Local authorities swaps litigation

[3] As a result of the decision over 200 separate actions were filed as hundreds of interest rate swap contracts had to be unwound by the courts at great expense.

In the course of those proceedings, in addition to the development of English law of unjust enrichment, numerous long established legal precedents of general application were overturned.

Local authorities also have limited powers to borrow money in order to fund capital projects and defray the cost over future years.

Most large participants in the swap market have their exposure balanced by taking positions on both sides and across multiple currencies, but Hammersmith was essentially repeatedly entering into one-way bets that sterling interest rates would fall; a bet that they would end up losing spectacularly when interest rates climbed from around 8 per cent to 15 per cent in the space of ten months.

Although during the 1980s the Audit Commission had become increasingly concerned about the use of financial derivatives, it had never taken any steps to prevent this other than simply advocating that local authorities use caution.

The Audit Commission then telephoned the council's district auditor, Mr Tony Hazell at Deloitte, who asserted that he had no idea about any significant swaps exposure on the part of the local authority.

The Audit Commission's in-house lawyer, Tony Child, expressed the view that the finance officers simply never really understood what it was that they were doing.

[16] Separately Hammersmith also obtained an opinion from a barrister, Anthony Scrivener QC, who also opined that swaps to hedge an exposure would be lawful, but for any other purpose would not be.

In a quirk of legal procedure, the case was commenced as Tony Hazell (as district auditor) against Hammersmith and Fulham LBC, alleging that they had engaged in unlawful practices.

The court delivered its judgment on 1 November 1989, and held that all of the swap transactions were ultra vires and beyond the powers of the local authorities.

He also noted that in the case of building societies Parliament has expressly conferred upon them a power to enter into swap transactions,[24] but no similar steps had been taken in relation to local authorities.

[26] The written evidence later submitted by the Bank of England to the Treasury and Civil Service Committee about the affair noted (at paragraph 3.4) that it "has caused considerable damage to the reputation of the City of London among counterparties who entered into swap transactions with local authorities in good faith during the period.

"[8] Most local authorities had mixed views; although many were exculpated from potential liabilities, they also faced the prospect of long and expensive litigation unwinding the swaps.

The council members at Hammersmith and Fulham were unsure how to react; they wanted to take credit for striking a blow against financial capitalism, but this was at odds with the evidence that they had been oblivious to what their finance department had been doing.

[26] The banks made a brief but concerted effort to have retrospective legislation passed validating the swaps, but were "robustly" rebuffed by the Chancellor of the Exchequer, Norman Lamont.

[27] The government was reported to have a sense of frustration that despite trying to close loopholes in relation to financing of local authorities, the banks had kept working around them and had subsequently received their comeuppance.

[27] One of the principles of English law embodied in a Latin maxim is fiat justitia ruat caelum ("let justice be done though the heavens fall").

Although the courts are often circumspect about handing down judgments which cause significant further litigation under the so-called floodgates principle, the decision of the House of Lords sparked off hundreds of further legal actions seeking recovery of payments made under the invalid swap contracts.

Perhaps unsurprisingly, with that amount of litigation, the various aspects of the law of restitution got significant further consideration from judges, practitioners and academics alike.

Professor Ewan McKendrick would later note that the swaps litigation had been instrumental in developing the modern law of restitution in England.

[31] After the ruling in Hazel v Hammersmith and Fulham LBC the banks, local authorities and their advisers were confronted with the legal problem of how to unwind hundreds of swap contracts made on notional amounts of billions of pounds in aggregate.

Of all the cases possibly the most significant was Westdeutsche Landesbank Girozentrale v Islington LBC, which is now the leading judicial statement of the English law of resulting trusts.

In determining whether the right to equitable tracing arose when a party received money mistakenly and unaware of the mistake, the House of Lords exhaustively reviewed and considered the existing law, before finally determining (by a bare majority) that the bank had no proprietary interest in the money and was not entitled to claim compound interest.

The swaps entered into between Kleinwort Benson and Glasgow City Council led to two separate case reports, of which the second was the more significant, and was appealed all the way to the House of Lords.

That Convention provides that the defendant should normally be sued in their domicile (i.e., in the case of Glasgow City Council, in Scotland) but it created exceptions for particular types of claim related to contract and tort.

It originally represented five (Kleinwort Benson Ltd v Glasgow CC was also included as a fifth co-joined appeal until it was stayed on jurisdictional grounds).

In Kleinwort Benson Ltd v Birmingham CC[44] the Court of Appeal was required to consider whether a defence of "passing on" existed under English law.

Kleinwort Benson v South Tyneside MBC[45] was a first instance decision of Mr Justice Hobhouse (who would hear a number of the swaps cases).

The court held that (1) for the purposes of limitation each contract had to be looked at separately, rather than simply looking at the bank's net claim; (2) payments by the local authority under the swaps did not amount to an "acknowledgement of indebtedness" for the purposes of the Limitation Act 1980; (3) the fact that banks had entered into back-to-back swaps was irrelevant in relation to liability under these swaps (the decision in Kleinwort Benson v South Tyneside MBC was handed down prior to the Court of Appeal decision in Kleinwort Benson Ltd v Birmingham CC); and (4) as the claim was at common law only simple interest could be recovered.

That inference would only be rebutted if the purpose and interest of both parties to the transaction was to wager, in which case the contracts would be legally invalid and unenforceable.