Swaps Litigation: Westdeutsche Landesbank Girozentrale v Islington LBC

DOIhttps://doi.org/10.1108/eb025788
Publication Date01 Jan 1997
Pages250-252
AuthorKaren Houston
SubjectAccounting & finance
Journal of Financial Crime Vol. 4 No. 3 Restitution
RESTITUTION
Swaps Litigation: Westdeutsche Landesbank
Girozentrale v Islington LBC
Karen Houston
An interest rate swap is an agreement between two
parties by which one party ('the fixed rate payer')
agrees to pay the other ('the floating rate payer')
interest on a notional principal sum at a fixed rate
over a certain period. The floating rate payer agrees
to pay the fixed rate payer interest on the same
notional sum at a fluctuating rate determined by
reference to a market rate such as the six-month
London Inter-Bank Offered Rate (LIBOR). Often
the fixed rate payer will make an upfront payment
to the floating rate payer with the result that the
rate of interest payable by the fixed rate payer is
reduced.
Such instruments were widely used by local
authorities until the House of Lords in Hazell v
Hammersmith
and
Fulham
LBC1 held that such con-
tracts were
ultra vires
local authorities and therefore
void. Not surprisingly this decision was followed
by litigation in which banks and other financial
institutions who had entered into interest rate
swap transactions with local authorities, sought to
recover the balance of the monies which they had
paid, together with interest. Of the many resulting
actions, one brought by Westdeutsche Landesbank
Girozentrale against Islington BC, which involved
an interest rate swap entered into in 1987 and
which included an upfront payment, was selected
as a test case.2
At first instance3 Hobhousc J held that the bank
was entitled to recover from the council the net
balance outstanding on the transaction together
with compound interest calculated at six-monthly
rests from 1st April, 1990. The Court of Appeal4
affirmed the judge's decision to award compound
interest but ordered that such interest should run
from the date of the upfront payment by the bank
in June 1987. The local authority appealed to the
House of Lords solely on the award of compound
interest and a majority of the House of Lords
(Lords Goff and Woolf dissenting) held that the
bank was only entitled to simple interest on the
net balance outstanding, calculated from the date
of the upfront payment.
EQUITABLE JURISDICTION TO GRANT
COMPOUND INTEREST
Before the House of Lords it was common ground,
between the parties that the court had no jurisdic-
tion to award compound interest either at law or
under s. 35A Supreme Court Act 1981 but that
there were certain limited circumstances in which
the courts of equity could award compound inter-
est. In the absence of fraud, however, the only
circumstances in which compound interest could
be granted in equity was where the defendant was
a trustee or other fiduciary and the plaintiff was
seeking to recoup an improper profit made by
him. In the
Westdeutsche
case therefore, unless the
bank could show that the local authority owed
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