In some cases the bank included a clause which allowed the bank to terminate the IRHP if it became unfavourable to them after say, 5 years and at quarterly intervals thereafter. In effect, the customer is therefore selling options to the bank. The bank has it both ways – if interest rates fall the customer pays; if the rates go up the bank can end the IRHP.
In many cases the bank sold customers IRHPs for longer periods than the loans they were meant to cover. This meant that the customer still had to make payments under IRHP contract even though the loan had finished and had to pay a breakage cost to terminate the IRHP.
One of the reasons that banks failed to explain the negative aspects of the IRHPs was because the IRHPs were sold by specialist teams who earned high levels of commission by selling them. These employees were introduced to customers by commercial lending managers as ‘advisers’ within the bank whose role was to explain and to facilitate.
They were actually salesmen from the banks’ treasury department whose role was to sell a financial product. In some cases the commercial lending managers dealing with customers were also paid commission for IRHPs sold to their customers.
If bank employees are highly incentivised to sell IRHPs it is easy to understand why those bank employees did not explain in great detail to the customer the risks and long-term liabilities that the customer was accepting when they entered into it. It is self-evident that that was not done because once those risks are explained it becomes clear that IRHPs are not suitable products for SMEs.
Aren’t there rules against this?
Yes, by selling IRHPs to unsophisticated business customers the banks breached the FCA Conduct of Business Rules (COBS) and the Business Banking Code, and arguably common law. COBS apply to banks selling an IRSA to a customer, and the most relevant of these are HERE.
COBS 9.2.1(1) – If the bank recommends an IRSA to a customer then it has to comply with the suitability obligation of COBS 9. This requires the bank to take reasonable steps to ensure that any personal recommendation given by it was suitable for the customer receiving the recommendation.
COBS 9.2.1(2) – To enable it to make a suitable recommendation the bank should have obtained information regarding the customer’s knowledge and experience in the field of interest rate derivatives and taken into account their personal financial situation.
COBS 9.2.2 – The information the bank obtains has to be sufficient to enable it to have a basic understanding of the essential facts about the customer and to establish a reasonable basis for believing that the product is such that the customer has the necessary experience and knowledge to understand the risks involved. Also, that it meets the customer’s investment objectives, and that the customer is able to financially bear the related risks.
COBS 9.3.2 – The Bank has to carry out an adequate assessment of the expertise, experience and knowledge of the customer in the field of interest rate derivatives to establish that he was capable of making an informed investment decision and capable of understanding the risks involved.
COBS 9.2.6 – The failure to obtain necessary information to assess suitability prohibits the Bank from making a personal recommendation.
The bank often told the customer all about the benefits of an IRHP in a high interest-rate environment and neglected to properly explain the potential risks in a low interest rate one. Often the banks acted as an adviser to the owner of the small business and this brings with it clear responsibilities and a duty of care which in many cases the bank breached.
It is quite clear that in many cases the customers did not understand the IRSA they were sold. Often their background and education meant they were not able to comprehend the arrangements being sold to them. In many cases the bank did not properly advise the customer about the potential costs of exiting the IRSA being proposed by the bank.
If the bank acted as an adviser then it has higher duties to the customer (including possible fiduciary obligations). Whilst in practice banks often advise customers when selling IRHPs, if a dispute arises, they will commonly deny that they did advise the customer.
This denial may well be in cases where it is self-evident from circumstances of the transaction that the bank did advise their customer to enter into an IRHP.
The bank will seek to rely on exclusion of liability and non-reliance clauses within the contract. Banks are keen to avoid the potential tortious and contractual liability which can follow from the relationship of adviser.
Exclusion clauses are the central means by which banks attempt to exclude liability for negligence. Non-reliance statements are the central means by which banks attempt to exclude liability for misrepresentation.