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Peter Hamilton: Why the Court of Appeal dismissed RBS misselling case

Despite a recent Court of Appeal decision which found there was no liability for execution-only business, advisers should still be wary of operating on this basis.

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Last month, the Court of Appeal dismissed an appeal against a judgment in favour of the Royal Bank of Scotland in which the trial judge decided that the bank had not missold a simple swap agreement to two of its customers. 

It is an interesting, and at first sight, a surprising, decision. So it is important to understand what the Court of Appeal did, and did not decide.

But first the facts: Mr Green and Mr Rowley were customers of the bank. Mr Green was an estate agent and Mr Rowley was a hotelier and property developer in Lytham St Annes. They carried on business together in partnership buying and developing commercial property. The trial judge described them as intelligent and experienced businessmen.

By May 2005, Green and Rowley had two loans from the bank secured on their properties. In simple terms, they had borrowed £1.5m for a term of 15 years on an interest-only basis at 1.5 per cent above base rate which was then 4.75 per cent.

On 19 May 2005 there was a meeting with the bank at which they were told that they could enter into a swap which would in effect fix the interest rate. They decided to do so for a term of 10 years only, because within that period they expected to have sold or refinanced their properties. The swap was entered into on 25 May 2005.

It is important to note that the bank’s terms of business, which the customers accepted, stated that the bank would provide its services on an execution-only basis and would not provide any advice.

After October 2008, interest rates fell to the all-time low of 0.5 per cent by March 2009. The swap, however, worked as intended and provided Messrs Green and Rowley with what was in effect a fixed rate of interest at about the original level when they first entered into the swap.

That meant, of course, that the bank was being paid the interest due under the loan agreement of base plus 1.5 per cent, as well as the difference between that and the rate fixed by the swap. The bank was, therefore, was “in the money”. But as Lord Justice Tomlinson said in his judgment, “Through thick and thin the swap achieved its purpose of, in effect, fixing the interest rate payable under the loan”.

Early in 2009, Green and Rowley wished to restructure their partnership, with Green taking most of the properties as well as most of the debt. This meant revising the swap which still had about 6 years to run. Under the terms of the swap, in the event of an early termination, a payment became due to the party which was “in the money” at the relevant time. That payment was calculated to be about £140,000 due to the bank.

That was a shock to the two customers. They then claimed that the swap had been mis-sold to them. In particular, they said that the bank was required by the COB rules in force at the time to communicate to them clearly, fairly and without misleading, the way in which an early termination of the swap would work and the way in which the cost of such a termination would be calculated.

They also said that the bank had failed to make sure the customers understood the nature of the risks involved in early termination. See COB 2.1.3 and 5.4.3. Any breach of those rules resulting in loss gives rise to a claim for breach of statutory duty under what was then s.150 of the FSMA.

On 25 May 2011, which was the last day of the six year limitation period, Green and Rowley issued a claim in court against the bank. At the trial, the matter proceeded on the footing that any claim based on a direct breach of statutory duty due to the failure to comply with the duties set out in COB was barred by the Limitation Act 1980, because those duties arose on 19 May 2005 when the bank met the customers to discuss the swap.

That left the claimants with a claim in negligence; in other words, for a breach of the bank’s duty of care owed to them which arises under the general or common law. The argument then became, what was the scope of that duty of care?

The claimants argued that that duty of care included a duty commensurate with the duties arising under COB 2.1.3 and 5.4.3; ie, to communicate the effect of the swap and the consequences of its early termination in a way which was “clear, fair and not misleading” and to ensure that its customers understood “the nature of the risks involved”.

The judge disagreed and dismissed their claim. He held that the bank gave no advice and did not recommend the swap; that the bank did not assume an advisory duty of care before the meeting on 19 May 2005 and nothing that was said by the bank’s employees at that meeting gave rise to such a duty. He also held that such duty of care as the bank did owe, did not include a duty in effect to comply with the rules in COB. Green and Rowley appealed.

The Court of Appeal agreed with the trial judge. The starting point of Lord Justice Tomlinson’s judgment was that there was no appeal against the finding of fact that the bank did not owe any duty to advise. The swap transaction was entered into on an execution-only basis. It followed, therefore, that the bank’s duty of care was limited to taking care that the information it provided to its customers was accurate in the situation in which the bank knew that the customers were relying on the bank’s skill and judgement.

Thus, the bank was under a duty not to mislead or mis-state the information it gave. But the duty of care did not extend to communicating clearly or fairly or to ensuring that the customers understood all the risks involved.

The argument for the customers amounted to saying that the mere existence of the COB rules gave rise to a co-extensive duty at common law. As Lord Justice Tomlinson said, that proposition invited the question, “why?”. If that were so, it would not have been necessary for Parliament to include s. 150 in the FSMA, which specifically provided that a breach of the COB rules can in certain circumstances give rise to a cause of action if a private person has suffered loss as a result.

If the bank had owed a duty to advise – and not merely to give accurate information – the answer could have been different.

It is well established that a duty to advise would be influenced by the duties in COB. A financial adviser’s duty to advise with skill, care and diligence would ordinarily include compliance with the rules of the relevant regulator.

This case turned on the finding that the transaction was execution-only. But it would be a mistake to think that advisers should seek to provide their services on an execution-only basis, because the courts, the FOS and the FCA will all examine all such cases very carefully and will be quick to spot anything that looks like advice such as an expression of opinion or value judgement on the part of the adviser. Also, most clients want advice and it is the adviser’s job to provide it.

Peter Hamilton is a barrister specialising in financial services at 4 Pump Court and co-founder of moneymatterslegal.co.uk

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Comments

There are 5 comments at the moment, we would love to hear your opinion too.

  1. This case appears to suggest that facilitating just about any transaction on an EO basis requires of the intermediary very nearly as much care as advising on it, not least in terms of assessing and recording in letters writ large whether or not the client is/was adequately experienced and capable of making their own determination as to whether or not the product in question was suitable for them. Plus, of course, the client needs to be told that they should read thoroughly and carefully all the relevant terms and conditions to ensure that they are fully aware of just what they’re entering into without having taken advice.

    Anecdotally, a common basis for a complaint is that the intermediary had a responsibility to assess whether or not the client was actually capable of making their own determination. If it can be proved to a third party arbitrator that they were not, the intermediary may then be deemed liable for having allowed them to proceed, no matter how confident the client may have been at the time. Yes, I know I said I was happy to proceed on an EO basis but the intermediary is still liable for having failed to determine that, in fact, I wasn’t actually competent to do so. The intermediary is responsible for having failed to protect me from my own misjudgement.

    Perhaps the only (relatively) safe basis on which to facilitate EO transactions is for the intermediary firm to make absolutely clear that they’re 100% EO and that neither advice or any assessment of suitability are available under any circumstances. If advice could have been provided, the intermediary may well be held liable simply for having failed to insist that it should have been.

    Very sticky territory.

  2. In 2009 the FOS limit was still £100,000 whereas the dispute was over £140,000.

    So it leaves the question of whether FOS would have acted differently unanswered.

  3. As ever…. excellent article Peter….

  4. I remember reading in Money Marketing about a year ago about a client who successfully sued a well-known building society for so-called execution only sale in respects to a structured product.
    The building society even had a signed document stating that the clients were taking the product out through an execution only service. However the judge ruled that the process was flawed due to the fact that the client entered into detailed conversations with the branch member of staff and therefore implied advice was given.

    Really wish Money Marketing would cross-reference this is a really do believe that execution only is a dangerous area for business owners. Particularly if clients can successfully claim that implied advice was given.

  5. Re: Peter Herd’s post ~ In future, any organisation offering any product on an EO basis should refuse point blank to enter into any discussion whatsoever with potential investors. Just make available a brochure, KFD and application form and that’s it.

    Anyone who wants one need only complete an application form, sign a disclaimer and pop them both with their cheque into the nearest post box. Applications by any other method of delivery and/or unaccompanied by the disclaimer will not be accepted under any circumstances. Application forms left in the branch will be shredded and binned.

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