High Court rejects misselling claim in respect of fixed interest rate loans

In Farol Holdings Limited & Ors v Clydesdale Bank PLC & National Australia Bank Limited [2024] EWHC 593 (Ch) the High Court dismissed claims brought by customers in relation to break costs charged by Clydesdale Bank PLC (Clydesdale) on the early repayment of fixed rate loans.

The Claimants alleged that Clydesdale and its former parent company, National Australia Bank Limited (NAB) (the Defendants) had made fraudulent or negligent (mis)representations at the times of entry into and termination of the loan agreements. They argued that Clydesdale had not been entitled to charge the break costs on early repayment, and also alleged that the explanation of the pricing of the loans had been misleading and the pricing included hidden profit.

The judgment will be welcomed by lenders.

Background

Clydesdale offered fixed interest rate loans to Farol Holdings Limited and other small businesses (the Claimants) from around 1999 to 2012. To manage its exposure to the interest rate risk, Clydesdale agreed back-to-back hedging agreements with its parent, NAB, mirroring the terms of the loans. Clydesdale was the fixed rate payer and NAB the floating rate payer. As a result of the global financial crisis in 2008, interest rates fell dramatically and the Claimants sought to refinance their loans, thereby incurring early repayment break costs under the loan standard terms.

The claims

(1) Break costs:

Upon termination of the loans, the hedging agreements also terminated resulting in payments becoming due from Clydesdale to NAB. Clydesdale passed on these costs to the Claimants as break costs under the loans.

The Claimants argued that Clydesdale was not entitled to charge break costs to customers based on its liability to NAB under the hedging agreements. Further, the Claimants alleged that it was an essential pre-requisite of an entitlement to claim break costs that Clydesdale had suffered an actual, crystallised loss or cost as a result of action taken by it in the external market following the early repayment. Clydesdale could not claim a notional loss calculated by comparing the Net Present Value (NPV) of the future income stream under the fixed rate loans with the anticipated future income stream that Clydesdale could expect by on-lending the monies repaid early.

(2) Misleading and/or false statements:

The Claimants also argued that when contracting for the loans, the Defendants provided a misleading description of the fixed interest rate. The fixed rate of interest comprised two components: a fixed rate and margin. However, the fixed rate itself included (a) a mid-market swap rate and (b) up to 50 additional basis points representing extra income to Clydesdale (the Additional Value), which was not disclosed to the Claimants. The Claimants alleged that the Defendants had made various fraudulent, alternatively negligent, misrepresentations to the effect that the fixed rate was a market rate which did not include any additional profit for Clydesdale, with the margin being Clydesdale’s only profit from the loans. The Claimants also alleged that fifteen current and former employees of the Defendants were deceitful.

Two of the Claimants also argued that the non-disclosure of Additional Value rendered their relationship with Clydesdale “unfair” within the meaning of section 140A of the Consumer Credit Act 1974.

Decision

The High Court dismissed the claims.

1. Break costs: The High Court held that the hedging agreements were legally enforceable and that the Defendants were contractually entitled to claim the break costs. Clydesdale did suffer a present loss, being the loss of the contractual right to recover interest at the fixed rate for the remainder of the term, and that loss occurred at the point of early repayment and was not a purely future loss. Although events occurring after the early repayment might be used to help calculate the amount of the loss, this did not reverse the general principle that losses in respect of a breach of contract were incurred at the moment of the breach. Comparing the NPV of the future income stream under the contract with the NPV of the income stream at current market rates was an established market technique for valuation. The sums due from Clydesdale to NAB upon termination of each hedging agreement were a reasonable proxy for that loss.
2. Misleading and/or false statements: The High Court held that the Defendants’ employees did not (by omitting any mention of Additional Value) represent, dishonestly or otherwise, that the only income Clydesdale generated on the loans was by way of the margin. Clydesdale’s employees were not dishonest in omitting to describe the Additional Value profit made outside the margin during well-established, routine booking calls. The employees were not aware they were making implied representations about the Defendants’ profits and definition of the fixed interest rate, and so could not have deceitfully made them.
3. Consumer Credit Act 1974: The Court held a reasonable customer would not think about the bank’s profits when agreeing to borrow nor about what the bank was telling them about the fixed rate’s composition. Their focus instead would remain on the overall interest rate and its competitiveness. A fixed rate loan provided additional and valuable benefits to the customer, and their provision involved the banks incurring additional costs. The Judge concluded that there was nothing unfair in Clydesdale making a profit from that service or in the fact that the Additional Value was not disclosed – it was “unsurprising that a bank would seek to make a profit from its lending business”. The Additional Value within the rate, therefore, did not constitute an unfair relationship between the Claimants and Defendants under the Consumer Credit Act 1974.

Key takeaways

1. Whilst lenders will welcome the upholding of Clydesdale’s right to charge break costs on a NPV basis, this case highlights the importance of the wording of the relevant terms and conditions and the basis on which banks are entitled to claim losses as break costs. Careful consideration needs to be given when drafting break clauses and what the banks are expecting to be able to recover under such provisions.
2. The Court placed emphasis on the fact that the employees were “following an established practice” as strongly suggestive that the employees were unaware of any implied representations. This position may be reassuring to employees, but it is noted that established practice alone is not a defence for mis-selling. Employees acting as part of an ‘inherently deceptive’ system can be liable if they are aware that they were making false representations on which others rely.
3. Lenders will also welcome (i) the finding that Clydesdale was entitled to charge a margin, in the form of Additional Value, both to cover the additional costs of providing fixed – compared to floating – rate lending and to earn an element of profit and (ii) the conclusion that making a profit from its lending business is not an indication of an unfair relationship.

With thanks to Anastasia Stepanova for her assistance in preparing this post.