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Derivative mis-selling & insolvency (guest post by Insolvency Assist)

Interest Rate Hedging Product ‘misselling’ and insolvency

Interest Rate Hedging Products (irhp) were sold on mass to small unsophisticated UK businesses under the guise of ‘protection’, mainly alongside new lending but always to businesses who were able to carry the products additional liability; a ‘contingent liability’.

This additional liability was often never disclosed before or after the sale and was a liability in addition to the main loan quantum.

These liabilities would lay passive until the Bank of England reacted to the necessity for economic stimulous in late 2008 eventually position the rate at 0.5% by early 2009.

This vital reduction in lending costs inevitably assist the great majority of businesses but had a catastrophic effect on the vast majority of businesses who had been ‘missold protection’ by their bank.

The contingent liability quickly became a very real ‘credit sanctioned’ liability and part of the businesses total liabilities with the bank.

But was it disclosed ?

In the vast majority of cases we triage the bank did not disclose the liabilities in meetings, annual audit requests or in any Independent Business Reports.

The banks credit underwriting is not to be confused with the irhp break cost, the MTM, as the two can vary dramatically based on the product type, term, rate, etc.

How did this effect the business ?

Although the liabilities would sit passive in the banks owns records and leave the business owners unaware of the credit teams perspective of the business, the banks had a very different approach to the matter.

The security placed to cover such foreseeable eventualities was in every case we have seen the same security the bank used to loan the monies. It has been well documented that holding an irhp can see an instant breach in Loan To Value covenants but the more interesting aspect is how the banks account the liability.

In the case of Lloyds bank the credit team would change the initial contingency liability from a ‘soft’ limit to a ‘hard’ limit and when assessing the companies viability would use specific credit forms to detail additional liability(s) to the core lending.

On review of the businesses exposure the banks would know and detail the likely effect of the irhp ‘missale’ on the business as it moved forward through the contracts term.

The effects of this on an SME when not disclosed add an additional layer of deceit to the ‘missale’, an implicit effect of the irhp on the banks security requirements.

The effects of a ‘missold’ irhp contract has two effects;

Explicit the premiums payable under the contract

Implicit the effect of the calculable liability on the security pledged

The implicit effect of the contract is known and is foreseeable before the point of ‘missale’

So how does this effect insolvency ?

From our research since 2013 it is apparent that the banks fail to issue Final Demands for loan repayment with customers who are experiencing financial difficulty.

This is because had the bank served final demands on perceived failing companies it knew that the security pledged for the loan could not be used to assist repaying the loan debt.

The demand would have had to have been for both the loan and the irhp contract at the same time.

It was not possible in the vast majority of cases we have investigated for the business to have sold its assets and paid back just the loan, it would have left the irhp contract running with monthly premiums to pay and a liability that would have no security.

A pattern has emerged where the banks fund the business by way of unsecured overdrafts to pay the ‘missold’ premiums to a certain level then simply remove the facilities and invite the business to allow the bank to appoint an Insolvency Practitioner (IP) of their chioce.

The questions is – “was the IP allowed full insight into the irhp contract and its effects on the business, including the necessity for the IP to agree to break the contract ?”

FCA redress scheme

The irhp debacle has seen circa 20,000 businesses form part of a review endorsed by the FCA for the banks to run their own redress scheme for ‘misselling’.

From this population the FCA informed us that 10% are now insolvent.

The redress scheme is a fantastic facility from which to understand better the irhp ‘missale’ but it is a light touch solution and one that leaves the IP responsible for any acceptance of redress offers.

As a bank appointed IP it is likely that an agreement to break the irhp contract was made within the first month of office but the review is now likely to want an endorsement and acceptance of the bank own decision of the ‘missale’

The review offers various outcomes but in three different categories;

  1. No redress
  2. Alternative product
  3. Full tear up

In each case it is the IP that has to agree to the offers terms including the necessity to accept Full & Final (F&F) Settlement that in the case of Lloyds bank includes Fraud.

The Settlement Offers are legally binding but described by the FCA and the banks as ‘simplistic’.

The reality is that the wording in the banks offers of cash in exchange for F&F settlement is anything other than simple for a non-sophisticated business owner but are the IP’s deemed to have a higher level of understanding ?

Cases pending in the court system are challenging the validity of the review scheme offers and in one case the actual liability of the Section 166 appointed Independent Reviewer (IR).

A ‘missold’ irhp contract can have both explicit and implicit effects but to be able to give consideration of these effects the assessment of the ‘missold’ irhp must include the consideration of banks selling process, its non-disclosure of liabilities and how the bank could have manufactured the financial instability of the business rendering it debilitated.

One question imperative to any IP’s file is “but for the missold irhp would the business have avoided the insolvency process ?”

When the answer to this question is known only then can an IP consider any bank offering of cash for F&F.

It is clear to me that the review scheme forms a full and final process to bring closure but what is unclear to me is if the IP’s are being positioned by the bank to be liable for their decisions ?

In rugby this is what we call a Hospital Pass

Jon Welsby
Insolvency Assist CIC

Nadia has a degree in Business Management and a Diploma for Financial Advisers (Level 4). She has ten years of experience in financial services. This includes FSA regulated adviser roles in HSBC, Halifax and Nationwide. As senior manager at Vedanta Nadia is responsible for managing the office, client contact and marketing for the business.

Nadia has a degree in Business Management and a Diploma for Financial Advisers (Level 4). She has ten years of experience in financial services. This includes FSA regulated adviser roles in HSBC, Halifax and Nationwide. As senior manager at Vedanta Nadia is responsible for managing the office, client contact and marketing for the business.