In earlier articles I have tried to present the facts as simply as possible but the story of Northern Rock is extensive and complex. I have tried to deal with the “complexity” issue by addressing various matters from different aspects as simply as can be achieved.
We live in a democracy and we are acknowledged world-wide as a people who are proud of our heritage of “abiding by the law”, we are on the whole a “law abiding people”. When “laws” are created, we obey them. However, we expect those laws to result in justice for everyone.
Our principal concern for the present purposes is with “laws” passed by Parliament. Our Parliament is comprised of 650 Members, all elected by us, the population of the UK, supplemented by about 800 un-elected Members of the House of Lords, many of whom are “life-peers” and political appointees. One purpose of so many individuals is to ensure, at least in principle, that they are representatives for us, thus when they pass laws, they are observed (by most people).
We should recognise from the outset that two entities are involved in refuting the claim by shareholders for compensation. They are: 1. The Government. 2. The Court system. Those two entities are supposed to be independent of each other and to work for our overall benefit.
In the debate on the Northern Rock (Special Provisions) Bill, (Sir) William Cash, MP (Con.) said --- “The Bill does not have the urgency that the Government seem to claim for it by the means of its introduction, but they are railroading a series of parliamentary conventions. In introducing retrospective legislation, the Government are in fact trying to avoid the prospect of introducing a hybrid Bill by transferring the provisions over to a hybrid instrument—if that is what it turns out to be—while dealing with the matter in a way that will bypass the courts if they can possibly get away with it”.
This is an interesting comment since the subsequent Court proceedings initiated by shareholders failed because the Compensation Order set artificial conditions based on “assumptions” that were applied only to Northern Rockand which ensured that “Lord Justices” had only a discretionary ability to set them aside.
Nationalisation is an accomplished fact and cannot be undone, therefore it was accepted as a “temporary” measure.
Our first consideration is with the laws involved. There are two ways in which laws can be interpreted:
A). literally, according to the “letter of the law.”
B). according to the spirit or intention of the law.
The second way involves the principle of Equity or “natural justice.” English Courts are presided over by “Judges” who are referred to as “Lord Justice X,” etcwhich describes their principal function which is to administer Justice that produces an equitable and fair judgement for everyone.
In English Law, the law of Equity has now been assimilated with Statute Law (law created by Parliament). Lord Justices are expected to take both into consideration. Common and statutory law typically refer to laws based on precedence and the rulings of Justices who hear a case in a courtroom. Equity, on the other hand, refers to laws that are similarly established by court rulings but deal with judgment and justice through equitable decisions. Equity law supercedes common law and statute law when there is a conflict between the two and neither can appropriately bring the correct verdict.
It is a source of law peculiar to England and Wales and is the case law developed by the (now defunct) Court of Chancery. Equity prevails over common law, but its application is discretionary.It is based on the principles of “natural justice” which is a concept of English Common Law.
Some Justices may exercise that discretionary power, others may choose, for a variety of valid reasons, not to do so. One reason may be that they do not see it as being appropriate in a particular case.
Statute laws are complex and must cover a wide range of circumstances, therefore they must also be interpreted in a flexible manner which is achieved by means of a fusion of Common Law, Statute Laws and the Law of Equity.
Parliaments around the World devise laws, some of which are designed to cope with specific as well as universal matters. It follows therefore, that the effects of laws can vary. That laws can be different from country to country emphasizes the fact that the interpretation of the law is determined by the considered opinions of one or, as in the case of some Courts, a majority of very experienced Lord Justices.
If we stay with “the letter of the law” principle, we shall not necessarily be able to cover all individual circumstances and before a person can understand and interpret complex “laws” he must be an experienced legal practitioner. It is not possible for laymen to achieve that level of understamding.
On the other hand, most people understand what is “fair and equitable.” Governments often select this as their “rallying cry” for much of what they seek to achieve whilst in office.
Returning to Northern Rock, we must consider which Laws were principally involved, they were:
The Banking (Special Provisions) Act 2009
The Northern Rock Shareholders Compensation Order
The Freedom of Information Act 2000
Insolvency Act 1986
Banking Act 2008
The Banking (Special Provisions) Act 2008 It is important to note that it was a temporary Act with a life of one year and that the “Special Provisions” related to theAssumptions that had to be made in the case of Northern Rock only. It was passed as a “stop-gap” because the full Banking Act which followed in February 2009 had not been enacted but could have been enacted in the five months prior to the date of Nationalisation. It was known that there was an awareness of its unavailability. In its place, the “Special Provisions” Act was hurried through Parliament retrospectively in a few days during the week that followed the declaration by The Chancellor of the Nationalisation of NR.
The Chancellor of the Exchequer, Alistair Darling, told the House of Commons at the first reading of the Bill on February 18 that: 'The Government have no intention at present to use the Bill to bring any institution other than Northern Rock into temporary public ownership.'
The Northern Rock Shareholders Compensation Order 2008, taken with the above mentioned “Special Provisions” Act was deliberately devised to ensure that a valuer had to assume a NIL value for the shares, notwithstanding that within recent months Goldman Sachs had identified Equity of 2.8 billion pounds, part of which was attributable to shareholders’ interests. The Order applied ONLY to Northern Rock
The Freedom of Information Act 2000. This Act enables adult residents of the UK to access information relating to most public offices, including Government entities. It is to be noted that whilst the Act applied to the Government owned holding company (UK Asset Resolution), it did not apply to its wholly owned subsidiary, Northern Rock Asset Management (later known as NRAM) on the grounds that NRAM had a separate Board of Directors operating at “arms-length” from Government. AsGovernment policies had to be followed within NRAM, the extent of “arms-length” is debatable.
Did that matter? Yes, it did, because it enabled NRAM to be operated without scrutiny as a Private Company even although it was Government owned and effectively controlled, in other words not transparently.
Insolvency Act 1986. This Act provides for two events, either one of which can be a basis for declaring a Company Insolvent.
A). The Company is unable to pay its due debts. However, a Company operating as a Bank is treated differently. If it is solvent, it can always access liquidity, also known as LOLR loans, not from the Government but from its Central Bank therefore this circumstance does not apply to a solvent Bank.
B). Where the Liabilities are greater than its Assets. That can result in any Company being Insolvent and therefore it does apply to InsolventBanks but Northern Rock was a Solvent bank, as was declared many times. The Act makes no provision for cases where a Company is deemed to be “effectively insolvent,” (as the Chief Secretary to the Treasury suggested), nor does it provide for a Company to be “assumed” to be insolvent.
“Assumptions,” applicable only to Northern Rock, had therefore to be created by a Ministerial Order, (as noted above).
The Banking Act 2009. This Act was a late enactment of the law adopted by all other G8 countries in 2003 but not by the UK until 2009. It was principally an Act to provide for the Resolution of Banks in situations, such as Northern Rock found itself, and which is to be the responsibility of the Bank of England. It should be noted that the Act required “Nationalisation” to be a “last resort.” Note also that the parent Company of NRAM was called “UK Asset Resolution” long before the 2009 Act was passed.Did it apply to NRAM, a Company created in 2010? No, because, although its Assets were all derived from Northern Rock Bank, it was regulated by the FSA, not as a Bank but as an Asset Management Company because, included in the definition of a Bank is that it must accept deposits from the public, which NRAM was specifically prohibited from doing. One is left with the impression that the separation of NRAM in 2010 was deliberately arranged to ensure that it could not be subject to this Act.
The Act also provides for the compensation of shareholders and inter alia, states: {11.16} “The authorities do not intend to profit from a resolution of a failing firm”.Contrast that statement with that of the Chancellor in 2008, less than one year earlier:“under public ownership the Government will secure the entire proceeds from the future sale of the business in return for bearing the risks in this period of market uncertainty.” Notwithstanding that HM Government acquired NR at no direct cost.
Also in the Banking Act 2009, Sec.{11.2} : “In order to strike a balance between public and private interests where property has been transferred compulsorily (for example, as a result of an exercise of the share transfer powers) it is appropriate to make provision for compensation to be paid which is normally required to be an amount reasonably related to the market value of the property in question”.
In the case of NR, “reasonably related to the market value of the property in question” can now be reassessed with reference to the extent of the profits and surplus assets finally accruing to HM Government as at 2020 rather than to the hypothetical and wrong conclusion that was estimated in 2007/8.
To continue the Northern Rock saga, it may be possible to argue, as the valuer did, that in February 2008 the liabilities of Northern Rock exceeded the realisablevalue of the assets at that time but was that a valid assessment? No, because it had no real basis, although up to a point some may justify it by an application of “the letter of the law” in repect of the “assumptions” that had to be observed.
Lord Justice Lewison, one of the three Appeal Court Justices in a case brought by Harbinger Capital, said “It is important to emphasise that the assistance that the Bank of England had provided was liquidity support; that is to say, the Bank's intervention enabled Northern Rock to pay its debts as they fell due. The Bank's intervention was not designed to shore up Northern Rock's balance sheet. That would have been incompatible with the principles on which the Bank acts as lender of last resort. There is no evidence or finding that Northern Rock's balance sheet was increased as a result of public sector support. As far as the evidence goes Northern Rock had a surplus of assets over liabilities when the Treasury first intervened, when the Bill that became the Act was introduced into Parliament and at the transfer time itself. The consequence of liquidity support was that Northern Rock was enabled to continue as a going concern.”
“Without that support, as was common ground, it would have had to have entered administration or liquidationbut it would have done so on the basis that the starting point of the administration or liquidation was a company whose assets, as shown in its balance sheet, exceeded its liabilities”.
The latter is an important point because it acknowledged that there should be a value to the former shareholder’s shares that has not been accepted by HM Government nor by its professional advisers. At the same time, everybody recognized that NR could not raise loans from other banks (inter-bank market) as it normally did, because that market had shut down completely.
Liquidity support was first given on 14 September 2007. The HM Treasury press announcement contained the statement that "The FSA judges that Northern Rock is solvent, exceeds its regulatory capital requirement and has a good quality loan book".Three days later the Chancellor of the Exchequer announced that the government would guarantee existing deposits in Northern Rock. The guarantee was paid for by a fee charged to Northern Rock.That Guarantee, athough paid for, was never utilized therefore should it, in terms of “Equity” qualify as “State Aid”?
Each year Northern Rock realised about one-third of its “teaser or fixed rate” short term mortgages, a fact that must have been known to the UK Government. Northern Rock held over 100 Billion of mortgages and the Bank of England had acknowledged that was sufficient to secure up to 40 Billion of Emergency Assistance, (a fact not made public until 2014 when The Bank had a new Governor) but over a period of several months the B of E only advanced 26.8 Billion. It also acknowledged that property values would have to fall more than 50% for a loss to accrue on the loans. (another of several facts that were not made public until 2014!!).
Of course, those were very large amounts which few would have regarded, at that time, as “normal” LOLR loans. Furthermore,they were of great concern in Government circles where, until that time, they presented a problem of a size the like of which nobody had prior experience.
A mortgage bank, such as Northern Rock, receives income monthly on its total of mortgage loans, in this case at least 5 Bn pounds per annum from over 100 billion pounds of mortgage assets. Remember that at time a typical mortgage interest rate was 6.75%. Those assets were used, in total, to secure (during the period the loans were “novated” to Government) a maximum of 15 billion of LOLR loans. On that basis alone “interference was not proportionate” and it was inconceivable that H M Government (or the “taxpayers”) could sustain a loss.
Northern Rock had a substantial annual cash flow which, together with customary remortgaging, was able to repay the LOLR loans within a reasonable and normal three -year period. HM Government, not the B of E, subsequently loaned to NRAM a further 10.5 billion pounds but why? The funds were allocated to NRAM, to stimulate the UK mortgage market and to capitalize a new separated NR but NRAM as such, could make no use of either amount, yet it alone was specifically made responsible for repayment with interest by a Conservative Government.
In the English Appeal Courts the determinations of the Lord Justices were not necessarily unanimous. In the Court of Appeal Lord Justice Laws, sitting with Master of the Rolls Lord Clarke and Lord Justice Waller, accepted that "Northern Rock's substantial assets ... will be as much a contributor to the sale price as will the support put in by the Government", but added “shareholders are likely to receive nothing" .A clear acknowledgment that the court had not determined a valuation of the shares.
The ruling of that Court was made, despite the fact that documents obtained under Court “disclosure rules” (and which, it is understood, could not be made public at the time) showed that NR had been secretly accorded a substantial valuation which demonstrated that the Government and its advisers knew that, through Nationalisation, they were acquiring a potentially valuable asset.
In a case brought by a Preference shareholder, Harbinger Capital in 2011, two of the Lord Justices agreed that the Government had acted within the law, as expressed in the Northern Rock (Special Provisions) Act 2008 which was a temporary piece of legislation replaced by a full Banking Act in February 2009. The “Special Provisions” were a reference to the requirement in the Act that “assumptions” had to be made. The third, Lord Justice Lewison said “Left to myself, therefore, I would allow the appeal on the question of interpretation; and remit the case to the valuer for reconsideration. However, since Mummery and Beatson LJJ disagree with my interpretation, the appeal must be dismissed.” Lord Justice Lewison also quoted the valuer as having said "I propose to assume that the best quality assets are realised and that the remaining assets on the balance sheet are of lower quality as they have more inherent risks."
“The impact of this assumptionwas to turn Northern Rock from being a company which was balance sheet solvent (which it had been in reality both when the Bank of England first intervened and also at the transfer time) into a company which, in the hypothetical world, was balance sheet insolvent. As a result of the assumptions that the valuer made, the balance sheet value of shareholders' funds was reduced from a surplus of about £1.6 billion to a deficiency of about £2.4 billion.” That was the inaccurately assumed basis on which the Valuer justified his “NIL Value” conclusion.”
How can that be squared with the 7,820,000,000 that HM Government derived from those same assets?
Lord Justice Beaton in his interpretation of the case, stated: “As was famously said in an earlier case by Lord Asquith,if you are bidden to treat an imaginary state of affairs as real, the statute says that you must imagine a certain state of affairs, it does not say that having done so, you must cause or permit your imagination to boggle when it comes to the inevitable corollaries of that state of affairs." In other words, Beaton LJ indicated that the consequences of such an “assumption” are not be to be considered.
The ruling of the various Courts was on the lawfulness of HM Treasury’s and H M Government’s right to set the terms for determination of compensation. The Courts did NOT extend the judgment to the Equitable Right of Shareholders to obtain compensation or whether the Assumptions imposed on the Valuer were “Fair” or, as he said, “Unreal.”The fact that three very experienced Appeal Court Lord Justices did not reach the same verdict illustrates that “the letter of the law”has to be interpreted and when “the law of Equity” is taken into consideration, the interpretation by individual Justices can vary.
The EU Court of Human Rights did not consider the Case for compensation. Their view was “It is for the legislature and the (UK) government alone to determine the provisions of the compensation scheme”. Also included in the ECHR judgment was: “It may have been their (i.e retail shareholders, in particular the 176,000 “small” shareholders) misfortune that their case was consolidated with the case of the two hedge funds. It is conceivable that a group of retail investors who had held the shares for long periods of time might have received a somewhat more sympathetic hearing from both courts”.
Bearing in mind that many MPs and others had misgivings about the activities of Hedge Fund Managers, one must consider whether those attitudes had an affect on the Court proceedings.
Regarding the “withdrawal and non-renewal” of loans, no differentiation appears to have been made between LOLR loans, provided legallyand properly by the Bank of England with the balance subsequently “novated” to HM Government and then characterised as “State Aid. The original loans (LOLR) were from the Bank of England and should not represent “State Aid” from HM Government before they were “novated” in September 2008 even although HM Goverrnment, technically, had guaranteed them. “The novation” to HMT was unnecessary, the loans could have remained as LOLR loans from the B of E. The only valid reason for the “novation” was to ensure that anticipated profits would accrue to HM Government.
HM Government has subsequently defended its stance based on the various Court Proceedings although none of the Courts mentioned above considered the question of shareholder compensation other than to rule that it would be “zero” and that only because of the “assumptions” included in The Banking (Special Provisions) Act 2008.
The Nationalisation of Northern Rock, not temporarily as a “stepping-stone towards a return to the Private Sector” as a Labour Chancellor had declared, (which may have involved continuation of LOLR support for another two years or so). Instead, a “novation” into (debatably) State Aid from Government, which successive Conservative Governments maintained for an extended period of 12 years, (notwithstanding that 167 Conservative MP’s had voted initially against nationalization {see Hansard}), and notwithstanding that the declared aim of HM Governmment was to have the loans repaid within as short a time as possible. It culminated in a profitable outcome for H M Government of 7,820,000,000 pounds. Therefore, all the talk of “Taxpayers at risk” or “maximise the return for taxpayers” is nothing more than “rhetoric,” or even a “red herring,” if one has regard to the B of E Minutes.
An individual “taxpayer’s” involvement ends when his due tax is paid, after that tax revenue is subject to distribution by H M Government. H M Conseervative Government has no intention of refunding taxpayers out of a profitable outcome.
How could it be proposed that Northern Rock was “insolvent” when it has produced, out of the “bad Bank” a total of 7,820,000,000 for H M Government, of which 4,957.8 Billion was accumulated NET income, after payment of all fees and expenses, out of NR funds and incurred through Nattionalisation had been paid to advisers, solicitors, Barristers and others and despite the fact that many assets were sold at a discounted value which cannot be assessed because that information has been kept secret. Discounts were appropriate but at what rate? None of that would have happened if NR had not been been Nationalised.
Shareholder compensation should be reviewed NOW, when the full outcome of Nationalisation has been determined, not in times of extreme financial stress in 2008 when nobody knew how matters would turn out. One has also to consider the income that arose since then and of which former shareholders have been deprived over a twelve-year period. Despite the exent of the Fimancial Crisis affecting the UK, it is significant that no other banks were “nationalised” during 2008.
The rights and wrongs of the valuer, Mr Caldwell’s NIL valuation could be debated indefinitely if one relies only on Court proceedings and an interpretation of the “letter of the law.” The legal debate on NR runs to many hundreds of pages, in and out of Courts. However, if considered according to the principles of a fair and equitable solution, it becomes clear that in the case of the former shareholders of Northern Rock “natural justice” was not delivered. The fact that Lord Justice Lewison reached a different conclusion from his fellow Lord Justices and that ECHR Judges considered that individual long-term shareholders “may have been more sympathetically treated” both support that conclusiom.
All this could have been avoided if the Government of the time had agreed for shareholders to be paid reasonable compensation when Northern Rock, a solvent Bank, was Nationalised, assuming that was an appropriate action, instead of accepting the advice of Goldman Sachs, its USA adviser. It is not a question of the conduct of the Northern Rock Board, Bank of England Governor, Financial Regulators, HM Government and its advisers, or even of Ministers. Whilst mistakes were undoubtedly made by each of them, they were made in good faith, mostly in times of extreme financial conditions and stress for which no one knew the outcome nor had they any prior experience.
It seems to be apparent that there was too much reliance on “the letter of the law” and that insufficient consideration was given to the principles of “thelaw of equity” which would have dealt with the matter on an equitable and fair basis and that “natural justice” would have ensued and prevailed in “a real-world situation.” It is important to remember that those Court cases took place either during, or shortly after, the height of the crisis when the financial situation of banks was in turmoil, here and in many other countries, and that the UK Courts had to take into account the “assumptions” specified in the Compensation Order because they had assumed a Statutory basis.
Parliament is responsible for introducing LAWS and does so on many different matters, intended for the benefit of the law-abiding population. However, Parliament, independently from the Court system has an ability to change such laws. It is within the powers of Parliament to take appropriate steps without recourse to the Courts, should it decide to do so on our behalf. The Court system has applied, to the advantage of an HM Conservative Government, the strict “letter of the law” that must be followed without regard to the actual situation which was quite different. On that basis the Courts may have produced a lawful determination but not not one taking account of the Law of Equity.
Is it appropriate for HM Government to maintain its stance whilst at the same time maintaining that it aims to treat everyone fairly?
What is important now is that the principles of “natural justice” are applied and former shareholders are awarded the compensation which, in the “real world” is their due. Even after payment of reasonable compensation, HM Government will still realise and retain a substantial profit. Remember, 7,820,000,000 is not an insignificant sum.
Compensation can be paid out of Northern Rock funds, not by the Government and even less so by “the taxpayer.”
13 October 2021
