Royal Bank of Scotland Plc v Highland Financial Partners Lp & Ors

This has been a hearing to assess quantum in the light of the summary judgment I granted to the Claimants (“RBS”) on 10 February 2010 ([2010] EWHC 194 (Comm)) (the “Liability Judgment”), as upheld by the Court of Appeal on 14 July 2010 ([2010] EWCA Civ 809), against the Second and Third Defendants (“Highland”) as borrowers and the First Defendant as guarantor. I do not propose to rehearse the full history of the Collateralised Debt Obligation transaction (“CDO”) between RBS and Highland which led to such judgment, for details of which I refer to the Liability Judgment. Suffice it to say that I concluded that there had been lawful termination by RBS on 31 October 2008 of the relationship between them and Highland constituted by a Mandate Letter (as amended on 25 March 2008) and the Interim Servicing Deed (“ISD”) between them dated 5 April 2007, such as to terminate the arrangements whereby Highland borrowed from RBS via a Special Purpose Vehicle or SPV (“the Issuer”) funds for the purpose of acquiring a portfolio or ‘Warehouse’ of Loans, with a view to issuing, to subscribing third parties, securities, for which those Loans would be collateral.

Unfortunately the autumn 2008 financial crash ended any chance of public interest in such securities, and, after two extensions of the proposed closing date, and the provision of substantial collateral by Highland, RBS served notice pursuant to the Mandate Letter and the ISD, triggering the repayment provisions of the ISD. Thereafter RBS purported to operate those provisions so as to liquidate the existing loans, in part by selling them to third parties and in part by purchasing them themselves, and to set off against the outstanding balance of advances by RBS the sums credited in respect of such disposal, leaving a shortfall calculated by RBS as some €35m.

There is no dispute about the outstanding balance of the advances. The dispute arises in respect of the sum which RBS has sought to credit against it. RBS asserts that it has correctly operated the provisions of Clause 4.2 of the ISD (to which I shall turn) and is not in breach of any obligation. Highland claim that RBS has not correctly operated the terms of that Clause, and is in breach of its equitable obligations as mortgagee, which are implied into or inform its obligations under Clause 4.2, such that Highland deny that, on a proper accounting, had RBS not been in breach of its obligations, any sum would be or is due, or indeed assert that monies would be or are owed by RBS. Each side called two expert witnesses, one as to valuation and the workings of the syndicated loan market, Mr Michael Constant for Highland and Mr Simon Hood for RBS, and one in relation to accounting treatment, Mr David Lawler for the Defendant and Mr Peter Chidgey for RBS. RBS called one factual witness live, Mr Sam Griffiths, who was the RBS leveraged loan trader responsible for the Highland portfolio at the material time, and one whose statement was read, namely Mr Simon Lowe, the then Global Controller, Credit Markets, for RBS, responsible for relevant accounting treatment. Highland called no factual witnesses, and the examination has been simply of the conduct and performance of RBS. The trial lasted four full days (after reading time) between 14 and 17 September, and then a day’s oral submissions, after delivery of written arguments, on 6 October 2010, which was followed by further written submissions from the parties on 12 and 15 October. I have been greatly assisted by Mr Johnson and Ms Stares, of Herbert Smith, for RBS, and Mr Auld QC and Mr Strong for Highland.

The only material clause of the amended Mandate Letter relied upon before me (by RBS) provides simply that “[RBS] agrees that, subject to obtaining its internal approval, the [Second and Third Defendants] will participate in the risk of the Warehouse Facility. If the transaction does not close, the economics will be 7.5% for the account of [the Third Defendant] and 92.5% for the account of [the Second Defendant].” So far as that is concerned, there is no doubt that 100% of the loss (if any) resulting from the transaction is to be carried by Highland. The issue is how that loss (if any) is calculated.

The crucial provision of the ISD, which took centre stage before me, is Clause 4.2, headed “No Closing Date”, i.e. it arose in the event that, as in fact occurred, the contractual arrangements between the parties came to an end without there having been a closing date when the securities were issued to the public (from which it was intended that RBS would have been repaid). In quoting such clause, I shall substitute “Highland” for the “Interim Servicer”, and “RBS” for the “Funding Note Holder”. The “Acquired Loans” referred to are, in the event, the 88 Loans which had been acquired by the Issuer with funds advanced by RBS, and which were now to be disposed of so as to fund and enable repayment to RBS upon the termination, there having been no Closing Date:

“4.2

If the Closing Date does not occur on or prior to the Termination Date the Acquired Loans shall be sold in accordance with the provisions set out below:

(a)

[Highland] shall have the right to purchase all Acquired Loans from the Issuer at market prices as determined by readily available quotes from independent, internationally recognised broker/dealers on commercially reasonable terms so long as there is no loss to the Loan Portfolio or as otherwise agreed between the parties, provided that in respect of any Acquired Loans not sold or agreed to be sold by the Issuer to [Highland] within 3 Business Days of the Termination Date, [RBS] will have the option to direct the Issuer to sell one or more of the Acquired Loans remaining in the Portfolio in such manner as specified below and as [RBS] shall determine in a commercially reasonable manner, which (for the avoidance of doubt) may include a sale of any such Acquired Loans to [RBS] or (if [Highland] so agrees) [Highland] at a price equal to the sum of the market values for such Acquired Loans provided:

(i)

if both [RBS] and [Highland] wish to purchase an Acquired Loan, then the party that makes the higher bid thereof shall purchase such Acquired Loan at such price;

(ii)

if both [RBS] and [Highland] wish to purchase an Acquired Loan and both offer the same price thereof, then [Highland] shall purchase 100 per cent of such Acquired Loan at such price;

(iii)

if neither [RBS] nor [Highland] wish to purchase an Acquired Loan, then such Acquired Loan will be sold in accordance with the procedures (i) mutually agreed between [RBS] and [Highland] within 5 Business Days, or else [(ii)] determined by [RBS] acting in a commercially reasonable manner.

…

(c)

if the actions specified in this clause 4.2 above are not completed to the commercially reasonable satisfaction of [RBS] within 30 calendar days after the Termination Date in the event of the occurrence of any event specified in paragraphs (b), (c) or (e) of the definition of Termination Date, an event of default shall be deemed to have occurred under the Variable Funding Note and [RBS] is hereby authorised to take whatever action it determines appropriate to sell each of the Acquired Loans still held by the Issuer.”

The following clarifications should be made at this stage:

The notice served by RBS dated 30 October 2008, terminating the Mandate Letter and the ISD as of 31 October, gave to Highland until close of business on 5 November to state which (if any) of the Loans were to be sold to them, no doubt by reference to the 3 Business Days, set out in Clause 4.2(a). As will be seen, in the event, of the 88 Loans, RBS itself purchased a total of 59, and 29 were sold to third parties. RBS did not take any step for the procedures to be mutually agreed in respect of such sale to third parties within 5 Business Days or at all in accordance with Clause 4.2(a)(iii) set out above. What occurred is that RBS devised what has been called a BWIC, which is the acronym for an informal quasi-auction known as “Bids Wanted In Competition”. Mr Griffiths gives this description in his witness statement:

“We decided to use a Bids Wanted In Competition (“BWIC”) process to liquidate the portfolio. This process, in broad terms, means that a list of loans is presented to the market and potential buyers are invited to submit bids for the individual names on the list. Bids are requested within a specific timeframe and the highest bidder purchases the specific loan or portfolio (subject, in this case, to RBS matching the highest bid and acquiring a Loan or Loans itself, as contemplated by Clause 4.2 of the ISD).

24.

… We had previously used a BWIC to sell a large amount of assets and, given the falling market, we decided that the best values would be obtained by going to the market quickly and with a BWIC open for a limited period of time.”

On 5 November 2008, Mr Griffiths sent an internal memo to a number of his colleagues at RBS, which reads as follows:

“Here is our proposed liquidation procedure for the Highland warehouse assets. Comments/feedback welcome.

1.

RBS will obtain, where available, bid side quotes for the Highland assets from Mark-It, Reuters LPC, Merrill Lynch and Deutsche Bank for Nov 6^th 2008 and record them in a spreadsheet.

2.

RBS will notify Highland of this procedure on the morning of Nov 6^th, in order to give them a head start if they would like to bid for any assets in the liquidation procedure.

3.

On Nov 7^th RBS will send out a list of all the assets in the portfolio to the market, requesting bids.

4.

Highland will be invited to bid for assets as part of the auction.

5.

RBS will also submit their bids in the auction.

6.

Auction deadline to be 2pm Nov 11^th.”

It is to be noted that, by paragraph 5, it was at that stage proposed that RBS would “submit their bids in the auction”.

By email of 6 November 2008, RBS, for the first time, notified Highland what it intended to do:

“We refer to the Interim Servicing Deed and our letter dated 30 October 2008 terminating the Interim Servicing Deed. As you have not informed us that you have purchased or agreed to purchase any of the Acquired Loans in accordance with the opening lines of clause 4.2(a) of the Interim Servicing Deed, we are writing to inform you of the process we intend to follow in accordance with the proviso in clause 4.2, which process we consider to be commercially reasonable. This is set out below.

1.

Today (6 November) we are seeking indicative prices or quotes for each Acquired Loan in the portfolio from Mark-it, Reuters LPC, and other third party market makers in order to gauge its market value.

2.

Tomorrow (7 November) we will send out a list of the Acquired Loans to market participants (including Highland) and seek firm bids in respect of each of them

3.

Bids must be submitted by 2pm on 11 November

4.

RBS shall also be entitled to bid

5.

Each Acquired Loan will be sold to the highest bidder

6.

If there is no bid for an Acquired Loan, RBS shall purchase it at fair market value which shall be determined by RBS using the indicative quotes/prices referred to in 1 above, but taking into consideration factors such as the liquidity of the loan in question and market conditions.”

It is to be noted that the BWIC was to open the following day, Friday 7 November, and terminate at 2pm on Tuesday 11 November and that RBS is now simply to be “entitled to bid”, and that “each acquired loan will be sold to the highest bidder”, which at least would appear to imply that it would be sold to the party who places the highest bid in the BWIC, be it a third party or be it RBS itself, which will be entitled to bid. The reference to “seeking indicative prices or quotes from Mark-It, Reuters LPC and other third party market makers” is a reference to the obtaining of prices from what have been referred to as “Price Sources” or “Data Services” (including Mark-It and Reuters, but also, as in paragraph 8 above, Merrill Lynch and Deutsche Bank), which are described as using market information to provide the best estimate of quoted prices. In the event, Mr Griffiths explains in his statement (at paragraph 38) that they decided to include in the BWIC “an indicative mark for each loan based on Mark-It prices, one of the Price Sources.”

Highland’s reaction, by email of 6 November 2008, was to “reiterate and emphasise our vigorous objection to RBS proceeding with its liquidation of the collateral as outlined in your correspondence. We consider not only … the process you outline to be unreasonable (commercially or otherwise), but the decision to liquidate at this time to be commercially unreasonable”.

RBS decided to include in the BWIC not only the 88 Highland Loans, but also some 40 loans from other sources. There was thus a total of some 120 loans included in the BWIC, which was notified, on RBS’s evidence, to at least 200 potential bidders. The published terms included the following:

“• Bids are requested on individual names for the entire position shown on the spreadsheet and/or for the entire portfolio. Bids need to be received by us by email by 2pm (GMT) on Tuesday 11 November 2008 and shall be irrevocable and binding on the bidders until 3.30pm (GMT) on that day.

• We reserve the right not to sell all or some of the positions according to bids received and/or to sell any individual positions in the secondary market at any time, although our current intention is to sell the majority of the portfolio by way of the BWIC.”

The BWIC (known, by way of codename, as the “Shingle BWIC”) was thus open for a total of 4½ days, including a weekend, and a Tuesday which was Veterans Day in the United States, a public holiday. RBS has compiled a list of at least 117 clients with whom RBS sales people communicated about the BWIC. A number of transcripts has been disclosed and considered in evidence, of telephone conversations between some of those sales people and representatives of financial institutions.

Notwithstanding enquiries by RBS to Highland by two emails dated 11 November, Highland did not bid. Nor did RBS.

The result of the BWIC was as follows:

RBS has consequently totalled, as being the proceeds of the 88 loans, the prices for the 36, calculated as above, plus the proceeds of the 29 Loans which were sold to third parties, plus the sums in respect of the 23 which neither they nor any third parties wished to purchase (by applying the WAD to the average bidside quote from the Pricing Sources, where there were such, and to the RBS mark of 15 October 2008, where there were not). After subtracting that sum from the uncontroversial figure owed in respect of RBS’ advances plus interest and fees, there is a shortfall of some €35m, which is what RBS claims. In making its claim for that sum in March 2009, RBS asserted on 26 March that it had “followed the process set out in [its] email of 6 November [referred to in paragraph 10 above]” and gave the account - though without any distinction between the 36 and the 52 and without reference to any such explanation as was eventually given by Mr Griffiths (to which I shall return) - set out in paragraph 16(i) and (iii) above. More information was sought by Highland by email of 30 March 2009, but none was given.

Proceedings were commenced by RBS for the full amount of the shortfall as calculated by RBS on 11 May 2009; and summary judgment for liability was obtained by RBS, as described in paragraph 1 above, after a contested hearing before me on 21 and 22 January 2010. It was only after that that, on the basis of disclosure by RBS, Highland was able to put forward, in their Particulars of Defendants’ Case Regarding Quantum on 4 June 2010, the case which has formed the basis of issues upon which the experts on each side have opined, and which I now have to resolve, but even that was still on the understanding by Highland, perpetuated right up to the hearing by Mr Griffiths’ statement (cited above) that the 36 loans were transferred to RBS’ banking books after the BWIC .

What was described by Mr Griffiths in paragraph 52 of his witness statement (set out in paragraph 16 (ii) above) as “another factor taken into consideration” was in fact central to the course of action taken by RBS, both in relation to its determination of the CDO and the steps it took in relation to liquidation of the Loans. The true position was not revealed at the time by RBS, and has only become clear during the course of this hearing.

IAS/39, or more particularly the “global amendment” to it referred to by Mr Griffiths, was an answer to the real and pressing financial and accounting problems caused by the crash of autumn 2008. RBS, like other banks, took advantage of it, as they were entitled to do, immediately after its publication on 13 October 2008. On that same day, as may or may not have been coincidental, RBS received an effective injection from HM Treasury, by way of underwriting of new shares and subscription for preference shares, of £20 billion. This rendered it even more significant for RBS to be able to take advantage of the new provisions of IAS/39, which required very speedy action indeed, as the necessary steps had to be taken, in order for benefit to accrue, by 31 October 2008, i.e. 18 days later. What was permitted by IAS/39 was for assets, such as loans, held by banks like RBS on their trading book, to be reclassified, on a one-off basis, as long term investments and transferred to their banking book, provided that they were to be held long term (i.e. in the case of loans until maturity or at least for 12 months). The enormous benefit of this was that, instead of having to write down the value of such loans on their books, as RBS had already been doing, to take in the substantial diminution of value of such assets as a result of the crash, they would be entitled to value the asset at a date which could be adopted retrospectively by the bank but could not be earlier than 30 June/1July 2008, thus reconstituting the value that the asset had had as at the chosen date, retrospectively, by valuing the assets as at that date. This would have the effect of enabling the bank to write back the losses for which it would otherwise have had to account.

Mr Lawler (in paragraph 71 of his report) said that “the accounting treatment adopted by RBS means that it increased the value of the recategorised loans on its balance sheet back to their 30 June 2008 values, and it follows … that the increase between the [decreased] carrying value at November and at June will have been booked as profit”. This new value credited in the RBS books would then be subject to amortisation, but would not (unless the loans became positively impaired) require regular reduction in its books by reference to its falling value, as it would have done if the loans had remained on trading account.

An exercise was immediately carried out by RBS, to see which loans could be so recategorised and transferred, by a team which included Mr Griffiths, on strict instructions from on high (a Mr Hourican) both to comply with the time limit and also to achieve as great a recoupment of losses, and hence increase in profits, as could be arrived at. Included in the loans so considered, indeed constituting a very significant part of them, were the Highland Loans, which had been properly carried on RBS’ books, even though strictly not owned by them, because of their collateralised status under the CDO.

This exercise became, for obvious reasons, a manifest priority for RBS and Mr Griffiths, and, given that a decision had to be made as to which, if any, loans were to be capable of such classification as being investments held long term by RBS, not only did the Highland Loans have to be considered for that purpose, but it was plain that the only way in which RBS could conclude that any of the Highland loans were to be held long term would be if the CDO were terminated. Hence (although this was not revealed at the time of the summary judgment application) the motivation for the termination, albeit termination which was in the event a lawful one, was that the CDO had to be terminated by 31 October, because otherwise if the loans remained under the control of the Issuer and in accordance with the CDO, RBS could not confirm that they would be held long term. Hence, notwithstanding that Highland had been led to believe that the CDO would be continued at least until January 2009, simultaneously with the accounting exercise preparation had to be and was made for the service of the notice to terminate, to which I refer in paragraph 7 above.

By an email from Mr Lowe to a large number of colleagues in RBS of 15 October, he laid down the ground rules for which loans should be selected for reclassification, making it clear that “once reclassified out of the fair value category an asset may not be reclassified back in. In other words this is a one-way action”. He made it plain that “in practice assets should only be reclassified if

On 22 October a Mr Berry from RBS Global Banking and Markets circulated an email confirming that:

“(1)

this is a top down process i.e. it has been mandated by John Hourican, thus it is not a case of shall we do this but how we will do this (2) he recognises that there is no way we can undergo our normalised approval process for the names in the time allotted, so therefore looks to us to devise a fast-track approach … The main driver here is clear, that an opportunity arises for assets to be transferred from trading book to banking book with valuation as at end June. This has several attractions for the business, primary one being that the anticipated transfer value will allow the business to write back some profits, given that most assets have reduced in value since end June.”

The loans that were examined were categorised, and the two classes which were concluded to be appropriate for such reclassification were Category A, where the loans were “bullet proof, money good at par” or Category B “money good at the transfer price [i.e. value as at 30 June]”. The 36 Loans were those selected by Mr Griffiths and his team from amongst the Highland Loans as fitting that description, most of them indeed being Category A.

By 31 October, a Mr Fulford of RBS was sending to (among others) Mr Lowe the “Final spreadsheets … evidencing assets being transferred to Loans and Receivables as of 31 October 2008”. The aim was what was called a “P & l Reversal”, and, as the calculations continued, the gain, or rather avoidance of loss, in RBS’ accounts as a result of the exercise was referred to as a “windfall”. The “Highland Sum of Windfall” was calculated first as at 21 October as £28,513,074.67: this, it seems, was arrived at by calculating how much the values would otherwise have fallen as between the June 30 and October 15 marks. In an email from a Mr Gulliver of RBS dated 24 October, the “windfall gain” was described as by reference to 46% of the Highland Warehouse.

By 4 November, four days after the precise loans transferred from trading books to banking books had had to be identified in order to capture the benefit of IAS/39, an email was sent by a Ms Sue Barnett to (among others) Mr Griffiths saying “we also need a decision as to whether to put the … sales to the banking book through our database at the current mark or the June 30^th price. … It isn’t totally irreversible, we can amend the sale price later if necessary so what’s the consensus “best” way …?”

None of this was explained or deposed to by Mr Griffiths, as is apparent from his witness statement quoted above. The impact was just as Mr Hourican would have wished, namely (as set out in the published Circular supporting the placement of new shares in RBS in November 2008) that “as a result of the reclassification, total income for the three months to 30 September 2008 was £1,442 million higher”; and in the Annual Accounts for the year ending 31 December 2008 there was, by virtue of reclassification of the leveraged finance, an increase in the profit and loss account of some £1.7 billion.

The following is thus entirely clear:

Although at no time prior to the hearing was any analysis of events possible by reference to clause 4.2 by Highland, nor in any event carried out by RBS, because of its failure to disclose the true position, it became apparent on the first day of the hearing that the treatment by RBS of the 88 Loans would need to be justified by reference to two different aspects of clause 4.2.

The 36 would have to be justified by reference to clause 4.2(a) itself, without recourse to its subparagraphs, colloquially called in the course of the hearing 4.2(a)(0) - given that what occurred in relation to the 36 did not fall within any of those subparagraphs. It was not a case in which both RBS and Highland wished to purchase an acquired loan ((i) and (ii)) nor a case in which neither RBS nor Highland wished to purchase the loans ((iii)). In relation to the 36, RBS is on the face of it permitted to sell (or direct the Issuer to sell) direct to itself, provided that (i) the manner in doing so is determined in a commercially reasonable manner and (ii) the price is at market value and that (iii), as is common ground (see paragraph 6(iv) above), RBS complied with its equitable duties as a mortgagee upon sale of such collateral, as enlarged by the right to sell to itself given by clause 4.2(a)(0), the onus being on RBS to establish that there was no breach of such duties.

So far as concerned the sale of the 52, which, given that neither RBS nor Highland wished to buy, were to be offered to third parties (although in the event RBS took those that had not been bid for in the BWIC), there are similarly equitable duties quae mortgagee on RBS (but in this case RBS does not bear the onus), the procedures must be mutually agreed and if not mutually agreed then must be determined by RBS in a commercially reasonable manner.

In the circumstances of non-disclosure, given that there were 88 Loans to be disposed of as of 30 October when the notice of termination was given (and the 3 Business Days for Highland to take them up pursuant to clause 4.2(a) started to run), there was not any such different treatment expressed or explained. Even without an immediate declaration by RBS, which there was not, that it intended to retain the 36 (which might well have led to a counter-bid by Highland in accordance with 4.2(a)(i) and (ii)), then in any event mutual agreement ought to have been sought in relation to the procedure for the whole 88. It was not. In the absence of such prior attempt at mutual agreement, the BWIC was launched for all 88, which was bound to involve the sham pricing exercise and the uncommercially reasonable procedure referred to in paragraph 30 (iii) and (iv) above.

Consideration was given in the course of the hearing to the provision in clause 4.2(a) that RBS will have the option to direct the Issuer to sell the Loans. This caused me some concern, because, on the face of it, it is not what happened when RBS decided which Loans it should keep and which it should sell and how. But in reality the Issuer was, being an SPV, a nominee company, and it could not have been the expectation of either party that it would be in a position to market the Loans or take any active steps in relation to their sale: hence my initial reaction that it would have been for the Issuer to hold some kind of auction, in which RBS could be expected to bid, was an unrealistic construction. I am satisfied that in reality what occurred is that it was indeed RBS which directed the Issuer to sell the Loans in the various ways spelt out in paragraph 16 above, not least because RBS held a power of attorney to act on behalf of the Issuer.

Such consideration is a suitable stepping off point for addressing an issue which was also examined at an early stage in the hearing, namely as to whether the right course would have been for RBS to have bid in some kind of auction, whether it be the BWIC or not. After all, it is what Mr Griffiths’ initial email said (at paragraph 5) that RBS would do (paragraph 8 above), albeit then palliated it to their being entitled to bid, in the email sent to Highland on 6 November. Neither Mr Griffiths nor (there being none) any other witness for RBS has given any evidence as to what lay behind, or occurred during, the IAS/39 exercise, the determination of the CDO and the choice and implementation of the BWIC. Although there therefore is not any such evidence, it is possible that what lay behind the pricing exercise contained in the BWIC, was some reflection of clause 1.1 of the ISD, to which I have referred in paragraph 6(i) above. As I have there set out, there is a definition of Market Value, which is expressly made relevant for the different exercise in clause 4.1 of the ISD there referred to. This definition reads as follows:

““Market Value” means, with respect to any Acquired Loan, an amount equal to the highest of at least one bid … from counterparties in the relevant market for firm commitments to purchase such Acquired Loan … minus all direct costs, fees and expenses.”

As I have said, there is no evidence that this was in RBS’ mind, and, although I agree with Mr Auld QC that the incorporation of this definition into clause 4.1 cannot dictate the meaning of clause 4.2, nevertheless, all other things being equal (commercially reasonable manner, compliance with equitable duties etc), such clause might give relevant background. However, what is utterly clear is that there could not have been an auction of that kind on this occasion in which RBS could have bid:

Before considering and analysing further the impact of the contractual and equitable obligations on the parties, I should set out the simple propositions which were effectively articulated by Mr Johnson on behalf of RBS as his starting and, indeed, finishing points:

The issue was plainly how far such simple propositions are able to get Mr Johnson and RBS home in this case. But Mr Auld QC submitted that the purpose of clause 4.2 is to enable fair disposal, and not to achieve a windfall gain for RBS. Mr Constant, in his expert’s report, described the position, as he saw it, thus (at paragraph 70):

“In my view, RBS appears to have taken advantage of this accounting treatment to generate a significant windfall profit at the expense of Highland by soliciting ‘market’ ‘prices’ and then buying the loans from Highland at these low prices while simultaneously planning to sell the loans internally to their banking book at a much high price.”

I turn to the question of equitable obligations. So far as concerns the ascertainment of the price for the sale of the 52 Loans out of the 88 which RBS had not concluded it would retain as a result of the IAS/39 exercise, there is no difference between the parties as to the obligations: obligation to take reasonable (and reasonably expeditious) steps to ascertain and obtain the market price: no obligation to delay a sale until a more opportune moment. It is really all said in the authorities to which brief reference was made in paragraph 6(iv)(a) above and in McHugh v Union Bank of Canada [1913] AC 299 PC at 311 per Lord Moulton: “It is well settled law that it is the duty of a mortgagee when realising the mortgaged property by sale to behave in conducting such realisation as a reasonable man would behave in a realisation of his own property, so that the mortgagor may receive credit for the fair value of the property sold”: and in Cuckmere Brick Co. Ltd v Mutual Finance Ltd [1971] 1 Ch 949 per Salmon LJ especially at 966C “In addition to the duty of acting in good faith, the mortgagee is under a duty to take reasonable care to obtain whatever is the true market value of the mortgaged property at the moment he chooses to sell it.”

As for the 36, that is a different matter, in that there was a sale by the mortgagee to itself, not permitted to a mortgagee ordinarily, but provided for, in accordance with its terms, by this contract. The fact here is that when RBS exercised its power (i) it knew that it had already decided to take for itself the 36 in any event – IAS/39 would not permit a disposal by RBS (ii) the price at which it had transferred the Loans on its own book was by reference to the RBS internal mark, arrived at in accordance with its regular valuation of the Loans as at 30 June 2008, since which time the most recent such mark (as at 15 October 2008), had substantially fallen, and the Mark-It prices ascribed to the loans in the BWIC as their “indicative prices” had fallen still further.

There was considerable discussion in the course of the hearing as to whether RBS should be treated as a special purchaser, and so the special purchaser cases were considered. Many of these cases were taxation cases, in which inevitably the question is much more hypothetical and speculative, being of a ‘what if’ variety. In particular in such cases, it will be important whether the alleged special purchaser was a party of whom potential purchasers of an asset were unaware. In IRC v Clay [1914] 3KB 466, at 475 Swinfen Eady LJ concluded that “a value, ascertained by reference to the amount obtainable in an open market, shews an intention to include every possible purchaser”, so that the probability of a special buyer purchasing, above the price which but for his needs would have been the market price, fell to be taken into consideration (see 476). In IRC v Crossman [1937] AC 26 HL, there were unfortunately different views expressed by their Lordships, even leaving aside the fact that the case was resolved by a majority of three (Viscount Hailsham LC, Lord Blanesburgh and Lord Roche) to two (Lord Russell and Lord Macmillan). Viscount Hailsham (at 44) drew the conclusion from the judgment of the judge below that “the extra sum which could be obtained from Trust Companies was not an element of the value in the open market, but rather a particular price beyond the ordinary market price which a Trust Company would give for special reasons of its own”. Lord Roche (at 75) agreed with Viscount Hailsham. But he also agreed with Lord Russell, who at 69, like Lord Blanesburgh at 62, appears to have concluded that “any possible bid for the shares by a Trust Company was allowed for” by the judge below, and he had thus excluded no one from the open market; and Lord Macmillan agreed with Lord Russell. Lord Reid in Lynall v IRC [1972] AC 680 concentrated on the facts that were known to or could be obtained by a seller (694-5). Peter Gibson LJ in Walton’s Executors v IRC [1996] 21 EG 144 at 161 indicated, in considering the concept of the open market, that each of the seller and the buyer “will have prepared himself for the sale, the seller by bringing the sale to the attention of all likely purchasers, and honestly giving as much information to them as he was entitled to give (Lynall v IRC … at 694 per Lord Reid) and the buyer by informing himself as much as he can properly do … Because the market is the open market, the whole world is to be assumed to be free to bid. But the valuer will enquire into what sort of person will be in the market for the property in question and what price the possible purchaser would be likely to pay”.

The really significant factors appear to me to be the following:

In those circumstances, the significant obligations on RBS, when setting out to take reasonable steps to obtain the market price for the Loans, fall to be considered differently as between the 36, which they were committed to purchase themselves, and the 52, which they had not decided to buy and were setting out to sell to third parties (though they subsequently purchased 23 of them themselves, when there were no bids for them in the BWIC). It is plain that, in respect of the 36, where they were exercising, unusually for a mortgagee, their right to sell to themselves, they inevitably had to act the more carefully.

They chose 36 out of the 88 to retain, and had done so before setting out the “proposed liquidation procedure” on 5 November. They were obliged to seek from Highland mutual agreement with regard to the 52. In my judgment it is plain that no genuine mutual agreement could be obtained if the true position were concealed from Highland. That required disclosure to Highland in order for them to be in a position to agree the procedure which was actually being carried out, namely (as now known) a BWIC (leaving aside the other factors of timing etc, to which I shall return when I deal with the 52) which would on the face of it consist of 88 Loans, but would in fact be a sale exercise in relation to only 52, while in regard to 36 it was to be a price fixing exercise, relating to assets not for sale. Unless this picture were given, indeed if agreement were sought on the basis of a BWIC for all 88 assets without disclosing it, any mutual agreement which had been obtained would have been obtained on a misleading basis.

Such duty to disclose, the equitable obligations of RBS as mortgagee seller and the duty to determine the manner of sale in a commercially reasonable manner (which applied both as to sales to itself (clause 4.2(a)(o) and sales to third parties (clause 4.2(a)(iii))) combine to lead to the following consequences and conclusions:

Highland make a number of other criticisms in relation to the BWIC, to which I shall refer below. But, irrespective of them, I am satisfied that the implementation of the sham BWIC, the lack of mutual agreement as to the BWIC, the lack of commercially reasonable manner in relation to its processes, renders this BWIC wholly unsustainable as a method of arriving at the sale prices, the market values, of the 36 Loans. RBS was in breach of its contractual obligations and has not satisfied the onus of complying with its equitable obligations: the simple propositions of Mr Johnson set out in paragraph 37 above do not apply in those circumstances.

I must, therefore, ask myself what the consequence is of that conclusion.

Highland’s case is that the 36 Loans were ‘sold’ by the Issuer to RBS at the time when they were transferred from trading book to bank book, at the IAS/39 valuation. If that is right then the prices for which RBS must account to Highland are those values. Mr Constant said as follows:

“72.

What is more, as a banker, I would regard the transfer of loans from RBS’ trading book to its banking book as a sale. Of course, I recognise that that transfer did not involve the sale from one entity to another (although the loans had originally been legally owned by the Issuer and became the property of RBS). But the Portfolio group of RBS (which ran the banking book) was a separate department to the group which booked the loans when they were required by the Issuer. … in my experience, when one department in a bank transfers an asset to another department the individuals involved treat the transfer very much in the same way as a sale to a third party because the transfer affects the results of their part of the business.”

Mr Lawler said in evidence:

“What I am saying [is that] on the transfer – either on the transfer of the loan to the banking book or the sale from the trading book to the banking book, the double entry would effectively be the same. If the transfer is made at an increased value, the trading book would have a profit. The difference between the carrying value and the trading book and the transfer value would be booked as a profit. So the double entry is exactly the same whether it’s a transfer or a purchase in the market.”

As referred to in paragraph 28 above, Ms Barnett of RBS in an internal email referred to putting “the sales to the banking book”.

But was there a sale? RBS submit that the sales of the Loans took place after the BWIC, when they activated the power of attorney, and when all the Loans were sold, both those sold to third parties and those (the 36 and those unsold in the BWIC) sold to RBS. Mr Auld submits that there is no sufficient paperwork evidencing this, and that what occurred in the BWIC took place after the Loans had been sold. Mr Griffiths’ evidence was that, in the pre-31 October exercise, he and his team were determining which loans would repay at par: that “we never took into account the price in our exercise … the exercise was not concerned with price; it was concerned with a question that was: is this asset going to default?”.

I am satisfied as follows:

It is plain to me that the priority for RBS was to terminate the CDO, so that they would be in a position to control the Loans, and know that they would be in a position to retain, and thus safely transfer to banking book, those Loans (36 in the event) which they felt qualified within IAS/39. They did not, at that stage, buy them: to that extent I agree with Mr Griffiths when he said: “For me, a sale or a trade happens when a price is determined”. Of course, there can be circumstances in which a sale is complete, but with a price to be determined. Further, if Mr Auld be right, this was a sale where the price was determined, namely the IAS/39 value. But I am satisfied that this was not such a sale, but rather that RBS had decided that they would buy, and that they would need to conclude what market value was, and that, misguided though their procedure was, it was intended to arrive at the price through the mechanism of the price-fixing BWIC, and that the sale took place at that price, after the BWIC.

The alternative case for Highland is that in fact, irrespective of when the sale took place, the market value of the Loans was the IAS/39 value, the June 30 RBS mark. This is not based on any reliance on RBS as a special purchaser, or as being prepared to pay over the odds, but the argument rests simply on the evidence of Mr Constant in his report:

“57.

… the 30 June 2008 prices are in my view a good guide as to the prices … which banking book buyers would pay for such loans and fairly reflect their value to a banking book buyer. RBS itself ought to have been prepared to pay up to those prices for the loans it wanted on its banking book, since it was going to value them at those prices in its accounts.”

The case that is made is that there was no real market after 30 June, and consequently that the best valuation is that by reference to the value at the last date that there was a real market. Another way of putting this, which certainly featured in the Defendant’s arguments, is that if RBS included the loans which they had already been satisfied were good loans (see paragraph 26 above) in their accounts at the IAS/39 30 June valuations, then those must have been the fair values, and hence the market values.

It is necessary to understand what the IAS/39 exercise (to which I have already made some reference in paragraph 20 above) involved and constituted. In paragraph 40 of his report Mr Lawler explains that if a Loan and Receivable previously held on a bank’s trading book is to be transferred to its banking book and retained, then “the current fair value of the Trading Asset becomes the new amortised cost of the Loan and Receivable”. However, Mr Lawler proceeds at paragraph 41 to point out that “as a concession, the amendment to IAS/39 allowed companies if they so wished, to backdate this re-designation to 1 July 2008”. Mr Chidgey says as follows:

“8.33

Mr Lawler states that implicit in the IASB’s decision to let companies look back to 1 July 2008 “… is that it is a time when quoted prices were unlikely to have diverged materially from underlying value”.

8.34

There is nothing that the IASB has issued which either explicitly or implicitly supports this view and it seems to be countered by the fact that companies had the ability to choose any date in the period up to 1 November 2008 to use as the reclassification date and indeed could reclassify after that …

8.35

The only stated reason I have found for the suggested use of the 1 July date is that for many companies it was the last period to which they had drawn up statements that had been reported in the market and thus it allowed for less complexity.”

I am satisfied that the retrospectivity was indeed a concession, and that what it, in fact, achieved was allowing banks to write back profits to a date just prior to the crash, in order to alleviate what would otherwise have been a massive accounting problem. But that does not mean that what was fair value as of 30 June 2008 was deemed to have remained fair value at all time thereafter. It quite plainly was not the case. Trading continued. The Pricing Sources continued to gather in and to give out information on trading. Both RBS and Highland continued to mark to market the values of their Loans. It is quite plain from all the evidence that the value of loans in the market fell after June, as did the value of so many other assets, tradeable or otherwise. Even as between October 15 and November 11, it is common ground in these proceedings (see paragraph 16(iii) above) that a percentage reduction in value (the WAD) occurred. It is clear from Mr Hood’s evidence that there was “steady volume of secondary market trading” and the Shingle BWIC itself obtained a notably large response (some $700 million of bids). I am satisfied that the values of the Loans in November 2008 were not the same as, and were on any basis less than, their values as at 30 June 2008.

What then is the consequence in my judgment of the breach by RBS of their equitable and contractual obligations? Plainly they should, in order to comply with those obligations, have disclosed that they had already decided to acquire the 36 Loans, such that there were only 52 to be sold. I am satisfied that there would have been no agreement with Highland to put the 36 into the BWIC. RBS would have had to disclose to Highland that the purpose of putting the 36 into the BWIC would be to arrive at a price to be paid by them for the Loans which they had already determined to buy. It seems to me inevitable that in such circumstances the reason why they had decided to buy those 36 loans would have had to be disclosed. Indeed it would have been in their interest to do so, because they would then have been able to explain, and powerfully so, why it is that, although they were to take the benefit of a June 30 2008 valuation into their accounts, because of the retrospective operation of IAS/39, nevertheless the contractual obligation was only to pay market value as of November 2008, which would, inevitably, be less (as Highland’s own marks to market would show).

The following factors would then come into play:

Doing the best I can, I conclude that, had there been compliance with RBS’s obligations and a full disclosure with regard to the 36, the outcome would have involved consideration of RBS’s October 15 mark - which is plainly what RBS was considering when it carried out the IAS/39 exercise (and worked out the windfall gain), but which it would have no doubt argued by November fell to be reduced - and the Highland November 11 mark, which would have been its best calculation of the value of the 36 Loans. Taking into account (i) the desire of RBS to buy, (ii) the negotiating position of Highland and (iii) the reality of what was plainly a falling market, I am satisfied that the market value of the 36 Loans was and would have been agreed to be, in the light of the above, one point over the October 15 2008 RBS mark for each Loan. There is no point in considering alternative methods to a BWIC, or targeted sales to third parties, or any other of the exercises canvassed between the parties primarily by reference to the 52 Loans, to which I now turn, because there was never any prospect of any other result than purchase by RBS.

There has been a considerable critique of the BWIC by Highland. Mr Constant and Mr Hood were both impressive witnesses. Mr Constant had experience of selling off a loan book in the second half of 2008 on behalf of his then principals Natixis, but his considerable experience has been in the primary loan market, not in the secondary or leveraged loan market, which is where Mr Hood’s equally considerable experience lies, and whereas Mr Constant emphasised the existence of what he called “bankers book buyers”, namely banks which would buy loans for long term investment in their books, Mr Hood had considerable experience of trading with banks and institutions in loans on the leveraged market, and was much more supportive of the reliability of the Pricing Sources, upon which he made it clear he relied in marking his portfolios weekly. Mr Constant regarded BWICs with suspicion and scepticism, and referred to press releases sceptical of them; but he was prepared to accept that they would be suitable for some (21) of the Loans. Mr Hood regarded them as “an established process, with a real explosion in BWICs occurring in October 2008”. The contentions of each side were obviously informed by the opinions of these two experts.

First. The BWIC was not genuine for the reasons which I have discussed at length above.

Second: Targeting. A BWIC, even if otherwise appropriate, was not appropriate for those Loans which were more saleable, because more bullet proof, namely 31 out of the 52. As to those 31, they should not have been in a BWIC at all, but should have been the subject of a targeting exercise carried out by RBS’ sales force over a period of weeks, or if necessary months, as described by Mr Constant. The 30 day period in clause 4.2(c) of the ISD, even if not expressly applicable, showed that the kind of speed adopted was not essential and was in fact to be ascribed to the urgency to implement the IAS/39 reclassifications. His recommended exercise would have involved a carefully structured and prepared approach, on a geographical basis by reference to the location of the various Loans, to bankers book buyers, who would, Mr Constant considered, have paid more than those purchasing for trade, if carefully addressed and targeted. Several bankers book buyers were identified by Mr Constant as not having been approached in the BWIC, and in any event he submitted that bankers book buyers should, and no doubt but for the inhibition of the presence of the 36 loans (referred to in paragraph 46(iv) above) would, have been more efficiently targeted.

Third: Timing and Duration. The BWIC was not long enough: 4½ days would be insufficient in Mr Constant’s view for banks to take a proper view as to whether to invest, banks taking longer than institutions to obtain authority. There was a number of references in the transcripts of telephone calls made by the sales force to the shortness of time. In particular there were four examples of recipients of telephone calls pointing out that the existence of the Veterans Day holiday on the Monday in the United States had seemingly been ignored and would or might cause problems.

Fourth: Indicative Prices. Mr Constant was critical of the inclusion in the BWIC (as referred to in paragraph 11 above) of the Mark-It prices as indicative prices or reserve prices, which he considered would amount to a discouragement to bidders, inhibiting them from offering more, or at any rate much more.

Five: The inclusion of other loans. Mr Constant criticised the inclusion of the extra 40 or so loans from other sources. If they had not been included (and of course if the 36 had not been included) in Mr Constant’s opinion there would have been a much more focused approach to the BWIC.

There was close engagement by RBS with the last four of these five criticisms. I have already dealt with, and made findings in respect of, the first, both as to the inappropriate inclusion of the 36 Loans and as to the inevitable damaging knock-on effect on the operation of the entire BWIC exercise.

I take RBS’ response to the second and third points together. So far as the time and duration of the BWIC is concerned, Mr Hood has no criticisms. If a bank or institution wished further time, he explains, they would have, in his experience, asked for it. As for the Veterans Day point, in his experience that would have caused no problem to American banks and institutions, who would either have in fact been open, or have had relevant European branches, or would have made sure they caught up over the weekend, particularly at such a difficult time for the markets. So far as the duration of the BWIC is concerned, not only did he indicate that he had had experience of a number of BWICs and did not consider this to be of unsuitable duration, but a schedule was produced by Mr Johnson of what were called “Non-Shingle BWIC’s communicated to RBS”, and by reference to the considerable number of those BWICs, and to other RBS BWICs, the period of this duration was, in fact, longer than most if not all, even allowing for the loss of the Veterans Day holiday.

Mr Hood was of the view that a BWIC was an entirely suitable way to approach sales, indeed (paragraph 161 of his Report) better than Mr Constant’s ‘bilateral’ marketing approach, and if some bankers book buyers were not specifically approached, he was of the view that they would not have offered anything over the kind of price at which the Pricing Sources showed the loans to be traded. I was certainly wholly unpersuaded by the Highland argument that buyers would be inhibited from buying at a lower price more of loans which they had previously purchased at a higher price before the market fell.

Both Mr Griffiths and Mr Hood emphasised the question of timing in a rapidly falling market, such as was the case in autumn 2008. It was, RBS submit, a perfectly rational view that there was no time to allow for what Mr Constant, perhaps unfortunately, described Natixis as having done, namely “dribbling out” sales over a period of months. The 30 day period referred to in clause 4.2(c) did not apply (as set out in paragraph 6(iii) above), but in any event the process which Mr Constant referred to, of assessing the loans and then planning a programme of approaches to them, while perfectly sensible, was not a course which RBS could be described as being unreasonable not to have followed in the falling market, given the nature of its obligations as described in (for example) Cuckmere Brick: see per Salmon LJ at 965G:

“Once the power has accrued, the mortgagee is entitled to exercise it for his own purposes whenever he chooses to do so. It matters not that the moment may be unpropitious and that by waiting a higher price could be obtained.”

Mr Constant accepted in cross-examination that “the decline in risk appetite in the secondary market would … have been a factor that it was legitimate [for RBS] to take into account in formulating the process to be adopted for liquidation of the Highland portfolio.”

As for the fourth point, relating to the indicative prices, Mr Hood did not conclude that including them was unreasonable. They would deter unacceptably low bids, and would encourage competition at the right level: and he did not accept Mr Constant’s view that there would be potential bidders who would not have had access to the Pricing Sources.

As to the fifth point, Mr Hood’s view was that adding in extra loans into the BWIC would not be detrimental, indeed it might well “spice up” what was on offer: adding non-Highland assets to the BWIC “broadened potential investor interest”.

The reality is, however, that the first point, the sham nature of the BWIC, is enough to destroy any prospect of reliance on it by RBS. Insofar as there were bids from third parties in the BWIC which were accepted as being the highest bid by RBS, there could be no confidence whatever that such prices were the market values, given the unsupportable nature of the BWIC. I am satisfied that the result is as unacceptable in relation to the prices bid for the 52 as it was for the prices bid for the 36.

I am, however, unpersuaded by Highland that RBS was unreasonable in not following a targeted process in respect of 31 of the 52 loans, as is suggested. For the reasons set out above, I am satisfied that RBS was entitled to expect a speedy closure, and that they are not to be concluded to have been unreasonable in entering into an exercise (had it been a genuine one) which arrived at market values within a short time, rather than indulging in the hypothetical exercise of marketing (not to speak of dribbling out) loans over a period. I am also unpersuaded by Mr Constant, experienced though he may be in relation to the primary loan market, as compared with the more relevant experience of Mr Hood, that there would indeed have been sales available to bankers book buyers at considerably over the price at which loans were being traded. I accept Mr Hood’s evidence that “the likelihood of many [such] bankers buying loans of the type that were in this portfolio is very, very limited”.

I have to do my best to conclude what the market values of the 52 loans would have been, had reasonable steps been taken to sell to third parties, or, if not sold, then for RBS to buy the loans in (as in the event they did). I remain persuaded by Mr Hood as to the utility of the Pricing Sources - which may indeed, for the reasons he gives, be too high, because of the “lagging effect” of reports to them in a falling market. I also remain persuaded by the provision for the use of those Pricing Sources in the contract, at clause 4.2(a) (referred to in paragraph 60(v) above), and by the existence and relevance of the contemporaneous marks to market by RBS as at 15 October 2008 and Highland as at 11 November 2008.

I conclude, in the light of all the evidence I have heard, that in this difficult and falling market, these Loans - albeit that most of them (though not selected by RBS) would have been regarded as reasonable bets in the long term - would not have been valued on the basis of a possible acquisition by a hypothetical bankers book buyer after a possibly lengthy period of marketing, but by reference to the market views at the time. I conclude that the liquidation values in accordance with clause 4.2(a)(iii) ought to be - sums I suspect considerably more than those arrived at by reference to the BWIC - now calculated by taking, in relation to each Loan, the average of the RBS 15 October mark, less the WAD to allow for the passage of a further month, and the Highland 11 November mark.

I must, therefore, ask counsel and solicitors to carry out the calculations as a result of my conclusion that the 36 Loans should be calculated in accordance with paragraph 61 above and the 52 Loans in accordance with paragraph 77 above. Given that all the other figures, save for the amount for which RBS should give Highland credit in respect of the liquidation of the 88 Loans, are agreed, that will enable a sum to be arrived at.