IPs in a predicament over interest rate swap mis-selling

THE MIS-SELLING of interest rate hedging products (IRHPs) has been a high profile subject for banks and their customers for several years. With the statutory six-year limitation period on legal action soon to expire – as many IRHP arrangements were entered into in 2008 – the matter has become more urgent. This issue is particularly challenging for insolvency practitioners (IPs) trying to decide how to deal with potential IRHP mis-selling claims held by insolvent companies.

It’s a predicament whose consequences look set to continue for some time yet. The banks’ review of IRHPs – set up after the Financial Conduct Authority found that over 90% of IRHPs may have been mis-sold during the 2008 financial crisis – has only addressed the transactions of ‘unsophisticated investors’, such as IRHPs valued at less than £10m; other companies excluded from the review have had to make up their own minds whether or not to bring legal proceedings against the banks for compensation.

Further, while the six-year limitation period may now be creating an obstacle to bringing claims, IPs should be aware that this may not be absolute. The start date of the limitation period can be delayed by up to three years if it can be shown that the company was only alerted to the facts that would allow it to make a claim at some time after the IRHP was entered into. And the outcome of cases like that of Kays Hotels Limited has shown the courts are more sympathetic to those wishing to extend the limitation period.

The challenges

IPs are clearly obliged to consider whether it is possible to realise a potential IRHP claim held by an insolvent company. However, doing so may present them with further concerns – particularly if it means bringing a claim against the bank that appointed them to the company in the first place, potentially leaving the IP between a proverbial rock and a hard place. IPs need to work through any such actual or perceived conflicts of interest – perhaps by appointing a second IP specifically to deal with the IRHP claim.

Then there’s the question of who should receive the proceeds of the claim. Where the shortfall on the underlying loan is greater than the value of the swap claim, the banks would argue that they are legally entitled to the proceeds of the claim under their floating charge security. Alternatively, the company’s claim could be subject to insolvency set-off.

But uncertainties surrounding these issues remain and some have concerns that the idea of banks seen to be profiting from their own bad practices creates a perception of injustice.

Of course, there will be situations in which the proceeds of the claim do not just benefit the banks:

• They might increase the amount due to unsecured creditors under the ring-fenced fund payable out of floating charge assets;
• They could create a surplus in the insolvent state which is returnable to shareholders; or
• There may be personal guarantors for whom any reduction in the debt due to the bank reduces their personal liability.

Even where an IP has considered whether to bring a mis-selling claim and has rejected the idea – either due to lack of funds or a weakness in the case – he or she may still be under an obligation to assign the claim to another interested party, such as another creditor, shareholder or personal guarantor.

Indeed, in the recent case of Hockin v Marsden, the High Court ruled that the administrator’s refusal to assign such a claim had unfairly harmed the creditor’s interests and ordered him to assign it to the creditor (who was one of the directors) in return for a share of the potential proceeds and a personal indemnity against costs.

Treading carefully

Of course, uncertainty still shrouds most IRHP claims brought by ‘sophisticated investors’ as classified by the FCA. While these may have fallen outside of the scope of the FCA’s review, they do have the option of pursuing their claims through the courts, but the jury is still out on the present state of the law relating to their position, with several court cases – such as Unitech v Deutsche Bank – still to be resolved, and IPs should await developments with bated breath.

In the meantime, they remain obliged to consider whether IRHP mis-selling claims could be brought in respect of potentially valuable assets and if they have not done so already, they will have to decide whether to issue proceedings in order to prevent the limitation period expiring.

All IPs out there need to be alert to the possibility of such claims and consider whether legal action is viable – and, if so, whether they can successfully bring such an action themselves or whether they should assign it to someone who is better placed to do so.

Robin Henry is a partner in the financial disputes team at London law firm Collyer Bristow

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  • Mark Beaumont, Annecto Legal

    There is also the question of how the legal costs of such cases can be financed. There is a definite lack of knowledge within the IP community of alternative funding models for litigation, and we continue to run free seminars to raise awareness. The evolution of litigation funding (in all its guises) over the past two years means that no claim for damages should be ignored because of a lack of cash to pay legal costs: funding exists for IP fees, legal fees and adverse costs from a variety of sources. At Annecto Legal we offer free advice on all types of case funding, so we do have an interest in this area!

  • Peter Crowley

    The accounting family, including auditors, accountants commissioned by banks to write reports in their clients, IPs and accountants employed in the FCA IRSA misspelling review would do well to be aware of ‘swapnodding’ – that is, ignoring the balance sheet affects of any derivative sold. For example, in the much publicised Bartells case (see, the bank involves has said ‘the swap payments only amount to a small percentage of the debt’. That is not the point, and the bank treasury department knows it. The point is the capital value of the swap, which, unbeknown to them, will have degraded their balance sheet, made them a worse borrowing risk to other banks, and pushed to the front of the smashup queue when the bank got into liquidity problems.

    The BBC has actually got this wrong – as have a lot of accountants – the swap was not ‘designed to protect them (the Bartells) against interest rate rises’ – in a bank’s eyes, it was designed to pay the bank a commission, and expose the Bartells to greater interest downside risk, than upside protection – read page 182 of Frank Portnoy’s book F.I.A.S.C.O. for an explanation.