When is a derivative a wagering contract? (WW Property Investments v National Westminster Bank)

When is a derivative a wagering contract? (WW Property Investments v National Westminster Bank)

A recent decision discusses whether or not certain derivatives should be categorised as wagering contracts.

Original news

WW Property Investments Ltd v National Westminster Bank plc [2016] EWCA Civ 1142

The claimant, WW Property Investments, had contended that certain interest rate hedging contracts that it had entered into with National Westminster Bank constituted wagering contracts.

What was this case about?

This relates to an application by WW Property Investments (WW) to appeal a decision by HH Judge Roger Kaye QC dated 1 March 2016 (the Original Decision) where he struck out in its entirety their claim against National Westminster Bank (NatWest) and refused WW permission to add a new claim.

What were the facts?

Between 2004 and 2010, WW borrowed money from NatWest and also entered into four interest rate hedging contracts. Three of them were collars and the fourth was a swap entered into after the collars closed-out. The collars were entered into in order to hedge WW's interest obligations under the loan and it was a term of the loan that it should be hedged. The way the collars worked were that if interest rates rose above a certain level, NatWest would pay WW but if they fell below a certain level, WW would pay NatWest. Because interest rates dropped in 2008 and remained low, the collars were in NatWest's favour.

In 2013 NatWest carried out an interest rate hedging product review (IRHPR) which led to some redress being given to WW. In October 2014, NatWest made offers to WW in relation to the collars which were accepted by WW in January 2015. The offers meant that WW received over £424,152.06. In the offer letter that WW signed was wording that WW may also claim for additional losses. WW did make a claim for additional losses but this was ultimately rejected by NatWest.

Lord Justice Christopher Clarke in this application to appeal discussed four main issues, each of which are discussed in more detail below:

  • the compromise issue
  • whether the contracts constituted wagers
  • the LIBOR claim, and
  • the IRHPR claim

What was the compromise issue?

In the Original Decision, the judge accepted that WW, in signing the settlement agreement had compromised its claims in respect of the collars. This was because any additional claims had to be through the IRHPR process. Therefore, he held that the additional losses could only be sought in relation to the swap.

Lord Justice Christopher Clarke thought that the matter was not quite as clear cut as the judge in the Original Decision did and that it was open for WW to bring a claim for additional losses separate to the losses agreed in relation to the settlement agreement.

Did the collars constitute wagering contracts?

WW made the claim that the collars and swap were wagering contracts. If they were classified as wagers, it would mean that on day one of the contracts, each party should have the same amount of knowledge or ignorance as to the prospects of the bet succeeding. However, as NatWest had greater knowledge on the prospects of the contracts on day one than WW and failure to disclose this amounted to cheating or skewing the odds in NatWest's favour. This argument has been raised in court on a number of occasions before and struck out and so the judge in the Original Decision said that WW did not have real prospects of success in this claim.

Lord Justice Christopher Clarke however considered at length the concept of each party needing to have equal knowledge or equal ignorance of the likelihood of the relevant event occurring. In many bets, each side has different expectations of what will happen. For example, the owner of a thoroughbred horse will have greater knowledge on the horse's probability of winning a race than a bookmaker. Equally the bookmaker has more knowledge on how people have been betting than someone who bets at the last minute. Despite the different knowledge that each party has, no party can influence the outcome of the event to improve his chances of winning the bet.

On this basis, NatWest did not have an obligation to declare the value they attributed on the contracts or what their expectations were on interest rate movements in the future.

Lord Justice Christopher Clarke discussed whether the collars and swap did constitute wagering contracts. The argument made by WW was that they were wagering contracts because they were contracts for difference as they did not involve physical delivery of anything. The judge noted that there is no statutory definition of either wagering contracts or contracts for difference. He therefore considered case law and looked into the regulatory provisions in force at the time the contracts were entered into. He concluded that there was no realistic prospect of persuading the Court that the collars or swap were wagers.

The judge then considered hypothetically what would happen if the collars and swap did constitute wagers and whether if they were wagers whether WW would be entitled to relief. The judge discussed the submission that NatWest should have made WW aware that they were entering the contract with a positive mark-to-market (MtM) value. However, the judge dismissed this contention saying that there is no basis for saying that there is an implied representation that on day one the MtM will be zero. It is not the same as declaring whether premium is being charged or not. On this basis, the judge held that even if the collars or swap were wagers, WW still had no claim.

Lord Justice Briggs commented that the arguments on this point were as lengthy as would ordinarily be heard in a full appeal, but hopefully laid to rest the idea that the collars could constitute wagering contracts.

What was the LIBOR claim?

It was argued that it was an implied term of the swap that NatWest had not previously and would not in the future seek to manipulate any LIBOR index but that it had prior to the conclusion of the swap and also after the contract had been concluded. As a result of this, it was argued that WW paid higher fixings than would otherwise have been the case and it also incurred losses because of mismatched hedges as a result of the LIBOR manipulation.

In the Original Decision, the judge thought that this claim was difficult to comprehend as the allegations were too wide.

Lord Justice Christopher Clarke thought that it was arguable that it was an implied term of the swap that NatWest would not manipulate GBP LIBOR rates (the rate applicable to the swap) but other LIBOR rates were irrelevant to the swap. He also thought that there was an implied representation that NatWest had not in the past and would not in the future manipulate LIBOR rates.

However, whilst RBS (said to be NatWest's agent) had been fined for manipulating LIBOR rates for Yen, Swiss franc and Dollar indices, there was no allegation that NatWest (or RBS) had manipulated the GBP LIBOR rate. Further, it was difficult to understand how WW could be entitled to recover damages for the breach of an implied term, let alone any consequential losses. There could be no claim for misrepresentation as there was no allegation that NatWest intended to manipulate any rates nor was there any pleading of reliance on any such misrepresentation. WW had affirmed the contract by:

  • continuing to make payments under the swap
  • participating in the IRHPR and pursuing the claim under the IRHPR claim, and
  • claiming in the proceedings for repayment of all cashflows under the swap

Therefore, Lord Justice Christopher Clarke held that the judge in the Original Decision was correct to find the LIBOR claim had no real chance of success.

What was the IRHPR claim?

WW sought to introduce a claim that NatWest assumed a duty of care to WW to carry out the IRHPR diligently and that NatWest had not considered all evidence adequately or at all. The judge in the Original Decision complained that the claim was ill thought out and as pleaded held no real prospect of success.

Lord Justice Christopher Clarke agreed that the claim was not comprehensible in relation to the collars but thought that there was a pleading of failure to carry out the review properly in relation to the swap and that there was a reasonable prospect of success in this area. He therefore gave permission to appeal in respect of this area.

To what extent is the judgment helpful and what practical lessons are there to be learned?

The judgment is interesting for a number of reasons. It is much lengthier than would ordinarily be heard for a permission to appeal but the reason was to dismiss the idea that the collars could constitute wagering contracts. Lord Justice Christopher Clarke discussed in significant detail the history of cases where this argument has been made. It is helpful for practitioners to remind themselves of the risks that derivatives run in being categorised as wagering or gaming contracts. Legislation restricts gaming or wagering and case law holds that although such contracts are not necessarily illegal, they may not be enforceable in law or equity.

It is therefore important for practitioners to ensure that commercial rationale for the derivative transaction is proven so as not to cross the line of a transaction being seen as purely speculative and hence potentially a gaming or wagering contract.

Case details

Court: Court of Appeal (Civil Division)

Judges: Lord Justice Christopher Clarke and Lord Justice Briggs

Date of judgment: 29 November 2016

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About the author:

Emma is head of the Banking and Finance team and the Finance Group at LexisNexis®UK.

Emma has wide-ranging experience in derivatives and capital markets with a particular emphasis on credit derivatives and structured products. Emma qualified as a solicitor with Allen & Overy LLP, working in the derivatives and structured finance teams in both their London and Paris offices before gaining experience with Deutsche Bank AG (advising the foreign exchange prime brokerage desk) and Crédit Agricole CIB (advising the fixed income and derivatives desk) before joining LexisNexis®.