Competition is so intense these days that lawyers in private practice have learnt by heart that their job is to help the client achieve his objectives. So when a lawyer advises you not to proceed with a tran saction, give him the chance to argue the point.
What has prompted this reflection is the realization that, after almost 15 years, the Hammersmith & Fulham swaps litigation is still going on. For bankers not around then, the cases arose out of interest-rate swaps that UK local authorities entered into in the early 1980s. They did so as part of complex financing arrangements designed to overcome central government borrowing caps.
The problem was that local authorities are statutory bodies. They owe their existence to enabling legislation, which defines what they can and cannot do. The courts held that they lacked the power to enter into interest-rate swaps – in the jargon, the swaps were ultra vires the local authorities.
Bankers still seethe at the memory. At the time, local authorities seemed the perfect credit risk, unable (in theory) to go bust. Banks rushed to do business with them. It would have been a brave lawyer who stood in the way, although no doubt there were some who had the hollow satisfaction of being proved right when, in the 1992 case of Hazell v Hammersmith & Fulham London Borough Council, the House of Lords confirmed that entering into swaps lay beyond their powers.
As recently as last year the Lords was called upon to rule whether simple or compound interest was payable on the amount due from Islington LBC to Westdeutsche Landesbank. In a sense the banks involved have had a lucky escape. Most have been able to recover principal paid under the swaps before they were declared unlawful on the basis of the doctrine of unjust enrichment. Although the jurisprudence is not yet settled law, there is a widespread belief that if a contract is void and one party is unjustly enriched, it cannot hold on to the money on the basis that the contract is a nullity, but would – if a case reached the Lords – be required to return it. This is known as the law of restitution. For this reason, Islington did not contest the duty to return the principal, but simply the nature of the interest on the amount outstanding. Under the swap with WestLB, it had received £2.5 million ($4.2 million), and £1 million was outstanding when the contract’s nullity became clear.
It must seem odd in retrospect that an issue as obvious as a counterparty’s capacity to contract did not ring alarm bells at the outset. The fact is that no-one knew. Local authorities’ powers are couched in general terms, akin to a company’s memorandum of association. If you have to consult a lawyer about an aspect of vires, it is likely to be because the point you are raising has never been decided definitively. At the time, the swaps market was relatively new. The International Swap Dealers Association (as it then was) had barely begun and there was still some question as to whether swaps fell foul of the Gaming Act – 18th-century legislation that rendered wagers unenforceable as contracts because they were regarded as being against the public interest. These factors might be reasons to exercise greater than normal caution, but they explain why no-one could provide a conclusive opinion. So the first lesson is that just because everyone else is doing it does not mean it is all right.
The second is that when things go wrong, they go badly wrong. Little could Morgan Guaranty Trust Co have known, when it entered into a swap with Lothian Regional Council, that the ensuing litigation would make legal history in Scotland. One of the absurdities of international financial legal practice is that Scotland is a separate jurisdiction from England & Wales and, indeed, from Northern Ireland. Much as foreign bankers doing business in the US discover that most agreements are written under New York law, most companies are incorporated in Delaware and each state has its own securities law, so foreign bankers doing business in the UK find lawyers quaintly restricting their opinions to the laws of England & Wales. A case in point was the financing of North Sea oil exploration, when lenders found themselves taking security under Scottish law which approximates to, but is not the same as, the English law equivalent.
Restitution in England is known as unjustified enrichment in Scotland. The two are not the same. Although Hazell has persuasive force in Scotland, it does not have precedential weight. So there was some doubt whether Morgan Guaranty would get its £350,000 back. The bank sued for repetition (repayment) in the Outer House, lost, and reclaimed (appealed) in the Inner House, which found in its favour.
Jurists had a field day. A case from 1733 was placed before the court in which all the arguments about unjustified enrichment had been argued, but which had been ignored by intervening cases because the full report had never been published at the time. Cases from other common law jurisdictions, including Australia, Canada and South Africa, as well as England & Wales, were also argued before the court.
Scottish law is no different in its vagaries than the laws of any other jurisdiction. The WestLB case came down on the side of simple interest by a 3:2 majority decision in the House of Lords.
There was – in coded language – a difference of opinion over the basis on which the bank was able to claim repayment. Reference was made to the case of Sinclair v Brougham, a Lords decision from 1913. No-one understands it, not even the Lords. Three of the law lords in WestLB agreed that it was a bewildering authority.
So if the judges don’t understand what their forebears were on about, don’t blame mere solicitors for hedging their bets.
