Links to Northern Rock files
Northern Rock Shareholder Action Group
Northern Rock Action Group - Some Comments
Northern Rock Event Photographs
Northern Rock - past events
Northern Rock shareholder meeting
Judicial Review and Demonstrations
Appeal on Judicial Review
Northern Rock EGM Voting
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:
- 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.
- The court failed to take into account that the contribution of the Government in ensuring that the company was able to continue to trade (such support being provided on a commercial basis) did not entitle it to acquire the whole value of the business – the “salvage” argument.
- 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:
- The company was in a perilous position and would have had to go into administration without Government support.
- The Government provided substantial support at considerable cost to the taxpayer.
- 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:
- Firstly any process must incorporate an adversarial procedure to meet A1P1 and A6P1.
- The valuer must be independent, must be impartial and must have full jurisdiction on the merits of the case.
- 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
