Leading up to the beginning of 2008, large numbers of small and medium size businesses agreed, often on the advice or insistence of the Bank, to financial products known as “swaps” or "hedges" in order to protect themselves against interest rate rises on their borrowings. While banks eagerly explained the benefits of swaps, in numerous cases they omitted advising the customers of the, often enormous, potential risks. Not only were those customers left paying increased monthly repayments when the economic crash hit and interest rates fell, but often were also faced with considerable breakage charges if they wished to repay early or rebank.
One of the most common forms of swap agreements is the “cap and collar” agreement. This type of agreement provides for a maximum rate (a cap) and a minimum rate (a collar, or floor), supposedly giving the business a form of certainty within this range, but in practice it was little more than a bet on future interest rate movements.
When the financial crisis hit in 2008 and interest rates plummeted, cap and collar customers did not enjoy the benefit of these low rates, but were instead crippled by having to pay substantially higher interest rates and penalty charges according to the floor and the other terms of the swap. Banks invariably never explained the downside risks when selling the product at the outset.
Another popular swap agreement is the fixed rate agreement, which essentially provides a means of converting floating rate debt to a fixed interest rate for a specified period. While such agreements are beneficial when interest rates rise, customers are unable to take advantage of reductions in interest rates. Furthermore, if these customers wish to exit the swap early or re-finance, they invariably face often very substantial breakage charges.
In a typical misselling case the Bank has either wholly failed to draw the customer’s attention to the risks, or even if reference is made to the potential breakage charges on early termination, this is usually by way of a clause contained within the facility documentation with no indication of extent of the potential liability attaching. Furthermore, in many instances, little effort was made by the Banks to ensure the customer fully understood the benefits and risks involved. Had those potential risks been explained to customers, there is little doubt that a large number of them would not have signed up to the swap.
In some extreme cases, the customers themselves asked for alternative hedging products such as a Base Rate Cap but were pushed hard by the bank to sign up to a fixed rate loan. A Cap carries an upfront premium and provides protection if interest rates rise above the Cap level but allows customers to take advantage of reducing interest rates with no breakage cost issues.
While the Financial Services Authority Regulations forbid misselling to customers, banks tend to argue as a defence to misselling claims that the customers concerned were experienced businessmen who could not have been taken to rely on the bank’s “suggestions”. While the currently existing case law has been strongly in the banks’ favour, the range of banking products and derivates such as interest rate swaps are far more complex than they used to be. We believe there is scope for arguing that a businessman, while experienced at, for example, property development, cannot be considered experienced at understanding highly complex financial interest rate products. Various routes are, therefore, developing for countering the banks’ non-reliance defences.
MBM Commercial has over the past three years handled a number of misselling claims against banks. We also have a separate Claims Funding Company which essentially provides in appropriate cases funding on a “no win, no fee” basis, as well as After The Event litigation insurance. If you think you have been missold a loan facility by a bank, please feel free to contact Cat MacLean, Partner and Head of Dispute Resolution