Kleinwort Benson V. Birmingham City Council Notes

Kleinwort Benson v. Birmingham City Council

Facts

During the 1980s a number of local authorities entered the financial markets in order to trade in a new form of derivative, known as the interest rate swaps contract. Then the courts held that these contracts were ultra vires the local authorities and therefore void. In some cases the market rates of interest had moved against the local authorities, and they were the plaintiffs. In others, including the present, the banks had paid out more by way of differences than they had received, and they claimed to recover the net overpayment.

In this case, the bank claims to recover 353,321·91 as the net amount of payments made by it to the appellant, Birmingham City Council ("the authority"), under a swaps contract dated 23 September 1982 which ran until September 1987. The authority applied for leave to amend its points of defence so as to raise what has come to be known as the defence of "passing on." What this means for present purposes is that the authority seeks to assert that the bank has not in fact suffered any, or any substantial, loss as a result of these transactions. The reason given is that the payments which the bank made to the authority and which it now claims to recover were in fact matched by payments which it received from third parties described as counterparties under hedging arrangements which it made with them… If those are the facts, says the authority, then the bank has suffered no, or no substantial, loss and its claim for restitution should fail.

Thus the form of "passing on" alleged by the authority in the present case is the bank's practice of hedging or otherwise covering itself against the risks inherent in the swaps contract.

Holding

The issue here is whether what is called the defence of passing on is available when the plaintiff is the bank. The hedging operations which it carries out in the normal course of its operations are not ones which would normally be undertaken by a local authority. But the same principle would apply if the local authority was the plaintiff and the bank as defendant contended that because of a hedging operation or for any other reason the authority had not suffered the depletion of its assets which it is said is essential to found a claim. The essence of the defence is that the plaintiff ought not to recover the payment which has "unjustly" enriched the defendant, if the result of restitution would be that the plaintiff, not being out of pocket, would himself receive a "windfall gain"

It is not disputed that the hedging arrangements, whatever form they take, are separate and independent contracts, not in any way conditional upon or related to the swaps contract itself. This is so, even if the hedge is a perfect match, i.e. the mirror image of the swaps contract, apart from the bank's profit or "turn."

Distinguishing Tax Cases: In my judgment, the taxation cases are of limited assistance in addressing the question of general principle which is raised by the present appeal. There is a public law element involved in them (see Air Canada v. British Columbia , 59 D.L.R. (4th) 161, 170, per Wilson J.) and a further question, akin to agency, which is whether the taxpayer should be regarded as having collected tax from his customers on behalf of the taxing authority.

The present case is far removed from the taxation authorities. No element of public law is involved. No question of a constructive trust or of any obligation to account to customers can arise. This follows from the admitted fact that the hedge contracts, even if they were perfect matches, were market transactions independent of the swaps contract which were and remained binding on the bank and third parties notwithstanding that the swaps contract was void. This also means that the bank paid its own money to the authority and for its own account: no question of agency or any third party interest can arise.

Citing Mason v. New South Wales, 102 C.L.R. 108: “If the...

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