Greenclose v National Westminster Bank plc

anus matronae parvae malas leges faciunt

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, to shortly 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 risk, but - once the borrower has blown up - they become the bank's problem. 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. RBS 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.