A loan but not forgotten

Recent victories by local authorities over banks have left their mark and may result in tighter controls, believes Roy Ambrose

In recent months, attention has been focused on a handful of cases brought by banks against local authorities that have borrowed money from them.

The authorities won, but the critics say the law is too loose to pin their obligations down. The cases are likely to bring about a change, to make local authorities comply with both the letter and the spirit of the law.

In two of the cases, Credit Suisse v Allerdale Borough Council and Credit

Suisse v Waltham Forest London Borough Council – brought before the Court of Appeal – the local authorities were refusing to honour loan guarantees they made on behalf of companies they set up, but which subsequently went bust.

And in Westdeutsche Landesbanke Girozentrale v London Borough of Islington, the authority argued it should only have to pay simple, not compound interest, on its loan.

The Allerdale and Waltham Forest cases involved companies formed by the local authority to carry out its functions “off balance sheet” in an

attempt to avoid the Government's local authority capital expenditure controls.

The Westdeutsche case involved a “swops” agreement – of the type ruled unlawful in Hazel v Hammersmith and Fulham London Borough Council in 1991 – and the issue of repayment of a loan to the bank and the interest payable on it.

Allerdale council formed a wholly-owned company to raise a £6 million loan from Credit Suisse to build a swimming pool and time-share apartments. Repayment of the loan was guaranteed by the council.

The loan was raised by the company and did not, therefore, count against the council's capital allocation. The profits from the time-shares were intended to cover the cost of the pool. But the time shares did not sell and the company went into liquidation. The bank called in the guarantee, but the council refused to pay, arguing it was

ultra vires.

In the Waltham Forest case, the council formed a 50/50-owned company with Credit Suisse, which raised a £11 million loan from Credit Suisse to acquire housing property which it would lease to the council for occupation by homeless people.

The council again guaranteed the loan, intending to sell the property after three years and pay off the loan from the profit. But the housing market recession put paid to that plan and the company could not repay the loan. The guarantee was called in and, again, the council refused to pay, arguing the guarantee was ultra vires.

In both cases, the Court of Appeal accepted the ultra vires argument and refused to uphold the guarantees. The court found that the purpose of the schemes was to circumvent the restrictions on borrowing and spending to which the authorities were subject.

Lord Neill held that the schemes were “not proper purposes for the council to pursue” and stated: “Statutory powers are conferred on local authorities on trust. These powers can only be used in the way that Parliament is presumed to have intended. Parliament has created an elaborate structure to provide for, and regulate the manner in which, a local authority can obtain funds to carry out its statutory functions.”

The court found that the formation of the companies didn't help the authorities to carry out their obligations and they could not, therefore, rely on Section 111 of the Local Government Act 1972 which enables a local authority to do anything that is calculated to help it in its duties.

It could be argued that these cases have re-established an underlying constitutional principle: that Parliament is sovereign and those to whom power is delegated by Parliament hold those powers at its behest. The cases also establish that this principle should be applied not only to the functions performed by local authorities but also to the manner of their performance.

In the short term, the Court of Appeal's decision in the Allerdale and Waltham Forest cases may give rise to concern regarding other public/private sector funding arrangements, including deferred purchase agreements.

But in the longer term, these judgments could lead to greater security. Parties to public/private sector dealings will be concerned to ensure that the transactions are clearly within the powers and controls placed on local government. This will lead to increased confidence in the legality of the transactions and provide the security the funders need.

The cases also have an impact on local authority companies. Although the law has changed with the enactment of Part V of the Local Government and Housing Act 1989 and the Local Authorities (Companies) Order 1995, local authority lawyers will still have to ensure that councils have the requisite powers to form companies. The narrower interpretation of Section 111 followed by the court in these recent cases will need to be adhered to unless other specific powers are available.

Greater care will need to be exercised in ascertaining how, exactly, the statutory functions of the local authority can be helped by forming the company. Similar considerations will apply to guarantees and indemnities issued by authorities in reliance on Section 111.

The Westdeutsche case is less far-reaching, but not unimportant. The principal argument before the House of Lords was whether simple or compound interest was payable by the London Borough of Islington on the money paid by the bank under the original ultra vires swops agreement. Islington accepted that the money was repayable with simple interest but challenged the Court of Appeal's decision that the money was held under a constructive trust and that compound interest was payable.

The House of Lords refused to find that a constructive trust existed (overruling the case of Sinclair v Brougham from the last century) and held that only simple interest was payable. The Lords held that it was contrary to general trust principles for a party to be found a fiduciary when they were unaware at the time of circumstances giving rise to trust obligations.

This case could lead to local authorities that are repaying money paid to them under an ultra vires contract incurring simple, not compound, interest. But in the lower courts, this case established the principle that money paid under such a contract is in fact recoverable by the payer.

Ray Ambrose is a consultant

in the public and administrative law group at Nabarro Nathanson.