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Northern Rock
Shareholders Action Group
Report on the Appeal of the Judicial Review
Note: please do not
telephone or email us asking for the verdict or asking whether we think
the case is won. The judgement will not be given for several weeks and
we do not wish to try to forecast the result.
This page contains
a summary of events in the Court and some comments thereon but it does not aim to be a
comprehensive or verbatim record of what was said. It simply provides a
record of some of the key arguments and points made by the parties to
the case. All the evidence and key legal arguments in such an appeal are
given to the Court in writing in advance. For background on the original
Judicial Review and the judgement issued in that case, go to this web
page: Judicial_Review - that page
also contains a link to a page that explains the reason for the legal action.
The Appeal hearing
commenced on the 10th June 2009, lasted 3 days and was presided over by
Sir Anthony Clarke, Master of the Rolls, supported by two other senior judges,
Lord Justice Waller and Lord Justice Laws.
The
legal teams and counsel representing the various plaintiffs and the
Government were as follows:
SRM
Global: White & Case, represented by Lord Pannick, QC.
RAB
Capital: Nabarro Nathanson, represented by Michael Beloff, QC.
The
private shareholders: Nabarro Nathanson, represented by Tom de la Mare.
Legal
& General will also be represented as an Interested Party.
The
Government: Slaughter & May, represented by Jonathan Sumption, QC.
The
arguments put to the appeal judges on behalf of the claimants were numerous and varied, but the
main issues were:
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Because the Compensation Scheme will result in nil value for
shareholders, the court failed to assess properly whether the
Compensation Scheme was compliant with the European Convention on
Human Rights (ECHR). Strasbourg judgements have held that confiscation
of property without compensation is justifiable only in very
exceptional circumstances, which do not apply in this case.
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The
procedural process required by judgements under the ECHR, namely that
claimants are able to fully challenge the basis of compensation, were
not met by the terms of the Compensation Scheme which laid down
artificial assumptions about the facts that the claimants could not
dispute.
Lord Pannick opened the case for the
claimants to a packed court of lawyers, claimants and Northern Rock
Shareholder Action Group supporters. He speaks in a very direct and
clear manner. He said that the Government's case was that:
a - The company was in a perilous position
and would have had to go into administration without Government support.
b - The Government provided substantial
support at considerable cost to the taxpayer.
c - If the company thrives and is then
resold back to the private sector, the Government should take all the
benefit.
But he said, these are superficial
arguments and if the legal issues are examined then there is no
substance. At all material times Northern Rock was a solvent business
with a strong asset base but had short term liquidity difficulties. But
nationalisation without compensation is not justified by the
Government's support which was at commercial, indeed penal, rates of
interest. The Government repeatedly said they were taking no risks so
they cannot come to the court now and say they were.
The Government took the view that the
Nationalisation Act and Compensation Order terms would result in nil
compensation. Suppose I own a perishable asset and a third party comes
along and protects the asset then the intervener can only claim a
reasonable fee for his services - not the full value of the asset. The
Law of Salvage is a good example of this. There needs to be a fair
balance and this is upheld by the ECHR and Strasbourg precedents. The
divisional court did not confront this issue.
If the Treasury is right then any company
that receives Government support can be subject to nationalisation
without compensation. The Treasury has also prevented the valuer from
using his professional judgement to determine a fair value based on all
the facts.
Regarding the Act and the Compensation
Order, Sir Anthony Clarke asked "Your case is that it is a charade"? Lord Pannick replied "Yes - it's a No Compensation Order, not a Compensation
Order".
Lord Pannick then pointed out that his
clients (SRM) were not speculators but long term investors who were
willing to underwrite a substantial rights issue.
Michael Beloff representing RAB then
spoke in a more discursive style, and covered some of the
issues regarding regulatory failure and the specific case law regarding
the confiscation of property. He said only one case had been upheld by
the European Courts of confiscation with no compensation - one related
to the reunification of Germany which was very exceptional in nature. There are
some cases where full value was not awarded - specifically where
measures of social or economic reform were involved, but departures from
full market value are quite rare. The state of Government finances can
be one justification but this had not been relied on as an argument by
the Treasury. There is a "margin of appreciation" but it is not
unlimited and is subject to review.
Lord Grabiner (for the Government in the
original hearing) had said we don't need the assumptions in the Act and
Compensation Order - Northern Rock was bust so proportionality and
margin of appreciation were irrelevant.
Mr Beloff said the valuer is not just
bound, but gagged as well. He suggested Mr Sumption seemed to be taking
a different perspective to Lord Grabiner by suggesting there was an
element of policy that might justify a margin of appreciation.
Mr Beloff then covered salvage law, which
was originally based on common law and had been established as a matter
of public policy. Compensation in salvage law is in proportion to the
services rendered. This suggests an underlying principle of justice.
To conclude Mr Beloff invited the court to
pierce the veil of language around this case.
Tom de la Mare then spoke on behalf of the
small shareholders, in a somewhat hectoring style. He covered the
requirements for fairness:
a - Firstly any process must incorporate
an adversarial procedure to meet A1P1 and A6P1.
b - The valuer must be independent, must
be impartial and must have full jurisdiction on the merits of the case.
c - Any scheme that is predetermined by a
valuation assumption is contrary to these principles.
It would be strange for any investor to be
penalised for continuing to hold the shares after LOLR support had been
provided when the Government continued to be so positive about the
prospects for the company.
Any legislation under A1P1 requires full
jurisdictional review for any valuation process (see Article 6), i.e.
the process must provide procedural safeguards for it to be lawful. Mr
de la Mare quoted several precedents, but is the judicial review
capability sufficient to meet this requirement was an issue raised by
the judges. But Mr de la Mare said we cannot challenge the
substance in that way - the process is foreclosed by the Compensation
Order and the Act. One of the judges said: "It's unfair that one
party should dictate the basis of valuation. Surely this is what you are
saying?" Sir Anthony Clarke then said: "The key question is whether the
assumptions are unfair or not. If they are then there is no issue re
process". But Mr de la Mare said there needs to be justification on
policy or other grounds. Artificial presumptions of facts that cannot be
challenged are insufficient. The valuation assumptions foreclose
examination of the facts.
Mr Sumption then opened for the
Government. He has a very animated and nervous style, perhaps even
suffering from a medical condition that means he twitches a lot. His key
points were:
- The valuation assumptions were a
fundamental policy decision and you have to decide whether that was
justified or not.
- The assumptions simply put the
shareholders back in the same position as they would have been if the
Government had not intervened.
- LOLR does not exist to protect the
interests of proprietors of a company that has failed. It is to protect
the general public interest.
It is not true that the statutory
assumptions are an opaque way of getting a zero valuation. There is
nothing in the Act that makes that outcome inevitable. There is no
evidence that there was a deliberate plan to ensure no compensation.
Policy should be reasonably aimed at
protecting the public interest and in essence it was.
It is accepted that without Government
assistance the company would have gone into administration. In addition
the risks associated with the company were so high as to deter any
private investors from buying it. The policy objective was to ensure no
moral hazard, i.e. to ensure no reward to the original proprietors. The
bail out was not done for the benefit of shareholders. The shareholder
capital has contributed nothing to the outcome.
Public assets might otherwise be used to
fund speculative gains (for example in this case by RAB/SRM who
purchased shares late in the day).
Provision of Bank of England support is
not analogous to salvage as it is not a provision of services to the
benefit of the original proprietors.
Discussion then took place on the Goldman
Sachs report (that used by the Government to justify nationalisation)
which was apparently only written days before nationalisation. The
figures therein were apparently "relative" rather than "absolute" in
terms of showing that nationalisation provided the most favourable
outcome (or least subsidy as they claim). He also commented that he
thought the statements of the Prime Minister were "aspirational" about
making a profit, but Mr Sumption also said that all of this was
irrelevant. Likewise the regulatory failures were not the prime cause of
the failure of the company which was down to its imprudent business
model.
Mr Sumption continued on the third day by
saying that the statutory assumptions in the Act are not statements of
fact. The truth or falsity of the assumptions are irrelevant. The
precedents do not substantiate Mr de la Mare's arguments. The issue is
whether the terms of reference are appropriate to implementation of the
adopted policy.
Sir Anthony Clarke said - suppose the
Government sold Northern Rock back to the open market at a profit. Would
it not justify paying some of the value to the former shareholders?
Sumption replied:
- It does not affect the legitimacy of the
policy adopted.
- The ability to resell at a profit
relates to the value of the assets at the nationalisation date so the
valuer can take that into account.
- As only the Government was prepared to
bail out Northern Rock, the Treasury has assumed all the business risk
and hence should take all the return.
Justice Waller then suggested it would be
possible for the valuer to take into account facts that arose later so
if it was sold at a profit he could take that into account [note from
editor: this suggestion contradicts the general rules followed by
independent valuers where only reasonably foreseeable events at the
valuation date can be taken into account - the valuer has to take a view
of the situation as someone would see it at the valuation date and the
likely value perceived at that date - they cannot take subsequent
events, positive ones or adverse ones, into account].
Lord Pannick then gave his rebuttal
arguments. He said my friends answer is that the statutory assumptions
simply ensure the shareholders are not rewarded for the value
contributed by the Government. Consider the car fire analogy mentioned
by Justice Waller. It might be saved for reasons of public interest (for
example, it might set fire to adjacent vehicles or buildings). Should
the salver take the whole value on the basis that it would otherwise be
a burnt out wreck? It cannot be right in principle to start from the
assertion that because the Treasury saved the asset it is entitled to
the full value of the asset.
The shareholders have contributed value to
the asset that is being preserved. Moral hazard is not relevant in terms
of valuing compensation - it is only relevant when deciding whether LOLR
should be provided. Mr Sumption asks why should the shareholders receive
more at the vesting date than they would have if it had gone into
administration? But it's the wrong question. The key question is what
was the value at the vesting date.
The fire sale valuation that is mandated
by the Act does not give the value based on the assets less the
contribution by the Government. It simply dictates zero. The key issue
for the court is that the compensation terms do not provide a value for
the assets less the Government support.
Lord Pannick then discussed the Goldman
Sachs report used by the Government to justify nationalisation. He said
the report is pure assertion. It provides no evidence on which it is
based. Based on this report, the company was an enormously valuable
asset, but on an "administration" basis nothing is going to be received
by shareholders.
He said the loans from the Government were
given on defined terms and the change of ownership of the bank did not
affect those terms, and claimed Mr Sumption denied that the Government
knew or intended that nil compensation would be paid, but there is no
evidence that shareholders would ever get anything but zero.
What was the value of the assets that the
Government received at the vesting date? The statutory scheme simply
ignores that question.
Mr Kingman (of the Treasury) argued that
the value of Northern Rock was less than cost of the Government
subsidies. But the notional cost in the Goldman Sachs report was a
"notional subsidy" - it has never been paid as a cash cost. It is also
entirely speculative. We do not know the assumptions or the basis of
calculation.
He alleged Mr Sumption was saying that his
clients were speculating on Government policy. But it is inappropriate
to criticise people who took the Governments statements at face value
about the state of the company.
Mr Beloff then recalled some of his
previous points and went over the case law. He said Mr Sumption says the
assumptions reflect a policy. Is such a policy justifiable under the
ECHR? Neither in James or in Lithgow (the relevant case law) upon which
Mr Sumption concentrated, was nil compensation paid.
We accept that in salvage the owner of the
asset is the main beneficiary whereas LOLR is aimed at other objectives.
But there is a more fundamental level of question posed by Lord Scott -
how does one apportion the fair value between the rescuer and the
rescued? It is clearly an issue of some nicety. But the valuer should be
free to make his own determination.
He said that Mr Sumption made no comment
on the issue of regulatory failure. But the Government allowed a
situation to develop due to regulatory failure. And the point is that on
the basis of the Strasbourg judgements the valuer should be able to take
into account the prior actions of the state.
Why have the shareholders of Northern Rock
been singled out for especially disadvantageous treatment? How does this
meet the requirement for consistency laid down by the ECHR?
Tom de la Mare then summarised his
key points. He said his clients were entitled to a procedure that is not
foreclosed by assumptions of fact. The drafting of the legislation goes
further than the policy articulated and dictates facts rather than
policy.
The vice is that the terms of reference
predetermine the compensation irrespective of the facts.
A Summary and Some Comments
The issues in dispute seemed clearer than
at the previous hearing, although the Government's stance seemed to have
changed somewhat. However the Government's position seems to contain a
major defect.
The Defect in the Government’s Arguments
Mr Sumption argued that it was primarily a
policy decision that justified the imposition of artificial compensation
terms, and went on to suggest that the policy was based on moral justice
– namely that as shareholders (or proprietors as he put it) had not
contributed to the bail-out of Northern Rock, they should not be
recognised in any way in the subsequent valuation of the property.
As Lord Pannick suggested in his opening
speech, this apparently attractive argument is simplistic and does not
stand up to scrutiny. Mr Sumption admitted he knew little about
accounting when he repeated Lord Grabiner’s quip that he became a lawyer
because he couldn’t add up, and there is certainly a basic financial
fallacy being propagated here.
The LOLR loans did not affect the balance
sheet of the company (even if they had not been supplied the company
would still have been balance sheet solvent). Any loans provided to a
company do provide cash to strengthen the balance sheet and is then
shown as an asset therein, but they are always offset by a matching
liability in the balance sheet to represent the fact that the loans must
be repaid in due course. The net effect is zero.
But the shareholders equity (i.e. the
surplus of assets over liabilities) is meanwhile providing the
underlying financial strength. That equity has been build up over many
years and effectively recognises the contribution of the owners of the
company in many ways. That equity was present both before and after the
provision of LOLR, was never withdrawn and was essential to the survival
of the company. A bank without positive net assets on the balance sheet
is certainly bust and will cease trading because it would be balance
sheet insolvent. So for Mr Sumption to suggest that “the shareholder
capital has contributed nothing to the outcome”, and hence shareholders
should not have their equity recognised when valuing the business is
nonsense.
The Government did not contribute anything
to the equity when it provided LOLR loans on a commercial basis, and
neither did those loans alter the net balance sheet position and net
assets for the reasons given above (those loans simply replaced the
retail deposits that had been withdrawn by the “run on the bank”). But
a valuation has to value the assets of the business so it is ridiculous
to suggest that no account be taken of the equity owned by shareholders.
However, there was indeed a “policy
agenda” pursued by the Government in formulating the compensation terms.
It was simply devised to ensure that the “hedge funds” – namely the two
main litigants in this case – lost out. The comments by Labour
politicians in Parliament make it quite clear their views on this
matter, and this was surely the underlying policy objective that
motivated the development of the above policy, not any attempt to
recognise the relative contributions of the Government and shareholders.
The equity shareholders (irrespective of
who actually held those shares latterly) were providing the long term
underlying balance sheet strength of the company, while the Government
was providing temporary short term cash liquidity. It should be for the
valuer to determine their relative contributions to the value of the
business at the nationalisation date.
Note also that in response to the
government's argument about LOLR being exclusively for the public
interest, it is in the general public interest that shareholders are not
wiped out at the first sign of turbulence. Indeed one of the problems
that the nationalisation of Northern Rock created was that it ensured
that private capital did not subsequently want to go anywhere near any
British banks, for fear of nationalisation, which is precisely the
reason why the government now holds 43% of Lloyds and 70% or so of RBS.
The nationalisation of Northern Rock in that sense was a negative event
for financial stability.
The Valuation Assumptions
There was some discussion in the hearing
about the valuation assumptions imposed by the Act and the Compensation
Order - namely that all Government assistance is withdrawn, that the
company is no longer a going concern and is in administration. There was
a suggestion that there might be value remaining but it is exceedingly
difficult to see how that would be so. If all Government loans were
withdrawn the company would immediately have to cease trading and its
banking licence would be withdrawn. All customer deposits would be
frozen by the administrator and the reputation of the company would
hence be totally destroyed. So all that would remain in terms of value
would be the fixed assets which would have to be sold off as soon as
possible to enable repayment of depositors, in other words a "fire sale"
would result. In such circumstances the likely value achieved for the
assets, particularly in the current financial climate would be much less
than their value currently recorded in the balance sheet of the company.
Unfortunately all banks have two large numbers representing assets and
liabilities on their balance sheet, and shareholders equity is the small
difference between them - this quickly gets wiped out if the assets are
sold off in a fire sale rather than being allowed to reach their normal
maturity dates. So it is totally unrealistic to expect any value to
remain for shareholders if the above conditions are imposed on the
valuation. Indeed the Government seemed to have taken both a "belt and
braces" approach to ensuring that the valuation will be zero.
R.W.Lawson 13/6/2009
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