Lendy Directions Hearing Day 3

Oral and Written Submissions made on Day 3 in the Matter of Lendy Ltd at the High Court in Birmingham.

The background to this week-long-hearing here: “Lendy Directions Hearing begins“
Read the submissions made on Day 1 here: “Lendy Directions Hearing Day 1“
Read the submissions made on Day 2 here: “Lendy Directions Hearing Day 2”
Read the submissions made on Day 4 here: “Lendy Directions Hearing Day 4”
And handed down some six weeks after the trial: Read the Judgment

The Transcript

Click to access day-3.pdf

Issue 8

Issue 8: Has Lendy breached any of its fiduciary duties regarding its charging fees and/or interest for its own account in connection with the Model 2 Loans? If so:
(a) what is the appropriate form of relief for Model 2 Investors and/or the Model 2 Transferees;
(b) is Lendy entitled to an equitable allowance to cover its costs as agent; and
(c) if the answer to the question in issue 8(b) is ‘yes’, how should that allowance be calculated in principle?

Nb the Applicants (the Joint Administrators) made their submissions on Issue 8 during the afternoon of day 2

The Respondents Position
(From their Skeleton Argument)

22. In the agreed list of issues, the next two concern whether certain provisions in the Model 2 Terms truly formed part of the bargain between Lendy and the Model 2 lenders (Issue 6), and if so, whether they are nevertheless void, by reason of the Consumer Rights Act 2015 (“CRA15”) (Issue 7). But since those points only arise at all if Lendy would (as Ms. Taylor maintains) otherwise have obligations to Model 2 lenders by reason of its breach of fiduciary duties, it is more logical to deal first with Issues 8-9, which concern whether Lendy owed such duties, and consequential issues of breach and remedy. Whether Lendy owed Model 2 Lenders fiduciary duties matters, because if it did, they will be able assert proprietary claims to the relevant receipts and their traceable proceeds which stand outside the insolvent estate, and this will be so whatever the outcome on Issue 5 above.

23. In her position paper, Ms. Taylor originally took the position that Model 2 Lenders were entitled to maintain such claims not only in respect of DI [default interest], but also in respect of Lendy’s share of the pre-default interest, and its arrangement/exit fees (see §19.4 at [A/8/143). On the information available to her, however, Ms. Taylor now confines her case to DI only.

(D)(ii) The legal principles applicable to Issue 8.

24. For the purposes of Issue 8, the court will need to consider (1) whether Lendy occupied a fiduciary position in respect of Model 2 Lenders, and if so, (2) to what duties that gave rise. Starting with the first point, the relevant principles are as follows:

24.1 A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence: see most recently Children’s Investment Fund v. Attorney General [2020] 3 W.L.R. 461 (S.C.), at §44-§48, and Company v. Secretariat Consulting [2021] 4 W.L.R. 20 (C.A.), at §41-§42.

24.2 The relationship of agency confers upon the agent the power to affect the principal’s relations with third parties, and that presumptively gives rise to fiduciary duties (Snell’s Equity (34th ed.) §7-005, text to note 48). But even mere introducers, who have no such power, will also be fiduciaries, if and to the extent they satisfy the criterion identified in paragraph 24.1 above: see Bowstead §1-020 (text to note 75), and for an example, Hurstanger Ltd. v. Wilson [2007] 1 W.L.R. 2351 (C.A.), at §33 (a mortgage broker).

24.3 The relationship between two persons may be fiduciary as to some of its aspects, but not as to others: New Zealand Netherlands Society v. Kuys [1973] 1 W.L.R. 1126 (P.C.), at 1130C-E. Where the relationship is contractual, the contract “can and does modify the extent and nature of the general [fiduciary] duty that would otherwise arise” (Henderson v. Merrett Syndicates Ltd. [1995] 2 A.C. 145 (H.L.), at 206D (per Lord Browne-Wilkinson).

25. Turning to the nature of the duty, the “distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary” (Bristol & West BS v. Mothew [1998] Ch. 1 (C.A.), at 18A-B). Unless excluded by something in the contractual context, that basic duty then engenders a variety of more specific obligations, two of which are relied upon by Ms. Taylor as particularly relevant:

25.1 Fiduciaries “may not put themselves in a position or enter into transactions in which their personal interest, or their duty to another principal, may conflict with their duty to their principal, unless the principal, with full knowledge of all the material circumstances and of the nature and extent of the agent’s interest, consents” (Bowstead art. 44, §6- 046: the “No Conflict Rule”).

25.2 “An agent may not in breach of duty acquire a benefit from a third party without the principal’s consent. The agent must account to the principal for any benefit so obtained” (Bowstead art. 48, §6-079).

26. The No Conflict Rule is engaged whenever there is “a real sensible possibility of conflict” between the fiduciary’s duty to his principal, and the competing interest or duty (Bowstead, §6-047). So far as what suffices for “full knowledge”, for the purposes of whether or not the principal has effectively consented within the meaning of the No Conflict Rule:

26.1 The principal will only be regarded as having had full knowledge if the fiduciary made “full and frank disclosure of all material facts”: NZ Netherlands Society at 1131H-1132A. In Gwembe Valley Development Co. Ltd. v. Koshy (No. 3) [2004] 1 B.C.L.C. 131 (C.A.), that was said to require not only disclosure by the fiduciary of the fact of his profit, but also disclosure “of its extent, including the source and scale of the profit made from his position” (at §65).

26.2 Since what is in play is an equitable principle, the disclosure standard is flexible, and its stringency will depend on the attributes of the principal(s), and the surrounding facts more generally:

26.2.1 Thus in Hurstanger (see paragraph 24.2 above), it was held that there had been insufficient disclosure to a “vulnerable and unsophisticated” mortgage borrower who had been told that the broker stood to receive commission from the lender, but had not been told of its amount (at §36).

26.2.2 By contrast, in Medsted Associates Ltd. v. Canaccord [2019] 1 W.L.R. 4481 (C.A.), disclosure was held sufficient where the principals were “wealthy Greek citizens” and “experienced investors” (at §43), in circumstances where they knew the agent stood to be remunerated by the counterparty, but no further details.

26.3 But since the principal’s consent operates by way of defence to a claim for breach of the No Conflict Rule, in all cases, “the burden of proving (1) full disclosure of a conflict of interest and (2) of obtaining consent lies on the agent” (Bowstead §6-039, text to note 268, with numbering added to highlight the separate elements; see further Hurstanger §35).

(D)(iii) Ms. Taylor’s analysis of Issue 8.

27. Ms. Taylor submits that two particular features of this case point unequivocally to the conclusion that the No Conflict Rule applied to Lendy, with the consequence that it stood in a relevant fiduciary relation to Model 2 lenders.

28. First, Lendy consistently assured both lenders and prospective lenders that investments made through its platform had a high degree of protection from loss, because Lendy saw to it on their behalf that only creditworthy borrowers were admitted to the platform, and only loans with acceptable security headroom were put up on it by Lendy for investment. Highlighting only some of the more important points in the evidence, to give the flavour:

28.1 The Lendy website included a page entitled “How it works” [E1/33/134]], the heading to which stated (in large print): “we secure loans against professionally valued UK property”. So far as material, it went on:

28.1.1 “When a borrower approaches our parent company Lendy Ltd they begin a full and in-depth assessment of the project. Professionally qualified chartered surveyors are instructed to value the property being used as security to ensure any loan is a maximum of 70% of the Open Market Value. If the borrower and security meet the criteria the loan is secured with a legal charge … ”

28.1.2 Under a sub-heading, “Where is the risk?”: “we make every effort to minimise the risks for our investors and to ensure, where possible, that all investments are repaid in full and on time. To date we have a 100% success rate with our repayments … we feel confident that we have a thorough and robust system in place to protect all Saving Stream investors” [E1/33/136].

28.2 Similar claims were made by Lendy in its email updates to lenders. For example:

28.2.1 The 25 August 2017 weekly update reassured them that while Lendy was “not able to protect investors from capital loss, we do take our responsibilities very seriously … Lendy already has a robust due diligence process, which includes a five phase, multi-step (49 in fact) credit assessment overseen by our Credit Committee” [E1/92/318].

28.2.2 An email sent on 9 October 2017 to mark what was claimed to be Lendy’s fifth anniversary boasted that it was “one of the only profitable fintech property platforms”, and went on as follows: “but we’ve also managed risk carefully, and always striven to strike the right balance between loan supply and investment demand” [E2/96/338].

29. Second, Lendy also assured lenders and potential lenders that it had robust policies in place to deal with loans that went past the contracted repayment date, and that in handling such situations, it put lenders’ interests at the forefront. Again, highlighting only some of the more important points:

29.1 Having described Lendy’s allegedly “robust due diligence process”, the 25 August 2017 weekly update referred to in paragraph 28.2.1 above went on to make this further claim: “But Lendy is not stopping there. It’s committed to having the best recovery processes in the P2P industry, to help protect investors’ hard-earned investments” [E1/92/318].

29.2 Lendy’s 13 April 2018 “Investor Round-up” email introduced investors to Lendy’s new “collections and recovery” policy (the “First Recovery Policy”), stating its purpose to be “to give our investors comfort about the robust procedures Lendy has in place to protect them in the case of the borrower’s default” [E2/112/493].

29.3 The First Recovery Policy assured lenders that they would be paid in priority to Lendy’s own “portion of interest or fees” (see further discussion of this in section (F)(iv) (paragraph 52ff) below), and made a number of representations about how Lendy would approach situations where there was a risk of default:

29.3.1 “Borrowers are not infrequently granted extensions to their loans … to prevent loans falling past due and to improve the position of Lendy investors who will continue to receive interest for the extended period. Lendy is careful to ensure that in granting an extension it is not increasing the risk profile of a particular loan” [E2/111/488].

29.3.2 “Where a borrower is unable to repay their loan in full but is able to repay their loan in part Lendy will encourage and incentivise a borrower to do this. The key benefit to partial repayment of a loan is that it enables the return of capital to platform investors and reduces the risk profile for the remaining capital by reducing the loan to value ratio” [E2/111/488].

29.4 In an “Investor Update Special” emailed on 23 February 2018, Lendy then gave the following, categoric, reassurances to its lenders: “we have never taken the support of our investors for granted, and nor shall we ever. You are our number one concern and protecting your interests and hard-earned capital is our top priority … Our job is to be the champion of our investors and protect your interests. And it is for this reason that we take any potential losses very seriously. Where we might be faced with a recovery shortfall, we will pursue every avenue available to us to recover investors’ capital in full, along with interest accrued and any bonuses owed” [E2/103/415].

30. So far as the management of loans post-drawdown is concerned, furthermore, it is quite clear that Lendy acted as agent on behalf of the lenders:

30.1 The point has been made above that Lendy’s RAO art. 36H regulated activity of “operating an electronic system” was primarily facilitative. But the legislative framework also cast mandatory agency duties on Lendy which went beyond mere brokerage, as follows:

30.1.1 By art. 36H para. (1), Lendy was required (so far as presently material) to satisfy the conditions specified in para. (2A) and (2C).

30.1.2 The para. (2A) condition obliged Lendy (whether itself or by a third party) to undertake to receive payments from borrowers on behalf of lenders, and remit them to lenders.

30.1.3 The para. (2C) condition obliged Lendy (again, whether itself or by a third party) to undertake either take (a) steps to procure the payment of the borrowers’ debts, or (b) exercise or enforce the lenders’ rights under the loan agreements.

30.2 Reflecting the statutory framework, the Original Model 2 Terms then contained the following six terms, each creating an express relationship of agency:

30.2.1 By clause 8.1.1, lenders agreed to “appoint Saving Stream to act as agent on your behalf in relation to the loan and instruct Saving Stream to sign the Loan Contract as agent on your behalf” [C/14/271].

30.2.2 By clause 8.1.2, lenders further appointed SSSHL to act as security trustee, and instructed Lendy “to sign such security documents as agent on your behalf” [C/14/271].

30.2.3 By clause 8.1.3, lenders authorised Lendy to give instructions on their behalf to SSSHL “in relation to the security documents and their enforcement” [C/14/271].

30.2.4 By clause 9.6, lenders agreed that Lendy, “in its absolute discretion … (acting as agent on your behalf) may agree with the borrower to restructure the loan and amend the Loan Contract” [C/14/272].

30.2.5 By clause 9.8.1, lenders constituted Lendy their agent for the purposes of “negotiating and agreeing amendments to the Loan Contract” [C/14/273].

30.2.6 And finally, by clause 9.8.2, lenders also constituted Lendy their agent for the purpose of “negotiating and settling any dispute relating to the Loan Contract” [C/14/273].

30.3 All these provisions were carried-over, with minor variations (which the court can see most easily see by looking at the track changes version at [E2/107/445]), into the Amended Model 2 Terms in March 2018 [C/15/286].

31. Against that background, Ms. Taylor suggests it is as clear as it could be that Lendy stood in a fiduciary relationship to Model 2 lenders in relation to the management of Model 2 loans post-drawdown, and in particular, loans that went (or might go) unrepaid on their due date. There is nothing to displace the presumption of a fiduciary obligation that arises out of the relationship of agency constituted by art. 36H and the Model 2 Terms: on the contrary, everything points to the conclusion that Lendy could not possibly put itself into a position where its own pecuniary interests conflicted with those of its lenders in recovery situations.

32. If the Administrators’ analysis of Issue 5 is correct, however, Lendy did precisely that: see the stark example put forward by the Administrators and summarised at paragraph 18.3 above, highlighting the extent to which Lendy’s and the lenders’ interests pulled in different directions. In any situation where a loan might go into default, Lendy stood to make substantial gains out of DI, always provided there was sufficient headroom in the security to meet its DI charges, or solvent third party guarantors able to do so. This must have coloured its decisions about when and how to take enforcement measures, with the consequence that while lenders believed (because Lendy told it so) that Lendy was their “champion” (see paragraph 29.4 above), its approach will in fact have been skewed by its own financial interests.

33. If the court agrees, Lendy clearly breached the No Conflict Rule, because there is no question of its having made proper disclosure to the lenders of its DI charges, and still less, of its having obtained their actual consent to them. Pending seeing what the Administrators may have to say on that point, it is necessary only to add that so far as the appropriate disclosure standard is concerned (see paragraph 26.2 above), its content in a FSMA-regulated context will be informed by the regulatory framework, and in particular, by the material provisions of the FCA handbook. COBS 4.2.1(R) obliged Lendy to communicate in a way that was “fair, clear and not misleading”, and it is also relevant to note the more specific obligations to give “information on costs and associated charges” in COBS 6.1.9(R). In failing to disclose the DI charges it was making — at all, let alone in clear and fair language — Lendy plainly failed to make appropriate disclosure.

Issue 7

Issue 7: Do any of the relevant clauses in the Model 2 Terms constitute ‘unfair terms’ under Part 2 of the Consumer Rights Act 2015?

The Applicants Position
(From their Skeleton Argument)

139. Again, this issue does not arise, having regard to the way in which the Applicants put their case. The answer is therefore, “No, none of the relevant clauses in the Model 2 Terms constitute ‘unfair terms’ under Part 2 of the Consumer Rights Act 2015”.

140. It is common ground that Lendy was a trader within section 2(2) of the Consumer Rights Act (the “2015 Act”) and that some or all of the Model 2 Investors were consumers within section 2(3). It follows that, in relation to any Model 2 Investors who were consumers, if there were a term which causes a “significant imbalance in the parties’ rights and obligations under the contract to the detriment of the [Model 2 Investors]”, that term would be unfair and would not be binding on such Model 2 Investors: see section 62 of the 2015 Act.

141. However, having regard to the way in which the Applicants put their case, no relevant contractual term could be said to cause a “significant imbalance in the parties’ rights and obligations under the contract to the detriment of the [Model 2 Investors]”. As explained above:

141.1. The Applicants’ primary position is that Lendy did not owe the No Profit Duty. The non-existence of the No Profit Duty is a function of the overall relationship between Lendy and the Model 2 Investors, not a function of any specific contractual term. Similarly, the Applicants do not rely on any specific term to “permit” Lendy to make a profit. There was no need for any such contractual permission, since Lendy did not owe the No Profit Duty in the first place.

141.2. The Applicants’ secondary position is that the Model 2 Investors gave informed consent to any breach of the No Profit Duty. Once again, however, this is not a function of any specific contractual term, and is based on a wider analysis of the information available to the Model 2 Investors: see paragraphs 101 to 104 above.

142. The 2015 Act is concerned with unfair terms. The 2015 Act does not confer a general power on the Court to interfere with a bad bargain; one must identify a specific term that is said to be unfair. Thus, in Schedule 2 to the 2015 Act, a series of examples of unfair terms can be found, most of which involve some form of exclusion clause. Moreover, the 2015 Act only applies to express terms, since it cannot be the case that terms would be implied if they are unfair: see the discussion of HHJ Pelling (sitting as a High Court Judge) in Baybut v Eccle Riggs Country Park Ltd (unreported, 2 November 2006) at [20]-[23] in relation to the predecessor of the 2015 Act; see also Chitty on Contracts (33rd edition) at paragraph 38-240. The fundamental problem for Ms Taylor is that none of the relevant express terms within the Model 2 Terms can be characterised as unfair.

143. Ms Taylor does not seek to argue that any term of the Model 2 Loan is unfair. She focuses her attention on the Model 2 Terms. However, the Model 2 Loan is the contractual document which requires the Borrowers to pay interest and fees to Lendy.

144. The Model 2 Terms state that “the Loan Contract governs the terms of repayment and payment of interest by the borrower” (see the provisions from Clause 9 quoted in paragraph 104.4 above). This is a statement of fact, not a contractual promise or exclusion clause. The statement of fact is accurate, since the applicable interest rates are indeed governed by the Model 2 Loan. A statement of fact (viz. that the applicable interest rates are governed by the Loan Agreement) cannot properly be characterised as unfair within section 62 of the 2015 Act.

145. Ms Taylor’s arguments do not engage the 2015 Act. Her real objection is that Lendy should not have been allowed to charge interest and fees for its own account. The resolution of this issue depends on whether Lendy owed the No Profit Duty and (if so) whether informed consent was given by the Model 2 Investors. It does not depend on the fairness of any specific provisions within the Model 2 Terms.

The Respondents Position
(From their Skeleton Argument)

43. Issue 7 concerns the application of CRA15 to the Relevant Terms in the further (and final) alternative, i.e. if the court concludes that as a matter of construction, they would otherwise be apt to enable Lendy to retain DI, and if it is against Ms. Taylor on Issue 6 above (incorporation).

44. The application of the consumer rights legislation was originally proposed by the FCA, following advice from leading counsel (Richard Coleman Q.C.), which was summarised in a note [E3/167/845], and provided to the Administrators. The court is invited to preread that note, and Ms. Taylor adopts it as her submission on this Issue 7, subject to only the following supplemental points:

44.1 So far as presently material, terms in consumer contracts are assessable for fairness under CRA15 s.63 unless they (1) fall within the exclusion contained in s.64(1), and (2) satisfy the criterion of transparency and prominence in s.64(2). §12-§15 of the FCA’s note [E3/167/847] does not contain much discussion of the scope of the s.64(1) exclusion, and appears to proceed on the footing that the Relevant Terms fall (or at least, may fall) within it.

44.2 Ms. Taylor does not accept this. The Relevant Terms:

44.2.1 Plainly do not specify “the main subject matter of the contract” (s.64(1)(a)).

44.2.2 Nor do they concern “the appropriateness of the price payable under the contract” between the trader (Lendy) and the consumer (the Model 2 lenders) (s.64(1)(b)). They relate to the charges Lendy may raise against third parties (i.e. borrowers) in consequence of breach of their obligation to repay on time: cf Cavendish Square Holding BV v. Makdessi [2016] A.C. 1172 (H.L.), at §102.

44.3 CRA15 part 1 of sch. 2 “contains an indicative and non-exhaustive list [the “Grey List”] of terms of consumer contracts that may be regarded as unfair for the purposes of this Part” (s.63(1)). The FCA’s note does not specifically address the relevance of the Grey List, but Ms. Taylor relies on it as follows:

44.3.1 Para. 11 of the Grey List concerns terms that have “the object or effect of enabling the trader to alter the terns of the contract unilaterally without a valid reason which is specified in the contract”.

44.3.2 This provision applies to clause 23.1 in the Original Model 2 Terms [C/14/283], and clause 24.1 in the Amended Model 2 Terms, both of which purported to give Lendy the right to amend the agreement “without your specific agreement” (the “Variation Terms”).

44.3.3 To the extent the Administrators rely on the Variation Terms in order to rely on the amendments to clauses 9.2-9.3 discussed in paragraph 41.1 above (or indeed, otherwise), Ms. Taylor will contend that the Variation Terms do not satisfy the s.62(4) test of fairness, with the consequence that both they, and the amendments purportedly made pursuant to them, are of no effect (see s.67).

Issue 9

Issue 9: Based upon the answers to the questions in issues 5 to 8, do the Model 2 Investors and/or the Model 2 Transferees have a legal or equitable proprietary interest in any of the following:
(a) any default interest payable by a borrower to Lendy under a Model 2 Loan;
(b) all standard interest payable by a borrower to Lendy under a Model 2 Loan; and
(c) any of the fees payable by a borrower to Lendy pursuant to a Model 2 Loan?

The Applicants Position
(From their Skeleton Argument)

146. It follows from the submissions set out above that:

146.1. Lendy was entitled to charge standard interest and fees for its own account. The Model 2 Investors and Transferees therefore do not have any legal or equitable proprietary interest in the interest and fees that Lendy was entitled to receive for its own account under the Term Sheet and Borrower Conditions.

146.2. As to the default interest on each Model 2 Loan, that should either be paid to Lendy in its entirety or, in the alternative, be split between Lendy (on the one hand) and the Model 2 Investors and Transferees in respect of that Model 2 Loan (on the other hand) in the same proportions as non-default interest is split between them: see Issue 5 above. Thus, Lendy has a contractual right against the Borrower to receive its share of the default interest, and the Model 2 Investors and Transferees have a contractual right against the Borrower to receive their share of the default interest. These sums will also rank for payment out of the security enforcement waterfall under the Model 2 Debenture: see Issue 10 below.

147. If (contrary to the above) Lendy did owe the No Profit Duty, and if Lendy acted in breach of the No Profit Duty by charging default interest and/or non-default interest and/or fees for its own account, then each set of Model 2 Investors and Transferees (under each Model 2 Loan) would prima facie be capable of asserting an equitable proprietary interest in the proceeds of the interest and/or fees payable to Lendy in respect of that Model 2 Loan: see the decision of the Supreme Court in FHR European Ventures LLP v Cedar Capital Partners LLC [2015] AC 250. However:

147.1. The relevant proceeds must be capable of being traced in accordance with the equitable rules of tracing. If the proceeds cannot be traced, then no proprietary claim would exist. Any contested issues of tracing would need to be resolved at a further hearing.

147.2. If the Court is satisfied that Lendy should be awarded an equitable allowance (see Issue 8), then the value of the equitable allowance would fall to be deducted from the proceeds of any interest or fees in which the Model 2 Investors and Transferees have a proprietary interest.

148. In the alternative to a proprietary claim, the Model 2 Investors and Transferees would be entitled to claim an account of profits from Lendy. This is personal remedy and would rank as an unsecured provable claim. In calculating the account of profits, credit would again need to be given for any equitable allowance awarded to Lendy.

The Respondents Position
(From their Skeleton Argument)

34. If Ms. Taylor is right on Issue 8, she submits that it follows that Model 2 Lenders have proprietary claims to DI and its traceable proceeds. If the court sustains Ms. Taylor’s analysis of Issue 5 and decides that Lendy collected DI for the account of Model 2 lenders, this follows straightforwardly from the fact that Lendy collected as agent and fiduciary for the lenders (see paragraph 25.2 above). If it did not, and if Lendy purported to collect DI instead for its own account, the lenders’ proprietary rights flow from the fact that the monies came into Lendy’s hands as the result of its breach of the No Conflict Rule.

35. The Administrators have advanced no separate reasons why this should not be so (see §38-§39 of their position paper), and it is consequently only necessary to direct the court to the controlling authority on proprietary claims to the products of breaches of fiduciary duty, being FHR European Ventures LLP v. Cedar Capital Partners LLC [2015] A.C. 250 (S.C.): see §50, finding in favour of “the wider formulation of the rule”, which can be see at §30, and again at §35 (“any benefit acquired by an agent as a result of his agency and in breach of his fiduciary duty is held on trust for the principal”).