The firm advises small and medium sized businesses in relation to their bank lending and other finance documentation. Its risk audit is designed to identify provisions in those legal documents that may create unforeseen financial liabilities.
All SMEs will have commercial banking relationships. Start-ups may require only a suite of basic accounts that will be the subject of standard-form, non-negotiable contracts. As a business grows, it may require additional bank facilities, the subject of more detailed documentation. For example, the ability to make and receive payments in different currencies or, in the case of any secured facility, the ability to deal with assets the subject of a floating charge. Again, the contracts are likely to be market-standard and non-negotiable. In some cases, personal guarantees may be required by the banks.
In all of these situations, there is likely to be little room for discussion or negotiation of the banks’ standard terms.
However, most banks will be keen to promote their other commercial products which generate for them fees outside of the standard (and keenly-priced) tariffs for the routine business banking services that are on offer in a competitive marketplace.
It is in these situations that SMEs need to take extra care. Caveat Emptor. Let the buyer beware! For we must understand that the banks, in these situations, are now motivated to transform from prudent advisers on their customers’ financial well-being, to commercial counterparties dealing at arm’s length with those same customers.
The dangers facing SMEs, when dealing with their banks on an arm’s-length commercial basis, were comprehensively illustrated by the long succession of claims brought against banks that had marketed interest rate-hedging products in the years leading up to the Global Financial Crisis. Many businesses with term loan facilities were required by their banks in the years prior to 2008, to hedge themselves against the possibility of increases in the Bank of England base rate, which would have made those bank loans more expensive to service. In most cases, all that those businesses needed was a simple hedge against interest rate rises. But relationship managers across the UK banking industry came under pressure at that time from the higher-ups to “sell“ riskier interest-rate products. Those products, of varying complexity, would generate greater profits for the banks, notwithstanding the fact that the upfront cost to the customer appeared to be lower than that of the simple interest-rate hedge that they required.
What later transpired was that interest rates did not rise. In fact, they did the very opposite. In late 2008, rates fell by a significant margin, as the Bank of England took emergency action to prop up the economy amid the most serious financial crisis in decades. The Daily Telegraph reported later that "tens, if not hundreds, of thousands of SMEs across the UK ... [suffered] as interest rates cuts designed to provide support for the economy at large caused huge damage as the swaps forced borrowers to hand over billions of pounds in extra payments to pay off the counter-parties to what had been sold as “simple” derivatives".
In recent times, banks and foreign exchange brokers have faced legal claims from small companies in relation to complex currency derivatives that imposed sudden severe financial burdens when foreign exchange markets have experienced momentary volatility. Many businesses have faced substantial losses from complex Forex derivatives contracts they had entered into on the understanding they were an appropriate means of hedging their FX exposure .The legal documentation involved is characterised by the customer unknowingly taking on excessive levels of a risk.
The history of interest rate swap and foreign currency hedge mis-selling claims by small and medium-sized businesses against major banks shows the ongoing need for smaller companies to fully understand the financial derivatives being offered to them by their banks.