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Hazell v. Hammersmith and Fulham London Borough Council and Ors; Hammersmith and Fulham London Borough Council v. Hazell and Ors

[1992] 2 AC 1
[1991] 1 All ER 545



(Judgment by: Lord Templeman)

Between: Hazell - Appellant
And: Hammersmith and Fulham London Borough Council and Ors - Respondents
Between: Hammersmith and Fulham London Borough Council - Appellants
And: Hazell and Ors - Respondents
Conjoined appeals

Court:
House of Lords

Judges:
Lord Keith of Kinkel

Lord Brandon of Oakbrook

Lord Templeman

Lord Griffiths

Lord Ackner

Subject references:
LOCAL GOVERNMENT
Powers
Financial transactions
Council incorporated by Royal Charter entering into speculative financial transactions
Profitability depending on interest rates falling
Whether transactions within powers of council
Whether council's capital market fund valid

Legislative references:
London Government Act 1963 - (c. 33), s. 1
Local Government Act 1972 - (c. 70), s. 111
Local Government Finance Act 1982 - (c. 32), s. 19

Case references:
Attorney-General v. Great Eastern Railway Co. - (1880) 5 App.Cas. 473, H.L.(E.)
Attorney-General v. Mersey Railway Co. - [1907] A.C. 415, H.L.(E.)
Bonanza Creek Gold Mining Co. Ltd. v. The King - [1916] 1 A.C. 566, P.C.
Cotman v. Brougham - [1918] A.C. 514, H.L.(E.)
Holsworthy Urban District Council v. Holsworthy Rural District Council - [1907] 2 Ch. 62
Norwich Provident Insurance Society, In re (Bath's Case) - (1878) 8 Ch.D. 334, C.A
Riche v. Ashbury Railway Carriage and Iron Co. Ltd - (1874) L.R. 9 Ex. 224; (1875) L.R. 7 H.L. 653, H.L.(E.)
Rutter v. Chapman - (1841) 8 M. & W. 1
Small v. Smith - (1884) 10 App.Cas. 119, H.L.(Sc.)
Sutton's Hospital Case - (1612) 10 Co.Rep. 1
Wenlock (Baroness) v. River Dee Co. - (1885) 10 App.Cas. 354, H.L.(E.)
Associated Provincial Picture Houses Ltd. v. Wednesbury Corporation - [1948] 1 K.B. 223; [1947] 2 All E.R. 680, C.A.
Attorney-General v. Fulham Corporation - [1921] 1 Ch. 440
Attorney-General v. Leeds Corporation - [1929] 2 Ch. 291
Attorney-General v. London County Council - [1901] 1 Ch. 781, C.A.; [1902] A.C. 165, H.L.(E.)
Attorney-General v. Manchester Corporation - [1906] 1 Ch. 643
Attorney-General v. Newcastle upon Tyne Corporation - (1889) 23 Q.B.D. 492, C.A.; [1892] A.C. 568, H.L.(E.)
Attorney-General v. Smethwick Corporation - [1932] 1 Ch. 562, C.A.
Attorney-General for Ceylon v. Silva - [1953] A.C. 461, P.C.
Ayers v. South Australian Banking Co. - (1871) L.R. 3 P.C. 548, P.C.
Bar Hill Developments Ltd. v. South Cambridgeshire District Council - (1979) 252 E.G. 915, D.C.
Beauforte (Jon) (London) Ltd., In re - [1953] Ch. 131; [1953] 2 W.L.R. 465; [1953] 1 All E.R. 634
Bell Houses Ltd. v. City Wall Properties Ltd. - [1966] 2 Q.B. 656; [1966] 2 W.L.R. 1323; [1966] 2 All E.R. 674, C.A.
City Index Ltd. v. Leslie - The Times, 10 October 1990
Cudgen Rutile (No. 2) Pty. Ltd. v. Chalk - [1975] A.C. 520; [1975] 2 W.L.R. 1, P.C.
Cunliffe Brooks & Co. v. Blackburn and District Benefit Building Society - (1884) 9 App.Cas. 857, H.L.(E.)
Deuchar v. Gas Light and Coke Co. - [1925] A.C. 691, H.L.(E.)
Dickson v. Pharmaceutical Society of Great Britain - [1970] A.C. 403; [1968] 3 W.L.R. 286; [1968] 2 All E.R. 686, H.L.(E.)
Dundee Harbour Trustees v. D. & J. Nicol - [1915] A.C. 550, H.L.(Sc.)
Great Eastern Railway Co. v. Turner - (1872) L.R. 8 Ch.App. 149
Introductions Ltd. v. National Provincial Bank Ltd. - [1970] Ch. 199; [1969] 2 W.L.R. 791; [1969] 1 All E.R. 887, C.A.
McDowell v. Standard Oil Co. (New Jersey) - [1927] A.C. 632, H.L.(E.)
Manchester City Council v. Greater Manchester Metropolitan County Council - (1979) 78 L.G.R. 71, C.A; (1980) 78 L.G.R. 560, H.L.(E.)
Moffat v. Eden District Council - (unreported), 8 November 1988; Court of Appeal (Civil Division) Transcript No. 919 of 1988, C.A.
National Telephone Co. Ltd. v. Constables of St. Peter Port - [1900] A.C. 317, P.C.
New, In re - [1901] 2 Ch. 534, C.A.
Provident Mutual Life Assurance Association v. Derby City Council - [1981] 1 W.L.R. 173, H.L.(E.)
Reg. v. Greater London Council, Ex parte Burgess - [1978] I.C.R. 991, D.C.
Reg. v. Greater London Council, Ex parte Westminster City Council - The Times, 27 December 1984
Reg. v. Reed - (1880) 5 Q.B.D. 483, C.A.
Reg. v. Richmond upon Thames London Borough Council, Ex parte McCarthy & Stone (Developments) Ltd - [1992] 2 A.C. 48; [1990] 2 W.L.R. 1294; [1990] 2 All E.R. 852, C.A.
Reg. v. Wirrall Metropolitan Borough Council, Ex parte Milstead - (1989) 87 L.G.R. 601, D.C.
Rolled Steel Products (Holdings) Ltd. v. British Steel Corporation - [1986] Ch. 246; [1985] 2 W.L.R. 908; [1985] 3 All E.R. 52, C.A.
Seagram v. Knight - (1867) L.R. 2 Ch.App. 628
Sinclair v. Brougham - [1914] A.C. 398, H.L.(E.)
Smith v. Croft - [1987] B.C.L.C. 355
Stockdale v. Haringey London Borough Council - (1989) 88 L.G.R. 7, C.A.
Swain v. The Law Society - [1983] 1 A.C. 598; [1982] 3 W.L.R. 261; [1982] 2 All E.R. 827, H.L.(E.)
Triggs v. Staines Urban District Council - [1969] 1 Ch. 10; [1968] 2 W.L.R. 1433; [1968] 2 All E.R. 1
Turner v. Shearer - [1972] 1 W.L.R. 1387; [1973] 1 All E.R. 397, D.C.
Wenlock (Baroness) v. River Dee Co. - (1887) 36 Ch.D. 674
Westminster City Council, In re - [1986] A.C. 668; [1986] 2 W.L.R. 807; [1986] 2 All E.R. 278, H.L.(E.)
Wheeler v. Leicester City Council - [1985] A.C. 1054; [1985] 3 W.L.R. 335; [1985] 2 All E.R. 1106, H.L.(E.)

Hearing date: 10-11, 15-18, 22-23, 25, 29 October 1990, 5-6, 8, 12 November 1990
Judgment date: 24 January 1991


Judgment by:
Lord Templeman

My Lords, by the Local Government Act 1972, England was divided into local government areas consisting of counties, districts, London boroughs and parishes. The local authority charged with the administration of local government in a local government area consists of an elected council which "shall have all such functions as are vested in them by this Act or otherwise:" sections 2(1) and (2) and 14(1) of, and paragraph 1(2) of Schedule 2 to, the Act of 1972.

A local authority, although democratically elected and representative of the area, is not a sovereign body and can only do such things as are expressly or impliedly authorised by Parliament. The functions of a principal council, defined by section 270 of the Act of 1972 as a county, district, or London borough council, extend under many statutes to public health, housing, planning and highways and other environmental matters and to education, housing and social and welfare services including the care and protection of children, the sick and the elderly. The expenditure incurred by a local authority in the discharge of its functions is funded partly by grants from Parliament, derived from the taxpayer, partly by rates and community charges derived from local residents and partly by income lawfully generated by the council in the due performance of some of its functions, for example, rents from council houses. Authorised expenditure by a local authority may be short-term or long-term. The authority will require revenue to pay its employees periodically and revenue to finance the capital cost of a housing or property development which may cost millions of pounds and produce revenue for a century. The receipt of revenue never coincides with expenditure because grants and rates are received at intervals which do not coincide with outgoings. Moreover the burden of long-term expenditure is in fairness spread over future generations of taxpayers and ratepayers and not imposed entirely on those who pay when the expenditure is incurred.

Accordingly Parliament has conferred on a local authority controlled power to borrow short-term and long-term.

The borrowing powers of a local authority are defined and controlled by the provisions of Part I of Schedule 13 to the Act of 1972 to which I must hereafter refer in detail. Those provisions limit the purpose and method of borrowing by a local authority and dictate internal accounting for repayment. A local authority which is lawfully borrowing may choose to borrow at a fixed or variable rate of interest. The advantages of a fixed interest rate are certainty and protection against increases in current interest rates from time to time. The disadvantage of a fixed interest is that no benefit can be derived from a fall in interest rates.

In exercise of their borrowing powers, the appellant Hammersmith and Fulham Borough Council ("the council") borrowed sums which on 31 March 1989 amounted to £390m., largely representing borrowings incurred to undertake capital projects over many years. Each borrowing had its own terms of repayment. The interest rate differed from one loan to another, some loans were at fixed rates of interest and some at variable rates of interest. The council when taking up a loan must have considered that its resources would be adequate to meet its obligations under the terms of the loan. No doubt has been cast on the legality of any of the council's borrowings. Each outstanding loan remains payable with interest according to its terms which cannot be altered without the consent of the lender.

From December 1983 onwards and principally between April 1987 and 23 February 1989 the council entered into numerous interest swap contracts. The council was in each contract anticipating a rise or fall in interest rates generally and if its anticipation was fulfilled would derive from the contract a profit which could then be employed, but was not bound to be employed, by the council in meeting the interest burden of its borrowings. The question is whether the council possessed power to enter into any swap contract.

To determine this question it is necessary to consider the statutory powers of local authorities and the nature and effect of the swap transactions which have been carried out by the council. These transactions are alleged by the appellant district auditor ("the auditor") to have been unlawful. Some of the transactions were carried out with the respondent banks ("the banks"). A decision that all the transactions were unlawful could have serious financial repercussions on the banks and other parties to unlawful transactions. The banks have therefore joined in these proceedings. The banks concede that the swap transactions carried out by the council between April 1987 and July 1988 were unlawful but contend that some of the transactions carried out after July 1988 were, or may on investigation prove to have been, lawful. All the transactions were held by the Divisional Court (Woolf L.J. and French J. [1990] 2 Q.B. 697, 707H) to be unlawful. The Court of Appeal (Sir Stephen Brown P., Nicholls and Bingham L.JJ. [1990] 2 Q.B. 697, 762) held that some of the transactions may have been incidental to the statutory functions of the council and therefore lawful.

The auditor appeals to this House against the decision of the Court of Appeal that some of the transactions entered into by the council could and may have been lawful. The council feel obliged to support the auditor and to argue that all the swap transactions entered into by the council were unlawful.

The evidence discloses that about 1981 there appeared in the world of international finance a new swap market comprising interest rate swaps, currency swaps and, recently, asset swaps. An illuminating article entitled "Recent developments in the swap market" by Miss G. M. S. Hammond in the Bank of England "Quarterly Review" of February 1987, explains that the swap market assists traders to solve financial problems arising out of variations in interest rates and currency exchange rates, different taxation regimes and rates of inflation and different creditworthiness. In the simplest case a bank which found it easy to raise fixed finance would swap its interest obligations with a company which could only borrow at variable rates but for good commercial reasons needed the certainty and security of fixed rates. In a more complicated case an American company creditworthy in the United States might build a ship in Italy for an English subsidiary claiming capital allowances and would require short-term and long-term borrowings and payments in Italian and British currency. A European trader creditworthy in his country might need to expend and borrow dollars. Through the intermediation of a bank the American company and the European trader could by swap transactions ensure that fluctuations in interest rates and exchange rates did not have disastrous consequences. The swap market enables a borrower to raise funds in the market to which the borrower has best access but to make interest and principal payments in its preferred form of currency. The swap market has provided a valuable method of carrying on international trade and finance. Swaps may involve speculation or may eliminate speculation. In most cases the advantage sought by a user of the swap market is the elimination of speculation and uncertainty.

The transactions in the swap market which are now impugned were not carried out in order to enable the council to borrow or to enable the council to choose to borrow at a fixed rate rather than at a variable rate or vice versa. The transactions were undertaken in the hope that the burden of interest payable in respect of borrowings by the council would be mitigated by profits from swap contracts whereby the council successfully forecast movements in interest rates. If the council swapped from a fixed interest to a variable interest the council gained if, after the swap, interest rates went down. The council lost if, after the swap, interest rates rose. Similarly, if the council swapped from variable interest to fixed interest the council gained if, after the swap, interest rates went up and lost if interest rates went down.

Swaps employed by the council and said by the banks to be available to all local authorities are lucidly and comprehensively described in the judgment of the Divisional Court and in particular in Appendix A to that judgment: [1990] 2 Q.B. 697, 739-740. The simplest form is a swap contract described as:

"an agreement between two parties by which each agrees to pay the other on a specified date or dates an amount calculated by reference to the interest which would have accrued over a given period on the same notional principal sum assuming different rates of interest are payable in each case. For example, one rate may be fixed at 10 per cent. and the other rate may be equivalent to the six month London Inter-bank Offered Rate ('LIBOR').

If the LIBOR rate over the period of the swap is higher than 10 per cent. then the party agreeing to receive 'interest' in accordance with LIBOR will receive more than the party entitled to receive the 10 per cent. Normally neither party will in fact pay the sums which it has agreed to pay over the period of the swap but instead will make a settlement on a 'net payment basis' under which the party owing the greater amount on any day simply pays the difference between the two amounts due to the other."

LIBOR is the interest rate at which major banks offer to lend funds to other major banks in the London Interbank Market. It may correspond to the rate of interest being offered on Eurodollar deposits. Eurodollars are United States dollars held outside the United States.

LIBOR has been used in these proceedings to demonstrate the operation and effect of swap transactions. LIBOR is not the only basis for swaps. The fixed rate agreed for a short-term swap transaction may differ from the rate agreed for a long-term swap. In a swap transaction the winning party to a contract relies on the financial ability and integrity of the loser. All these complications have led to a swap industry which includes brokers advising clients and banks acting as intermediaries or guaranteeing performance by their clients of their swap operations. These complications do not affect the principle involved in these proceedings but emphasise that swap transactions are not free of cost and emphasise the degree of speculation inherent in a swap transaction which is undertaken solely for the purpose of obtaining a profit by forecasting future interest trends.

If a local authority borrowed £10m. in 1986 for five years at 10 per cent. per annum and LIBOR in 1987 was 12 per cent., the local authority would be unlikely to contemplate a swap. But if in 1987 LIBOR was 10 per cent. and the local authority believed that LIBOR would fall to eight per cent., the local authority might be minded to enter into a swap. In that event the local authority would agree to pay a bank LIBOR every year and the bank would agree to pay interest at 10 per cent. on a notional sum of £10m. until 1991. If in 1988 LIBOR fell to eight per cent., the bank would pay the local authority £200,000 being the difference between the LIBOR of eight per cent. and the fixed rate of 10 per cent. on £10m. The local authority must still pay interest at 10 per cent. on the sum of £10m. actually borrowed in 1986 but the gain of £200,000 from the bank would be available to meet the interest payment. If in 1988 LIBOR instead of falling to eight per cent. rose from 10 per cent. to 12 per cent., the local authority would pay the bank £200,000 and would also be bound to discharge the interest at 10 per cent. due on the sum borrowed in 1986. The success of the swap "replacing" the fixed rate of 10 per cent. by LIBOR would depend on LIBOR falling below 10 per cent. and on average remaining below 10 per cent. until 1991.

If a local authority correctly forecast a fall in interest rates, the authority could protect itself against a subsequent rise. If, in the example given, the local authority borrowed £10m. in 1986 for five years at 10 per cent. and in 1987 thought that interest rates would fall, the local authority could enter into a swap transaction to pay LIBOR and receive 10 per cent. If in 1988 LIBOR fell to eight per cent. the local authority could enter into another swap to pay eight per cent. and receive LIBOR. The effect of the two swaps would be to guarantee two per cent. to the local authority and this gain could be used to help pay the 10 per cent. on the actual borrowing. If in 1988 or thereafter the local authority thought that interest rates were likely to fall below eight per cent. the local authority could enter into another swap which if successful would provide a further gain indirectly reducing the burden of interest payments and that gain could again be consolidated.

A swap transaction is successful if a rise or fall in interest rates is correctly forecast; once the forecast has been proved to be accurate the local authority can consolidate the gain thus made by a reverse swap. But if after any swap transaction entered into in anticipation of a fall in interest rates there is a rise in LIBOR or if after any transaction anticipating a rise in interest rates there is a fall in LIBOR the local authority will suffer a loss which will be payable in addition to the net interest payable under the terms of the original borrowing. For a local authority the swap market provides the opportunity of reducing indirectly the burden of interest on its borrowings at the risk of increasing that burden. The only evidence presented by a local authority (other than the council) was the evidence of the treasurer of Westminster City Council.

He deposed that Westminster City Council entered into approximately 12 swap transactions between 1983 and 1989; on investigation by the auditor it appeared to him that only nine transactions had been entered into. The treasurer of Westminster City Council does not vouchsafe any details. He says that:

"By way of example the council might enter into a swap contract under which a 11 per cent. per annum fixed rate of interest is swapped for, say, a variable interest rate of 10 per cent. This gives an immediate benefit to the council of a one per cent. difference in interest rates. Were market rates of interest to rise above 11 per cent. I would enter into another reverse swap contract to return to a position of paying the fixed rate of 11 per cent. again."

The treasurer does not explain why a bank would be willing to accept a variable rate of 10 per cent. while agreeing to pay a fixed rate of 11 per cent. Nor does he explain why a bank would be willing to accept a fixed rate of 11 per cent. after market rates of interest had risen above 11 per cent. As I understand it, the treasurer begins by exploiting the favourable rate of interest obtainable by a local authority on its borrowing from public sources. The fact remains that a swap transaction depends for its success on interest rates rising or falling in conformity with the expectation of the local authority at the date of the swap.

From investigations made by the auditor it appears that 77 local authorities out of 450 principal local authorities entered into about 400 swap transactions, nearly all between 1987 and 1989. Only 10 local authorities (other than the council) entered into more than 10 swaps and only 18 (other than the council) entered into more than five. By 31 March 1989 the council had entered into 592 swap transactions and 297 of these were still outstanding. The total notional principal sum involved in all the transactions entered into by the council amounted in the aggregate to £6,052m. The transactions outstanding on 31 March 1989 involved notional principal sums amounting in the aggregate to £2,996m. These figures distort the position because some swap transactions were a hedge against others. But there is no doubt that the volume of swap business undertaken by the council was immense. The council's actual borrowing on that date amounted to £390m. its estimated expenditure for the year ending 31 March 1989 was £85.7m. and its quoted budget for that year was £44.6m. The auditor swore an affidavit on 30 May 1989, in which after exhibiting a summary of calculations, he said:

"this indicates that at current interest levels and using the five year swap rate on 9 February 1989 (11 per cent.) as the basis for the calculation for swaps, swap options, caps and floors (including collars), the result would be a loss of £74.3m. If interest rates fall, the council will still lose £12.8m. if the fall is by one per cent. If interest rates rose by one per cent., the council will lose £185.7m. If six month LIBOR on 9 February 1989 (13 per cent.) is used as the basis of the calculation for swaps, swap options, caps and floors (including collars) the result would be a loss of £292.7m. If interest rates fall, the council will still lose £193.5m. if the fall is by one per cent. If interest rates rise by one per cent. the council will lose £406.3m."

A local authority might wish to undertake swap transactions for three different reasons. First, a local authority which believed that interest rates were falling and that all swaps were lawful, could enter into swap agreements to pay LIBOR and receive a fixed rate of 10 per cent. If the swap transaction was affected by reference to a notional principal sum of £100m. and LIBOR fell to nine per cent., the local authority would make a profit of £1m. If LIBOR rose to 11 per cent. the local authority would lose £1m. This general speculation is admitted to be unlawful. The banks admit that the swap transactions by the council between April 1987 and July 1988 were unlawful because in that period the council were simply speculating. Secondly, a local authority which believed that interest rates were falling and that swaps designed to reduce the burden of interest payments on a particular borrowing were lawful, could enter into a swap for that purpose.

Thus if the local authority had borrowed £10m. at a fixed rate of 10 per cent. and believed that interest rates were falling, the local authority could enter into a swap agreement to pay LIBOR and receive 10 per cent. If LIBOR fell to nine per cent. the local authority would make a profit of £100,000. If LIBOR rose to 11 per cent. the local authority would lose £100,000. This swap agreement is referred to as a "parallel contract" because the notional principal sum involved does not exceed a principal sum borrowed and because the effect of the contract and any subsequent swap transaction entered into for the same purpose is said to convert indirectly a fixed interest obligation into a variable interest obligation or vice versa. The swap agreement in these circumstances is said to be a "parallel contract" and to "replace" the interest payable under the actual borrowing. The banks contend that the local authority may lawfully enter into parallel contracts and the council may have done so. But 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 though different in magnitude from a swap contract which is not entered into by reference to any existing borrowing.

Thirdly, a local authority might seek to increase the proportion which its variable interest rate obligations bore to its fixed interest obligations. If 90 per cent. of the local authority's borrowings were at fixed rates of interest and 10 per cent. at variable rates, the local authority might by swapped contracts agree to pay fixed interest and receive LIBOR and thus increase the proportion of its variable interest obligations. This process is known as "re-profiling." The banks contend that a local authority may lawfully enter into swaps for the purpose of re-profiling and the council may have done so. But if there is any difference between re-profiling and general speculation the notional sums must be limited to notional sums corresponding to some existing interest obligations. Basically therefore "re-profiling" is only an extension of "replacing."

Swap transactions include swap contracts, swap options, caps and floors, gilt options and cash options and forward rate agreements, all of which are explained in Appendix A to the judgment of the Divisional Court [1990] 2 Q.B. 697, 739-741. All these transactions are said by the banks, with some hesitation so far as cash options are concerned, to be lawful if undertaken by a local authority provided the transactions are "replacement" or "re-profiling" exercises intended to provide profits to be employed in the reduction of interest on particular borrowings and are limited to profits and losses on amounts which do not exceed the principal sums borrowed. The most material distinction between swap contracts and other types of swap transactions is that swap contracts do not usually require the payment of a premium whereas swap options and other types of swap transactions usually provide for a premium to be paid. The rate of interest which will attract payment when an option is exercised is negotiated in the light of the size and date of the payment of the premium. Swap transactions which involve premiums and options exercisable at future dates may increase the element of speculation and distort the local authority's pattern of borrowing. A local authority should, so far as possible, spread the burden of capital borrowing evenly over present and future taxpayers and ratepayers. A premium which is received by a local authority in 1990 reduces the cost of the borrowing in 1990 but increases the annual cost if and when the option is exercised. A premium which is paid by a local authority in 1990 increases the immediate cost of the borrowing in 1990 in the hope that the cost will be reduced when the option becomes exercisable.

The banks concede that local authorities have no express power to enter into any swap transaction. The banks contend that local authorities have an implied power to enter into "replacement" and "re-profiling" swap contracts. The council may have entered into some lawful "replacement" or "re-profiling" swap contracts. In addition the banks contend that the council was entitled to enter into swap transactions after July 1988 in order to mitigate the effect of unlawful swap transactions previously undertaken.

These arguments of the banks are based on section 111(1) of the Act of 1972, which, so far as material, provides as follows:

"(1)
 Without prejudice to any powers exercisable apart from this section but subject to the provisions of this Act... a local authority shall have power to do any thing (whether or not involving the expenditure, borrowing or lending of money or the acquisition or disposal of any property or rights) which is calculated to facilitate, or is conducive or incidental to, the discharge of any of their functions."

The banks contend that swap transactions which are intended to "replace" or "re-profile" existing interest obligations are within the words of section 111 "calculated to facilitate" or are "conducive to" or are "incidental to" the discharge by the local authority of its admitted function of borrowing or an alleged function of debt management.

Counsel for the auditor submitted that a local authority's power to borrow is not a "function" within the meaning of section 111 and that the local authority can do nothing which only facilitates or is conducive to or incidental to the power of borrowing.

In Attorney-General v. Great Eastern Railway Co. (1880) 5 App.Cas. 473, Lord Blackburn said, at p. 481:

"where there is an Act of Parliament creating a corporation for a particular purpose, and giving it powers for that particular purpose, what it does not expressly or impliedly authorise is to be taken to be prohibited;..."

In the same case Lord Selborne L.C. said, at p. 478, that the doctrine of ultra vires:

"ought to be reasonably, and not unreasonably, understood and applied, and that whatever may fairly be regarded as incidental to, or consequential upon, those things which the legislature has authorised, ought not (unless expressly prohibited) to be held, by judicial construction, to be ultra vires."

In the same vein Lord Blackburn said, at p. 481:

"those things which are incident to, and may reasonably and properly be done under the main purpose, though they may not be literally within it, would not be prohibited."

Section 111 embodies these principles.

I agree with the Court of Appeal [1990] 2 Q.B. 697, 785C that in section 111 the word "functions" embraces all the duties and powers of a local authority; the sum total of the activities Parliament has entrusted to it. Those activities are its functions. Accordingly a local authority can do anything which is calculated to facilitate or is conducive or incidental to the local authority's function of borrowing.

So the question is whether a swap transaction is "calculated to facilitate, or is conducive or incidental to," the discharge of the local authority's function of borrowing.

Swap transactions could be said to "facilitate" borrowing if the prospect of being able to reduce the burden of interest by swaps encouraged the local authority to enter into a borrowing which it would otherwise decide against. But this approach is impermissible. A local authority when considering expenditure must carefully consider the amount required to be borrowed and the resources available for payment of interest and capital. A local authority which borrowed in reliance on future successful swap operations would be failing in its duty to act prudently in the interests of the ratepayers.

Similarly, swap operations cannot be said to be "conducive to" borrowing because local authorities should not be encouraged to borrow by the prospect of swap transactions. It was submitted that swap transactions are "incidental to" borrowing. The first difficulty is that a swap transaction is a separate collateral contract which may be undertaken long after a borrowing has been effected. The local authority hopes that by a successful forecast of future interest trends it will provide itself with an income which can be employed in paying the interest on a borrowing. Assuming that this objection is not fatal, it is then necessary to consider what kinds of operations have been held to have been incidental to the discharge of the functions of a statutory corporation.

In Small v. Smith (1884) 10 App.Cas. 119, a building society which had power to enter into a second mortgage was held not to have an incidental power to guarantee payment of a prior mortgage. The Earl of Selborne L.C. said, at p. 133:

"But the argument really is that because the rules permit this kind of security to be taken, that is to say, give very large and general powers as to securities, which do not exclude the taking of a security on which there is a prior mortgage, therefore there is a potential necessity for entering into a transaction of this kind to protect that security, and therefore there is a reasonable implication that there is power to do it. But I wholly deny that there is any potential necessity at all.... there is no more potential necessity for doing this in order to meet a temporary inconvenience than there is for doing anything else in the world which in the opinion of the directors might tend to obviate that inconvenience."

The same reasoning could be applied to the argument that a local authority needs power to swap because it has power to borrow.

In Baroness Wenlock v. River Dee Co. (1885) 10 App.Cas. 354, a statutory river company possessed express power to borrow £50,000 secured by bond or mortgage. Any implied power to borrow was negatived by the express power to borrow not more than £50,000. Lord Watson said, at p. 362:

"The qualification attached by the legislature to the borrowing powers sanctioned by the Act of 1851, was, in my opinion, fatal to the continued existence of any implied power which the company had under their previous statutes."

As will be seen, Part I of Schedule 13 to the Act of 1972 imposes restrictions on the borrowing powers of local authorities.

In Attorney-General v. Mersey Railway Co. [1907] A.C. 415, a railway company was held not entitled to run a number of omnibuses which it claimed were incidental to the railway enterprise itself. Lord Loreburn L.C. said, at p. 415:

"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; and it is a question in each case whether it is so or whether it is not so."

Lord Macnaghten said, at p. 417:

"The question is this: Is the business of omnibus proprietors as the defendants were carrying it on when the action was brought reasonably incidental to their business as authorised by their special Act? The principle to be applied is perfectly clear. The difficulty is all in the application. Hundreds of cases may be suggested where the thing done comes very near the line and may fairly be open to a difference of opinion.... Here, I think, the respondents have transgressed the line. It may be in doing what they wish to do they cannot help it. But that, in my opinion, is no justification for their action. If they wish to extend their undertaking beyond the limits authorised by their charter, the proper course is to apply to Parliament for further powers. In my opinion a matter of this sort is much better left to Parliament. There everybody who has a right to be heard will be listened to, and there the interests of the public will be protected."

The same considerations apply in the present case.

Several other authorities were cited to illustrate incidental powers but each case turned on its own facts.

The authorities deal with widely different statutory functions but establish the general proposition that when a power is claimed to be incidental, the provisions of the statute which confer and limit functions must be considered and construed. The question is not whether swap transactions are incidental to borrowing but whether swap transactions are incidental to a local authority's borrowing function having regard to the provisions and limitations of the Act of 1972 regulating that function.

The authorities also show that a power is not incidental merely because it is convenient or desirable or profitable. A swap transaction undertaken by a local authority involves speculation in future interest trends with the object of making a profit in order to increase the available resources of the local authorities. There are many trading and currency and commercial swap transactions which eliminate or reduce speculation. Individual trading corporations and others may speculate as much as they please or consider prudent. But a local authority is not a trading or currency or commercial operator with no limit on the method or extent of its borrowing or with powers to speculate. The local authority is a public authority dealing with public moneys, exercising powers limited by Schedule 13.

Section 172 of the Act of 1972 directs that Part I of Schedule 13 "shall have effect with respect to the powers of local authorities to borrow and lend money and with respect to their funds..." Part I of Schedule 13, so far as material, provides as follows:

"1.
 Without prejudice to section 111 above -
(a)
 a principal council may borrow money for the purpose of lending money to another authority...
(b)
 a local authority... may borrow money for any other purpose or class of purpose approved for the purposes of this sub-paragraph by the Secretary of State and in accordance with any conditions subject to which the approval is given."

The Secretary of State from time to time issues block borrowing approval and may give a specific approval. The block borrowing approval defines the purposes for which money may be borrowed, the period during which borrowings must be repaid and limits the aggregate amount which an authority can borrow. For example, money may be borrowed for a maximum period of 60 years for land purchase and house building, for 40 years for other building and landscaping works and for 20 years for some furniture and other equipment. The maximum periods relate roughly to the expected life of the asset for which the money is to be borrowed.

"2(1)
 Where a local authority are authorised by or under this Act or any other enactment to borrow money, they may raise the money - " by mortgage, by the issue of stock, by the issue of debentures or annuity certificates, by the issue of bonds, by the issue of bills and "(f) by an agreement entered into with the Public Works Loan Commissioners under section 2 of the Public Works Loans Act 1965, or (g) by any other means approved by the Secretary of State with the consent of the Treasury."

Borrowings from the Public Works Loan Commissioners ("the P.W.L.B.") account for some 80 per cent. or more of local authority borrowings. The P.W.L.B. offer loans to local authorities at fixed or variable rates both of which are below the market rate because of the power of the government to negotiate its own borrowings. If a local authority borrows at a variable rate from the P.W.L.B. the local authority may elect thereafter on one occasion by the terms of the loan to change from a variable rate to a fixed rate without penalty. If, therefore, a local authority is compelled to borrow at a time when interest rates are thought to be abnormally high, the authority can borrow from the P.W.L.B. at a variable rate and then convert into a fixed rate when interest rates have fallen.

"4(1)
 The Secretary of State may by regulations made with the consent of the Treasury" prescribe the form of any mortgage deed, regulate the issue of stocks and bonds including the terms on which they may be issued, and regulate the manner of transfer dealing with and redeeming any mortgage deed, stocks or bonds. Thus the Secretary of State retains complete control over local authority borrowings.
"5(1)
 A local authority may borrow by the issue of bills, payable within 12 months from the date of issue," inter alia, such sums as may be required for the purpose of defraying expenses pending the receipt of revenue; but the amount so borrowed is limited to a specified proportion of the authority's estimated gross income derived from rates. It might have been thought that a similar power was incidental to the local authority's function of borrowing but any incidental power is negatived by this express provision.
"7(1)
 Where expenditure incurred by a local authority for any purpose is defrayed by borrowing, the local authority shall... debit the account from which that expenditure would otherwise fall to be defrayed with a sum equivalent to an instalment of principal and interest combined such that if paid annually it would secure the payment of interest at the due rate on the outstanding principal together with the repayment of the principal not later than the end of the fixed period."

If a local authority borrowed at a fixed rate and entered into a swap contract to "replace" the fixed rate by a variable rate, paragraph 7 does not enable any variation to be made in the required annual debit and does not take into account profits made or losses suffered as a result of the swap.

"8.
 A local authority who borrow money... may during the fixed period borrow further sums, without the approval of the Secretary of State under that sub-paragraph, for the purpose of repaying the money so borrowed."

Paragraph 8 thus confers an express power on the local authority truly to replace a loan. This power could be exercised, for example, if a fixed loan of 15 per cent. could be replaced by a fixed loan of 10 per cent. if rates had fallen. Such a true replacement would not involve the local authority making gains or suffering losses associated with swap transactions.

"10(1)
 A local authority may, without the approval of the Secretary of State... borrow by way of temporary loan or overdraft from a bank or otherwise any sums which they may temporarily require - (a) for the purpose of defraying expenses... pending the receipt of revenues."

Here again what might have been thought to be an incidental power is made the subject of express enactment.

"20.
 A person lending money to a local authority shall not be bound to inquire whether the borrowing of the money is legal or regular or whether the money raised was properly applied and shall not be prejudiced by any illegality or irregularity, or by the misapplication or non-application of any of that money."

The banks concede that this paragraph cannot be construed so as to afford protection to persons who enter into swap transactions with local authorities.

When a local authority considers whether to expend money and if so whether to borrow and on what terms, the local authority must have regard to the provisions of Schedule 13, the method of borrowing and terms of repayment, the prevailing interest rates and the possibility that interest rates may rise or fall during the period of the loan. If the local authority finds that after it has borrowed that there has been a violent change in interest rates which affects a particular borrowing, the local authority is not without remedial action. It can convert a loan taken out with the P.W.L.B. from variable rate of interest into a fixed rate of interest. It can pay off an expensive loan and take out a new loan. It is said that the cost of paying off an old loan and taking out a new loan would be greater than the cost of entering into swap transactions. But this fact alone cannot render swap transactions legal.

Schedule 13 establishes a comprehensive code which defines and limits the powers of a local authority with regard to its borrowing. The Schedule is in my view inconsistent with any incidental power to enter into swap transactions.

There is a further difficulty. If swap transactions are incidental to the function of borrowing, it would appear that swap transactions can only be entered into by the local authority and not by a committee or officer. Section 101(6), before its amendment by section 45(5) of the Local Government and Housing Act 1989 provided that:

"A local authority's functions with respect to levying, or issuing a precept for, a rate or borrowing money shall be discharged only by the authority."

The Court of Appeal found that section 111 applied but that section 101(6) did not. The court managed to reach this conclusion by accepting the argument that swap transactions are not so much incidental to the function of borrowing as incidental to the function of debt management, defined as a duty to take reasonable care to manage its borrowing prudently in the best interests of the ratepayers. Before this House, counsel for the banks, repeated the submission that swap transactions, if not incidental to borrowing, were nevertheless incidental to debt management.

Debt management is not a function. Debt management is a phrase which has been coined in this case to describe the activities of a person who enters the swap market for the purpose of making profits which can be employed in the payment of interest on borrowings. The expression debt management could be employed to describe the duty of a local authority to consider from time to time whether it should change a variable P.W.L.B. loan into a fixed interest loan; whether it should redeem one loan and take out another; whether when a new borrowing is contemplated, the borrowing should be at a variable or fixed rate taking into account all the other borrowings of the local authority. Debt management is a phrase which describes prudent and lawful activities on the part of the local authority. If swap transactions were lawful a local authority would be under a duty to consider entering into swap transactions as part of its duty of debt management. But if a swap transaction is not lawful then it cannot be lawful for a local authority to carry out a swap transaction under the guise of debt management.

The Divisional Court [1990] 2 Q.B. 697, 725 came to the conclusion that it would be inconsistent with the structure of the Act of 1972 as a whole, to which the provisions of section 111(1) are expressly made subject, to regard swap transactions as falling within that subsection. I agree.

For the banks it was argued that swap transactions are akin to insurance which enables provision to be made for possible risks. By insurance, an assured sacrifices a premium which when aggregated with premiums from other assured, will form a pool from which the insurer will indemnify the unfortunate victim (if any) who suffers from the risk insured against. A swap contract based on a notional principal sum of £1m. under which the local authority promises to pay the bank £10,000 if LIBOR rises by one per cent. and the bank promises to pay the local authority £10,000 if LIBOR falls by one per cent. is more akin to gambling than insurance.

The Court of Appeal were impressed by the argument that if swap transactions were unlawful a local authority could not take advantage of reductions in interest rates. But the success of swaps depends on a successful forecast of future interest rates. The power of a local authority to choose between long-term and short-term borrowings and to choose between variable and fixed interest rates, and the power of a local authority to borrow from the P.W.L.B. on favourable terms and to change from variable to fixed rates of interest and the power of the local authority to replace a borrowing with another borrowing, provide opportunity for the local authority to consider whether the overall rate of interest paid by the local authority is reasonable and is protected against volatility of interest rates. The greater the volatility of interest rates, the greater the risk of loss to a local authority as a result of swap transactions. Despite the urgings of counsel for the banks to the contrary, it seems to me there are substantial risks. There is no evidence that local authorities which have abstained from the swap market have forfeited substantial profits. These are all matters for Parliament to consider and the banks are not debarred from impressing upon Parliament the advantages to local authorities of a power to enter into swap transactions.

In the case of a building society Parliament has conferred express power to enter into swap transactions but that power was only conferred after the building societies had been given wide powers of entering into commercial transactions. The powers to enter into swap transactions were at first limited and when extended, Parliament continued to insist that the power should be subject to the approval of the members of the society who will suffer if the power is ineptly exercised.

The Building Societies Act 1986 conferred power on a building society to provide, inter alia, banking, investment and insurance services. Section 23 authorised a building society to effect contracts of a description to be prescribed by the building society's commission with the consent of the Treasury for the purpose of reducing the risk of loss arising from changes in interest rates, currency rates, or other forms of prescribed risk which affects its business. Section 23(5) directed that this power to hedge should only be exercisable if adopted by the society. The Building Societies (Prescribed Contracts) Order 1986 (1986 S.I. No. 2098) made by the commission pursuant to the Act of 1986 authorised a building society to enter into sterling interest rate swaps and capital and interest currency swaps but by article 3:

"(2)
 A society may only effect a prescribed contract where it has borrowed or intends to borrow a principal sum and the prescribed contract relates to a principal sum equal to it or less than it. (3) No prescribed contract may be effected by a society save where another party is a bank authorised... to hold funds of societies..."

Thus in 1986 Parliament conferred on building societies, which by the Act of 1986 were given wide functions, a power to enter into swap transactions which were limited to parallel contracts, could only be effected with leading banks, and only after the members of the society had approved the exercise of the power to hedge. In 1988 [by the Building Societies (Prescribed Contracts) Order 1988 (S.I. 1988 No. 1344)] Parliament extended the hedging power so as to apply to all the forms of swap transactions which are specified in Appendix A to the judgment of the Divisional Court in these proceedings [1990] 2 Q.B. 697, 739-741. Parliament, however, retained the requirement of approval by members of the society of the exercise of the power to hedge. It is for Parliament and not the courts to decide whether there should be conferred on local authorities unlimited power to hedge or a power limited for the protection of taxpayers and ratepayers. Parliament might decide that it was unnecessary or unwise to confer power on local authorities to enter the swap market at all.

Counsel for the banks contended that the application of the ultra vires doctrine in the present circumstances is so harsh that if swap transactions entered into by local authorities are unlawful, the swap market and the banks and other parties to swap transactions will be involved in great difficulties, the creditworthiness of local authorities would be impaired and there would be an increase in taxation. The major problem concerns the activities of the council which indulged in speculation on a vast and admittedly unlawful scale. It may not follow that, as between the council and the banks, payments made by the council before or after the period of the interim strategy can be recovered by the council. Nor does it follow that payments received by the council before or after the period of interim strategy cannot be recovered by the banks. The consequences of any ultra vires transaction may depend on the facts of each case. The banks have expressly reserved the right to argue in any proceedings arising out of a swap transaction that the banks are not tainted by illegality and that, for a variety of reasons which cannot now be canvassed, payments made pursuant to swap transactions can be retained by the banks or recovered from the council. The creditworthiness of local authorities has nothing to do with swap transactions. Paragraph 20 of Schedule 13 to the Act of 1972 is a complete protection for any person who lends money to a local authority. The object of the doctrine of ultra vires is the protection of the public. In Cotman v. Brougham [1918] A.C. 514, Lord Parker of Waddington referring to a company whose functions were defined by its memorandum of association said, at p. 520:

"The question whether or not a transaction is ultra vires is a question of law between the company and a third party. The truth is that the statement of a company's objects in its memorandum is intended to serve a double purpose. In the first place it gives protection to subscribers, who learn from it the purposes to which their money can be applied. In the second place it gives protection to persons who deal with the company, and who can infer from it the extent of the company's powers.... Even a power to borrow money could not always be safely inferred, much less such a power as that of underwriting shares in another company."

In the same case Lord Wrenbury said, at p. 522, that the memorandum of association:

"must delimit and identify the objects in such plain and unambiguous manner as the reader can identify the field of industry within which the corporate activities are to be confined. The purpose, I apprehend, is twofold. The first is that the intending corporator who contemplates the investment of his capital shall know within what field it is to be put at risk. The second is that anyone who shall deal with the company shall know without reasonable doubt whether the contractual relation into which he contemplates entering with the company is one relating to a matter within its corporate objects."

In the result, I am of the opinion that a local authority has no power to enter into a swap transaction. The banks nevertheless argued that swap transactions entered into by the council after July 1988 were lawful because they were intended to eliminate or reduce the risks inherent in earlier swap transactions. At the end of July 1988 the council was advised by the auditor that swap transactions which were not parallel contracts were of doubtful validity. For the purpose of this appeal, I assume, without deciding, that the council thereupon adopted a policy, now described as "the interim strategy" of refraining from entering into swap transactions save for the purpose of reducing the potential loss which might be suffered as a result of earlier swap transactions. The interim strategy came to an end on 23 February 1989 when the council determined to take no further action with regard to existing or future swap transactions until the law had been clarified.

The interim strategy took the form of fresh swap transactions designed to hedge the risks of earlier transactions. In addition, some swaps were terminated by cash payments, some swap contracts may have been assigned thus putting an end to the obligations of the council thereunder, and financial obligations under existing swap contracts were honoured. Since I have concluded that a local authority has no power to enter into swap transactions, it must follow that a swap transaction entered into pursuant to the interim strategy was also unlawful.

Any power to carry out the interim strategy activities must be derived from section 111 of the Act of 1972; a function must be identified to which the interim strategy activities were incidental. Miss Gloster on behalf of the banks submitted that the interim strategy activities were incidental to the duty of the council to take such reasonable steps as were very desirable or necessary to preserve and protect the ratepayers' funds from the adverse consequences of a previous act of the local authority, in circumstances where there were doubts at the time that the protective steps were taken as to whether the previous act was ultra vires or an abuse of power. In the alternative, Miss Gloster submitted that the interim strategy was carried out in discharge of or was incidental to the duty of the council to make arrangements for the proper administration of their financial affairs. My Lords, a local authority owes a duty to its ratepayers to preserve ratepayers' funds and to arrange for proper administration. But the reasonable steps and arrangements carried out by the council for the purpose of discharging its duties must be lawful. No authority was cited which suggested that in certain circumstances an ultra vires transaction could be remedied by another ultra vires transaction, possibly with different parties.

A large number of authorities were cited by way, it was said, of analogy. The first batch of authorities established the right of a corporation to compromise an ultra vires claim; but in each case the compromise did not involve the corporation in performing any unlawful act.

In In re Norwich Provident Insurance Society (Bath's Case) (1878) 8 Ch.D. 334, 340 Sir George Jessel M.R. said that a corporation has under the general law the same right to compromise claims brought against it as individual persons have:

"It would be a startling proposition that, whereas an individual may always avoid having to resort to litigation by compromising a claim against him, a corporation can never avoid it, but must either fight out the claim or make arrangements sanctioned by the order of a court of justice; yet such would be the result of holding that a corporation has no such general power."

In my opinion it would be a startling proposition that an individual or a corporation may always avoid having resort to litigation by agreeing, by way of compromise, to carry out an unlawful act.

The position was made abundantly clear by Warrington J. in Holsworthy Urban District Council v. Holsworthy Rural District Council [1907] 2 Ch. 62. He decided that a compromise agreement entered into bona fide by two councils, was not rendered invalid by the fact that one of the claims included in the compromise subsequently proved to be unfounded in law. Warrington J. said, at p. 73:

"a compromise, if entered into bona fide, and if it does not involve the doing of an act by one of the parties which is itself ultra vires, may be made by and may be binding on a corporation just as on an individual."

In this House, Miss Gloster also cited, by way of analogy, the well recognised authorities which established the jurisdiction of a Court of Equity to sanction a breach of trust by trustees. Such sanction may be granted retrospectively after the unauthorised transaction has been carried into effect. But while a court has jurisdiction to sanction any transaction which the settlor could have authorised and which all beneficiaries being sui juris could sanction, the court has no jurisdiction to extend the powers conferred on a corporation by Parliament or to approve an unlawful transaction by a corporation. The Court of Appeal in the instant case summarised the authorities cited by Miss Gloster by way of analogy and observed [1990] 2 Q.B. 697, 794 that:

"it is sometimes necessary to accept that 'What's done is done' and, even if it should not have been done, the law should lean in favour of such solution as enables the situation to be so far as possible rectified with minimum loss and inconvenience to all involved."

The Court of Appeal therefore held that the interim strategy transactions were lawful. I do not believe that the Court of Appeal would have reached the same conclusion if they had not, erroneously in my opinion, already held that a swap transaction which is a parallel contract was within the power of a local authority. No authority is needed for the proposition that the law should lean in favour of such lawful solution as enables the situation to be so far as possible rectified with minimum loss and inconvenience to all involved. No authority satisfies me that the law should lean in favour of such unlawful solution as enables the situation to be so far as possible rectified with minimum loss and inconvenience to all involved.

Accordingly swap transactions undertaken during the period of the interim strategy are no different from swap transactions entered into at any earlier period.

Finally, the banks deployed an argument, described by the Court of Appeal [1990] 2 Q.B. 697, 770A as "a somewhat arcane point." The argument proceeds on the basis that though the incorporated Hammersmith and Fulham Borough can only act by the unincorporated Hammersmith and Fulham Borough Council and though the powers of the council are limited by the Act of 1972, the borough acting by the council has all the powers of a natural person and is not confined by the Act of 1972. Therefore any swap transaction entered into by the borough was lawful. It is conceded that neither the borough nor the council could lawfully devote moneys held as part of the general rate fund in order to comply with swap transaction obligations because the general rate fund may only be expended by the council and solely for purposes authorised by the Act of 1972 and other statutes. But it is contended that there might be some property perhaps generously donated to the borough which was in some way not held by the borough acting by the council for the benefit of the ratepayers or which, although held for the benefit of the ratepayers was not subject to the same inhibitions as the general rate fund and other property held for the benefit of the ratepayers. This argument strikes me as being not so much arcane as absurd.

The argument starts with the year 1612 and the report of Sutton's Hospital Case (1612) 10 Co.Rep. 1. That report, although largely incomprehensible in 1990, has been accepted as "express authority" that at common law it is an incident to a corporation to use its common seal for the purpose of binding itself to anything to which a natural person could bind himself and to deal with its property as a natural person might deal with his own: Riche v. Ashbury Railway Carriage and Iron Co. Ltd. (1874) L.R. 9 Ex. 224, 263. The doctrine applies only to a corporation created by an exercise of the Royal Prerogative. A corporation created by or under a statute has no power except the powers granted expressly or by implication by that statute. As will appear, the corporation in the present case was a hybrid, created by Royal Charter issued pursuant to a statute. Sutton's Hospital Case did not deal with this situation.

There is a long history of the incorporation of municipalities. The Municipal Corporations Act 1835 (5 & 6 Will. 4, c. 76) and the Municipal Corporations (General) Act 1837 (7 Will. 4 & 1 Vict. c. 78) regulated boroughs already incorporated by Royal Charter and provided that upon the petition of the inhabitant householders the Crown might create a new municipal borough, incorporate the inhabitants and extend to that municipal borough and the inhabitants the provisions of the Municipal Corporations Acts. In Rutter v. Chapman (1841) 8 M. & W. 1, it was decided per Patteson J., at p. 74, that the effect of the Act of 1837 was:

"not in derogation or abridgment of the power of the Crown to grant charters of incorporation at common law, which it may still do without any petition; but it is to enable the Crown, in case of any such petition, to extend to any new corporation, when created, the powers of the Municipal Corporations Act, some of which, as for instance the taxing of the inhabitants by a borough rate, may not have been grantable by the Crown at common law. The Act does not profess to enable the Crown to grant charters, but only, if it shall think fit to grant them upon petition, to extend to the grantees, by those charters, certain powers and provisions."

In Bonanza Creek Gold Mining Co. Ltd. v. The King [1916] 1 A.C. 566 the Privy Council considered the effect of a Royal Charter granted pursuant to statute. The British North America Act 1867, by sections 12 and 65, transferred to the Lieutenant Governor of Ontario the prerogative power of incorporation in relation to the province. Section 92 of the Act of 1867 conferred exclusive power upon the provincial legislature to make laws in relation to the incorporation of companies with provincial objects. The Ontario Companies Act passed pursuant to section 92 authorised the incorporation of companies by the Lieutenant Governor. Viscount Haldane, delivering the advice of the Board, said, at p. 577:

"that it is wrong, in answering the question what powers the corporation possesses when incorporated exclusively by statute, to start by assuming that the legislature meant to create a company with a capacity resembling that of a natural person, such as a corporation created by charter, would have at common law..."

It must not be assumed, at p. 588:

"that the legislature has had a common law corporation in view, whereas the wording may not warrant the inference that it has done more than concern itself with its own creature. Such a creature, where its entire existence is derived from the statute, will have the incidents which the common law would attach if, but only if, the statute has by its language gone on to attach them....

The question is simply one of interpretation of the words used. For the statute may be so framed that executive power to incorporate by charter, independently of the statute itself, which some authority, such as a Lieutenant Governor, possessed before it came into operation, has been left intact. Or the statute may be in such a form that a new power to incorporate by charter has been created, directed to be exercised with a view to the attainment of, for example, merely territorial objects, but not directed in terms which confine the legal personality which the charter creates to existence for the purpose of these objects and within territorial limits. The language may be such as to show an intention to confer on the corporation the general capacity which the common law ordinarily attaches to corporations created by charter."

In my opinion where a statute authorises the grant of a Royal Charter, then, the extent of the powers exercisable by a corporation created by a charter granted pursuant to the statute will depend on the true construction and intent of the statute.

Under the London Government Act 1939, consolidating earlier legislation, the administrative county of London included 28 metropolitan boroughs. By section 17:

"(1)
 For every metropolitan borough there shall be a metropolitan borough council consisting of the mayor, aldermen and councillors, and the council shall have all such functions as are vested in it by this Act or otherwise.
(2)
 A borough council shall be a body corporate... and shall have perpetual succession and a common seal with power to hold land for the purposes of its constitution without licence in mortmain."

A London metropolitan borough council being created by statute could only exercise the powers conferred by statute. Neither the council nor the borough, so far as it existed apart from the council, had the powers of a natural person.

By section 1(1) of the London Government Act 1963, the metropolitan boroughs of the county of London were enlarged, re-organised and converted into London boroughs forming part of the administrative area of the Greater London Council. Section 1 of the Act of 1963 continued as follows:

"(2)
 If in the case of any London borough, on representations in that behalf made to the Privy Council by the minister, Her Majesty by the advice of her Privy Council thinks fit to grant a charter of incorporation of the inhabitants of that borough, Her Majesty may by that charter -
(a)
 make provision with the respect to the name of the borough; and
(b)
 subject to the provisions of this Act, make any provision such as may be made by virtue of section 131 of the Local Government Act 1933 by a charter granted under Part VI of that Act;
 and any charter which purports to be granted in pursuance of the Royal prerogative and this subsection shall be deemed to be valid and within the powers of this Act and Her Majesty's prerogative and the validity thereof shall not be questioned in any legal proceeding whatever.
(3)
 In the case of any London borough whose inhabitants are not incorporated by such a charter as is referred to in the last foregoing subsection, provision for their incorporation shall be made by the minister by order (hereafter in this Act referred to as an 'incorporation order') which may include any such provision as is mentioned in paragraph (a) or (b) of that subsection...
(6)
 The Municipal Corporations Act 1882 shall apply to every London borough and... the expression 'borough' when used in relation to local government... shall... include a London borough; and the council of a London borough shall be a local authority..."

The Act of 1963 did not confer and showed no intention of conferring on London boroughs or their councils any power exceeding the statutory power formerly exercised by metropolitan borough councils.

Under the Act of 1963 every London borough was bound to be incorporated, either by the Crown under section 1(2) or by the minister under section 1(3). Nevertheless the banks argue that it is possible that some swap transactions were entered into by the council and that other swap transactions were entered into by the borough acting by the council. Swap transactions entered into by the council would be unlawful for the reasons I have already indicated but, say the banks, swap transactions entered into by the borough acting by the council would be lawful because the borough which was, in 1964 incorporated by the Crown, possessed all the powers of an actual person. If the argument for the banks is correct, the Act of 1963 had the effect of dividing London boroughs into two classes. The first class incorporated by the Crown upon the representations of the minister would have all the powers of a natural person. The second class, incorporated by the minister, would have only the powers conferred by statute. Yet both classes of London boroughs would fulfil exactly the same functions by exactly the same machinery. Councils of both classes whether or not acting on behalf of the borough would be constrained by the limitations on their powers imposed by statute. In my opinion the Act of 1963 intended and provided that every London borough should be constrained by statute. This does not mean that Parliament intended or provided for any restraint on the Royal Prerogative. The Crown retained the right, in theory at any rate, to incorporate a London borough otherwise than on the representation of the minister and in sole exercise of the prerogative. But if the Crown elected to incorporate a London borough pursuant to the Act of 1963 then in my opinion the combined effect of the statute and the Charter was to create a statutory corporation.

A Royal Charter dated 10 March 1964 referred to the Act of 1963 and recited that representations for incorporation had been made by the minister in accordance with the Act. The grant of incorporation was expressed to have been made "by virtue of our Prerogative Royal and in pursuance of the London Government Act 1963 and of all other powers and authorities enabling us in this behalf." The charter ordered and declared as follows:

"1.
 The London borough comprised of the areas of the existing metropolitan boroughs of Fulham and Hammersmith (hereinafter referred to as 'the borough') shall be named 'the London Borough of Hammersmith.'
2.
 The inhabitants of the borough shall be and are hereby incorporated by the name of 'the mayor, aldermen and burgesses of the London Borough of Hammersmith' with perpetual succession and a common seal...."

In my opinion that charter made pursuant to the Act of 1963 did not confer on the borough or the council any greater power than the statutory power exercisable by any other London borough. On 1 September 1979 the name of the borough was changed to the "London Borough of Hammersmith and Fulham."

There is a further obstacle to the argument of the banks. By Schedule 2, paragraph 1(2) of the Act of 1972:

"For every London borough there shall be a council consisting of the mayor and councillors and the council shall exercise all such functions as are vested in the municipal corporation of the borough or in the council of the borough by this Act or otherwise."

The council is constrained by statute and cannot enter into swap transactions. In my opinion the council cannot ignore their statutory constraints and lawfully exercise in the name of the borough a power which upon the true construction of the statutory powers of the council was not open to the council. For example, the council is restrained by Schedule 13, paragraph 1 of the Act of 1972 from borrowing in a foreign currency without the consent of the Treasury. The council could not lawfully without the consent of the Treasury borrow in a foreign currency in the name of the borough. So in the present case the council has no power to carry out swap transactions either in its own name or in the name of the borough.

In the final result the council had no power to enter into the swap transactions which are recorded in the Capital Markets Fund Account kept by the council. By section 19 of the Local Government Finance Act 1982:

"(1)
 Where it appears to the auditor carrying out the audit of any accounts under this part of this Act that any item of account is contrary to law he may apply to the court for a declaration that the item is contrary to law except where it is sanctioned by the Secretary of State."

The auditor is responsible for auditing the accounts of the council.

"(2)
 On an application under this section the court may make or refuse to make the declaration asked for, and where the court makes that declaration, then... it may also...
(c)
 order rectification of the accounts.
(5)
 On an application or appeal under this section relating to the accounts of a body, the court may make such order as the court thinks fit for the payment by that body of expenses incurred in connection with the application or appeal by the auditor or the person to whom the application or appeal relates or by whom the appeal is brought, as the case may be."

In the present case the Divisional Court on 1 November 1989 made certain orders and declarations. In particular:

"It is ordered and declared that the items of account appearing within the capital markets fund account of the council of the London Borough of Hammersmith and Fulham for the financial years beginning on 1 April 1987 and 1 April 1988 are contrary to law. It is further ordered that the accounts of the said council for the financial years beginning on 1 April 1987 and 1 April 1988 be rectified with liberty to the parties to apply if what is required to rectify the said account is not agreed."

These orders were varied by the Court of Appeal but in my opinion should now be restored in their original form.

The Divisional Court made certain orders with regard to costs and expenses. These orders were not varied by the Court of Appeal and should stand.

The Court of Appeal ordered that one half of the cost of the bank incurred in the appeal should be paid by the auditor. This order should be discharged.

The auditor having succeeded in this House against the banks is entitled to an order for his costs of the appeal to the Court of Appeal and the appeal to this House to be taxed and paid by the banks. The council must bear their own costs of the appeal to the Court of the Appeal and the appeal to this House.

The auditor seeks under section 19(5) of the Act of 1982 an order against the council for his expenses (so far as they exceed taxed costs) incurred in the appeal to the Court of Appeal and in the appeal to this House. These expenses if not paid by the council will form part of the general expenses of the audit and supervision of public authorities borne by the taxpayer. Since the council was not responsible for the appeal to the Court of Appeal or the appeal to this House and since the appeal dealt with questions of general importance, no order for the council to pay the expenses of the auditor should be made.

Case Judgement
Table of contents
  Order
  Judgment by Lord Keith of Kinkel
  Judgment by Lord Brandon of Oakbrook
  Judgment by Lord Templeman
  Judgment by Lord Griffiths
  Judgment by Lord Ackner


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