Barnett Waddington Trustees (1980) Ltd & Anor v The Royal Bank of Scotland Plc

An internal arrangement between departments of the same bank is not a “transaction” for the purposes of an indemnity covering the cost of unwinding funding transactions. The relevant wording must be construed in its contractual and commercial context. Internal accounting arrangements do not create a borrowing, lending or payment obligation between separate legal entities. An external hedge may potentially qualify as a funding transaction, but the court must examine its precise structure and connection with the facility. The court declined to determine that issue where it was not properly pleaded or supported by sufficient evidence.

The claim concerned a fixed-rate, limited-recourse loan used to finance the acquisition and letting of commercial property. The borrowers sought a declaration that they were not liable to pay the bank an alleged interest-rate-swap termination cost on redemption of the loan.

The bank relied primarily on an internal swap between its Corporate Banking business and its Markets desk. Those departments were not separate legal entities. The central question was whether that arrangement was a “funding transaction undertaken in connection with the Facility” within the indemnity in clause 12.1(f) of the loan agreement.

1. Declaration granted. The borrowers were not liable to pay the bank any sum in respect of the internal swap.
2. The agreement was construed by applying the ordinary principles applicable to commercial contracts. The court considered the language used, the relevant background known to the parties, the surrounding circumstances and, where appropriate, business common sense, following Investors Compensation Scheme Ltd v Wet Bromwich Building Society [1988] 1 WLR 896 and Rainy Sky SA v Koomin Bank [2011] UKSC 50; [2011] 1 WLR 2900.
3. The word “transaction” contemplated dealings between different legal entities. The internal swap was only an arrangement between departments of the bank. Corporate Banking could not borrow from, or pay interest to, Group Treasury in the ordinary legal sense. The internal arrangements were virtual constructs used for the bank’s financial and accounting purposes.
4. The internal swap was therefore not a “funding transaction” within the definition of “Loss” or clause 12.1(f). The conclusion was unaffected by the bank’s external portfolio hedging, because the external hedge protected the bank against its exposure on the loan, not against any legal risk arising from the internal swap.
5. Viewed alone, the internal swap also caused no loss or cost to the bank. The bank’s financial position remained the same before and after its unwinding. Any consequential cost associated with external hedging raised a separate issue.
6. The court neither accepted nor rejected the bank’s secondary case that the internal swap and external portfolio hedging together constituted a funding transaction. The issue had not been properly argued and the evidence did not disclose sufficient detail about the portfolio arrangements. The declaration was not to be treated as deciding whether the external hedging arrangement itself qualified.