What Insolvency Practitioners need to know
Introduction to IRHPs
Interest Rate Hedging Products (IRHPs or Interest Rate Swaps) are products which are used either to fix, or to limit fluctuations in, interest rates. These were sold to small and medium-sized businesses as protection from rising interest rates when taking out loans.
In many cases however, customers ended up paying punitive rates of interest that they could not afford. This was because they had not been made fully aware of the risks attached to these hedging products if interest rates moved in certain ways. Swaps were often sold for periods far exceeding the term of the original loan, on the assumption that the business would probably need further credit after the term of the loan ended. Customers were also not properly informed about potentially exorbitant exit fees.
Types of IRHP
There are four main types of hedge products which were sold to businesses:
- A swap is a contract whereby if the interest rate of the underlying loan rises above an agreed point, the bank makes a payment to the customer. If the interest rate falls below the agreed point, the customer makes a payment to the bank. The effect of these payments is supposed to offset the difference in interest rate, and keep the customer’s payments stable.
- A cap is a contract whereby the customer pays a premium in order to effectively stop their payments rising above a certain amount. If interest rates rise above the agreed level, the customer receives a payment from the bank. If interest rates fall below the agreed level, the customer does not receive a payment.
- A simple collar is a contract whereby if the interest rate rises above an agreed point (the ceiling), the bank will make a payment to the customer to offset this. If interest rates fall below a different agreed point (the floor), the customer makes a payment to the bank. The effect is to restrict fluctuation in the payments to within these pre-agreed limits.
- A structured collar differs from a simple collar in that if the interest rate falls below the agreed floor, the customer can end up paying a higher interest rate to the bank.
Why do IRHPs matter to IPs?
Soaring IHRP costs could be one of the contributing factors to a company going into administration. Redress could make the difference between insolvency and rescue. Some of the sums awarded run into millions. For example, Barclays recently offered £1.5 million redress to Bill Haslam, a holiday resort owner and director of campaign group Bully Banks.
IPs do of course have a responsibility to ingather the maximum potential assets for companies in administration and their creditors, while balancing the likely cost of doing so. Seeking expert advice on this complex issue at an early stage could minimise costly mistakes and maximise the chances of a successful claim.
Introduction to the review
A preliminary review carried out by the Financial Conduct Authority (FCA) found that 90% of interest-rate swaps may have been mis-sold. The FCA have now agreed with a number of banks, that these banks will review all IRHP sales since December 2001, and provide redress where appropriate. Banks have now started writing to affected customers, asking them if they would like the sale of their product to be reviewed.
Scope of the review
The FCA reported that the most frequently mis-sold products were swaps, collars and structured collars, and have limited their review to these products. Caps are not automatically included in the review. If a company has concerns about a cap they were sold, they can still complain to the bank.
The FCA have also restricted the scope of the review to cover just those customers who are considered ‘non-sophisticated’ – using criteria set out by the FCA but interpreted by the bank.
The sophistication test
The sophistication test involves a number of objective measures based on turnover, net assets and number of employees, as well as a subjective test whereby the bank judges whether the customer had the relevant knowledge and experience to make an informed decision on the product. If the notional value of swap products held by a customer immediately after the sale was more than £10 million, the customer is automatically considered ‘sophisticated’.
If you get a letter on behalf of a company in administration about the IRHP review what should you do?
If you do get a letter, you must opt in to the review by returning the appropriate form – inclusion is not automatic. The letters we have had sight of seem keen to give the impression that the review process is relatively simple and customers should not need specialist advice, so you may judge that you can take this forward without further support. However, the banks themselves will be bringing expert counsel into the review process. The customer also needs to have access to expert advice from someone with experience of these products and the regulatory framework surrounding their sale. We would always advise seeking such advice to give the customer the best possible chance of success.
What if the company is excluded from the review?
If you receive a letter on behalf of a company in administration, stating they have been categorised as sophisticated and therefore are excluded from the review, it is worth checking the assumptions made by the bank against the FCA criteria and challenging if appropriate.
Even if you have not received a letter, check if the company had a qualifying loan and if so, contact the bank and request a review. Even if the loan expired before the company went into administration, the sale may be covered under the review. In either of the above situations we would suggest you seek further advice as soon as possible.
The fact-finding interview
As the administrator of the company, you will be invited to have a face-to-face meeting or teleconference with the bank, in order to gather the facts of the case. This meeting will be recorded and will typically be two to three hours long. There will usually be two people representing the bank, who could be bank employees, consultants or lawyers. In addition there may be an independent reviewer who will observe the meeting.
Following the meeting the bank will assess the case and if appropriate, agree suitable redress which must be approved by the independent reviewer.
These meetings have been described to us by those who have experienced them as formal, even intimidating. It is vital that you understand the importance of this meeting and are fully prepared.
If the bank agrees to pay redress, this will not necessarily mean the full return of all payments made on the product. The bank may argue that the award should be limited to the difference in cost between the product sold to the customer, and a notional product they might otherwise have bought. There is a big difference between the cheapest and most expensive product the customer might have bought and it is in the bank’s interest to argue that the customer would have purchased one of their more expensive products. Expert advice from someone with market knowledge could ensure that the client receives the maximum appropriate redress.
Another factor affecting the award is the issue of consequential loss. Examples might include lost business from competitive disadvantage, costs from additional borrowing, or opportunity costs arising from the inability to expand or make investments. However, it has to be proven that these costs were incurred directly because of the IRHP, and that they were reasonably foreseeable at the time the swap was sold. At this stage, it is vital to work with a forensic accountant to identify all possible consequential loss for the company.
Alternatives to the review
Affected companies may feel that if they have been excluded from the review, there is no alternative course of action. This need not be the case. For example, it has recently been reported that Lord Sugar may be the highest profile victim of mis-selling. He is complaining to Lloyds Bank after paying £10 million in break fees on a swap product that would be excluded from the review. It is vital to take advice, to evaluate other options such as pursuing a negotiated settlement with the bank.
This article was printed in the November Edition of Impecunias Magazine.
- Scott Cowan Director 07768 902 675 Email me