Fixed Rate Loans - A Bank's Duty to Inform Its Customers

Another recent case increases the duties on lenders providing a fixed rate loan, to clearly explain to the borrower the potential financial implications of prepayment.

Introduction

In October 2015 we published a blog alerting lenders and borrowers of the need to get the funding indemnity drafted correctly in a fixed rate loan.

Another recent case increases the duties on lenders providing a fixed rate loan, to clearly explain to the borrower the potential financial implications of prepayment. The position lenders are now in with regard to fixed rate loans is not dissimilar to the position with interest rate swaps, such that there is a clear need to explain carefully the potential financial implications arising from the entry into a fixed rate loan, before entering into the contracts.

The legal background

Banks have long been under a common law duty to take reasonable care not to mislead or misstate information provided to a customer and on which it is expected that a customer may rely. In a recent case, Thomas and another v Tridos Bank NV (Tridos) the High Court considered the question of the circumstances in which a bank owes a higher duty of care to its customer.

Relevant facts

In Tridos, a family business took out a series of loans over a period of time with Tridos Bank. In 2008, the borrower entered into a fixed rate loan where the interest was fixed for a period of 10 years.The fixed rate loan agreement contained a provision providing for the payment of an early prepayment premium in the event that a fixed rate loan is prepaid or converted to floating rate (which was an option in the document) prior to the expiry of the fixed rate term.

When the borrower looked to convert the fixed rate back to a floating rate under the terms of the documentation, the prepayment premium was significantly higher than they had anticipated, as a result of the financial crash and the drop in LIBOR.

Claim

The borrower claimed the bank owed a duty of care to explain the implications of breaking the fixed interest rate before the expiry of the term and that the conduct of the bank breached such duty.

Findings

The court found on the facts that whilst the information provided to the borrower by the bank did not result in a higher duty of care than the legal duty not to mislead or missate (as it was held the bank was not "advising" in this case, but providing information), the fact the bank was a signatory to the voluntary British Banking Code (the "Code") placed it under a higher duty. .

The Code contains a "fairness commitment", under which banks subscribing to the Code promised to give customers information in plain English and to explain the financial implications of a customer's choices ("Code Duty"). The Code Duty specifically referred to the implications of entering into long term financial commitments and gave the example of withdrawing early from a fixed-term loan.

The court said as the bank was bound by this higher Code Duty, it should have explained to the customer when asked:

• the period for which the rate could be fixed (eg. minimum and maximum time) 

• where the fixed rates could be found (eg. on the internet) 

• what those rates represented (eg. forward cost of money) 

• the effective rate that would be payable by the customer (eg. the fixed rate plus margin) 

• the financial implications of terminating the fixed rate before the end of the period for which it is fixed.

The court found the bank in breach of the Code Duty because it failed to give the borrowers a clear explanation of the financial implications of fixing the interest rate and the manner in which the clause providing for the prepayment premium actually would work.

Take aways

The key take ways from this case is that, as a matter of practice, banks should ensure:

• they explain to customers any premiums, fees or other charges that will attach to prepayment of a fixed rate loan or an early break of a swap before entering into the relevant contract with such customer, including, if the bank feels appropriate, to work through an example prepayment scenario with the customer; and 

• provisions in their loan agreements setting out the calculations for such premiums, fees or other charges are drafted clearly and in "plain English" and should be drawn to the attention of the customer.