The Finniestone Crane and Finnieston Bridge on the River Clyde, Glasgow.

Royal Bank of Scotland v. James O’Donnell and others.

Posted on 21/01/2015 · Posted in Financial Litigation

If any benefit resulted from the Lehman Brothers collapse of 2008, it may be the increased scrutiny under which retail lending banks must now operate, as a growing number of decisions resulting from the 2008 financial trauma have done much to describe a safer and more responsible lending industry. The 2013 decision in Royal Bank of Scotland v. O’Donnell is one such case where a relatively small real estate development transaction may have a wider impact on how banks make loans to retail customers, and is highly instructive as to when banks must disclose information to retail loan customers in the course of setting loan terms.

In September 2007 James O’Donnell and Ian McDonald were directors of Whinhill Developments Ltd., a company formed to purchase and develop a residential complex in Greenock, near the Port of Glasgow. Whinhill was to purchase the property and obtain planning permission to develop a 112-unit housing scheme with a mix of detached houses and flats, which would then be sold to a house builder or developer. Whinhill purchased the site for £1.5 million with an RBS loan of £1.65 million and a term of one year; Whinhill would pay an exit fee of £160,000 at the term of the loan (a concession given to RBS in light of Whinhill’s lack of planning approval). At the time, the project was valued at £3.237 million, with an ultimate developed value of £18.097 million. That overall value led RBS to accept that the project offered ‘good loan security’.

Glasgow is still full of churches built in the last century. Half of them have been turned into warehouses.”
Alasdair Gray

Within a year, Whinhill obtained planning permission but the market had collapsed in the wake of the Lehman Brothers failure, and Whinhill was unable to sell the project. Faced with default on the loan, and feeling the market collapse presented but a short-term challenge, O’Donnell negotiated a new loan with RBS to replace the initial purchase loan. The new loan was for £1.695 million, plus interest, which was required to be repaid by 31 March 2011. Unlike the earlier loan, this loan was supported by personal guarantees from both O’Donnell and MacDonald in the aggregate amount of £300,000 plus interest and expenses. In 2011, with the market still suffering and the Greenock project going nowhere, the partners defaulted on that loan as well, and further declined to satisfy their personal guarantees. Whether the personal guarantees were fairly negotiated was the dispute before the court.

O’Donnell’s claimed that the bank had essentially fraudulently induced him and MacDonald into providing the personal guarantees by over-valuing the project for refinancing purposes. Before issuing the second loan, RBS asked Ryden LLP, who performed the first project assessment, to update their opinion of the property’s value. Ride came back with an estimate of £1.75 million, or less than 60 percent of the 2007 value and well below the RBS loan-to-value ratio of 70 percent (the original loan was now up to £1.8 million). This was as problematic for RBS as it was for Whinhill and O’Donnell: a default by Whinhill would move the loan from the commercial side of the bank to the risk management side as an under-performing account, and meant calling in other loans from RBS to O’Donnell. Further RBS discussions with Ryden raised the value to a range of £1.75-2 million, but only after some tweaking of the underlying assumptions, i.e., the building density for the project now used only detached housing and more of it. Such a scheme was in fact not practicable, and so the £2 million figure could never be achieved. Moreover, Ryden stated that the figures were ‘indicative only’, and not sufficiently supported to constitute a formal and binding opinion of value given market conditions. Ryden letter’s concluding paragraph stated:

“We are of the opinion that the market value of the development site….as at 19 December 2008 is a sum in the order of £2 million. The above opinion of value is prepared solely for the use of the Royal Bank of Scotland and no responsibility is accepted to any other party. We would highlight that the above opinion of value has been carried out on a desktop basis without a re-inspection of the premises and should be used for indicative purposes only.”

This language at least told RBS that the valuation was not a fair market value, but something far more tenuous. The court concluded that RBS had instructed Ryden to provide a figure more nearly the maximum potential of the project property in order to maximise value (and thus help Whinhill meet the Bank’s LTV) and keep the loan alive.

A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.”
Mark Twain (1835 – 1910)

O’Donnell was never provided with the Ryden letter, but was told only that the property had been valued at £2 million. If the property was in reality insufficient to secure the loan, then the personal guarantees of O’Donnell and MacDonald were likely required to cure any eventual default. The main issue in the case was thus: was RBS obligated to provide O’Donnell with the full terms of the latest appraisal of the project before finalising the new loan and personal guarantees? In general, a borrower must look to his own interests, and a bank is entitled to proceed upon the basis that he will do so. Smith v Bank of Scotland (1997). In fact, a bank need not make any disclosure to a borrower but if disclosure is made, it must be “full and fair”, including any material change in circumstances affecting representations previously made. Shankland & Co v Robinson & Co (1920). RBS position was that its officer, Mr. Marsh, had done nothing wrong: the Ryden letter suggested the £2 million valuation was acceptable and Marsh was otherwise unaware that the underlying terms might be important to the borrowers, who were obligated to do their own due diligence.

At trial, RBS did not dispute that it had a duty of care to O’Donnell and MacDonald, and so the sole issue was whether greater disclosure of the informal survey letter and its underlying assumptions would have been material to the borrowers’ decision to provide their personal guarantees for the loan. The Ryden letter’s language should have been a red flag for RBS officer Marsh, demanding that he inquire as to the status of the revaluation report and its affect on the accuracy of the information previously tendered to the borrowers in light of the new assumptions. In the court’s opinion, the letter cast doubt over not only the durability of the 2007 appraisal, but equally did not support RBS representations to O’Donnell that the project property was worth £2 million in the current market. Marsh was thus under a duty specifically to inform the borrowers of the potential implications of the tenuous valuation, including seeking further information and clarification from Ryden. By using the valuation to persuade the borrowers to accept their guarantee, Marsh assumed responsibility for its accuracy. Marsh may not have appreciated that the change in underlying assumptions was potentially critical information, but the court held that he should have under the circumstances.

While RBS and Marsh initially claimed that the appraisal advice letter was sent to O’Donnell during the renegotiation period, O’Donnell did not receive it, and so was unaware of the fundamental shift in valuation methodology. Occurring so soon after the initial survey, though, O’Donnell reasonably believed the project conditions in the new analysis had not changed from the first appraisal (including the building density figure), and that his and MacDonald’s personal guarantees were unlikely to be utilised. The court was satisfied that RBS personnel but did not give the letter of appraisal to the borrowers. (Marsh’s claim that he had put the letter in an ‘out’ tray for delivery to O’Donnell would have been insufficient to satisfy his duty in any event). This was confirmed by the fact that O’Donnell and MacDonald raised no concerns about the impact of the valuation; had they known about the letter and the change in valuation methodology, they would not have guaranteed the loans to RBS.

The decision in RBS v O’Donnell arguably raises the bar concerning a bank’s duty to disclose information to potential borrowers. By making RBS liable for negligent omissions of material information, the court placed an affirmative duty on lenders to put themselves in the shoes of clients so to better understand their interests in a transaction and properly identify what information may be important to them. By doing so, banks will have a clearer understanding of their own duty to research and disclose aspects of loans they are about to make. If previously a negligent failure to disclose a material change in circumstances could be excused where the lender was innocently unaware of the change or its importance, the decision in RBS v O’Donnell clarified that such is no longer the case.

Link: Outer House, Court of Session [2013] CSOH 78 CA149/11

Expert Evidence Limited is a professional firm concentrating on the four main areas of dispute resolution; acting as expert witnesses in financial litigation, mediation, arbitration and adjudication. The firm has a civil, criminal and international practice and has advised in many recent cases. Areas of specialisation include banking, lending, regulation, investment, and tax.

Ask a question about expert witness services. We are here to help!

Contact Us Now

Disclaimer: The above case summary is derived from publicly available information and is not intended to be anything more than a statement of the author’s views on the salient factors of the case. It is not intended and should not be understood to be legal advice of any sort. All views are solely those of the author and no use of the summary should be made without statements being checked against the source of information. Expert Evidence Limited takes no responsibility for the views expressed. The copyright of the summary is owned by Expert Evidence Limited but may be used with written permission which may be forthcoming on application through the contact us page. This news item is not intended to imply or suggest that Expert Evidence Limited was involved in the case, only that it is considered an interesting legal development.