UK High Court reluctantly upholds bank disclaimer of liability after negligent sales

The fallout from the 2008 Credit Crunch provided yet another court decision last week about the duties banks owe to borrowers when selling sophisticated derivative products. Tim Kerr, QC, ruled in the case of Crestsign Ltd v NatWest and RBS (26 September 2014) that a bank may limit its exposure to borrowers’ common law negligence claims by including specific contractual disclaimers that it provided “advice” during loan negotiations.

The court’s meticulous decision examines claims arising from real estate loans taken by Crestsign Ltd, a small private company to invest in commercial property for letting to commercial tenants and created by the family of Mr Ian Parker and his wife Mrs Gillian Parker. In 1997, the company purchased four commercial properties, the cash flow from which was expected to provide the Parkers with an income stream and funding for their retirement in the not-too-distant future. The purchases were refinanced in 2005 with a loan from Northern Rock PLC. By July 2007, however, Crestsign was paying annual interest at a level close to 8 per cent against the Bank of England’s much lower base rate of 5.75 per cent. When Northern Rock (facing its inevitable demise in 2008) altered the terms of the loan to include capital repayment as well as interest, the Parkers began to look at alternative sources of finance. Crestsign began negotiating with National Westminster Bank (‘NatWest‘) for a ten-year, interest-only loan. There was a time constraint as Northern Rock had allowed Crestsign until June 2008 to refinance subject to a special early-repayment penalty, and so, as the court concluded, lacked ‘any realistic prospect of timely access to adequate expert advice’ as to the appropriateness of the NatWest loan proposals.

The proposal accepted by Crestsign included an “interest swap” with the Royal Bank of Scotland (‘RBS‘) as a hedge against interest rate increases. A five-year loan was set with NatWest at 1.5% over the base rate. After the first two years of the NatWest loan, Crestsign would make payments via a second, ten-year loan with RBS at a fixed rate of 5.65%. If base interest rates went up, Crestsign would receive payments from RBS greater than its NatWest liability (because they were tied to the floating rate), and so the “swap” provided a hedge against future base rate increases. If rates went down, though, Crestsign would have to pay RBS the difference between the prevailing base rate and the 5.65% fixed rate of the swap loan. The effects of this loan structure were far from clear to Crestsign: during negotiations with NatWest the Parkers admitted they were “stupid” about hedging strategies, and given the time pressure they were under from National Rock, they did not receive additional advice from an outside source. They apparently (and according to the court, reasonably) believed that they had a single loan for ten years to finance their property that was protected against future interest rate increases. NatWest’s loan manager, the court’s estimation, did little to clarify things for Crestsign.

The first two years of the NatWest loan were unhedged and benefitted from the lowering interest rates; by June 2010, the base rate had dropped to .5 percent. Had interest rates increased beyond the RBS swap’s 5.65% rate, Crestsign would then have been protected from those higher payments. With the base rate at .5%, however, when the RBS loan kicked in and Crestsign had to pay RBS 5.15%—5.65% minus the .5% base rate—plus the interest on the NatWest loan, then at 2 percent. Crestsign’s attempts to refinance the loans with another lender proved futile as the penalties of escaping the swap loan, described in the documentation as merely “substantial“, exceeded £600,000. In 2013, NatWest had no obligation to renew its loan, leaving Crestsign with the RBS swap loan alone at rates greatly in excess of base rates and no actual financing for its properties.

The court was asked to decide whether the banks breached a duty to advise Crestsign of the appropriateness of the swap loan structure. Much of the dispute between Crestsign, NatWest and RBS is a matter of ongoing regulatory action so the court’s decision on these points only addressed the narrow issue of whether a disclaimer in the loan documents could insulate NatWest and RBS from Crestsign’s common-law negligence claims, which are inferred from the Financial Conduct Authority’s Conduct of Business (COB) rules (which governed banking transactions up to November 2007). Because Crestsign is a limited company carrying on a business it could not bring a claim directly under COB rules, but as the COB sets standards of conduct generally for banks, the rules may imply standards of care in common law.

The disclaimer in the NatWest/RBS loan documents stated: “We will not except where we have specifically agreed to do so, provide you with advice on the merits of a particular transaction or the composition of any account, or provide you with personal recommendations (as defined by the FSA) in relation to any transaction or account. Accordingly, you should make your own assessment of any transaction that you are considering or of the composition of any account and should not rely on any opinion, research or analysis expressed or published by us or our affiliates as being a recommendation or advice in relation to that transaction or account.“

The court reluctantly concluded that these terms protected the banks from Crestsign’s negligence claims. The court found that NatWest and RBS had given advice to Crestsign on the suitability of the swap loan package and thus initially incurred a duty of care, citing Hedley Byrne v. Heller & Partners (1964). The loan documents, however, protected NatWest and RBS from claims that they violated that duty according to the court, effectively stating to Crestsign that “although [we] recommend one of these products as suitable, [we] do not take responsibility for [that] recommendation; you cannot rely on it and must make up your own mind“. See generally, Henderson v. Merrett Syndicates Ltd (1995).

Having found the disclaimer effective, the court did not need to go further, but it is an indication of the problematic distinctions being drawn, and the behaviour of NatWest/RBS agents that the court went on to analyse the other issues “in case it is of help to the parties, given the possibility that the case might be taken further“.

If the court was wrong about it’s construction of the banks’ disclaimer, then the court concluded that they were negligent in the sale of loans to Crestsign, particularly in trying to sell unsuitable loan products (the swap loan) to the borrower. Expert testimony received from Crestsign showed that the swap was “manifestly unsuitable, not just with hindsight, but at the time as well“: it hedged 100 per cent of the debt, was inflexible, hedged beyond the term of the loan which might not be renewed or adequately refinanced, placed nearly all the risk on Crestsign and little on RBS because of its cancellation option, exposed Crestsign to adverse interest rate conditions for seven of the ten years and exposed Crestsign to high break costs which would dwarf the premium for a cap. Moreover, to the extent that the banks’ representative sought to explain those products which he wished to sell to Crestsign, he came under a duty to explain fully and accurately the nature and effect of the products in respect of which he chose to volunteer an explanation. He was not obligated to explain alternative products the bank could offer, but he did at least have to explain in full those products he offered.

The court’s commentary in this instance will have to await efficacy on appeal (should this be applied for and allowed): if on appeal the court decides that the NatWest/RBS disclaimer was not an effective shield against common-law negligence claims, then the lower court’s factual findings will result in a very different outcome for consumers and banks.

Link: Crestsign Ltd v National Westminster Bank and RBS (EWHC) 2014 3043(Ch)

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