Divisional court and Court of Appeal Recognising the importance of the point, the case was heard by two judges at first instance in a
divisional court,
Woolf LJ and
French J. They delivered a judgment on 1 November 1989, and they held that the swap transactions were
ultra vires and beyond the powers of the local authorities. It was noted, with no small sense of irony, that "the decision had the bizarre effect of 'benefiting the chief culprit' (Hammersmith), while hurting the more prudent local authorities." The case was appealed and came before
Sir Stephen Brown P,
Nicholls LJ and
Bingham LJ who handed down their decision on 22 February 1990. The
Court of Appeal broadly divided the swap entered into by the local authorities into three different types: • Purely speculative swaps, which it held were void; • Swaps which were part of managing the local authorities' interest rate exposure under their borrowing, which it held were valid; and • Swaps which were entered into by local authorities once it became apparent that earlier swaps might be void to mitigate the damage caused by those void swaps (called the "interim strategy"), which it held were also valid. Both at first instance and in the Court of Appeal, the judgments were deliberately handed down at a time when the markets were closed. The case was then appealed to the House of Lords.
House of Lords The main judgment was given by Lord Templeman, with whom all judges agreed.
Lord Ackner gave a short concurring judgment. After recounting the facts and describing in brief terms what an interest rate swap contract is, Lord Templeman then expanded upon the facts, noting that the various swaps fell into three categories. • The first category was where swaps were entered simply to speculate. In relation to those swaps the banks conceded that they were unlawful. • The second category was where swaps were entered into with respect to an existing loan to try and capitalise upon a change in interests. Accordingly, whilst they were also speculative in nature, they did directly relate to an existing loan exposure of the local authority. In the judgment these were referred to as "parallel contracts" or "replacing" interest rates. Lord Templeman noted quickly that "a parallel contract does not in fact replace the interest under the original borrowing and the swap transaction is a speculation no different in quality although different in magnitude from a swap contract which is not entered into by reference to any existing borrowing." • The third category related to swaps also entered into in connection with an existing loan, where the local authority sought to use swaps to alter the proportion of the interest which was paid on either a fixed or variable basis through swap contracts. In the judgment these were referred to as "re-profiling". Similarly, Lord Templeman determined fairly immediately in his judgment that these were in his view largely indistinguishable from parallel contracts.
Powers of local authorities Having almost immediately stated that all swaps were, in his view, conceptually the same as the types of swap which the banks had admitted were unlawful, Lord Templeman then explored the limits of the powers of local authorities under the Local Government Act 1972. He sought to explore whether the "replace" and "re-profile" swaps could be said to be "calculated to facilitate" or were "conducive to" the power of the local authorities to borrow under section 111 of the statute. He referred to the judgments of
Lord Blackburn and
Lord Selborne LC in
Attorney-General v Great Eastern Railway Co (1880) 5 App Cas 473 where the House of Lords had held unequivocally that where powers are conferred upon a statutory corporation "what it does not expressly or impliedly authorise is to be taken to be prohibited". He referred further to the decision of Lord Selborne LC in
Small v Smith (1884) 10 App Cas 119 where the House of Lords held that granting powers to deal generally in a certain type of business did not mean that there is a potential necessity for entering into all manner of related transactions. Lord Templeman thought that reasoning directly analogous to the case in hand. Finally, Lord Templeman referred to the decision of
Lord Loreburn LC in
Attorney-General v Mersey Railway Co [1907 AC 415] where he said "The rule of law has been laid down in this House to the effect that it must be shown that the business can fairly be regarded as incidental to or consequential upon the use of the statutory powers." Lord Templeman held that "The same considerations apply in the present case." Having considered the weight of authority, Lord Templeman noted that, despite its title, debt management is not in itself a function. He also noted that in the case of
building societies Parliament has expressly conferred upon them a power to enter into swap transactions. He finally concluded:
The "arcane point" Lord Templeman finally addressed what he referred to as the banks' "arcane" argument. Broadly, that stated that the incorporated Hammersmith and Fulham Borough (representing the concept of inhabitants as a whole group) could only act through the unincorporated Hammersmith and Fulham Borough Council (made up of the mayor and councillors), and though the powers of the council are limited by the Local Government Act 1972, it claimed the borough itself had all the powers of a natural person. The argument conceded that this would not save transactions entered into out of the general rate fund (which would presumably be most of them), but might save transactions funded from other sources. Lord Templeman stated "This argument strikes me as being not so much arcane as absurd." The argument drew on ''
Sutton's Hospital Case (1612) 10 Co Rep 1 that the use of a common seal allowed a corporate to do anything that a natural person might do. This only applies to a corporation created by exercise of the royal prerogative (Riche v Ashbury Railway Carriage and Iron Co'' (1874) LR 9 Ex 224 at 263). But in the present case, Hammersmith, as a London borough, was a hybrid corporation created by royal charter under the
London Government Act 1963. ==Reaction==