Banking and Finance Insights – July 2024

Welcome to the second edition of Banking and Finance Insights. The intention of these updates is to highlight some recent legal developments in bite-sized summaries of key points.  

We are of course happy to discuss any issues in more detail and would also welcome any requests for areas which you would like to see covered in future editions – please do get in touch with one of the team! 

Cases of interest from H1 2024  

By Susan Mitchell 

1. Break costs and back-to-back hedging arrangements 

In March, the High Court considered claims by four small or medium-sized enterprises that Clydesdale Bank was not entitled to charge break costs on the early repayment of their fixed interest rate loans. In Farol Holdings Limited and others v Clydesdale Bank Plc and National Australia Bank Limited, the court held that: 

• the back-to-back hedging arrangements Clydesdale entered into with National Australia Bank (NAB) in respect of each of these loans were legally binding  

• payments under each hedge fell within the break costs indemnity applicable on the prepayment of the underlying loan  

• Clydesdale was entitled to calculate its loss upon prepayment of a loan on the basis of the net present value (NPV) of the difference between the fixed interest rate due for the remainder of the term of the loan and the prevailing floating interest rates for the same period, and the sum due from Clydesdale to NAB upon termination of the relevant hedge was a reasonable proxy for that loss. 

The claims related to fixed rate loans entered into between 2002 and 2010 which each borrower decided to refinance (following the dramatic fall in interest rates post-2008 global financial crisis), thereby incurring break costs in respect of the related hedging. In addition to the break costs claims, the claimants also claimed that Clydesdale had misrepresented the profit element in the fixed interest rate offered and that non-disclosure of that profit element made the loans an “unfair relationship” under section 140A of the Consumer Credit Act 1974 – these claims were also rejected by the court. 

Conclusion  

Whilst the judgment in respect of break costs depended largely on an interpretation of the relevant contractual provisions, the finding that the contract terms permitted break costs to be charged on an NPV basis will be of interest to fixed rate lenders. The court noted that more than 900 other claimants had also commenced proceedings on similar bases, with these other claims being stayed by agreement to await the result of these four initial actions. 

2. Undue influence and guarantees/security – independent legal advice 

In March, the Court of Appeal considered the principles laid down by the House of Lords in Barclays Bank plc v O’Brien [1994], C.I.B.C. Mortgages plc v Pitt [1994] and Royal Bank of Scotland v Etridge (No. 2) [2002] on when security given for the debts of another can be set aside on the grounds of undue influence.   

In One Savings Bank plc v Catherine Waller-Edwards, the court noted that the above House of Lords authorities provide for two categories of cases relating to secured borrowings by two persons in a relationship: 

• “surety case” – non-commercial situations where, for example, one borrower guarantees the debts of the other or a company, or both borrowers take on new borrowing secured on jointly owned property to pay off debts of only one of them. In this case, the “Etridge protocols” should be followed, including the provision of independent legal advice.   

• “joint borrowing case” – where a loan is taken for the joint non-commercial purposes of two borrowers in a relationship. The lender will not normally have constructive notice of the possibility of undue influence and will not be put on inquiry. 

The appeal before the court related solely to the question of what is the correct legal test in a “hybrid case”, where a loan is taken out by the borrowers partly for their joint non-commercial purposes and partly for the benefit of one borrower only. The court held that Etridge does not demand that a lender is put on inquiry in a hybrid case unless the element of the transaction that is for the sole benefit of one of the borrowers is trivial. Instead, Etridge requires the court to look at such a transaction as a whole and to decide, as a matter of fact and degree, whether the loan was being made for the purposes of the borrower with the debts rather than for joint purposes. (Although not part of the appeal, the court also agreed with the decision of both the trial judge and the previous appeal judge that, looked at as a whole (and from the point of view of what the bank knew), the loan was a joint borrowing made for joint purposes.) 

Conclusion  

In this case, the Court of Appeal has rejected an attempt to widen the scope for undue influence to invalidate security. However, the case is a reminder that lenders should be alert to the possibility that knowledge that a part of a loan may be used for the benefit of only one borrower might be a factor indicating undue influence and could put the lender on inquiry. The safest course in such a hybrid situation may be for the lender to comply with the “Etridge protocols” and take steps (such as insisting on independent legal advice) to satisfy itself that the agreement to guarantee the borrowings of another has been properly obtained. 

3. Fixed and floating charges 

In May, the High Court turned again to the question of when a charge is fixed and when it is floating. In the Matter of UKCloud Ltd was an application by the Official Receiver and liquidator of UKCloud Ltd, in which the court held that the effect of the debenture in question was to give the chargeholder only a floating charge over certain internet protocol (IP) addresses. 

The case concerned a charging provision which purported to grant a fixed charge over “licences, consents and authorisations”. The court held that the language used evinced an intention to create a fixed charge on the IP addresses. However, the court then went on to consider: 

• Authority that a single charging provision (here a sub-clause) cannot create a fixed charge on some assets in a class and only a floating charge on others (the “all or nothing” principle) 

• Whether the IP addresses are of a nature that makes them susceptible of being subject to a fixed charge or only a floating charge. 

• Whether the chargeholder had sufficient control of the IP addresses for the creation of a fixed charge. While the debenture provided for control to be exercised, the chargeholder did not in fact exercise control or seek to do so. 

Following such consideration, the court held that the charge was a floating charge. 

Conclusion 

This is another case highlighting how much the analysis for characterisation of a charge as fixed or floating will depend on both the particular facts of the case and the particular drafting in the documents. Both must be considered carefully where a fixed charge is required, and care must be taken to ensure that control provisions are actually followed in practice once the charge document has been put in place. 

New legislation to watch out for 

By Jessica Caws

Building Societies Act 1986 (Amendment) Bill 2023-24 receives Royal Assent 

The Building Societies Act 1986 (Amendment) Bill 2023-24 received Royal Assent on 24 May 2024 as the Building Societies Act 1986 (Amendment) Act 2024 (2024 Act). The 2024 Act aims to make it easier for building societies to access funding from sources other than customer savings. The 2024 Act also takes certain steps to “modernise” the law relating to building societies. For example, the 2024 Act amends the Building Societies Act 1986 to allow real-time virtual participation in annual general meetings.   

Other market developments 

By Susan Mitchell and Jessica Caws 

1. LMA Guidance Note on the Building Safety Act 2022  

In April, the Loan Market Association (LMA) published a guidance note in respect of the impact of the Building Safety Act 2022 (the BSA) on real estate finance transactions. The BSA came into force on 1 April 2023, with many of its detailed provisions planned to be implemented over a two-year programme of secondary legislation. The BSA’s primary intention is to improve the design, construction and management of higher-risk buildings in England and Wales following the Grenfell Tower fire in 2017. 

The LMA guidance notes that: 

• The provisions of the BSA will not necessarily apply to every transaction documented by a facility agreement based on the LMA REF Development Facility Agreement, and whether or not it does apply is a matter to be determined by the parties to the transaction. 

• They do not consider it is necessary to add undertakings to comply with the BSA, because this is already covered by the compliance with laws and authorisations undertakings in the LMA document. 

Document changes 

The LMA note that, if the parties consider that the BSA will apply to their transaction, there are some areas where the parties may wish to include additional provisions, such as: 

• Additional conditions precedent to reflect any additional due diligence required by the BSA. 

• Amendments to the definition of “Practical Completion” to take account of additional requirements which must be satisfied under the BSA in order for the property to be used for its designated purpose. 

• Amendments to the information undertakings, particularly on-going information undertakings in respect of sharing the “golden thread” information about a building that will assist the safekeeping of that building.   

The LMA has concluded that it is not appropriate at this stage to make changes to its recommended forms of real estate finance facility agreements to incorporate such additional provisions, but they intend to reconsider the matter in six/nine months’ time to see if a market standard has emerged on these points. In the meantime, they have asked that LMA members let them know what developments they are seeing on this front.  

2. The Financial Conduct Authority’s response to Federation of Small Businesses super-complaint on lending to small and medium-sized enterprises 

On 5 March 2024 the FCA confirmed that it will be investigating the Federation of Small Businesses’ (FSB) super-complaint (raised in December 2023) regarding requirements for personal guarantees when lending to small and medium-sized enterprises (SMEs). These types of loans are not currently “regulated” by the FCA. However, since many lenders require personal guarantees from the directors of these SMEs, the FSB has argued that these individuals should be subject to the protection of the FCA’s consumer credit rules in the FCA’s Consumer Credit Sourcebook.   

The FCA has confirmed that the lending that the FSB is concerned with is outside the regulatory remit of the FCA and therefore is outside the scope of the super-complaint process.  As a result, the FCA’s ability to investigate and act is limited. However, the FCA is able to (and will) investigate data from regulated lenders providing regulated loans. The FCA will also pass on any evidence of harm in this sector to HM Treasury. The FCA further makes the point that it is the Government that sets the limit of its remit through legislation (and extending the scope of the consumer credit regime is not within the FCA’s power).   

The Chair of the FSB (Martin McTague) expressed his dissatisfaction with the FCA’s response and commented: “The FCA’s response is just not good enough…”. He complained that the FCA’s failure to gather evidence on the loans of concern increases the urgency to extend the regulatory perimeter. He says the FSB’s concern is the excessive imposition of personal guarantees, not the use of them per se. Mr McTague “urges the FCA to broaden this exercise to gather as much evidence as they can on lending to limited to companies by regulated lenders, which is where the real problem lies”.