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Volatility: Lenders’ duties in economic downturn

Will your insurance respond?

Risk & Analytics|Financial, Executive and Professional Risks (FINEX)
COVID 19 Coronavirus

By Claire Nightingale | August 13, 2020

This article looks at legal and regulatory risks to lenders and how insurance might respond to allegations of economic duress.

As the fallout from COVID-19 continues, we look at the legal and regulatory risks to lenders and ask how insurance might respond in the face of allegations of economic duress.

Introduction

Dealing with customers in financial distress is of course not a novel situation for lenders, and the global financial crisis of 2008 and aftermath remains in recent memory, with some lenders still dealing with the criticism sustained in the way they treated customers in the years following 2008. That said, public criticism was not necessarily vindicated by the claims which followed and we consider below a recent case in which allegations of breach of duty and economic duress were decided in the Bank’s favour. Nevertheless, lenders facing these increased risks would be well advised to consider whether their financial lines insurance policies, particularly Civil Liability and Directors’ and Officers’ Liability (“D&O”) policies, are fit for purpose.

Regulatory risk

Having faced criticism of failing to respond to the concerns of SME Bank customers and lack of recourse available to them in the wake of the 2008 financial crisis, the Financial Conduct Authority (FCA) have taken several proactive steps: 

  • Guidance for lenders
    The FCA have issued guidance for the lenders which currently offer: mortgages, loans, overdrafts, credit and store cards, and catalogue credit1. This sets out the steps which firms are expected to take in order to best help customers weather the storm during this challenging time. Although we anticipate that it will remain challenging for lenders to distinguish between customers facing temporary payment difficulties and longer-term difficulties, this provides some clarification for lenders who will otherwise try to resolve the complexity themselves.
  • “Dear CEO” letter
    The FCA has published a “Dear CEO” letter to UK regulated Banks on lending to small businesses2. It reminds Banks of the importance of ensuring that the benefits of the Government’s loans are passed on to businesses in need. While commercial lending is generally not regulated, the FCA has the ability to hold individuals accountable under the Senior Managers and Certification Regime (SMCR), which applies to all activities conducted by a Bank, regardless of whether the activity is regulated. The FCA has confirmed that it expects Banks that lend to SMEs to appoint a Senior Manager to have responsibility for the Bank’s SME lending activity. Consequently, there may be a heightened risk of enforcement action against such individuals.

Risk of claims: duties of good faith and economic duress

Morley v RBS

In this case3, in which the Bank prevailed, the claimant (a property developer) sought damages from the Bank arising from a £75m loan facility agreement which he was unable to repay when it expired in 2009. The claimant’s portfolio of commercial properties was charged to the Bank to secure the facility agreement. The portfolio had dropped in value significantly as a result of the financial crisis and Mr. Morley and the Bank entered into various negotiations in an attempt to restructure the loan. Ultimately Mr. Morley entered into an agreement with the Bank in which he agreed to pay £20.5m for a portion of the portfolio and transferred the remainder of the portfolio to one of the Bank’s subsidiary vehicles. Mr. Morley claimed, amongst other things, that the Bank had breached its duty (in tort and in contract) to provide banking services with reasonable care and skill.

The Court had to consider whether a lender was bound by a duty of faith when exercising discretions under a loan agreement. The Court held that a loan agreement was not a “relational” contract and the Bank was entitled to exercise contractual discretions under the agreement for a legitimate commercial aim. The Court also held that the discussions surrounding the negotiation of the restructuring of the loan were commercial discussions and did not amount to intimidation or economic duress by the Bank’s employees as the claimant had alleged.

While findings such as these may provide some element of reassurance to lenders and may make it more challenging for groups of claimant customers to secure litigation funding, who will assess the merits of actions before committing funds, customer claims are certainly not going away. Moreover, there may be a sense that while Banks often do well at defending claims in Court, that is not necessarily the case when defending complaints made to the Financial Ombudsman Service (FOS) which are decided on the basis of fairness. The FCA requested clarification around how the FOS may judge complaints in light of the temporary measures put in place by the FCA. The FOS adhered to this request and confirmed that “…in deciding what is fair and reasonable in the circumstance of an individual complaint, we must take into account relevant law; regulators' rules, guidance and standards; codes of practice and what the ombudsman considers to have been good industry practice at the time. We do not make decisions with the benefit of hindsight…"4.

Insurance cover

Civil Liability insurance

Lenders may look to their Civil Liability policies where they face claims alleging failings in their provision of services, either before the FOS or the Courts, for example; claims alleging that a lender’s actions or failures have led to a customer’s insolvency (see the Morley example above). Such claims may face legal hurdles, not least in respect of causation – having to demonstrate that it was the Bank’s actions, rather than the economic environment, which led to insolvency. In any event, the legal costs of defending such actions can be substantial. Civil liability policies generally cover, subject to policy terms and conditions, the costs of defending actions, as well as damages or settlements. They may also cover the costs of responding to regulatory investigations which can also be expensive.

D&O insurance

Directors and senior individuals will no doubt be particularly mindful of their duties when operating in the current challenging business environment, particularly since the implementation of the SMCR. Ensuring there are systems and controls in place to ensure the Bank treats its customers (including SME customers) fairly is key. Where senior individuals are required to provide information to the regulator - attend their interviews - or find themselves embroiled in a claim and look to the D&O insurance policy for financial support, the scope of what cover and policy limits are available will be particularly important.

Comment

Lenders face an array of challenges in the current environment. Dealing with customers who may find themselves in financial difficulties as a result of the pandemic increases the risk of legal claims and regulatory action arising. Corporate insurances can provide protection from these risks.

As always, discuss the scope of your cover with your insurance broker and consider notification of any potential issues at an early stage to ensure you are provided with the best available options and protection of the policy most appropriate for you and your needs.

This article offers a general overview of its subject matter. It does not necessarily address every aspect of its subject or every product available in the market. It is not intended to be, and should not be, used to replace specific advice relating to individual situations and we do not offer, and this should not be seen as, legal, accounting or tax advice. If you intend to take any action or make any decision on the basis of the content of this publication you should first seek specific advice from an appropriate professional. Some of the information in this publication may be compiled from third party sources we consider to be reliable, however we do not guarantee and are not responsible for the accuracy of such. The views expressed are not necessarily those of Willis Towers Watson. Copyright Willis Limited 2020. All rights reserved.

Footnotes

1 https://www.fca.org.uk/publications/finalised-guidance/mortgages-and-coronavirus-updated-guidance-firms
https://www.fca.org.uk/publication/finalised-guidance/finalised-guidance-overdrafts-coronavirus-updated-temporary-guidance-firms.pdf
https://www.fca.org.uk/publication/finalised-guidance/finalised-guidance-personal-loans-coronavirus-updated-final-guidance-firms.pdf
https://www.fca.org.uk/publication/finalised-guidance/finalised-guidance-credit-cards-coronavirus-updated-temporary-guidance-firms.pdf

2 https://www.fca.org.uk/publication/correspondence/dear-ceo-lending-small-businesses-coronavirus.pdf 15 April 2020

3 Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch)

4 https://www.fca.org.uk/publication/correspondence/letter-fos-reply-fca-re-complaints-handling-coronavirus-2020.pdf?LinkSource=PassleApp

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