The Sword of Damocles: lender/borrower relations at the dawn of foreclosure

The High Court has set a high bar for claims alleging that the "rough and tumble" of restructuring negotiations have rendered settlement agreements voidable for breaches of duty, tortious intimidation or economic duress.

With a factual matrix emerging from the ruins of the 2007-2010 subprime mortgage crisis, Kerr J's judgment is set to become a powerful precedent for loans which become distressed as a result of the COVID-19 pandemic. 

Facts

In late 2006, RBS granted Mr Morley, a successful commercial property developer, a £75 million facility to refinance a substantial portfolio of commercial properties in northern England, over which the facility was secured. 

To sweeten the deal, RBS provided this on a non-recourse basis. Furthermore, £20 million was earmarked for Mr Morley's personal use, which, according to the judgment, he spent on sports cars and a villa in southern France.

At the onset of the subprime mortgage crisis, the fall in market value of the secured properties caused, inter alia, a breach of the LTV covenant.

RBS subsequently engaged in protracted restructuring negotiations with Mr Morley, culminating in three settlement agreements being signed in July 2010, whereby West Register, a subsidiary of RBS, acquired the majority of the secured properties by way of a pre-pack sale.

Breaches of Duty

Mr Morley pleaded breaches of three duties.

Firstly, he claimed that RBS breached its duty to provide banking services with reasonable care and skill under s13 of the Supply of Good and Services Act 1982 and Hedley Byrne & Co v Heller & Partners Ltd [1964] AC 465, pointing to RBS's internal policy guidelines to define best practice.

Kerr J held that in ascertaining the relevant standard of care, a court will have regard to external "evidence of what reasonable people in the trade or profession would expect of its members" [ para 157] as well as the relevant regulatory standards. A lender's internal policies and procedures, on the other hand, may constitute merely a counsel of perfection. Thus, Mr Morley was unable to rely on the "business turnaround standards" of RBS' Global Restructuring Group.

Secondly, Mr Morley claimed breach of a duty to act in good faith, pointing to the bank's obtaining of a revaluation; charging default interest rate; and the manner in which the negotiations were conducted as alleged breaches of this duty.

He furthermore asserted that the loan agreement was a "relational contract" of the type envisaged by Leggatt LJ in Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] 1 Lloyds Rep 526, requiring a higher degree of "co-operation, communication and confidence between the parties".

The reasons for suggesting so were as follows:

• the loan was non-recourse, evidencing a high degree of trust reposed in Mr Morley
• the parties shared a common intention to develop further properties in the future, and
• the parties insisted on entering into a hedging instrument capable of protecting both from adverse interest rate movements.

Kerr J commented that even though tenancy occupancy rates were good, and tenants were paying their rent on time, this did not mean that the bank were at fault at calling in the loan on the basis of the LTV breach.

The only relevant restrictions on the bank's exercise of its contractual discretions were as noted in Property Alliance Group Ltd v Royal Bank of Scotland plc [2018] 1 WLR 3529, where the court stated that discretions must be exercised so as not to vex the borrower maliciously, or pursue purposes unconnected to the bank's commercial interests. The Judge did not, therefore, accept that it was a wrongful exercise of the bank's discretion to impose the default interest rate of 3% above base rate.

Kerr J considered that RBS had at all times pursued its legitimate commercial interests in a rational and reasonable manner. Given Mr Morley's bargaining power as an experienced developer, Kerr J considered that RBS had conducted the negotiations fairly, in the face of a deteriorating property market.

To many lenders' relief, the Judge found that it was not necessary to the proper working of the loan agreement to imply an obligation of good faith. Echoing the words of Fancourt J in UTB LLC v Sheffield United Ltd [2019] EWHC 2322 (Ch):

"not all long term contracts that involve an enduring but undefined, cooperative relationship between the parties (…) will, as a matter of law, involve an obligation of good faith". 

Thirdly, Mr Morley claimed he had relied on the duty on RBS in its role as mortgagee to sell the secured properties in good faith and to take reasonable steps to obtain the best price reasonably obtainable (see Salmon LJ's speech in Cuckmere Brick Co Ltd v Mutual Finance Ltd [1971] 1 Ch 949). He alleged that the bank had failed to discharge this duty.

Since Kerr J considered that RBS was in fact straddling the realms of illegality in this respect, its duty as mortgagee was considered in the context of Mr Morley's claims for tortious intimidation and economic duress, addressed below.

Tortious intimidation and economic duress

The elements of the tort of intimidation were set out by Longmore LJ in Berezovsky v Abramovich [2011] 1 WLR 2290. There must be:

• a threat to do something "illegitimate", and
• an intention to coerce the claimant, which in fact coerces the claimant to take (or not take) certain action; and which causes damage to the claimant.

Economic duress on the other hand, as per Dyson J in DSND Subsea Ltd v Petroleum Geo-Services ASA [2000] BLR 530, consists of: 

• pressure to enter into a contract
• with the practical effect of compulsion, which is "illegitimate", and is a significant factor in inducing the victim to enter into the contract.

Since both causes of action require some form of illegitimate coercive pressure, Kerr J considered both in parallel. 

The relevant threat made by an RBS representative was that if Mr Morley did not enter into the proposed settlement, the lender would appoint a receiver "to sell the portfolio on a pre-pack basis to a connected party (West Register)" [para 241]. 

To establish whether this amounted to a threat to commit an unlawful act, and therefore an exercise of illegitimate coercive pressure, Kerr J carried out a two-pronged "conventional analysis". 

Were RBS and West Register sufficiently separate?

As per Lord Templeman in Tse Kwong Lam v Wong Chit Sen [1983] 1 WLR 1349, a mortgagee selling secured assets to a connected party is burdened with a "heavy onus" to justify such transaction. 

In particular, the mortgagee must demonstrate that alternative transactions were duly considered, that the sale was in good faith and for a proper purpose and that the mortgagee was not swayed by any conflict of interest.

The facts suggested insufficient separation, as both entities shared mutual employees and sources of funds. Indeed, both entities were "lumped together as "we" in the parlance of the bank's and West Register's employees" [para 250].

Did RBS take reasonable steps to obtain the best price reasonably obtainable?

Kerr J noted that West Register made no serious attempts to ascertain the market value of the properties, which would have been necessary, particularly given the lack of comparables due to market conditions prevailing at the time. Kerr J would have expected West Register to at least seek an updated valuation and to place the properties on the open market.

Furthermore, Kerr J would have expected West Register to seek independent advice as to the bundling of properties, to establish whether selling these as one batch, in clusters or individually, would yield the best price obtainable in total.

Therefore, on a purely conventional analysis, economic duress (and possibly tortious intimidation) would have been made out. 

Was the conventional analysis appropriate to Mr Morley's case?

On these particular facts, Kerr J took the view that the conventional analysis did not apply.

Firstly, Mr Morley waited five years to bring proceedings. Had he challenged them promptly by attempting to restrain the appointment of a receiver in 2010, things might have been different. West Register might have redeemed the situation by on-selling the properties on the open market.

Secondly, the Court might have found that the value of the properties was now so low that Mr Morley would not have had any locus standi to challenge the receivership. In other words, the combination of the properties' negative equity position, together with the (rather unusual) non-recourse nature of the loan, meant that Mr Morley could not have had any equity in the properties.

It could not, therefore, be said that the bank was threatening to do an unlawful act, because the act "might or might not" have turned out to be unlawful. Kerr J came to the conclusion that the Bank's threat, although "close to the borderline", came within the boundaries of normal commercial negotiations.

Mr Morley actually carried out his contractual duties under the settlement agreements in respect of the properties which he retained and managed accordingly, for over five years. His delay also allowed third parties to acquire interests for value in the properties held by West Register. He therefore affirmed the settlement agreements.

Comment

Lenders will welcome this decision on face value, since Kerr J found in favour of the Bank and firmly quashed the borrower's arguments concerning relational contracts. 

However, it is worth noting that in relation to the intimidation and economic duress claims, the Judge was more sympathetic to the borrower's arguments. He was at pains to categorise this as a "borderline" [para 268] case. A different court, faced with a different factual matrix, particularly one set against a less borrower-friendly loan agreement, may well come to different conclusions. In particular, lenders may need to watch their negotiation tactics even more closely if courts take a borrower-friendly approach to defaults resulting from the COVID-19 pandemic. 

This decision may also support the efforts of the All Party Parliamentary Group on Fair Business Banking to finally establish an independent Financial Services Tribunal, potentially ushering in a new era of judicial protection for SME borrowers (see the Treasury Committee's Report on SME Finance, October 2018). 

Oliver Dean Morley (t/a Morley Estates) v Royal Bank of Scotland plc [2020] EWHC 88 (Ch)