The importance of carefully constructed loan agreements

Barnett Waddington Trustees v The Royal Bank of Scotland – The importance of carefully constructed loan agreements

The recent case Barnett Waddington Trustees v The Royal Bank of Scotland [2015] EWHC 2435 (Ch) highlights the importance of ensuring loan agreements are carefully constructed with clearly drafted provisions.

The Barnett case concerned a 30 year fixed rate loan of £9,237,500 made by The Royal Bank of Scotland (“RBS”) to Barnett Waddington Trustees (the “Borrowers”) to finance the acquisition, development and letting of a property. In order to fund the fixed rate loan to the Borrowers, RBS undertook the following:

  • the RBS Group Treasury department (an internal division of RBS) provided a loan with a floating rate of interest to the Corporate Division of RBS (another internal division of RBS);
  • the Corporate Division then entered into an internal interest rate swap with the Interest Rate Desk (another internal division of RBS) in order to hedge the interest rate risk on the internal loan and to fund the interest payable on that internal loan. The Borrowers were unaware of the internal interest rate swap;
  • RBS also maintained interest rate hedging with an external party on a “portfolio basis” to cover all its interest rate risks under a number of different loans to a number of different Borrowers.

After 5 years had passed, the Borrowers considered redeeming the whole loan. RBS argued the loan agreement contained an indemnity clause whereby the Borrowers were liable to indemnify RBS for any loss suffered by it as a result of unwinding the internal interest rate swap because it was classed as a “funding transaction undertaken in connection with the Facility".

The court held that the indemnity wording within the loan agreement (although not particularly well drawn) provided for a transaction between “two different legal entities” and that “different departments of the Bank do not qualify as separate entities”. Accordingly, the internal swap on its own did not constitute a contractual arrangement and was not a “transaction”. Rather, it was an internal accounting arrangement within RBS and could not, in the context of the indemnity given by the Borrowers, be construed as a “funding transaction” under which RBS could recover from the Borrowers the costs it incurred in breaking that swap.

The Barnett case emphasises the need for clear, well-constructed agreements and stresses the need for lenders in particular, to expressly state in clear terms that their internal hedging and funding arrangements are to be covered by an indemnity clause and that the Borrower would be liable for any loss incurred as the result of the early termination.

 
 

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