Hazell v Hammersmith and Fulham LBC
Cue lightning, a peal of thunder, a blood-curdling scream and pallid faces at the very mention of its name. Hazell v Hammersmith and Fulham LBC [1992] 2AC 1 declared that, under the Local Authorities Act 1972, local authorities had no power to engage in interest rate swap agreements because they were beyond the Council’s borrowing powers, and that all the contracts were void.
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Under the Local Authorities Act 1972, the local authorities had power to borrow and certain local authorities entered swap transactions to hedge their exposure to fluctuations in interest rates on these loans. A leading commercial silk had advised that a rate swap undertaken as part of the proper management of the council’s fund would be intra vires.
Most local authorities did this prudently and in small scale, but Hammersmith and Fulham went to town. They had 6 billion quid in notional, all on the same side of the market, by the time the local district auditor Tony Hazell twigged and sought court review of the enforceability of the contracts, and joined the banks as co-defendants.
Judgment
Cut to the chase: It got to the house of lords.
Lord Templeman found the various swaps fell into three categories.
- Purely speculative. These banks conceded that these were unlawful.
- “Parallel contracts”: Those relating to existing loan designed to capitalise upon changes in interest rates. These were also speculative in nature, but did relate to an existing loan exposure of the local authority, which Lord Templeman called “parallel contracts” or “replacing” interest rates. Here “the swap transaction is a speculation no different in quality although different in magnitude from a swap contract which is not entered into by reference to any existing borrowing”.
- “Re-profiling”: Swaps relating to an existing loan, intended to alter the proportion of the interest which was paid on either a fixed or variable basis. Lord Templeman thought these were largely indistinguishable from parallel contracts.
Having almost immediately stated that all swaps were, in his view, conceptually the same as the types of swap which the banks had admitted were unlawful, Lord Templeman then explored the limits of the powers of local authorities under the Local Government Act 1972. Again, cutting to the chase, he said, “In the result, I am of the opinion that a local authority has no power to enter into a swap transaction.”
Ouch ouch ouch, investment banking dudes.
Cue a torrent of litigation from local authorities across the land to recover swaps losses.