The recent Inner House decision of Royal Bank of Scotland plc v James O’Donnell and Ian McDonald  CSIH 84, provides a useful summary of the law on innocent and negligent misrepresentations when a half-truth is made by one party to the other in the context of personal guarantees being given by borrowers to a bank.
The Outer House judge, Lord Malcolm, in the Commercial Court decision, said that the litigation was a good case study of the causes and consequences of the property crash in 2008 and few could argue with that view.
A site in Greenock was bought for just over £1.5 million in September 2007 at the height of the property boom. A company, Whinhill Developments Ltd (“Whinhill”), was incorporated by Mr McDonald and Mr O’Donnell (“the property developers”) to purchase the land and carry out development. The Royal Bank of Scotland plc (“RBS”) provided a loan to a company with no assets other than the site on the strength of a £3 million valuation from surveyors, Ryden.
In September 2008, the global credit crunch happened and the UK was engulfed by financial crisis hitting the property market hard. During this turbulent time, the Whinhill loan was up for renewal; the timing couldn’t be worse for the property developers and the bank. The fall in property market values gave RBS concerns that it would create a shortfall in their security. This put pressure on the RBS relationship director responsible for Whinhill, Mr Leonard Marsh, to obtain a new valuation for the site and a meeting was arranged with Mr O’Donnell on 16 December 2008 to discuss the matter.
FIRST ALLEGED MISREPRESENTATION
On 16 December 2008, Mr Marsh and his collegue Mr Wallace met Mr O’Donnell. They told Mr O’Donnell that Ryden would value the site at £2 million and suggested that a new loan agreement could be granted if him and Mr McDonald provided a personal guarantee in the sum of £300,000 (this would have remedied the facility’s loan to value breach). The following day the property developers told RBS they would grant a personal guarantee on the basis of the £2 million valuation they had been advised.
THE DESKTOP UPDATE VALUATION
On 19 December 2008, Ryden provided a “desktop update” valuation of the site which valued the site at £2 million based on 128 units on the site. The valuation stated that it was “for indicative purposes only” and this was to prove to be of critical significance. The Inner House concluded that “indicative” meant something that is less than reliable.
THE SECOND AND THIRD ALLEGED MISREPRESENTATIONS
On 9 January 2009, Mr Marsh sent an email to Mr O’Donnell advising him that he had obtained approval for a renewal of the facility for two years and continued “As you know Ryden have revalued the site at £2m”. No reference was made to the “indicative” nature of the report or to check that Mr O’Donnell had received a copy (Mr Marsh said he had sent a copy but conceded he may have misremembered).
On 20 March 2009, a second loan agreement was executed between the property developers and RBS. A property covenant clause stated the valuation was acceptable to the bank when an indicative report would clearly not be. On the same day, the property developers signed a joint and several personal guarantee for £300,000.
In February 2010, the property developers finally received the desktop update valuation and immediately raised concerns about it. A different firm of surveyors valued the site at £156,000 and RBS put Whinhill into administration. The site was subsequently sold for £65,000.
The Inner House decided in the property developers' favour and upheld Lord Malcolm’s Outer House judgement which entitled them to have their personal guarantee cancelled and damages awarded to them by the bank of £39,600 each plus 4% interest.
The case flagged up the following four legal points for banks and borrowers to bear in mind:
1. PASSING ON INFORMATION & HALF-TRUTHS
The bank argued earnestly that Mr Marsh was just passing on information so there could be no misrepresentation. However the case is a timely reminder to banks to ensure that any information they pass on/communicate during pre-contractual negotiations does contain any caveats.
Borrowers and banks should be acutely aware that if there is a failure to flag up anything of significance which would undermine the reliability and accuracy of an important document then this is a half-truth that may be considered a misrepresentation and failing to correct that inaccurate information would be negligent. The Inner House underlined that half-truths are dangerous as it is more difficult to discover they are false when a statement is largely true but false in one critical aspect.
2. ENHANCED DUTY FOR PERSONAL GUARANTEE
It should also be borne in mind by banks and borrowers that when personal guarantees are the contract in question then the duty to avoid making half-truths is enhanced so greater care should be taken when making statements or passing on information during pre-contractual negotiations.
3. CONTINUING MISREPRESENTATION
Another feature of this case was that the banks do not escape liability if their statement was true when first made but subsequently becomes false before the contract is entered into and they are not aware it has become false.
4. NO DUTY FOR TECHNICAL ERRORS
However banks will take some comfort from the fact that the Court did not expect the bank to correct errors in a valuation report which were of a more technical nature. The indicative nature of the report meant it was unsuitable for lending or personal guarantee purposes which was plainly much more fundamental and a banker would be expected to understand the implications of this caveat and alert the borrowers to the consequences.
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