16 April 2020

Is Lender subject to broad duty to act in good faith?

This article was written by Joe Su and Rosanna Muñoz-Britton.

Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch)


Summary: 

In the recent case of Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), the English High Court was asked to consider whether a lender was bound by a duty of faith when exercising discretions under a loan agreement.

It was found by the High Court that a loan agreement was not a "relational" contract and so the bank's exercise of contractual discretions under that agreement was only subject to a duty to exercise them for a legitimate commercial aim and not so as to vex the borrower maliciously. It was also held that while compliance with regulatory standards was relevant to whether the bank had satisfied the duty to provide banking services with reasonable skill and care, whether it had complied with its internal policies and procedures would not be taken into account. 

The claimant, a property developer, also claimed that the bank had made threats which amounted to intimidation and economic duress in its negotiation of the restructuring of the loan agreement. It was held by the High Court that the bank had conducted discussions commercially. Although threats of insolvency proceedings were made, they were not sufficient enough to amount to economic duress or intimidation. 

Facts: 

The claimant was a commercial property developer (‘Morley’ or the ‘claimant’) who sought damages against the defendant bank (the ‘bank’ or the ‘defendant’) arising from a loss in 2010 of part of the claimant’s portfolio of commercial properties in northern England (the ‘Portfolio’) which were charged to the bank in 2006 to secure a £75 million loan facility agreement (the ‘Facility Agreement’). When the Facility Agreement expired in 2009, Morley was unable to repay his debt in full and the value of the Portfolio secured in favour of the bank had dropped significantly. 

From 2007, as the value of the Portfolio fell, there were various negotiations between Morley and the bank which attempted to restructure the loan. There were also a number of disputes over breaches of the terms of the Facility Agreement including of financial covenants and payment obligations thereunder. The relationship between the parties deteriorated against a backdrop of the financial crisis. The bank considered that a ‘pre-pack’ receivership sale of the whole Portfolio was potentially the best option for the defendant. 

In August 2010, the claimant and the defendant entered into agreements (the ‘Agreements’) pursuant to which Morley agreed to pay to the bank the sum of £20.5 million for a portion of the Portfolio and transfer the remainder of the Portfolio to one of the bank’s subsidiary vehicles (‘West Register’).  

Arguments: 

The claimant alleged that the bank had: 

  1. breached its duty (in tort and in contract) to provide banking services with reasonable care and skill.[1]  In addition, that the standard of care should include compliance with relevant regulatory rules and compliance by the bank with its own policies and procedures which stipulated giving precedence to rehabilitating ailing businesses before taking enforcement measures. The claimant put forward that but for breaches of these duties, the claimant would not have entered into the Agreements; 

  2. breached its duty owed in contract to act in good faith and not for an ulterior purpose unrelated to pursuit of the bank’s legitimate commercial interests.[2]  Further, the claimant asserted that the Facility Agreement should be viewed as a ‘relational’ contract which requires a higher standard of co-operation, communication and confidence between the parties[3]

  3. engineered a default of the Facility Agreement by subjecting the claimant to higher rates of interest and obtaining a revaluation of the Portfolio in 2009 to ‘force’ a breach of financial covenant (the ‘2009 Valuation’) and that again, but for these breaches, the claimant would not have entered into the Agreements; 

  4. breached its duty owed in its capacity as mortgagee to sell the mortgaged assets in good faith and to take reasonable steps to attain the best price reasonably attainable,[4]  and that the pre-pack sale to West Register did not have the characteristics of an arm’s length transaction between commercial parties independent of each other; and 

  5. procured the claimant’s entry into the Agreements by threats which constituted the tort of intimidation for which the claimant should be entitled to damages, and that the Agreements were entered into under economic duress and were therefore liable to be set aside and that the court should award damages or equitable compensation in lieu of rescission of the Agreements. 

In response to the claimant’s arguments, the bank: 

  1. denied any breach of duty on the grounds that it had exerted legitimate pressure in the course of normal commercial relations and negotiations with a counterparty who knew well how to negotiate[5]. In addition, that the bank’s internal policies and procedures were not relevant for determining the standard of care. Further, that even if it had breached the duty to use reasonable skill and care, the breach did not cause the claimant to enter into the Agreements; 

  2. disputed that the Facility Agreement should be classified as a ‘relational’ contract on the basis that the parties did not have to collaborate to perform their obligations; 

  3. acknowledged that the defendant’s right to call for a valuation must be exercised for legitimate commercial purposes and not for the purpose of vexing the claimant maliciously. The bank submitted that it had obtained the 2009 Valuation for such commercial purposes in order to confirm its entitlement to take enforcement action and thereby enhance its negotiating position in the restructuring discussions;

  4. set out that it had an absolute contractual right to communicate an intention to appoint a receiver if an agreement could not be reached and such communications were thereby legitimate. Further, that there was no reasonable prospect than an open market sale of the Portfolio would raise more than the £75 million owed by the claimant, the pre-pack sale would be to a separate entity, would not be at an undervalue and would save considerably on transaction costs which was a proper commercial purpose; and 

  5. argued that the claimant would have entered into the Agreements without the breaches which reliance was placed on as he did not have access to the required funds from elsewhere. 

Judgement:

Claims dismissed. 

Breaches of duty

The court did not dispute the bank’s duty to exercise reasonable skill and care in providing lending services to the claimant and its obligation to comply with regulatory standards. However, that the bank’s internal policies and procedures may have little to do with the standard of care required and are not to be treated in the same way as rules setting industry wide professional standards.[6]  Further, that the Facility Agreement was not a ‘relational’ contract but an ‘ordinary loan facility agreement’ and the restructuring negotiations had been at arm’s length and commercial.[7]  Moreover, that the bank’s conduct in considering the various offers put on the table during the discussions had not fallen below the reasonable care and skill standard required nor had it fallen foul of the obligations of the bank as a provider of lending services. 

The court set out that the bank’s right to demand repayment of the loan was contractual and not discretionary. With regard to the bank’s contractual discretion to obtain the 2009 Valuation and charge default interest, such discretion was within its legitimate remit and had been exercised for purposes connected with the bank’s commercial interests and not so as to vex the claimant maliciously.  

The court further set out that as the property market fell and the value of the defendant’s security deteriorated, it would be unrealistic to expect the bank to do nothing, that the bank’s actions were rationally connected with its commercial interests and its attempts to agree a restructuring of the Facility Agreement must be seen in the context of the financial crisis at the time. 

With regard to the argument that the defendant had engineered a default by the claimant in order to enable it to seize the Portfolio, that there was not any need on the part of the bank to engineer such default as there was a clear and apparent breach of the loan to value covenant which had already occurred before the 2009 Valuation was obtained and the 2009 Valuation merely provided evidence of the breach.[8]  

Intimidation and economic distress

In relation to the claimant’s arguments for damages based on the tort of intimidation and economic duress, the court considered the threats alleged by the claimant. The claimant set out that the defendant had threatened that unless the claimant signed up to a consensual deal, the bank would appoint receivers and sell the Portfolio on a pre-pack basis to West Register at an undervalue and/or without proper market testing and/or for an improper purpose. 

It was found that there was no evidence of any threat to sell the Portfolio at an undervalue or for an improper purpose. In respect of the remainder of the alleged threat, the court outlined that in the absence of bad faith, a valid claim for duress could only be made if it were found that the defendant had threatened to do an unlawful act[9] and the tort of intimidation similarly required the threat to contain an intention to carry out an act the individual making such threat was not lawfully entitled to do. 

The court emphasised that if a conventional analysis were to be applied, it is likely that what the bank was threatening it would do would amount to an unlawful and defective performance of the bank’s duties as mortgagee. Factors such as there being no real separation between the bank and West Register, the two entities’ closely aligned commercial interests and a lack of valuation which properly tested the market were considered. However, the court concluded that in the present case, the bank’s position was such that the claimant had no financial interest in how any receivership was conducted because the claimant could have no possible equity in the Portfolio. On this basis, any breach of the bank’s mortgagee duties as conventionally formulated would therefore cause the claimant no loss. This unusual position arose because of the non-recourse nature of the loan (the claimant could not be made to pay back the debt personally).[10] 

The court found that evidence of an unlawful act in the bank’s threat was borderline as the threat might or might not turn out to be unlawful but concluded that, in this case, it could be categorised as ‘the rough and tumble of the pressures of normal commercial bargaining’.[11]  The court further ruled that the defendant’s assertion that the claimant had affirmed the Agreements was grounded on the basis that the claimant had not taken any step to have them set aside until over five years later and that it was far too late for the Agreements to be rescinded. For these reasons, amongst others, the arguments for intimidation and economic duress were found not to be substantiated and the claim for damages was dismissed. 


[1] As per section 13 of the Supply of Goods and Services Act 1982 and the House of Lords decision in Hedley Byrne & Co v. Heller & Partners Ltd [1964] AC 465 (per Lord Morris at 502-503) cited in Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), at [128].

[2] Property Alliance Group Ltd v. Royal Bank of Scotland plc [2018] 1 WLR 3529, at [169] cited Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), at [141].

[3] Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), at [142].

[4] Cuckmere Brick Co Ltd v. Mutual Finance Ltd [1971] 1 Ch 949, cited in Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), at  [197].

[5] Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), at [137].

[6] Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), at [157].

[7] Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), at [159].

[8] Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), at [183].

[9] Times Travel (UK) Ltd v. Pakistan International Airlines Corporation [2019] 3 WLR 445 followed, cited in Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), at [236]

[10] Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), at [262].

[11] Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch), at [268].

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