No conspiracy in UK GRG case

The conduct of RBS’ loan workout unit GRG in the aftermath of the GFC was highly controversial, attracting media and Parliamentary attention, and resulting in a series of inquiries and reports (discussed here and here), as well as litigation by unhappy borrowers.

Some of the judgements have provided insight into the inner workings of bank restructuring teams, such as the claims pursued by PAG (discussed here), and most recently, a case in which the borrower claimed conspiracy on the part of the Lender arising from the involvement of a borrower-side adviser (the Adviser) engaged and paid by the borrower but nominated by the lender.

Background

The claims were brought by a chiropractor and his wife, and various associated entities which operated sixteen chiropractic clinics and owned property (the Claimants).

Banked by RBS since 1999, control of the account was transferred into GRG in 2009, and shortly thereafter GRG proposed a strategy which included the engagement of the Adviser.

A range of measures were tried, including a restructure in 2011, but none were successful. In February 2013 RBS appointed administrators following an attempt by the chiropractor to liquidate the companies, and in due course the Claimants commenced action for damages in respect of three claims alleging:

Mis-selling of an interest rate swap in 2007 which locked in a base rate of 5%, resulting in an interest cost £100,000 per year higher it would have been with a variable rate.
Mis-selling said to arise from the 2009 restructuring of the 2007 swap.
Conspiracy to exploit a claimed “breach by [the Adviser] of her duties of loyalty.”

A contrast in witness credibility

The Court found that the chiropractor “had become obsessed with blaming the Bank for the collapse of his business…[which] meant that it was difficult for him to give evidence comprising his best recollection…[some parts were] at best wishful thinking, mis-recollection and bluster, and at worst (as the Bank submitted) an obvious lie.”

By contrast the Court found that the Adviser was “an impressive witness” whose evidence was comprised of “honest and (usually) brief and clear answers to questions,” and that it was “easy to see why…[she] had been held in high regard by RBS.”

Findings

In CJ & LK Perks Partnership & Ors v NatWest Markets Plc [2022] EWHC 726 the Court found, in relation to the mis-selling claims:

There was no complaint by the chiropractor at the time when advised that loan approval was subject to interest rate hedging.
There was no evidence to support the conclusion that a claimed misrepresentation – that interest rates were going to rise – was made at all; and there was no evidence that the chiropractor relied upon it, because the chiropractor “wanted to expand the business and wanted the loan which RBS was proposing” and he was “happy to enter a swap if that is what the Bank wanted.”
There was no misstatement in the information provided by RBS, who in fact had warned him of significant risks which were associated with the swap.
There was no evidence to support the existence of other purported unadvised risks, and no evidence that those purported risks had actually impacted the Claimants – but even if there had been, the chiropractor would still have entered the swap, because he wanted the loan.
A claim for improper advice also failed. Not only had the RBS banker recommended that the chiropractor seek independent advice, but there was no causation grounds because the chiropractor “would still have entered into the swap, because [he] wanted the loan.”
The more limited claim in respect of the 2009 swap was also unsuccessful because there was “no substance to the case that the [relevant] risks…were not sufficiently explained.”

In relation to the conspiracy claim, the Court held:

There was no evidence whatsoever to support the allegation that the transfer to GRG “was driven by an ulterior motive on the part of RBS.”
A payment default was “obviously a serious matter” and together with clear evidence that the business would not be able to meet future obligations, justified transfer to GRG.
It was true that the Adviser had put moderate positions to RBS, but that was because she recognised that a favourable outcome for the businesses required the agreement of RBS, and that “it was unproductive to take positions which were likely to be rejected.”
Not only was there “no substance in the case of conspiracy” it was appropriate to “exonerate” the Adviser and the RBS staff, who had “acted with integrity.”

The Claimants were unsuccessful.

How do we measure up? Australian treatment of SME borrowers

The first hearings of Australia’s Banking Royal Commission began in March 2018 – only one month after the final conclusion of a long running UK review into the post-GFC handling of problem loans by UK’s Royal Bank of Scotland.

A so-called ‘Skilled Person’ report was commissioned by the UK Financial Conduct Authority in January 2014, and delivered in September 2016. But it was only released to the public in February 2018 when an apparently impatient Parliamentary Committee acted unilaterally by publishing the full report online here.

Whereas the Royal Commission hearings in June 2018 presented a small and carefully curated selection of customer complaints, the RBS review conducted an extremely detailed analysis of more than 200 cases – an unprecedented insight into the working of a workout team.

The background to the report is discussed in detail here.

The report concluded that there was ‘widespread inappropriate treatment of customers’ by GRG – RBS’ workout team. It included recommendations for RBS specifically, and also made recommendations ‘for the wider market.’ Both are reproduced in full below.

How does Australia measure up against the RBS report recommendations?

At a time when there appears to be fierce scrutiny of the treatment of small business borrowers by Australian banks, it is appropriate to measure the current Australian position against the four general recommendations contained in the RBS report:

1. Extension of Unfair Contract Terms protections to SMEs

The UK’s Unfair Contract Terms regime does not apply to SME businesses at all.

The Australian UCT regime does not completely align to the UK regime (for a careful comparison see here) but what is in place does apply to loans of less than $1 million to small business (defined as those with fewer than 20 FTE) made or varied after 12 November 2016.

The ASBFEO and others argue that the $1m limit is too low, but Australia at least has some coverage.

2. Greater access to the Financial Ombudsman Service

In the UK, ‘micro-enterprises’ (an EU definition: businesses with an annual turnover of up to two million euros and fewer than ten employees) can access their FOS scheme, with compensation awards limited to £150,000.

In Australia, the current FOS scheme compensation is limited to $323,500. At present then, the UK and Australian schemes provide broadly similar coverage, however from 1 November 2018 the new Australian Financial Complaints Authority will commence operations. AFCA will have power to award compensation of up to $1m in relation to business credit facilities up to $5m provided to businesses with less than 100 staff.

As of 1 November the Australian scheme will therefore be available to micro, small, and medium businesses, and it will provide significantly larger compensation. Australian businesses will clearly have better protection from 1 November than their UK counterparts.

3. Introduction of a Code for bank support of customers

There is a ‘Lending Code’ in the UK, but it provides limited guidance in the area of bank support, and in any event it only applies to micro-enterprises.

The Australian Code of Banking Practice – approved by ASIC last week, but to apply no later than 1 July 2019 – is available here.

The CoBP is stated to apply to ‘small businesses’ (yet another definition!): those with fewer than 100 staff and annual turnover of less than $10 million in the previous financial year, and less than $3 million total debt.

Part 6 of the CoBP sets out protections for small businesses. Perhaps the most significant development is a limitation on the recovery of loans based on the grounds of non-monetary default. That said, careful explanation is required because some non-monetary defaults will still apply if material: formal insolvency, lapsing of insurance, failure to provide correct and complete information, a loss of license or breach of law, or use of the loan funds for an unauthorised purpose. There also specific types of loans where ‘financial indicator’ non-monetary defaults are ‘ruled in’ : margin lending, SMSF loans, bailments, invoice finance, construction finance, foreign currency loans and tailored cash flow lending.

Other changes include:

A minimum 30 days’ notice of enforcement action (albeit with some exceptions where special risks are evident).
A minimum of 3 months’ notice where a bank decides not to extend a loan beyond its original term.
A blanket prohibition against the use of ‘material adverse change’ clauses.
Clarity around valuation processes: clear explanation around the purpose of the valuation, with copies of property valuations and valuer instructions to be provided to the borrower unless enforcement action has already commenced.
An undertaking to ensure that valuers and investigating accountants are members of professional organisations with appropriate codes of conduct. Banks must apply additional internal oversight if investigating accountants are to be appointed as receivers.

ASBFEO argues that the $3m limit is too low and should be increased to $5m, but again, Australia is clearly ahead of the UK in relation to a formal code of practice.

4. Dealings with third-party providers, especially in relation to secondees.

The RBS report identified issues which it said gave rise to concerns that third-party service providers ‘may be too ready to see the bank’s point of view.’ Most would expect that a service provider would work hard to see things from a clients’ point of view however, so it is not clear at first reading what criticism was intended by the authors of the report.

More clearly, the report identifies the need for controls around distribution of sensitive information to advisers, and the potential for conflicts of interest where secondees are involved.

Most lenders would have their own controls around such issues, but there is no industry standard in either the UK or Australia.

Recommendations do not apply to non-bank lenders

The RBS recommendations refer specifically to ‘banks’ rather than ‘lenders.’

At least in Australia, the market share of non-banks is growing strongly in some sectors. Some part of that growth may be due to a customer preference for Fintech offerings, but it also reflects the lack of alternatives for borrowers who are excluded by the CoBP criteria (for example, those who are ‘asset rich’ but ‘income poor’), or seeking funds in areas where bank portfolio management issues translate to limited appetite (currently: property development).

Some critics of banks may argue that it is appropriate that banks are subject to a higher standard than other lenders. Leaving the merits of that argument to one side, it raises an interesting policy question: is there a need for non-bank borrowers to have a real understanding of which regime applies, or is it acceptable for that to be left to the ‘small print’ of the loan agreement?

Overall

It may not suit the narrative of some bank critics, but protection of small business bank customers is greater than that available to small business non-bank customers, and it is clear that both have significantly better regulatory protection in Australia than their UK counterparts.

Part 7 of RBS Group’s treatment of SME customers referred to the Global Restructuring Group (available online here) is reproduced in full below.

Part 7 – Recommendations

7.1 Throughout this report, we have Identified Issues relating specifically to RBS, but we also believe that there are wider lessons for RBS and for the industry as a whole. In this Part we draw together specific recommendations for RBS and draw out some wider observations in the light of our findings.

7.2 The FCA has instigated a review of its own approach to SMEs as users of financial services and we see our report and its recommendations as a contribution to that work. There are also Important Implications for other lenders, the professionals with whom they work, policy makers, and SME customers.

Recommendations for RBS

7.3 The conclusions we have reached in this report warrant a fundamental rethink by RBS of how it handles Its SME customers in financial distress.

7.4 We recognise that some change was already being made at the end of the Relevant Period. But the terms of reference for Phase One meant that we did not review whether or not the lessons from these events have been learnt by RBS, or whether the wide-ranging changes that we consider to be necessary have been made and are embedded. As we did not review changes made by RBS after the end of the Relevant Period we recognise that some of the recommendations set out below may already have been addressed or their relevance superseded by subsequent events but nonetheless they provide a framework within which future treatment of SME customers can be developed and provide an opportunity to address the weaknesses in governance and oversight, and indicators of poor culture in GRG that we have highlighted In this report.

7.5 We recommend that a review is carried out to ensure that our conclusions and recommendations that remain relevant to RBS have been implemented and in particular, to provide assurance to RBS, customers and the FCA that adequate governance and oversight arrangements are now in place to ensure that similar poor treatment of distressed SME customers could not happen in future.

7.6 Specifically we recommend that in carrying out that review RBS should, in the light of the observations and conclusions in this report:

Improve its governance arrangements and in particular*:
- Review the objectives set for its turnaround division – the revised objectives should be agreed by the RBS Group Board;
- Review the governance of its turnaround division to ensure that it is subject to effective scrutiny, and establishes effective second and third lines of defence;
- Review the content and form of management Information to ensure that customer outcomes and experience are accurately reported:
- Review the staff objectives set for, and culture of, those In Its turnaround unit dealing with SME customers to ensure that these more closely align with the revised objectives the RBS Board has agreed;
Improve the arrangements around transfer into and out of the turnaround unit:
- Revise the criteria for the consideration of referral to the turnaround unit In respect of SME customers;
- Review the governance of the transfer process for SME customers to ensure that It is acting both efficiently and fairly: specifically we recommend that the chair of the group considering transfers should be independent of both B&C and the turnaround division;
Ensure that its arrangements for returning customers to mainstream banking are clearly signposted to SME customers and that where RTS is appropriate this can be expedited promptly;
Provide a greater focus on turnaround options where these are viable:
Review and Improve Its training and guidance for staff handling turnaround issues and ensure that staff have the necessary support and training to deliver good turnaround practice;
- Ensure in future that viability assessments are carried out on all cases following transfer and that where customers are potentially viable, a clear turnaround plan with milestones and targets should be produced and wherever possible shared and agreed with the SME customer;
- Review the role and purpose of the Strategy and Credit Committee (or its successors) to ensure the terms of reference contain a requirement that turnaround options and the fair treatment of customers are reviewed in addition to credit considerations;
Rethink its approach to pricing in respect of distressed SME customers:
- Review the policy and practice of the turnaround unit on pricing to ensure that Relationship Manager pricing decisions and reasoning are fully documented and validated and that turnaround considerations are taken Into account;
- Review the range and form of fees and other charges for SME customers and set out for customers a clear and simple guide to when fees wiII be applied;
- Review the rationale for an additional administrative/management fee being routinely levied on distressed customers;
Ensure any internal valuations are handled more carefully:
- Ensure that internal valuations and the reasoning behind them are fully documented and that this information is shared with the customer if the valuation is to be used in the development of strategy, or in decisions around the level of facilities or pricing;
- Where in-house resources are used to provide valuations upon which significant decisions are made In the context of a turnaround unit, RBS should ensure that there is a clear separation of functions and adequate safeguards to prevent conflicts of Interest;
Review its policies and practices on dealing with customers and on complaints:
- Review its policy and procedures for Relationship Managers’ engagement with SME customers. In particular RBS should consider how Its engagement with SME customers takes appropriate account of the different circumstances of the diverse group of SMEs with which it deals;
- Review and revise its communications with customers to ensure that it is transparent, clear and informative,
- Revise its approach to complaint handling and provide SME customers with clearly signposted routes to escalate their complaint if necessary;
Review its use of third-party firms and in particular the use of secondees’

RBS should ensure that appropriate guidelines and mechanisms are in place to guard against conflicts of interest in these areas;

Fundamentally review its approach to the purchase of distressed assets:

Amend the governance, policies and practices and other arrangements relating to circumstances where it (West Register) acquires or considers the acquisition of assets owned by its distressed SME customers to address the shortcomings in arrangements that we have Identified and ensure effective separation of the function from any turnaround unit;

Review the use of Upside Instruments in the context of SME customers:
- Review the Information provided to SME customers In relation to PPFAs to ensure that the agreements and the associated costs are transparent; and
- Review the role of EPAs In relation to SME customers, in so far as RBS Judges their continued use is justified and helpful to some customers it should further consider customer communication, minimum timescales and notification of buy-back terms, the governance around the arrangements and more widely the Interaction between SIG, the turnaround unit and SME customers

7.7 Addressing these recommendations will help ensure that similar problems to those experienced In RBS’s GRG during the Relevant Period do not occur in future. These recommendations do not, however, address the concerns and Issues of those SMEs that were handled by GRG. We make two recommendations that are intended to address specific unfairness that we observed during the course of our review. These are:

Revisit the cases Identified in our review where it Is clear that GRG failed to respond to a complaint or where Its response was Inadequate, and
Review the position of those SME customers who entered Into an EPA during the Relevant Pernod with a view to ensuring that where a West Register minority holding in their business remains in place that they have a fair means of resolving disputes about the value of that holding.

7.8 But those specific recommendations do not address the central findings of our review. We have identified a number of cases where we conclude that the actions of RBS are likely to have caused material financial distress to the customers affected and there are other cases where it seems clear that the customer will have suffered from some unfairness. It is understandable that there will be calls for RBS to compensate the customers affected.

7.9 As we have noted previously the extent and nature of financial distress vary considerably and are often hard to quantify with any precision. The circumstances of GRG customers often meant that the Bank had considerable discretion under the law, and those Individuals who suffered may not have a straightforward legal position. In any case, for example because the company was the Bank’s customer, and they may no longer be the owners, or the company may have ceased to exist. The inappropriate actions we identify and their wide ranging consequences for customers were not caused by breaches of regulatory rules or principles so the scope for regulatory action is limited

7 10 Responsibility for responding to these Issues and the distress GRG caused many of its customers rests with the Board of the RBS Group. We do not underestimate the challenges of any redress scheme it would likely require independent, lengthy and complex mediation, operating outside the strict legal framework.

7.11 Nevertheless we recommend that RBS should consider the practicalities of providing redress to GRG customers who are likely to have experienced financial distress as a result of its actions.

7.12 There are also some wider Issues for RBS to consider. First the extent to which the Issues we report here In respect of GRG were or In particular remain features of other units handling SME customers. We recommend that RBS reviews the relevance of these findings more widely to its handling of SME customers.

7.13 Second the terms of the Requirement Notice meant that we did not review the extent to which those in RBS outside GRG were aware of the Issues. In any event it appears to us that there are wider lessons for RBS to consider in terms of how the events in GRG could have continued for so long apparently either unnoticed or unchallenged by others in the wider RBS Group.

Lessons for the wider market

7.14 The FCA has, as noted above, Instigated a review of its own approach to SMEs as users of Manual services. Our report and its recommendations can be viewed as a contribution to that work. Our findings highlight the diversity of SMEs and the Inequality of bargaining power between less sophisticated SMEs and banks. They also underline the lack of protection available more widely to SMEs.

7.15 The case for standards – established either by regulation or by agreement – In relation to lending to SMEs Is derived from the special features of the market, as described In the CMA/FCA Market Study and the wider CMA Retail Banking – SME market Investigation: a sector with high concentration in lending, the lack of understanding of many SMEs as to the pricing of banking products Including loans, and the paradox of Simultaneous low levels of satisfaction and of switching among SME bank customers. As our work has shown, SME customers facing hardship may have even more limited choices. They will often have little realistic prospect of changing their banking arrangements – whatever their level of satisfaction or dissatisfaction with the services provided, and whatever the price of those services. This Is particularly the case during periods of economic uncertainty

7.16 The SMEs In our sample illustrate the variety of SMEs that banks have to deal with. They included some SMEs with a reasonable level of financial sophistication who had available to them expert advice; but they also included SMEs without access to Independent advice, and with little financial experience. Even when a SME had some reasonable understanding of financial Issues, this was not necessarily sufficient for the increased complexity of the Issues which often arose once the SME was transferred to GRG, where the situation could be complicated both by general legal issues such as the different protections and treatments offered to limited companies and to sole traders, and by the complexity of the solutions which GRG on occasion brought forward. There were other important differences some were In effect sole traders or owner managers where the sickness of a key individual could have catastrophic consequences for the business for some smaller customers the lending was closely intertwined with personal financial arrangements, so that when things went wrong in the business the consequences were personal as well as professional.

7.17 We have noted that GRG had few arrangements for drawing such distinctions in its customer base and for shaping its services and communications with an eye to these differing levels of capability. Indeed, it is not clear that RBS now accepts the need for this.

7.18 We believe that policies and practices for the SME sector need to be based at least In part on an appreciation of differing customer capabilities, if the SME customer is to be treated fairly. This is not readily defined by arbitrary limits such as amounts of debt or even turnover. But it will be relevant to take account of the stage in the banking relationship reached by the customer, to ensure that products, services and communications are appropriate for the needs of the SME customer.

7.19 The present regulatory protections for SME-related conduct are limited. Given the widespread inappropriate actions Identified in this report in relation to lending activities, we consider that the FCA should work with the government and other relevant parties to extend the protections available to SME customers.

7.20 One option would be to extend the regulatory perimeter to bring SMEs within the scope of FCA’s regulated activities, to ensure that regulatory action can be taken to guard against unfair treatment of customers and that the principles for business and standards of good governance and personal respon5ibility apply to this sector as they do to other parts of retail banking However a higher priority may be to give SMEs avenues to challenge banks where they are treated unfairly For example consideration should be given to extending the unfair contract terms protections to SMEs, and giving them greater access to the F0S.

7.21 Contracts with SMEs for the provision of credit facilities and other services can be markedly more complex than their retail market equivalents. In part this reflects limited protections for SMEs – in particular the Unfair Terms in Consumer Contracts Regulations (UTCCRs).

7 22 As a result, SME contracts can give banks wide discretionary rights to vary terms that would not be compliant with unfair contract terms provisions in a retail setting. The lack of unfair contract terms protections, taken together with the restricted access to redress/dispute mediation for SMEs, can give rise to a risk of unfair treatment of customers. Whilst some discretion may be inevitable given the nature of the products involved, the ability of banks to change lending criteria, or to treat many loans as well as overdrafts as ‘on demand’, means that banks have a wide discretion that SMEs cannot readily plan against or challenge.

7.23 The Law Commission’s recommendation” that Unfair Terms in Consumer Contracts provisions should be extended to at least some SME customers has not been progressed. Coupled with the restrictions on access to dispute resolution services, this can place SMEs at a material disadvantage

7 24 A concern raised by many SME customers in our sample related to the absence of any serious consideration of their complaints while RBS had a policy to respond to complaints in line with its requirements under regulatory rules, many SME customers were not micro-enterprises and as such complaints from them were not covered by DISP. That meant the Bank had no regulatory obligations to handle complaints promptly, to investigate them fairly or to consider the root causes of such complaints. And there was no obligation to record and report on those complaints or to publish information about them.

7.25 For customers other than micro-enterprises there is no access to the F0S. The ability, alternatively, to litigate for most of these customers will be limited, litigation is notoriously slow and costly and detracts from the running of the business. FCA is committed to reviewing the scope of FOS following the report of the Banking Standards Commission. But the micro-enterprise definition is not the only barrier facing SMEs in their dealings with FOS. Even for micro-enterprises, the F0S award limit (£150,000), coupled with the inability to litigate for any additional compensation Following a FOS decision, limits the relevance of FOS as a redress option

7.26 We encourage the FCA to work with the government to ensure that there are adequate protections for the less sophisticated SMEs. This could include the extension of the unfair contract terms protections to SMEs and greater access to the F0S.

7.27 An alternative (or supplementary) approach would be to develop professional standards governing banks’ lending to SMEs. The Lending Code applies to some SMEs, but only micro-enterprises. It includes some provisions on helping micro-enterprises who are experiencing financial difficulties and complaints handling. The Lending Code is monitored by the Lending Standards Board.

7.28 In relation to turnaround divisions the need for additional protection for SME customers is more acute. At present there are no generally recognised professional standards for turnaround or restructuring units in the UK, although various guides and codes exist which are seen as relevant. These include for restructuring the IMF Restructuring Guidelines, the ‘London approach’ and the INSOL Principles. Both the Insolvency Practitioners Association and the Institute for Turnaround publish codes of ethics, and the latter has recently published a ‘Statement of Principles for the UK ‘ Business Support Units’ of Banks’.

7.29 The principles cover Issues we identified as part of our review, including provisions on treating customers sympathetically, communication, appropriate pricing and complaints handling. They have been endorsed by several banks. However, there is little transparency about what banks have done to ensure that they meet the principles, and it seems no independent monitoring of compliance with the principles it is unlikely, therefore, to give customers confidence that this will make a difference to their treatment in future.

7.30 Both the Lending Code and the Institute for Turnaround Statement may have a useful role here. What is Important is that any self-regulatory action has the confidence of both banks and customers and has demonstrably effective independent oversight and monitoring.

7 31 We encourage the industry and customer groups to develop a code on how banks can best support customers in need of business support. Such a code should be subject to independent oversight and monitoring.

7.32 The situation In RBS and GRG was particular to that organisation at that time. Nevertheless the themes raised in this report may have wider resonance as banks consider how they should further develop turnaround units. For example, a concern that was raised with us by some stakeholders was the nature of the relationship between lenders and various professional firms that support the turnaround or Insolvency process.

7.33 Inevitably banks are a major user of accounting/Insolvency, valuation and legal services. Given their scale and scope providers of these services will understandably wish to have strong and constructive relationships with banks. A complex pattern has emerged of links between Individual suppliers and banks which, It Is argued, includes frequent use of secondees from professional firms, complex and sometimes non-transparent fee and revenue agreements between advisers and individual banks, and questions around the control of sensitive information between the banks and their advisers

7.34 Such Issues can give rise to concerns about the availability of qualified third-party support with the relevant experience to support customers (given that most with experience will have extensive conflicts with the banks serving those customers) There is also a perception that customer perspectives will be Ignored because of the commercial significance of meeting wider bank requirements where a bank Is a major client of a specific adviser and that the professionals may be too ready to see the bank’s point of view.

7.35 In the case of GRG we identified weaknesses in the management of potential conflicts of interest, in particular around the use of secondees. It was not surprising that many customers were left with the Impression that third-party providers were too close to the Bank. But a more general comment is that, whether or not such behaviours take place, the absence of agreed standards can create a suspicion of inappropriate practice, particularly where clients are facing economic distress, even If this may not In fact exist.

7.36 We suggest that banks should review how they interact with third-party providers, especially in relation to secondees.

7.37 More generally we suggest that banks should review their own turnaround units with a view to ensuring that the lessons from this report in so far as they are relevant to other institutions are applied more widely.

Subsidiary roman numerals do not reproduce in WordPress format, so they appear here as second-order bullet points

PAG v RBS: Calling for Valuations – A final outcome

Property Alliance Group is an ex-customer of the Royal Bank of Scotland so unhappy about its treatment by GRG – RBS’ workout unit – that it took legal action against the bank.

Some of the issues raised by PAG concerned an interest rate hedging program entered into before the transfer to GRG, and are not relevant to restructuring and turnaround practitioners. However, PAG also complained about management by GRG, including decisions to seek updated valuations, which resulted in breach of a loan to valuation ratio, and led to a subsequent renegotiation of terms.

As discussed here, PAG was unsuccessful in its first attempt before the UK High Court, but it kept on fighting, with an appeal. PAG argued that the judge at first hearing was wrong to decide that RBS’ contractual power to call for a valuation was completely unrestricted – PAG said that there were implied terms which meant that for example RBS could not call for a valuation capriciously or vexatiously.

In a judgement (available here) handed down last week, the Court of Appeal agreed with PAG that the power was ‘not wholly unfettered’ – but it found that RBS was free to seek an updated valuation if it was for a purpose related ‘to its legitimate commercial interests.’

On that point, on the facts the Court held that it was

‘very far from apparent, however, that the Judge would have held the valuation at issue to have been pointless, lacked good or rational reason or been commissioned for a purpose unrelated to RBS’s legitimate commercial interests or when doing so could not rationally be thought to advance them…’

After providing some rare behind-the-scenes glimpses of a loan workout, it appears that we have now reached a final resolution, leaving the law probably as most impartial observers expected the position to be.

Bank support for small business turnaround

The ongoing political scrutiny of the treatment of distressed small business customers by the Royal Bank of Scotland (some background here) led to a letter from the Treasury Committee on 27 February 2018.

Amongst other things the committee asked RBS to confirm whether it supported the Principles for Best Practice in UK business support banking promulgated by the UK’s Institute for Turnaround.

The principles are:

i. The primary focus of Business Support Units is to protect the Bank’s capital by working consensually with customers to promote and support viable recovery strategies:

Business Support Units will work openly and constructively with customers, with the aim of returning the business to viability in a timely and cost-effective manner, wherever achievable.

The need for Business Support Unit involvement will be kept under continuous review.

ii. Business Support Units will treat customers fairly, sympathetically and positively, in a professional way with transparent processes and procedures.

iii. On transfer to a Business Support Unit, the Bank’s concerns and the proposed next steps will be clearly communicated to customers.

iv. Business Support Units will ensure that any formal property valuations required will be undertaken by independent advisers on the Bank’s panel.

v. Business Support Units will seek appropriate fees and margins taking account of the customer’s financial circumstances and ability to pay:

Fees and interest margins will be appropriately priced to reflect the risk, the additional management time required and the financial circumstances of the customer. These will be set out in writing, will be discussed with the customer and agreed with the customer wherever possible.

vi. Business Support Units will manage complaints in line with clearly defined policies and procedures:

The process for making a complaint will be clearly set out ensuring recognition and a timely response.

Customers should always feel able to complain (and know that any complaint will be treated fairly in accordance with published complaints protocols)

vii. Occasionally equity stakes in a customer may be acquired through a debt for equity restructuring. Business Support Units will handle equity stakes in customers under their management in the spirit of the ‘primary focus’ – to protect the Bank’s capital by working consensually with customers to promote and support viable recovery strategies.

viii. Business Support Units will monitor their turnaround statistics with a focus on returning customers to a normal banking relationship.

For some time Insol has provided guidance for the workout of large syndicated loans (discussed here) but these principles, supported by Lloyds, HSBC and Barclays, appear to be the only guidance for support of small business lending.

Loan workouts: insights from the UK

Introduction

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.

Background

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

Bad Reputation? …Reputational issues for lenders and their advisers

[First published on Linkedin.com on January 23, 2017]

Brand and reputation may be intangibles in an accounting sense, but the latest development in the long-running investigation into the Royal Bank of Scotland’s Global Restructuring Group shows that there can be real and significant costs arising from their loss.

In November 2016 RBS announced a complaints process for GRG SME customers, as well as the automatic refund of so-called ‘complex fees.’ RBS estimated that the total cost of the scheme administration and likely refunds would be as high as £400m.

Closer to home, claims about ‘artificial’ loan defaults have been raised in Australia via the Parliamentary Joint Inquiry into Impaired Loans, and so the issues and outcomes are important for Australian lenders and their advisers.

The Large Report

In 2013 RBS commissioned an Independent review of lending standards and lending practices. The 95 page report (‘the Large Report,’ named for the main author) released in November 2013 mostly dealt with origination issues, but there was some discussion about GRG – RBS’ workout function – which had been raised by a submission from the Department for Business, Innovation and Skills (‘BIS’) written by Lawrence Tomlinson, and others. The report referred to allegations that RBS was working against the best interests of customers, but explained that an inquiry into individual cases was outside its scope, and recommended that RBS conduct a formal forensic inquiry.

Tomlinson, and his report

Lawrence Tomlinson is the owner of the LNT Group, which employs over 2,000 people. In April 2013 he was appointed as an ‘Entrepreneur in Residence’ for BIS – an honorary position intended to assist BIS in policy formulation.

On the day that the Large Report was released, Tomlinson distributed a paper (available here). Effectively a modified version of the BIS submission, the Tomlinson report was highly critical of GRG, and the insolvency professionals who advised it. The key claim in the report was that RBS was using so-called ‘technical defaults’ to move customers into GRG, so that it could charge much higher fees. If it could not find an existing default, then apparently RBS might ‘engineer’ one, with the assistance of complicit valuers.

Even though secured creditors in the UK can no longer appoint receivers (as explained here) they may still call in loans if there is a default. Tomlinson claimed that defaults were called without consideration of the impact on the customer, and in fact if the customer’s business failed then it might even create an opportunity for a bank subsidiary (West Register) to buy the assets at undervalue.

The Tomlinson report is concise – only 21 pages long – and provides a number of starkly-phrased conclusions, for example describing some bank action as ‘utterly disproportionate at best and manipulative and conspiring at worst,’ and the media certainly responded.

Media and Political response

It seems that it was easy for journalists to find case studies supporting the report’s conclusions, and there was widespread media coverage. A Daily Mail headline ‘A State-owned Bank that kills small firms to feed off their corpses. And still not a hint of shame!,’ was perhaps the most striking example, but it seemed to capture the general mood, and the BBC current affairs show Panorama also ran the story (available here).

There was also an immediate political response leading to an appearance by Tomlinson before a Treasury Select Committee in January 2014. It is clear from that hearing (shown live and still available here) that his report resonated with the members of the committee, with several referring to complaints received from their own constituents.

Queries over Tomlinson’s motivation and method….didn’t seem to matter

It was soon clear that Tomlinson was not asked to conduct a review. Neither the government nor RBS was aware it was being undertaken, as neither had the opportunity to provide any input into his report.

There was some criticism of Tomlinson’s method, and suggestions that he himself was a disgruntled RBS customer, unhappy about fees levied against his business. Tomlinson admitted that he was an unhappy RBS customer, but said that that the criticisms were valid regardless, and maintained that the focus on RBS was appropriate because it was the subject of the greatest number of complaints.

By and large, the claims about bias and the queries about his methodology were lost in the media and political storm. RBS was left to deal with the issue – whether that was fair, or not.

RBS commissions Clifford Chance

RBS responded within two days, announcing it would instruct panel law firm Clifford Chance to investigate ‘the most serious allegation’ that ‘RBS conducted a “systematic” effort to profit from customers in financial distress.’

The April 2014 Clifford Chance Report available here concluded that there was no evidence of a systematic program to take advantage of RBS customers. Some parts of the report were less helpful however: Clifford Chance said that they were unable to assess whether fees were fair or not because it was ‘difficult to understand’ how fees were calculated ‘in any particular case.’

The Clifford Chance report did not seem to help to close the issue. Some challenged the firm’s independence (for example The Huffington Post: 7 Things RBS Hoped You Would Not Notice In Its Clifford Chance Report), and it gave Tomlinson the opportunity to point out that the focus on the most extreme allegation left the others unaddressed.

Regulatory Response

The FCA is an independent government authority responsible for protecting and enhancing the integrity of the UK financial system. The FCA issued a statement explaining that the allegations gave rise to concerns about governance and culture, and announced an independent ‘Skilled Person’ review of the allegations by consulting firm Promontory Financial Group and accountants Mazars.

Project ‘Dash for Cash’

The controversy didn’t go away, but it seemed to quieten – until a joint investigation by BBC NewsNight and Buzzfeed in October 2016 which released RBS documents alleged to show that ‘under pressure from the government’ (an interesting sidebar for those who argue that Australia should have a government owned bank: the Tomlinson complaints relate to conduct after the government took a 63% stake in the bank), RBS had:

Provided staff with financial incentives (called ‘Project Dash for Cash’!) to force customers into GRG, so that it could extract higher fees.
Transferred businesses into GRG for reasons that had nothing to do with financial distress.
Not maintained proper Chinese walls between GRG and West Register, and instructed staff to conceal conflicts of interest from customers.
‘Generated a profit’ of more than a billion pounds in a single year through GRG fees and rate increases.

RBS denied the allegations in a statement, and an in-depth interview with the NewsNight reporter the next day. Regardless of RBS denials, the Chairman of the Treasury Select Committee soon released a letter calling for the full release of the Skilled Person Report, which had been delivered In September 2016 – almost two years later than planned.

Two years on…the Skilled Person report is delivered

On 8 November 2016 the FCA released a statement setting out a high level summary of the main findings and key conclusions.

The reviewers concluded that RBS did not set out to artificially engineer the transfer of customers to GRG, and in fact reported that customers transferred to GRG were exhibiting clear signs of financial difficulty. They found no evidence of West Register targeting customer assets for purchase, and could not find any examples of property purchase by West Register that increased financial loss to the customer.

Less happily for RBS however, the FCA said that the inappropriate treatment of SME customers appeared ‘widespread’ and that ‘much communication was poor and in some cases misleading.’ It also identified a failure to support businesses ‘consistent with good turnaround practice,’ and an ‘undue focus’ on pricing increases and debt reduction rather than longer term viability of customers.

RBS response

On the same day that the FCA released the summary of the Skilled Person report, RBS released an LSX announcement outlining a response to the report, described as having been ‘developed with the involvement of the FCA.’

RBS announced a new complaints process to be overseen by a retired High Court Judge, and the automatic refund of ‘complex’ fees paid by SME GRG customers between 2008 and 2013. RBS said that the estimated £400m total cost of the program was approximately 20% of the amount it lost from lending to SME customers in that period.

An analysis by UK solicitor Cat MacLean identifies the fees which are said to attract an automatic refund, a long list including Management fees, Asset Sales fees, Exit fees, Mezzanine fees, Ratchet fees, Risk fees, Late Information fees, Property Participation fees and Equity Participation Agreement fees.

Is this the end?

RBS must hope that their response to the Skilled Person report will close the issue, but that seems unlikely:

There are still calls and campaigns for the release of the full report.
The £400m refund and compensation scheme will not resolve all claims (borrowers with debt facilities or turnover higher than £20m are excluded).
The outcomes do not appear to be binding on borrowers, so borrowers unhappy with the decisions may still pursue the normal avenues.

The total cost is already higher than £400m – UK-based claim adviser Seneca Banking Consultants claims to have recovered £100m just for its own clients – and there are other claims in the wings, most notably the RBS-GRG Action Group claims to be organising ‘group litigation’ involving more than 400 borrowers with claims reported as totalling more than £1b.

So, we should give a damn….

Three years after complaints were raised in the Tomlinson report, the worst of the allegations appear to have been discredited. But that conclusion has only been reached after considerable damage to the RBS brand and reputation, and now, very real and significant financial cost.

‘Do our loan documents allow this?’ is still a very important question for workout bankers, but it is not the only question to be asked. The RBS experience shows very clearly that lenders and their advisers are wise to address other questions around transparency and fairness before determining a final course of action – even more so given that there is no lessening in calls for the independent review of lender conduct.

Update: For more recent developments please see The beginning of the end? The RBS – GRG saga

The Tomlinson Report and its Aftermath

[Originally published in the March 2014 issue of the Australian Insolvency Journal, and reproduced here with permission]

In November 2013 a UK government adviser issued what is now referred to as The Tomlinson report. It was highly critical of the workout function of the Royal Bank of Scotland (RBS) and the insolvency professionals who advise it.

The report was the subject of a great deal of media attention in the UK, and has been reported, albeit less intensively, in the US, Asia, and Australia. In the UK, the Financial Conduct Authority has initiated its own review, and in Australia the report has been linked with the upcoming Murray inquiry.

Later media reporting raises questions about whether Lawrence Tomlinson himself has a conflict of interest in criticising RBS, and arguably the report itself is an aggregation of complaints rather than an objective review. In one sense however, such complaints are irrelevant – the response to the report highlights the very challenging reputational issues faced by banks and the insolvency profession, whether in the UK or Australia.

Background to Tomlinson

An engineer by training, Tomlinson is the owner and chairman of the LNT Group, which employs over 2,000 people in five separate businesses, with significant reported net wealth.[i] Tomlinson was appointed as an Entrepreneur in Residence for the Department for Business, Innovation and Skills (BIS) in April 2013. With hindsight it is notable that on appointment he identified his key focus as addressing ‘some of the key concerns around access to finance and improving bank lending to business’, and advised his intention to ‘share the views and experiences of my peers with Ministers and officials’[ii].

Looking back it is clear that by issuing his report, Tomlinson has done exactly what he said he would do. But in another sense his report appears to have been a surprise to the Government, RBS and the insolvency profession, none of whom were consulted or invited to provide input or comment.

Independent Lending Review and Large Report

In July 2013 RBS appointed former Deputy Governor of the Bank of England Sir Andrew Large and the management consultancy Oliver Wyman to undertake an independent review of lending standards and practices for small business lending.[iii]

The objective of the Independent Lending Review (ILR ) was to: ‘identify steps that RBS/ NatWest can take to enhance its support to SMEs and the economic recovery whilst maintaining safe and sound lending practices’, and ‘promote a common understanding of the way in which the bank makes its judgements and decisions on SME lending’.

The ILR was a wide-ranging review of all aspects of SM e business lending, drawing on a very wide range of internal data, customer surveys and comprehensive stakeholder consultation.

Relatively late in the ILR process BIS made a submission prepared by Lawrence Tomlinson that raised concerns about the work undertaken by the Global Restructuring Group (GRG), the RBS workout function.

On 25 November 2013 the ILR issued its report (the Large report). While the majority of the 95-page report deals with origination and ‘front-end’ issues, there is some discussion of the GRG function.

The report observed that: ‘GRG has been successful in executing its mandate’, noting that ‘over half of all customers under the relationship management of GRG are returned to normal relationship management … around a third refinance with another bank or repay through asset disposals and only a minority (~10 percent) enter insolvency proceedings.’

The Large report referenced ‘more extreme accusations’ made by ‘a small minority of RBS customers’ primarily based on the Tomlinson material, which it summarised as a perceived conflict of interest such that RBS ‘may even be profiting by working against the best interests of financially distressed customers’.

The report also referred to the role of West Register, an RBS subsidiary that acquired properties from RBS customers for later sale, with the end result that any uplift in value would accrue to RBS rather than the former owners.

The report explained that an inquiry into individual cases was outside its scope and recommended that RBS ‘address the concerns that have been raised by some customers and external stakeholders about its treatment of SMEs in financial distress and minimise the perceived conflict of interest within GRG’ through a formal forensic inquiry.

The Tomlinson Report

Presumably it was no coincidence that Tomlinson issued a 21-page redacted version of the material that he had provided to the ILR (now widely referred to as the Tomlinson report) on the same day that the ILR released the Large report.[iv]

The Tomlinson report sets out conclusions drawn by Tomlinson following his own investigations into complaints he had received, apparently without input from RBS. The absence of RBS input does not of itself render his conclusions invalid. But critics of Tomlinson would point out that the assessment was conducted based on ‘one side of the story’ and risks a lack of context.

The redacted report provides a small number of examples, but there is no reference to data or data analysis. Again though, we should note that of itself this omission does not automatically render the conclusions invalid. Tomlinson later clarified that the full report provided 23 examples drawn from around 200 complaints. [v]

The report does include a number of very quotable observations and it is no surprise that media attention focused very heavily on the Tomlinson report in preference to the Large report:

The trigger point [for transfer to GRG] … is sometimes so insignificant, given the otherwise positive performance of the business, that the reaction by the bank can only be considered as utterly disproportionate at best and manipulative and conspiring at worst.

The bank artificially distresses an otherwise viable business and through their actions puts them on a journey towards administration, receivership and liquidation … it became very clear, very quickly that this process is systematic and institutional.

It is undeniable that some of the banks, RBS in particular, are harming their customers through their decisions and causing their financial downfall.

Tomlinson also raises criticisms about the scope and role of the Investigative Accountant (IA):

The potential for conflicts of interest in insolvency is also rife … there are many occasions in which the IBR who works with the business whilst in business support is also the business administrator.

There is also often a requirement for an Independent Business Review (IBR) … at great cost to the business, who often do not even get to see the report.

At best, there is little accountability for the IBR and resulting actions, denying the business of the ability to respond to parts of the report or challenge it (sic) accuracy.

Tomlinson concludes by calling for bank break-ups: ‘The ideal scenario would be the creation of six banks out of RBS and Lloyds … to create fully functioning challenger retail and commercial banks.’

Media Response

One of the first reports was an article in The Independent on 25 November 2013. It focused on the high-profile head of GRG, Derek Sach, known for ‘treading on toes and slaying sacred cows’ by calling for tenders for receiverships and blocking IAs from taking a later role as administrator or receiver of the same company. This second point is noteworthy because it contradicts Tomlinson’s first complaint about IAs.

On the same day, the BBC summarised the two reports and reported that RBS had instructed the law firm Clifford Chance to investigate the allegations. The Daily Mail provided a spectacular headline ‘A State-owned Bank that kills small firms to feed off their corpses. and still not a hint of shame!’ above an article that referred to ‘new-wave grave robbery’.

The Independent returned to the story the following day with two articles. The first called for a break up of RBS, describing it as ‘a vertically integrated, systematically organised asset stripping machine’. The second focused on the information in RBS’s 2012 Annual report which showed that only six percent of GRG customers were returned to normal management.[vi]

The following day, The Guardian published a case study of an aged care home business which had reportedly ‘never missed a mortgage payment’ and was in credit across all bank accounts when it made a request to change one loan to an interest-only basis. According to the story, this led to a transfer to GRG, a visit from a pink-Porsche driving RBS staffer who ‘said she knew nothing about care homes’ so would have to engage an IA.

The Tomlinson report also attracted international interest, and was reported in the New York Times, The Irish Times and The Australian. The Australian reported that ‘similar allegations have been aired in Australia by customers of the major banks’, and quoted Senator John Williams as saying that he had ‘no doubt’ that issues similar to those in the Tomlinson report would be brought before the Murray inquiry.[vii]

The British weekly The Spectator covered the issue with a case study, ‘How our company was nearly bullied to death by a desperate RBS’, describing how RBS had threatened to call a default because a borrower had commenced ‘negotiating with a creditor with a view to rescheduling indebtedness.’

In fact those negotiations were with RBS itself; the borrower had asked RBS to consider changing a repayment schedule. Notably, the article described the GRG bankers as ‘the warrior trolls of Orwellian “corporate recovery”’ and the ‘sharp-suited’ IA team as charging ‘£600 per valueless hour as they tap us for the knowledge that will reappear, beautifully presented, in a report to RBS that we will never be allowed to see in full’.

Tomlinson’s Conflict of Interest?

On 3 December 2013, The Financial Times raised concerns about selective editing in the Tomlinson report, explaining that similar criticism of Lloyds appeared in an early draft, but had been removed in the final version[viii]. The paper said that Tomlinson’s ‘willingness to make such a fundamental change to his report at a late stage, and to direct his criticisms at a single named bank, has caused some to question his methods and motivation.’

The Financial Times also referred to an unnamed government minister that Tomlinson was ‘gunning for RBS from the start’, and reported that he had made a formal complaint about the behaviour of two executives at the bank and expressed ‘frustration’ at the lender’s approach to a refinancing a four-bank £100m facility to his ln T Group which cost £1.4 million in fees to arrange.

Tomlinson did not deny the reports of his personal dissatisfaction with RBS but pointed out, rightly, that any dissatisfaction with RBS did not mean that the complaints were unfounded.

Uncertainty over the RBS Repatriation Rate

The repatriation rate (the percentage of workout customers that return to normal management) is a key performance indicator for a turnaround function. By contrast, a recovery team is more likely to focus on a loss rate.

The Tomlinson report referred to an ex- RBS whistleblower unable to recall any examples of repatriation. The Large report referred to repatriation of ‘over half’, but unhelpfully provided no more data than Tomlinson. RBS’ own 2012 annual report, scrutinised by auditors, refers to a six percent repatriation rate.

The numbers are different, but they will not necessarily reconcile. Firstly, the annual report speaks to repatriations achieved in a 12 month period, the whistleblower is presumably intending to describe a broader period, and we simply don’t know which time period the Large report describes. Secondly, the annual report appears (and it’s not as clear as it could be) to measure repatriation of incorporated borrowers, whereas Large may be referring to both incorporated and unincorporated borrowers.

However, with all the uncertainty about the data noted, an outsider can reasonably conclude that:

The discrepancy between six percent (annual report) and ‘over half’ (Large report) is so great that it is difficult to believe that both are correct.
A repatriation rate of six percent must be regarded as disappointing for a team working towards a turnaround objective.

RBS’ Response

RBS provided an initial response on 25 November 2013 via an open letter from the CEO[ix]. It was careful to show that it accepted the Large report, describing it as ‘a thorough and balanced analysis of the business’ which at the same time provided ‘a tough read for the bank’.

However, they also used their response to provide some context for their actions, explaining the impact of regulatory pressure via regulators who ‘want the bank to remove problem loans more quickly’.

Finally, RBS announced it would engage a newly – appointed panel law firm Clifford Chance to undertake an independent inquiry, and undertook to address any shortcomings identified and share all findings with the Financial Conduct Authority (FCA ).

A statement on 27 November explained that Clifford Chance would focus on ‘the most serious allegation’ that ‘RBS conducted a “systematic” effort to profit’ from customers in financial distress[x]. This second announcement appears to quite significantly narrow the focus of the review: Clifford Chance might find widespread poor treatment of customers yet reasonably conclude that it had not been systematic.

Political Response

The Tomlinson report generated immediate political interest. The BBC analysis quoted Chancellor George Osborne describing the reports as ‘shocking,’ Andrew Tyrie, chairman of the Treasury Committee, as saying ‘The reports … make clear that there is a fundamental cultural problem with RBS’s lending to and treatment of SMEs’, and Business Secretary Vince Cable as saying ‘we are pretty confident that the evidence is solid’.

A Treasury Select Committee questioned the Bank of England governor Mark Carney, who told them he thought the allegations were ‘both deeply troubling and extremely serious’.

Both Sir Andrew Large and Lawrence Tomlinson were invited to appear before the Treasury Select Committee in January 2014. Introductory remarks by the chairman that ‘We have all had huge problems with RBS in our constituencies one way or another’ were typical of the members’ views, and there was very little challenge to Tomlinson’s evidence or independence.[xi]

Responses discussed by the Committee included an expansion of the role of the Financial Ombudsman Service (FOS). FOS is an independent statutory body available to private individuals and micro-enterprises (businesses with an annual turnover of less than two million Euros and fewer than 10 employees) with complaints against financial businesses. FOS can order compensation of up to £150,000.

Regulatory Response

The FCA is an independent government authority with a strategic objective ‘to ensure that the relevant markets function well’. Its operational objectives are ‘to secure an appropriate degree of protection for consumers, to protect and enhance the integrity of the UK financial system [and] to promote effective competition in the interests of consumers.’

On 29 November 2013 the FCA issued a statement in response to the Tomlinson and Large reports.[xii] The FCA explained that while commercial lending was not directly within its purview, the nature of the allegations in the reports gave rise to concerns about governance and culture, which are. Thus they announced the statutory appointment of ‘an independent skilled person’ to review the allegations and report to the FCA.

The FCA would also write to other banks seeking confirmation that they ‘do not engage in any of the poor practices alleged in the reports’.

On 17 January 2014 the FCA announced that consulting firm Promontory Financial Group and accountants Mazars had been engaged to review a sample of GRG customers including some of the Tomlinson complainants. The review would specifically assess whether any poor practices identified were widespread and systematic, and if so make recommendations to address any shortcomings. The FCA advised that it expected to publish the outcomes of the review in the third quarter of 2014.

Conclusions

The nature of the allegations and their headline-friendly wording has attracted the attention of a public that was clearly prepared to believe the worst of bankers and insolvency practitioners, highlighting the reputational issues that both face.

Critics have raised questions over Tomlinson’s independence as well as the strength of the evidence and analysis to support his allegations. In a sense these criticisms are almost irrelevant, because they emerged only after the FCA had already initiated a review. It is also noteworthy that the original allegations received heavy media coverage, whereas the questions over Tomlinson’s independence have been mostly confined to the specialist finance media.

Once the crisis broke RBS handled it in text-book fashion. If we ask ‘what could they have done differently?’ the challenge is clear because RBS appear to have been excluded from Tomlinson’s process altogether. Two points stand out:

If RBS had engaged with Tomlinson immediately after his on-appointment comments they may have had the chance to inform and influence him.
RBS has not been able to present a clear and understandable picture of the success of their turnaround function i.e. their repatriation rate.

RBS will incur costs in running the Clifford Chance investigation and responding to the FCA inquiry. However, those costs will not be material. In my view, the more significant impact will be on senior management in dealing with the inquiries and their consequences.

To this observer at least it seems unlikely that the review will result in the bank break-up that Tomlinson calls for. But an expansion of the role of the Financial Ombudsman might be proposed even in the absence of any evidence of systemic wrongdoing.

Update: For more recent developments please see The beginning of the end? The RBS – GRG saga

[i] Biographies at http://www.tomlinsonreport.com and http://www.ginetta.com/lnt

[ii] Department for Business, Innovation & Skills media release http://www.gov.uk/government/news/you-re- hired-entrepreneurs-in-residence-to-advise-government

[iii] The background to and the report itself is available at http://www.independentlendingreview.co.uk/index.htm

[iv] available at http://www.tomlinsonreport.com

[v] Tomlinson’s evidence to the Select committee on 29 January 2014 is available as a transcript http://data.parliament.uk/writtenevidence/Writtenevidence.svc/evidence html/5629 , or via Parliament TV: http://www.parliamentlive.tv/Main/Player.aspx?meetingid=14764 ; evidence from Sir Andrew Large on 22 January 2014 is available at http://data.parliament.uk/writtenevidence/Writtenevidence.svc/evidence html/5605

[vi] RBS Annual report 2012, page 174

[vii] More correctly this is the Financial System Inquiry, headed by David Murray AO, the former CEO of the Commonwealth Bank, announced by the Government on 20 November 2013, http://www.pm.gov.au/media/2013-11-20/financial-system-inquiry.

[viii] ‘Criticism of Lloyds removed from Tomlinson report’ by George Parker and Andrew Bounds http://www.ft.com/intl/cms/s/0/550c5360-5c31-11e3-931e-00144feabdc0.html#axzz2oxojGGic

[ix] http://www.rbs.com/news/2013/11/distressed-business-customer-review-terms-of-reference.html

[x] http://www.rbs.com/news/2013/11/final-lending-review-report.html

[xi] See footnote 5

[xii] http://www.fca.org.uk/news/press-releases/statement-regarding-royal-bank-of-scotland