The Bottom Line
- Scrutinize termination and restructuring costs. Banks can be held liable for undisclosed margins applied when terminating or restructuring derivative contracts, even if an initial margin was expected. A client is entitled to the true market value unless other fees are explicitly agreed upon.
- A promise is a promise. A bank’s assurance that a contract’s value will remain unchanged through a restructuring is a binding commitment. If new terms secretly worsen the client’s financial position, the bank is liable for the difference.
- General risk warnings still matter. While a bank may be found liable for specific misrepresentations, courts will still hold that companies are expected to understand the fundamental risks of derivatives (like negative market value) if they have been adequately warned.
The Details
In a significant ruling following a referral from the Dutch Supreme Court, The Hague Court of Appeal has found a major bank liable for causing financial harm to a corporate client through its handling of interest rate swap agreements. The court identified two key breaches of contract and its duty of care.
The first breach involved the early termination of a swap in 2008. The court found that while the swap had a positive market value of nearly €847,000, the bank only paid out €765,000, unilaterally withholding a margin of approximately €82,000. It ruled that while a margin upon initiating a swap is expected, the client had no reason to anticipate an additional, undisclosed margin being applied upon termination. The agreement was to settle at market value, and the bank’s failure to do so constituted a breach.
The second, more substantial, breach occurred when another swap was extended in 2012. The bank explicitly assured the client that the swap’s existing negative market value of approximately €5.5 million would remain the same after the extension. However, the court found that the new terms were structured in such a way that they immediately increased the negative value by over €630,000. The court treated the bank’s assurance as a binding commitment. By building this hidden cost into the restructured deal, the bank broke its promise and misled its client. Consequently, the court ordered the bank to compensate the client for this full amount, treating it as direct damage.
However, the ruling also clarifies the limits of a bank’s liability. The court dismissed the client’s other claims, which alleged that the bank provided poor advice when the original swaps were initiated. It held that the bank had provided sufficient warnings about the inherent risks, including the potential for negative market value and the risk of a mismatch between the swap’s duration and the underlying loan. Furthermore, the court confirmed the established principle that a client should reasonably expect a bank to earn a margin when entering into a financial product. This decision draws a clear line: liability arises not from the disclosed, inherent risks of a product, but from specific misrepresentations, broken promises, and hidden costs that violate the terms of the agreement.
Source: Gerechtshof Den Haag
