Court of Session dismisses one of the first interest rate swap mis-selling claims against a bank

In his ruling Lord Hodge said that property developer Grant Estates Ltd (GEL) could not argue a breach of financial services regulatory rules in the civil courts. In addition the agreement between the bank and the company's directors, brothers Ruari and Jamie Stephen, provided that customers should seek independent advice before entering into a contract and warned that customers should not deal in products which they did not understand.

"In this case there was a written contract setting out what [the bank] was to undertake and expressly warning GEL that it should obtain its own independent financial, legal and tax advice," he said. "The acts of the employees of [the bank] are consistent with a contractual regime in which the customer had agreed that it would not treat any views which they expressed in bringing about the derivative transaction as advice on which it was entitled to rely."

GEL had obtained a loan from the Royal Bank of Scotland (RBS) in October 2007, which was tied to an interest rate hedging arrangement protecting the company from the risk of rising interest rates. However, the arrangement also prevented the company from benefitting if interest rates fell. The company went into administration last year, and the directors argued that this was because they had been able to meet the cost of the repayments under the swap arrangement.

The company had argued that employees of RBS gave "fraudulent or at least negligent" advice about the product to its directors, breaching the regulatory rules in the Financial Services Authority (FSA) Conduct of Business Sourcebook (COBS). COBS, which sets out the conduct of business requirements the FSA applies to regulated firms, prevents them from recommending products which are unsuitable or inappropriate for the customer in question. In addition, firms must ensure that any communications or promotions are "fair, clear and not misleading".

However, the Financial Services and Markets Act (FSMA) only permits "private persons", rather than companies or partnerships, bringing cases against banks in the civil courts. FSMA provides protection to consumers through a "self-contained regulatory code and statutory remedies", Lord Hodge said, meaning that GEL

Lord Hodge said that he had borne in mind that the bank and GEL were of "unequal bargaining power" in reaching his decision, acknowledging that the Stephen brothers "did not have experience of investing in complex financial instruments". He said, however, that unless the company could establish a breach of the Unfair Contract Terms Act there was "no basis" for overriding the allocation of responsibility under the contract signed by the company.

"In the relevant paragraphs of the terms of business RBS made it clear that it was willing to enter into the IRSA with GEL only on the basis that GEL should take independent advice and that is should understand the risks which the transaction involved," he said. "While I recognise the inequality of bargaining power between GEL and RBS ... company law expects directors of a limited liability company to achieve an objective standard of competence and knowledge."

Swaps provide borrowers with protection against changes in interest rates by locking in net cash outflow to a fixed interest rate. The product is designed so that the swap provider - usually the bank which also provided the underlying loan - covers the cost of increased payments if the interest rate rises while customers have to pay the bank if rates fall. Simple products merely fix an upper limit to the interest rate on a loan, while more complex 'structured collars' introduce a degree of interest rate speculation to the transaction. In all cases, customers risk having to make higher payments than anticipated if the market does not perform as expected.

In June, the FSA announced that it had found "serious failings" in the way four major banks - including RBS – had marketed and sold the complex products to small businesses. Barclays,HSBC, Lloyds and RBS have each agreed to an investigation into their sales by an independent reviewer, and to provide redress to any customers mis-sold the products. Last month, seven smaller banks agreed to voluntary reviews by the regulator on similar terms.

Publishing the terms of its review on its website earlier this week, RBS said that it would prioritise "those customers who are most financially vulnerable" as it worked through the cases.
"We have committed that, except in exceptional circumstances ... we will not foreclose on or adversely vary existing lending facilities, without giving prior notice to the customer and obtaining their prior consent until a final redress determination has been issued or redress provided to the customer," the bank said.