In the UK, the handling of financially stressed business customers by RBS’ Global Restructuring Group (the loan workout unit) has been highly controversial, and attracted a great deal of media attention.
However, very few disputes between borrower and lender have actually progressed through to final judgement, until the December 2016 decision in Property Alliance Group Ltd (PAG) v The Royal Bank of Scotland plc.
In that case the borrower claimed (amongst other things) that RBS had breached a duty of ‘good faith’ in its conduct of the loan workout.
In the judgement the Court held that there was no such common law duty in the UK, and so there could be no breach – but is there such a duty in Australia? That’s a difficult question: one academic said the answer was “incoherent”! Perhaps the answer does not matter, however, because the Australian Code of Banking Practice includes a requirement to “act fairly and reasonably.” *
The decision will be of interest to Australian lenders and their advisers, even more so because the conduct at issue goes to the heart of allegations about ‘constructive default’ that have been raised in the PJC Inquiry into the Impairment of Customer Loans and the forthcoming Senate Select Committee on Lending to Primary Production Customers.
PAG is a property investment and development business – still trading today – that operates primarily in the North West of England. It borrowed money from RBS, and entered into a series of interest rate derivative products (‘swaps’) prior to 2009.
In the aftermath of the GFC LIBOR fell significantly and by December 2009 sat at 0.60%, and consequently the swaps were ‘out of the money’ by more than GBP9m. A fall in the value of PAG’s real estate portfolio, on top of the liability for the break cost, resulted in a loan to valuation ratio of more than 90% – and led to a transfer to GRG. After extensive negotiations in June 2011 the swaps were closed out a cost of GBP8.2m. Part of that cost was absorbed by RBS, but most of it was funded by an additional loan.
PAG remained under the control of GRG until July 2014 when it refinanced to another lender, shortly after initiating the legal proceedings against RBS.
Three elements to the claims
PAG claimed that the swaps were mis-sold. Instead of providing a hedge as represented, PAG argued, in fact they left PAG in a worse financial position than otherwise.
PAG’s claim also involved the widely reported allegations that LIBOR had been manipulated by RBS and other LIBOR participants. PAG said that it was unfair that RBS knew of the manipulation, but PAG did not.
The last claim, and the part most relevant to this discussion, was that by transferring management of PAG into GRG – and by what occurred after that transfer – RBS had breached an implied duty to act in good faith.
What did the RBS workout team actually do?
Arguably, GRG (referred to by some critics as the Grim Reaper Group!) did not quite live up to its apparently fearsome reputation (discussed in more detail here).
GRG did not appoint an Investigative Accountant, or appoint receivers. It did obtain updated valuations and seek a one-off debt reduction to improve the LVR, but even the deputy Chairman of the borrower, who lead the negotiations for re-financing, described RBS’s role amongst other things as ‘reasonable’, ‘friendly’, ‘helpful’ and ‘constructive.’
Alleged breach of good faith #1 – the transfer to GRG
PAG claimed that the stated reason for its transfer to GRG control was a pretext: it said that it had little need to restructure because there was ‘no risk of default.’ PAG said that the real reasons for transfer were to stifle anticipated litigation over the swaps mis-selling, and to extract as much revenue from PAG as possible.
The Court held that there was no contractual right to be managed by a particular team, and so it was open to RBS to transfer management control to GRG, and there was ‘substantial documentation’ which showed the transfer clearly as being within RBS policy. Secondly, the Court found that at the time of the transfer RBS was not really aware of PAG’s mis-selling complaints, and so could not have made a decision to attempt to stifle them.
Finally the Court said that there was simply no evidence that there was an intention to extract as much as possible from PAG.
Alleged breach of good faith #2 – retention in GRG
PAG claimed that it was ‘wrongfully retained’ in GRG, to impose a 100% ‘cash sweep’ in order to maximise value for RBS and (continue to) deprive PAG of funds for litigation.
The Court held that there was simply ‘no evidence’ to support those contentions. The Court accepted that RBS policy required an updated valuation before the customer could be returned to the frontline team, and information about an associated entity. RBS’ failure to address these reflected a far more mundane reason: overwork.
Alleged breach of good faith #3 – Demanding an unnecessary and onerous ‘Security Review’ at PAG expense
The Court said that the requirement for a security review was not capricious, it was a condition of the very significant new lending that RBS provided to fund the close out the swaps.
Alleged breach of good faith #4 – Calling for updated valuations of PAG’s portfolio in both 2010 and 2013.
There was a clause in the loan documents that allowed RBS to call for an update of valuations at borrower expense, but it had opted not to exercise this right until 2010, and then again in 2013. The Court held that the decision to seek valuations was not ‘capricious’ – the bank needed valuations to make an informed assessment as to whether PAG met the criteria for transfer back to the front line, or refinance by another bank.
Alleged breach of good faith #5 – applying improper pressure on the valuers to manipulated the result of the 2013 Valuation
It was true that RBS had raised queries about a draft valuation, which had led to a 1.5% reduction in the valuation, and thereby increased the amount of the payment that PAG had to make to improve the LVR. However, the valuer had not challenged the legitimacy of the questions, and there was nothing in the valuer’s evidence to suggest that he had been placed under improper pressure.
Alleged breach of good faith #6 – a threat to appoint receivers
It was clear that there had been discussion about the possible appointment of receivers – although it was less clear what the context was. The Court accepted that an RBS staff member did threaten to appoint receivers, and that ‘the incident amounted to an improper threat,’ but found that single incident by itself did not justify a conclusion ‘that the alleged implied duties were breached.’
Bank wins 3 – nil
PAG was unsuccessful on all counts. The Court held that RBS had a ‘non-advisory’ role, and that the terms of the contract between PAG and RBS prevented PAG from claiming otherwise, and so the misspelling claim was doomed.
The rejection of the LIBOR claim was comprehensive. The Court said that linking a transaction to the LIBOR rate did not automatically give rise to any implied representation, but in any event there was no evidence that PAG had relied upon such representations.
Finally, even though there is no general duty of good faith under English law, the behaviour complained of would not have breached any hypothetical breach.
What should Australian Lenders and their advisers take from the decision?
The judgement is unusual in revealing some of the inner workings of a loan workout team – but what it does reveal is fairly mundane. It highlights that banks are best prepared for challenges to conduct by having policies that set out what is expected, and ensuring that where discretion is exercised there is contemporaneous documentation to explain how it was exercised.
*My thanks to Michael Murray of Murrays Legal for guiding a non-lawyer through the complex issues of good faith!
Update: For more recents developments please see The beginning of the end? The RBS – GRG saga
4 thoughts on “Loan workouts: insights from the UK”