This guidance note is in four parts:
Overarching principle - compensation for financial D & C losses
How is our methodology different from the one used in the Customer Review?
General approach to assessing D & C losses as a result of the IAR Fraud
Establishing the Actual Scenario
Cash inflows from:
Cash outflows from:
Relevant Period – Actual Scenario
Say the Company entered the IAR in December 2003, from which point it was immediately exposed to the fraudulent activity through interaction with the criminals.
The first financial impact of the fraud might have been a loan advanced by the Bank in March 2004.
Hence in this example the Company began to be financially affected by the fraudulent activity from March 2004 onwards, which would mark the start of the Actual Scenario.
Constructing the Non-Fraudulent Scenario
What would a Hypothetical Reasonable Bank have done in the Non-Fraudulent Scenario?
Would a Hypothetical Reasonable Bank have simply continued to support the business in the ordinary way by providing an appropriate overdraft or credit facility for its needs?
Or if the Company was in financial difficulty would a Hypothetical Reasonable Bank have restructured the terms of the existing finance facilities, or advanced additional loans or overdrafts?
Or would a Hypothetical Reasonable Bank have used its powers as a creditor to put the Company into some form of administration or liquidation process, and if so when?
What would Company management, or Shareholders, have done in the Non-Fraudulent Scenario?
Would management have sold/acquired assets, continued or ceased certain trading activities, or made loans or injected funds?
What would the outcome have been for the Company?
Would the Company have been able to operate within its existing credit facilities without the need for further finance?
Would it have been able to service a bridging loan and within a few months been generating sufficient trading profits to start to re-pay a Hypothetical Reasonable Bank in instalments?
Would it have succeeded in obtaining alternative financing if a Hypothetical Reasonable Bank had withdrawn support?
Different cash flows may arise from different events occurring (such as an immediate pre-packaged sale and administration in the Non-Fraudulent Scenario, compared to continuation of a loss-making business for longer than was appropriate due the fraudulent activity).
Or similar decisions might have been made in the Non-Fraudulent Scenario, but with different financial results - e.g. management may have decided to sell part of the business, but the proceeds would have been higher if the assets had been sold at arm’s length to entities not involved in the fraud.
Relevant Period – Non-Fraudulent Scenario
Say the first cash flows affecting the Company due to the IAR Fraud were a loan advanced by the Bank in March 2004, whereas in the Non-Fraudulent Scenario a Hypothetical Reasonable Bank may have continued to provide support through an overdraft facility.
Say, in the Actual Scenario QCS fees were paid in late 2004 and then in 2005 part of the business was sold at a loss under the influence of the fraudsters, whereas in the Non-Fraudulent Scenario there would no QCS fees paid and the business would have continued to trade.
The end date could be the date of the Company’s closure if it had been honestly, properly and reasonably placed into an insolvency process by a Hypothetical Reasonable Bank.
Or, if the business had been struggling, but based on realistic assumptions it could have been turned around, it could be the date that the Company might subsequently have been sold for a profit.
If a Director/Manager suffered reputational damage from association with the fraudsters and this meant that they could not start a new business or gain suitable employment after their Company had closed, the financial impact through loss of earnings could have continued for many years after the IAR Fraud had ended.
The loss of a family home due to the IAR Fraud could potentially continue to have a negative impact on an individual’s financial position even today, even if, say, the Company had in the Actual Scenario been closed down years ago by the Bank.
Financial loss arising from attempts to avoid the fraudulent activity
The chance of certain events occurring
Assume that in a Non-Fraudulent Scenario, we consider there was a 30% chance of a venture capitalist stepping in and injecting funds, and that this would have saved the Company from an insolvency process and ultimately ensured its survival. Assume also that the positive cash impact for a Director/Manager was, say, £100,000 better overall than under the Actual Scenario, had this occurred.
This would mean that the amount of financial loss to the Customer would be £30,000 (i.e. being the loss of a 30% chance of getting £100,000). This follows established legal principles that we will use to guide us governing hypothetical loss of chance situations.
D & C losses are calculated net of any gains
If a Director/Manager lost £500,000 in the Actual Scenario (e.g. in loans to the Company that were written off), but they would only have lost £100,000 in the Non-Fraudulent Scenario (after taking into account the chances of the events leading to this happening), the loss would be the difference between the outcome in the two Scenarios, i.e. £400,000.
Compensatory Interest Rate – 8% per year
If we consider that in the Non-Fraudulent Scenario a Customer would have been better off by £ 100,000 in 2004 and by £ 300,000 in 2005 compared to the Actual Scenario, we will add simple interest to each of those amounts at 8% per year (that is, £ 8,000 per year in respect of the £ 100,000 amount and £ 24,000 per year in respect of the £ 300,000 amount) for every year from the respective date of deprival up to the date of assessment in the Re-Review.
Amounts previously awarded by the Bank in the Customer Review
Additional debt relief, following the Cranston Review