The English High Court has dismissed an application for an injunction to prevent an airline group from making demands under bank-confirmed standby letters of credit (SBLCs), securing aircraft leases granted to the claimant (a budget passenger airline), on the basis that it was not sufficiently arguable that the leases were frustrated due to the effects of the COVID-19 pandemic: Salam Air SAOC v Latam Airlines Group SA  EWHC 2414 (Comm). Continue reading
Tag: UK court decisions
The English High Court recently struck out a claim by a parent company (i.e., a shareholder of its subsidiary) for negligence and breach of retainer against a law firm in conducting due diligence and preparing for the subsidiary’s IPO, on the basis that the loss claimed by the parent company was reflective of the loss claimed by the subsidiary and therefore fell squarely within the confines of the reflective loss principle: Naibu Global International Company plc & Anor v Daniel Stewart & Company plc & Anor  EWHC 2719 (Ch) (Naibu).
The Reflective Loss Principle
This case applies the principle of reflective loss that was recently confirmed and restated by the English Supreme Court in Sevilleja v Marex Financial Ltd  UKSC 31 (see our London office’s banking litigation e-bulletin for a detailed discussion of this case: Untangling, but not killing off, the Japanese knotweed: Supreme Court confirms existence and scope of “reflective loss” rule). According to this principle, a shareholder’s loss in respect of a diminution in share value is not, in the eyes of the law, damage which is separate and distinct from the damage suffered by the company, and is therefore irrecoverable by the shareholder. As a result, even if the shareholder has also, in addition to the company, been wronged by the defendant’s conduct and the company has not commenced proceedings against the defendant, any claim for damages brought by the shareholder will be barred by this principle.
The claim in Naibu arose out of the dissipation of assets of a Chinese sportswear company, Naibu (China) Co Ltd (Naibu China), by its founder. Naibu China was wholly owned by Naibu (HK) International Investment Limited (Naibu HK), which in turn was wholly owned by Naibu Global International Company plc (Naibu Jersey).
Naibu Jersey was originally floated on the Alternative Investment Market (AIM) in London in 2012, but was subsequently delisted in 2015 following the dissipation of Naibu China’s assets and the closure of its factory. The shares of Naibu HK and Naibu Jersey in Naibu China became valueless as a result. A law firm was retained as the legal adviser to both Naibu China and Naibu HK in relation to the AIM flotation, and Naibu HK and Naibu Jersey argued that the law firm had acted negligently and in breach of their retainer in conducting due diligence and preparing for the IPO. Naibu Jersey alleged that it had incurred losses at different times which might be different in amount and nature from the losses sustained by Naibu HK.
The law firm argued that the loss claimed by Naibu Jersey was almost entirely reflective of the losses claimed by Naibu HK and was therefore irrecoverable under the principle of reflective loss.
Bacon J rejected Naibu Jersey’s argument, holding that the losses claimed by Naibu Jersey as the parent company were entirely reflected in the diminution in the value of its shareholding in its subsidiary, even though the amount of the losses caused to Naibu Jersey might not be identical to that caused to Naibu HK. Bacon J held that, if the application of the rule against reflective loss could be avoided by identifying different losses occurring at different times (as Naibu HK and Naibu Jersey sought to do) in order to argue that the losses of the two companies might not have been identical, that would entirely undermine the purpose of the rule. In particular, the supposedly separate category of losses named by Naibu HK/Naibu Jersey (i.e., disbursement of the proceeds of flotation) was, in reality, part of the same loss, representing the investment made by Naibu Jersey in Naibu China, through Naibu HK, the value of which was now reduced to nil. Accordingly, the correct legal position was that it is the nature of the loss, rather than the amount, that is decisive as to whether the reflective loss principle is engaged.
For a more detailed discussion of the case, please refer to our London office’s banking litigation e-bulletin here.
The Reflective Loss Principle in Hong Kong
A month before the English Supreme Court delivered its judgment in Sevilleja v Marex Financial Ltd  UKSC 31, the Hong Kong Court of Appeal explored the same doctrine in Topping Chance Development Ltd v CCIF CPA Ltd  HKCA 478, which was an application before the Hong Kong Court of Appeal to strike out a part of a claim brought by the plaintiff for infringing the rule against recovery of reflective loss. The Court of Appeal held that the two seminal authorities in Hong Kong on this point are Johnson v Gore Wood & Co  2 AC 1and Waddington Ltd v Chan Chun Hoo (2008) 11 HKCFAR 370.
In Topping Chance, the Hong Kong Court of Appeal considered, on the facts, whether the rule against recovery of reflective loss should not apply because the circumstances of the case were akin to the second exception to the rule set out by Lord Bingham in Johnson v Gore Wood & Co i.e., where a company suffers loss but has no cause of action to sue to recover that loss, the shareholders of that company may sue in respect of it (if the shareholder has a cause of action to do so), even though the loss is a diminution in the value of the shareholding.
The Hong Kong Court of Appeal held that the ‘no reflective loss’ principle is engaged not only where the company had the right to sue but also where it had declined or failed to sue, whether for lack of merits or lack of financial resources caused by the wrongdoer. It is not concerned with barring causes of action but with barring recovery of types of loss. It is based on the nature of the loss and what is important is that the company’s loss would be made good if the shareholder recovers from the defendant.
Although the facts in Topping Chance were different from those in Naibu (in that in Naibu both the company and the shareholder had a cause of action, whereas in Topping Chance, the Hong Kong Court of Appeal found that the company did not have a realistic claim), both courts looked at the nature of the loss in determining whether the ‘no reflective loss’ principle was engaged. Given that the principle in Hong Kong closely resembles that in England, if a similar factual situation as in Naibu were to arise in Hong Kong, the Hong Kong court is likely to follow the reasoning in Naibu, and hold that it is the nature of the loss, rather than the amount or its timing, that is decisive in determining whether the ‘no reflective loss’ principle is engaged.
The English Court of Appeal has held that, where an auditor negligently failed to detect management’s dishonest concealment of the claimant’s insolvency, it was liable for the losses suffered by the claimant in continuing to conduct its loss-making business: Assetco Plc v Grant Thornton UK LLP  EWCA Civ 1151.
While the decision recognises that a negligent auditor will not be liable for losses suffered simply because a business continues to trade, in the circumstances of this case the claimant’s business was ostensibly sustainable only on the basis of management’s dishonest representations representations to the auditors in the course of the audits. By negligently issuing unqualified audit reports, the business appeared to be sustainable when in truth it was insolvent, and this deprived the claimant’s shareholders or non-executive directors of the opportunity to call the senior management to account. The English Court of Appeal found that the claimant’s losses from continuing that business fell within the scope of the defendant’s duty: the negligence was not merely the occasion for the losses but was a substantial cause of them.
The judgment is of particular interest for the English Court of Appeal’s discussion of the so-called SAAMCO principle, which was established in South Australia Asset Management Corpn v York Montague Ltd  AC 191 (SAAMCO) and expanded upon in Hughes-Holland v BPE Solicitors  UKSC 21. Essentially, this says that where a professional is responsible only for providing information on which a decision will be taken, rather than advising on the merits of a transaction overall, the professional will be responsible only for the consequences of the information being wrong – not all the financial consequences of the transaction. This means that the claimant must establish that its loss would not have been suffered if the information had in fact been correct.
In the present case, the English Court of Appeal confirmed that the SAAMCO principle applies to general audit cases, even though the purpose of an audit is not to enable a decision to be taken in respect of a particular transaction. However, the decision emphasises that the SAAMCO principle may not need to be addressed in all cases, and in any event is not to be applied mechanistically. It is merely a tool the court may employ for determining which losses fall within the scope of the defendant’s duty, and it may be subject to exceptions.
As a result, it was not fatal to the claimant’s case that it had not asked the judge to determine whether the losses it claimed would have been suffered if the information in the audit reports had been correct, and the judge had not done so. However, in cases where the provision of negligent advice or information is alleged, it would be prudent for the parties to consider the application of the SAAMCO principle and be ready to persuade the court, if necessary, why it should not be applied.
The SAAMCO principle is due to be considered by the UK Supreme Court in an appeal against the decision in Manchester Building Society v Grant Thornton UK LLP  EWCA Civ 40 (considered here), in which the English Court of Appeal applied the principle to conclude that an auditor was not liable for losses suffered following negligent advice regarding the accounting treatment of interest rate swaps. That decision was also considered by the English Court of Appeal in the present case.
The present decision is also of interest for the English Court of Appeal’s discussion of the correct approach to assessing damages in “loss of a chance” cases, where the claimant’s loss depends on the hypothetical acts of third parties. The decision illustrates in particular that, in some cases, it may be appropriate to treat the lost chance as a certainty.
For a full discussion of the case, please click here.
Trustees often seek to limit their liability in the form of exoneration clauses in trust deeds. As such, it is generally difficult for a beneficiary to challenge a trustee’s decision that falls within the scope of the exoneration clause.
In Sofer v SwissIndependent Trustees SA  EWHC 2071 (Ch), the England and Wales High Court confirmed just how high the bar can be for beneficiaries to overcome the limitation on liability provided by exoneration clauses and also set out a test for doing so. Here the defendant (the trustee) applied for striking out or summary judgment of a claim pursued by a beneficiary for breach of trust, on the basis that the trustee’s relevant action was covered by an exoneration clause. The strike out was granted.
The judgment is also noteworthy in particular for Hong Kong and Australian trustees and beneficiaries. The judge relied on both English and Australian case law and highlighted that “the relative homogeneity of trust law in this and other Commonwealth jurisdictions” meant the Australian case law had “considerable persuasive value”. Continue reading
The English High Court in Lehman Brothers International (Europe) (In Administration) v Exotix Partners LLP  EWHC 2380 (Ch) found it necessary to imply a term to a debt security trade agreement that was otherwise unworkable. It is generally uncommon for a Court to imply terms into a commercially negotiated agreement given the restrictive nature of the relevant test, although this is more often seen in the case of an oral agreement as in this case. This is even more so in the context of the securities market.
In 2014, Lehman Brothers International (Europe) (In Administration) (“LBIE”) entered into a trade of Peruvian government-issued bonds (otherwise known as, Peruvian Government Global Depository Notes (“GDN”)) with Exotix Partners LLP (“Exotix“) by oral agreement.
The parties were, however, mistaken as to the nature and value of the debt securities being traded. In particular, the parties incorrectly thought that the securities involved were of insignificant value. The perceived value of the GDN was approximately US $7,000 but the securities were, in fact, worth over US $7 million. The parties were blind-sided by the fact that the GDN were issued in Peruvian Nuevo Sol, the local currency in Peru, and did not realise that the coupon payments accrued under the securities were in US Dollars. For this reason, their valuation was over 1,000 times off the mark.
Eventually, Exotix realised the mistake when it received a coupon payment vastly greater than what it had expected. Instead of notifying LBIE of their mistake, however, Exotix sold the GDN and profited massively from the sale.
The Court’s analysis
The court considered the true meaning and effect of the bargain struck between LBIE and Exotix. In doing so, the court looked at the objective intentions of the parties on the transaction. The court had to decide whether the parties agreed to trade: (a) a specific number of GDN (Exotix’s case); or (b) a number of GDN equating to a particular value in the currency that they were issued (LBIE’s case).
The court found that the parties’ intention was most likely the latter i.e., the parties had intended to trade securities worth approximately US $7,000 as opposed to a specific number of GDN. Accordingly, it could not have been the objective intention of the parties to trade with over US $7 million at stake.
For this understanding to work, however, a term that enables the delivery and trade of a fraction of a GDN must be implied. A trade of an integer quantity of GDN would amount to a value exceeding the approximate US $7,000 traded, and would also contradict the court’s finding that the parties intended to trade on a value as opposed to a quantity.
In making the decision, the court relied on the Supreme Court case of Marks & Spencer plc v BNP Paribas  UKSC 72 (“Marks & Spencer“), a leading authority on when an implied term should be read into the relevant contract. There, the court held that the relevant question is whether the term is so obvious and necessary to provide commercial and practical coherence to the agreement that it must be implied for the sake of business efficacy.
The court was understandably hesitant in finding that the proposed implied term was clearly obvious and necessary. At the same time, it noted that proper understanding of the parties at the time when the transaction was entered into would have led the parties to realise the blatant mistake they had made. This rendered the problem between the parties a misunderstanding as opposed to an omission (which would otherwise have likely led the court to find that the contract was fundamentally defective and void).
Relying on Nazir Ali v Petroleum Company of Trinidad and Tobago  UKPC 2 (“Nazir Ali“), another Supreme Court case, the court applied the principle that a term may be implied if the contract would otherwise lack commercial or practical coherence. In short, the term must be necessary to ensure that the agreement is workable.
Following the court’s analysis, it held that the trade agreement could only be made to work if an implied term for the settlement of a fraction of GDN was found. The court recognised that the law prefers giving effect to the parties’ agreement as opposed to dismissing the parties’ bargain altogether. For this reason, the court’s finding that the issue before it was due to a misunderstanding between parties rather than an omission of the parties was paramount to the court in finding in LBIE’s favour.
As relief, LBIE was awarded restitutionary relief on the basis that Exotix would have otherwise been unjustly enriched by the value of GDN it had received and the profit that it made from that amount.
Relevance to Hong Kong
While the impression is often that the courts will decline to enforce an agreement where obligations are omitted or ambiguous, the English High Court case serves as a helpful reminder that the courts can also be sympathetic and imply necessary terms into contracts where there is a genuine agreement between the parties. The case highlights the preference of the courts to uphold the parties’ bargain as opposed to dismissing the parties’ mutual understanding in its entirety.
References to Marks & Spencer and Nazir Ali in the High Court’s decision emphasises the relevance of these English Supreme Court authorities. It demonstrates a consistent approach taken by English courts when considering the matters of contractual interpretation.
Although the same authorities have not been considered by the Court of Final Appeal in Hong Kong, the application of principles derived from these cases provide a helpful indication as to the direction the Hong Kong courts are likely to take when similar issues are argued before them.
Take the Privy Council decision in Attorney-General of Belize v Belize Telecom Ltd  UKPC 10, for example, this case has been considered by the Hong Kong courts in Guo Jianjun v Dragon Fame Investment Ltd  2 HKC 213 and Tadjudin Sunny v Bank of America, National Association  HKEC 1128 with the former being a Hong Kong Court of Appeal case. It would not be surprising to find the authorities of Marks & Spencer and Nazir Ali being discussed and applied before the Hong Kong courts in the near future.
The UK Supreme Court has recently upheld a claim for breach of the so-called Quincecare duty of care, which requires a financial institution to refrain from executing a customer’s payment mandate if (and so long as) it is “put on inquiry” that the payment order is an attempt to misappropriate its customer’s funds: Singularis Holdings Ltd (In Official Liquidation) (A Company Incorporated in the Cayman Islands) v Daiwa Capital Markets Europe Ltd  UKSC 50. The UK Supreme Court’s judgment in this case follows hot on the heels of the English Court of Appeal’s refusal to strike out a separate claim for breach of a Quincecare duty (in JP Morgan Chase Bank NA v The Federal Republic of Nigeria  EWCA Civ 1641). Of itself, the English Court of Appeal decision has, arguably, expanded the scope of the Quincecare duty of care.
The expanded scope in JP Morgan does not yet apply in Hong Kong. At present, the traditional Quincecare duty continues to apply: see DEX Asia Ltd v DBS Bank (HK) Ltd  5 HKLRD 160 and more recently PT Tugu Pratama Indonesia v Citibank N.A.  5 HKLRD 277, in which the Court of First Instance considered, obiter, the extent to which a bank’s duty of care owed to its customers requires the bank to make inquiries of suspicious transactions in their bank accounts. The expanded scope of the Quincecare duty of care may, however, be considered in Hong Kong sooner rather than later, if Tugu Pratama were to be appealed.
The judicial attention that this cause of action is currently receiving in England & Wales, and to some extent, in Hong Kong, highlights this as a risk area for financial institutions handling client payments. In particular, there is litigation risk where there are inadequate safeguards/processes governing payment processing at financial institutions. This is a good time for financial institutions to review safeguards governing payment processing, and also review the protocols in place governing what steps must be taken in the event a red flag is raised.
Further, the UK Supreme Court decision in Singularis is also of significance to corporate claimants – and insolvency office holders – in particular in clarifying the test for corporate attribution in England & Wales. The court declared that the often criticised decision in Stone & Rolls Ltd v Moore Stephens  UKHL 39 (considered here and here) can “finally be laid to rest”. In particular, it confirmed that whether the knowledge of a fraudulent director can be attributed to the company is always to be found in consideration of the context and the purpose for which the attribution is relevant – even in the case of a “one-man company”. This clarification is welcome as the law in England & Wales is now somewhat aligned to the Hong Kong position set out in the Court of Final Appeal decision of Moulin Global Eyecare Trading Limited (in liquidation) v The Commissioner of Inland Revenue FACV 5/2013, in which Lord Walker provided welcome clarification on whether the fraudulent knowledge of directors can be attributed to a company. Lord Walker, in that case, admitted that his analysis in Stone & Rolls was wrong, in particular, to regard the fraud exception as being of general application, regardless of the nature of the proceedings.
JP Morgan – Quincecare duty of care
The claimant brought a claim against the defendant bank to recover funds held in its depository account, which the bank paid out in accordance with instructions given by the claimant (from persons authorised to give those instructions under the terms governing the account). The claimant alleged that the payments were made by the bank in breach of its Quincecare duty. This is the duty imposed on a bank to refrain from executing an order if (and for as long as) it is ‘put on inquiry’ in the sense that it has reasonable grounds (although not necessarily proof) for believing that the order is an attempt to misappropriate the funds of its customer. This is an objective test, judged by the standard of an ordinary prudent banker. The bank applied for reverse summary judgment/strike out on various grounds, including that there was no Quincecare duty of care applicable on the facts because such a duty was inconsistent with, or was excluded by, the express terms of the depository agreement. The English High Court refused the bank’s application and the bank appealed. The English Court of Appeal upheld the High Court’s decision, rejecting all grounds of appeal put forward by the bank. There are three particularly significant points arising from the judgment.
Amongst those, the English Court of Appeal held that, in most cases, the Quincecare duty will require “something more” from the bank than simply pausing and refusing to pay out on the mandate when put on enquiry that the order is an attempt to misappropriate funds. The effect is that the Quincecare duty comprises both (i) a negative duty to refrain from making payment; and (ii) a positive duty on the bank proactively to do “something more”. In the English Court of Appeal’s view, these negative and positive duties carry equal weight, and neither is separate nor subsidiary nor additional to the other. In the High Court, the judge inclined to the view that the positive duty was a duty of enquiry. However, the English Court of Appeal’s formulation of the positive duty is not limited to one of enquiry or investigation and for that reason it has arguably expanded the scope of the Quincecare duty. The English Court of Appeal, however, consciously avoided identifying factors which might be relevant to assessing what the “something more” is or might consist of, thus offering banks little practical guidance; it will instead and unhelpfully depend on the facts of the case in question. Other significant points are discussed in detail in our blog post here.
Quincecare duty of care in Hong Kong
The arguably expanded scope of the Quincecare duty of care in JP Morgan does not yet apply in Hong Kong. At present, the traditional Quincecare duty continues to apply. The Quincecare duty was considered and applied in Hong Kong in DEX Asia Ltd v DBS Bank (HK) Ltd  5 HKLRD 160 and more recently in PT Tugu Pratama Indonesia v Citibank N.A.  5 HKLRD 277, in which the Court of First Instance considered, obiter, the extent to which a bank’s duty of care owed to its customers requires the bank to make inquiries of suspicious transactions in their bank accounts. The expanded scope of the Quincecare duty of care may, however, be considered in Hong Kong sooner rather than later if Tugu Pratama were to be appealed.
In Tugu Pratama, rogue directors of the plaintiff (an insurance company) instructed the defendant bank to make payments in excess of US$50 million (over four years) to their personal accounts from the plaintiff’s private banking account. The plaintiff alleged that the payments constituted misappropriation of its money and were made without its authority. Instructions for the payments, however, were given in accordance with the account opening mandate. The Honourable Mr. Justice Anthony Chan held that the defendant bank had acted in breach of its duty of care to the plaintiff by effecting the payments (but on the facts of the case he held that the Plaintiff’s claim was time-barred).
Following both Barclays Bank Plc. v. Quince Care Limited and another  4 All ER 363 and DEX Asia, Anthony Chan J held that, in assessing whether the bank was put on inquiry, factors such as (i) the standing of the corporate customer; (ii) the bank’s knowledge of the signatory; (iii) the amount involved; (iv) the need for a prompt transfer; (v) the presence of unusual features; and (vi) the scope and means available to the bank for making reasonable inquiries, were all relevant. Importantly, the judge held that the duty of inquiry is only triggered in a clear case. Whilst it is a duty not to facilitate a fraud practised on its customer, it is clearly not the function of a bank to act as a fraud detector. Had it been otherwise, banks would have to employ teams of additional and specialist staff to carry out such detective work. This is contrary to the banking relationship, which is founded on trust. Therefore, the threshold which triggers the bank’s duty to make inquiries is quite high.
On the facts of the case, the factors that led the judge to conclude that the defendant bank had acted in breach of its Quincecare duty of care included the fact that there was no apparent connection between the plaintiff’s business and the payments, which were of high value, frequent, and often were directed by the directors into their personal accounts. In addition, there was little other activity on the account. The judge held that these factors, when viewed together, were sufficiently indicative of fraud to put the bank on enquiry.
In practice, some of the factors banks should look at when processing instructions include: (i) the connection between payments and the company’s business; (ii) the identities of the payees (e.g., in particular where they are directors of the company); and (iii) the value and frequency of the payments.
Singularis – corporate attribution where breach of Quincecare duty has been established
The claimant held sums on deposit with the defendant bank. An authorised signatory had extensive powers to take decisions on behalf of the claimant including signing powers over the company’s bank accounts, and was the sole shareholder, a director and also chairman, president and treasurer of the company. In 2009, the bank was instructed by the authorised signatory on the account to make payments out of the claimant’s account. The defendant bank approved and completed the transfers notwithstanding “many obvious, even glaring, signs that the authorised signatory was perpetrating a fraud on the company” and that he “was clearly using the funds for his own purposes and not for the purpose of benefiting the company”. It was common ground at trial that the authorised signatory was acting fraudulently when he instigated the transfers. In 2014, the claimant (acting by its joint official liquidators) issued a claim against the defendant bank for US$204m, the total of the sums transferred in 2009. The matter went all the way up to the Supreme Court. The English High Court held that the bank acted in breach of its Quincecare duty by making the payments in question without proper inquiry. The decision on the breach of Quincecare duty was not appealed. The issue for the Supreme Court was of corporate attribution – whether the fraudulent state of mind of the authorised signatory could be attributed to the company (which had been defrauded) and, if so, whether the claim for breach of the Quincecare duty could be defeated by the defence of illegality (and certain other grounds of defence). The Supreme Court found against the defendant on both points. The Supreme Court’s decision and analysis is discussed in detail in our blog post here.
Corporate attribution in Hong Kong
The law on corporate attribution in Hong Kong is neatly summarised in Moulin Global Eyecare Trading Limited (in liquidation) v The Commissioner of Inland Revenue FACV 5/2013, in which the Hong Kong Court of Final Appeal provided clarification on whether the fraudulent knowledge of directors can be attributed to a company.
The former directors of the company fraudulently inflated the profits of the company and paid almost HK$89 million in inflated profits tax to the Inland Revenue. When the company was subsequently wound up, and provisional liquidators appointed, the liquidators attempted to reclaim the tax paid, on the basis that the Company had not made any taxable profits in the relevant years. For a detailed discussion, please see our blog post here.
The majority of the Court of Final Appeal upheld the Court of Appeal’s decision and ruled, on the facts of the case, that the fraudulent knowledge of the company’s former directors regarding inflation of profits should be attributed to the company. Accordingly, the fraud exception did not apply and the liquidators of the company could not rely on provisions of the Inland Revenue Ordinance to claim repayment of excess tax payments made to the Inland Revenue.
The Court of Final Appeal in Moulin held (similar to the decision in Singularis) that context is crucial, such that questions of attribution are always sensitive to the factual and statutory background and the nature of the proceedings in which they arise. In Singularis, it was held that whether knowledge of a fraudulent director can be attributed to the company is to be found in consideration of the context and the purpose for which the attribution is relevant, including where it is a ‘one-man show’, effectively laying the often criticised decision in Stone & Rolls to rest. In the Hong Kong case of Moulin, Lord Walker admitted that his analysis in Stone & Rolls was wrong, in particular to regard the fraud exception as being of general application, regardless of the nature of proceedings.
Lord Walker in Moulin, however, went further and shelved cases into two distinct categories – namely “redress’ and “liability” cases – the former being cases where the company is suing the director/officer for wrongs done to it and the latter being cases where the third party is suing the company for a wrong done. For liability cases, he held that the fraud exception does not apply i.e., fraudulent knowledge of directors can be attributed to a company whilst for “redress” cases, fraudulent knowledge of directors cannot be attributed to the company. He further went on to hold that there are some cases that fall in between and do not fit into either liability or redress categories. There is no clear analysis for these cases apart from a general view that “there is no reason for the law to apply the fraud exception“. These cases include claims against insurers or auditors who have, for value, undertaken to provide protection against the risk of internal fraud, or to use reasonable professional skill to uncover internal fraud. As it was held in Quincecare, in the relationship between a banker and a customer, there is an implied term of the contract that the bank will observe reasonable skill and care in executing the customer’s orders. Arguably, therefore, claims against banks would fall into this middle category. We have yet to see how the courts in Hong Kong will apply corporate attribution where the bank is held to have breached its Quincecare duty of care towards a company whose directors have fraudulently transferred money out of a company’s accounts at the detriment of the company. If such a case was to see its day in the Hong Kong courts, the UK Supreme court’s analysis in Singularis may provide helpful guidance.
The UK Employment Appeal Tribunal (EAT) recently ordered an employer to disclose its external lawyer’s comments in relation to the dismissal of an employee. The EAT held that the employer waived privilege in redacted parts of a draft dismissal letter setting out its lawyer’s comments, as a result of the employer’s decision to rely on other privileged material relating to the claimant’s dismissal: Kasongo v Humanscale UK Ltd  UKEAT 0129_19_0909.
It is well established, both in the UK and in Hong Kong, that a party who chooses to waive legal professional privilege over selected documents may find that the waiver extends further than he intended. This is known as the principle of “collateral waiver” or, more colloquially, the cherry-picking rule. It is designed to prevent a party choosing to rely on favourable aspects of his privileged material while hiding behind legal professional privilege to avoid having to disclose less favourable aspects. Even with a break in time between communications, if the advice relates to the same matter or legal question, privilege cannot be selectively waived for some communications related to it, but not others. In the present case, the EAT rejected the employer’s submission that the redacted comments represented a separate “transaction” from the legal advice given six days earlier and therefore were not caught by the cherry picking rule. It was held that they were all part of the same transaction, which was advising the employer on the claimant’s dismissal.
While the decision is not surprising on its facts, it acts as a reminder of the dangers of relying on privileged material (even where it appears on its face to be helpful to a party’s case) if there is related privileged material which is less helpful and may undermine the benefit obtained. The risk of waiving privilege over more than you wanted, and the difficulty of anticipating where the line will be drawn in a given case, gives reason to pause and think before deciding to disclose and rely on otherwise privileged material.
The claimant was dismissed after 11 months’ service. She brought claims against her former employer for unfair dismissal and discrimination due to pregnancy, alleging that she informed her manager that she was, or might be, pregnant. The employer defended the claim on grounds that it was unaware of the pregnancy and that her dismissal was entirely due to performance issues.
Documents disclosed by the employer in the proceedings included the following, which appeared to corroborate its position that the claimant’s dismissal was already in hand before the date she says she told her manager she might be pregnant:
- a contemporaneous note of a telephone call between the employer’s senior HR manager and its external solicitor setting out advice about the possible termination of employment;
- an email sent by the HR manager to the employer’s in-house counsel later that day, explaining that the employer “would like to terminate an employee asap based on behaviour (issues with tardiness, attendance and quality of work)”, summarising the external legal advice received, and asking for views; and
- a draft dismissal letter which had been prepared by the employer’s lawyers and sent to the employer 6 days later, from which certain comments by its lawyers had been redacted.
The claimant somehow managed to read the redacted words and sought to rely on them at the employment tribunal hearing. The employer objected. Amongst other points, the employment tribunal held that the claimant could not rely on the redacted part of the letter as it was covered by legal professional privilege and it would have been obvious to the claimant that the employer had not intended to disclose it. The claimant appealed.
The EAT allowed the appeal and held that the claimant could rely on the redacted words in the draft dismissal letter.
The EAT firstly held that the note and email were both privileged, however the employer had waived privilege by choosing to disclose them to assist his case. In respect of the draft dismissal letter, the employer submitted that there was a clear distinction and difference between the legal advice given earlier and the advice on the wording of the draft dismissal letter which came six days later. Although the employer conceded that the waiver led to a risk of a partial or misleading picture, it argued that the draft dismissal letter was not part of the same “transaction” as the note and email, and therefore the redactions were not caught by the cherry picking rule and unaffected by the waivers of privilege.
The EAT agreed with the claimant’s submission that this was a “wholly artificial distinction”. The documents were all part of the same transaction, ie the giving of legal advice about the claimant’s dismissal and the possible legal implications. That was not affected by the six-day gap between the documents.
The EAT, however, did not provide any guidance on how to assess whether documents were part of the same transaction, but even a gap of six days was not enough to create ‘separate transactions’.
What does this mean for employers
This decision is interesting as it is not common for the EAT to deal with issues of privilege. It provides a stark reminder to employers, not only in the UK but also in Hong Kong, that they ought to tread cautiously when deciding whether to waive privilege on communications made between an employer and its counsel or any evidence that is likely to support their claim. Policies or strategies to use legal advice in a selective manner to obtain a forensic advantage will not be accepted by the courts.
While a pure reference to the existence of the privileged document may not constitute a waiver, a reference to and reliance upon the content of the document is more likely to result in a loss of privilege. Where privilege is waived in relation to parts of a document, or in relation to one document amongst a number of documents relating to the same issue, this may result in the waiver of privilege in relation to the whole document and/or other related privileged documents as a result of collateral waiver.
In an important recent decision (FSHC Group Holdings Ltd v GLAS Trust Corporation Ltd  EWCA Civ 1361), the English Court of Appeal confirmed that the test for rectifying a contractual document on the grounds of common mistake is a subjective one – clarifying the previous uncertain state of the law on this point. The court confirmed that to establish a claim for rectification, a party must prove that the document failed to give effect to either:
- a prior concluded contract, in which case the terms of the prior contract must be objectively determined; or
- a common intention shared by the parties, in which case the existence of the intention must be established as a subjective state of mind – though it must also be shown that, as a result of communication between them, the parties understood each other to share that intention.
Notably, the court disagreed with Lord Hoffman’s (obiter) observations in Chartbrook Ltd v Persimmon Homes Ltd  UKHL 38 that, even for a case with a fact pattern falling under the second limb above, the test is purely objective and subjective intentions are irrelevant. On the facts of the present case, the Court upheld a decision of the lower court granting rectification of two deeds on the basis that they did not reflect the parties’ subjective common intention (and there was no prior concluded contract).
In most cases, a subjective test is likely to mean (even) greater difficulty in establishing a claim for rectification for common mistake, in the absence of a prior concluded contract. In particular, a claim will not succeed unless the claimant can establish not only that it had a particular intention but that the defendant shared that intention, and that the parties understood one another to share that intention. (There may however be a claim based on unilateral mistake, if the defendant knew the claimant believed there to be a common intention when that was not in fact the case, and knew the document did not give effect to the claimant’s intention). Unless and until there is a further appeal to the Supreme Court, therefore, the test to be applied in England and Wales is as set out above. For a full background on the case, please see our litigation blog post.
Meanwhile in Hong Kong the objective test as clarified by the Court of Final Appeal in Kowloon Development Finance Limited v Pendex Industries Limited & Ors  HKEC 704 still applies. The 2013 case involved two consent orders that had been drafted to reflect settlement terms between the parties. The Plaintiff had loaned considerable amounts of money to the Defendant. The Defendant fell behind with its repayments and the Plaintiff brought proceedings against the Defendant for repayment of the outstanding amount plus interest. The parties entered into two consecutive consent orders providing for payment of certain instalments. The Defendant argued that the second consent order was in full and final settlement, whereas the Plaintiff asserted that both consent orders only documented agreements as to payments to be made by the Defendant in 2004 and 2005, with the outstanding balance to remain payable in accordance with arrangements to be reached between the parties thereafter. The second consent order had not been drafted very well. One of the arguments advanced by the Plaintiff was that the consent order should be rectified for either a mutual or unilateral mistake to make it clear that it did not completely discharge the outstanding debt.
In respect of a mutual or common mistake, in Kowloon Development Finance, Lord Hoffman (with whom the other judges agreed) stated that for the purpose of establishing what the actual agreement between the parties is, the common law applies an objective test. This means that the proper question to ask is what a reasonable observer would have understood the parties to have agreed taking into account all relevant background facts known to the parties at the time. The subjective intentions of the parties are irrelevant. For a detailed review of the Kowloon Development Finance case, please see our previous blog post.
Going forward, however, Hong Kong courts are likely to consider the subjective test laid down in FSHC in cases with a fact pattern falling under the second limb above ie, where there is a common intention shared by the parties and no prior concluded contract/agreement. In particular it is noteworthy that the English Court of Appeal, in FSHC, conducted a well-rounded analysis from the point of view of principle, precedent and policy. Amongst other considerations, notable ones include the following: (i) there was no discussion in Lord Hoffmann’s judgment in Chartbrook of the history of the equitable remedy of rectification for common mistake, which showed that courts of equity had always been concerned with the actual intention of the parties; and (ii) the purely objective approach endorsed in Chartbrook was inconsistent with how the doctrine of rectification was understood and applied in most other common law jurisdictions, most notably Australia.
Two recent English decisions highlight the particular challenges when managing legal professional privilege in the context of resolving employee issues.
We consider these decisions and how the principles may apply in Hong Kong and other common law jurisdictions in relation to dominant purpose, waiver and iniquity and the lessons that they provide to employers in the context of employee investigations and disciplinary actions. Continue reading
The UK Supreme Court (“UKSC“) has handed down its much anticipated judgment in NB Banca Nazionale del Lavoro SPA v Playboy Club  UKSC 43, ruling that a bank owed no duty of care to undisclosed third parties who ultimately relied on their references.
In this instance, a bank had provided a credit reference for its client for the purposes of applying a cheque cashing facility at the London Playboy Club. The Club did not request for the reference in its own name, but through an associated company, to avoid disclosing the purpose of the reference. Subsequently, the cheques that were drawn by the client in the Club’s favour were returned unpaid, and the Club suffered losses as a result. It was common ground that only the Club had an interest, given that other parties, including the associated company suffered no losses.
The issue was whether the bank owed any duty of care to the Club, which was an undisclosed third-party. The UKSC ruled in the negative, and it is likely that the Hong Kong Courts will adopt the same approach in similar cases. See our UK banking litigation e-bulletin for a more detailed discussion: https://sites-herbertsmithfreehills.vuturevx.com/34/17764/compose-email/supreme-court-provides-clear-guidance-on-liability-to-third-parties-for-bankers–references.asp