Court of Appeal Opens the Door to LIBOR and Benchmark Misrepresentation Claims

21 03 2018

Property Alliance Group Ltd v The Royal Bank of Scotland Plc [2018] EWCA Civ 355 (02 March 2018)

Infamously, the London Inter-bank Offered Rate (LIBOR) used to be a code word for corruption in the world of finance. In more ways than one, it is still a dirty word from the point of view of ethics. However, even now, despite planning to phase it out by 2021 and replacing it with a proxy, the FCA calls LIBOR a “systemically important benchmark”. Property Alliance Group (PAG) appealed Asplin J’s decision to dismiss its claims against the Royal Bank of Scotland (RBS) arising out of interest rate swap agreements. RBS advanced funds to PAG at interest rates referenced to LIBOR, which was published relying upon submissions from panels of banks on borrowing rates. These proceedings arose out of four swaps that RBS sold to PAG between 2004 and the spring of 2008. The first swap had a trade date of 6 October 2004 and a notional amount of £10 million. The second swap had a trade date of 25 September 2007 and a notional amount of £15 million for 4 years and then £30 million for a further six years. The third swap had a trade date of 14 January 2008 and a notional amount of £20 million. The fourth swap had a trade date of 16 April 2008 and a notional amount of £15 million. The global financial crisis of 2007-2008 trigged a fall in interest rates. All the swaps were tied to 3 month GBP LIBOR which plummeted and stayed low. The upshot was that the rates of interest that PAG was paying under the swaps far exceeded what it was receiving under them.

One consequence of the prolonged period of unusually low interest rates was that the swaps had a very large negative market-to-market value (MTM) from PAG’s point of view. The break cost incurred by PAG in 2011 was correspondingly substantial. PAG issued proceedings in 2013 seeking relief by way of rescission of the swaps and/or damages. The claims were divided into three categories: “the swaps claims”, which involved allegations of misrepresentation, misstatement and breach of contract on the part of RBS in connection with its proposal and sale of the swaps to PAG; “the LIBOR claims” which rested on RBS’s knowledge of and participation in manipulation of LIBOR rates; and “the GRG claims” by which PAG complained of breaches of contract arising out of its transfer to, and subsequent management within the controversial Global Restructuring Group to which RBS transferred its relationship with PAG in 2010. Asplin J dismissed the claims in their entirety. However, despite dismissing the onward appeal, light of the circumstances Sir Terence Etherton MR, Longmore and Newey LJJ were satisfied that RBS did make some representation to the effect that RBS itself was not manipulating and did not intend to manipulate LIBOR.

The Court of Appeal

In summary, in the Court of Appeal, PAG relied on the following claims (i) a claim arising out of RBS’s liability in tort for negligent misstatement as a result of failure to provide PAG with information about potential break costs or “the negligent misstatement claim”, (ii) a claim that RBS falsely represented to PAG that each of the swaps was a “hedge” and, hence, that it would reduce PAG’s interest rate risk or “the misrepresentation claim, (iii) a claim that RBS fraudulently made implied representations about LIBOR and how it was set which were false or “the LIBOR claims”, and (iv) a claim that RBS was wrong to have PAG’s portfolio revalued in August 2013 or “the valuation claim”. However, despite making clear that LIBOR manipulation was “deeply shocking”, Etherton MR, Longmore and Newey LJJ dismissed the appeal but their judgment nonetheless makes rather interesting reading for parties claiming misrepresentation against the banks.

(i) Negligent Misstatement

Their Lordships held that Asplin J had rightly rejected both the allegation of a breach of the Hedley Byrne [1964] AC 465 duty and the existence of any wider duty that might have included an obligation to disclose the credit limit utilisation (CLU). The court applied the approach articulated by Mance J (as he then was) in Bankers Trust International plc v PT Dharma Sakti Sejahtera [1996] CLC 518 on which PAG’s case on negligent misstatement was substantially based. In essence, Mance J held that:

In short, a bank negotiating and contracting with another party owes in the first instance no duty to explain the nature or effect of the proposed arrangement to that other party. However, if the bank does give an explanation or tender advice, then it owes a duty to give that explanation or tender that advice fully, accurately and properly. How far that duty goes must once again depend on the precise nature of the circumstances and of the explanation or advice which is tendered.

The Court of Appeal went on to hold that the bank had not breached its Hedley Byrne duty by failing to present a full and proper explanation of the potential break costs or the CLU. It held that the documentation and other evidence at the trial were clear that PAG was made fully aware that (a) breaking any of the swaps could carry adverse financial consequences, (b) the size of those financial consequences would depend upon interest rates at the time the swaps were broken, and (c) the precise calculation of any amount to be paid by PAG would take into account the extent to which, if at all, the floating-rate payable by RBS under the swaps was lower than the fixed interest payable by PAG.

Their Lordships noted that in Bankers Trust the factual context was such that the bank put forward an explanation that entering into the proposed substitute swap would improve the risk exposure of the customer. This particular factual matrix led Mance J to hold that the duty not carelessly to misstate facts obliged the bank to present the financial implications of the proposal by a properly constructed graph and letter, which presented the downside and upside of the proposal in a balanced fashion. The present case could be distinguished on the facts.

The court also advised against using the expression “mezzanine” duty or intermediate duty first coined in Crestsign [2014] EWHC 3043. All other things being equal, there is no duty to speak. If, however, a defendant does speak, they fall under a duty not to be dishonest or fraudulent in what they say under Derry v Peek (1889) 14 App Cas 337. The court found no basis for holding that RBS had assumed responsibility for disclosure of the CLU or any indication of the possible size of future break costs. Similarly, there was also no basis to hold that that it would be fair, just or reasonable to impose on the bank an advisory duty requiring such disclosure.

If RBS was under a duty to disclose the possible or probable size of future break costs at any time during the lifetime of the swaps, that could only have arisen under one or more of the three tests for tortious liability summarised by Lord Bingham in Customs and Excise Commissioners v Barclays Bank plc [2006] UKHL 28. None of them were satisfied in the instant case. It was also true that the CLU was the bank’s internal assessment of risk inherent in the swaps and was based on subjective criteria.

(ii) Misrepresentation

The factual context in which the term “hedge” was used permitted Asplin J to reject PAG’s definition of an interest rate hedge as a product which reduced the risk of loss in the event of interest rate changes. Critically, the hedging agreements entered into were to be acceptable to the bank. This meant that the purpose of the hedging agreements was to protect PAG from increases in interest rates which might otherwise undermine its ability to pay interest on its loans to RBS. A reasonable representee would not have understood RBS to have used the term “hedge” in the sense contended for by PAG. Accordingly, there had been no misrepresentation. In any event, Asplin J had found as a fact that PAG did not enter into the swaps in reliance on the hedging representations.

(iii) The LIBOR Claims

The manipulation of LIBOR between 2006 and 2012 meant that some of the panel banks had made submissions. The submissions were in breach of the integrity of LIBOR and did not reflect the rate at which the banks genuinely thought they could borrow funds. Instead, the rates used were thought to benefit those banks’ own trading positions. RBS had been investigated by the Financial Services Authority which imposed a fine of £87.5 million on the bank for breaching principle 3 (reasonable care) and principle 5 (observe proper standards of market conduct) of the regulatory Principles for Businesses. PAG placed reliance in the approach espoused by Flaux J in Graiseley Properties Ltd v Barclays Bank plc [2012] EWHC 3093 (Comm):

19. … It seems to me that it is a wholly artificial exercise to seek effectively to divide up the various LIBOR fixings or manipulations into separate currencies. It seems to me that it is a wholly artificial exercise to seek effectively to divide up the various LIBOR fixings or manipulations into separate currencies. It is quite clear that there was fixing not only of sterling LIBOR but also of dollar LIBOR and of EURIBOR, and that, as I said during the course of argument, there is inevitably scope for cross-infection here.

In all, PAG made four types of allegations of LIBOR related misrepresentations against RBS. Interlocutory applications had been made to the court in Graiseley Properties Ltd v Barclays Bank plc [2013] EWCA Civ 1372 (see here) where Longmore and Underhill LJJ and Sir Bernard Rix were unimpressed with the banks’ denial of responsibility. They thought that if the counterparties knew at the time of the contracts that the banks had been and intended to manipulate LIBOR but would be happy to pay any loss that their borrowers could prove then the borrower would (arguably) be sufficiently horrified so as to think he would be entitled to rescind the deal. The court found that the banks did propose the use of LIBOR and it must be arguable that, at the very least, they were representing that their own participation in the setting of the rate was an honest one. The court left the matter to a full trial; adding “the law should strive to uphold the reasonable expectations of honest men and women”.

In Geest Plc v Fyffes Plc [1999] 1 All ER (Comm) 672, Colman J held that there was no general duty of disclosure before entering into a contract of guarantee or indemnity but only a duty not to make express or implied misrepresentations. Toulson J had been attracted to the test in IFE Fund SA v Goldman Sachs International [2007] 1 Lloyd’s Rep 264 and in Raiffeisen Zentralbank Osterreich AG v Royal Bank of Scotland plc [2011] 1 Lloyd’s Rep 123 Christopher Clarke J cited the dicta of both Toulson J and Colman J and echoed Colman J’s helpful test:

Whether a reasonable representee would naturally assume that the true state of facts did not exist and that, had it existed, he would in all the circumstances necessarily have been informed of it.

Christopher Clarke J held that on the facts, no implied representation had been made. In Casa di Risparmio della Repubblica di San Marino SpA v Barclays Bank Ltd Hamblen J also adopted the remarks of Toulson J in considering whether implied representations had been made (he held that they had not). UBS AG v Depfa Bank plc [2014] EWHC 3615 (Comm), Males J endorsed the test. Accordingly, as for the existence of an implied representation, Etherton MR, Longmore and Newey LJJ approved the approach in Geest v Fyffes which proposed a useful test to consider whether a reasonable representee would naturally assume that the true state of facts did not exist and that, if it did, he would necessarily have been informed of it.

However, that was not to mitigate the requirement that there had to be clear words or conduct of the representor from which the relevant representation could be implied. In the present case, evidence existed that RBS had made a representation to the effect that it was not itself seeking to manipulate LIBOR. Asplin J had thus erred in holding that no representation could be implied from its conduct in proffering the swaps. Notably, their Lordships held:

133. In the present case there were lengthy discussions between PAG and RBS before the swaps were concluded as set out by the judge in the earlier part of her judgment. RBS was undoubtedly proposing the swap transactions with their reference to LIBOR as transactions which PAG could and should consider as fulfilment of the obligations contained in the loan contracts. In these circumstances we are satisfied that RBS did make some representation to the effect that RBS itself was not manipulating and did not intend to manipulate LIBOR.

Pointing out that Flaux J’s concern about the risk of “cross-infection” might therefore become relevant in some cases as a matter of fact, the court held:

139. The admitted manipulation of Japanese yen LIBOR and Swiss franc LIBOR is, of course, deeply shocking but that is not, of itself, a reason for holding that representations made to PAG should go further than representations about the sterling LIBOR rate. If, of course, a submitter in yen or Swiss francs had also made sterling submissions, that might render false the representation about sterling LIBOR but there is no evidence that any such submission occurred.

Overall, the court disagreed with Asplin J when she held, no doubt in the context of the intricate pleaded representations, that the proffering of the swaps was not in the context of this case conduct from which any representation could be inferred. Their Lordships held:

141. … We do not therefore agree with the Judge in this respect and would hold that RBS did impliedly represent that it was not manipulating and did not intend to manipulate sterling LIBOR.

But her Ladyship had found as a fact that there was no evidence of manipulation by the bank of sterling LIBOR, and the Court of Appeal was in no position to form a view of its own on that issue. Any errors on her part were insufficient to warrant the “unpalatable conclusion” of ordering a new trial.

(iv) The Valuation Claim

There was no reason to doubt Asplin J’s conclusion that RBS was entitled to commission the 2013 valuation of £35,000 plus VAT and to recover its cost from PAG. Therefore, the valuation claim failed.

Analysis and Comment

In addition to endorsing the logic in Graiseley – that the banks were representing that their own participation in the setting of the rate was an honest one – the outcome in this case marks a significant development and it shall undoubtedly steer future misrepresentation claims of this nature. US regulators have also fined RBS for market manipulation. The US Commodity Futures Trading Commission (CFTC) fined RBS $325 million and the US Department of Justice (DoJ) fined the bank $150 million. The DoJ remarked the near 300-year-old bank was guilty of a “stunning abuse of trust”. Of course, bad culture was to blame. Equally, its misconduct also spread into foreign exchange (FX) manipulation and it was fined £217 million by the FCA. The CFTC also imposed a fine of $290 million on RBS manipulate, global FX benchmark rates such as World Markets/Reuters Closing Spot Rates to benefit the positions of certain traders.

In addition to RBS, other banks such as Barclays have also been punished for fixing LIBOR and EURIBOR benchmarks. Barclays was fined $200 million for its misconduct by US regulators. The FCA imposed a fine of £216 million on HSBC and the bank paid a $100 million settlement for currency rigging to the CFTC. HSBC is also facing a potential £1.5 billion penalty for money laundering at its Swiss private bank. However, US authorities have finally lifted the historic “sword of Damocles” which hung over the lender’s head for historic misconduct and money laundering for Mexican drug cartels.

Lloyds was also fined £105 million for LIBOR and rate rigging by the FCA. In addition to these banks, Deutsche Bank was also fined $2.5 billion for LIBOR and EURIBOR rigging by the CFTC, DoJ and NYDFS. CFTC said that the bank’s “culture allowed such egregious and pervasive misconduct to thrive”. Similarly, the FCA also fined Deutsche Bank £227 million. Notably, Deutsche Bank’s star trader Christian Bittar recently pleaded guilty to EURIBOR manipulation. He earned a $126 million bonus in 2008 alone and is awaiting sentence. Bittar was identified only as “Manager B” in the FCA’s enforcement notice and as “Trader Three” by the American authorities. He raked in €2 billion in profits for Deutsche Bank over a five year period. The trial of the other defendants – Achim Kraemer, Colin Bermingham, Carlo Palombo, Philippe Moryoussef and Sisse Bohart – is scheduled to begin at Southwark Crown Court on 9 April.

Significantly, the present judgment has opened the door to misrepresentation claims against more than a dozen banks involved in historic misconduct and blatant benchmark rigging applying a if you aint cheating, you aint trying philosophy.

Overall, RBS which is 71 per cent government owned, made a $752 million profit in 2017 after reporting a £7 billion loss in 2016. The bank is under investigation by the DoJ for selling financial products linked to risky mortgages and is bracing itself for a record penalty which is expected in settlement for that misconduct. As noted previously, such fines, penalties and costs – or conduct costs – have already amounted to £264 billion from 2012 to 2016 and they seem set to rise even further in the future.



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