Hazell v Hammersmith and Fulham London Borough Council

Facts

Between 1983 and 1989 the London Borough of Hammersmith and Fulham entered a very large number of interest rate swap transactions with banks, with a notional capital value running into billions of pounds. The swaps were not linked to a particular borrowing; the council aimed to make a profit by predicting movements in interest rates. The district auditor, Hazell, applied to the court under the Local Government Finance Act 1982 for a declaration that the transactions were unlawful.

Issue

Whether a local authority had power, under its statutory borrowing powers, under section 111 of the Local Government Act 1972 or otherwise, to enter into interest rate swap transactions; and, if not, what followed for the contracts.

Held

The council had no power to enter into the swaps, which were therefore ultra vires and void. The swap transactions were speculative, not part of the management of the council's debt, and section 111 could not supply a power that was not conferred by the statutes that regulated borrowing.

Ratio

• A local authority, as a statutory body, has only the powers conferred by statute or reasonably incidental to them; it cannot enter into a transaction which is not authorised by the legislation regulating its functions.
• Section 111 of the 1972 Act allows a local authority to do things calculated to facilitate, or conducive or incidental to, the discharge of its functions, but does not enlarge its powers or authorise speculation on interest rates that is not conducive to proper debt management.

The judgments

Key reasoning

• The statutory powers of local authorities to borrow, to lend and to manage their debt were limited and were set out in the legislation, and swaps were a different kind of transaction that Parliament had not authorised.
• The swaps lacked any connection with the local authority's existing borrowing and existed to take advantage of changes in interest rates, so they could not be described as incidental to its borrowing powers.
• It follows that the contracts, made without capacity, were void and not merely voidable, so that neither estoppel nor ratification could give them validity.

Where it fits in the module

On Capacity to contract, Hazell is the standard authority that a local authority can contract only within its statutory powers and that a contract made outside them is void. Candidates link it to Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669 and Kleinwort Benson Ltd v Lincoln CC [1999] 2 AC 349, which deal with the recovery of money paid under void swaps, and to the Local Government (Contracts) Act 1997, which Parliament passed to give protection to counterparties to certain local authority contracts. The FHS debate asks whether the capacity of public bodies should be limited by statute at all, how the public law notion of ultra vires interacts with private law contract, and whether the harshness to third parties justifies a more flexible approach such as the Companies Act model.

Criticisms

• Treating councils as having no power beyond the words of statute puts the whole commercial risk on banks that dealt in good faith with a public body, even though the council was at fault and had misled them by acting beyond its powers.
• The doctrine encourages public bodies to escape contracts from which they have benefited, so the law on void contracts alone gives the authority a one-sided advantage and weakens confidence in contracting with the public sector.
• The conclusion that section 111 could not support the swaps rested on a fine distinction between debt management and speculation, which the statute did not state and which is hard to apply in practice.
• The strict approach to capacity sits uneasily with modern reform of company law, which has largely abolished ultra vires for commercial bodies, and with the idea that public bodies should be able to manage their finances with commercial tools.