Greenclose v National Westminster Bank plc

A fine example of that old legal maxim anus matronae parvae malas leges faciunt: Little old ladies - and aggrieved Welsh hotel owners - make bad law.

A case opining on the meaning of the apparently harmless Notices Section (Section 12) of the 1992 ISDA, and in particular what is “an electronic messaging system” and more to the point what it is not - which, in the opinion of learned Justice Andrews, includes email.

Facts

The Loan and the interest rate hedge

Mr. Leach, of Greenclose, was one of those fabled little old ladies of the law. He was also, the court found, a sophisticated and successful owner of family business running small luxury hotels in and around Wales. But he also seemed to be the wrong end of the interest rate swap mis-selling scandal, wherein NatWest and others lent to mid-sized corporates on condition that they enter a derivative to their hedge interest-rate risk. In Leach’s case, Greenclose was obliged to buy a rate collar for five years, and to grant the bank an option to extend it for seven years.

The notional point of the hedge was to protect Greenclose against interest rate rises over the term of the loan: interest rates being an uncommonly low 4.5% in 2006, and generally expected, in those good old days, shortly to rise.

The bank’s theory here is interesting: “I will lend to you at a floating rate for ten years,” says the bank. “But if interest rates rise too high, you may not be able to repay your loan. You may default. In that case, I lose. So therefore I need you to hedge your interest rate risk.”

At first blush, rising interest rates are the borrower’s problem, but - once the borrower has blown up - they become the lender’s. It was the Bank, not Greenclose, that insisted on the collar. You might think the Bank could otherwise manage that risk by lending at a fixed interest rate. But it’s easy to be wise in hindsight.

So NatWest charged Greenclose a premium to reduce its own tail risk to Greenclose’s insolvency. With a kicker: Of course, capping future exposure to interest rates that you expect to go up is an expensive business: To reduce the cost, NatWest suggested Greenclose limit its downside interest rate risk also, and make it a collar - thus limiting Greenclose’s exposure to interest rates between 5.07% and 6%. This locked in a rate of at least 5.07% on the loan.

Of course, low interest rates weren’t a risk to Greenclose at all. the lower the better.

Greenclose therefore borrowed at that handsome rate but also entered an extendable collar transaction under a 1992 ISDA Master Agreement - the edition is important - which would expire on 30 December 2012 unless NatWest gave proper notice of its extension before that time.

The collar renewal in 2012

If interest rates were agreeably low in 2006, they were even lower in 2012, such that the collar trade was massively out of the money. NatWest of course wanted to exercise the option, notwithstanding that there was no real risk to Greenclose, but because they would make a ton of money. Economically this was the saving Greenclose had agreed to forgo by accepting the collar (and the lower cost of the interest rate hedge) in 2006.

Now discarding for a moment the fact that the plaintiff was a little old lady, let’s be clear here: this is fair enough. NatWest had priced this so it wasn’t taking this risk. But it still managed to look like a big, bad bank.

The errors

Schoolboy error no.1 by NatWest was to agree a notice deadline which expired when Greenclose was highly likelihood to be out of the office. But that’s as may be.

Learning Number 1: Don’t set an option expiry period that obliges you to serve notice in the Grundle.

Error no. 2 - less of a schoolboy one, in this reviewer’s opinion, was to assume that an email - being, after all, an electronic mail message sent over a computer system (so sayeth Wikipedia) fell within the meaning of an “electronic messaging system”. Not so, thought Andrews J. because

”In 1992, email was not in common use and thus the reference to “electronic messaging system” is unlikely to have been intended to include it.”

The court does not seem to have heard any evidence on this point. A cursory glance at Wikipedia would suggest this is wildly wrong: the SMTP protocol - over which email is still transferred today - was published in 1982. It is true that the expression “email” didn’t enter the lexicon until 1993 - but that is consistent with nascent email being treated as a kind of electronic messaging system.

Andrews J compared with the equivalent provision in the 2002 ISDA. This 'does include email, as a separate item from “electronic messaging system”:

12. Notices

12(a) Effectiveness. Any notice or other communication in respect of this Agreement may be given in any manner described below (except that a notice or other communication under Section 5 or 6 may not be given by electronic messaging system or e-mail) to the address or number or in accordance with the electronic messaging system or e-mail details provided (see the Schedule) and will be deemed effective as indicated:―

(i) if in writing and delivered in person or by courier, on the date it is delivered;

(ii) if sent by telex, on the date the recipient’s answerback is received;

(iii) if sent by facsimile transmission, on the date it is received by a responsible employee of the recipient in legible form (it being agreed that the burden of proving receipt will be on the sender and will not be met by a transmission report generated by the sender’s facsimile machine);

(iv) if sent by certified or registered mail (airmail, if overseas) or the equivalent (return receipt requested), on the date it is delivered or its delivery is attempted;

(v) if sent by electronic messaging system, on the date it is received; or

(vi) if sent by e-mail, on the date it is delivered,

unless the date of that delivery (or attempted delivery) or that receipt, as applicable, is not a Local Business Day or that communication is delivered (or attempted) or received, as applicable, after the close of business on a Local Business Day, in which case that communication will be deemed given and effective on the first following day that is a Local Business Day.
12(b) Change of Details. Either party may by notice to the other change the address, telex or facsimile number or electronic messaging system or e-mail details at which notices or other communications are to be given to it.

The intellectual endeavour here is interesting: Firstly, to deduce the meaning of the words in that agreement Andrews J looks at the intention of the person who crafted the 1992 ISDA, and not the intentions of the parties who actually negotiated the agreement. The agreement was signed in 2006 - by which stage email was widely known and understood, and it seems fanciful to suggest parties would intend to include all electronic messaging systems but email. There is a long disquisition on what ISDA intended, which this reviewer submits is utterly irrelevant because ISDA was not a party to the contract.

Andrews J needs also to draw a peculiar, narrow meaning of the word “system” to rule that while email may be a means of communicating electronic messages, it is not a “system”. SWIFT is a messaging system. SMTP over the Internet is, apparently, not. You have to squint really hard and hold your head in a funny way to follow that logic.

What’s oddest about this is that the court needed to make none of these assertions to find NatWest’s attempted service wasn’t valid, because Greenclose hadn’t specified an email address in the ISDA Schedule. Simply put, there was no agreed email address to which NatWest could send Greenclose a message, however you construe Section 12. Greenclose didn’t specify an email address. Therefore communication by email (within in the contemplation of Section 12) wasn’t possible. Case closed.

(Andrews J also was exercised mightily about whether a notification, even if undisputedly effective, not consistent with Section 12 would count for the purposes of exercising options under the ISDA Master Agreement. Andrews J chose the path less travelled, in finding that “any notice or other communication may be given in any manner described below” meant it may only be given in that manner. Which raises the question: what if the court found on the facts that a non-compliant notice had, nonetheless made its way to the relevant person, been appropriately adverted to: would it still follow substance over form?

But what would the court have found if Greenclose had specified an email address? That he was wrong to do so, because that wasn’t an identifier on a valid “electronic messaging system”?