Wed, 06 Feb 2013
By Philip Mantle
Following the announcement in June 2012 by the Financial Services Authority of a two month investigation in to the sale (and in particular mis-selling) of interest rate hedging products such as swaps, collars, structured collars there is considerable interest in whether such claims are likely, following Payment Protection Insurance, to become another key battleground in financial services litigation.
Whilst a number of customers who had taken out such products have commenced proceedings, there has been a dearth of reported authority on such claims. The first such reported decision (south of the Scottish Border) has now been handed down in Green v Royal Bank of Scotland  EWHC 3661 (QB).
C had a pre-existing loan liability to D in the amount of £1.5m, repayable over a term of 15 years on an interest only basis of 1.5% above base rate. On 25th May 2005 C, having met with two of D’s employees (G and H) entered in to a swap agreement for a matching notional amount of £1.5m, repayable over a period of 10 years with a fixed base rate of 4.83%. The prevailing interest rate at the time of inception was 4.75%.
The swap operated thusly. If the interest rate fell below 4.83%, C’s loan repayments would decrease but they would have to pay a corresponding sum to D under the swap. By contrast, if the base rate exceeded 4.83% then D would pay to C an amount representing the difference between the interest which would have accrued in the period on the notional £1.5m at the base rate and at the fixed rate of 4.83%.
The Judge (His Honour Judge Waksman- whom it ought to be noted was the source of a number of leading, and lender friendly, decisions in the context of PPI mis-selling claims) summarised the position under the swap as being "the same as converting the variable rate loan to a fixed rate loan with all the potential advantages and disadvantages that has, depending on the state of the market".
After a period of initial stability, the base rate of interest rose sharply to the manifest benefit of C who was protected from the rise in interest rates. However by Marcy 2009 interest rates had fallen to a historic low of 0.5% and C, being effectively tied in to a rate of 4.83%, had to continue to make payments under the swap negating the benefit of the low rates.
C enquired about the cost of breaking the swap early, and was informed by D that the cost of the same would be £138,650.00. In light of this information, C launched proceedings alleging that the swap had been mis-sold.
C’s action was brought upon the following grounds;
(a) That D had breached its common law duty of care owed to C in making negligent mis-statements and giving negligence advice in relation to the swap;
(b) That D had breached the FSA’s Conduct of Business (COB) Rules, and rule 2.1.3 (duty to take reasonable steps to communicate in a way which is clear, fair and not misleading) and 5.4.3 (prohibition on a firm making a personal recommendation, or arranging/executing a deal in a warrant or derivative with or to a private customer unless it has taken treasonable steps to ensure that the private customer understands the risks involved).
C subsequently accepted that the cause of action with respect to an alleged breach of the COB Rules was time barred, but argued that nevertheless the rules were relevant to the common law negligence claims as the same provided evidence of the duty of care required under the principles espoused in Hedley Bryne v Heller  AC 465.
The claims were advanced under two broad categories, “information claims” and “advice claims”.
With respect to the information claims, C contended that D was liable for negligent misstatement with respect to various details of the swap arrangement, namely;
- Either that C was told that the break costs were modest or otherwise that the D ought to have told C that they were not;
- That the swap was separate to the loan, when in fact it was linked by an “all monies” and “cross default” clause;
- That the swap would fix the rate of the margin on the loans, as well as the base rate, which it not in fact do;
- That the swap was portable to another lender, when in reality this was unlikely to be practicable.
With regard to the advice claims, C alleged that D’s representatives had gone beyond the mere provision of information and had advised C to enter in to the swap arrangement. Such advice gave rise to a duty of care owed by D to C, which had been breached on the basis that the swap was not suitable for C.
The Judge found that the case was highly fact sensitive, turning on what had been said at and before a meeting on the 19th May 2005 attended by C, G (then Commercial Manager for D and friend of C) and H (area manager with D specialising in interest rate hedging products).
Where there was a conflict in the evidence, the Court preferred the evidence of D’s witnesses and H in particular, who the Court considered to have been an “impressive witness”. Importantly H was the only participant at that crucial meeting who had kept formal contemporaneous notes of the meeting itself together with illustrative diagrams and figures.
Further to the oral evidence of H, there existed a series of transactional documents being both contractual as well as post contractual documentation. Although C disputed that they had even seen such documentation the Court, in keeping with its approach to the conflicts in the evidence generally, found that they in fact had. The importance of the same was that the documents contained statements making clear both the terms of the swap and D’s resistance to the adoption of a duty of care.
By contrast, C’s evidence was (as between the two partners) found to be inconsistent and hampered by the lengthy lapse of time, the absence of contemporaneous documentation and the fact that they (C) had “now persuaded themselves that the Bank was to blame”.
The Information Claims
The Court found that, when considering whether a statement amounted to a mis-statement, the context in which the statement is made and understood was important, and that only rarely will a statement that is true on its face be regarded as a misstatement.
The general principle, derived from Hedley Bryne demonstrates that in order to be successful in a claim for negligent misstatement, it is incumbent on C to show that the defendant owed it a duty of care and that the same was breached by the defendant carelessly making a false statement which C relied upon, thus suffering loss.
With respect to C’s attempts to argue that breach of COB was relevant (notwithstanding that an express claim under Section 150 of the Financial Services and Markets Act 2000 was time-barred), the Court concluded that whilst there was authority for the proposition that the rules provided guidance as to the extent of the common law duty of care in an advisory context, the duty to take care not to mis-state was much narrower than the advisory duty where the relevant professional standards form part of the assessment as to whether the duty has been broken.
The Court concluded that Hedley Bryne did not give rise to a duty to give information unless without the provision of such information a statement would become misleading.
In summary, as to the “information claims” the Court found;
Statements given by H as to the break costs were not misleading, unclear or unfair. There would not have been a breach of COB Rule 5.4.3;
As to the separate nature of the loan and swap, the Court concluded that references to that effect denoted only that the loan and swap were two separate contracts and that it was not being asserted that the same were not in any way linked. Further, whilst the Court concluded that there had been no breach of the principles in Hedley Bryne, he found that if he had, causation had not been established by C;
With respect to the fixing of the margin, on the facts the Court concluded that C had resisted any significant change to the margin. There was some evidence that statements had been made by G, on behalf of D, supporting the proposition that the margin would not be changed from 1.5% which the Court concluded might estop D from increasing the margin in the future, but on the claim before the Court the Judge was satisfied that he could reject any notion that C had been told by D that the swap would fix the margin;
In regard to statements as to the portability of the swap, the Judge found that it was clear that C appreciated that any transfer to another bank would require that second bank’s consent, and that H could not possibly have been saying that in all events the second bank would be obliged to accept the swap arrangements. Subject to the requirement of consent, the swaps were in essence portable. Furthermore, the Court concluded that even if duty and breach had been made out the case would have failed on causation.
D accepted that if a duty of care existed, in considering whether there had been a breach of the same regard ought to be had to both COB Rule 5.4.3 and Rule 5.3.5 namely;
"(1) A firm must take reasonable steps to ensure that, if in the course of a designated investment business: (a) it makes any personal recommendation to a private customer to: (i) buy, sell, subscribe for…a designated investment…the advice on investments or transaction is suitable for the client."
The Judge approved of the approach in Rubenstein v HSBC Bank plc,  EWHC 2304, to the effect that when considering whether advice had been given, it was enough that the product in question was recommended.
However the Judge was satisfied that no recommendation or advice as to suitability had been given either before or at the meeting on the 19th May 2005. The Court formed the clear view that the person responsible for speaking about the products was H, and notwithstanding a lack of formal training, the standard way in which she carried out her meetings included her saying that she was not there to give advice. Accordingly there was nothing in the sale process which involved D assuming an advisory role and therefore there was no advisory duty of care.
Further, the Judge found that D was entitled to rely upon its brochure and standard terms of business, which made it clear that D was not providing advice. C argued that D ought not be permitted to rely upon the same given that COB Rule 2.5.3 bars firms from seeking "to exclude or restrict, or to rely on any exclusion or restriction of any duty or liability it may have to a customer". Given his other findings, the judge found it unnecessary to determine the matter, so the point remains open.
Finally the Judge concluded that even if a duty of care had existed, it would nevertheless have not been breached, as the swap was suitable for C and thus there was no breach of COB Rule 5.3.5. That the drop in interest rates had left C paying large sums under the swap did not necessarily mean that the swap was an unsuitable product.
The decision highlights the difficulties that prospective Claimants in these actions are likely to encounter, particularly with respect to the production of contemporaneous evidence and remembrance of events and conversations which may have occurred a considerable period of time ago. In many ways these difficulties echo the difficulties encountered by Claimants with respect to other mis-selling claims, in particular PPI. The reality is that Claimants are unlikely to have kept such notes and may well, due to the passage of time, be unable to recall key elements of the advice that they received. By contrast, Defendants are likely to have ready access to computerised records and furthermore will be able to rely upon assertions of routine procedures that would have been followed as being supportive of the steps that would have been taken in the particular case in question. Indeed, bearing in mind the value of such swaps, the attention paid by the Defendants both at the time and subsequently to the preservation of records (and therefore evidence) is likely to be greater than one might ordinarily expect to encounter in the sale of lower value financial products.
Further the Court highlighted the important principle that the mere fact that the interest rate moved against those who had taken out such arrangements, with the effect that they became a “bad deal” does not automatically lead to the conclusion that the same were mis-sold.
By contrast, the sheer fact that the FSA have considered it appropriate to explicitly investigate such products and that there is growing evidence of very complex financial products being sold to small and medium sized enterprises who could not possibly have realistically understood the nature of what they were being sold is suggestive that this case is unlikely to be the last word on these claims. Indeed at the time of writing C had given instructions to appeal the decision, and the guidance of the higher courts on these claims is awaited with interest by both sides.