Court of Session Restricts Application of Collateral Warranties in Lending Transactions

A recent decision of the Inner House of the Court of Session in Scotland will be welcomed by lenders who are challenged to honour ‘promises’ of additional funding made to customers.

25 September 2013

A recent decision of the Inner House of the Court of Session in Scotland will be welcomed by lenders who are challenged to honour ‘promises’ of additional funding made to customers.

RBS v Carlyle concerned the extent to which a customer could rely on spoken assurances by an employee of a lender to: - (i) defend an attempt by the lender to recover sums loaned to him; and (ii) recover from the lender damages for losses suffered as a result of the failure to provide the funding in dispute.

Mr Carlyle, a property developer, sought funding in 2007 from the Royal Bank of Scotland (“RBS”) to develop two plots of land being offered for sale by the Gleneagles Hotel.

The funding was required in 3 stages to cover (1) the deposit, (2) the land purchase and (3) the development costs. A buy-back clause was inserted into the purchase contracts for the two plots which allowed the hotel to buy the property back at the original purchase price if houses were not constructed on the plots by March 2011.  As a result, Mr Carlyle was likely to incur substantial losses if the houses were not completed by the deadline. 

As a result of the buy-back clause, during negotiations with RBS, Mr Carlyle advised that the deposit and land purchase funding should only be provided if funding for the development would follow.  Although the loan documentation signed by RBS did not relate to the development costs, Mr Carlyle was given oral assurances on several occasions by employees of RBS (who were aware of the buy-back clause and its consequences) that RBS would also provide funding for the development. 

However, after providing funding for the purchase in July 2007, RBS made it clear that it would not provide funding for the development. It then sued for repayment of the loan when it was not made on the due date in August 2008.  Mr Carlyle argued that the assurances of RBS that it would provide the development funding amounted to a “collateral warranty” and counter claimed for damages for losses suffered by him as a result of the failure of RBS to provide the funding.  At first instance, the Court agreed with the arguments put forward by Mr Carlyle and found that that the representations of RBS amounted to a binding collateral warranty and the court held that RBS could not recover from the customer the sums initially loaned.

That decision was reversed by the Inner House which concluded that the bank employee’s assurances could not create a legally enforceable obligation to lend monies to the customer and was no more than a statement of future intention. The legally enforceable obligations could only arise by means of a written contract in accordance with the bank’s standard procedures.  

Whilst the appeal court’s decision will no doubt be of assistance to lenders, the challenge is to prevent such disputes from escalating.  The importance of a paper trail cannot be over stated.  Employees move on, recollections of telephone calls had weeks/months/years ago fade but as many lenders will know, a dispute can last for (what seems like) a lifetime.

It is of critical importance that lenders maintain a clear record of what has been discussed with customers.  Whilst there is very little scope for arguing about the terms of letters, terms and conditions and loan agreements, the same cannot be said for telephone calls and meetings.

A contemporaneous record of important telephone calls or an email confirming what was discussed during a call means that lenders will be in a stronger position to rebut any suggestions that any agreement, not reflected in the terms of the loan/guarantee, was reached with the customer. 

Finally, lenders should ensure that all loan/guarantee documentation contains a clause prohibiting any amendment or supplement without it being in writing.