Developments In Finance Litigation

Disclosure In Work-Outs

Banks who are participating in a borrower "work-out" or negotiating an agreement whereby one bank will "take out" the other, should take note of a recent decision of the High Court in National Westminster Bank plc v Rabobank Nederland [2007] EWCH 1056 (Comm) in which the Court ruled on the duties of disclosure in such circumstances.

Rabobank Nederland ("Rabobank") and National Westminster Bank plc ("NatWest") made available an unsecured credit facility and overdraft facility to Yorkshire Food Group Plc ("the Borrower"), a public company in the business of the processing and sale of dried fruit and nuts, founded by a Mr Michael Frith ("Mr Frith"). Both these facilities were extended in March 1996 to a US$100 million credit facility and a 4 million overdraft facility.

By August 1996, the Borrower's financial position deteriorated and Rabobank and NatWest therefore agreed to place the Borrower into a 'work-out', for the purpose of minimising the banks' risk of loss. Rabobank and NatWest appointed Price Waterhouse to investigate and report on the Borrower's position. In the light of reports produced by Price Waterhouse, both banks provided further loan finance to the Borrower. Despite this, the Borrower's financial position did not improve.

Faced with this situation, a novation agreement was concluded in October 1997 ("the Deed of Transfer"), whereby NatWest assigned to a subsidiary of Rabobank its US dollar and sterling indebtedness at a discount. It was a term of the Deed of Transfer that Rabobank would release NatWest as agent in respect of the credit facility and from any obligations, liabilities and responsibilities in respect of any action taken or not taken in its capacity as agent under the credit agreement or any security documents ("the Release Clause").

NatWest's Claim

NatWest brought a claim against Rabobank for damages for breach of contract on the basis that Rabobank, in breach of the Release Clause, had commenced a claim against NatWest in California. NatWest claimed the costs which it had incurred, but not recovered, in the US proceedings. The Judge held that NatWest was entitled to judgment on liability, with damages to be assessed at a later date.

Rabobank's Counterclaim

Following the commencement of NatWest's claim, Rabobank brought a counterclaim. From March 1996 to October 1997, NatWest had advanced to certain directors of the Borrower (who were also shareholders), substantial sums by way of personal loans secured on the directors' shareholdings. The existence of these loans and other surrounding facts were not disclosed by NatWest to Rabobank. Rabobank's case was that NatWest's failure to disclose these facts constituted fraudulent misrepresentation or, in the alternative, misrepresentation contrary to Section 2(1) Misrepresentation Act 1967. Further, Rabobank alleged that the non-disclosure was in breach of an obligation for both banks to negotiate the Deed of Transfer in good faith. Finally, Rabobank alleged that NatWest had induced Price Waterhouse to breach its professional duty by not disclosing these personal borrowings in its reports.

The Misrepresentation Claim

Rabobank's claim for misrepresentation was made on the basis that there was a common practice between banks involved in a "work-out" that each would disclose to the other all facts known to it which were relevant or material to the other's decision making, such that one bank was entitled to infer that the only material facts that were known to the other bank were those that it had disclosed. Similarly, silence on the part of one bank to a "work-out" would amount to a representation to the other bank that it did not know of any material facts. NatWest contended that while this practice was a "normal practice" it was "not an invariable practice".

The only express misrepresentation pleaded by Rabobank related to statements made at a meeting in September 1997 between representatives of Rabobank and NatWest. It was Rabobank's case that during this meeting, Mr Van Der Schrieck, the General Manager of Rabobank London, asked whether NatWest knew anything which Rabobank did not know and which was material to the proposed take out, and the representatives of NatWest answered that they did not.

The Judge held that, while the evidence showed that banks involved in a "work-out" considered it to be good practice to disclose information known to them, in the absence of an express contractual framework to the contrary, there was no legal duty to adhere to that practice. In the light of this, the Judge held that it was up to each bank to make its own enquiries and conduct its own due diligence in relation to the Borrower. A bank was not entitled to assume that the other bank had disclosed to it each and every piece of information which it or bankers generally might consider material. Similarly, in the appointment of an investigating accountant (such as Price Waterhouse), while it was good practice for banks involved in the "work-out" to disclose information which they considered material, there was no legal duty of disclosure.

Further, the Judge held that where there is a take out of one bank by another bank, the duty of the bank to be taken out in disclosing information in response to questions from the other bank would depend on the terms of the questions and the circumstances in which they were asked. On the facts of the present case, the Judge found that Mr Van Der Schrieck's question at the meeting of September 1997 would have been understood as confined to the viability of a particular proposal then under consideration, rather than the issue of the take out. The Judge held that, in this context, the answer given by the representatives of NatWest was not only honest, but true.

In conclusion, the Judge held that Rabobank's case on misrepresentation failed as, to the limited extent that NatWest made representations, such representations were true.

Breach Of The Good Faith Agreement

Rabobank's claim for breach of the good faith agreement also failed. The Judge held that the good faith agreement related only to the documenting of the take out agreement, which had already been arrived at in principle, and not to a general duty of disclosure. In any event, the Judge held that an agreement to negotiate in good faith would be unenforceable on the basis of uncertainty.

Inducing Breach Of Duty

The Judge found that the representative of NatWest who had requested that Price Waterhouse do not disclose the personal borrowings in the reports, did believe in truth that the directors' personal borrowings were irrelevant to Price Waterhouse's remit. On this basis, Rabobank's claim failed as intention to procure breach of duty was a fundamental element of the cause of action. Further, the Judge held that Rabobank's claim failed because Price Waterhouse's terms of reference were framed such that a failure to disclose the directors' personal borrowings would not amount to a breach of duty.

Practical Implications

Banks participating in a "work-out" or seeking to enter into an arrangement whereby one...