The claim was brought against the Treasury by two of Northern Rock’s former largest shareholders, RAB Special Situations (Master) Fund Ltd and SRM Global Master Fund LP, along with representatives of 150,000 smaller shareholders.
The shareholders claimed that legislation enacted by the Government regarding compensation payable on the nationalisation of Northern Rock was unfair and incompatible with Article 1 of the First Protocol to the European Convention on Human Rights (“Art 1 ECHR”), since it provided that compensation must be valued on the basis that all public financial support had been withdrawn and the company was in administration.
The shareholders did not challenge the decision to nationalise the bank itself; merely the amount of compensation that would be payable.
Background
As is now well known, Northern Rock was particularly vulnerable to the recent lack of liquidity in the market place, since it relied heavily on borrowing from the wholesale money market and the issue of bonds backed by mortgage loans, rather than on retail deposits.
In September and October 2007, the Bank of England agreed to provide facilities to Northern Rock, and the Treasury agreed to provide guarantees in relation to its deposits, in order to try and maintain stability and public confidence in the domestic banking system. On 5 December 2007, the European Commission gave the Government until 17 March 2008 to ensure that the loans were repaid in full and the guarantees terminated, or to put in place a “credible and substantiated restructuring plan, or a liquidation plan”.
On 28 January 2008, the Treasury announced that, if no private sector solution was proposed that met its objectives of protecting taxpayers, promoting financial stability and protecting consumers, the Government would enact legislation enabling the Treasury to take Northern Rock into public ownership.
The Treasury confirmed that, if Northern Rock was nationalised, compensation would be payable on the basis that all financial assistance of the Bank and the Treasury had been withdrawn and no other financial assistance would be made available, since the Government should not be required to compensate shareholders for value that is dependent on taxpayers’ support.
On 17 February 2008, the Chancellor announced that neither of the two private sectorproposals that had been put forward delivered sufficient value for money for the taxpayer, and that the Government had therefore decided to put Northern Rock into temporary public ownership. The Government enacted legislation, which came into effect on 22 February 2008, transferring all shares in Northern Rock to the Treasury Solicitor, as nominee of the Treasury. On nationalisation, SRM held nearly 50 million shares in the company, and RAB held nearly 35 million. The legislation provided that, in determining the amount of compensation payable by the Treasury, it must be assumed that all financial assistance provided by the Bank and the Treasury had been withdrawn.
Arguments of the parties
The shareholders argued that the assumption that all financial assistance had been withdrawn meant that the calculation of compensation for their shares would be unfair and incompatible with Art 1 ECHR, which provides that “Every… person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law”.
The shareholders argued that a fair approach would have meant that it was up to the valuer to decide the basis for the valuation, without being required to make any assumptions.
The Treasury argued that Northern Rock was not entitled to any financial assistance, without which it would have been insolvent. They argued that an EU Member State enjoys a wide margin of appreciation in relation to decisions about compensation for property appropriated by the State, and that the Courts will only intervene if the legislature’s judgement was “manifestly without reasonable foundation”.
The Treasury further noted that SRM and RAB had invested in Northern Rock at a time when they knew its financial position to be precarious, on the basis of their own presumptions and predictions about the continuation of public support, which turned out to be incorrect, and that they should not be compensated for loss suffered as a result of the commercial risk taken by them that turned out to be unsuccessful.
The decision of the Court
Burnton LJ rejected the shareholders’ claim at First Instance.
He found that, if the authorities had decided not to provide financial support to Northern Rock in September 2007, it would have gone into administration. If nationalisation had been decided upon at that time, the fair value of the shares would have been assessed on the basis that it was not a going concern. The fact that the authorities decided to provide financial support to Northern Rock, before then making the decision to nationalise it, should not make any difference to the assessment of the fair value of the shares.
Burnton LJ appeared to have little sympathy for SRM and RAB, particularly in relation to the shares they bought once the difficulties of Northern Rock were well known, and even more so in relation to shares bought following the announcement that any compensation payable would be based on the assumption that all public financial support had been withdrawn.
He noted that “clearly, they were speculating on the basis that nationalisation would not take place” and that they “must have knowingly taken the risk that nationalisation would take place on the terms that had been announced”.
While Burnton LJ appeared to have slightly more sympathy for the smaller shareholders, who included employees who had acquired shares through pension schemes or incentive plans, he noted that “all shareholders, large or small, professional or private, are investors in the fortunes of the company the shares of which they hold, and the smaller shareholders had the misfortune to hold investments in a company that… [became] cash flow insolvent”.
Burnton LJ concluded that “we do not see that fairness requires the state, as representative of the taxpayer, having provided financial support to Northern Rock, in addition to pay to its shareholders the added value to their shares brought about by that support, without which the Company would have ceased to be a going concern” and that there had therefore been no infringement of the shareholders’ rights under Art 1 ECHR.
Conclusion
It is clear from the judgment that the Court will have little sympathy for those who suffer losses as a result of strategic investments in UK companies in difficulty.
Furthermore, the Court has also made clear that, while it may have slightly more sympathy for smaller, long term investors, they too must bear the risk of their investment, and the losses that have been suffered. Surprisingly, given that the claim was so roundly rejected, it has been reported that the shareholders are expected to appeal. However, this may be more a reflection of the amounts the shareholders stand to lose, than their evaluation of their prospects of success.
ABOUT THE AUTHORS
Nick Brocklesby joined SJ Berwin LLP from Freshfields Bruckhaus Deringer LLP in September 2005. He became a partner in 2008. He has considerable experience of complex commercial litigation, often encompassing an international element, and financial services and regulatory work. He has acted for and advised major corporate entities, investment banks, hedge fund managers, private equity funds and other financial institutions. Brocklesby was educated at St Edmund Hall, Oxford. He is qualified as a Solicitor Advocate.
Since qualifying into the Commercial Litigation and Dispute Resolution Department in September 2007, Faye Parker has worked on a number of financial services and general commercial disputes. In particular, Parker was involved in a large piece of banking litigation for several global investment banks, regarding an investor’s refusal to take up its allocation of a syndicated loan. She has also been involved in a number of disputes regarding credit default swap agreements and other derivatives, claims brought by disgruntled investors against brokers and hedge funds, warranty and escrow account claims and Financial Services Authority investigations. Parker studied Jurisprudence at St Catherine’s College, Oxford.