationship under the Act than an exclusion clause which is held to be unreasonable under UCTA.
The court’s approach to basis clauses will be of particular interest to institutions and finance lawyers alike, as it supports the status quo, namely that such clauses can form the basis for a contractual estoppel which can be useful in negating the existence of various duties. Those drafting such clauses should take some comfort from the court’s guidance that basis clauses falling outside of UCTA are less likely to fall foul of the unfair relationship regime under the Act. The decision therefore closes a further avenue to claimants bringing such claims.
The claimants (the “Borrowers“) were two couples of British expatriates resident in Spain. They entered into loan agreements (the “Loan Agreements“) with NM Rothschild & Sons Limited (the “Bank“).
The purpose of the loans was to advance funds to the Borrowers for the purpose of investing in a fund. The underlying investment was in notes issued by Barclays Bank plc (the “Issuer“) which in turn represented investments into three highly rated funds. The Issuer gave a capital guarantee on the notes so that at maturity, the Borrowers would receive approximately 100% of the capital invested in order to repay the loans. The purpose of the scheme was to avoid adverse tax consequences which could arise if the Spanish version of inheritance tax (“ISD“) applied to the Borrowers’ properties. Other lenders had, prior to the Bank’s involvement, expressed an interest in providing loans in connection with the scheme but did not participate. The loans to the Borrowers were secured by these investments and unencumbered properties in Spain.
The constituent parts of the scheme, being the notes and the loans were separate. An independent financial adviser, Henry Woods Investment Management (the “IFA“), was responsible for promoting the scheme to investors. There was a dispute (see below) about the nature and extent of the role of the Bank in its dealings with the Borrowers prior to the making of the Loan Agreements and the investment.
There was a relatively complex fee structure which, insofar as is relevant, meant that the fund charged an 8% fee (paid out of the loan monies), of which 4% went to the IFA. The only fee charged by the Bank was a 0.5% set-up fee in relation to the loans; the Bank made its money on the spread of interest rates.
The investments underperformed. In part, the High Court commented that this appeared to have been caused by the financial crisis of 2007-2008, and due to a desire on the part of the Issuer to deal with the investments conservatively so as to ensure that it would not have to use its own funds to repay the guaranteed amount. There were various related proceedings in Spain.
The sole cause of action advanced by the Borrowers was pursuant to s.140A and s.140B of the Act. Specifically, the Borrowers alleged that an unfair relationship arose between them and the Bank in relation to the Loan Agreements. The principal relief sought was the cancellation of the existing indebtedness owed to the Bank and the discharge of the related security. As part of that unfair relationship claim, the Borrowers alleged that incorrect advice was given as to the suitability of the scheme and misrepresentations made by (or on behalf of) the Bank to the Borrowers in relation to the scheme and its efficacy in relation to tax.
The Bank denied the entirety of the claim brought against it, although it accepted that it owed a duty not to mislead or misrepresent, and that it was subject to the regime under the Act. The Bank denied that any advice was given or any actionable representations were made (and if they were made, denied that they were wrong or false). The Bank relied on various clauses in the Loan Agreements defining the scope of its relationship with the Borrowers (which it said was not in any sense advisory), the absence of any representations made by the Bank and the absence of any reliance by the Borrowers. These same basis clauses were relied on by the Borrowers as factors (among others) which they alleged showed the relationship was unfair.
Law on unfair relationships
The substantive claim (i.e. whether incorrect advice was given or misrepresentations made, making the relationship unfair) fell to be considered under s.140A(1)(c) of the Act because it concerned things done or not done by the Bank prior to the making of the Loan Agreements. Claims as to whether the nature of the clauses of the Loan Agreements themselves (i.e. the basis clauses) contributed to the unfairness, fell to be considered under s.140A(1)(a) of the Act. Section 140B provides for the type of relief available where an unfair relationship claim has been made out.
The court completed a detailed review of the relevant legal principles in relation to unfair relationship claims, the key aspects of which are listed below.
The court relied on Lord Sumption’s leading judgment in Plevin v Paragon [2014] UKSC 61 on the effect of s.140A of the Act in determining that the court’s role, in assessing the relationship between the parties, was in fact “more than an exercise of discretion” and would require a “large amount of forensic judgment“.
The court noted that the advice and misrepresentation elements of the unfair relationship claim could have been separate causes of action in themselves. Significantly, the court therefore proceeded on the basis that the “same elements as are required by the cause of action should be shown when such matters are raised as constituting an unfair relationship. Otherwise, there is a danger that the analysis of their significance or otherwise becomes blurred and uncertain“. However, the court noted that the burden of proof was on the creditor to prove that the relationship was not unfair.
On causation, if the debtor would have entered into the relevant agreement in any event, the court said this “must surely count against a finding of unfair relationship“.
The fact that there has been no breach of a relevant regulatory rule may be “highly relevant” but was “not determinative” in the court’s view. By contrast, if the conduct on the part of the creditor would have amounted to breach of such a rule, but the rule did not apply, that “can be relevant“. The court concluded that it could consider the conduct of an agent in this respect too.
The court noted that (so far as it was aware) this was the first case in which the efficacy of basis clauses in relation to an unfair relationship claim had been tested. The court stated that the assessment of the unfairness or otherwise of basis clauses was not the same exercise as that which would be conducted under UCTA, the Misrepresentation Act 1967 or the Unfair Terms in Consumer Contracts Regulations 1999 (“UTCCR“). This was because of the “different and wider exercise” set out in the unfair relationship provisions of the Act. As such, a term may not be unfair under the UTCCR, but still give rise to an unfair relationship, although the court noted in the present case that it did not matter much which unfairness or unreasonableness regime was relied upon. However, the court said that as a matter of “common sense“, a clause which is found to fall outside of the UCTA regime (i.e. a basis clause) should have “much less” impact on the issue of the unfair relationship than an exclusion clause which is found to be unreasonable under UCTA.
In the context of assessing whether there was any unfair relationship, the court considered each element of the advice and misrepresentation causes of action in turn.
Breach of advisory duty
The court addressed two questions on this issue: whether the Bank actually gave advice; and if in doing so, it assumed the role of an adviser:
First, the court concluded that overall the Bank “did not give any material advice“. The reality of the Borrowers’ evidence at trial was to the effect that the Bank’s representative had made misrepresentations as part of a sales pitch, rather than giving negligent advice.
Second, the court commented that it was “quite impossible” to see how the Bank had assumed an advisory role. The Loan Agreements and an article included in the IFA’s newsletter (setting out details of the scheme) clearly pointed to the fact that the Bank had not. Moreover, the court commented that “importantly” there was already the IFA whose job it was to advise on the scheme and specifically the investment. The Borrowers’ attempts to downplay the significance of the role played by the IFA were rejected. The Bank did not receive any commission for any advice, whereas the IFA received 4%.
Consequently, while accepting that someone could have more than one adviser, the court found there was no basis for that finding in the present case. The court also found that the relevant clauses of the Loan Agreements made clear that the Bank was acting as lender only and not assuming an advisory role, which had the effect of negating the existence of any advisory duty (if there was one).
The question then arose as to whether the clauses were susceptible to judicial control, for which the court said a useful starting point was to consider whether such clauses would be regarded as exclusion clauses for the purpose of UCTA and s.3 of the Misrepresentation Act 1967. The court set out a number of factors for determining this. The court considered the question was multifaceted and that none of the factors was necessarily determinative. With these factors in mind, the court found that the clauses in question were basis clauses and not exclusion clauses and therefore (in keeping with other recent decisions) not susceptible to judicial control under UCTA, on the basis that:
The language was not expressly that of exclusion of liability.
There were other clear indications that this was not an advisory relationship. In particular: (a) the IFA’s article in its newsletter; and (b) the terms of certain confidential reports produced by the IFA for (and signed by) the Borrowers, stating that the IFA was acting as adviser and the fact that the Bank did not provide investment, tax or legal advice.
The clauses could not sensibly be described as artificial or “rewriting history”; rather they affirmed it.
The clauses were not to be found within a mass of standard terms as one might see in a typical consumer contract.
Even if the relevant clauses were exclusion clauses, the court concluded that they were “manifestly reasonable“. The court highlighted that the question in the instant case was unfairness rather than reasonableness, but held that – on the facts – the analysis and the result should be the same. In particular, the court stated that the clauses were a proportionate and legitimate attempt by the Bank to limit its exposure to a wider role for sound commercial reasons.
Consequently the court concluded that there was no “advice-based element of unfairness“.
The court forensically analysed whether each of the 49 alleged representations had been made by the Bank. The court concluded that the alleged representations had either not been made (by the Bank, at least) or were – to the extent that they were made – not false. Even if the misrepresentations had been made by the Bank, the court concluded that the evidence suggested the claims would have failed on causation and the court expressed doubt as to whether the alleged representations had been relied upon.
The court went on to consider the effect of clauses in the Loan Agreements which stated that no representations had been made. Taking a similar approach as it did in relation to the advice claim; the court found that these clauses were basis clauses which established a contractual estoppel. Citing Crestsign Ltd v National Westminster Bank Plc [2014] EWHC 3043 (Ch), the court noted that these clauses served the “the useful function of removing a grey area as to what might or might not be a representation, [which] is very apposite here where many of the alleged representations were given orally in a quasi-social setting and where differences of emphasis could make all the difference“.
Again, the court considered that the clauses in question would be found to be reasonable for the purpose of UCTA even if they were found to be exclusion clauses. If the clauses were reasonable for the purpose of UCTA, then there was no reason to suggest that they would be unfair for the purpose of s.140A of the Act.
Unfairness on other grounds
The Borrowers also relied on a number of other (unspecified) clauses which were said to be unfair and other points of unfairness. The court rejected all such arguments. In particular, the court considered the Borrowers’ argument to the effect that, even if there was no positive misrepresentation by the Bank, it failed to warn the Borrowers of certain risks. For example, the Borrowers said that the Bank had not warned against the risk that the investment returns might not cover the interest due. However, there was no advisory duty on the Bank (in contrast with the IFA) and there was no “mezzanine” duty. This element therefore did not lead to any unfairness.
Accordingly, the court considered that the Borrower had clearly satisfied the burden of showing that there was no unfair relationship and the claims failed.
The decision will be welcomed by financial institutions which, unusually, have the burden of proof in unfair relationship claims. There is now clear guidance on the approach that the courts will take in such cases. The decision also follows a number of other recent mis-selling cases that cumulatively illustrate the difficulty for claimants that allege, in ordinary lender-borrower relationships, that financial institutions owed an advisory duty in relation to the product or scheme in question. Moreover, this is another case in which basis clauses have been found to be effective in negating the existence of an advisory duty of care.
Paul Crowther & Anor v Arbuthnot Latham & Co Ltd[2018] EWHC 504 (Comm) provides an interesting example of how the High Court applied the test of objective reasonableness to the exercise of a bank’s discretion to consent to the sale of a secured property. In reaching this conclusion, the court refused to apply the so-called Braganza duty to the exercise of the contractual discretion, i.e. whether it was exercised in a way which was not arbitrary, capricious or irrational in the public law sense. Central to the court’s decision was its conclusion that the wording of the clause in the instant case (that the bank’s consent should not be “unreasonably withheld or delayed“) was “essentially the same” as the wording of a clause in a landlord and tenant case in which the Court of Appeal applied the objective test of reasonableness: Straudley Investments Ltd v Mount Eden Land Ltd [1996] EWCA Civ 673(citation corrected from the judgment).
Applying this objective test, the court held that the bank’s refusal was unreasonable. The bank’s position was that any consent to sell was conditional on the provision by the claimants of further security, because the proceeds of the sale would not discharge the outstanding debt in full. However, the court emphasised that at the time the relevant agreement was entered into, the estimated value of the property was “very considerably less” than the outstanding indebtedness, and so the position had not really changed. Essentially, the court took the view that the bank should have sought further security (in excess of the value of the secured property) at the outset, if it wished to have security for the full amount of the outstanding debt.
This decision will be of interest to lenders, particularly those considering the exercise of a contractual veto to prevent the sale of secured property, although each case will turn on its own facts and the express wording of the clause. One way in which the interpretation of a similarly worded clause might be distinguished in the future is where (at the time the relevant agreement was executed) the full outstanding liability was secured by the property in question. The instant decision is also vulnerable to criticism that the principles applied were specific to the landlord and tenant context and attempts to transfer such principles outside of that sector are inappropriate. In particular, the court failed to address the fact that the analysis of the requirement not to unreasonably withhold or delay consent in Mount Eden, on which much emphasis was placed, was (at least in part) informed by the requirements of the Landlord and Tenant Act 1988 which also uses the same wording.
However, if this decision is followed, it may increase the risk for lenders who withhold consent to the sale of secured property in circumstances where there is an express provision that such consent should not be withheld unreasonably. This is because the application of an objective test (as opposed to one based on rationality) will arguably make it more difficult for a lender to prove that consent has been withheld legitimately.
In December 2001 the claimants issued proceedings against Arbuthnot Latham & Co Ltd (the “Bank“) before the Brighton County Court alleging that, as a result of a number of loan facilities entered into between them, an unfair relationship within the context of the Consumer Credit Act 1974 arose. These loans were secured by a charge over the claimants’ property in France (the “Property“). The proceedings were subsequently transferred to the High Court, and the claim was settled in September 2013 by a Tomlin order, with settlement terms included in a schedule to that order (the “Settlement Agreement“). Further to the Settlement Agreement, the charge and only one facility (with approximately €5.9 million outstanding) remained in place and their original terms were superseded by those included in the Settlement Agreement.
Over the years the claimants tried to sell the secured Property to reduce their indebtedness and towards the end of 2016 they received an offer of €4.5 million, which was in line or slightly over the market valuations at the time and was considered by the Bank as “an agreeable offer“. However, the sale would have left the Bank with a considerable shortfall (€1.7 million) and no security. The Bank was prepared to agree to the sale on the condition that further security was provided by the claimants. Since no further security was provided, the sale was lost. The claimants did not accept that the Bank’s requirement for further security as a condition of consent was a legitimate or reasonable basis for its refusal.
The current dispute between the parties concerned the construction of the following clause of the Settlement Agreement (the “Clause“): “If with the prior approval of the bank (such approval not to be unreasonably withheld or delayed) the property is sold, you shall immediately repay to the bank the net proceeds of sale“. The claimants sought a declaration that the Bank had unreasonably withheld its consent to the sale of the Property.
The court held that the Bank’s refusal to consent to the sale was unreasonable, granting declaratory relief against the Bank. The key question considered by the court was the proper scope of the Bank’s discretion to consent to the sale, in other words, the proper purpose of the Clause.
The court first referred to Mount Eden, a landlord and tenant case where the wording of the landlord’s veto clause was essentially the same as the Clause in the instant case, i.e. that consent should not be unreasonably withheld. The landlord was only prepared to give consent for its tenant to sublet, subject to a condition which would improve the landlord’s own security position, whereby the deposit from the new subtenant was required to be held in a joint account. The court held that the landlord’s consent to the subletting was unreasonably withheld, stating that it would not normally be reasonable for a landlord to seek to impose a condition which was designed to increase or enhance the rights that he enjoyed under the headlease (i.e. retaining a security interest in the deposit to which only the tenant would normally be beneficially entitled). In the instant case, the court said that the decision in Mount Eden was of assistance in two ways:
Mount Eden stated that it was not necessary for a landlord to prove that the conclusions which led him to refuse consent were justified, if they were conclusions which might be reached by a reasonable man in the circumstances. This suggested that the test for reasonableness was an objective assessment.
Mount Eden stated that a landlord is not entitled to refuse his consent to an assignment on grounds which have nothing to do with the relationship of landlord and tenant in regard to the subject matter of the lease, referring to a recent example of a case where the landlord’s consent was unreasonably withheld because the refusal was designed to achieve a “collateral purpose” unconnected with the terms of the lease. As such, a “collateral purpose” would include where a party withholding consent does so in order to obtain rights he did not otherwise have.
It is noted that Mount Eden appears to have been decided (at least in part) on the requirements of the Landlord and Tenant Act 1988, rather than purely on the basis of a landlord’s veto clause in the head lease. The implications of this are discussed in the introduction.
The court distinguished Barclays Bank Plc v Unicredit Bank AG (formerly Bayerische Hypo-und Vereinsbank AG) [2014] EWCA Civ 302, in which the fact that the bank had only regarded its own commercial interests in refusing consent to an early termination of derivative transactions was found to be reasonable. In Unicredit, the clause required consent to be determined in a “commercially reasonable manner” and the nature of the reasonableness test was by reference to Wednesbury unreasonableness or a form of Braganzaduty, i.e. a test of rationality as opposed to the common law, reasonable person test. The key points of distinction made were as follows:
In the instant case, the court saw no basis for a Wednesbury reasonableness test, given that the wording of the Clause followed the landlord and tenant-type clause (per Mount Eden, which applied a reasonable person test) and was different to the wording of the clause in Unicredit.
Further, the court noted that the discretion considered by the Court of Appeal in Unicredit concerned the process or manner of the determination of whether to consent to the early termination, by contrast to the Clause in this case, which was about outcome.
The court noted that the Clause did not qualify or define its object or target in respect of the reasonableness of the refusal in any way, but stated it was “very hard to see why the scope of the [Clause] should go any further than a concern which [sic] the aim of permitting disposal of the [Property] at a proper price“. In this context, the court held that the Bank’s reasons for refusing the sale had no connection with the aim of getting a sale at a proper value at all. Although the proposed sale would have left a shortfall, the court noted that the value of the Property at the time of the Settlement Agreement was “very considerably” less than the outstanding indebtedness. As such there was no expectation at that time that a potential sale of the Property would pay off the entirety of the outstanding loan and so the position had not really changed. The court commented that, although the Bank’s desire for more security was about the loan and its relationship with its debtors, that did not stop it from being a collateral purpose as the decision in Mount Eden made clear.
Accordingly, the court held that the disputed Clause should be construed so that the reasonableness of the discretion exercised by the Bank was determined by reference to whether the proposed sale was “at fair market value and at arm’s length“. The court did not accept that the reasonableness criteria in that context was limited to ensuring that the Bank acted in a Wednesbury reasonable or rational way in reaching its decision. Consequently, upon the facts of the case, the Bank’s refusal to the sale was deemed unreasonable.