Wouldn’t bank on it: borrowers, lenders and the duty of care

Posted: 25/11/2013

The Court of Appeal has handed down its first decision arising from the mis-selling of Interest Rate Hedging Products (“IRHP”), holding that a bank does not owe its customers a common law duty of care to ensure that they understand the nature of the risks involved in signing up to an IRHP.  While Green & Rowley v The Royal Bank of Scotland plc unquestionably sets the bar high for potential claimants, this was very much a case which turned on its facts.

The facts

John Green, an estate agent, and Paul Rowley, a hotelier and property developer (together “G&R”) operated a partnership buying and developing commercial property in and around Lytham St Annes. As at May 2005, G&R had two loans with RBS of £1.5 million, repayable on an interest-only basis at 1.5% above base over a fifteen year term (the “Loans”). Base rate at that time was 4.75%.

In May 2005, G&R tried to protect themselves against anticipated interest rate rises by entering into an interest rate swap with RBS (the “Swap”). The Swap was discussed at a meeting with RBS representatives on 19 May 2005, and the Swap was entered into on 25 May 2005. The Swap effectively fixed an interest rate of 4.83% against a so-called notional amount of £1.5 million, which matched G&R’s existing liability to RBS. G&R chose a shorter term of ten years, on the basis that they would sell or refinance their properties within that period so that there was no need to be locked in for longer.

The Swap provided that, where the base rate exceeded 4.83%, RBS would make quarterly payments to G&R of the net difference between the fixed rate and base rate as applied to £1.5m. This meant that, if interest rates went up, while G&R would pay more under the Loans, they would recoup the enhanced payment from RBS under the Swap. Conversely, where the base rate was lower than 4.83%, G&R would pay RBS the difference between the fixed and base rates, calculated in the same way. As Tomlinson LJ observed, the obvious corollary to this was that if the base rate went down, G&R would be worse off than had they not entered into the Swap (para 11). While they would pay less interest under the Loans, G&R would have to pay that saving to RBS under the Swap.

In essence therefore, the Swap operated to fix G&R’s liability to pay interest to RBS under the Loans. The Court of Appeal was clear that “it is of the essence of a fixed loan that a borrower is protected against increases in base rate but does not get the benefit of a decrease in base rate (para 11)”. At that time, both RBS and G&R thought that interest rates would decrease in the short term and rise again thereafter.  This confidence turned out to be misplaced.

Between 2006 and 2008, G&R were “in the money” under the Swap, as interest rates rose and payments G&R received from RBS under the Swap compensated them for the higher interest rates payable under the variable loan facility. However, as the global economic crisis caused interest rates to plummet to 0.5% in March 2009, the position was reversed and it was RBS which was “in the money”.

In early 2009, G&R tried to restructure their partnership, with Mr Green taking most of the properties and with them most of the debt. This also necessitated revising the Swap. G&R discovered that a break charge of £138,650 would be payable if they terminated the Swap early. This came as a shock both to them and their bank manager, Mrs Gill. G&R issued proceedings against RBS, claiming that the bank had missold them the Swap.

The claim

G&R issued their claim on 25 May 2011, on the six year anniversary of the date on which the Swap had been signed. G&R ran two main arguments. First, that RBS had breached its duty of care under Hedley Byrne & Co Ltd v Heller & Partners Ltd by making various negligent mis-statements about the Swap, including the costs of early termination (the “Information Claim”). Secondly, that RBS had negligently advised them to enter a Swap which was unsuitable for their requirements (the “Advice Claim”).

G&R also sought to argue that RBS was in breach of its statutory duty under the Conduct of Business Rules (“COB Rules”) under section 150 Financial Services and Markets Act 2000 (“FSMA”). However, this additional claim was dropped when G&R conceded that the relevant limitation period had expired.

First instance

HH Judge Waksman QC dismissed both claims (Green v The Royal Bank of Scotland plc).

The Information Claim failed because the Hedley Byrne duty did not include a duty to give information, unless without that information a statement would be misleading. The statutory duty to take reasonable steps to ensure that a party to a transaction understood the nature of its risks (COB Rule 5.4.3) also fell outside the duty not to misstate. The evidence did not suggest that the explanations given to G&R by RBS’ representatives were misleading, unclear or unfair.

The Advice Claim failed because, on the facts of the case, RBS’ representatives had not advised or recommended that G&R enter the Swap. The fact that the relative advantages and disadvantages of the Swap were discussed did not mean that the Swap was recommended. Since no advice was given, no actionable advisory duty had arisen as a result of anything the RBS representatives had said at the meeting to discuss the Swap.

The appeal

G&R appealed. The central thrust of their argument, relying on X (Minors) v Bedfordshire County Council was that a “breach of statutory duty is actionable as a breach of concurrent common law duty of care where either the purpose of the statute is to confer protection on a defined class of individuals (sounding in an entitlement to damages) or (in like circumstances) where the duty has been carelessly executed” (para 19).

Where a bank undertakes a regulated activity in circumstances where failure to comply with a statutorily imposed regulation is likely to cause damage to the counterparty, robbing it of its informed choice, a duty of care arises at common law which is co-extensive or concurrent with the statutory duty (the “Concurrent Duty”). In this case, RBS was required by COB 2.1.3 to communicate in a way which was clear, fair and not misleading. COB 5.4.3 required RBS not only to warn that break costs could be substantial but also to explain clearly and fairly the potential magnitude of those costs so that G&R could understand the risks of the Swap. G&R alleged that the bank had failed in that duty by making inadequate disclosure of the break costs.

If their Concurrent Duty argument succeeded, it would have been open to G&R to side-step the time-bar on the breach of statutory duty claim by claiming a breach of the common law Concurrent Duty (which was still within time).

Court of Appeal

Tomlinson LJ gave the leading judgment for a unanimous Court of Appeal. The Court of Appeal dismissed the appeal, and made it clear that no Concurrent Duty arose.

It was clear that, under s150 FSMA, a breach of the COB Rules was actionable. A judicial finding that RBS had failed to understand the risks involved in the Swap or had failed to communicate with them in a way that was clear, fair and not misleading would give G&R “without more a cause of action for breach of statutory duty, or a cause of action akin thereto, subject only to questions of causation, reliance and proof of loss” (para 15). However, this argument had not been pursued before the judge; G&R’s junior counsel had conceded that such a claim was time-barred, the allegations being focussed on what was said at the meeting on 19 May 2005, which was (one week!) more than six years before the claim was issued.

Although, on appeal, leading counsel argued that his junior’s concession was “likely to be wrong” because any breach of duty would continue until the transaction had been executed, G&R did not resile from that concession and accordingly the Court of Appeal gave no opinion on when time began to run. Tomlinson LJ did however note that this background history provided a distinctly unpromising start to G&R’s quest to persuade the court of the existence of the Concurrent Duty; not least because one justification for its existence was the more generous limitation period available under common law.

Information claim

In relation to the Information Claim, Tomlinson LJ upheld Waksman J’s uncontroversial finding that the Bank owed G&R a duty to take care when making statements in relation to which it knew or ought to have known that G&R would rely on its skill and judgment. He rejected G&R’s argument that the Hedley Byrne duty should be informed by the content of the COB Rules: “the Hedley Byrne duty does not comprise a duty to give information unless without it a relevant statement made within the context of the assumption of responsibility is misleading” (para 17).

Accordingly, the requirement of COB 2.1.3 to take reasonable steps not to mislead falls within the common law duty; the requirement to take reasonable steps to communicate clearly or fairly falls outside the Hedley Byrne duty. Similarly, the duty imposed by COB 5.4.3 to take reasonable steps to ensure that that G&R understood the nature of the Swap was “well outside” any notion of a duty not to misstate (para 17).

Advice claim

By contrast, the Court of Appeal endorsed Waksman J’s finding that, had RBS undertaken an advisory duty, the content of that duty would have been informed in part by the content of the relevant COB Rules. This is because, to quote Beatson J in Shore v Sedgwick Financial Services Ltd “the skill and care to be expected of a reasonably competent financial advisor ordinarily includes compliance with the relevant regulatory rules” (para 18). However, as RBS did not advise G&R on the transaction, no such action arose.

Concurrent duty

The Court of Appeal did not accept that a Concurrent Duty should be imposed. Section 150 FSMA provides a remedy for contravention of the COBS Rules, in the shape of an action for breach of statutory duty (or something similar). RBS had not crossed the line between giving G&R information about and selling the Swap and advising them in relation to the Swap.  Without that advice, there was neither justification nor need to impose the Concurrent Duty (para 23).

Tomlinson LJ also agreed with RBS that neither of the relevant COB Rules provides any pointer at all as to the assumption of a duty of care to advise or as to the appropriateness of imposing such a duty, since both impose statutory duties which are owed by firms acting in a non-advisory or execution only relationship with their counterparty as well as by firms acting in an advisory role.

The Court of Appeal analysed Lord Browne-Wilkinson’s discussion in X v Beds of private law claims for damages arising out of beach of statutory duty, and dismissed each category in relation to G&R’s claim. G&R’s reliance on the existence of a private right of action where the statutory duty was imposed for the protection of a limited class of the public was misplaced because Parliament had provided another means of enforcing the duty through s150 FSMA.

The second category, the careless performance of a statutory duty, was not relevant because RBS had no duty to sell derivative products. In any event, the Court of Appeal held that such a claim would involve the assertion of either a cause of action for breach of statutory duty or a cause of action at common law.

Tomlinson LJ then considered Lord Browne-Wilkinson’s final category, in which the claim alleges either that a statutory duty gives rise to a common law duty owed to the claimant by the defendant to do or refrain from doing a particular act or (more often) that in the course of carrying out a statutory duty, the defendant has created a relationship with the claimant that gives rise to a duty of care at common law. This was of no relevance here as RBS was not carrying out a statutory duty.  However, this analysis was “inimical” to the notion that “the mere existence of a statutory duty of itself brings about the creation of a co-extensive common law duty” (para 29). A common law duty of care which arises from the relationship formed between the parties during the performance of a statutory duty is not co-extensive with the statutory duty and does not arise by virtue of the statutory duty being imposed.

Points to bank

This judgment will have given the banks affected by the mis-selling litigation some comfort. The common law duty of care established in Hedley Byrne remains unaltered and narrow in scope, and potential claimants will not be able to use it to sidestep limitation issues.

However, the case was, as ever, fact-specific: G&R were characterised by Waksford J as intelligent and experienced businessmen, who would have had no difficulty in understanding the very straightforward Swap. They also had access to their own independent financial and legal advice, and had been given a copy of RBS’ Interest Rate Hedging Solutions pamphlet, which did set out that break costs would be payable in certain circumstances.

It is also clear that the courts view the s150 FSMA mechanism as fit for purpose, and will apply it where the facts (and timescale) allow.  The COB Rules are also broader in scope than the Hedley Byrne duty. Potential claimants should move quickly to minimise the chances of actions being time-barred – many swaps were sold between 2005 and 2008 so time is of the essence in bringing claims.

This article was published in the Commercial Litigation Journal in November 2013.

Return to news headlines