‘Interest rate swaps mis-selling’ Ronan McGoldrick discusses how the banks’ win/win is becoming a loss/loss

Cosgrave -v- Ulster Bank

Earlier this month three brothers of the Cosgrave Property Group and one of their companies issued proceedings claiming more than €250 million in damages from Ulster Bank over alleged mis-selling of financial derivative instruments know as interest rate “swaps” under which some €370 million is allegedly outstanding to the bank.

Peter, Joseph and Michael Cosgrave allege breach of fiduciary duty and deceit arising from the selling of the instruments which, they contend, were unsuitable for them. The bank denies those claims and contends the swaps were “standard” swaps, known as “vanilla” swaps, with no particularly complex or unusual features.

It’s the latest high profile case in a series making their way through the courts here and in the UK. Media reports confirmed in 2012 that Ulster Bank wrote off €30 million of debt in a Court settlement with developer and businessman David Agar and covered his legal costs.

Why Irish Banks are worried

But Ulster Bank is not the only domestic bank in trouble over swap-mis-selling. Last year a Dublin couple Robert and Rosaleen Madden initiated a claim against AIB for €45 million. With the Central Bank demonstrating reluctance to investigate swap mis-selling, and put in place a general compensation fund, it’s very likely that the number of swaps mis-selling cases is going to rise considerably. The Irish banks are rightly worried.

How do Interest Rate Swaps Work?

There are numerous types of swaps. The relevant swaps for this article are interest rate swaps or products that banks sell to borrowers along with loans which provide insurance against interest rate increases affecting the loan. They were sold on the purported basis that they would protect business borrowers from fluctuations in interest rates. For example if you borrow €100m when the interest rate is 5% you might buy a swap to protect you if the interest rate rose above 6%.

However, many of the interest rate swaps were sold during the boom or towards the end of it. As the world economy slipped into recession and interest rates fell sharply, the borrower had to pay the bank simply eye-watering sums of money. In the case of the Madden couple and their case with AIB, they claimed they were paying €1.3m per annum in additional payments to AIB for the swap products. Worse, it turned out that in many cases the term of the swap deal was very considerably longer than the term of the associated loan.

The situation is somewhat analogous to a contract for difference. And indeed like a CFD a swap is a financial derivative. A CFD is based on the value of the security to which it is linked. When the value of the underlying security goes up you make lots of money, much more than your original investment. But when the value goes down you lose lots more money than your original investment. The experience of Sean Quinn with Anglo shares demonstrates precisely how dangerous CFDs can be to the uninitiated investor.

Complex Financial Derivatives

Financial derivatives like swaps and CFDs were created in the 1980s and 1990s by very highly sophisticated financial investment specialists usually with mathematics backgrounds. They were created for use by investment professionals and suitably qualified financial officers in very large corporations used to dealing with enormous sums of money. They were never meant to be used by retail investors or SMEs as they were here and elsewhere. But in the boom banks and financial services firms sold these highly complex products to people who ought to have been advised better. Indeed, it is a feature of the general practice in Ireland that borrowers were forced under duress to buy the swap product to secure the loan.

We don’t know yet what the High Court will make of Ulster Bank’s contention that the swaps in the Cosgrave case were “standard” “vanilla” swaps, with no particularly complex or unusual features. What we do know is that whatever the complexity or otherwise of the swap, in many Irish cases, any potential benefit to a borrower buying a swap was wholly disproportionate to the risk. And in the UK approximately €3 billion has been refunded to borrowers so far.

The Mis-Selling

Where the bank may have moved from lender to adviser in offering a swap product then, as the Cosgraves contend, the bank assumed a fiduciary duty to act in the best interests of its client and not in its own interests. It therefore firstly had an obligation to properly explain the downside to its client and that, no matter what happened to interest rates, the bank would either win, or it would win big. It follows that secondly, the bank had an obligation to put itself in the shoes of its client and make a professional assessment as to whether or not the swap was a suitable product for the client. If it didn’t then that may be a breach of its fiduciary duty.

The 6 Year Rule

But many of the swaps that may have been mis-sold were sold some years ago. And so the 6 year rule may appear to apply to prevent potential plaintiffs from launching actions. But a defendant is estopped from relying the 6 year rule in cases here there has been misrepresentation or deception. For there to be mis-selling there must usually either have been a fraudulent or negligent misrepresentation by the bank. In that case the borrower may be entitled to rescind the contract and recover any losses in the form of repayments made. In conjunction with a claim for misrepresentation plaintiffs may be entitled to claim, as the Cosgraves have, deception. Deception is a tort arising from a false statement of fact made knowingly so that it would be acted on by another who suffers damage as a result. If that claim is successful it may also entitle the plaintiff to recover damages.

Conclusion

The banks are worried. And they should be.

Disclaimer
This publication is for guidance purposes only. It does not constitute legal or professional advice. No liability is accepted by Leman Solicitors for any action taken or not taken in reliance on the information set out in this publication. Professional or legal advice should be obtained before taking or refraining from any action as a result of the contents of this publication. Any and all information is subject to change.

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