On August 1, the European Court of Human Rights (ECHR) dashed hopes of Northern Rock shareholders to obtain compensation from the UK for the collapse and nationalization of British bank Northern Rock. The Fourth Section of the ECHR unanimously dismissed the case Dennis Grainger and others v. UK (Application No. 34940/10) as manifestly ill-founded and inadmissible. The decision has broader ramifications. It suggests that ECHR member countries have a very wide margin of appreciation in setting macro-economic policy in general and in the resolution of banking and financial crises in particular. The ECHR decision suggests that creditors and other interested parties will face an uphill struggle in challenging measures taken in the context of financial crisis resolution before the ECHR and in obtaining compensation. It is an important decision at the intersection of international finance and human rights. Investors holding the debt of Eurozone governments will take note.

The court fully endorsed the holding and approach of the English courts. Like the English domestic courts, it found that the assumptions that  the valuer of Northern Rock shares was required to make pursuant to the Banking (Special Provisions) Act 2008 s.5 (4) did not violate the rights of shareholders under Article 1 of the First Additional Protocol.

The Act granted interim powers to Tripartite authorities – HM Treasury, the Financial Services Authority and the Bank of England – to allow for the nationalization and compulsory acquisition of shares. Following recent controversies and some extraordinarily critical coverage in the UK press about the allegedly negative impact of the ECHR in the domestic legal system (e.g. A and others v. UK; Othman (Abu Qatada) v. the United Kingdom), the optimist may be tempted to think that the ECHR’s Northern Rock decision, fully endorsing the reasoning of the English courts, could help to calm public anxiety about the ECHR in the UK.

The shareholders claimed that Article 1 of the First Additional Protocol had been violated by an unfair valuation of their shares following nationalization of Northern Rock. They also allege that they had been treated less favourably than other banks, such as those of Royal Bank of Scotland that had since that time received large capital injections from the government without outright nationalization. The Northern Rock Compensation Scheme Order, based on the Banking (Special Provisions) Act of 2008, provided that compensation to Northern Rock shareholders should be assessed by an independent evaluator, based on what the bank would be worth if all financial assistance had been withdrawn and Northern Rock placed in administration. Shareholders argued these parameters rendered their shares automatically worthless.

Northern Rock shares had traded at £ 0.90 immediately prior to the announcement of nationalisation by the British government – typically, the critical date for assessing compensation.  The valuer determined in March 2010 that the value of the shares was zero, whereas the shareholders argued that £ 2-4 was their fair market value. The High Court had upheld the compensation parameters ([2009] EWHC 227(Admin). The Court of Appeal dismissed the appeal on 8 July 2009 ([2009] EWCA Civ 788). The UK Supreme Court refused permission to appeal on 16 December 2009 (UKSC 2009/0179). The UK sold Northern Rock in November 2011 to Virgin Money.

The High Court had dismissed the initial application for judicial review and held that nationalization did not infringe shareholder rights under Article 1 First Protocol ECHR. It found that the actions by the tripartite authorities did not impose an ‘individual and excessive burden’ on Northern Rock shareholders. The court reasoned that the only source of financing after Northern Rock became insolvent was the Tripartite Authorities.  Prior to nationalization, Northern Rock shareholders had no legitimate or reasonable expectations of public financial support through the lender of last resort function of the Bank of England. Tripartite authorities owed no duty of care to shareholders, even if claimants had a reasonable prospect of establishing regulatory failure. Their duty of care is only to the public. The government’s actions in relation to other banks at other times in different circumstances did not have any bearing on the fairness of the compensation scheme. The determination by Parliament to put in place this particular compensation scheme was inside even the narrowest margin of appreciation. It is for the legislature and the government alone to determine the provisions of the compensation scheme.

In its decision dismissing the application, the ECHR reiterated several general rules of the protection of property under the ECHR: that Article 1 of the First Additional Protocol sets out the principle of peaceful enjoyment of property, that deprivations of property are possible under certain conditions, and that the use of such property may be controlled in accordance with the general interest. These three rules are ‘not “distinct” in the sense of being interrelated.’ There was no right to full compensation in all circumstances: ‘Legitimate objectives in the “public interest”, such as those pursued in measures of economic reform or measures designed to achieve greater social justice, may call for less than reimbursement of the full market value.’ (para. 37).

The ECHR underscored that its role was limited, and that in principle the national authorities are better placed than international judges to establish what is in the public interest because of the direct knowledge of their society and its needs (para. 36). Its power of review was limited to ascertain whether the parameters for compensation fell inside the state’s margin of appreciation.

The court then turned to applying these general considerations to the facts of this case. It considered

The Court of Appeal took the view that the Government should be afforded a wide  margin of appreciation in this case, since the impugned action arose in the context of macro-economic policy. The Court agrees that given the exceptional circumstances prevailing in the financial sector, both domestically and internationally, at the relevant time, a wide margin of appreciation is appropriate. It is clear from the material before it that the financial assistance provided by the Tripartite Authorities from 2007 (that  is, the LOLR support) was provided with the aim of protecting the financial sector in the United Kingdom from the contagion that might spread to other key institutions if  Northern Rock were allowed to fail. The subsequent nationalisation of Northern Rock  served the same aim. Like the earlier loans, it was carried out as a last resort, when no viable commercial solution could be found which would have prevented the bank from going into liquidation without continued support from public funds. The Court considers that the Compensation Scheme must be seen as integrally linked to the  series of support measures which ended with nationalisation. Throughout the entire process, the Government’s focus was on protecting a key sector of the national economy. In accordance with its case-law, therefore, the Court must respect the  decisions of the national authorities unless it finds them to be “manifestly without reasonable foundation”.

This statement by the ECHR reflects some elements of US Supreme Court Justice Brandeis’ famous dissent in New State Ice Co. v. Liebmann. Referring to the Great Depression as ‘an emergency more serious than war’, Justice Brandeis explained, in the specific context of US federalism, that:

[For judges] [t]o stay experimentation in things social and economic is a grave responsibility. Denial of the right to experiment may be fraught with serious consequences to the nation. It is one of the happy incidents of the federal system that a single courageous state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country. This Court has the power to prevent an experiment. We may strike down the statute which embodies it on the ground that, in our opinion, the measure is arbitrary, capricious, or unreasonable. We have power to do this, because the due process clause has been held by the Court applicable to matters of substantive law as well as to matters of  procedure. But, in the exercise of this high power, we must be ever on our guard, lest we erect our prejudices into legal principles. If we would guide by the light of reason, we must let our minds be bold.

The ECHR also highlighted that lender of last resort support was discretionary and dependent on complex policy judgments of what was in the public interest:

… the Court accepts that the Government’s objective throughout its dealings with Northern Rock during this period was to protect the United Kingdom’s financial sector. As part of this policy, they aimed to maintain depositor confidence in the    safety of placing money with banks. On the other hand, however, they also sought to avoid encouraging the management boards of other financial institutions from making bad business decisions on the assumption that the State would provide a safety net. There was no obligation under domestic law for the Tripartite Authorities to provide LOLR support, and no duty owed by the State to the shareholders to protect their investments in Northern Rock. Nor does Article 1 of Protocol No. 1 impose such a positive obligation on the State; indeed, the Court has stressed on many occasions   that this provision cannot be interpreted as imposing any general obligation on the Contracting States to cover the debts of private entities … The LOLR support enabled Northern Rock to continue trading for a few more months but the company was not able during this short period to restructure in such a way as to enable it to survive without support. In the Court’s view, the decision taken in the legislation that the former shareholders of Northern Rock should not be entitled to take the value which had been created by the Bank of England’s loan was far from being “manifestly without reasonable foundation”. Instead, it was clearly founded on the policy of avoiding “moral hazard”, which is at the heart of the principles which regulate the provision of LOLR. In the Court’s view, it was entirely legitimate for the State authorities to decide that, had the Northern Rock shareholders been permitted to benefit from the value which had been created and maintained only through the provision of State support, this would encourage the managers and shareholders of other banks to seek and rely on similar support, to the detriment of the United Kingdom economy.

Northern Rock shareholders at the time of the nationalisation were diverse. The ECHR described the Claimants as follows (para. 1):

One of the applicants, SRM Ltd Global Master Fund Partnership, is an investment  fund incorporated in the Cayman Islands. As a result of transactions between 14  September 2007 and 12 February 2008 it became the largest shareholder in Northern Rock plc, with 48,452,655 shares, amounting to 11.5% of the issued ordinary share capital. Another applicant, RAB Special Situations (Master) Fund Ltd is also an investment company incorporated in the Cayman Islands. It acquired its shares in Northern Rock by transactions between 19 September 2007 and 14 February 2008. By the date of Northern Rock’s nationalisation, it owned 34,444,299 shares, amounting to 8.18% of the issued ordinary share capital. The remaining applicants are individual small shareholders, some of whom acquired their shares on demutualisation; others of whom acquired theirs as employees under an approved profit share scheme or share incentive plan, or other incentive schemes, or by contributions to the company pension fund. Others were small investors who bought their shares on the stock exchange. At the date of nationalisation there were some 150,000 small shareholders.

The ECHR, similar to but even more strongly than the High Court, emphasised that the two largest claimants were hedge funds incorporated in the Cayman Islands, a British overseas territory with a reputation as a tax haven. As distressed debt investors, they had bought their shares when the financial difficulties of Northern Rock were widely apparent. Both courts gave less attention on the plight of retail shareholders, some of them, such as lead claimant Dennis Grainger, former employees of Northern Rock. Some retail shareholders held Northern Rock shares for retirement purposes and had bought them in the 1990s. It may have been their misfortune that their case was consolidated with the case of the two hedge funds. It is conceivable that a group of retail investors who had held the shares for long periods of time might have received a somewhat more sympathetic hearing from both courts.

The Northern Rock saga now appears to be closed, at least as far as the courts are concerned. No doubt some shareholders will continue their struggle for compensation. In theory, they may be tempted to bring investment arbitrations against the UK. Based on decisions such as Saluka v. Czech Republic and Genin v. Estonia, this may not be an entirely hopeless cause. However, given that the respondent would be the UK, a central player in the global financial system, bringing a successful claim is a much longer shot compared to bringing it against most other countries. In addition, the British nationality of most of the shareholders, including the two hedge funds incorporated in the British Overseas Territory of the Cayman Islands, is very likely to rule out this avenue for obtaining compensation from the UK.

For more on this story go to:

http://www.ejiltalk.org/echr-leaves-northern-rock-shareholders-out-in-the-cold/