By Kalvin P. Chapman
On our Lloyds page (please see here) I discussed issues relating to Lloyds, HBSO and Bank of Scotland. One of the issues raised is Cerberus. Here I develop the issues and perceived issues with Cerberus.
The best explanation of issues relating to Cerberus was set out by George Kerevan MP. George Kerevan is the SNP MP and Chairman of the All Party Parliamentary Group (“APPG”) on Fair Business Banking
“I beg to move,
That this House has considered the purchase of distressed assets by Cerberus Capital Management.
Cerberus Capital Management is an American private equity firm that specialises in distressed investing—purchasing so-called distressed or non-performing loans. Few people in the UK have heard of Cerberus, but it is the biggest purchaser of distressed assets in the world. Since 2010, Cerberus has acquired more than 1.2 million distressed or non-performing loans, worth more than $80 billion. Simply put, Cerberus is the world’s largest debt collector.
Let me begin by saying that so-called distressed loans are often anything but. Since the banking crisis of 2008, we have seen a sorry catalogue of thousands of instances in which banks have forced legitimate borrowers into distress or even insolvency, through no fault of their own. The so-called distress that we are discussing is largely manufactured. That has come about for a variety of reasons: interest rate swap mis-selling, the infamous Royal Bank of Scotland global restructuring group’s dash for cash, and outright criminal fraud such as occurred at HBOS Reading.
Even where such egregious or criminal behaviour has not taken place, there are too many instances of banks deciding that they no longer wish to support small and medium-sized enterprise customers in sectors that the lender now considers non-core to its shrinking loan book. As a result, thousands of legitimate customers find themselves being sold on to firms such as Cerberus without their knowledge or against their wishes. Because loans to SMEs are unregulated, those customers have little or no redress. My intention today is to put on record the plight of those badly served bank customers and to expose the exploitative and often inadequate business model used by Cerberus—a model that is also bad for the British taxpayer.”
The APPG on fair Business Banking was set up earlier this year. Muldoon Britton’s Michael Muldoon, Kara Britton and me (Kalvin Chapman) were invited to their launch night. The cross-party group intends looking at, and lobbying about, unfair business practices in banking that are of concern to SME businesses in the UK. Despite all of the advances in banking as a consequence of the 2007/08 banking crisis, very little has changed legally in relation to how SMEs are treated by banks. SMEs, except sole traders, still cannot sue a bank for breaching COBS. Banks can still force ISDA master agreements on SMEs allowing banks to literally mislead and misrepresent with no legal repercussions. And, importantly, a Bank can still decide that an SME customer is too much to handle and sell their loans and security to entities like Cerberus.
As noted above, Cerberus is the world’s largest buyer of purported distressed debt. Banks throughout Europe still have balance sheets filled with loans that do not meet the modern criteria. Prior to 2008 business loans would tend to be 75% LTVs, with security up to that 75% figure and repayments terms of 10 – 20 years. Modern commercial loans will be 50-60% LTVs, security covering more than 100% of the loan, personal guarantees to back them up and repayment of no more than five years. If you have a commercial loan that comes outside of the modern requirements, then the bank must either remedy this or sell you to a company like Cerberus.
The following is a summary of issues that I as a commercial litigator have seen over the last seven years. Not every case will be like this, and this does not (except where stated) concern an actual case, it is an amalgam of many cases.
Prior to 2007/08 RBS, HBOS, Bank of Scotland (a part of HBOS) and Lloyds would sell loans to SMEs on pretty much the same terms. RBS and Bank of Scotland were in fierce competition. HBOS, when it was created in 2001, did amazingly well in SME loans. RBS had always been very good at commercial loans. The banks therefore really had to compete against each other, as they were the largest SME lenders in the UK. They found more and more innovate ways of under-cutting the other. Loan margins were cut for the larger loans. More and more single name entities were offered more and more and larger & larger loans.
HBSO and Bank of Scotland had an even more imaginative way of financing loans. They used a subsidiary to act as an equity business partner to the customer. One client I had, who had taken a £110 million loan to buy property portfolios, was directly told by Peter Cummings (the head of commercial lending at HBOS) that he was sick of seeing clients borrow money and make a fortune. He wanted the bank to also share in the property price bonanza, hence the sue of a bank subsidiary to work in partnership with the customer to share in the vast profits customers made. This ultimately cost the Bank even more money.
Prior to 2002 the largest single loan HBOS made was just under £1 billion, and only four facilities were greater than £500 million. It was substantially more in 2008. In regards to the security and risk, the Bank of wengland report says this:
342. Following a re-indexation exercise(61) in early 2008, the weighted average LTV of the division’s property investment portfolio was 77%.(62) However, 50% of the portfolio had a LTV greater than 80%, 36% greater than 90% and 14% (or £2.4 billion) greater than 100%.
343. By the end of 2008, the IPD index had fallen 24% since March 2008 and by 36% from its high in 2007. This implies that a significant percentage of the HBOS property investment book no longer had adequate security against which to recover the loan in the event the borrower got into difficulties. HBOS, therefore, faced significant impairment losses.
344. The risk was increased by failures to perfect the security arrangements. In a meeting with the FSA it was reported that following a sample check of security 52% had issues. Similarly, the Bank of England, when reviewing a pool of property loans put forward as collateral, noted that HBOS had not registered its security interest on the property for a third of the loans. However, risks to the adequacy of security had been known: the CCRC recorded that valuation clauses were often negotiated out of contracts, or that clients would only accept a valuation every seven years, and that in practice it was difficult to get valuations. In February 2007, it had been discovered that almost 20% of valuations recorded in the division’s systems were unattributed and therefore could not be relied upon. In effect HBOS had no or very weak security against a significant proportion of commercial property loans and was aware its security cover was potentially ineffective.
348. Despite the market having turned in 2007, it appears that HBOS still had appetite to grow into 2008. There is no evidence of any significant restraint being placed on lending in late 2007, and a review of the HBOS Real Estate Portfolio in May 2008 noted that limits for further property lending were in the process of being approved by Corporate and Group Risk. Eventually growth was slowed, but ultimately the property portfolio expanded by 6% in 2008.
349. The dangers of HBOS lending into the property market late in the cycle were raised by certain external commentators (Section 2.10) but these concerns failed to resonate with the firm, which expressed disappointment that the market did not understand its business model.
350. In summary, Corporate undertook significant commercial property lending at the height of the market, immediately prior to 2008. During this period the lending can be characterised as declining margins for increasing risk – rising LTVs, poor security and pressure on covenants. HBOS was thus more exposed than most when the crisis emerged. A number of large loans and investments made to companies during this period subsequently experienced difficulties, leading to debt restructuring and impairment losses.
The Bank had made loans of up to 90% LTV, with a HBOS subsidiary putting in 5% and the customer putting in 5% in order to buy high risk speculative property. This was not all loans, but was a feature that caused some of the biggest losses the bank sustained. HBSO expected the cycle of property prices could see the value of the portfolio increase, and with it HBOS’s investment, given that it had a subsidiary acting as a partner. In 2007 when property prices were dropping HBOS increased its lending. It was a disaster.
In October 2008 RBS, HBOS and Lloyds received bail-outs by the Government. It was terminal for HBOS, and Lloyds announced as part of the bail-out that it was acquiring HBOS. As HBOS held such a substantial part of the UK’s residential and commercial lending, it was simply too big to fail. Had it failed it would have created an economic disaster as SMEs and residential mortgage customers found their loans being called in. The Government had asked Lloyds to buy HBOS, which they agreed to and which is still the subject of litigation.
Lloyds went into HBOS and started looking at the books. Very quickly they found that it had existing outstanding debt and equity of £200 billion most of which emanated from its commercial lending division. Distressed loans were incredible. The HBOS reports concludes:
“50. In the three-year period from 2005 to 2007, the annual impairment losses recognised in the HBOS Group’s income statement(4) ranged between £1.7 billion and £2.1 billion. The losses on the Group’s lending portfolios increased markedly from September 2008 onwards, with impairment losses of £13.5 billion being ultimately recognised for the 2008 year-end.
51. Within Corporate, despite the deteriorating economic outlook in 2008, the business functions were reluctant to accept that the loans were going bad, and were reluctant to re-categorise and escalate them to the division’s specialist ‘impaired assets’ team. In many cases, when they were recategorised, the business functions and executive management maintained their expectation that they would be able to implement ‘workout solutions’ on the distressed loans and thereby suffer no loss or only a small one. As more and more Corporate loans deteriorated, the division’s impaired assets team became overwhelmed with their sheer volume and was unable to properly re-categorise the loans in a timely fashion. All of these factors meant that difficult decisions about deteriorating loans had to be taken later, and in a declining market, at higher ultimate cost.
52. The optimism also meant that throughout 2008 the division proposed levels of provisions which did not reflect the declining market conditions, and were increased following intensive discussions with the firm’s external auditors. Even then, the firm consistently chose the level of Corporate provisions at the least prudent end of the range deemed acceptable by its external auditors, though the approach had changed by the time that the 2008 year-end impairment figures were finalised in early 2009.
53. In its Annual Report and Accounts for the year ending 31 December 2007 (published early 2008) HBOS reported a profit before tax of £5.5 billion. The Annual Report and Accounts for 2008 (published early 2009) showed a loss of £11 billion. In its half-year interim results for the year to June 2008 (published 31 July 2008), the charge for Group impairment losses was £1.3 billion; yet by year-end 2008 this figure had risen to £12 billion. The deterioration in the quality of HBOS’s loan book and the speed with which it all happened, are a notable part of the HBOS story.”
Lloyds had a lot to do. It had a duty to its shareholders and to the wider economy to remove the so-called Toxic Loans. Slowly between 2009 (it started investigating the HBOS books in January 2009) and 2012 it identified business that had to immediately be put into administration, or identified businesses that could survive and offered them the opportunity of changing the terms of their lending to bring it in-line with new loan requirements (as noted earlier) or to re-bank. Businesses that could not reduce loans, increase security or re-bank had their assets re-valued, all of which were well below the LTV rates in the loan (and which many people now claim was engineered) allowing the bank to formally default the loans or reserve their right to default the loans. Then in early 2012 onwards businesses were told that Lloyds had sold their loans and security. It was a rolling manoeuvre.
As noted, Cerberus bought these loans. Billions and billions of pounds of commercial loans were bought by Cerberus. Cerberus and its subsidiaries would immediately demand full repayment of the loans. When they could not businesses with good quality security were put into administration. Some businesses did in fact get offered deals by Cerberus (by which we also mean its European subsidiaries). The new deals were very much in favour of Cerberus. Directors had duties to their companies, to their shareholders and to their employees. They agreed to the new terms, and some survived. Other were put into administration and their assets sold off.
I have been instructed by a hotel owner who found out about the Cerberus sale when he saw his own hotel group for sale on-line. He then was told that Cerberus had acquired his loan and security. He offered the bank £11.4 million to buy out the £18 million loan. It was rejected. Cerberus bought the loan for £11.1 million. Due to limitation and funding his ability to sue was lost. There are countless other cases like this.
So, the question of Cerberus still arises. Cerberus is entitled to buy loans lawfully offered to it for sale by a bank. It has investment and can afford to buy loans.
The question that arises more often is not the way that Cerberus has acted (though there are cases that include this) the question is often how the bank acted. In many cases the allegation goes to the valuation. This is a very difficult area of law. A valuer is almost always instructed by the bank. You, the customer, must pay for the valuation. As such, contractually and in common law, the duty that under-pins a legal claim is owed by the valuer to the bank, not the customer. Obviously, if there is fraud then the customer may have a claim against the valuer – but the ability to find evidence to prove fraud is vanishingly rare. A valuer must give his/her personal opinion on the value of the asset and that makes allegations of fraud almost impossible. Two valuers looking at the same asset may come to very different opinions. Solicitors and barristers are prohibited from alleging fraud without clear and convincing evidence of it. You may think the case is self evidently fraud, but without clear and convincing direct evidence (and not just an assumption) then you will be unlikely to find a barrister and/or solicitor to represent such a claim. Judges will look very unkindly on any claim that pleads fraud if the Judge finds that there is no evidence of fraud.
Many SMEs lost everything when the economy collapsed. They then lost their livelihoods when Lloyds, RBS and Clydesdale/Yorkshire Bank all sold their loans and security to Cerberus and Cerberus’ European subsidiaries. Without money and without access to the documents needed to prove their cases they allowed their claims to become time-barred. Many, especially HBOS and Lloyds cases, are still within time. Clydesdale Bank and Yorkshire Bank customers together with HBOS and Lloyds customers that saw their loans/security sold in 2012 are still in time. Those that had their loans sold to Cerberus prior to March 2011 are time-barred unless an exception can be pleaded.
Limitation: Limitation is the short hand expression relating to the time in which you must bring a claim in Court. The rules are within the Limitation Act 1980. The general rule is that a claim against a Bank in common law or contract must be brought within six years of a right of action first arising. So, for Cerberus cases that is usually going to be either six years from being moved into Lloyds’ Business Support Unit (BSU) or six years from the date of the valuation report being received by the Bank or six years from the date of the default notice being received. In some cases, it may be six years from the date at which the sale to Cerberus happened, though most cases are not that the bank had no rights to sell the loans (because almost all bank loan agreements contain the right to sell the loan), but are that the defaulting event was at fault.
You will see a number of people who wish to argue s. 14A, which relates to negligence. This is very difficult, because the rule (broadly speaking – please speak to a solicitor before making any decisions on limitation) the rule is that limitation starts from the date at which you first became aware of something hidden, and not necessarily the date upon which you could have evidenced the argument. It only relates to claims in negligence. Many people wish to rely on s. 14A and cite Kays Hotel as the reason. S. 14A is very difficult to plead and, as noted, the knowledge upon which s. 14A starts to run is quite often very limited knowledge and not – as many people think – the date upon which concrete evidence first became known.
Others also wish to rely upon s. 32. S. 32 relates to where something was hidden from you as a result of deceit or fraud or mistake. The rules relating to alleging fraud are relevant here. It is possible to cite it, but you must be able to properly and fully evidence your claim, which can be difficult.
If you think you have a claim in respect of loans and security sold to Cerberus and any of Cerberus’ European and British subsidiaries, speak to one of Muldoon Brittons solicitors 0161 826 6922.
Twitter: https://twitter.com/appgbanking  Hansard 22 February 2017 Column 441WH Westminster Hall
https://hansard.parliament.uk/Commons/2017-02-22/debates/92838813-D3EE-493E-BD45-EED766235F34/CerberusCapitalManagementPurchaseOfDistressedAssets  HBOS: The failure of HBOS plc (HBOS) jointly by the FCA and PRU November 2015 Collapse Page 83 para 314.
http://www.bankofengland.co.uk/pra/Documents/publications/reports/hbos.pdf  HBOS report page 88  HBOS Report page 89  BBC news 13 October 2008 “UK banks receive £37bn bail-out”
http://news.bbc.co.uk/1/hi/business/7666570.stm  13 October 2008 Lloyds press release “Lloyds TSB announces revised terms for the acquisition of HBOS and the raising of £5.5 billion of new capital”
http://www.lloydsbankinggroup.com/globalassets/documents/investors/2008/2008oct13d_ltsb_hbos_acquisition__raising_new_capital.pdf  22 July 2015 Telegraph “Lloyds shareholders launch £350m HBOS lawsuit”
http://www.telegraph.co.uk/finance/newsbysector/epic/lloy/11755921/Lloyds-shareholders-launch-350m-HBOS-law-suit.html  HBOS report (see footnote 3] Page 46 paragraph 148.  Paragraphs 4 to 11 Finch v Lloyds Bank plc & Promontoria Holding 87 BV  EWHC 1236 (QB)
http://www.bailii.org/ew/cases/EWHC/QB/2016/1236.html  Kays Hotel Limited v Barclays Bank Plc  EWHC 1927 (Comm)
http://www.bailii.org/ew/cases/EWHC/Comm/2014/1927.html  See for instance Burton v Bowdery  EWHC 208 (Ch) or Burrell v Clifford  EWHC 294 (Ch)