justice court scales
Iain Farrimond has been sentenced to six years prison time - representational image

Hundreds of small to medium enterprises (SMEs) are turning to specialist lawyers from overseas to help them wrangle their way out of what they believe are mis-sold complicated financial contracts, sold as loan protection products, that are now suffocating them financially.

The groundswell comes alongside Barclays' chief executive Bob Diamond's admission that the bank "made some mistakes" in the market for interest rate products during last week's annual general meeting. Diamond, whose bank has has come under fire for allegedly mis-selling interest rate swaps and had the most banking customer complaints in 2011 according to regulators the Financial Services Authority (FSA), said: "There was a worry about interest rates going higher in 2005, particularly in the property sector where consumers wanted to lock in interest rates. I can guarantee you we have made some mistakes, when we have a mistake we're going to own up and fix it."

The admission raises concerns that perhaps thousands of UK businesses may have been mis-sold complicated financial products, such as interest rate swaps, that are essentially placing a bet on the movement of interest rates. This follows a damning indictment of some of the industry's practices last year, when a six-year probe by the FSA in to the selling of payment-protection insurance plans (PPIs) resulted in a potential £6bn in compensation claims. So far the UK's five biggest lenders have set aside £6bn to cover PPI claims, making it one of the most costly consumer scandals ever. Sixteen financial firms paid out £1.9bn in claims last year, according to FSA figures.

Interest rate swap agreements, or IRSAs, are contracts between a bank and its customer where typically one side pays a floating, or variable, rate of interest and receives a fixed rate of interest payments in exchange. They're used to hedge against extreme movements in market interest rates over a given period. Companies that have seen the value of these products move against them as rates fell during the recession, now owe banks crippling sums of money in interest payments each year.

But if these businesses want to cancel these contracts, the cost of doing so would be even higher in a lump sum payment, as banks demand cash upfront in lieu of future revenue.

Now hundreds of firms believe they should never have been sold the products in the first place, say a German law firm. They are moving towards taking banks to court to release them from contracts that they say they either did not fully understand, or were misrepresented as just "payment protection" against rising interest rates.

"Derivatives are a totally different kettle of fish and it is a dubious business to start, especially if you don't fully understand the products. If the client doesn't understand the contract, at best, they are gambling blind," says Professor Julian Roberts, partner at law firm Wolfsteiner Roberts. "Derivatives don't work like normal investments such as stocks, shares or savings accounts. As the German courts now recognise, they are more akin to bets. Unless customers clearly understand that, and all the consequences that follow, they are definitely not in a position to make an informed judgment about the bank's offer. Clearly the banks discovered a market opportunity by selling these types of instruments to individuals and SME's as a protection or loan enhancing method, but which are in fact excessive and risky for the individual who does not stand to gain a benefit from these massive bets."

Wolfsteiner Roberts is a German-based law firm, but it has started to see a rapid increase in UK clients seeking representation for cases against banks mis-selling interest rate hedging products, after the firm successfully led the first legal case in Germany on this matter.

"These smaller businesses are normally bound in real estate deals and products, such as interest rate swaps that are sold to clients by saying it will keep their interest rate costs down, and that this would benefit them," Roberts says. "However, in Germany there are a lot more complicated products that have been sold, compared to the UK, such as giving exposure to the businesses based on bits of a yield curve and currency exchange rates."

A case study of Adcock & Sons, a small privately owned electrical retailer in Norfolk, is a business that is not represented by the Wolfsteiner Roberts but is indicative of thousands that are in the same situation.

Despite UK interest rates being held at a record low of 0.5%, Adcock & Sons is paying an interest rate of 9% on a commercial mortgage, which is generating a bill of just under £80,000 a year. The joint owner of the business, Paul Adcock first told the BBC that he did not know that the interest rate swap that came with the extra features would have triggered the deal swinging against him. He was sold, he says, a bet on the Bank of England's office rate not falling below 4.7%.

Since rates have stood at 0.5% since May 2009, he, like many others, has been paying unsustainable amounts on a product that bears little resemblance to the loan he thought he had taken out in the first place. He has had to lay off staff and now says it is unlikely that the business will survive much longer. Adcock says that the Barclays Capital salesman who sold him the contracts had said that the protection would be "free".

Barclay's responded said in a media statement that "interest-rate risk management products were sold by Barclays to customers in accordance with the regulatory framework. Barclays is satisfied it provided sufficient information to enable clients to make an informed, commercial decision about the products it offers. Barclays has an ongoing dialogue with Mr Adcock. We continue to work with the company, utilising the expertise of our Business Support team to respond to the challenging market conditions faced by the retailing sector."

The level of complaints has compelled the FSA to begin its first formal review of interest rate swap mis-selling cases last month. The regulator has since asked the UK's major banks to provide them with details of their sale of interest rate hedging products that were sold to small and medium-sized businesses.

However, unlike Germany, where a lot of businesses are able to reach a suitable settlement with the banks, UK case law has not been favourable towards SMEs and is notoriously unsympathetic, says Roberts, when it comes to the argument that the client didn't fully understand the contracts they were entering into.

According to company filings, Barclays, for example, has sold 2000 swaps of a similar nature to smaller businesses, while 5000 RBS customers RBS have been sold similar products. While hard data concerning actual complaints is not available, if these customers made similar complaints, this could cause thousands to seek legal assistance.

However, with the sheer volume of businesses stepping forward, Roberts sees a chance for a new UK case law precedence to be set that in turn will lead to businesses reaching settlements with the large banks.

"Since last autumn, we have had a significant number of other SMEs from the UK turning to us, and in many cases they are small UK businesses with modest property loans and mortgages that are small in comparison to the German companies we have represented," Roberts says. "I do see from the level of response we have had from clients in the UK in such a short space of time, that this could open a can of worms regarding the number and types of cases in which SMEs have claimed the mis-selling of derivatives. Derivatives are deceptive and very complicated. You need to spend a lot of time understanding the contracts, and even then realising that you don't understand it fully. However, if the level of cases continues to grow and is gathering more attention in court, there is a good chance of the UK changing its case law for derivatives."