Options for borrowers
Most businesses have some bank indebtedness and, given market conditions, this is typically secured by a complicated series of debentures, fixed/floating charges, personal and group guarantees and deposits. Together such security documentation gives banks a great deal of leverage when borrowing businesses get into financial difficulties and become unable to comply fully with the terms of the relevant bank facilities.
There is something of a perfect storm at present in the banking market following the collapse of Lehman Brothers and the ensuing ‘banking crisis’; not only has the suite of security documents which protect banks never been more draconian, but also, given the pressure on banks as a result of recent fines, the desire of some banks to pull out of certain markets and the economy in general, banks have never been quicker to use these powers.
Business owners frequently find that their contractual arrangements with their bank have been subjected to a change in policy within the bank, (sometimes dictated at group level) requiring loan exposures to be reduced. New loan reduction targets are set and the individual within your bank with whom you have been dealing may find his job on the line if such targets are not met. One notable case of a policy decision being dictated at group level and which has been in the news recently (Financial Times April 30th 2012) is where the National Australian Banking Group (the parent company of Yorkshire Bank and Clydesdale Bank) announced its intention to cease all UK based property development lending, particularly London, with an anticipated loss of 1400 jobs.
This article looks at some of the ways banks currently treat struggling businesses and offers some options which can protect businesses and their owners when banks overstep the mark.
Unlawfully calling personal or group company guarantees
As their name suggests a guarantee is a contractual promise to pay. The guarantor is typically a shareholder, director or group company with assets and the sums guaranteed are the debts of the borrowing company. The lending bank is the recipient of this guarantee and is usually able to enforce the guarantee in all circumstances, even where the indebted company has a realistic prospect of repaying the bank and its breach is minor. (For further details on challenging bank guarantees.)
Treating term loans as ‘on demand’
Many loans are for a fixed length of time and are categorised as ‘term loans’. If a borrower is not in breach of its obligations under the relevant facility documentation, then the bank cannot simply demand immediate repayment of the loan.
It is not uncommon to hear of situations where business owners have been asked to attend a meeting at their bank where they are told that the bank is to ‘restructure’ the facility often with higher interest rates and new arrangement fees. In this way the bank has fulfilled its need to close down a particular loan exposure (whether for policy reasons, commercial reasons or otherwise) and has created a new loan on more favorable terms.
It may be put to a business owner that the choice to reschedule is a condition of the bank’s ‘continuing support’, i.e. if the new terms are not agreed then the existing loans will be called. If an existing term loan is operating properly and the bank does call the loan then the bank may well be in breach of its own contract. Be that as it may, many businesses feel unable to stand up to their bank in such situations. Businesses should stand firm though, check the terms of the original facility by reference to the original signed documentation and take legal advice. It should not be assumed that the bank’s demand is lawful and valid.
Alleged breach of financial covenants
The financial covenants are the terms in the facility documents which impose certain financial tests on the borrower. If the borrower fails to meet these tests then this typically is an event of default and this in turn allows the bank to call the loan. By way of example, one such common covenant relates to ‘interest cover’, that is that the borrower’s profit levels month to month must exceed the interest charged by the bank by an agreed multiple. Another such common test measures the ratio of borrowing to security for that borrowing. As in both of these examples it is clear that there is an element of subjectivity in how these are measured and calculated and of course scope for making an arithmetical error or an error in the interpretation of the relevant terms of the contract.
Interest incorrectly calculated
The most common and simplest errors involve calculations of interest. Again it is worth checking the facility documentation to see how the interest to be charged is defined. What is the applicable rate? Interest may be referable to the bank’s base rate or LIBOR or by reference to another rate which may be unclear. Calculation of interest by reference to a rate that is not in fact the true contractual rate can distort the true picture significantly and create an apparent breach of financial covenant where none exists.
Indebtedness inflated by incorrect bank charges
Much has been written on the subject of bank overcharging. However, sometimes an analysis of interest actually charged over a period of time when compared to a similar analysis of the contractually applicable contractual rate over the same period can reveal surprising discrepancies (even where the contractual rate is easily ascertainable). Such discrepancies can be enough to overstate significantly the true balance outstanding to the bank. Even modest overcharging over, say, a number of years will accumulate gradually but will eventually have a dramatic impact on any total outstanding. This is particularly true when interest is compounded monthly, which is how most banks now operate. Such errors will create apparent breaches of the financial covenants and apparent events of default upon which a bank may purport to call in a facility when in fact it is the bank which is in breach.
Facility letters between a bank and its borrower may often state that the balance certified by the bank as owing is to be taken as correct unless it can be established that there has been ‘manifest error’ on the part of the bank. While this does put the bank in the driving seat in the calculation of the sums owing, borrowers will be able to resist a bank’s demand to call the loan where such demand is based on an error of interpretation or calculation. The borrower can also at that point require a properly calculated account.
Incorrectly valued assets/security
It pays to check the facility documentation to see if the basis of valuation of assets has been defined in the contract and then applied correctly. One of the most common examples of this being used against borrowers’ interests is in loans relating to property redevelopment. There have been a number of instances where loans have been advanced in relation to what in effect is the value of the site after it has been developed or the ‘gross development value’ (GDV) of a particular site. However, where the facility documentation is poorly drafted and ‘Value’ or ‘Valuation’ are not defined or are defined in ambiguous terms there is considerable scope for the wrong valuation to be used. For example, a borrower may clear a site for redevelopment and demolish the property(ies) on it. This will reduce the value of the site and is a necessary and entirely foreseeable part of the project. The facility documents and demand letters must be very carefully checked where a bank calls the loan based on a breach of a site valuation covenant. All the more so as if the bank is allowed to call the loan when the value of the site is low then the borrower will not only be unable to fund the development, but may also find the asset is sold at a time when its value is low, leaving insufficient proceeds to repay the bank in full and therefore causing the bank to call the relevant personal guarantee. In such circumstances the borrower will need to contest the validity of the demand based on the banks deviation from what the facility documents said, or, where ambiguous or silent, should have said.
What constitutes a valuation?
The bank will need to have procured a valuation for the purposes of the facility agreement. The term ‘valuation’ may be defined in the facility letter, in which case the valuation supplied must be measured against the valuation produced by the bank. In the absence of a more particular definition then the borrower can argue that the term ‘valuation’ implies a degree of formality and independence. It cannot be sufficient, for example, for a bank employee to request an informal off the cuff opinion by e-mail from their usual valuer and for the resulting email to stand as evidence of a breach of financial covenant. Therefore before accepting the position as stated by the bank it is worth asking to see the valuation relied upon and the basis upon which the ‘valuation’ was requisitioned.
Representations and misrepresentations by bank staff
How banks make money and how they pay their employees are currently the subject of much public interest. Currently bank fees for loans and financial products are a major source of income for the bank and a key determinant of the performance of those bank employees putting them in place. It therefore comes as no surprise to learn that bank sales staff (for that is really what they are) will make promises to borrowers about the financial product or loan to be provided and borrowers will rely upon these representations.
Where these representations subsequently turn out to have been incorrect, then serious damage to the borrower’s business can ensue. A common misrepresentation made by ‘enthusiastic’ bank staff is that the bank will not rely on the strict written contractual wording of a particular document. Sometimes such representation accompanies a request for increased security such as the giving of a personal guarantee for the first time.
Consider the following example; a borrower enters into an on demand loan in reliance on a representation from the bank that the loan itself would not be called for a fixed period of, say, three years. If that loan is called after, say, 12 months, and if doing so causes the borrower to suffer a loss, then the borrower will have an action against the bank.
Such a case is going through the courts at present. In July 2012 Chris Walsh, a Belfast property investor owning many shopping centres in London, Leeds and Belfast secured an injunction in the Northern Ireland High Court preventing RBS taking action on securities held by it. Mr Walsh had successfully argued that he had agreed to a proposal to acquire a property only on the basis that a three-year term loan could be renewed for a longer-term facility. The case will now proceed to a full trial on this issue. Interestingly Mr Walsh is reported to claim that he was told in January 2012 of a ‘non-negotiable’ policy of RBS to wind down its former bank loan book within 12-18 months.
Legally such representations could constitute a binding collateral contract between the business and the bank. In that case the bank will be in breach of this collateral contract if it seeks to call in a given facility before the expiry of the agreed term, albeit the term was agreed outside the scope of the formal facility documentation.
Alternatively representations may be made by Bank staff that are actually incorrect at the time they are made. This would be a ‘misrepresentation’ and if relied upon to the detriment of a party will be actionable under the Misrepresentation Act 1967 S. 2(1). Under this Act, if any representation is something to which liability would attach if made fraudulently, then damages will follow unless it can be proved that there were reasonable grounds to believe the accuracy of the statement made.
Conclusion
Traditionally banks have the upper hand in negotiations with borrowers. They have the cash the borrowers seek and teams of skilled lawyers to ensure the banks interests are protected. However, this is not the full picture. Banks are themselves under pressure to perform and to exit from certain markets. Borrowers in those markets do therefore have an opportunity to react to changing bank policy and to re-negotiate with the bank from a position of strength or to move to a new bank.
Furthermore, for all their resources, banks make mistakes. If a borrower receives a demand it, and the facility documentation, security documentation and the conduct of the bank should be examined very carefully for errors on the bank’s part.
Finally, the incidence of banks calling personal guarantees is on the increase. Borrowers who have given a personal guarantee may be able to resist the bank’s enforcement efforts. The entering into of loan documents and the consequences when the bank wishes to withdraw the loan is a complex matter and borrowers and guarantors should take legal advice at an early stage.
Most businesses have some bank indebtedness and, given market conditions, this is typically secured by a complicated series of debentures, fixed/floating charges, personal and group guarantees and deposits. Together such security documentation gives banks a great deal of leverage when borrowing businesses get into financial difficulties and become unable to comply fully with the terms of the relevant bank facilities.
There is something of a perfect storm at present in the banking market following the collapse of Lehman Brothers and the ensuing ‘banking crisis’; not only has the suite of security documents which protect banks never been more draconian, but also, given the pressure on banks as a result of recent fines, the desire of some banks to pull out of certain markets and the economy in general, banks have never been quicker to use these powers.
Business owners frequently find that their contractual arrangements with their bank have been subjected to a change in policy within the bank, (sometimes dictated at group level) requiring loan exposures to be reduced. New loan reduction targets are set and the individual within your bank with whom you have been dealing may find his job on the line if such targets are not met. One notable case of a policy decision being dictated at group level and which has been in the news recently (Financial Times April 30th 2012) is where the National Australian Banking Group (the parent company of Yorkshire Bank and Clydesdale Bank) announced its intention to cease all UK based property development lending, particularly London, with an anticipated loss of 1400 jobs.
This article looks at some of the ways banks currently treat struggling businesses and offers some options which can protect businesses and their owners when banks overstep the mark.
Unlawfully calling personal or group company guarantees
As their name suggests a guarantee is a contractual promise to pay. The guarantor is typically a shareholder, director or group company with assets and the sums guaranteed are the debts of the borrowing company. The lending bank is the recipient of this guarantee and is usually able to enforce the guarantee in all circumstances, even where the indebted company has a realistic prospect of repaying the bank and its breach is minor. (For further details on challenging bank guarantees.)
Treating term loans as ‘on demand’
Many loans are for a fixed length of time and are categorised as ‘term loans’. If a borrower is not in breach of its obligations under the relevant facility documentation, then the bank cannot simply demand immediate repayment of the loan.
It is not uncommon to hear of situations where business owners have been asked to attend a meeting at their bank where they are told that the bank is to ‘restructure’ the facility often with higher interest rates and new arrangement fees. In this way the bank has fulfilled its need to close down a particular loan exposure (whether for policy reasons, commercial reasons or otherwise) and has created a new loan on more favorable terms.
It may be put to a business owner that the choice to reschedule is a condition of the bank’s ‘continuing support’, i.e. if the new terms are not agreed then the existing loans will be called. If an existing term loan is operating properly and the bank does call the loan then the bank may well be in breach of its own contract. Be that as it may, many businesses feel unable to stand up to their bank in such situations. Businesses should stand firm though, check the terms of the original facility by reference to the original signed documentation and take legal advice. It should not be assumed that the bank’s demand is lawful and valid.
Alleged breach of financial covenants
The financial covenants are the terms in the facility documents which impose certain financial tests on the borrower. If the borrower fails to meet these tests then this typically is an event of default and this in turn allows the bank to call the loan. By way of example, one such common covenant relates to ‘interest cover’, that is that the borrower’s profit levels month to month must exceed the interest charged by the bank by an agreed multiple. Another such common test measures the ratio of borrowing to security for that borrowing. As in both of these examples it is clear that there is an element of subjectivity in how these are measured and calculated and of course scope for making an arithmetical error or an error in the interpretation of the relevant terms of the contract.
Interest incorrectly calculated
The most common and simplest errors involve calculations of interest. Again it is worth checking the facility documentation to see how the interest to be charged is defined. What is the applicable rate? Interest may be referable to the bank’s base rate or LIBOR or by reference to another rate which may be unclear. Calculation of interest by reference to a rate that is not in fact the true contractual rate can distort the true picture significantly and create an apparent breach of financial covenant where none exists.
Indebtedness inflated by incorrect bank charges
Much has been written on the subject of bank overcharging. However, sometimes an analysis of interest actually charged over a period of time when compared to a similar analysis of the contractually applicable contractual rate over the same period can reveal surprising discrepancies (even where the contractual rate is easily ascertainable). Such discrepancies can be enough to overstate significantly the true balance outstanding to the bank. Even modest overcharging over, say, a number of years will accumulate gradually but will eventually have a dramatic impact on any total outstanding. This is particularly true when interest is compounded monthly, which is how most banks now operate. Such errors will create apparent breaches of the financial covenants and apparent events of default upon which a bank may purport to call in a facility when in fact it is the bank which is in breach.
Facility letters between a bank and its borrower may often state that the balance certified by the bank as owing is to be taken as correct unless it can be established that there has been ‘manifest error’ on the part of the bank. While this does put the bank in the driving seat in the calculation of the sums owing, borrowers will be able to resist a bank’s demand to call the loan where such demand is based on an error of interpretation or calculation. The borrower can also at that point require a properly calculated account.
Incorrectly valued assets/security
It pays to check the facility documentation to see if the basis of valuation of assets has been defined in the contract and then applied correctly. One of the most common examples of this being used against borrowers’ interests is in loans relating to property redevelopment. There have been a number of instances where loans have been advanced in relation to what in effect is the value of the site after it has been developed or the ‘gross development value’ (GDV) of a particular site. However, where the facility documentation is poorly drafted and ‘Value’ or ‘Valuation’ are not defined or are defined in ambiguous terms there is considerable scope for the wrong valuation to be used. For example, a borrower may clear a site for redevelopment and demolish the property(ies) on it. This will reduce the value of the site and is a necessary and entirely foreseeable part of the project. The facility documents and demand letters must be very carefully checked where a bank calls the loan based on a breach of a site valuation covenant. All the more so as if the bank is allowed to call the loan when the value of the site is low then the borrower will not only be unable to fund the development, but may also find the asset is sold at a time when its value is low, leaving insufficient proceeds to repay the bank in full and therefore causing the bank to call the relevant personal guarantee. In such circumstances the borrower will need to contest the validity of the demand based on the banks deviation from what the facility documents said, or, where ambiguous or silent, should have said.
What constitutes a valuation?
The bank will need to have procured a valuation for the purposes of the facility agreement. The term ‘valuation’ may be defined in the facility letter, in which case the valuation supplied must be measured against the valuation produced by the bank. In the absence of a more particular definition then the borrower can argue that the term ‘valuation’ implies a degree of formality and independence. It cannot be sufficient, for example, for a bank employee to request an informal off the cuff opinion by e-mail from their usual valuer and for the resulting email to stand as evidence of a breach of financial covenant. Therefore before accepting the position as stated by the bank it is worth asking to see the valuation relied upon and the basis upon which the ‘valuation’ was requisitioned.
Representations and misrepresentations by bank staff
How banks make money and how they pay their employees are currently the subject of much public interest. Currently bank fees for loans and financial products are a major source of income for the bank and a key determinant of the performance of those bank employees putting them in place. It therefore comes as no surprise to learn that bank sales staff (for that is really what they are) will make promises to borrowers about the financial product or loan to be provided and borrowers will rely upon these representations.
Where these representations subsequently turn out to have been incorrect, then serious damage to the borrower’s business can ensue. A common misrepresentation made by ‘enthusiastic’ bank staff is that the bank will not rely on the strict written contractual wording of a particular document. Sometimes such representation accompanies a request for increased security such as the giving of a personal guarantee for the first time.
Consider the following example; a borrower enters into an on demand loan in reliance on a representation from the bank that the loan itself would not be called for a fixed period of, say, three years. If that loan is called after, say, 12 months, and if doing so causes the borrower to suffer a loss, then the borrower will have an action against the bank.
Such a case is going through the courts at present. In July 2012 Chris Walsh, a Belfast property investor owning many shopping centres in London, Leeds and Belfast secured an injunction in the Northern Ireland High Court preventing RBS taking action on securities held by it. Mr Walsh had successfully argued that he had agreed to a proposal to acquire a property only on the basis that a three-year term loan could be renewed for a longer-term facility. The case will now proceed to a full trial on this issue. Interestingly Mr Walsh is reported to claim that he was told in January 2012 of a ‘non-negotiable’ policy of RBS to wind down its former bank loan book within 12-18 months.
Legally such representations could constitute a binding collateral contract between the business and the bank. In that case the bank will be in breach of this collateral contract if it seeks to call in a given facility before the expiry of the agreed term, albeit the term was agreed outside the scope of the formal facility documentation.
Alternatively representations may be made by Bank staff that are actually incorrect at the time they are made. This would be a ‘misrepresentation’ and if relied upon to the detriment of a party will be actionable under the Misrepresentation Act 1967 S. 2(1). Under this Act, if any representation is something to which liability would attach if made fraudulently, then damages will follow unless it can be proved that there were reasonable grounds to believe the accuracy of the statement made.
Conclusion
Traditionally banks have the upper hand in negotiations with borrowers. They have the cash the borrowers seek and teams of skilled lawyers to ensure the banks interests are protected. However, this is not the full picture. Banks are themselves under pressure to perform and to exit from certain markets. Borrowers in those markets do therefore have an opportunity to react to changing bank policy and to re-negotiate with the bank from a position of strength or to move to a new bank.
Furthermore, for all their resources, banks make mistakes. If a borrower receives a demand it, and the facility documentation, security documentation and the conduct of the bank should be examined very carefully for errors on the bank’s part.
Finally, the incidence of banks calling personal guarantees is on the increase. Borrowers who have given a personal guarantee may be able to resist the bank’s enforcement efforts. The entering into of loan documents and the consequences when the bank wishes to withdraw the loan is a complex matter and borrowers and guarantors should take legal advice at an early stage.
Patrick SelleyProfile: Patrick Selley - Keystone Law
E: patrick.selley@keystonelaw.co.uk
T: 020 7152 6550
M: 07976 911936
See Patrick Selley in the Financial Times
http://www.ft.com/cms/s/0/784df3d4-12e9-11e2-aa9c-00144feabdc0.html#axzz2aQyGEARG
Profile Patrick Selley
www.patrickselley.com
Patrick is an experienced commercial litigator who has taken many cases to trial in the High Court and the Court of Appeal. Patrick strongly believes in using flexible approaches to dispute resolution; he is a qualified mediator and a Fellow of the Chartered Institute of Arbitrators. Previously, Patrick has conducted professional negligence defence work, but he now acts for claimants, particularly against solicitors and financial advisers.
Patrick was admitted as a solicitor in the UK in 1983 and in Hong Kong in 1986.
Patrick is a keen exponent of mediation from the outset having been a director of ADR Net and, with Bond Pearce, a branch founder of the Centre for Mediation in the 1990’s. Trained with both CEDR and ADR Net Patrick has successful experience of many mediations both as mediator and advocate. In addition to his work as a litigator and a mediator, Patrick also runs mediation training courses for non legal professionals.
Patrick was admitted as a solicitor in the UK in 1983 and in Hong Kong in 1986.
Patrick is a keen exponent of mediation from the outset having been a director of ADR Net and, with Bond Pearce, a branch founder of the Centre for Mediation in the 1990’s. Trained with both CEDR and ADR Net Patrick has successful experience of many mediations both as mediator and advocate. In addition to his work as a litigator and a mediator, Patrick also runs mediation training courses for non legal professionals.
