Hazell v. Hammersmith and Fulham London Borough Council and Ors; Hammersmith and Fulham London Borough Council v. Hazell and Ors
 2 AC 1
 1 All ER 545
(Judgment by: Lord Ackner)
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
House of Lords
Lord Keith of Kinkel
Lord Brandon of Oakbrook
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
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
Attorney-General v. Great Eastern Railway Co. - (1880) 5 App.Cas. 473, H.L.(E.)
Attorney-General v. Mersey Railway Co. -  A.C. 415, H.L.(E.)
Bonanza Creek Gold Mining Co. Ltd. v. The King -  1 A.C. 566, P.C.
Cotman v. Brougham -  A.C. 514, H.L.(E.)
Holsworthy Urban District Council v. Holsworthy Rural District Council -  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 -  1 K.B. 223;  2 All E.R. 680, C.A.
Attorney-General v. Fulham Corporation -  1 Ch. 440
Attorney-General v. Leeds Corporation -  2 Ch. 291
Attorney-General v. London County Council -  1 Ch. 781, C.A.;  A.C. 165, H.L.(E.)
Attorney-General v. Manchester Corporation -  1 Ch. 643
Attorney-General v. Newcastle upon Tyne Corporation - (1889) 23 Q.B.D. 492, C.A.;  A.C. 568, H.L.(E.)
Attorney-General v. Smethwick Corporation -  1 Ch. 562, C.A.
Attorney-General for Ceylon v. Silva -  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 -  Ch. 131;  2 W.L.R. 465;  1 All E.R. 634
Bell Houses Ltd. v. City Wall Properties Ltd. -  2 Q.B. 656;  2 W.L.R. 1323;  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 -  A.C. 520;  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. -  A.C. 691, H.L.(E.)
Dickson v. Pharmaceutical Society of Great Britain -  A.C. 403;  3 W.L.R. 286;  2 All E.R. 686, H.L.(E.)
Dundee Harbour Trustees v. D. & J. Nicol -  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. -  Ch. 199;  2 W.L.R. 791;  1 All E.R. 887, C.A.
McDowell v. Standard Oil Co. (New Jersey) -  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 -  A.C. 317, P.C.
New, In re -  2 Ch. 534, C.A.
Provident Mutual Life Assurance Association v. Derby City Council -  1 W.L.R. 173, H.L.(E.)
Reg. v. Greater London Council, Ex parte Burgess -  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 -  2 A.C. 48;  2 W.L.R. 1294;  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 -  Ch. 246;  2 W.L.R. 908;  3 All E.R. 52, C.A.
Seagram v. Knight - (1867) L.R. 2 Ch.App. 628
Sinclair v. Brougham -  A.C. 398, H.L.(E.)
Smith v. Croft -  B.C.L.C. 355
Stockdale v. Haringey London Borough Council - (1989) 88 L.G.R. 7, C.A.
Swain v. The Law Society -  1 A.C. 598;  3 W.L.R. 261;  2 All E.R. 827, H.L.(E.)
Triggs v. Staines Urban District Council -  1 Ch. 10;  2 W.L.R. 1433;  2 All E.R. 1
Turner v. Shearer -  1 W.L.R. 1387;  1 All E.R. 397, D.C.
Wenlock (Baroness) v. River Dee Co. - (1887) 36 Ch.D. 674
Westminster City Council, In re -  A.C. 668;  2 W.L.R. 807;  2 All E.R. 278, H.L.(E.)
Wheeler v. Leicester City Council -  A.C. 1054;  3 W.L.R. 335;  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
My Lords, the legality of interest swaps by local authorities - the determination of the issue - are interest swap transactions capable of being within the powers of local authorities - depends, in my judgment, on the answer to a single question - are interest swap transactions incidental to the borrowing powers conferred upon local authorities by statute?
So expressed, it emphasises that which I consider so important, namely, that the word "incidental" must be construed in its context and not in isolation.
The question is so formulated by reason of the provisions of section 111(1) and (3) of the Local Government Act 1972 which provide:
- subject to the provisions of this Act... a local authority shall have power to do any thing (whether or not involving the... borrowing... of money...) which is... incidental to the discharge of any of their functions.
- A local authority shall not by virtue of this section raise money, whether by means of... borrowing, except in accordance with the enactments relating to those matters."
Since section 111 is expressly made "subject to the provisions of this Act," regard must be had to the other provisions of the Act and in particular to section 172 which provides:
"Part 1 of Schedule 13 to this Act shall have effect with respect to the powers of local authorities to borrow and lend money and with respect to their funds..."
I accept that "functions" in section 111(1) covers the powers and duties of the local authority under the various provisions of the Act. The function with which your Lordships are concerned is the power to borrow. Schedule 13 of the Act contains extremely detailed provisions dealing with the powers of the local authority to borrow money. The Schedule provides a high degree of limitation and control of those powers. Part I of the Schedule in effect contains a detailed code as to the powers of local authorities to borrow and lend money. Paragraph 8 is of particular significance since it provides:
"A local authority who borrow money under paragraph 1(b) above 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."
It would thus appear that "debt or interest management" has been narrowly confined. Given this express limited power then I would expect to find that any additional such power would also need to be given in express terms in the statute. No such power is to be found.
The purpose and function of swap transactions is not to facilitate, to help, or to make more easy the discharge by the local authority of its function of borrowing. The original underlying debt or debts continue in existence and are all unaffected by the swap transactions. In many cases the swap transactions are entered into long after the underlying borrowing and probably were not even in contemplation when such borrowing took place. The function and purpose of the swap transactions is to alleviate the consequences of borrowing by the local authority purchasing what has been conveniently called "a stream of income" or "a cash flow" which will enable it to reduce the nett cost of its borrowing. In the words of Mr. Sumption, appearing for Barclays Bank, interest swap transactions are "a risk mitigating activity." They are designed not to meet any specific loss but to seek to ensure that the local authority pays as little interest on its loans as can be achieved. In this respect they are indistinguishable from any other transaction which involves the hope of gain, which gain is intended to reduce a risk attendant on an underlying transaction. Although the phrase "debt management" may be a convenient one, swap transactions in fact leave the debt wholly unmanaged.
Even in the most limited form of "hedging" the swap transaction involves the local authority incurring the following risks.
- That the movement of interest rates will be contrary to what is anticipated, with the result that the local authority will have wasted the transaction costs, that is the money paid to its brokers for arranging the swap.
- The credit risk that the opposite party to the transaction may default.
The "parallel" swap doctrine propounded by the Court of Appeal, which is not espoused by Mr. Sumption, if it were to provide an appropriate limitation on what would otherwise be very extensive powers, needs careful definition, which is not to be found in the Court of Appeal's judgment. There are frequent references in the judgment to the need for "a linkage" with a particular debt or a particular borrowing. How close this linkage must be, is nowhere stated.
I have found the position of building societies helpful. The Building Societies Act 1986 conferred on building societies a power, which did not previously exist, to enter into a limited category of swap transactions. Subsequently in the Order of 1988 Parliament radically extended this power. It was clearly Parliament's policy to proceed gradually with this new market so as to ensure adequate public protection. Parliament's concern to protect ratepayers from excessive borrowing or lending by local authorities is clearly demonstrated by the restrictions imposed by Schedule 13. To leave ratepayers unprotected from unlimited resort to the swap market would clearly run counter to this policy. This litigation demonstrates forcibly the considerable risks involved in these transactions, and how serious wrong decisions can be. Whether or not local authorities should be empowered to use this market raises important questions of policy. Parliament may or may not be satisfied that there is sufficient need to justify the risks involved even in limited hedging operations. The evidence before your Lordships was that 80-90 per cent. of local authority borrowing was achieved through the Public Works Loan Board at advantageous fixed interest rates. To "hedge" such borrowing with variable rate interest swaps would be to move from certainty to uncertainty. Whether or not power should be given to local authorities to engage in interest swaps and if so the nature of those swaps, involves a balancing operation - balancing the advantages against the risks in the light of the overall need for such activity. This is essentially a matter that should be left to Parliament, which, as with building societies, may wish to proceed, if at all, by stages.
I therefore conclude that swap transactions are essentially speculative methods of raising money in the hope of reducing the burden of interest payable on money already borrowed. They are a separate and distinct activity - a form of diversification. In view of the circumscribed power of borrowing conferred by the statute (see in particular Schedule 13, Part I of the Act) interest swap activities cannot be treated as incidental to the function of borrowing conferred upon local authorities by the Act.
It is common ground that the power to carry out the interest swap activities involved in the interim strategy must be derived from the statute. Thus once again your Lordships are brought back to section 111. Once more an underlying function must be identified, to which the interim strategy activities were incidental. However on this occasion the underlying function cannot be the original borrowing. The interim strategy activities were clearly incidental to the initial ultra vires activities of unlawful interest swapping, since the purpose and function of the interim strategy activities was to mitigate the damage done by, or the risks outstanding arising from, the unlawful interest swaps. Where then is the lawful underlying function to be found?
Miss Gloster, who appeared on behalf of the banks, other than Barclays Bank, in her able argument suggested that this function arose:
- under section 111 of the Local Government Act 1972 and was comprised in the duties of a local authority to hold and preserve ratepayers' funds.
- Even were I to assume, and I am not persuaded that it would be right to do so, that the obligation of a local authority to exercise proper care with regard to these activities is a function within the meaning of section 111, that obligation can only be discharged by lawful means;
- under section 151 by reason of the local authority's duty to "make arrangements for the proper administration of their financial affairs...."
Section 151 is however concerned with administrative matters and once again I am not persuaded it provides any "function" within the meaning of section 111. However were it to do so, then in discharging its obligations and duties under this section, the local authority is only entitled to have resort to lawful, as opposed to unlawful activities.
Miss Gloster accepted that all the interim strategy activities took place in the swap market. Indeed this was a part of the strategy, since otherwise it might have been disclosed that there was considerable doubt about the legal validity of the earlier transactions. Although there were clearly different categories of swap activities involved, as a matter of principle they could not be differentiated for the purpose of deciding the lawfulness of the transactions. I therefore conclude that the only underlying activity to which the interim swap activities were incidental was the original ultra vires interest swaps. Accordingly they suffered likewise from the same stigma of being unlawful.
For the above reasons and for those set out so much more fully by my noble and learned friend, Lord Templeman, I too would dismiss these appeals and make the identical consequential orders.
Respondent banks to pay the costs of auditor in Court of Appeal and in House of Lords.
Solicitors: A. A. Child; Herbert Smith; Clifford Chance; Linklaters & Paines.
Local Government Act 193, s. 1(2): see post. p. 41F-G.
Local Government Act 1972, s. 111(1): see post,p. 28G-H.
Local Government Finance Act 1982, s. 19: see post, p. 43E-G.