Case No: 2008 Folio 1320 IN THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION COMMERCIAL COURT
Royal Courts of Justice Strand, London, WC2A 2LL Date: 4 September 2009 Before :
THE HON. MR JUSTICE TOMLINSON - - -
Between :
HAUGESUND KOMMUNE
NARVIK KOMMUNE
Claimants - and -
DEPFA ACS BANK Defendant
- and -
WIKBORG REIN & CO Third Party - - -
- - -
Iain Milligan QC and Sean Snook (instructed by Messrs Macfarlanes) for the Claimants David Railton QC and Andrew Fulton
(instructed by Messrs Denton Wilde Sapte) for the Defendant Gregory Mitchell QC and Richard Brent
(instructed by Messrs Reynolds Porter Chamberlain) for the Third Party
Hearing dates: 22, 23, 24, 27, 28, 29 and 30 April, 1, 5, 7 and 8 May 2009 - - -
Approved Judgment
I direct that pursuant to CPR PD 39A para 6.1 no official shorthand note shall be taken of this Judgment and that copies of this version as handed down may be treated as authentic.
...
THE HON. MR JUSTICE TOMLINSON
The Hon. Mr Justice Tomlinson : Introduction
1. The Claimants in this action are Norwegian municipalities. The municipalities are at the bottom of the three-tier system of government in Norway, beneath the central government and the nineteen county authorities. There are 430 municipalities. They are autonomous bodies although their powers are limited by legislation. They are led by directly elected assemblies and have their own administrative officers. I shall refer to the Claimants as “Haugesund” and “Narvik” respectively.
2. The Defendant is an Irish bank, a subsidiary of Depfa Bank plc, which is owned by a German company. It specialises in public sector lending outside Germany. I shall refer to it as “Depfa”.
3. To English eyes the litigation has some familiar features. Haugesund and Narvik were advanced money by Depfa pursuant to contracts which were called “swaps”.
Having invested imprudently the money advanced, sustaining massive losses, the municipalities deny their liability to the bank to repay the advances, relying upon their alleged lack of capacity ever to have entered into the transactions with Depfa in the first place. They rely upon a provision in the Norwegian Local Government Act 1992 which restricts their borrowing powers.
4. The transactions were the brainchild of Norwegian financial advisers Terra Fonds AS, subsequently Terra Securities ASA. I shall refer to this company as “Terra”.
Haugesund and Narvik acted on the advice of Terra, both as to the advances from or
“swaps” with Depfa and as to the disastrous investments made with the proceeds thereof. In November 2007 the financial supervisory authority of Norway, Kredittilsynet, warned Terra that the revocation of its licence to provide financial services was under consideration on the grounds of its systematic violation of its duties. Terra’s response was to petition for bankruptcy the following day. It is now in insolvent liquidation.
5. The Third Party in this litigation is Wikborg Rein & Co. Wikborg Rein is a well- known and highly respected firm of lawyers in Norway. Before entering into the
“swap” agreements with Haugesund and Narvik Depfa sought the advice of Wikborg Rein on the question whether the municipalities had the power and authority to enter into them, which transactions Depfa pointed out were in fact loans. Wikborg Rein advised in unequivocal and unqualified terms that for the purposes of the Norwegian legislation the “swaps” were not in fact to be regarded as loans and that the municipalities had full power and authority to enter into and perform the agreements.
In the event that it cannot recover, or recover in full, from the municipalities Depfa claims damages against Wikborg Rein for breach of contract and negligence.
6. Haugesund and Narvik are not the only Norwegian municipalities to have entered into transactions such as I have described in reliance upon advice from Terra. I am told that the episode is in Norway regarded as something of a national scandal. Litigation is apparently pending in Norway. Although the “swap” agreements are governed by English law, the approach of English law is to regard the question whether the municipalities had capacity to enter into the contracts as governed by the law of Norway, the law pursuant to which the municipalities are constituted. The liability of
Wikborg Rein to Depfa is also governed by Norwegian law, although it is no longer suggested that in the relevant respects the law of Norway is any different from the law of England. The duties owed by Wikborg Rein to Depfa are the same as the duties which English law would in such circumstances regard as undertaken. However the impugned advice of Wikborg Rein relates to the capacity of the municipalities, or more immediately to the application of the Norwegian Local Government Act, both questions of Norwegian law. In these circumstances it is I think unfortunate that the English court should have to resolve this litigation before there is available from the Norwegian courts guidance on the central issue of Norwegian law, underlying as it does the Terra scheme which has resulted in widespread losses for municipalities in Norway. However the “swaps” are, as I have already mentioned, by express choice of the parties governed by English law and provide for the jurisdiction of the English court. Haugesund and Narvik have invoked the jurisdiction of the court, seeking on an expedited basis declaratory relief as to their non-liability to Depfa. Depfa for its part counterclaims in restitution in the event that the “swaps” are unenforceable against the municipalities. That counterclaim is governed by English law and Depfa is entitled to ask the English court to decide it, just as the municipalities are entitled to ask the English court for a declaration of non-liability. Wikborg Rein has not contested the jurisdiction of the English court and indeed could not successfully have attempted so to do. All parties invite the English court to resolve the disputes of which it is seised. It was only very shortly before the trial began that I became aware that Narvik is a defendant in Norway to a claim brought by a Norwegian bank arising out of a similar “swap” transaction. It is the contention of Mr Iain Milligan QC, for the municipalities, that the English court lacks the power to defer determination of the dispute until after the central issue has been considered by a Norwegian court. I do not need to decide whether that is so. However much I regret the lack of guidance from the Norwegian court, it quite quickly became plain to me that this court must now proceed to resolve the disputes of which it is properly seised and for the determination of which the parties had made expensive preparation.
Background
7. Many of the Norwegian municipalities have available to them in addition to locally raised taxes a source of revenue derived from the presence of power generating plants within the municipality. In some cases this is simply an entitlement to purchase electricity at a concessionary price and then to resell it at market price. In the case of Haugesund it is, relevantly, dividend and interest revenue which it derives from its shareholding in the local generating company Haugaland Kraft AS. In the case of Narvik it is, relevantly, a property tax imposed on power stations within the municipality. The basis for property taxation of power stations is the market value of the station, calculated according to a formula which has regard to a rolling average of the last five years’ sales revenue minus operating costs. Norwegian municipalities enjoy a good credit rating.
8. It would seem that in 2001 Terra proposed to the municipality of Vik that it could increase its income by borrowing, at low cost, reflecting its good credit risk, the present value of its expected revenue from the resale of concessionary electricity and investing the proceeds in financial markets at a higher rate of return. The repayment schedule would reflect the expected revenues from the resale of electricity. No details are available of this transaction, except that it resulted in a “swap” agreement between
DnB Markets, a Norwegian bank, and Vik and the consequent investment of funds by Vik in the financial markets. However it seems that the “interest rate swap” must have been a “zero coupon swap” whereunder the sole obligation of the bank was to pay to Vik the discounted present value of Vik’s expected revenue from the resale of electricity over the next ten years, with the liability of the bank to pay interest reduced to zero.
9. In Westdeutsche Landesbank Girozentrale v Islington London BC [1996] AC 669 Lord Goff explained how an interest rate swap works and how it can become a form of borrowing. At page 680 he said this:
“Under such a transaction, one party (the fixed rate payer) agrees to pay the other over a certain period interest at a fixed rate on a notional capital sum; and the other party (the floating rate payer) agrees to pay the former over the same period interest on the same notional sum at a market rate determined in accordance with a certain formula. Interest rate swaps can fulfil many purposes, ranging from pure speculation to more useful purposes such as the hedging of liabilities. They are in law wagers, but they are not void as such because they are excluded from the regime of the Gaming Acts by section 63 of the Financial Services Act 1986.
One form of interest rate swap involves what is called an upfront payment, i.e. a capital sum paid by one party to the other, which will be balanced by an adjustment of the parties’
respective liabilities. Thus, as in the present case, the fixed rate payer may make an upfront payment to the floating rate payer, and in consequence the rate of interest payment by the fixed rate payer is reduced to a rate lower than the rate which would otherwise have been payable by him. The practical effect is to achieve a form of borrowing by, in this example, the floating rate payer through the medium of the interest rate swap transaction.”
In the present case both parties were described as “fixed rate payers” with the rate of interest payable by Depfa, the “first fixed rate payer”, reduced to zero. Depfa’s liability was in each case to pay simply a “Fixed Amount”.
10. In the Norwegian context the significance of an interest rate swap taking on the characteristics of a loan is that section 50 of the Local Government Act 1992 restricts the circumstances in which a municipality may borrow money. Borrowing is permitted only for certain budgetary purposes. Section 50 provides, so far as relevant:
“Section 50. Raising loans
1. Any local authority may raise a loan for the purpose of financing investments in buildings, installations and permanent operating equipment for its own use. A loan may be raised only in respect of measures that have been included in the annual budget.
2. Any local authority may raise a loan for the purpose of converting an older debt relating to a loan. Further a loan may be raised where this is essential to discharge liability for a guarantee.
3. Any local authority may raise a loan to ensure full cover in terms of insurance practice in any pension scheme for its own employees where the municipality or the county municipality wishes to move the pension scheme from its own pension fund to an insurance company. The entitlement to raise a loan applies only if the lack of cover arose prior to 1 January 1998 and the loan must be deemed to be essential.
4. Any local authority may raise a loan to ensure cover in terms of insurance practice in any pension scheme administered by an insurance company, where this is a requirement for becoming a party to the agreement on the transfer of accumulated superannuation rights, laid down in pursuant of section 46 of Act No. 26 of 28 July 1949 (Public Service Pension Fund) Act. The entitlement to raise a loan applies only where the loan must be deemed to be essential.
5. Any local authority may borrow by way of overdraft or enter into an agreement on the right to overdraw.
6. Any local authority may borrow for the purpose of lending.
A loan may be raised for the purpose of advancing money where an agreement for full repayment has been made.
The condition is that recipients are not engaged in business activity and that the funds shall be used for investments.
7. The money owing on loans raised by local authorities shall be repaid in the following manner:
a. The total sum owing on loans raised by local authorities in pursuance of subsections 1 and 2 of this section shall be repaid in equal annual repayments. The remaining period of the municipal or county authority’s overall debt may not exceed the estimated life of the municipal or county authority’s equipment at the end of the last calendar year. …”
It will be seen that section 50.7a prescribes the manner in which a permitted loan must be repaid. From this and from subsection 1 it can be seen that underlying these restrictions is a philosophy that, putting it broadly, one generation should not be permitted to saddle the next with debt. For completeness I should here set out also section 52 of the Act. That provides:
“Section 52. Financial administration
1. The municipal council and the county council shall themselves issue rules for the financial administration of the municipal or county authority.
2. The Ministry may by regulations issue further rules concerning disposition of funds that entails financial risk.
3. Local authorities shall administer their funds in such manner that a satisfactory return may be achieved, without the entailment of any significant financial risk, and with consideration for the fact that the local authority shall have funds to meet its payment obligations when such payments fall due.”
The financial officers of the municipalities who gave evidence in this case told me that they did not consider that the investments which they made on the advice of Terra entailed any significant financial risk. History has shown them to have been woefully mistaken.
11. In the light of the restriction on the municipalities’ powers, considerations such as those set out by Lord Goff evidently led the District Auditor for the County of Sogn, in which lies Vik, to question the lawfulness of the “swap” into which it had entered with DnB Markets. The auditor questioned the lawfulness of the swap on the grounds that the borrowing of money by a municipality for investment, other than in buildings, installations and permanent operating equipment for its own use, was prohibited by section 50 of the Act. The auditor therefore sought the advice of the Ministry of Local Government. The Ministry responded in a letter dated 20 September 2002, hereinafter referred to as it was at trial as “the Vik letter”, saying that the swap should not be equated with a loan within section 50 because the future payment obligations were covered by the revenue from the energy licence fees. However, the Ministry questioned the appropriateness of such transactions and said that it would evaluate whether it might be necessary to subject them to regulation.
12. In view of its importance I set out below the full text of the Vik letter:
“RE. FINANCIAL SALE OF HYDROPOWER LICENCE AND THE RELATIONSHIP TO LOCAL GOVERNMENT ACT SECTIONS 50 no.1 AND 59a no.1
We refer to your letter of 25.6.02 regarding the Ministry’s evaluation of the financial sale of an energy licence in Vik municipality seen in the light of the provisions of the Local Government Act relating to the raising of loans.
In its auditor’s report for 2001, Sogn Auditing District wrote the following:
‘In connection with the restructuring, the local municipal authority has entered into an agreement which secures the price of the energy licence for 10 years. This is valued at an annual payment of NOK 9,750,500. Through an ‘interest rate
swap’ with DnB Markets, the local authority has agreed to pay this amount against a one-time payment of NOK 69,211,000.
The local authority has through administrators invested this one-time payment in bonds and shares from 2002. It is our opinion that the interest rate swap must be equated with a loan, and pursuant to Local Government Act section 50 there is no opportunity to raise a loan to purchase shares and bonds. We therefore reserve the right to question whether the interest rate swap is lawful.’
The Ministry is requested to assess the case in light of the auditor’s comments.
The term ‘loan’ is not defined in the Local Government Act.
The term must thus be interpreted in light of the considerations which the provisions of the Local Government Act are meant to safeguard, between the national considerations and the consideration for a healthy municipal economic control.
A balanced national economic development requires control of the local authorities’ use of resources in the short and long term. This requirement for balance is related to the annual budget and part of the State’s control of the local authorities’
revenues, and is a way of controlling in the short term local government expenditure over and above the revenues that stem from State transfers, taxes and user-payments. One method the local authorities have at their disposal to increase the use of resources in the short term is by borrowing. Based on consideration for State control of local authority revenues, a loan will involve a method whereby one binds future revenues against receiving a one-time payment today. As such, the Ministry believes that the agreement with DnB Markets has the same economic realities as a loan, in that Vik municipality received a one-time payment today against payment of an annual sum in the years ahead.
Local Government Act section 50 contains regulations about what purposes the local authorities can raise loans for. These regulations are based on the principle of financial responsibility and the view that the local authorities must maintain a level of activity that matches revenues in the long term. The agreement between Vik municipality and DnB Markets is part of a greater structure where the aim is to increase the return from the energy licence and give the local authority a one-time payment against an underlying cash flow related to the energy licence.
In that respect, the agreement involves no uncovered future payment obligation where the local authority, which by borrowing, has to cover interest and repayments with revenues which otherwise could have been used for providing services.
The Ministry finds that the agreement between Vik municipality and DnB Markets cannot be equated with a loan.
The Ministry wishes to emphasise that the municipal sector has a considerable effect on the national economy, and thus it is necessary to have adequate State control of local authority revenues. Effective control of these revenues means that the local authorities must give due consideration to the terms and conditions inherent in revenues frameworks and legislation.
The municipal authorities finance their activities through fiscal revenues and user fees. The Ministry places a question mark against transactions that provide this type of revenue. Financial agreements that have the same economic realities as a loan should in the regulations be equated with a loan. The Ministry will therefore evaluate whether it might be necessary to regulate the use of such agreements.
By entering into complex financial agreements with complicated risk structures, local authorities can find themselves exposed to even greater risk. The Ministry will generally underscore that it is important for local authorities to act as professional contractual parties with an informed approach to risk, and that they aim for minimum exposure to risk. In this case, the Ministry takes for its basis that Vik municipality has not taken any risk that violates current laws and regulations. Otherwise, the Ministry has not evaluated the degree of risk involved.”
13. In the following year, 2003, Terra itself sought legal advice on the lawfulness of municipalities entering into similarly structured transactions involving the up-front payment of the present value of revenues expected to accrue to the municipalities through franchise charges related to power generation. They sought advice from Messrs Bjerknes Wahl-Larsen to whom I shall refer hereafter as “Bjerknes”.
Bjerknes is a law firm in Oslo. Advice was given by letter of 29 April 2003 by Mr Conradi Andersen of that firm. Mr Andersen advised that financing in this manner could properly be implemented in accordance with the Local Government Act and the other regulations affecting the use to which municipalities may put revenue accrued from power franchise charges. He identified that a point to be clarified with respect to section 50.1 is whether the transaction can be characterised as a loan. In that regard he said:
“The transaction outlined may have certain features in common with a loan. The municipality receives a one-off amount from a trustee (preferably a bank) and ensures that there is subsequently a cash flow to the trustee. This is where the similarity stops.”
In the case he was asked to consider it would seem that the lump sum payable up- front had a current value larger than the current value of the funds coming from the franchise fees for the relevant period. That is not a feature of the cases with which I am concerned. However the essence of his reasoning is I think to be found in the following paragraphs:
“The main consideration for restricting municipal borrowing is not applicable to the transaction in so far as it can be said to relate to financial leasing. The key consideration behind the restrictions is the financial responsibility principle, which suggests that purchases that are fully consumed in the year should be paid for in full from the year’s revenues. In Ot.ptp.
43 (1999-2000) it is stated as follows:
‘Financing municipal measures by borrowing will always lead to a reduction of services in the long term. This is because part of the municipal revenues must cover the payment to the lenders for them to provide the funds for the municipality.
These funds which could otherwise be used directly for the provision of services’
Furthermore, it is stated that
‘the rules of the municipalities [A]ct on financial management are intended to contribute to … an economic management which ensures stable welfare provision in the short and long- term, and to ensure that the municipality, at the beginning of the new budget period, is that least as well equipped to discharge welfare tasks as at the beginning of the previous budget period. … The objection to borrowing is that it is future generations that will carry the cost of the provision.’
Assuming that the transaction took account of negative changes in taxation in the period, the transaction in any case will not mean that there will be an uncovered repayment obligations that could be offset against future services or entail a burden for future generations. The transaction would be more likely to have the effect that the municipality intended to achieve: the municipalities receive greater returns from their assets. This is good economic management that gives also the municipality freedom of action in the long term.
Another really important factor is that the transaction is virtually identical to what several municipalities have done in relation to franchise power. A financial transaction with the sale of franchise power was accepted by the Municipality and Regional Department by letter dated 20 September 2002 to fall outside the provisions of the Act on borrowing.”
The reference in the first and second paragraphs is to a statement in the “Proposition to the Odelsting”, a consultative stage within the Norwegian legislative process, which in this case preceded the amendment to the Local Government Act 1992 which led to its current form. I discuss the nature of the amendment hereafter. It is common ground that in the Norwegian legal method it is a proper approach to have regard to such “travaux preparatoires” when construing the ensuing legislation. The reference in the last paragraph is of course to the Vik letter.
14. The content of the Vik letter was summarised and repeated by the Ministry of Local Government in its Circular H-15/03 dated 1 July 2003. In material part that read:
“The Department has received a question from a local authority ombudsman about the financial sale of franchise power and compliance with the rules of the Municipalities Act on received loans. The background to the case was that a municipality had concluded an agreement which secured the price of the franchise power of the municipality for 10 years in advance.
Through an interest swap agreement with a financial institution, it was agreed that this cash flow would be paid to the municipality in the form of a one-off amount corresponding to the current value of the cash flow. The audit department of the municipality considered that the agreement should be regarded as equivalent to a loan.
The Department made the basic assumption that the concept of loan is not defined in the Municipalities Act, but that the concept must be considered in connection with the purpose which the Municipalities Act is intended to serve, including national supervision and supervision of sound local authority financial management. In the light of the balance requirement, the department considered that the interest swap agreement, to that extent, had the same economic reality as a loan, but that the basis for the provisions of section 50 no.1, including the financial liability principle and the reference to a stable level of activity in the municipalities, mean that the agreement cannot be equated to a loan.”
Professor Graver, one of the expert witnesses at trial as to Norwegian law, explained that the reference here to “the balance requirement” is to the balance between earning and spending. The philosophy underlying the restriction enshrined in section 50.1 of the Act is that current expenditure should not exceed current income.
15. It was against this background that Terra first presented the “zero coupon swap”
concept to Depfa in May 2003. They found a willing and enthusiastic listener in Mr Ole Witmeur who worked for Depfa in Copenhagen as a “Public Sector Originator”.
The Norwegian market had historically been dominated by one or two local Norwegian banks and it was difficult for outsiders to achieve entry. Mr Witmeur was extremely keen on a new vehicle which appeared to offer the opportunity to interest the municipalities in longer-term financing than they had hitherto historically undertaken.
16. In the light of arguments deployed against Depfa by both the municipalities and Wikborg Rein it is right that I should notice that in Mr Witmeur’s note of his initial meeting with Terra to discuss this concept, which took place on 16 June 2003, he referred to it as “a way of circumventing the legislation”. Even Mr Witmeur however recorded in the same note that should the proposal end up having the interest of Depfa, Depfa should possibly ask for its own legal opinion, additional that is to the Vik letter and to the Bjerknes opinion with which Mr Harald Norberg of Terra had at this meeting promised to supply him. Without Mr Witmeur’s persistent championing
this proposal would I think never have got past the Depfa credit committee. When ultimately it did, there was never any doubt in the minds of those responsible, who did not include Mr Witmeur, that Depfa could not and would not proceed without the benefit of external legal advice.
17. Matters were taken forward at a meeting between Terra and Depfa in Dublin on 12 August 2003. Amongst others in attendance were Fiona Flannery, a Senior Credit Manager at Depfa and a member of the Credit Committee, and Philip O’Sullivan of the Depfa Legal Department. At this meeting Mr Witmeur said that the Norwegian Ministry of Local Government and Regional Development had given approval for the use of zero coupon structures “on the basis that they are connected with the annual cashflow from the taxes and power plant”. Mr O’Sullivan, who was as I understand it an Irish qualified lawyer with no expertise in Norwegian law, said at the meeting that Depfa would need an external legal opinion to confirm the legality and enforceability of such a structure.
18. Following that meeting there ensued a dialogue within Depfa as to whether to pursue the matter. It first came before Depfa’s Credit Committee on 14 October 2003 in relation to an application from Bremanger, a small municipality. The application was declined on the basis of Bremanger’s credit risk. The Credit Committee also made a number of comments about the nature of the business, including a concern expressed by Dr Grzesik that it “appeared to be more investment banking oriented” and “that it was not a transaction which would benefit the economy of the municipality”. At this stage, as Ms Flannery explained, the Credit Committee did not have any strategic guidance from the Executive Committee as to this type of business. Neither did it have the comments from Depfa’s Legal Department, which it noted were awaited, let alone an external opinion.
19. Mr Witmeur, who was of course the originator of the Bremanger proposal, was both surprised and disappointed at the Credit Committee’s decision, and on 17 October 2003 he prepared a draft memorandum to the Credit Committee which he forwarded also to his superior, Mr Juergen Karcher, a member of the Executive Committee. At the same time, the Credit Department produced a draft Credit Application in relation to Haugesund, which recommended declining the credit on the basis of the proposed business, rather than upon the credit rating of Haugesund, which it deemed satisfactory. A credit analyst, Matthew Lloyd, identified three weaknesses in the proposal, which he expressed as follows:
• “Proposed financing is not driven by the municipality’s budgetary needs and in no way benefits the municipality’s operating or capital budget
• Risk of speculative investment since municipalities are not contractually obliged to invest prudently
• Legislation risk – while the proposed ‘swap’ does not violate Norwegian law, the Ministry of Local Government has expressed reservations about this type of transaction and has stated that it will consider legislation to curb such activity in the future.”
In the light of the Credit Department recommendation Ms Anne Butler of Client Transaction Management decided to withdraw from the agenda for the next meeting of the Credit Committee on 21 October 2003 both this application and another similar application from the neighbouring municipality of Karmoy.
20. Attached to the Haugesund Credit Application had been the comments of the Depfa Legal Department in the shape of a memorandum prepared by Mr O’Sullivan. In it he considered the Vik letter and the Bjerknes opinion with which he had been supplied by Terra. Again I must set out the contents of this memorandum in full:
“Norwegian Municipalities’ Financing of Licence Fees using zero coupon swaps
Norwegian municipalities have turned to using zero coupon swaps to obtain the present value of concession fees due from power providers over a certain period. In reply to a query from a municipality’s auditor, the Ministry of Local Government and Regional Development opined as to its view of the zero coupon structure.
In its opinion, the Ministry arrived at the view that the structure did not amount to a ‘Loan’ primarily because it did not imply an unfulfilled duty of payment on the part of the municipality, depriving the municipality in the future of funds that could be applied in the provision of services. This financing, so the logic of the Ministry, by linking itself to future fee payments, was not depriving the municipality of its capacity to provide services in the future, the way a loan would. Of course, this reasoning itself implies that the interest payable on a loan is greater, and therefore more burdensome, than the amount of the fee payments forgone.
However, while the Ministry permits the use of this structure, it does so reluctantly stating it is ‘dubious to financial transactions that yield this type of revenue’ and ‘will therefore consider whether it may be necessary to lay down regulations that limit the use of such agreements’. The risk is that any departure by the municipality from the principles of sound financial management of its funds, using zero coupon swaps or other instruments, will lead to regulation and possible prohibition of financing of this type.
In a legal opinion aimed at examining the legal basis of the zero coupon structure, lawyers Bjerkens Whal-Larsen (sic), have opined that the swap would not be in breach of current or planned laws, as it does not amount to a ‘Loan’. The main plank in their argument is that this financing does not imply an unfulfilled duty of repayment that could affect future services offered to lead to a strain on future generations, echoing the language used in the Ministry’s letter.
The critical factor in differentiating a zero coupon swap from a loan is the burden it can impose on a municipality, and by extension, its citizens. The burden would be increased by a fall off in the level of fees payable by the electricity suppliers or by their default in payment altogether. That in turn would move the transaction closer to being characterised as a ‘Loan’ and therefore prohibited. Were the municipality, furthermore, to engage in unsound financial management with the funds received under the swap, then a burden on the citizens could be said to have been created as an indirect result of the swap.
Again, while strictly speaking legal, it is probably more meaningful to state that the swap is not illegal, not yet at least.
Interpreting both the Ministry’s letter and the legal opinion, the grounds for legality are contingent on (1) the fee payments from the electricity suppliers continuing unabated at least their current level and (2) the financial management policies of the municipality remaining sound.”
21. Mr Witmeur was again surprised and disappointed at the recommendation of the Credit Department and he sent a memorandum to Mr Lloyd on 20 October 2003 making the point, amongst others, that what might happen in the future would not affect whether the transaction was legal or not at the time it was entered into. He also invoked, and obtained, the support of Mr Karcher for his proposal, although the documents do not reveal any reason given by Mr Karcher for espousing this view.
There followed further internal debate within Depfa, in which further views were expressed about the merits of the proposed transaction. In an e-mail to Mr Witmeur of 21 October 2003 Mr Lloyd said this:
“I note your comments from yesterday. In my view this case could not be more straightforward; however I accept your point that legislation is unlikely to be applied retroactively and the transaction follows the letter of the law.
In your response, you do not address the point in my paper that this activity in no way related to the budgetary activity of the Municipality or its inhabitants. On the basis of this alone, I do not support this credit. I refer you again to the minutes of the Credit Committee meeting of 14 October in which Dr Grzesik expressed similar concerns.”
In the course of this further debate Terra provided Depfa with a copy of an extract from Circular H-15/03, together with the contact details of a person to speak to at the Ministry, in fact the author of the Vik letter, albeit coupled with a request, passed on by Mr Witmeur, not to refer to any specific transaction. Neither Ms Flannery nor Mr Lloyd were further persuaded.
22. On 31 October 2003 Mr O’Sullivan sent to Mr Witmeur an e-mail in these terms:
“Following our meeting this morning I wish to clarify the uncertainty about the legality of the zero coupon swap structure
you are proposing. We can be assured that the structure is legal under Norwegian law. For that we have the assurance of the Ministry responsible for the municipalities and an independent legal opinion. What was implicit in both the legal opinion and the views of the Ministry was that the legislature could change its assessment and pass a law prohibiting municipalities from entering those swaps. It would do so if circumstances changed and the municipalities were to lose money or suffer a burden as a result of this structure. It is my view that existing deals would not be affected, though we should request that Norwegian counsel confirm this.”
Contrary to suggestions made at trial by Mr Gregory Mitchell QC for Wikborg Rein I do not regard this message as indicating that the legal issue “was now resolved”. Nor do I regard this message as demonstrating any sea change in Mr O’Sullivan’s thinking. There is no real difference between what Mr O’Sullivan said here and what he had said in his earlier memorandum. The language is different, but it does not in my view convey even a change of emphasis. Furthermore the exercise conducted by Mr O’Sullivan was never intended to be any more than an Irish lawyer’s evaluation of the materials supplied by Terra. No doubt Mr O’Sullivan’s view, particularly if even less encouraging, could have led to rejection of the proposal. However Mr O’Sullivan’s assurance that the structure was lawful in Norwegian law would never have been regarded by Depfa as sufficient to enable it to proceed. Depfa would not have proceeded to enter into a transaction of this type in reliance alone upon its own Legal Department’s evaluation of the Norwegian legal materials supplied by Terra.
As Mr Pheifer, the Head of the Legal Department at Depfa, made clear, what Mr O’Sullivan was attempting was not Depfa’s own analysis of the legal position, on which they were not qualified to express an opinion, what he was doing was simply reviewing the existing legal analysis proffered by Terra. Depfa would never have regarded this as a substitute for its own external objective legal advice from an appropriately qualified source.
23. On 5 November 2003 Mr Witmeur e-mailed Mr Karcher, updating him on the position, and referring to the concern about the use of funds which had been raised by the Credit Committee. He said that Credit and Legal had agreed that this point was not really a matter for the Credit Committee to decide upon, and it was “more a principal issue for Depfa Bank” by which he meant, I think, an issue of principle. Mr Witmeur specifically sought guidance as to which body within Depfa should consider this question of principle, i.e. the question whether Depfa should lend to municipalities for non-budgetary purposes. On 11 November 2003, following discussion with Mr Karcher, Mr Witmeur sent to him a summary of the business opportunity which had been prepared by Ms Anne Butler. The matter was then considered by Depfa’s Executive Committee at the end of November and was referred back to the Credit Committee. A memorandum was produced for the Credit Committee by Ms Butler, which was sent to Mr Karcher for his comments, and was approved by him. It was considered at the Credit Committee meeting on 16 December 2003. Ms Butler was present at this meeting and Mr Witmeur participated by telephone from Copenhagen. Ms Butler made it clear to the Credit Committee that these transactions and the Norwegian market strategy had been explicitly approved by the Executive Committee, and had the support of the Board Member responsible for
origination, Mr Karcher. As Ms Flannery explained, the Credit Committee now had strategic guidance as to whether this was business which the Executive Committee was willing to undertake, i.e. whether this type of lending, for non-budgetary purposes, was lending which Depfa was in principle prepared to undertake. With the benefit of that guidance the Credit Committee “agreed in principal (sic) with the product” noting however that the creditworthiness of the municipality would need to be satisfactory from a credit risk view.
24. Mr Mitchell submitted that at this point Depfa had committed itself in principle to the lending structure, subject only to the assessment of each individual credit risk, and that Depfa did not thereafter rely upon the advice of Wikborg Rein in entering into the transactions upon which they were already resolved. He even went so far as to suggest that had Wikborg Rein provided advice which cast doubt on the legality of the proposed structure Depfa would simply have gone to other Norwegian lawyers and that they would have had no difficulty in obtaining a favourable opinion. The latter is speculation. I shall return to the question of Depfa’s reliance upon the advice given by Wikborg Rein, but at this stage I reject Mr Mitchell’s characterisation of the effect of the Credit Committee’s agreement in principle with the product. As Miss Flannery explained, it was outside the remit of the Credit Committee to consider legality, further than that of course it was assuming legality, as otherwise there would have been no purpose in giving approval in principle. However no transaction could proceed in reliance upon Credit Committee approval without the Legal Department being satisfied as to the legality and enforceability of the transaction. That, as Miss Flannery explained and as Mr Pheifer confirmed, was ultimately a matter for Mr Pheifer. By its decision the Credit Committee neither expressed an opinion on nor reached a conclusion as to the legality of the transaction in Norwegian law, the law of the place where the municipalities were constituted. Mr Iain Milligan QC for the municipalities suggested to Miss Flannery that after the Credit Committee had, on 13 January 2004, approved Haugesund’s renewed credit application, it essentially handed the problem of legality over to the Legal Department or shut its eyes to it. Miss Flannery replied, consistently with all her other evidence, that the Credit Committee was passing the issue to Legal who could best address it. I accept Miss Flannery’s evidence, which in any event accords with how one would expect any bank to proceed. Her evidence was entirely consistent with Mr Pheifer’s understanding of his own role. Mr Pheifer likewise was an entirely reliable and straightforward witness.
25. As foreshadowed above, Credit Committee approval for the Haugesund application was given on 13 January 2004 in the shape of a limit of NOK 275 million with a tenor of ten years. It was not until May 2004 that the Haugesund application was taken further. It was then that Mr Pheifer sought advice from Norwegian lawyers. I shall describe that process in a little more detail hereafter. However it culminated in a written opinion from Wikborg Rein dated 30 June 2004, preceded by an e-mail of 17 June. Both were prepared by Mr Johan Rasmussen, a partner in the firm. In the e- mail message Wikborg Rein said that based on a circular from the Norwegian Ministry on Municipalities it was their opinion that the transaction was not a loan under the Norwegian Municipality Act. In its formal opinion letter Wikborg Rein expressed the unequivocal and unqualified opinion that Haugesund as a Norwegian municipality had in Norwegian law full power and authority to execute, deliver and perform the Agreement, by which was meant the ISDA Master Agreement, Schedule and Confirmation to which I refer hereafter. Wikborg Rein went on to state their
opinion that the Agreement constituted in Norwegian law a valid and binding obligation of Haugesund.
26. I must now sketch in as briefly as possible the manner in which Haugesund and Narvik respectively became committed to the transactions.
Haugesund
27. Terra introduced the zero coupon swap concept to Haugesund at a presentation in Edinburgh on 19 August 2003 which was attended by representatives of various municipalities. In particular it was attended by Ms Gunbjorg Lothe, who was at all material times the Head of Finance and Budget employed in the administration of Haugesund to give support to the elected representatives. In this role she had responsibility for all matters related to finance, although she was ultimately answerable to the Chief Executive Hildegunn Staurseth. It was clear from the slides shown at the presentation that the purpose of the structure was to borrow at a rate based on the municipality’s good credit risk and then to seek to make a turn by investing the proceeds.
28. Shortly after the August 2003 presentation in Edinburgh the idea emerged, although it is unclear from whom, of using Terra’s zero coupon structure for the dividend and interest revenue from Haugesund’s shareholding in the power company Haugaland Kraft. There followed a further presentation by Terra on 16 September 2003, on this occasion addressed to Haugesund and to Karmoy, a neighbouring kommune which was a co-shareholder in Haugaland Kraft. Terra raised the prospect of investing the proceeds of the swap in a Credit Linked Note, hereinafter a “CLN”, a financial product which, as Ms Lothe understood, would involve Haugesund taking the credit risk of each of the underlying entities.
29. A further presentation took place on 11 November 2003, on this occasion attended also by Ms Staurseth and by the Chief Auditor of the municipality, Bente Syre. On this occasion Terra emphasised the risk involved in the management of the investment, and specifically stated in the presentation (in the first slide on page 10 of the printed version) that “a high expected return will include a high risk”. The relationship between risk and reward was well known to Ms Lothe, and she accepted that it was “obvious” to her that there was in fact a risk of loss. Ms Lothe said that the risk was always presented as being very small, although the slide in the presentation from which I have quoted above would seem to indicate the contrary.
30. Following that presentation and further discussion within the administration of Haugesund, the administrative officers were persuaded by the proposal and believed that the risk inherent in it was an acceptable one for Haugesund to take. Ms Lothe and Ms Staurseth decided to present the matter to the elected representatives. Mr Norberg of Terra prepared a draft presentation which he sent to Ms Lothe on 15 December 2003. Ms Lothe then adapted this document and made it the basis for her own written presentation to first the Executive Committee and then the full Town Council which met on 11 and 25 February 2004 respectively.
31. Ms Lothe’s proposal was that the municipality should enter into a zero coupon swap for NOK 230-240 million, that being equivalent to the net present value of the cash flow from Haugaland Kraft AS over the next eight years. It was further proposed that
the proceeds should then be invested in either the purchase of single interest bearing papers (debenture bonds) or in a CLN, investment in which would be effected by Statkraft, a Norwegian entity. Ms Lothe’s paper stated that “the bulk of the risk in this construction lies in the management and the credit risk we assume when placing investments”. The paper suggested that “added value” generated through placement in the market in this way would be approximately NOK 20 million over eight years.
The nature of an investment in debenture bonds and in a credit linked note was explained. Under the heading “legality of zero coupon swap” Ms Lothe quoted from the Ministry Circular No. H-15/03 the passage concluding “the agreement cannot be said to equate a loan”. The Council resolved to adopt the proposal, opting for model two, investment in a CLN. The Council imposed as a condition that the Chief Executive should select the broker after a “bid competition” had been implemented.
The meetings were presided over by Chief Councillor Petter Steen. His unchallenged evidence is that he did not understand either the structure or the details of the deal proposed. He was prepared to support it because it was recommended by his administration and by Terra – either Mr Norberg or Mr Opstad of Terra gave a presentation before the full meeting of the Town Council. Mr Steen derived the impression that the level of risk was very low, little more than that involved in depositing the funds in a savings bank. There was very little discussion and the resolution was passed unanimously.
32. The purpose of this transaction, as Ms Lothe appreciated, was to enable the municipality to make a turn on the sum advanced to it pursuant to the zero coupon swap, and to do so by borrowing that sum at a rate of interest which was lower than the return which Haugesund would hope to obtain from investing the proceeds in the financial markets through the CLN proposed by Terra. Ms Lothe recognised that this necessarily involved Haugesund taking a greater credit risk in its investment than would be taken by the counterparty under the zero coupon swap. She thought that the risk was small. Nonetheless, she appreciated that there was a risk.
33. It was clear both from the terms of Ms Lothe’s presentation to the Town Council and from her oral evidence at trial that it was the intention of Haugesund that the amount advanced by the counterparty to the zero coupon swap would be repaid out of the cashflow generated by the investment in the financial markets. The revenues from Haugaland Kraft were not intended to be the source of the repayment. Haugesund intended to treat and in due course did treat that revenue in the same way as it had done in the past, i.e. as part of the normal income out of which it discharged its municipal obligations. That income was in no way hypothecated to repayment of the amount advanced. The expected revenues from Haugaland Kraft were used as the basis of the calculation of the amount of the up-front payment from, in the event, Depfa, but otherwise had no relevance to the structure of the transaction or to the repayment schedule. Ms Lothe fully appreciated that the investment risk, whether large or small, and she thought small, was being taken by Haugesund rather than by the counterparty to the swap. She appreciated that should for whatever reason the proceeds of the investment be insufficient out of which to repay the counterparty, then Haugesund would have to make up the shortfall out of its other resources. The liability to repay the counterparty would subsist whatever the outcome of the investment. In due course, entirely appropriately, the liability to repay Depfa was recorded as such in Haugesund’s accounts.
34. On 14 June 2004 Mr Norberg of Terra e-mailed the Haugesund resolution to Mr Witmeur. By then of course Depfa had already accepted the Haugesund proposal in principle. On 17 June 2004, Mr Pheifer received by e-mail Wikborg Rein’s opinion that the transaction was not a loan under the 1992 Act. “As of 22 June 2004”
Haugesund and Depfa entered into the original zero coupon swap by which Depfa agreed to pay NOK 231,300,000 to Haugesund on 1 July 2004 and Haugesund agreed to pay (i) 31 quarterly payments, starting on 15 September 2004 and ending on 21 March 2012, of amounts varying from about NOK 3.5 million to about NOK 3 million, and (ii) a “bullet” repayment of NOK 216 million on 20 June 2012. The quarterly payments consist principally of interest although with a small element of amortisation. Depfa’s payment and the quarterly and “bullet” repayments were described as respectively the “first” and the “second” “Fixed Amount”.
35. The transaction was recorded in three documents which it was expressly agreed formed a single agreement:
i) an ISDA (International Swaps and Derivatives Association, Inc) Master Agreement;
ii) the Schedule to the Master Agreement and iii) a Confirmation dated 22 June 2004.
The Confirmation contains the essentials of the transaction including, at Appendix 1, the repayment schedule. By section 3 of the ISDA Master Agreement, Haugesund expressly represented to Depfa (as at the date of both the original swap, and the amended swap):
i) By section 3(a)(ii), that “[Haugesund] has the power to execute this Agreement and any other documentation relating to this Agreement to which it is a party, to deliver this Agreement and any other documentation relating to this Agreement that is required by this Agreement to deliver and to perform its obligations under this Agreement … and has taken all necessary action to authorise such execution, delivery and performance”;
ii) By section 3(a)(iii), that “such execution, delivery and performance does not violate or conflict with any law applicable to [Haugesund], any provision of its constitutional documents, any order or judgment of any court or other agency of government applicable to it or any of its assets…”;
iii) By section 3(a)(iv), that “all governmental and other consents that are required to have been obtained by [Haugesund] with respect to this Agreement … have been obtained and are in full force and effect and all conditions of any such consents have been complied with”;
iv) By section 3(a)(v), that “[Haugesund’s] obligations under this Agreement … constitute its legal, valid and binding obligations, enforceable in accordance with their respective terms (subject to applicable bankruptcy, reorganisation, insolvency, moratorium or similar laws affecting creditors’ rights generally and subject, as to enforceability, to equitable principles of general application
(regardless of whether enforcement is sought in a proceeding in equity or at law).”
Further, by section 4 of the ISDA Master Agreement, Haugesund expressly agreed:
i) By section 4(b), that it would “use all reasonable efforts to maintain in full force and effect all consents of any government or other authority that are required to be obtained by it with respect to this Agreement…”;
ii) By section 4(c), that it would “comply in all material respects with all applicable laws and orders to which it may be subject if failure so to comply would materially impair its ability to perform its obligations under this Agreement…”.
36. With the approval of Ms Staurseth Ms Lothe did not conduct the “bid competition”
envisaged by the Town Council with a view to looking at alternatives to Terra. She thought that it would involve a lot of work. Thus it was that Terra on 22 June 2004 bought a CLN, Cloverie 2004-33, from SEB Merchant Banking with a par value of NOK 327,500,000 at 99%, i.e. for NOK 324,225,000, for settlement on 15 July 2004.
Part of that note was credited to Haugesund for NOK 228,690,000, being 99% of the par value NOK 231,000,000. The use of a CLN issued by Cloverie rather than Statkraft was I think another departure from the Council’s resolution, although nothing turns on this either.
37. Under the terms of the CLN, Cloverie is a pass-through vehicle, promising to pay no more than it receives. It promises to pay two income streams to the holder, namely the coupon of three month NIBOR + 55 bps from Statkraft bonds maturing on 15 June 2011 and the fixed rate payments received from CitiGroup Global Markets Limited under a credit default swap on 23 corporate credits. Other than the credit risk of Statkraft and CitiGroup, the risk to the purchaser of the CLN is that one or more of the corporate credits defaults, in which event the recovery value of the defaulted credit is paid out to the purchaser, but the par value of the corporate credit is lost.
38. In March 2005 Terra offered Haugesund the opportunity to increase its credit exposure in the CLN, and thereby the returns from it, by increasing the number of credit reference entities to 125. This was agreed to by Haugesund, and as a result on 7 September 2005 Terra sold the CLN on behalf of Haugesund at 99% and on 15 September 2005 bought another CLN, Cloverie 2005-77, at par. This was presented by Terra as an opportunity to increase the total annual cash flow from the CLN by 50%. Ms Lothe appreciated that in order to achieve this higher cash flow the municipality was taking a greater risk.
39. The assumption of greater risk promptly led to a loss. At the end of 2005 one of the credits, Delphi Corporation, defaulted, resulting in a loss to Haugesund of NOK 3.5 million. It seems that Terra then suggested that the CLN should be replaced with a Collateralised Debt Obligation, hereinafter “CDO”, apparently on the basis that this would be “more secure and flexible”. Ms Staurseth and Ms Lothe, without any further consultation, agreed to the change. On 26 April 2006 Terra sold the Cloverie CLN and with the proceeds on 29 May 2006 bought a CDO issued by Libretto Capital Plc. This was certainly a more flexible investment, in that the Portfolio Manager, an entity wholly unknown to Haugesund, had the power to change the underlying
reference entities. The investment involved significant financial risk, and was therefore made in breach of section 52.3 of the Act. It was not an investment to which the Haugesund Town Council had agreed.
40. The maturity date of the CDO was in June 2013. In order to accommodate this the maturity date of the “swap” with Depfa was extended from June 2012 to June 2013.
This obviously resulted in a corresponding increase in Haugesund’s liability to pay interest, although because of the element of amortisation included in the quarterly payments the bullet repayment became reduced by NOK 3 million. The Haugesund Town Council had of course approved a swap with an eight year tenor. Ms Lothe could recall no discussion surrounding this extension, although she accepted that it is likely that at the time she realised what she was doing. Although in view of my later conclusions it is I think academic, I should nonetheless record that in my view this amendment to the swap fell outside the scope of the original resolution and was thus unauthorised. This was the evidence of Professor Braathen, and it is consistent with the agreement of Professors Graver and Woxholth that only in relation to very minor amendments do officials employed by the municipalities have the power to undertake changes in relation to a clear municipal resolution. The resolution authorised only a swap with an eight year duration. Depfa was invited to agree to the extension of the maturity date of the swap and did so. There is no evidence that Depfa was told why it had become necessary to effect an extension. Depfa was at no stage consulted over Haugesund’s investments.
41. By letter dated 21 January 2008 the County Governor of Rogaland in which lies Haugesund annulled the resolutions of Haugesund to make both the original investment in the CLN and the subsequent investment in the CDO. Implicitly he directed the sale of the Libretto CDO. I examine the decision of the County Governor in more detail at paragraphs 178 and 180 below. In the event the Libretto CDO was redeemed early at 42.54% on 20 February 2008, resulting in a loss to Haugesund of the order of NOK 125 million.
42. On 20 June 2008 Messrs Lund & Co, Norwegian lawyers instructed on behalf of Haugesund, wrote to Depfa and asserted that the interest rate swap agreements must in reality be considered to be loans, and further that the loan agreements were null and void, partly because the agreements were entered into in breach of the stipulations on loans laid down in the Local Government Act. Messrs Lund referred Depfa to a statement made by the Legal Department of the Ministry of Justice and the Police dated 28 January 2008, and also to a letter to all local councils and county councils from the Ministry of Local Government and Regional Development dated 18 April 2008. The statement made by the Legal Department of the Ministry of Justice and the Police to which Messrs Lund referred was in fact a letter of 28 January 2008 from that department to the Ministry of Local Government and Regional Development. By letter dated 20 December 2007 the Ministry of Local Government and Regional Development asked the Legal Department to assess whether the advice given in the Vik letter of 20 September 2002 was correct. In view of the relevance and importance of the letter of the Ministry of Justice to the issues in the case I propose again to set it out in full:
“Local Government Act section 50
In a letter dated 20 December 2007, the Ministry of Local Government and Regional Development (KRD) has required the Legal Department to assess whether the conclusion in KRD’s letter of 20 September 2002 to the Chief Administrative Officer in Sogn og Fjordane is in line with Local Government Act section 50. In the letter, KRD concluded that an agreement entered into between Vik municipality and DnB Markets does not imply that the local authority took up a “loan” such as the term “loan” is applied in Local Government Act section 50.
The agreement between Vik municipality and DnB Markets was part of a larger financial construction organised by Terra Fonds ASA. The financial construction was called a zero- coupon swap. The aim was to exchange a number of cash flows (current revenues) from the local municipal authority’s sale of an energy licence with a single cash flow (one-time payment), and thereafter invest the on-time payment in financial instruments. It was presupposed that management of these financial instruments would give Vik municipality a greater return from the energy licence.
On one side, Vik municipality entered into long-term agreements concerning the sale of the municipality’s rights to an energy licence. The agreement was for 10 years and secured the municipal authority an annual payment of NOK 9,750,000, which corresponds to a total payment of NOK 97,500,000 for the entire period.
On the other side, Vik municipality entered into an agreement with DnB Markets which involved Vik municipality being paid a one-time sum of NOK 69,211,200 against an amount corresponding to the cash flows from the agreements concerning the sale of an energy licence being paid to DnB Markets.
The economic reality of this financial construction was such that the local authority exchanged a current cash flow with a duration of 10 years and totalling NOK 97,500,000 against a one-time payment of NOK 69,211,200.
The local authority also entered into an agreement with the Terra Group concerning management of this one-time payment.
The question is whether the agreement between Vik municipality and DnB Markets involved the local authority raising a ‘loan’ pursuant to Local Government Act section 50.
A natural understanding of the wording ‘loan’ suggests that one acquires a right to borrow or use something, in exchange for accepting an obligation to return that which is borrowed at a later date. The obligation to return the object can be
determined by the nature of the object borrowed or on an individual basis. With the borrowing of money in the capacity of spending power, the obligation to return will be determined by the nature of the object borrowed.
In the contractual relationship between Vik municipality and DnB Markets, the local authority acquired the right to use money that belonged to DnB Markets, against the local authority accepting an obligation to repay the amount to DnB Markets over a ten-year period. The difference between NOK 97,500,000 and NOK 69,211,200 may be regarded as a borrowing cost, including interest. Whether this borrowing cost is high or low is, in our opinion, of no significance as to whether or not a ‘loan’ was raised. The expression ‘loan’ does not suggest that interest or other costs must be paid, or that repayment of the money must happen within specified deadlines or in a specific way. The wording only suggests that one accepts an obligation to repay that which is received, at a later point in time.
The wording suggests, therefore, that the local authority took up a ‘loan’.
Thus, the question is whether there is a basis for departing from the wording.
From KRD’s side, the decisive factor was that the overall financial construction meant that the payment to the municipal authority and repayment to DnB Markets had more of a character of being an advance rather than a ‘loan’. It was stated that the local authority generally did not assume payment obligations that resulted in the local authority’s freedom to manoeuvre financially being reduced. With reference to the fact that Local Government Act section 50 shall primarily limit the possibility of a local authority taking on long-term interest and repayment obligations at the expense of the municipality’s provision of services, KRD accepted that the agreement between Vik municipality and DnB Markets did not involve the local authority raising a ‘loan’.
In terms of the information received about the case, we must take as a basis that only the local authority which was the rights and obligations subject in the agreements concerning the sale of an energy licence, in the agreement with DnB Markets concerning the one-time payment, and in the agreements concerning investment of the one-time payment. From a legal point of view, therefore, it is our opinion that the total construction cannot be regarded as a package in which the agreement with DnB Markets was one of several elements.
From a legal point of view, the relationship to DnB Markets
must be evaluated in isolation pursuant to Local Government Act section 50.
As the case has been described to us, we further take as a basis that the local authority’s obligation to pay DnB Markets NOK 9,750,000 a year for ten years exists regardless of what happens with the cash flows from the energy purchasers and with management of the one-time payment. In our opinion, therefore, the relationship to DnB Markets must be characterised as a ‘loan’ pursuant to Local Government Act section 50. Central to the term ‘loan’ is the obligation to repay that which is borrowed. This obligation rested with the local authority. It could only be possible to consider the payment from DnB Markets as anything but a loan if this obligation related to whether the energy purchasers actually paid or to the development of the investment. At any rate, we do not go into what relationship might have existed.”
By its letter of 18 April 2008 the Ministry of Local Government and Regional Development advised local councils of the outcome of this consultation process, and directed them to act in accordance with the advice of the Legal Department of the Ministry of Justice. I understand that in Norway the views of the Legal Department of the Ministry of Justice are accorded great weight and respect.
43. On 8 September 2008 the Haugesund Town Council resolved that no further payments should be made to Depfa, with the result that no payment was made on the next due payment date, 17 September 2008.
44. By letters from Lund & Co dated 18 September and 13 October 2008 Haugesund offered to pay to Depfa the net proceeds of the investments which they had made with the money advanced.
45. Thereafter Depfa terminated the amended swap with effect from 31 October 2008 on the grounds of failure to pay in accordance with its terms, as they were entitled to do according to those terms. On 4 November 2008 Depfa advised Haugesund that the amount payable was NOK 232,379,029.95 together with interest.
46. From the initial advance of NOK 231,300,000 the net proceeds of the investments were NOK 96,777,994.44. In addition Haugesund had paid to Depfa under the original, followed by the amended, swap principal and interest totalling NOK 55,269,224.
Narvik
47. I can deal quite shortly with the manner in which matters developed at Narvik because the process was very similar to that which obtained at Haugesund. Narvik was first introduced to the “zero-coupon swap” concept by Terra on 23 April 2003. Terra in its paper described the model as “comprised of two integrated main elements:
safeguarding a regular cash flow over a determined period and the exchange of cash flow from licensed energy revenue to a cash flow from the financial markets”. This was followed up at the presentation in Edinburgh in August 2003 to which I have
already referred which was attended also by Mr Svein Olaf Hestdahl, the person principally responsible at Narvik. Mr Hestdahl was at all material times adviser for the Planning and Strategy Department. His role was to deal with financial matters for the municipality, in particular to handle all budgetary and debt matters. He was answerable to the Chief Executive, who until July 2005 was Mr Stromme and after July 2005 Mr Trond Hermansen. There were further proposals from Terra in October 2003 and April 2004, which in turn led to Mr Hestdahl drawing up a paper for presentation to the Executive Committee and Town Council in June 2004.
48. The June 2004 proposal related to the proposed restructuring of licensed energy fees.
This is not the proposal with which I am concerned. It was however approved unanimously by the Town Council on 1 July 2004, and in the event the transaction proceeded with DnB, involving an advance of NOK 52.5 million for a ten year period.
It was invested in a Cloverie CLN.
49. The proposal with which I am concerned is a proposal to restructure the municipality’s property tax which first appeared in a presentation made by Terra in May 2005. The property tax in question is that levied on power stations within the municipality. As happened at Haugesund, a draft paper for presentation to the Town Council was prepared by Mr Norberg and adopted and modified by Mr Hestdahl. The essence of the transaction is encapsulated in the following paragraphs from Mr Hestdahl’s presentation:
“In that the Municipality’s credit rating enables the Municipality to obtain cheaper credit than others, and at the same time place investments on the same terms, this can be exploited to gain additional dividends (additional income) from the fixed annual incoming cash flows provided by property tax.
The annual incoming cash flows from property tax are, at a certain rate of interest, recalculated to ‘current worth’ of the cash flows, i.e. the annual amounts are discounted to the current worth of these amounts. An amount equal to the said current worth is taken up on behalf of the Municipality in the financial markets on the basis of a pre-agreed cash flow from property taxes (zero-coupon swap).
By exchanging the current worth of property tax for the next twelve years for a given sum in today’s financial market the Municipality will pay interest of approximately 4.5% per annum … The acquired sum can then be placed back in the financial market at an interest rate of approximately 6%. This restructuring is purely financial, and as such maintains the Municipality’s future rights to regulate the levy (property tax).
The additional revenues earned by the Municipality result from the difference in the interest rates for these two alternatives.”
50. Before the proposal was put before the Council it was questioned by members of the Socialist Group. The Socialist Group could not understand why the proposed transaction did not amount to a loan, and questioned the wisdom and legality of borrowing power taxes in advance of their receipt. Mr Hestdahl told them that they
