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Derivatives decisions may open floodgates

Recent decisions by the Financial Ombudsman Service on the mis-selling of derivatives to small businesses could "open the floodgates" to legal settlements, a Scottish law firm claims.

MBM Commercial, which is acting for a number of firms against banks, said a recent judgment in favour of RBS in the Court of Session had "dampened Scottish SMEs' desire to go down the court route".

In the judgment, which came after the Financial Services Authority set up a review into past sales of interest rate swap agreements (IRSAs), Lord Hodge decided RBS had not breached any statutory or common law duties, as it was protected by a contract saying it had not advised the customer.

But two recent provisional decisions by financial ombudsman Tony Boorman, in favour of SMEs, "have come as a welcome surprise", MBM partner Cat McLean wrote in her firm's blog.

"In both cases the product was made a precondition of a loan, which has also been the case for most of MBM's mis-sold clients," the lawyer said.

Mr Boorman concluded the banks "had been driven by an imperative to sell more of the interest rate hedging products to SMEs, rather than a thoughtful assessment of the clients' interests and needs".

The ombudsman also ruled that where the bank supposedly gave "no advice" the bank should have drawn the SME's attention "to the significant breakage costs".

Ms McLean noted: "The SMEs, similarly to most of the mis-sold SMEs in the UK, did not expect the breakage charges to be so onerous and at worst expected them to be a few months' interest payments. Crucially, nowhere in the documentation made available to the SMEs (either before or immediately after the transaction) was there a clear statement of the possible scale of the fees involved in cancellation."

Mr Boorman concluded that whether or not advice was given, the banks had encouraged a focus on short-term rates while effectively hiding the potential long-term impact. The blog states: "That had the effect of tieing the SMEs into long-term arrangements that had not met their needs."

The lawyer said that although ombudsman decisions were not binding on Scottish courts, the two recent decisions suggested the regulatory attitude towards banks' liability was changing. "If the courts are now minded to follow the ombudsman's reasoning, then this may finally open the floodgates for mis-sold SMEs."

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