If the title of this piece leads the reader to infer that I am a classicist, then I can only apologise since nothing could be further from the truth! However, I have read sufficiently from works of profundity such as "Rumpole of the Bailey", "What Ho, Jeeves" and "Yes, Prime Minister" to recognise the odd classical allusion when it is dropped. And thus my derivative classical antennae twitched upon reading the judgment of Mr Justice Kerr in the Chancery Division of the High Court in England in the recent case of Morley (trading as Morley Estates) v. The Royal Bank of Scotland plc, in which reference is made to a "Sword of Damocles" hanging over a borrower in connection with enforcement options open to the defendant bank in a real estate finance restructuring process.
The levity of the opening paragraph of this piece perhaps detracts somewhat from what was a very serious case emanating from the detritus left behind by the 2008 financial crash and its aftermath. The case revolved around, amongst other things, whether the claimant had been induced to enter into a financial restructuring transaction by intimidation and economic duress brought to bear upon him and his negotiating team by representatives of RBS during the course of negotiations.
What is clear from the case is that a very high standard is set for establishing a claim based on those causes of action in a situation involving negotiations between commercial persons.
The case will be of interest to finance and insolvency professionals generally, and particularly to those involved in debt restructuring transactions.
The facts of the case
The judgment is quite fact heavy and is a laborious read at times, but it can be "summarised" relatively quickly as follows:
- Mr. Morley was a comparatively young, and successful property investor and developer who had built up a portfolio of commercial properties through a process by which he would borrow substantially to acquire a property, then embark on development or property improvement works before tenanting the property out to commercial tenants.
- By 2006 his portfolio amounted to some twelve properties that had an aggregate market value in excess of £100mn.
- In December 2006, the claimant (as a sole trader trading under the name "Morley Estates") and RBS entered into a loan agreement for the provision of a loan facility of up to £75mn at an interest rate of 1.00% over base rate, an interest cover covenant (ICR) ratio of 1.3x and a loan to value covenant (LTV) ratio of 75% ratcheting to 80% at certain times. The facility was secured by way of legal charges on each of the properties in the portfolio, but otherwise the facility was "non-recourse" to Mr Morley or his personal assets.
- The claimant was entitled to utilise £15mn to £20mn of the facility for his own personal use. He used the money to acquire a yacht, sports cars, a jet airplane (with a mortgage on it), a villa in France and certain South African mining investments.
- As is common knowledge, the financial crisis commenced in 2007 through 2008 and the global downturn it triggered, particularly following the bankruptcy of Lehman Brothers, caused a collapse in values across asset classes, with commercial real estate being no exception. This had an adverse effect on the claimant's property portfolio, with warning signs first developing when the ICR covenant in the loan agreement was breached falling below the 1.3x cover ratio.
- A series of valuations carried out between 2008 and 2009 evidenced a rapidly collapsing aggregate market value for the portfolio falling from £98.45mn to £58.6mn. This latter figure gave an LTV of 125% (measured against a financial covenant default level of 75% / 80%).
- The loan facility was very obviously in default and discussions therefore commenced between Mr Morley's negotiating team and various representatives of RBS in relation to a consensual restructuring involving either a refinancing with RBS on varied terms or a redemption of the bank's mortgages for an amount which was less than the outstanding indebtedness owed to RBS. Various proposals and counter-proposals were made over the course of this negotiation period, but no agreement was reached. A "stand-off" developed between the parties and this caused RBS to escalate the exposure to its Global Restructuring Group (GRG).
- GRG eventually became solely responsible within RBS for the management of the exposure. The exposure was also incorporated into the Asset Protection Scheme set up by HM Treasury under which losses suffered in respect of certain "covered assets" of an eligible financial institution would be underwritten by the UK government, and the Asset Protection Agency (being an executive agency of HM Treasury, APA) would work with the financial institution in question to minimise such losses as far as possible. Accordingly, GRG was in regular contact and dialogue with APA in relation to the loan facility with Mr Morley and the various restructuring options.
- All the way through the negotiations, it was made clear to Mr. Morley's team that a consensual deal was very much in Mr Morley's interests as, failing that, RBS had as an ultimate remedy a contractual entitlement to accelerate the loan facility based on the continuing Events of Default and thereafter to appoint receivers to the various property assets to effect a sale. It was also made clear that RBS could, and indeed would, structure such an enforcement process by way of a "pre-pack" deal under which the portfolio would be "sold" by the receiver to a subsidiary of RBS set-up to take title to distressed assets in an enforcement scenario called West Register. The APA favoured the West Register option, but RBS was wary since it would involve the management of a large portfolio of commercial properties over what may transpire to be a lengthy period of time (perhaps several years) for which West Register had no experience and therefore external property and asset managers would have to be appointed. RBS's preference was to reach a consensual deal with Mr Morley, but to keep the West Register option in reserve as a fall-back position and also as a bargaining tool through which to exert pressure on Mr Morley to reach a deal consensually.
- Mr Morley was, however, not keen on the various refinancing proposals which were put forward by RBS and sought to negotiate those to more favourable terms. He objected in particular to the requirement that he enter into property participation agreements with RBS under which RBS would share in a proportion of the "equity" (if any) derived from the property portfolio after its indebtedness had been paid off. For its part, RBS was not satisfied with the various counter-proposals put forward by Mr Morley and his negotiating team, particularly the various figures proposed by Mr Morley for the redemption of the mortgages on his portfolio.
- Negotiations became fraught. The relationship between the parties was strained to the point of breaking. It was alleged in the evidence that "robust language" was used by participants in one particular meeting. Mr Morley involved his local MP publically as a means of bringing pressure to bear on RBS to offer him better terms.
- By August of 2010, Mr Morley was faced with a stark choice. In essence
- he could make a payment to RBS in the sum of £20.5mn as the "price" for retaining title to five of the properties in the portfolio, and sign a voluntary transfer of the remainder of the portfolio to West Register, in return for which he would be released from all of his obligations and liabilities owed to RBS; or
- RBS would appoint a receiver to the entirety of the portfolio and enforce a "pre-pack" sale of all of the properties to West Register.
13. Finding himself trapped like Odysseus plotting a course between Scylla and Charybdis (or caught between a rock and a hard place in more contemporary parlance), Mr Morley chose the first option and signed the necessary settlement documentation to give effect to that transaction.
14. Five years later, Mr. Morley brought his claim against RBS seeking damages for the losses incurred by him in having been, as he alleged, induced into signing the various settlement documents through intimidation and economic duress (amongst other alleged wrongs and breaches of duty).
The West Register option analysed
This case revolved around a number of issues and legal causes of action, but I have deliberately focussed on the West Register option and its legality or otherwise in the context of the intimidation and economic duress causes of action as being what I consider to be the most interesting aspects of the case. The other causes of action were, I think, holed below the waterline from the outset amounting, in my opinion, to an argument that RBS was required to essentially forsake its own commercial interests in favour of those of the borrower in order to demonstrate that it had provided banking services to its customer with reasonable care and skill per section 13 of the Supply of Goods and Services Act 1982 and the House of Lords' decision in Hedley Byrne & Co v. Heller & Partners Ltd.
In this context, it is worth pausing to consider the West Register option more carefully as the "threat" of falling back on this formed the crux of the claimant's case that he had been subjected to intimidation and economic duress. It was accepted that those causes of action could not be engaged if the thing threatened was a legal act (unless there was bad faith present in the threatening of that legal act). Accordingly, much of the debate turned on whether the West Register option was a legal or an illegal transaction and whether RBS had acted in bad faith in threatening its use.
It is not entirely clear from the judgment in the case just precisely how the West Register option would have been structured, but I think we can infer the following from the facts and from restructuring experience:
- RBS would appoint a receiver to the entire portfolio (as it was perfectly entitled to do at law following demand for payment since the ICR and LTV covenant breaches gave rise to clear Events of Default).
- The receiver would then transfer title to the property portfolio for value to West Register immediately on a "pre-pack" basis - i.e. on the basis of a pre-agreed package of documents on pre-agreed terms.
- The consideration "paid" by West Register would be the market value of the properties and this was to be determined by obtaining two separate valuations of the portfolio and settling on the average of the two.
- This consideration would need to have been funded, or at least accounted for, in some way. I suspect there would have been an internal accounting arrangement between RBS and West Register under which the consideration payable would be represented by a loan balance owed by West Register to RBS perhaps with interest accruing, perhaps not.
- However, there would not have been a funds flow as such since there would be little point in RBS advancing monies to West Register so that it could advance monies to the receiver so that the receiver could then advance those monies to RBS in redemption of its mortgages. In practice, a series of account entries would be made internally within RBS group to reflect the value transfers.
- Presumably, RBS would then have settled the expenses of the receivership from its own funds.
It is perhaps not difficult to understand why Mr Morley regarded the above transaction as unconscionable and perhaps even menacing. He would lose the entirety of his property portfolio with "nothing" in return other than being released from his obligations and liabilities owed to RBS. He would lose all of his potential future equity upside. As a man of business, he desperately wanted the chance to trade out of his difficulties and wait for property values to rise again allowing him to either dispose of the properties at a profit or refinance with another lender. It must have been especially galling for him as a property man to contemplate the loss of his "equity" in a process through which the properties would not be floated on the open market. Balanced against this, however, he would also have been aware that he was in substantial negative equity territory with the value breaking uncomfortably (for both parties) within the amount of the outstanding senior debt. The facility was also very clearly and obviously in default as a result of the ICR and LTV financial covenant defaults.
In addition to those commercial considerations, from a legal perspective, the West Register option must have looked suspiciously akin to a foreclosure on the property portfolio under which the properties would be in essence appropriated by the RBS group. As a matter of English law, forelcosure is regarded as a "clog on the equity of redemption" and therefore a mortgagee may only foreclose on mortgaged property with an order of court after a lengthy period of time has been allowed for the mortgagee to satisfy the underlying debt due. However, the key difference here is that West Register was a separate legal person, albeit closely connected to RBS, and therefore the proposal was not a foreclosure as such, but rather the exercising of a power of sale through a lawfully appointed receiver.
Nevertheless, mortgagors are entitled to various legal protections when a mortgagee is enforcing a power of sale. In particular, a mortgagee must act in good faith, the mortgagee may not sell to itself, and the mortgagee must take reasonable steps to obtain the best price reasonably obtainable. In a typical arm's-length scenario, this would involve placing the property on the open market in order to demonstrate that the best price is obtained.
Where the purchaser is a connected person, there is a heavy onus on the mortgagee to demonstrate that it has acted fairly towards the mortgagor.
In the course of the judgment, Kerr J referred to the case of Australia & New Zealand Banking Group Ltd v. Bangadilly Pastoral Co Pty Co Ltd and the judgment of Jacobs J, sitting in the High Court of Australia:
"… when there is a possible conflict between that desire [to get the best price reasonably obtainable] and a desire that an associate should obtain the best possible bargain the facts must show that the desire to obtain the best price was given absolute preference over any desire that an associate should obtain a good bargain. When those circumstances exist it may not be sufficient that steps are taken in the conduct of the sale which would suffice to support the validity of the sale when there was no conflict of interest. The steps taken or not taken in the conduct of the sale cannot be considered separate from the conflict of interest."
Mr Morley's legal counsel submitted that the West Register option was illegal based on these tests since there was no real separation between RBS and West Register (other than their distinct legal personae) with the two entities being part of the same group and sharing many of the same employees. It was submitted that, as a result of failing to float the properties on the open market, it was impossible for RBS to demonstrate that it had acted fairly towards the mortgagor by taking all reasonable steps to obtain the best price reasonably obtainable for the portfolio. It was far from clear, for example, that a better overall price might not have been achieved by marketing each property for sale separately rather than appointing a receiver to the entire portfolio and having it sold to West Register. Accordingly, threatening Mr Morley with the West Register option was, it was submitted, intimidation or economic duress since it was a threat to pursue an illegal act, and Mr Morley was therefore entitled to damages in lieu of rescission of the settlement documents.
The court's decision
Ultimately, the court found in favour of RBS on all of the causes of action, including those pertaining to intimidation and economic duress. As far as those latter causes of action were concerned, it is clear from the judgment that Kerr J found the decision to be finely balanced. He believed that it was possible that the West Register option may have involved illegality depending upon how it was structured and implemented. In particular, he was not convinced that the proposal whereby two valuations would be obtained and the consideration payable by West Register would be based on the average of those valuations would have evidenced that the best price was obtained (why not opt for the highest valuation, for example?) But he was equally cognisant of the fact that Mr Morley had no reasonable prospect of recovering any "equity" from the process as he was so far out of the money in terms of where the value broke in the outstanding senior debt.
Kerr J was not persuaded that a reasonable lender would have allowed the portfolio to continue to trade until asset prices had recovered, as Mr Morley wished RBS to do, noting that the entire financial system was in the midst of a liquidity crisis at that time and RBS was perfectly within its rights to seek liquidity through enforcement against defaulted positions so long as it acted in good faith in so doing.
Kerr J had regard to the judgment of Dyson J (as he then was) in respect of economic duress in the case of DSND Subsea Ltd v. Petroleum Geo-Services ASA. In that case, Dyson J held that, in order to make out the cause of action, there must be pressure to enter into a contract with the practical effect of compulsion or a lack of practical choice, which is “illegitimate” and is a significant cause inducing the victim to enter into the contract. In making the determination as to what is or is not "illegitimate", a range of factors will have to be taken into consideration, including any actual or threatened breach of contract; good or bad faith; whether the victim had any real choice; whether the victim protested at the time and whether he affirmed or sought to rely on the contract. However, Dyson J also noted that conduct which is “illegitimate” must be “distinguished from the rough and tumble of the pressures of normal commercial bargaining”.
In making his judgment on this issue, Kerr J determined that RBS's use of the West Register option as a bargaining tool should Mr Morley not acquiesce in a consensual refinancing or settlement fell on the right side of the line in the sense that it was part of the "rough and tumble" of what had been a lengthy, difficult and acrimonious negotiation process. Accordingly, Mr Morley's case failed.
The case sets a high bar for establishing a cause of action based on intimidation or economic duress. The fact that a "threat" used to induce a contract might involve an element of illegality in its implementation is not sufficient to engage the causes of action. There must be clear illegality specifically threatened giving rise to a compulsion which is illegitimate.
Also, the courts again show themselves unwilling to interpose themselves between commercial persons engaged in negotiations even where the bargaining positions of the parties are not balanced, as was the case here with RBS holding what was clearly the better hand. Given the reference to the "rough and tumble" of commercial negotiations, it is clear that it will be difficult to make out a case based on these causes of action in most typical restructuring scenarios. In this case, evidence was adduced that "robust language" had been used by RBS representatives during one particular meeting and emails were seen by the court in evidence in which the West Register option was referred to as a "Sword of Damocles" hanging over Mr Morley, and forthcoming meetings between the parties were referenced in graphic terms as regards the likelihood of Mr Morley emerging from them with a good deal for him. Yet the court was unmoved - this was all acceptable "rough and tumble".
It is, however, also clear that the decision here was finely balanced and was on the borderline of what may be regarded as legitimate or not. It seems clear that the court was influenced by the particular circumstances of the case in which the claimant's equity position was hopelessly out of the money with no prospect of any financial recovery for him, other than through a long term property management strategy which RBS was under no compulsion to acquiesce in. It may be that the case would have been decided differently if the position in relation to the value-break was more marginal whereby an open market process may well have resulted in a better end-position for the claimant.
It is also worth noting that Mr Morley acquired his property portfolio and incurred the £75mn facility in his capacity as a sole trader trading as Morley Estates. He therefore could not give floating charge security. In most real estate finance transactions, the borrower is a corporate vehicle the ultimate beneficial owner of which is either an individual or an investment fund or other form of property investment vehicle. In those circumstances, floating charge security can be given and this opens up other forms of enforcement options such as an administration process. It is not necessary for administrators to jump through the same hoops as a fixed charge receiver or a mortgagee in possession when implementing a sale process whether pursuant to a "pre-pack" arrangement or otherwise. Whilst Kerr J may have felt that this was a borderline case in terms of impropriety with not much more needed to push it over the line, I suspect that a lot more would have been needed to establish any impropriety where what was being proposed was being carried out by a duly appointed administrator.
Emails - a lesson for us all….
Whilst there's an element of "there but for the grace of God go I" in this, I think practitioners, bankers and professionals generally might usefully take time to reflect on the role that emails sent in the course of the negotiations had in this case when adduced in evidence before the court. The sender of the "Sword of Damocles" email in particular expressed regret in court at having used that particular term, and some of the other emails referred to do raise an eyebrow insofar as they did not display an overly sympathetic attitude towards Mr Morley and his position.
I think the lesson here is to be very careful with emails in particular and to always pause before hitting the "send" button to consider whether you would feel comfortable if the content of the email in question became evidence in a court of law….
 My thanks and gratitude are extended to my colleague, Alan Meek, for his time in reviewing this piece and his thoughts on the nature of the borrower as a sole trader as opposed to a separate and distinct incorporated entity with limited liability.
  EWHC 88 (Ch).
 As an aside, it seems extraordinary to me that the courts are still hearing cases from that tumultuous period, and yet here we are twelve years later still sifting through the wreckage. My own personal opinion, for what it’s worth, is that the US authorities should not have allowed Lehman Brothers to go under, regardless of the moral hazard implications of keeping it afloat, but that is perhaps a debate for another time….
 GRG was established within RBS to manage relationships where the underlying loan documentation was in default with a view to minimising losses from non-performing loans.
  AC 465.
 There is an exception to this rule in respect of financial collateral (i.e. cash, shares and securities) where the Financial Collateral (No.2) Regulations 2003 are applicable, in which case there is a right of appropriation, although equitable relief from forfeiture may be available in these circumstances. See Cukurova Finance International Ltd and another v Alfa Telecom Turkey Ltd (No 2)  4 All ER 936.
 Cuckmere Brick Co Ltd v. Mutual Finance Ltd  1 Ch 949; and Tse Kwong Lam v. Wong Chit Sen  1 WLR 1349.
 Tse Kwong Lam v. Wong Chit Sen  1 WLR 1349.
  HCA 21.
  BLR 530.