How the ongoing problem of interest rate “Swaps” is turning economic waves into a storm for SMEs
In its Autumn Statement earlier this week the Government announced plans to ease credit by underwriting up to £40bn in low-interest loans to small and medium-sized firms. The Government hopes the scheme will make it easier to underwrite bank loans to small firms and says it will cut the average interest rate for those firms by 1%. Alongside this scheme, the Government announced it is launching a £1bn Business Finance Partnership to invest in funds that lend directly to mid-sized companies, in partnership with other investors like pension funds and insurance companies. Both proposals follow numerous largely unsuccessful attempts to get banks to lend to UK businesses.
But while the Treasury does its best to encourage lending, an additional problem is crippling many UK businesses, namely interest rate swap agreements. These products were sold to businesses, mainly in the period 2004 – 2008, as a form of insurance to protect them from rising interest rates. However the banks neglected to explain properly what would happen if base rates fell and what it would cost the relevant business to extricate itself from the product.
Carter-Ruck is currently conducting a number of claims arising out of such products, and we receive new approaches on an almost daily basis. Below are some hypothetical examples (broadly based on enquiries we’ve received) which reveal the sort of impact these products are having on the businesses that have been sold them:
A farmer was sold a 10 year multi-callable base rate swap for a total sum of £4m over the telephone. As soon as the written terms and conditions arrived the farmer realised the product was not at all what he had understood it to be. He immediately told the bank this was not what he wanted, but the bank said it was too late, the deal was done. They told him it will cost him £1.2m to terminate the agreement. The farmer fears he may have to lay off workers in order to continue servicing a product he considers was missold to him.
A marketing company
An individual who started their own marketing firm, at the bank’s behest entered into a “cap and collar” agreement in conjunction with a mortgage. The terms were not explained to him and he did not understand how much he would have to pay if the base rate fell below the floor rate. The large monthly repayments his company is having to pay to service the product has resulted in severe cash flow difficulties for the company. It even meant the individual had to sell his home to free up equity to service the repayments. He has been told that he will now have to pay over £200,000 for his company to exit the product.
A restaurant owner
A restaurant owner was told by his bank that it was a condition of the loan he required to purchase a new restaurant that he enter into an interest rate hedge for a minimum period of 10 years. Further to the bank’s recommendation he entered into an enhanced interest rate collar agreement with a duration of 15 years. He can afford to pay the monthly capital repayments but cannot afford to pay the collar agreement as well. Having defaulted on the underlying loan that gave rise to the collar, the bank is now threatening to force the sale of the security (the restaurant he purchased with the loan). Prior to entering into the agreement he was not told that a substantial termination charge would apply if he wished to exit the product early, so he was shocked when his bank told him it would cost him £400,000 to break the agreement.
A timber merchant
A timber merchant that has been in business for over 85 years, entered into a 10 year structured interest collar agreement with their bank. The product was linked to a loan they required for the purchase of a new business. The company considers it was missold the collar and claims the bank misrepresented the product to them. They estimate the collar has already cost them £300,000. They maintain that at no time during the discussions prior to entry into the product did the bank explain the termination charges that would be payable which the bank has now said are over £150,000.
A toy manufacturer
The toy manufacturer entered into a 15 year base rate knock in collar agreement with his bank. He estimates the product has already cost his business over £900,000 and has been told it will cost over £1.5m to terminate the agreement. He considers he was pushed into the product by his bank and says they failed to explain properly the potential risks should the base rate fall as low as it has done and remain at that level for such a prolonged period of time. Although the business is currently surviving, he fears that if turnover falls further, he will be unable to meet the costs of the product and the business he has worked for 30 years to build will end up in receivership.
As the above examples demonstrate these agreements are strangling such businesses and, even if they do not destroy them, they prevent them from expanding and increasing their number of employees.
As we mention, the above are hypothetical examples in order to protect confidentiality. However, they are typical of the cases we are dealing with. In all such cases our clients’ starting point is that a negotiated agreement with the relevant bank to persuade them to reduce their demands, terminate the arrangement and/or compensate our clients is always preferable. However, where the banks are not willing to compromise then litigation is inevitable.