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Law360, London (May 27, 2020, 5:35 PM BST) -- The COVID-19 crisis is poised to spur enforcement action and litigation over potential misconduct involving billions of pounds in emergency funding dished out under Britain's government-backed coronavirus lending schemes.
Britain's City watchdog already fired an early warning shot at lenders over their conduct, saying in April that it had "credible reports" of a small number of banks treating corporate clients in financial difficulty unfairly when negotiating new or existing debt facilities.
In a strongly worded letter to the bosses of U.K. lenders, the FCA said it had been made aware that some unidentified banks had abused their lending relationship with clients to pressure companies into handing them roles on equity finance raisings that they otherwise would not have obtained.
"You might have customers saying, 'We were pressured into these arrangements, we survived and are now stuck with an agreement that was not in our best interests at the time,'" said Peter Dodge, a barrister at Radcliffe Chambers specializing in banking and financial services disputes.
In some cases, these roles were essentially in name only, with the bank providing few or no additional services to earn a share of the fees, the FCA said. Such conduct would likely increase companies' transaction costs and calls the integrity of firms and individuals into question, according to the watchdog.
The FCA warned that tying clients to additional services, or demanding fees for services not provided, would potentially violate U.K. regulations governing standards of market conduct, acting in clients' best interests and preventing conflicts of interest.
It is not just institutions that could face sanctions. The FCA spelled out in its "Dear CEO" letter — used to highlight specific issues of concern that have arisen in certain industry areas — that individuals subject to the Senior Managers Regime may also be at risk of investigation and enforcement.
"The more they emphasize the Senior Managers Regime, the more they are implying the possibility of enforcement proceedings against individuals," Dodge said. "It is a warning shot."
The FCA said it "will be looking into this further," warning that it will take action if it finds further evidence to support its concerns, "as this conduct has no place in well-functioning markets."
And anyone on the losing end of an enforcement action could well see litigation follow, according to Dodge.
"When you are looking at a misselling case, guidance from a regulator can be manna from heaven. It changes the parameters," he said. "Claims tend to be stronger once there has been some FCA guidance. You have got what you must or mustn't do on paper. That obviously can strengthen a case."
The objective of the letter, the FCA said, is to prevent a "repeat of the well-documented historic issues in the treatment" of small businesses.
Small companies have complained about treatment by banks in the past, for example, accusing Royal Bank of Scotland's global restructuring group of "systemic and widespread" mistreatment of small and medium-sized business customers between 2008 and 2013.
But according to Dodge, it is too early to see the sort of behavior that took place during the banking crisis, where banks were accused of trying to to asset-strip their financially distressed clients.
"I haven't seen any indication of this sort of thing going on," Dodge said.
But nevertheless, there will "almost inevitably be claims with hindsight," including allegations lenders shouldn't have pulled the plug on a company's finances for some benefit.
"There's clearly potential for litigation in due course," Dodge said.
The scrutiny has come as U.K.-listed companies have raised billions of pounds in debt and equity finance in response to the coronavirus pandemic — either by tapping government-backed lending schemes or by issuing new shares.
The U.K. launched a coronavirus business interruption loan scheme in March, offering loans of up to £5 million ($6.1 million) for which the government guarantees 80% of the loan, but banks will be liable for the remaining 20% if borrowers default. That was later extended to other, larger companies, which could secure loans of up to £25 million, while businesses with turnover of more than £250 million could gain loans of up to £50 million.
A further program of 100% government-backed "bounce back" loans to sole traders and micro-businesses was announced in April, offering firms loans up to £50,000 within days of applying. It aims to unlock a backlog of credit checks by banks amid fears many small firms could fold before getting loans.
Lenders have approved £27.5 billion to more than 650,000 businesses so far through the three major government-backed lending schemes, according to figures published by the government's finance department on May 27.
"Some banks thought they had their business customers over a barrel at the start of the crisis. The message from the FCA to banks is that if they apply pressure to their business customers to take products outside available government schemes they may well be committing offences under the Financial Services and Markets Act," said John Gibson, a partner at Cohen & Gresser LLP. "The FCA has put a very firm stake in the ground."
But the schemes are equally "ripe for exploitation" by fraudsters, which could give rise to fraudulent misrepresentation claims on behalf of the banks, according to Fieldfisher LLP partner Tony Lewis.
"We see a huge number of people taking advantage of easy money and taking advantage of a banking system backed by the government. I can see this as a big area that will be used by fraudsters," Lewis said. "It will be more a case of borrowers taking advantage of lenders rather than the other way round."
The FCA has also agreed to give banks more flexibility over compliance with certain rules by relaxing financial crime checks on existing customers seeking loans during the COVID-19 crisis to speed up the rate at which companies can get emergency loans.
Rules will mainly be relaxed only for existing bank customers, who are deemed less of a risk for fraud or money laundering. The regulator has said the standard checks should apply to new customers, but that lenders should use their discretion.
Gibson said he believes there could be widespread abuse of the schemes, which he likened to the United Nations' oil-for-food program in the 1990s — originally conceived as a means of providing humanitarian aid to the Iraqi people — that fell prey to systematic fraud.
"The U.N. oil-for-food grant was a massive opportunity to claim funds from a well-funded and well-intentioned project. It took years to chip away at all the fraudulent claims," he said. "This is like the oil-for-food program on acid."
--Additional reporting by Joanne Faulkner. Editing by Marygrace Murphy.
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