Interest Rate Swap Misselling Where Are We Now

Interest Rate Swap Mis-selling: Where Are We Now? David Mc. Ilroy DMc. Ilroy@forumchambers. com www. mblseminars. co. u k 0161 793 0984

The FCA Redress Scheme • • 10, 000 customers have accepted an offer of basic redress Many small and medium-sized businesses excluded because they failed the “sophistication” test The banks themselves carry out the review The banks do not admit that they have breached the regulatory duties in the FSA Handbook

The Banks’ Agreements with the FCA • The banks agreed to provide redress when they had breached the Principles, Rules or Guidance in the FSA Handbook • Some banks, with the knowledge of FCA, did not comply with the Agreements they signed. • The independent reviewers were not shown all the documents by the banks

Redress • • • The offer of basic redress takes many months to obtain The offers are subject to very short time limits for the service of claims for consequential loss There is no binding time limit for payment of redress Some banks require resolution of consequential loss claims before any redress will be paid The law at present does not allow business to sue for breach of the COB or COBS rules

The effect of accepting redress on litigation • In Freehold Estates Ltd v Nat. West [2014] EWHC 4621 (Comm), Hamblen J held that a claimant did not have to pay the costs of discontinuing a claim in respect of seven swaps where it had accepted redress under the FCA Redress Scheme. • However, where the Claimants had also discontinued claims in respect of a further 13 swaps where the bank had not offered redress, the Claimants had to pay the costs in respect of those discontinued claims in accordance with the usual rule.

• • • A claim for breach of statutory In Figurasin v. Centralduty Capital Ltd [2014] EWCA Civ 504 the Defendant breached ICOB 2. 2. 3 R by failing to communicate with the Claimant in a way that was clear, fair and not misleading. The Defendant had loaned £ 25, 000 to the Claimant over 10 years without mentioning the cost of PPI. The Court of Appeal that ICOBS had to be complied with whenever the Defendant communicates with a customer during the sales process.

Al Sulaiman v. Credit Suisse Securities (Europe) Ltd [2013] EWHC 400 (Comm) confirmed technical breaches of COBS 9 will not give rise to a loss MTR Bailey Trading Ltd v. Barclays Bank [2014] EWHC 2882 QB, • COBS 9 concerns the suitability of the product in question • COBS 10 addresses “whether the client has sufficient knowledge and understanding to make it appropriate to sell the relevant product to them”. • The duty of best execution under COBS 11 applies to the mechanics of transactions.

Companies cannot claim under COBS HHJ Keyser QC held that a company cannot sue for a breach of the regulatory duties contained in the FSA Handbook, following Titan Steel Wheels v. The Royal Bank of Scotland [2010] EWHC 211 (Comm). He rejected the argument that compliance with the regulatory duties was an implied term of the contract between the parties.

A claim for Francovich damages against the UK Government The Sunday Times 24 January 2015: “Taxpayer may face £ 2 bn bill over swaps misselling scandal” • Mi. FID gives a cause of action to all customers classified as retail clients OR • Excluding some retail clients from the FCA redress scheme by inventing a “sophistication” test is disproportionate and discriminatory

What has to be said when advice is given • • • In Crestsign Ltd v. National Westminster Bank Plc [2014] EWHC 3043 (Ch) the Judge held that the advice given had been negligent and manifestly unsuitable because: the swap was longer than the loan the swap was cancellable at the bank’s option the swap exposed Crestsign to large break costs the swap meant Crestsign was taking on significant risks, of which it was unaware

Misrepresentation • • In Nextia Properties Ltd v. Natwest [2014] EWCA Civ 740, the Claimant argued that the Bank had misrepresented that the Swap was at “no premium” because on day one the Swap had a value to the Bank. The Judge held that even though the Bank had made a profit from the Swap, and it had a market value in the Bank’s favour from the start, that did not a mean a premium was payable.

Misrepresentation • • In Webster v. Liddington [2014] EWCA Civ 560, the Court of Appeal upheld a decision that saying a rejuvenation therapy would “utilize only your own living cells” was a misrepresentation when in fact the injectate contained between 0 and 0. 2% of foetal calf serum. The misrepresentation was material because the omitted information “may well have affected” the decision of customers to go ahead with the treatment.

Implied Misrepresentation • • In UBS AG v. Depfa Bank Plc [2014] EWHC 3615 (Comm), the judge applied the test for implied representations: what a reasonable person would infer was being implicitly represented by the representor’s words and conduct in their context UBS was found to have made implied representations that it did not know or believe the counterparty to be dishonest

Fiduciary Duties In Fujitsu Services Ltd v. IBM United Kingdom [2014] EWHC 752 (TCC) it was held that the reposing of faith by one party to a contract in the other party was not enough in itself to impose any fiduciary duties In Barclays Bank v. Unicredit Bank [2012] EWHC 3655 (Comm), it was held that a bank could prefer its own interests when exercising a discretion in a commercially reasonable manner

Exclusion Clauses • • In Barclays Bank Plc v. Svizera Holdings BV [2014] EWHC 1020 (Comm) the court held the bank could rely on its standard clauses to exclude liability for misrepresentation In Crestsign v. Natwest the judge found that liability for negligent advice had been excluded by clauses in standard terms and conditions, though they had not been sent until after the advice had been given.

The Duty to Explain • • In Green and Rowley v. RBS [2013] EWCA Civ 1197 the Court of Appeal distinguished negligent advice in an advisory relationship from negligent misstatement where the bank had actively misled the client. In Cornish v. Midland Bank Plc [1985] 3 All ER 513 the Court of Appeal confirmed that once a bank has begun to give an explanation of its products , the explanation must be full, accurate, and proper.

The Duty to Explain • • A “full explanation” is only a duty to explain fully and accurately the nature and effect of the products which the bank wishes to sell. The duty is a duty to explain, not a duty to educate. Obvious misunderstandings must be corrected and reasonable questions must be answered. A claim can be brought for a failure to explain even though there is a partial overlap between that duty and the regulatory requirements under COBS.

The Duty to Explain In Crestsign, the judge held that the bank had done just enough to satisfy the duty because: • • • It had not given any information which was factually wrong; It had flagged the mismatch between the length of the loan and the length of the Swap; It had flagged the existence of the bank’s cancellation option and it was so obvious as to go without saying that the bank would exercise it should interest rates rise

The Duty to Explain • In Crestsign the judge found that describing break costs as “substantial” was an adequate warning of the £ 660, 000 cost. • This was the respect in which the Bank had come closest to breaching its duties. • For the Judge, everything turned on the client's failure to make his own ignorance of how much break costs could be or what was meant by “substantial” known to the Bank.

THE FIVE LEVELS OF COMMUNICATION • MISREPRESENTATION – no false statements of fact • INFORMATION – an accurate description (the Hedley Byrne duty) • EXPLANATION – a sales pitch which is full and accurate (the Cornish duty) ADVICE – reasonable value judgments (which must comply with the regulatory standards) • PERSONAL RECOMMENDATION – advice specific to customer (which must be suitable for the customer) •

UNFAIR CREDIT RELATIONSHIPS Section 140 A Unfair relationships between creditors and debtors (1) The court may make an order under section 140 B in connection with a credit agreement if it determines that the relationship between the creditor and the debtor arising out of the agreement (or the agreement taken with any related agreement) is unfair to the debtor because of one or more of the following— (a) any of the terms of the agreement or of any related agreement; (b) the way in which the creditor has exercised or enforced any of his rights under the agreement or any related agreement; (c) any other thing done (or not done) by, or on behalf of, the creditor (either before or after the making of the agreement or any related agreement).

Unfair Credit Relationships • • • In Harrison v. Black Horse Ltd [2010] EWHC 3152 (QB) Tomlinson LJ held that where a product is regulated, a creditor's acts cannot amount to an unfair relationship if not breaches of the regulatory rules. In Plevin v. Paragon Finance [2014] UKSC 61 the Supreme Court overturned Harrison, thus giving eligible Claimants a significant advantage in litigation. Would work for individuals and small partnerships where the swap or embedded swap was linked to

EMBEDDED SWAPS When is a swap not a swap? When it’s embedded (so the banks say). • Some Tailored Business Loans provided for a variable rate, a fixed rate (swap), a flexible maturity fixed rate (extendable swap), and a modified participating fixed rate (enhanced collar). • Since the bank entered into a back-to-back hedge, the customer wishing to exit a Tailored Business Loan will be charged breakage costs. • An embedded swap has the same effect on the customer as a swap but the banks say it is not regulated.

EMBEDDED SWAPS Regulated or not? Banks’ stance is that because tailored business loans are embedded, they are not regulated “The key point is that a contract for these loans is for the customer to borrow and the bank to lend. It is not to secure a profit or avoid a loss by reference to fluctuations in interest rates. The break costs arise only when a customer decides to terminate the contract early; as a contingent clause, it does not operate to change the purpose of the contract as a whole. ” (Jonathan Fisher QC) giving a second opinion

EMBEDDED SWAPS Regulated or not? R (on the application of London Capital Group) v FOS and Shrubb [2013] EWHC 2425 (Admin) suggests that matters may not be so cut and dried The purpose of the fixed rate loan is not just to borrow money, it is to borrow money at a fixed rate of interest, i. e. to avoid the risk of a loss which might otherwise occur because of fluctuations in interest rates

REGULATED ACTIVITIES ORDER 2001 Specified kinds of activity Article 14 - “Buying, selling, subscribing for or underwriting securities or contractually based investments. . . as principal is a specified kind of activity. ” Article 21 confirms same activities as agent Article 25(1) - Making arrangements for another person. . . to buy, sell, subscribe for or underwrite a particular investment which is (a) a security, (b) a contractually based investment, or (c) an investment of the kind specified by article 86, or article 89. . . is a specified kind of activity. ”

REGULATED ACTIVITIES ORDER 2001 Extended definitions of buying and selling Article 3: "buying" includes acquiring for valuable consideration; "selling", in relation to any investment, includes disposing of the investment for valuable consideration, and for these purposes "disposing" includes (a) in the case of an investment consisting of rights under a contract (i) surrendering, assigning or converting those rights; or (ii) assuming the corresponding liabilities under the contract; (b) in the case of an investment consisting of rights under other arrangements, assuming the corresponding liabilities under the arrangements; and (c) in the case of any other investment, issuing or creating the investment or granting the rights or interests of which it consists;

REGULATED ACTIVITIES ORDER 2001 ARTICLE 85(1) Contracts for differences etc (1) Subject to paragraph (2), rights under— (a) a contract for differences; or (b) any other contract the purpose or pretended purpose of which is to secure a profit or avoid a loss by reference to fluctuations in— (i) the value or price of property of any description; or (ii) an index or other factor designated for that purpose in the contract.

REGULATED ACTIVITIES ORDER 2001 ARTICLE 85(2) There are excluded from paragraph (1) — (a) rights under a contract if the parties intend that the profit is to be secured or the loss is to be avoided by one or more of the parties taking delivery of any property to which the contract relates;

REGULATED ACTIVITIES ORDER 2001 • Questions for court in Shrubb: 1) Given structure of Article 85, did the arrangements for the foreign exchange trading account amount to a contract for differences? 2) Did the foreign exchange trading account fall within Art 85(1)(b)? 3) Did the foreign exchange trading account fall outside the definition of a regulated investment under Art 85(2)(a)?

REGULATED ACTIVITIES ORDER 2001 • Leggatt J in Shrubb: “Crediting a sum of money to a client’s account does not constitute delivery of any property by the institution to the client. It is merely an acknowledgement by the institution with whom the account is held of a debt owed to the client. Delivery of property would come about only if cash was physically transferred to the client or if the money was transferred on the client’s instructions to another account. ” (para. 65). ”

REGULATED ACTIVITIES ORDER 2001 THE DIFFICULT POINT • Do the transactions involved in a tailored business loan amount to “property” or “delivery” under Art 85(2)?

EXCLUDING LIABILITY BY A NOVATION In Deutsche Bank v Unitech Global Ltd, the banks argued that even if the initial bank which entered into the agreement could have been sued for misrepresentation, the agreement had been novated and the banks which had taken the novation was immune from such a claim. The Court of Appeal thought that the new bank might nonetheless be liable if what had occurred was to be construed as a partial rather than a total novation.

EXCLUDING LIABILITY BY A NOVATION In Langston Group Corporation v Cardiff City Football Club Ltd [2008] EWHC 535 (Ch), Briggs J. held that the substitution of one obligor for another in relation to a particular contractual obligation could take place only by novation, but it did not necessarily follow that a large and complex contract containing other obligations which were not so novated had to be treated as having itself been terminated by novation and replaced by a wholly new contract.

EXCLUDING LIABILITY BY A NOVATION According to Morris v Baron & Co. [1918] AC 1, in order for there to be a total novation, “What is, of course, essential is that there should have been made manifest the intention in any event of a complete extinction of the first and formal contract, and not merely the desire of an alteration, however sweeping, in terms which still leave it subsisting. ” (per Viscount Haldane, p. 19).

EXCLUDING LIABILITY BY A NOVATION The issue at stake in relation to novation of swaps is this: does a novation from one bank to another, at a time when the customer is entirely ignorant of the fact that the characteristics of the swap were misrepresented and that the rules contained in the FSA Handbook have the effect of extinguishing the customer’s claims for misrepresentation, negligence and breach of statutory duty against the bank which mis-sold the swap?

WHAT’S WRONG WITH THE MANIPULATION OF LIBOR? A bank can set interest rates in its own interests provided that the rates are not so arbitrary, capricious or unreasonable that no reasonable bank would have insisted on them: see Nash v. Paragon Finance plc [2001] 2 All ER (Comm) 1025, CA; Sterling Credit Ltd v. Rahman [2002] EWHC 3008 Ch; Marex Financial Ltd v Creative Finance Ltd [2013] EWHC 2155 (Comm); Barclays Bank v Unicredit Bank [2014] EWCA Civ 302, CA

MANIPULATION - LIBOR is theoretical rate at which a contributing bank can borrow funds, were it to do so by asking for, and then accepting, interbank offers in reasonable market size just prior to 11: 00 London time on each banking day. A key vulnerability of the system was that “Since the rates are hypothetical, they are dependent on the subjective judgement of the personnel on the money market desk in a contributing bank, as opposed to being derived from actual bank lending rates. ”

MANIPULATION - LIBOR This led to a culture of manipulation of the LIBOR rates. “It is clear that from at least 2005, there was a cultural acceptance that LIBOR was simply a variable, to be managed just like any other variable, to maximise the returns being generated by individual traders, for their own personal financial benefit, and to bolster the banks’ trading revenue. ” (Paul Downes QC)

MANIPULATION – LIBOR (Rounds 1 and 2) Round 1: Graiseley Properties v Barclays [2012] EWHC 3093 (Comm) says that there is a claim against the banks for implied misrepresentation that LIBOR was not being manipulated Round 2: Deutsche Bank v Unitech Global [2013] EWHC 471 (Comm) says that the claim against the banks is only for an implied warranty that they themselves would not manipulate LIBOR What’s at stake? In case of misrepresentation, the customer is entitled to rescission or to damages in lieu of rescission. In a claim for breach of a contractual warranty customer must prove loss.

MANIPULATION - LIBOR (Round 3) Deutsche Bank v Unitech Global [2013] EWHC 2793 (Comm), Teare J. • held Unitech was barred by Cooke J’s decision from claiming rescission as a remedy • held Unitech could amend its Defence to allege that Deutsche Bank was in breach of an implied term that it would not seek to manipulate the relevant LIBOR rate • held whether or not a breach of that term was repudiatory would have to be determined at trial

MANIPULATION - LIBOR (Round 4) Graiseley Properties Ltd v Barclays Bank plc and Deutsche Bank v Unitech Global [2013] EWCA Civ 1372 • Any case of implied misrepresentation is fact-specific and therefore it is dangerous to dismiss such a claim summarily • It is arguable that: • By proposing the use of LIBOR the banks were representing that their own participation in the setting of the rate was an honest one • If the banks had told the customers that they had been manipulating LIBOR in the past, the customers would have rescinded the contracts • The representations about the conduct of other banks were held to be weaker but still arguable

MANIPULATION - LIBOR (Round 5) Graiseley’s lawyers had obtained disclosure of a 2007 e-mail from Jerry Del Missier, the former chief operating officer of Barclays, in which he had described the LIBOR rates as a “fantasy”. Graiseley Properties Ltd v Barclays Bank plc was due to be tried in April 2014. Barclays settled by re-structuring Graiseley Properties’ loans in a deal that was reportedly worth £ 40 million to the customer. The week after Barclays had settled with Graiseley Properties, it settled a claim with Domingos da Silva Teixeira, which had added allegations of LIBOR manipulation to its € 11. 1 million mis-selling claim relating to interest rate and foreign exchange swaps.

LIBOR (Round 6) In Deutsche Bank AG v Unitech Global Ltd [2014] EWHC 3117 (Comm), Teare J. held that, although the customer would be ordered to pay the bank $120 million by way of counter-restitution if its defence to the bank’s contractual claim succeeded, the bank would not have “obtained judgment” for that sum because it would not have succeeded in a cause of action which the bank had pleaded. Instead, the bank would have failed, but the customer would have been ordered by the court to pay $120 million as a condition of obtaining the equitable relief which it was seeking.

LIQUIDATION AND ASSIGNMENT In Hockin v Marsden [2014] EWHC 673 (Ch), the court considered that although the decision by the company’s administrators not to pursue a claim against the bank seeking damages in relation to an interest rate swap agreement was a reasonable decision for the administrators to make, the decision not to assign the right to bring the claim was not justifiable. The court noted that if the claim were to succeed the creditors of the company would benefit, but if the claim failed the creditors would suffer no prejudice as a third party would be the one bringing the claim and bearing the costs of doing so. The court therefore made an order under Schedule B 1, paragraph 74 of the Insolvency Act 1986 directing the administrators to assign the claim to the applicants.

THE INTEREST RATE TO BE APPLIED TO LOSSES In Secretary of State for Energy & Climate Change v Jeffrey Jones [2014] EWCA Civ 363, CA, the Court of Appeal held that a judge had been entitled to award pre-judgment interest, at 4 per cent above base rate, on disbursements paid by a firm of solicitors for their clients. The court had to conduct a general appraisal of the position having regard to what was reasonable for both the paying and receiving parties. In commercial cases the rate of interest was usually set by reference to the short-term cost of unsecured borrowing for the relevant class of litigant. Historically, first class borrowers had generally recovered interest at base rate plus 1 per cent, unless that was unfair. SMEs and private individuals tended to recover interest at a higher rate to reflect the real cost of borrowing to that class of litigant.

LIMITATION • • In Kays Hotels Ltd v. Barclays Bank Plc [2014] EWHC 1927 (Comm) held the type of knowledge needed under S. 14 A of the Limitation Act 1980 depends on the negligence alleged. Knowledge of mis-selling depends on the client having reason to question professional advice or information received and having reason to investigate.

LIMITATION • • In Susan Jacobs v. Sesame Ltd [2014] EWCA Civ 1410 the Court of Appeal held that whether a Claimant could rely on the special time limit under s. 14 A, Limitation Act 1980 depended on a) identifying the damage, and b) knowledge of material facts about the same. The Claimant was out of time because she knew in July 2009 that she was not guaranteed to receive back all the money she had invested.

LOOKING FORWARD • Claims by companies disappointed by the Redress Scheme • Claims for breaches of the FSA Handbook • Claims for failure to give a proper explanation • Claims based on implied representations • Claims based on unfair credit relationships • Challenges to banks’ basis and exclusion clauses • Disputes regarding limitation