Is it about to go to the Wall for GRG and RBS?
By Kalvin P. Chapman
To the wider public RBS’s fall from grace, which led to it asking the then Chancellor of the Exchequer for a bail-out to stop it folding into bankruptcy has Fred Goodwin in the lead role. To those of us in the financial litigation sector, Goodwin is a red herring, someone we rarely consider unless we are reading Ian Fraser’s Shredded. No, the name that is almost always at the front of our minds of Derek Sach. Derek Sach has taken on a person of epic proportions in the minds of litigants and their lawyers.
In 2007 RBS was in big trouble. Its finances were in the toilet. By August 2007 the traders at RBS knew they were in serious trouble. Fred Goodwin appears to have thought he could fight his way out of the trouble.
Someone realised that the bank’s Achilles heal is real estate. The bank had, in a really big way, gone after property developers, care homes, caravan parks, hotels and other leisure industries with real estate assets. They had lent money in absolutely remarkable ways. Property developers tell us, often, that in the 2006/07 period they were ordered to take out more lending by their relationship managers or their existing funding would be revoked (at the same time as selling them hedging. In the last quarter of 2007 Fred Goodwin told a conference that the sale of IRHPs was up 90%). By the start of the second quarter of 2007 people in the know knew that RBS had two major problems. Property prices were going to tank, having risen substantially since the start of the golden age in 2004. That would mean that businesses with assets in real estate would have loans that were bigger than the security the bank held. In addition to this, property collapses also mean sub-prime mortgages default in large numbers. RBS had made eye watering sums of money off the back of securitised mortgages, securities the bank had under-pinned with sub-prime mortgages. The US regulators are about to fine RBS between $3 and $15 billion because of its illegality in selling the securitised mortgage securities. The UK regulators have not fined RBS for this.
By August 2007 LIBOR rates had risen through the roof and base rate was expected to fall (and did). Therefore, the cost to the bank of borrowing money was steadily getting more expensive than they what the bank made by charging interest (at base rate) and the margin combined. As a consequence, banks around the world just stopped lending money on the wholesale market. Banks need steady injections of cash from the wholesale markets in order to feed their lending and repay old lending. With the tap turned off most banks were able to cope, but for banks like RBS and HBOS that had built their aggressive lending strategies on borrowing huge amounts on the wholesale markets this tap being turned off meant only one thing: financial oblivion. It killed HBOS and almost killed RBS.
In early to mid 2007 someone realised that the RBS clients who had commercial real estate would become insolvent, or could be made to look insolvent. For the business, real-estate dropping through the floor can usually be irrelevant. Income is made from rent, not the value of the property. So long as they have tenants the loans get paid and the profits get paid, no worries. But for a bank it is different. A bank cannot have more lending than it has security and cash deposits (and other assets). RBS and HBOS both were in this position to such an extent that they were effectively insolvent. So, RBS started moving commercial real estate based clients into a newly set up “turnaround” division. It became known as Global Restructuring Group, or GRG. Those three letters make a lot of people’s blood run cold.
I have worked on one of the first GRG cases from mid-2007. My client was a care home operator. GRG simply walked in one day and told my client he was insolvent. He had to pay substantially more on his loans and he had sell off his care homes to repay the loans. If he did not (which he said he would refuse to do so) the bank would put him in administration. My client and his then business partner were terrified. An auditor, paid by the client but under the direct control of GRG, came in and after a short review confirmed the client was effectively about to become insolvent. In almost every case where the client alleges a forced distress by GRG the same thing happens. The auditors almost always say that they will face a cash flow catastrophe in the next three months. It is never an immediate cash flow catastrophe, nor is it ever an insolvency. It almost every time a future cash flow catastrophe. Obviously, there are businesses that were genuinely insolvent and the auditors said this. I am referring to businesses that claim to have been artificially distressed by GRG. The bank has its insolvency event and defaults the lending and hedging, causing an actual insolvency event thus proving GRG was needed, despite that it was the bank that caused the alleged default. The client was in serious trouble, so the bank agrees to new, but vastly more expensive, lending on LIBOR, PPFAs and the break fees on the hedging is bundled up into new hedging, so the client never notices.
They got very good at this. They forced Property Participation Fee Agreements (“PPFAs) onto the clients. They are a future requirement to pay the bank an excessive amount of money. That agreement acts as security which the bank can use to prop up its balance sheet – it is an actual asset to the bank with a very real financial value. The bank had collapsed because it did not hold enough security. The PPFAs helped change that.
The PPFAs were made out to a subsidiary of the bank, known as West Register. The company is now known as Sig 1 Holdings Limited. This is what GRG did to their accounts:
| Year | Turnover | PPFA Income | Fees | Dividend Income |
| 2004 | £10,301,772.00 | £0.00 | £0.00 | £570,081.00 |
| 2005 | £77,854,608.00 | £0.00 | £0.00 | £645,534.00 |
| 2006 | £29,736,529.00 | £0.00 | £14,000.00 | £691,943.00 |
| 2007 | £36,193,655.00 | £0.00 | £13,000.00 | £573,858.00 |
| 2008 | £14,762,638.00 | £1,702,128.00 | £124,916.00 | £1,446,247.00 |
| 2009 | £8,890,534.00 | £367,007.00 | £196,688.00 | £471,398.00 |
| 2010 | £11,865,831.00 | £1,473,485.00 | £678,261.00 | £555,002.00 |
| 2011 | £17,945,502.00 | £4,319,621.00 | £564,114.00 | £768,659.00 |
| 2012 | £58,007,175.00 | £3,175,269.00 | £1,237,005.00 | £3,822,169.00 |
| 2013 | £56,302,462.00 | £4,802,413.00 | £921,139.00 | £13,711,795.00 |
| 2014 | £95,056,493.00 | £2,928,765.00 | £708,846.00 | £31,575,685.00 |
| 2015 | £153,859,937.00 | £1,539,733.00 | £0.00 | £52,378,134.00 |
| Totals | £570,777,136.00 | £20,308,421.00 | £4,457,969.00 | £107,210,505.00 |
So, GRG was set up. It ruined a lot of people’s lives. It stripped SME businesses of their profits. First came the IRHP review into the sale of hedging, then came the Lawrence Tomlinson report in 2014 outing GRG as the nefarious bad witch that came along and ruined viable businesses. It is very true that many businesses that simply were not viable went into GRG – RBS is very quick to point those out. But there were businesses that could have survived and either did not or did survive but being vastly reduced. A lot of businesses will now no longer consider bank lending, even though their businesses can only grow with funding, because of what RBS and Lloyds did to them. It is very distressing and heart breaking to see people whose lives have been utterly ruined by the banks. The nightmare continues for many at RBS and Lloyds.
Bank lending to SMEs is entirely unregulated. The relationship between the bank and its customer is regulated by common law and contract law. The bank can effectively do what it wants, so long as the contracts allow it. This is what a recent GRG claim said
“RBS was entitled to act in what were its commercial interests. Those were the interests to which I have referred. RBS was also, no doubt, obliged to act vis-à-vis Mr McCarthy in accordance with the principles to which I have just referred. I do not accept that adherence to those principles required RBS to act differently in this case. If Mr McCarthy has grounds for complaint, it is for him to make an appropriate complaint in the appropriate venue alleging that the principles have not been complied with. That, however, is not the claim which is before me; indeed, no such complaint has, at least as I understand it, ever been asserted.” [Emphasis added]
We have also seen the Property Alliance Group Limited v Royal Bank of Scotland Plc[2] case decided following a substantial trial. A part of their claim was that RBS had artificially distressed them and put them into GRG unlawfully and in bad faith. The Court ruled that there is no implied term of good faith in bank SME relationship[3] and that the Bank has the right to put a business into GRG if it deems them to be in financial difficulty or potentially going to suffer financial difficulties[4]. The Judge in PAG finds that no-one has a right to be managed by any part of the bank – the bank can choose which division or group looks after a customer’s case, including GRG.
So, the two Titans of GRG Cases will be heard at trial in 2017. They are cases that law students will take time out to go and watch. Journalists will cram the courtrooms on the first two days of opening remarks and the last two days of closing. One case is Hockin v RBS and the other case is Wall v RBS.
We do not at present know the costs of Hockin but we know that in the Wall case, RBS estimate that at the end of the trial costs will be £9 million[5].
In Wall it has been reported[6] that Mr Wall’s team is requiring Derek Sach to give evidence. Mr Sach was the director in charge of GRG, famed for having misled the Treasury Select Committee. RBS claim that Mr Sach (and one of his colleagues) inadvertently misled the Committee. RBS insulated itself from a lot of litigation by having a solicitor present at most sensitive and high level meetings about GRG and GRG customers. That makes anything said or written in those meetings subject to client-solicitor privilege and/or litigation privilege. So, it is quite telling that Wall’s legal team have apparently been able to get Mr Sach into the case.
Both Hockin and Wall are slightly different to PAG. PAG survived. Neither Hockin’s nor Wall’s businesses survived. The assets of the businesses were packaged up and sold off by RBS. Both went into GRG and both allege that GRG had no rights to do what they have done.
Hockin is set for trial in April 2017 before the same Judge as PAG, Mrs Justice Asplin. The Judge is on the specialist finance list of judges. She found against PAG on everything. So, it is great to have a specialist, but the total loss of PAG does provoke concerns. According to the last reported Wall decision Wall is set for trial between September and November of 2017.
Both cases will be epic battles between ordinary people who had made big successes of themselves having their entire life’s work ripped away from them by a bank that bankrupted itself and is alleged by many to have trampled on SME business in order to claw its way out of that bankruptcy. In 2016 RBS once again reported a multi-billion-pound loss and is facing a fine of potentially double digit billions for its past failures on selling securities in the US.
The RBS litigation bus, it seems, will continue for the near future.
Resources:
[1] The Royal Bank of Scotland Plc v MccArthy [2015] EWHC 3626 (QB) (21 December 2015)
[2] Property Alliance Group Ltd v The Royal Bank of Scotland Plc [2016] EWHC 3342 (Ch) (21 December 2016)
[3] Ibid at paragraph 275 & 276
“that there is no general duty of good faith in English contract law, although it may be implied in certain categories of contract such contracts of employment. However, as Leggatt J stated in Yam Seng at [131] in a passage cited by Jackson LJ, following the established methodology of English law for the implication of terms, such a term may be implied based on the presumed intention of the parties.
“In my judgment, applying that established methodology, such a term cannot be implied in the 2009 and 2011 Facility Agreements which were contracts between sophisticated commercial parties negotiated at arm’s length. In this regard, I take into account that the contracts do not fall within any of the recognised categories in which good faith is to be implied and their express terms and standard terms excluding any fiduciary or equitable duties arising in the provision of the services by RBS, militate against such an implication. In the circumstances, it seems to me that such an implied term cannot have reflected the presumed intention of the parties nor is necessary for the proper functioning of the contracts. Accordingly, I agree with Mr Handyside that such a term should not be implied in what is standard banking documentation.”
[4] Paragraph 302 – 308:
If I had found that the alleged terms should have been implied in the light of the Socimer principle, I would not have found that RBS was in breach of those terms in relation to PAG’s transfer into GRG, its retention in GRG and the other alleged breaches relied upon. First, in relation to the transfer into GRG, it is important to bear in mind that there was no contractual right to be managed by a particular team with RBS, in a particular location. Secondly, in my judgment, there is no basis for the allegation that the transfer was irrational or conducted in bad faith.
Despite the fact that the contemporaneous emails contain a number of cryptic remarks which remain unexplained in the light of the fact that their authors were not called to give evidence, it seems to me that it is highly implausible that the remainder of the substantial documentation is inaccurate. Given that Mr Whatham, Mr McCoy and Mr Thomson from GRG were called, I also decline to draw adverse inferences from the failure to call each and every correspondent involved in this matter. Although each such failure must be judged on its own facts, it seems to me that in general, parties should seek to limit the number of witnesses called in the light of the overriding objective.
In any event, it was not put to any of Mr Whatham, Mr Thomson and Mr McCoy that the such documentation was a sham. It also seems to me that the concerns raised about the Watch Committee notes come to nothing when viewed in the light of Mr Cocking’s email to Mr Logan and copied to Mr Thomson, sent very shortly after the meeting in which reference was made to the decision having been made to transfer PAG to GRG. Furthermore, the fact that the witnesses referred to a variety of reasons for transfer, does not seem to me to be enough to found a claim of bad faith, arbitrariness or capriciousness. Equally, the fact that PAG’s LTV was much lower than the level justifying mandatory transfer when viewed in isolation, is neither here nor there. It seems to me that the combination of reasons set out in the GRG Referral Form dated 7 April 2010 render the allegation of bad faith, arbitrariness and capriciousness hopeless.
I also agree that there is no evidence to support what PAG describes as the “real” reasons for its transfer. First, there is no evidence that there was a campaign to extract as much as possible from PAG. I will deal with the valuation and security review below. Secondly, the only evidence of complaints about the Swaps at this stage (which it is said were intended to be stifled by the transfer) is Mr Russell’s evidence in cross-examination that he complained on numerous occasions to Mr Goldrick. He was unable to be precise about the complaints or the occasions on which they were made and the point was never put to Mr Goldrick. In the circumstances, I am not able to accept Mr Russell’s evidence and consider that there is no foundation for the “stifling complaints” alleged “real” reason.
[5] Wall v The Royal Bank of Scotland Plc [2016] EWHC 2460 (Comm) (07 October 2016) at paragraph 98:
“This litigation is large and complex. It raises for investigation events spanning a period of at least six years. There will be expert evidence from up to five different expert disciplines. RBS estimates that to the conclusion of the trial its costs will exceed £9 million (before VAT). “
[6] the London Evening Standard 30 January 2017 “Former RBS man Sach embroiled in GRG case”
http://www.standard.co.uk/business/former-rbs-man-sach-embroiled-in-grg-case-a3453286.html
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