Change Red Ltd v Barclays Bank Plc

This is a ruling following the hearing of a CMC. The case was begun by a claim form under CPR Part 8 issued on 16^th March 2016, raising a question of law as to the true construction of an agreement between the defendant Bank and the Financial Conduct Authority (the ‘FCA’). In particular there is a question as to whether the defendant was obliged to have regard to the claimant’s filed revised annual accounts in considering whether the claimant was or fell within the review provided for in the FCA agreement. The claim form is supported by a witness statement of Mr. Edward Klempka dated 9^th March 2016, who is and has been since November 2015 the chairman and a director of the claimant.

The acknowledgement of service was filed in April 2016, stating an intention to contest the claim. That position was supported by the witness statement of Theresa Clare Stothard, which was followed by a witness statement in response from Edward Klempka. Then, finally, there is a further witness statement which has been filed on behalf of the defendant, from Keith Ho.

I may say that the FCA agreement referred to is actually found in two documents. Originally there was a review agreement dated 3^rd August 2012. Then there was a supplemental agreement dealing with IRHPs on 4^th February 2013.

It is also to be borne in mind that a further claim, this time under CPR Part 7, has been issued between the same parties - that is to say by the claimant against the defendant. This is essentially a ‘swaps’ mis-selling claim.

The CMC in this case was heard on 8^th December 2016, when all directions were agreed, except for the question of permission for the defendant to adduce expert accountancy evidence. I merely record in passing that there had originally been a dispute about whether the claim should proceed under Part 8 or not, but it is now agreed between the parties that it should proceed under Part 8. Secondly, there was a contested application by the defendant to adduce the further factual evidence from Mr. Keith Ho, but that has also now been agreed.

The background facts to this case are, shortly, as follows. The claimant carried on business as a money lender in the sub-prime home credit market. It banked with the defendant bank, which provided a rolling credit facility and an overdraft. The defendant also sold to the claimant IRHPs (interest rate hedging products or ‘swaps’) to hedge their risks in connection with changes or future changes in interest rates. There was one swap sold in each of 2003, 2005, 2006, 2007 and 2008. Three of those five were significantly to the benefit of the claimant. One of them, that in 2005, made a small loss for the claimant, and one of them, that in 2007, made a net loss of nearly £2 million for the claimant. The focus of the claim is in relation to this swap, entered into on 31^st July 2007.

The swaps sold to the claimant were of three different kinds: interest rate swaps, cancellable interest rate swaps, and basis swaps. The 2007 swap was a cancellable interest swap, just as was the 2006 swap, under which the claimant benefited by some £300,000. A cancellable interest swap is an interest rate swap where the customer exchanges a floating rate payable under the existing facilities for a fixed rate payment, but giving the Bank an option to terminate the swap at a specified date. This obviously reduces the Bank’s risk, and so it offers a reduced fixed rate to the customer by comparison with an ordinary interest rate swap.

In 2009, errors were discovered in the valuation of the claimant’s loan book and in its bad debt provisions. The defendant bank, who was then owed some £16.29 million, realised it could not recover the whole sum. It assigned the debt to a corporate third party, whose management comprised mostly the same people as that of the claimant, for £890,000, and wrote off the rest. The claimant itself was acquired by a different third party, but once again run by the same people. Ultimately, in fact, the claimant ceased trading on 10^th October 2010. To come forward in time, the accounts up to 31^st August 2015 show that the claimant at that date had fixed assets of £82,000 and creditors of some £12.4 million.

In June 2010 the claimant adopted a new accounting policy designed to present turnover and cost of sales as excluding loan principal amounts. The board used the new policy for accounting years 2008 onwards. The filed accounts for 2007 were not revised, though in the 2008 accounts the comparison with 2007, as is normal, was shown in restated figures as if the new accounting policy had then been in force. But in both the 2007 accounts under the original policy, and in the 2008 accounts under the new policy, the profit and loss account both referred to ‘turnover’, rather than to any other term.

In 2012 the Financial Conduct Authority was concerned about possible mis-selling of IRHPs to small businesses. It entered into voluntary agreements with various banks to set up a redress scheme. That was to be a speedy, straightforward but independently monitored process, avoiding the need for litigation, but preserving the customer’s pre-existing rights. The FCA entered into an original agreement for this purpose with the defendant on 29^th June 2012 and a supplemental agreement on 31^st January 2013 following a pilot exercise that had been carried out. This required the defendant Bank to review all its category B business - that is IRHPs which were not so-called structured collars or caps which had been entered into with customers who did not meet the so-called sophisticated customer criteria. All the claimant swaps were category B business, so the question was, therefore, whether the claimant met the sophisticated customer criteria.

The original sophisticated customer criteria had two limbs, one objective and one subjective, and if either of them was met the customer would fall outside the review. The objective criterion was that in the financial year of the sale the customer met two of three factual conditions: its turnover was greater than £6.5 million, its balance sheet total was greater than £3.26 million, and the number of employees was greater than 50. Any two would ensure that the objective criterion was met. The subjective criterion was whether the Bank could show that at the time of the sale the customer had the necessary experience and knowledge to understand the service and the type of product or transaction which was in view.

The effect of the supplemental agreement of January 2013 was to modify the sophisticated customer criteria, so that in relation to the claimant - and I am only talking about the claimant now - it met the criteria if in the year of the sale the claimant met the thresholds under s.382 of the Companies Act for turnover, balance sheet and employees, or the s.382 thresholds for turnover and balance sheet only, or the s.382 thresholds for turnover and the number of employees. The s.382 thresholds defined the turnover as being greater than £6.5 million, the balance sheet as being greater than £3.26 million, and the number of employees as greater than 50. These were calculated, or were to be calculated, in accordance with the relevant provisions of the Companies Act 2006, including s.382 of course. That refers on to the definition of ‘turnover’ in s.474.

I set out here certain relevant provisions of the Companies Act to which I was referred at the hearing:

The defendant considered whether the claimant was eligible for review in 2012/2013. The claimant’s accounts for the relevant year of the swap, which was on 31^st July 2007, was the financial year from 1^st January 2007 to 31^st December 2007. According to the defendant, the turnover and the balance sheet exceeded the s.382 thresholds. There was correspondence between the defendant and the claimant about this. The defendant obviously reviewed the claimant’s case in about February 2013, and then asked the ‘skilled person’, which was KPMG - this is in the agreement, the independent monitor - whether the skilled person agreed, and the skilled person did so agree. So in May 2013 the defendant told the claimant that the claimant was ineligible for the review.

The claimant challenged this by its solicitors, then Speechly Bircham, in a letter in June 2013, and there was a discussion in that letter about the impact of International Accounting Standard, IAS 39, to which I will return, but there was no statement then of an intention to file revised statutory accounts.

In July 2013, the defendant wrote to the claimant saying that the defendant had been entitled to rely on the filed accounts, and it was irrelevant that they might have been drafted differently. Two days later, 10^th July 2013, the claimant’s directors approved revised statutory accounts for 2007. These showed not ‘turnover’ but a new concept, ‘net interest income’ and, importantly, showed this figure as being less than £6.5 million.

There was a further letter from the claimant’s solicitors to the defendant on 24^th July, basing the challenge to the decision of the defendant on the new revised accounts, and the revised accounts were actually filed at Companies House on, I think, 2^nd August 2013. They were then produced by the claimant’s solicitors to the defendant, and subsequently they were criticised by Ernst & Young on various grounds in a report to the defendant’s solicitors. The defendants requested copies of the full audited accounts on 22^nd August. But the claimant’s letter, on 19^th September, declined to give that information, and would only give audited reconciliations. The defendant wrote again on 5^th November to the claimant’s solicitors saying that the defendant was not required to consider the revised accounts.

There matters stood for some time and then in March 2015 the claimant took up with new solicitors, LEXLAW, and the process of correspondence began again.

I want to say something about accounting standards because it is important for what follows. There are two important sets of accounting standards which are involved here. One is the UK Generally Accepted Accounting Principles, GAAP, and accounts which use these are referred to as ‘Companies Act accounts’. The other is the International Financial Reporting Standards, the IFRS. These were developed by the International Accounting Standards Board, IASB, and accounts that use these are often referred to as IAS accounts. International Accounting Standard, IAS 39, to which I referred earlier, is implemented by the IASB. As I should have made clear, the original 2007 accounts of the claimant were drawn up in accordance with GAAP.

There exists a statutory mechanism for the revision of filed accounts. Section 454 of the 2006 Act governs this:

In summary, the directors can prepare revised accounts if it appeared to them that the original accounts did not comply with the requirements of the Companies Act 2006, but revisions have to be confined to the correction of the non-compliance with the requirements of the 2006 Act. As I have said, that primary legislation is supplemented by the Revision Regulations. In my view there is some significance in the title of those regulations referring to ‘Defective Accounts’.

The defendant has pointed out by reference to the various documents, including correspondence, that the explanation by the claimant for the revision of the accounts in 2013 did not assert that the original 2007 accounts did not comply with the requirements of the Companies Act 2006. On the other hand, the claimant did rely on the fact that the original accounts had included ‘loan principal’ in turnover, whereas many lenders did not do so. It also relied on the fact that the accounts did not follow IAS 39 in measuring loans at amortised cost using the so-called ‘effective interest’ method. This produced a figure for what the claimant calls ‘net interest income’.

In the claim form which, of course, was issued in 2016, the claimant now says that the turnover figures had been incorrectly stated in the claimant’s originally filed accounts for 2007. On the face of it, that is a rather surprising assertion. However, it is interesting to recall that, as I have said, in the original 2008 accounts (drafted in 2010) a new accounting policy was introduced compared with 2007, explicitly, so it was said, to exclude loan principal from turnover, and to recognise income over the loan period in proportion to the amount outstanding from time to time.

Again, as I have already said, this change in policy involved restating the 2007 turnover figure, originally £28.6 million, as £9.2 million. But this was done only to be compared with the 2008 figure in the 2008 accounts, which was £9.7 million. It was not to revise it for the company’s statutory accounts, which at that stage were left untouched.

The further revision of the accounts in 2013, however, does not use the concept of ‘turnover’ at all. Instead it refers to ‘net interest income’, and, as revised for 2007, this is stated to be £3.5 million, and £3.2 million in the following year, 2008.

The claim form states that the sole question of law for the decision of the court is whether, on the true construction of the FCA agreement, the defendant was obliged to have regard to the claimant’s revised annual accounts – that is, in deciding whether to consider the claimant’s complaint regarding the 2007 swap as being within the scope of the FCA review which it had agreed to undertake. The claimant seeks declarations that the defendant has not acted in accordance with the FCA agreement, and is therefore in breach of it.

The defendant says, first of all, that the claimant has no standing to seek the declarations sought. It says, secondly, that, even if the claimant has standing, the court should decline to give a declaration, on the grounds that, amongst other things, the review in fact concluded in April 2016. Thirdly, the defendant says that, in any event, the defendant did not breach the FCA agreement because the defendant was not obliged to have regard to the claimant’s revised 2007 accounts. In this CMC I am not concerned with the first two of these three matters, but I am concerned with the question of expert evidence in relation to the third.

At the hearing, the claimant told me that it was not seeking permission to adduce any expert opinion evidence at the trial unless the defendant obtained permission to do so, and then it would wish to do the same. On the other hand, the defendant very definitely does want to adduce such evidence. That means that I must consider Part 35 of the Civil Procedure Rules. Part 35 lays down a code for dealing with expert opinion evidence. The purpose is, explicitly, to restrict such evidence to what is, as Rule 35.1 puts it, ‘reasonably required to resolve the proceedings”.

The defendant wishes for permission to adduce in evidence the report of Rachel Sexton of Ernst & Young. In very brief summary, this says that ‘turnover’ is gross income before the deduction of expenses, but that ‘net interest income’ is interest income, less commissions paid to agents, allowances for bad debts, and interest expenses. It also says that, under IAS 39, turnover should be expressed as ‘interest income’ rather than ‘net interest income’. Of course, the significance of that is, the defendant says, that if you look at the calculation for interest income for the claimant for 2007 the figure you get is higher than £6.5 million.

However, although the claimant said at the CMC that it was not seeking permission to adduce expert evidence, the claimant has, without permission, put some opinion evidence before the court in the first witness statement of Mr. Klempka. I am referring particularly to paras. 48, 60 (at least the first two sentences), 62, 69 (the whole of the paragraph except the first sentence), and 79. All of those passages except what is stated in para. 79 appear to be the opinion of Mr. Klempka himself. There is no evidence before the court that Mr. Klempka has any expertise, let alone sufficient expertise, to be giving expert accounting evidence. The witness statement says he is a company director, and I cannot, as at present advised, treat that as a sufficient qualification for giving expert accountancy evidence. I also note, purely in passing, that, of course, if he were sufficiently well qualified as to be able to give expert accountancy evidence, that might bear on the question of whether any company of which he was a director ought not to be treated as a sophisticated customer by virtue of the subjective condition. As I say, that is something in passing.

The question for me, however, is whether the evidence put in by Mr. Klempka in the passages which I have indicated ought to be allowed to stand, absent an application for permission, and permission is being granted. As I have already said, the issue in the case is whether the defendant is obliged to have regard to the claimant’s revised annual accounts for 2007.

At the hearing I looked at some authorities, and in particular at a long passage from the judgment of Hildyard J in the RBS Rights Issue Litigation[2015] EWHC 3433 (Ch) paras.13 to 20. In that passage the judge dealt with a number of other authorities which bore on the question of the court’s approach to giving permission for expert evidence to be adduced. In para.13 he referred to the famous dictum of Evans-Lombe J in Barings Plc v Coopers & Lybrand[2001] PNLR 22, para.45. He referred in para.15 to restrictions from other cases, including JP Morgan v Springwell[2006] EWHC 2755 (Comm) at para.21, and Midland Bank Trust Company Limited v Hetts Stubb & Kemp[1979] 1 Ch 384 at 402. In para.17 he referred to the Australian case of R v Bonython[1984] 38 SASR 45 at 46. Then at 19 and 20 he referred to the decision of Warren J in British Airways Plc v Spencer[2015] EWHC 2477 (Ch) where Warren J proposed a three stage test for the application of Rule 35.1, bringing out, as the judge said, the sliding scale implicit in the assessment of what is ‘reasonably required’ from the essential to the useful.

After the hearing was concluded, and whilst I was considering my notes before giving judgment, I came across two other authorities which seemed relevant. I asked the parties by email if they wished to make any submissions on them. These were Camden v The Inland Revenue Commissioners [1914] 1 KB 641 (CA), a decision which was subsequently taken to the House of Lords and affirmed, but the point about expert evidence was not raised; and LHS Holdings Limited v Laporte Plc [2001] EWCA Civ 278, also a decision of the Court of Appeal.

In the former case a question had arisen about the meaning of the words ‘nominal rent’ in the Finance (1909 -1910) Act, s.12. The appellant, Marquess Camden, by his counsel had asked a land surveyor in the witness box at trial a question as to whether those words ‘nominal rent’ had a particular meaning to land surveyors, but the respondent objected and no evidence was given, therefore, as to any particular meaning. In the Court of Appeal the appellant said he should have been allowed to adduce that evidence. The Court of Appeal said No. I will come back to this case.

LHS Holdings v Laporte was a case of a share sale and purchase agreement, and a question subsequently arose as to the validity and effect of a dispute notice which had been served by the seller under that agreement. In order to be valid, according to the contract, it had to give ‘reasonable details’ of the grounds of dispute. One item that was said to be in dispute was written as follows in the notice, “UK GAAP override not appropriate/improperly applied”. The seller argued that it was appropriate for the court to receive expert evidence as to how an accountant would understand the notice. The Court of Appeal agreed with the trial judge that that evidence ought not to be received. Again, I will come back to that case.

The issue in this case is whether the defendant is obliged to have regard to the claimant’s revised annual accounts for 2007 in considering whether the claimant falls within the scope of the review. Whether the claimant so falls depends on the claimant’s ‘turnover’ (as defined) for the accounting year 2007. The FCA contract refers to the use of the word in s.382 of the Companies Act, which itself refers on to the definition of ‘turnover’ in s.474 of that Act. The claimant here says that turnover for the purposes of the FCA agreement is whatever the claimant puts in its revised statutory accounts as net interest income, as long as, and the claimant does accept this, the revision complies with s.454 and the Revision Regulations. The claimant further says that that is a question of construction of the word ‘turnover’ as used in the FCA agreement. That is, it says, a question for the judge at trial. No expert evidence should be admissible in relation to it.

The defendant therefore says that, if that is the issue, expert evidence showing that from an accounting perspective net interest income does not (or even if it does) equal turnover is both relevant and useful to the court and should be admitted. The problem is that that argument is the argument that was put in Camden v IRC. At p.645 of the report the argument made on behalf of the appellant, Marquess Camden, by Mr Danckwerts KC, is stated as follows:

At pp.647 to 648 Sir Herbert Cozens-Hardy MR, said this:

Again, at p.649, the Master of the Rolls says:

The same argument, as it seems to me, was also put in the case of LHS Holdings v Laporte in relation, as I have said, to the validity of a notice served pursuant to a contract between the parties. At para.31 of his judgment Jonathan Parker LJ, with whom both the Lord Chief Justice and May LJ agreed (although May LJ did add a short supplemental judgment of his own), said this:

Then at para.36 Jonathan Parker LJ concludes thus:

In my judgment, the accounting treatment of the income of the claimant in this case is not the point. The question is, what does ‘turnover’ in the FCA agreement mean in the context of the claimant’s business, and in particular what was the claimant’s ‘turnover’ in that sense in 2007? In my judgment, the expert accountancy evidence proposed is inadmissible. It goes to the very issue which the judge has to decide, which is the meaning of ‘turnover’. It is for the judge to say what ‘turnover’ means, and not for an accountant.

The defendant says, that is unfair because it will not be able to meet the evidence put in by Mr. Klempka. I agree: it would be unfair not to be able to meet that evidence. But if no expert opinion evidence is admissible then, a fortiori, the non-expert opinion evidence of Mr. Klempka is not admissible either.

So the question arises, what should I do about Mr. Klempka’s first witness statement? I have not heard any submissions on this point, but I will state that I am minded, subject to those submissions, to strike out passages in his first witness statement. They are the passages to which I earlier referred - that is para.48, the first two sentences of para.60, para.62, the whole of para.69 except the first sentence, and para.79. I recognise that that is simply a view that I have formed by reading that one witness statement. It may be that I am going too far; or it may be that I am not going far enough. I must, therefore, hear from the parties as to what they think. We can do that in one of several ways: I can either receive submissions orally now; or I can receive them in writing over the next few days, so that the matter can be concluded before the end of term; or there can be a further hearing fixed at a future date, but in that case I think it would be in the New Year.