High Court considers reliance in s.90A FSMA claims in context of split trial application

March 8, 2023

A recent judgment handed down by the High Court will be of interest to financial institutions following developments in securities class actions: Various Claimants v Serco Group plc [2023] EWHC 119 (Ch).

The decision considers the identity of sample claimants, for the purpose of a split trial order. For those monitoring the risk profile of claims under s.90A of the Financial Services and Markets Act 2000 (FSMA), the most interesting aspects of this judgment are the observations made by the defendant, and the court, on the critical question of reliance, which has become a central battleground in such claims.

The judgment reveals that the shape of the Serco litigation has changed significantly since the first case management conference (CMC) last year. During this period, the court handed down judgment in the first s.90A FSMA case to come to trial in this jurisdiction, in ACL Netherlands BV & Ors v Lynch & Ors [2022] EWHC 1178 (Ch) (otherwise known as the Autonomy litigation; see our banking litigation blog post). In the Autonomy judgment, the court confirmed that reliance must be upon a statement or omission, rather than, in some generalised sense, on a piece of published information (e.g. the annual report for a given year).

The defendant suggested that the Autonomy judgment has had the following impact on the scope of the claims against it in the Serco litigation: (i) cases based on direct reliance are now much more limited; (ii) a material number of claimants have dropped out; and (iii) those claiming on the basis of indirect reliance have great difficulties because of the clarification of reliance in Autonomy. These are interesting (although not unexpected) developments, given that the requirement for a claimant to show what it relied upon will make it more difficult to bring a successful s.90A claim.

The present judgment also confirms that the claimants in the Serco litigation are now relying on two categories of indirect reliance as follows:

  • Market reliance: i.e. a decision, including an automated decision to acquire, continue to hold or dispose of shares in the market at the (inflated) price at which they were in fact acquired and held.
  • Price reliance: i.e. market reliance in circumstances in which the claimant was also aware of the price of the shares, and believed the published information to be true, complete and accurate.

The court accepted that (in some respects) the developments which have occurred since the first CMC have been significant, and the fact that no claimant seeks to advance a direct reliance case based on specific statements in the defendant’s published information is “material”. However, in the context of the application relating to the identity of sample claimants, the court was not persuaded to move away from the sampling approach ordered at the first CMC, and it rejected the defendant’s move to include all of the indirect reliance cases in the second trial.

Background

The decision relates to a claim for losses suffered by certain institutional investors, in relation to shares held in a listed company, Serco Group plc (Serco), between 2006 and 2013, based on s.90A and Schedule 10A FSMA.

The key question before the court in the present judgment related to an order for a split trial, which was made following the first CMC in this case. The court directed that there would be a split trial, as follows:

  • A first trial covering the standing of the claimants and so-called common issues relating to Serco (whether there was fraud; the content of or omissions from published information; whether there had been dishonest delay; who were persons discharging managerial responsibility (PDMR); and whether any PDMR had the requisite knowledge).
  • A second trial covering so-called individual issues related to the claimants, namely, reliance, causation, loss and quantum, and limitation. The issues at the second trial were to be determined in respect of a sample of the claimants or sample funds only.

Since the CMC, the parties had made some progress in agreeing on the number and identity of the sample claimants, but two significant issues remained outstanding, which in large part related to questions of reliance.

Decision

By the time of the hearing, the following important points on the claimants’ reliance case were clear:

  • The reliance placed by the claimants on the defendant’s published information can be categorised as either: (1) direct reliance; or (2) two forms of indirect reliance: market reliance and price reliance.
  • The claimants described what they meant by the two categories of indirect reliance as follows:
    • Market reliance is “[a] decision, including an automated decision to acquire, continue to hold or dispose of shares in the market at the (inflated) price at which they were in fact acquired and held.”
    • Price reliance is market reliance in circumstances in which the claimant was also aware of “(a) the price of the shares and (b) the published information being true, complete and accurate.”
  • Where direct reliance is alleged, it is limited to reliance on the defendant’s published information as a whole, not on individual statements within the published information.

The defendant submitted that it would be proportionate for all of the non-direct reliance cases to be tried at the second trial, because such claimants were likely to have great difficulties in light of the Autonomy decision, and it would achieve certainty if they could be disposed of. However, the claimants said that this approach would move away from the sampling approach and be wrong in principle.

The court accepted that, in some respects, the developments since the first CMC had been significant (in particular, it was material that no claimant sought to advance a direct reliance case based on specific statements). However, in the court’s view, the developments did not justify an inclusion of all the indirect reliance cases to the existing cohort of sample claimants. The court justified this decision based on the following factors and conclusions:

  • Appropriate weight must be given to the fact that the parties have proceeded for the past year on the course set by first CMC order.
  • The addition of 27 master claimants at trial two would detract from a just and effective resolution of the dispute, and from costs efficiency.
  • The defendant had underestimated the evidence required from the claimants to make good the price reliance claims, which may not be straightforward and may well be challenged.
  • The defendant had underestimated the extent of the evidence and disclosure required from each individual claimant to prove that facts relevant to their cause of action under s.90A FSMA had been deliberately concealed from them by the defendant (thereby discharging the burden under s.32 of the Limitation Act 1980).
  • The same point could be made about the expert evidence required for quantification.
  • Each of the new master claimants would have to be treated as a separate claim and the additional burden imposed by their inclusion did not justify the limited benefit of a final resolution of those claims.

Accordingly, the court concluded that a sampling approach for both indirect and direct claims remained the right way forward.

A sampling approach has been adopted in earlier claims under s.90A FSMA, against RSA Insurance and G4S, and the court explained that its purpose is to try to ensure that decisions on individual issues provide as much guidance as possible, while recognising that the court’s decision will not be binding in respect of individual issues of other claimants. The court stated in this case that sampling requires:

“A balance to be struck between ensuring that appropriate similarities are identified in order to maximise the number of cases which will in practice be resolved, while not at the same time having so many sample cases that the exercise becomes unwieldy and fails to achieve the purpose for which it was imposed”.

The court also rejected an alternative proposal by the defendant: that the existing body of sample claimants should be expanded to add certain specified claimants with market reliance and price reliance claims, because there were no other claims in the sample with the same form of reliance, and/or because it was desirable for larger claims to be resolved at trial two if at all possible.

The court did not agree that it should automatically direct large claims to be included within the sample group, if there was no other justification for doing so. Stepping back and looking at the group of sample claimants as a whole, the court said it must always recognise that not every difference between the position of individual claimants and funds can be captured by a sample, and no answer is perfect. The key is to try to pick those cases which appropriately represent a wider body of claimants and common issues without overcomplication, recognising that not every fine detail can be captured.

The court therefore approved the group of sample claimants agreed by the claimants.

Rupert Lewis
Rupert Lewis
Partner
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Simon Clarke
Simon Clarke
Partner
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Ceri Morgan
Ceri Morgan
Professional Support Consultant
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Sarah Penfold
Sarah Penfold
Senior Associate
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Court of Appeal confirms reflective loss rule will bar claims of former shareholders of a dissolved company because the principle must be determined at time of alleged loss

November 25, 2022

The Court of Appeal has upheld a decision of the High Court to strike out a claim by the former shareholders of a dissolved company against an investor on the basis that all the losses claimed were barred by the reflective loss principle: Burnford & Ors v Automobile Association Developments Ltd [2022] EWCA Civ 1943.

As a reminder, the Supreme Court in Sevilleja v Marex Financial Ltd [2020] UKSC 31 confirmed that the reflective loss principle is a bright line legal rule, which prevents only shareholders from bringing a claim based on any fall in the value of their shares or distributions, which is the consequence of loss sustained by the company, in respect of which the company has a cause of action against the same wrongdoer (see our blog post).

In the present case, the Court of Appeal agreed with the High Court that although the company had been dissolved, the claimants’ claim fell within the ambit of the reflective loss principle. The decision puts the time at which the reflective loss rule falls to be assessed beyond doubt: it is the time when the claimant suffered the alleged loss and not at the time proceedings were brought.

This timing point has been the subject of uncertainty following the decision of Flaux LJ (as he then was) in Nectrus Ltd v UCP plc [2021] EWCA Civ 57. Sitting as a single judge of the Court of Appeal, Flaux LJ refused permission to appeal in Nectrus and in doing so held that the claim of an ex-shareholder was not barred by the reflective loss principle, finding that the rule should be assessed when the claim is made. Although the Board of the Privy Council in Primeo Fund v Bank of Bermuda (Cayman) Ltd [2021] UKPC 22 found that Nectrus was wrongly decided, the High Court in the present case considered that it was bound by the decision (albeit distinguishing the present case from Nectrus on the facts). On appeal, the Court of Appeal took the opportunity to set the record straight, confirming that the Privy Council’s decision in Primeo is the correct view.

We consider the decision in more detail below.

Background

The claimants were former shareholders in a company called Motoriety (UK) Ltd (Motoriety), whose business was the exploitation of two software-based products for the motoring industry. In 2015, Motoriety wished to expand its customer base and entered into negotiations with Automobile Association plc (better known as “the AA”), on the basis that the AA could invest in the company. Motoriety and the claimants subsequently entered into an investment agreement with the defendant subsidiary company of the AA. The defendant agreed to subscribe for 50% of the share capital of Motoriety and the defendant had a call option for the remaining 50% of Motoriety for consideration produced by a formula contained in the agreement. On the same day, Motoriety granted the defendant a licence to use its software and associated intellectual property rights. In 2017, Motoriety went into administration and was bought from its administrators by another company in the AA group.

The claimants subsequently brought a claim against the defendant for fraudulent or negligent misrepresentation and/or for breach of contract. The claimants alleged that they had entered into the investment agreement and the licence agreement in reliance on false representations by the defendant. The claimants also alleged that the defendant breached implied terms of the investment agreement by pursuing a course of conduct that undermined the basis of the arrangements between the claimants, Motoriety and the defendant. The claimants alleged that this led to Motoriety going into administration. The claimants also pleaded an alternative breach of contract claim that, had it not been for the defendant’s breach of contract, the defendant would have exercised the call option and paid the consideration due.

The claimants sought damages for losses incurred as a result of the fraudulent/negligent misrepresentation and/or breach of contract. On the claimants’ misrepresentation claim, losses were claimed on the basis that, had the alleged misrepresentations not been made, the claimants and Motoriety would not have done the deal with the defendant, but would have entered into a venture with a third party company and the value of the claimants’ shareholdings would have increased accordingly. Similarly, in relation to the original breach of contract claim, the claimants claimed that if the contract had been properly performed, Motoriety would have thrived and the value of the claimants’ shareholdings would have increased. Alternatively, had it not been for the defendant’s breach of contract, the defendant would have exercised its call option, so that the claimants would have been entitled to the consideration provided for by that option. Three of the claimants also claimed for the loss of their initial investments in Motoriety.

The defendant denied the claim and brought an application to strike out the claim or for reverse summary judgment on the basis that all the losses claimed by the claimants were barred by the reflective loss principle.

High Court decision

The High Court found in favour of the defendant and granted its application to strike out the claim. The High Court’s reasoning is discussed in our previous blog post here.

In summary, the High Court found that the claimants’ claims satisfied all of the conditions (set out in Marex) needed for a claim to be barred by the reflective loss rule. The claimants’ alleged losses were entirely derived from the claimed losses of Motoriety and were not separate and distinct losses. If Motoriety was restored to the register, the loss would still be in the company.

The claimants appealed.

Court of Appeal decision

The Court of Appeal upheld the High Court’s decision to strike out the claim on the basis that all the losses claimed were barred by the reflective loss principle.

The key issues which may be of interest to financial institutions are set out below.

Grounds of appeal

Two of the claimants’ grounds of appeal related to the applicability of the reflective loss principle. The first ground was that the issue was not suitable for summary determination because it raised fact-sensitive questions and the relevant law is uncertain and developing. The second ground was that the claimants’ claims were not in any event barred by the reflective loss principle.

The “reflective loss” principle

The Court of Appeal drew the following points from its review of the authorities, in particular Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, Johnson v Gore Wood & Co [2000] UKHL 65, Marex, Primeo, Allianz Global Investors GmbH v Barclay Bank plc [2002] EWCA Civ 353, and Nectrus:

  1. The reflective loss principle applies where a shareholder brings a claim “in respect of loss which he has suffered in that capacity, in the form of a diminution in share value or in distributions, which is the consequence of loss sustained by the company, in respect of which the company has a cause of action against the same wrongdoer” (Marex at paragraph 79);
  2. A shareholder cannot escape the reflective loss principle merely by showing that he has an independent cause of action against the defendant. He must also have suffered separate and distinct loss, and the law does not regard a reduction in the value of shares or distributions which is a knock-on effect of loss suffered by the company as separate and distinct;
  3. There need be no exact correlation between the shareholder’s loss and the company’s for the reflective loss principle to be applicable. The reflective loss principle can apply “where recovery by the company might not … fully replenish the value of its shares” (see Marex at paragraph 42). Equally, the company’s loss can exceed the fall in the value of its shares;
  4. The reflective loss principle will not be in point if, although the shareholder’s loss is a consequence of loss sustained by the company, the company has no cause of action against the defendant in respect of its loss;
  5. Nor will the “reflective loss” principle apply to a claim which is not brought as a shareholder but rather as, say, a creditor or an employee;
  6. The Court has no discretion in the application of the reflective loss principle, which is a rule of substantive law;
  7. The applicability of the reflective loss principle is to be determined by reference to the circumstances when the shareholder suffered the alleged loss, not those when the claim was issued (as confirmed in Primeo).

Although not emphasised in the judgment, proposition (7) had been the subject of uncertainty following the decision of Flaux LJ (as he then was) in Nectrus. Sitting as a single judge of the Court of Appeal, Flaux LJ refused permission to appeal and in doing so held that the claim of an ex-shareholder was not barred by the reflective loss principle, finding that the rule should be assessed when the claim is made. In Primeo, the Board of the Privy Council found that Nectrus was wrongly decided, confirming that the rule falls to be assessed as at the point in time when a claimant suffers loss and not at the time proceedings are brought (see our blog post).

Notwithstanding the decision in Primeo, the High Court in the present case considered that it was bound by Flaux LJ’s decision in Nectrus, albeit the High Court considered that the present case was distinguishable on the facts from Nectrus. However, in the context of the present appeal, the court said that two further decisions of the Court of Appeal indicated that Primeo was the “correct view”, namely Allianz and a subsequent decision in the Nectrus litigation: UCP plc v Nectrus Limited [2022] EWCA Civ 949 (granting Nectrus’ application to reopen Flaux LJ’s decision and granting Nectrus permission to appeal).

Suitability for summary determination

The Court of Appeal was not persuaded that the reflective loss issue was unsuitable for summary determination on the basis that the law is uncertain and developing.

The Court of Appeal underlined that the reflective loss principle had recently been considered in depth by the Supreme Court in Marex, where its existence and scope were confirmed. Also, while the principle had been the subject of debate in a number of subsequent cases, the points aired in those cases did not give rise to any legal uncertainty relevant to the present case. The Court of Appeal went on to emphasise that it is also not the case that the court should not entertain a strike out or summary judgment application wherever an undecided question can be discerned in the relevant area of law.

The misrepresentation claim

The Court of Appeal found that the misrepresentation claim was wholly barred by the reflective loss principle and the High Court was right to strike it out. The applicability of the principle did not depend on any factual disputes.

The Court of Appeal highlighted that it was evident that if the allegations of misrepresentation were well-founded, Motoriety would itself have (or have had) a cause of action against the defendant in respect of them. There were multiple references in the particulars of claim to Motoriety having relied on all the alleged representations implying that they had been made to it as well as to the claimants. The Court of Appeal also considered that the loss of the claimants’ share value was a knock-on effect of loss suffered by Motoriety for which it would itself have (or have had) a cause of action and hence was not separate and distinct. The Court of Appeal concluded that, as per Marex, the claim is in this respect one relating to loss which the claimants would have suffered as shareholders “in the form of a diminution in share value…which is the consequence of loss sustained by the company, in respect of which the company has a cause of action against the same wrongdoer”. It was thus barred by the reflective loss principle.

The breach of contract claim

The Court of Appeal found that the breach of contract claim was also barred in its entirety by the reflective loss principle and the High Court was right to strike it out.

The Court of Appeal said that any good faith obligations would have been owed to Motoriety as well as the claimants. The Court of Appeal could not see that the terms the claimants alleged would have been implied solely in favour of the claimants. If the terms were implied in the investment agreement, they would surely have been implied in favour of all the defendant’s counterparties, including Motoriety, the more so since they related to the conduct of the business which Motoriety was conducting. The Court of Appeal therefore considered that if the claimants had a contractual cause of action in respect of the matters they alleged, so would Motoriety. That being so, the claimants’ claim would be barred by the reflective loss principle unless they were alleging separate and distinct loss.

The Court of Appeal then noted that the loss of the claimants’ share value did not constitute a separate and distinct loss and the position was similar to the corresponding head of claim for misrepresentation. The loss in share value would be reflective of loss sustained by Motoriety in respect of which it would itself have (or have had) a cause of action against the defendant.

The Court of Appeal also considered that the reflective loss principle applied to the loss of the consideration from the call option the claimants claimed the defendant would have exercised. This loss related to what the claimants’ shares would have fetched if sold to the defendant following its exercise of the call option. The claimants’ allegation was that the defendant’s alleged breaches of contract meant that the claimants would not be paid anything for their shares and that reflected the fact that the breaches had brought about Motoriety’s failure such that there was no longer any prospect of either earnings or distributions. The loss claimed represented one way of measuring loss of share value. If the claimants’ case was correct, breaches of contract by the defendant caused Motoriety to fail and, in consequence, rendered the claimants’ shares worthless, both in the sense that they lost any value in the general market and in the sense that there was no longer any prospect of selling them to the defendant pursuant to the option. The Court of Appeal concluded that the claimants were therefore claiming in respect of loss “in the form of diminution in share value…which is the consequence of loss sustained by [Motoriety], in respect of which the company has [(or had]] a cause of action against [AAD]”. Further, there may or not be a precise correlation between the claimants’ loss and Motoriety’s, but no such correlation was required for the reflective loss principle to apply.

Accordingly, for all the reasons above, the Court of Appeal found in favour of the defendant and dismissed the claimants’ appeal.

Julian Copeman
Julian Copeman
Partner
+44 20 7466 2168
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7466 2529
Claire Nicholas
Claire Nicholas
Senior Associate
+44 20 7466 2058

Herbert Smith Freehills launches new edition of Class Actions in England and Wales

November 8, 2022

Herbert Smith Freehills has launched the second edition of our text, Class Actions in England and Wales. The book was co-authored by Herbert Smith Freehills lawyers and published in the UK by Sweet & Maxwell. It has been edited by Damian Grave, Maura McIntosh and Gregg Rowan and co-authored, in addition, by partners Greig Anderson, Neil Blake, Simon Clarke, Julian Copeman, Kim Dietzel, Harry Edwards, Rupert Lewis, Andrew Taggart, Howard Watson, Alan Watts and Stephen Wisking.

Class actions have become an increasingly significant area of law and procedure, with growing numbers of claims being brought by large groups of claimants. This text will provide a comprehensive source of guidance for those looking to bring or defend class action litigation in England and Wales.

The second edition has been updated to reflect significant decisions and developments affecting class actions since the first edition was published in 2018. It also includes four new chapters on the following topics: data protection claims, product liability, insurance, and employment.

For more information, please see our litigation blog post.

COURT OF APPEAL OVERTURNS DECISION STRIKING OUT CLASS ACTION DESPITE PARALLEL CLAIMS OVERSEAS

July 15, 2022

The Court of Appeal has held that claims brought in the English court by over 200,000 claimants arising out of the 2015 collapse of the Fundão Dam in Brazil can proceed, overturning the High Court’s decision which had struck out the claims as an abuse of process in light of concurrent proceedings and compensation schemes in Brazil: Municipio de Mariana v BHP Group (UK) Ltd [2022] EWCA Civ 951.

Whilst set in a non-financial context, this decision is relevant to UK-domiciled financial institutions who might be considered to be at risk of claims being brought which allege a duty of care in relation to the actions of their foreign subsidiaries or branches.

The High Court had concluded that the proceedings would be “irredeemably unmanageable”, and that allowing the claims to progress simultaneously in England and Brazil would “foist upon the English courts the largest white elephant in the history of group actions”. The Court of Appeal, however, held that unmanageability could not itself justify a finding of abuse of process, and in any event a conclusion as to unmanageability could not be reached safely at such an early stage of the proceedings, when the precise nature and scope of the issues between the parties had yet to be identified. The proper time for considering how to manage the proceedings would be at a case management conference before the assigned judge, at which point the parties would be obliged to co-operate in putting forward case management proposals.

It was also significant that the Court of Appeal disagreed with the judge’s conclusions as to the claimants’ ability to obtain full redress in Brazil against the particular defendants. In light of the particular procedures in Brazil, and the uncertainty as to which entities could properly bring proceedings, the court was satisfied that there was a real risk that full redress could not be obtained.

For a more detailed discussion of the Court of Appeal’s decision, please see our litigation blog post.

Latest split trial decision in securities class action under s.90A FSMA

July 14, 2022

At a recent Case Management Conference (CMC), where a split trial was proposed by the claimants in a claim brought pursuant to Section 90A and Schedule 10A of the Financial Services and Markets Act (FSMA), the High Court has held that reliance issues should be heard at the second trial, with defendant liability issues to be heard in the first: Various Claimants v G4S Limited [2022] EWHC 1742 (Ch).

In securities class actions, claimants will often seek to postpone issues involving reliance, causation, quantum and limitation to a second trial. This has the double advantage of (a) enabling the claimants to postpone incurring a significant portion of their costs until after the question of liability has been determined; and (b) making the defendant’s conduct the sole focus of the first trial.

Defendants will generally seek to resist this split, noting the potential for unfairness in the allocation of the litigation burden, as well as the potential for the claimants’ witnesses to be influenced by the findings in respect of liability when preparing their evidence in relation to reliance. Furthermore, to the extent findings are made against the defendant in the first trial, the overall length of the process would likely be significantly longer than if there was no split.

Ultimately in this case, although the court held that there should be a split trial, and that reliance issues ought to be heard at the second trial (noting, in particular, the complexity of the claimants’ reliance cases), it acknowledged the potential unfairness to the defendant if disclosure and witness statements were not provided by the claimants in advance of the first trial. In order to seek to mitigate the potential unfairness, the court determined that:

  1. All claimants must provide the defendant with a minimum amount of information in relation to:
    1. Their reliance cases, including (a) whether it is said that particular named individuals reviewed the relevant published information and relied on it or whether, for example, the only evidence a particular claimant can provide in that respect is of a general practice; and (b) whether the claimant relies only upon the most recently published information, or also upon historic information;
    2. Their limitation arguments, such as whether it will be alleged that there is something particular to a specific claimant that means that they could not with reasonable diligence have discovered something, as compared to another claimant;
    3. Information about whether a claimant claims to have relied upon meetings with the defendant (noting that liability under section 90A and Schedule 10A is by reference to “published information” only and not to comments in meetings); and
    4. Disclosure, such as the document retention policies each claimant has in place.
  2. That information must be provided in order to ensure that the claimants’ reliance cases are properly particularised, and also to enable effective sampling to occur, so that the parties can minimise the risk that more than two trials will be required (as would be necessary, for example, if the sample selected did not fully reflect the characteristics of all claimants).
  3. Sample claimants, once selected, must give disclosure in advance of the first trial (including in relation to all aspects of their reliance case).
  4. A further CMC will be held after the claimants have provided the defendant with the further information outlined in (1) above, at which the court will determine which claimants will be required to provide witness evidence in relation to their reliance cases in advance of the first trial. The court indicated that this would be likely to include claimants bringing specific reliance claims.
  5. That CMC will also consider whether there are any further points of law which might sensibly be disposed of at the first trial.
  6. To the extent that any claimants wish to rely upon meetings with the defendant in relation to their claims, evidence in relation to those meetings must be provided in advance of, and will be heard at, the first trial.

Such an approach will help to balance the litigation burden, alleviate concerns over the influence that any findings from the first trial may have upon witness recollections, and will mean that, to the extent a second trial is required, it can be heard relatively soon after judgment is given in the first, mitigating the defendant’s timing concerns.

Chris Bushell
Chris Bushell
Partner
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Sarah Penfold
Sarah Penfold
Senior Associate
+44 20 7466 2619

ESG Updates – The Bank of England Climate Biennial Exploratory Scenario

June 15, 2022

The Bank of England (BoE) has published the results of the Climate Biennial Exploratory Scenario (CBES), which explores the financial risks posed by climate change for the largest banks and insurers operating in the UK. In line with the findings of other central bank stress tests across the globe, the CBES found that while the financial system might be adequately capitalised to absorb the shocks of climate change scenarios, the sector would suffer losses across each scenario, with the greatest quantifiable losses suffered in a No Action and Late Action scenario. This reaffirms the BoE’s drive to an early and orderly transition to a net-zero economy.

  • In June 2021 the BoE launched the CBES, seeking to explore and better understand the financial risks posed by climate change to the UK financial system, and to ensure that real change is effected to help with systemic resilience.
  • Following the submission of participants’ initial responses in October 2021, we looked at the CBES in the context of other central bank initiatives and stress tests across the globe, to understand the scope of the CBES as part of our November 2021 Global Banking Review, which focussed heavily on the issues facing financial institutions in connection with Climate Change.
  • Just over six months later the BoE has published the results of the CBES, and we consider here what it has learnt, where will the focus fall, and what will come next?

Summary of key findings – Banks

The climate risks captured in the CBES scenarios are likely to create a drag on the profitability of both UK banks and insurers. Loss projections varied across participating firms and the three different climate scenarios but equated to an annual drag on profits of around 10-15% on average. Projections suggested (unsurprisingly) that the overall costs will be lowest in scenarios with early, well-managed actions to transition to a net-zero economy.

However, the CBES found that there was substantial uncertainty as to the magnitude of climate risks. The figures identified in the BoE report were heavily caveated to allow for various acknowledged limitations, with this, its first CBES, including:

  • The banks’ projections were focused on credit risk, and did not yet fully take into account possible impacts resulting from market risk;
  • The data used to populate responses from firms was incomplete and inconsistent in its approach – for example, loss estimates on the same corporate customers differed substantially in participating firms’ responses;
  • The ‘No Action’ scenario would likely incur losses past the time horizon selected for the CBES projections, and as such projections for this scenario were likely partial; and
  • The BoE acknowledged the limitations of the fixed balance sheet approach adopted for the CBES.

Despite these, and other limitations, the CBES included a number of interesting observations for market participants:

Quantitative findings – calculating the risk

  • Projected climate risk impacts were highest for banks’ wholesale and mortgage exposures, and projected climate-related consumer credit losses were relatively low.
  • Institutions which relied upon third-party modelling and data without sufficient internal capability to challenge and scrutinise often gave rise to materially lower loss projections than those institutions which had invested in and developed their own internal models. The development of internal models was more established in the insurance than the banking sector.
  • Limitations caused by data gaps and inconsistent data provision from third parties such as clients and counterparties were again noted. In particular, the lack of available data regarding corporates’ current value chain emissions and future transition plans was a common issue affecting firms. The BoE also recommends that banks act to encourage remediation of data limitations and gaps to help firms meet the PRA’s supervisory expectations, as set out in SS3/19. Firms’ efforts in this area will be supported by initiatives currently in train to resolve some of these data gaps.

Qualitative findings – planning ahead

  • Responses to the qualitative secondary part of the CBES, which focused on transition planning, suggested that some banks, in particular, were not considering their transition plans holistically: they were failing to take into account the likelihood of similar management actions from competitors or adjusting for different macro scenarios.
  • Transition plans suggest that banks intend to divest from energy-intensive sectors. The BoE sounded a note of caution in relation to these suggestions and to the idea that capital requirements could be used to target investment towards “green” sectors and away from energy-intensive sectors. The BoE noted the systemic risk inherent in depriving energy-intensive sectors from the funding they would need to transition towards net-zero, and also the economic repercussions of mass divestment from providing finance to carbon-intensive sectors ahead of the expansion of renewable energy supply.
  • Capital adequacy remains at the forefront of the BoE’s mind, but in the context of developing (along with other central banks) Solvency II to better accommodate the nuances of climate change risk, rather than using the BoE’s prudential regulation as a pseudo-governmental arm seeking to drive policy change.
  • While participating firms were making good progress in some aspects of climate risk management, they all had more work to do to improve their climate risk management capabilities.

Climate Litigation Risk 

As part of the CBES, the BoE engaged with members of the London Insurance Market to understand the extent to which existing policies would cover climate-related litigation. Following the trend of increasing climate-related litigation (particularly in the United States, which is ahead of many European jurisdictions in this regard), the BoE wanted to look at the impact of this development in the contentious landscape. The BoE identified seven ‘types’ of climate-related litigation, these are set out in full below:

  • Direct causal contribution: a corporate is found liable for its representative contribution to manmade climate change.
  • Violation of fundamental rights resulting in cessation or reduction of operations: a corporate is prevented from practising carbon-intensive activities that violate fundamental human and dignity rights, this has a significant impact on financial revenues.
  • Greenwashing: a corporate is found to be misleading customers (e.g. false advertising, mislabelling as ‘environmentally friendly’, underreporting disclosures) and must pay out compensation to customers/investors.
  • Misreading the transition: a corporate is sued on the basis that it continued to sell a carbon-intensive product while in knowledge it would become redundant due to government net-zero policy, they must refund and compensate customers.
  • Indirect casual contribution (related to exposure to Utilities sector only): utilities are sued for their indirect contribution to climate change which amplifies physical risks due to inadequate or negligent preparation.
  • Directors’ breach of fiduciary duties (related to cover against asset managers only): investors of an asset manager allege that the entity’s directors have understated the physical and/or transition risk to their assets in their disclosures. Investors seek payment for damages from the directors’ breach of fiduciary duty.
  • Indirect causal contribution (financing): a case is brought against financiers of carbon-intensive activities, as they have contributed indirectly to manmade climate change through financing activities of carbon majors.

                                                  Taken from Table 1 of Box C of the CBES Results

Following engagement with members of the insurance market, the BoE identified that (in aggregate) just under half of the D&O insurance policies currently in place would cover these types of litigation risk; while approximately a quarter of the professional indemnity policies would cover climate related litigation. The respondents noted that this figure may not reflect coverage of the defendant’s own legal costs, which could often be high, particularly where the claims were investor-led.

While the focus of these questions was on the impact to the insurance industry of the developing trend, the analysis should focus the minds of banks and asset managers: have they sufficiently considered their litigation risk? Have they considered whether their policy coverage is adequate? As we move forward, have they budgeted for the increasing cost of Profin and D&O insurance which may arise from developing trends in this area?

What next

  • The BoE’s work on climate scenario analysis, including that done as part of the CBES, provides a key tool supporting firms and policymakers as they navigate uncertainty over future climate policy and climate change, enabling assessment against a range of possible outcomes.
  • As set out in the PRA’s October 2021 Climate Change Adaptation Report, the PRA and the BoE are undertaking further analysis to determine whether changes need to be made to the design, use, or calibration of the regulatory capital frameworks.
  • To support this work on the capital framework, the BoE will host a research conference on the interaction between climate change and capital in Q4 2022, and has already put out a ‘Call for Papers’. The BoE will publish follow-up material on the use of capital, including on the role of any future scenario exercises, informed by the conference and the findings of the CBES.
  • While no future CBES has been announced, it is clear that more work is needed before the BoE and market participants understand the stress that they may soon be under as a result of climate risks.
Simon Clarke
Simon Clarke
Partner
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Sousan Gorji
Sousan Gorji
Senior Associate
+44 20 7466 2750
Eleanor Dole Sheaf
Eleanor Dole Sheaf
Associate
+44 20 7466 7612

How to navigate the Autonomy judgment: guidance for corporate issuers defending Section 90A / Schedule 10A FSMA shareholder claims

June 9, 2022

The High Court has handed down its long-awaited judgment in the US$5 billion civil fraud action brought by the Hewlett Packard group in connection with its acquisition of the UK software company Autonomy Corporation Limited in 2012: ACL Netherlands BV & Ors v Lynch & Ors [2022] EWHC 1178 (Ch).

The judgment follows a previously published Summary of Conclusions, in which the High Court confirmed that the claimants “substantially succeeded” in their claims against two former Autonomy executives (see this post on our Civil Fraud and Asset Tracing Notes blog, which sets out the background facts to the dispute and summarises the outcome).

The successful claims were brought under s.90A of the Financial Services and Markets Act 2000 (FSMA), common law misrepresentation and deceit, and the Misrepresentation Act 1967, as well as claims for breach of the defendants’ management duties.

The 1657-page judgment is significant, not only because the case is one of the longest and most complex in English legal history, but also because it is the first s.90A FSMA case to come to trial in this jurisdiction.

As a reminder, s.90A (and its successor, Schedule 10A FSMA) is the statutory regime imposing civil liability for inaccurate statements in information disclosed by listed issuers to the market. It imposes liability on the issuers of securities for misleading statements or omissions in certain publications, but only in circumstances where a person discharging managerial responsibilities at the issuer (a PDMR) knew that, or was reckless as to whether, the statement was untrue or misleading, or knew the omission to be a dishonest concealment of a material fact. The issuer is liable to pay compensation to anyone who has acquired securities in reliance on the information contained in the publication, for any losses suffered as a result of the untrue or misleading statement or omission, but only where the reliance was reasonable.

In recent years, there has been a noticeable uptick in securities litigation in the UK, in particular in claims brought under s.90A/Sch 10A FSMA. The purpose of this blog post is to distil the key legal takeaways on s.90A FSMA arising from the judgment, which may be relevant to such claims.

Scope of s.90A / Sch 10A FSMA

The court accepted the defendants’ “general admonition” that the court should not interpret and apply s.90A/Sch 10A FSMA in a way which exposes public companies and their shareholders to unreasonably wide liability.

It emphasised that, in considering the scope of these provisions (and in particular in considering the nature of reliance which must be shown and the measure of damages), the history of the s.90A regime is relevant. The court highlighted the following background to the provisions of FSMA, in particular:

  • Prior to s.90A, English law did not provide any remedy (statutory or under the common law) for investors acquiring shares on the basis of inaccuracies in a company’s financial statements (in contrast to the long-established statutory scheme of liability for misstatements contained in prospectuses). The rationale for the different treatment of liability for misstatements in prospectuses and those in other disclosures was because an untrue statement in a prospectus can lead to payments being made to the company on a false basis, but the same cannot be said of an untrue statement contained in an annual report, for example.
  • The ultimate catalyst for the introduction of a scheme of liability was the Transparency Directive (Council Directive 2004/1209/EC), which included enhanced disclosure obligations and the requirement for a disclosure statement. This gave rise to concerns that the English law’s restrictive approach to issuer liability would be disturbed and that issuers (and directors and auditors) might be made liable for merely negligent errors contained in narrative reports or financial statements.
  • The regime for issuer liability was introduced in this jurisdiction in a piecemeal fashion, recognising the historical tendency against liability. The government was aware that the scheme would involve a balance between: (a) the desire to encourage proper disclosure and affording recourse to a defrauded investor in its absence; and (b) the need to protect existing and longer-term investors who, subject to any claim against relevant directors (who may not be good for the money), may indirectly bear the brunt of any award against the issuer.
  • The original s.90A provisions introduced by the government were subsequently extended with effect from 1 October 2010 as follows: (a) to issuers with securities admitted to trading on a greater variety of trading facilities; (b) to relevant information disclosed by an issuer through a UK recognised information service; (c) to permit sellers, as well as buyers, of securities to recover losses incurred through reliance on fraudulent misstatements or omissions; and (d) to permit recovery for losses resulting from dishonest delay in disclosure. However, liability continued to be based on fraud and no change was suggested or made to the limitations that: (i) liability is restricted to issuers; and (ii) liability can only be established through imputation of knowledge or recklessness on the part of PDMRs of the issuer. Further, no specific provisions to determine the basis for the assessment of damages were introduced.

Two-stage test for liability under s.90A /Sch 10A FSMA

The court confirmed that the provisions of s.90A / Sch 10A FSMA make clear that there is an objective and a subjective test, both of which must be satisfied to establish liability:

  • Objective test: the relevant information must be demonstrated to be “untrue or misleading” or the omissions a matter “required to be included”.
  • Subjective test: a PDMR must know that the statement was untrue or misleading, or know such omission to be a “dishonest concealment of a material fact” (referred to in the judgment as “guilty knowledge”).

Each of these tests is considered separately below.

The objective test (untrue or misleading statement or omission)

The court said that the objective meaning of the impugned statement, is “the meaning which would be ascribed to it by the intended readership, having regard to the circumstances at that time”, endorsing the guidance provided in Raiffeisen Zentralbank Osterreich AG v The Royal Bank of Scotland plc [2010] EWHC 1392 (Comm).

The court gave some further guidance as to how to establish the objective meaning of a statement for the purpose of a s.90A/Sch 10A FSMA claim, including the following:

  • The content of the published information covered by s.90A/Sch 10A will often be governed by certain accounting standards, provisions and rules, which involve the exercise of accounting judgement where there may be a range of permissible views. The court confirmed that a statement is not to be regarded as false or misleading where it can be justified by reference to that range of views.
  • Where the meaning of a statement is open to two or more legitimate interpretations, it is not the function of the court to determine the more likely meaning. Unless it is shown that the ambiguity was artful or contrived by the defendant, the claim may not satisfy the objective test.
  • The claimant must prove that they understood the statement in the sense ascribed to it by the court.

The subjective test (guilty knowledge)

As in the common law of deceit, it must be proven that a PDMR “knew the statement to be untrue or misleading or was reckless as to whether it was untrue or misleading”; or alternatively, that they knew that the omission of matters required to be included was the dishonest concealment of a material fact. The court noted that for both s.90A and Sch 10A, the language used shows that there is a requirement for actual knowledge.

The court clarified several key legal questions as to what will amount to “guilty knowledge” for the purpose of the subjective test, including the following:

  • Timing of knowledge. In the context of an allegedly untrue/misleading statement, a party will be liable only if the facts rendering the statement untrue were present in the mind of the PDMR at the moment the statement was made. In the case of an omission, the PDMR must have applied their mind to the omission at the time the information was published and appreciated that a material fact was being concealed (i.e. that it was required to be included, but was being deliberately left out).
  • Recklessness. In the context of s.90A/Sch 10A FSMA, recklessness bears the meaning laid down in Derry v Peek (1889) 14 App. Cas. 337, i.e. not caring about the truth of the statement, such as to lack an honest belief in its truth.
  • Dishonesty
    • Even on the civil burden of proof, there is a general presumption of innocent incompetence over dishonest design and fraud, and the more serious the allegation, the more cogent the evidence required to prove dishonesty.
    • For deliberate concealment by omission, dishonesty has a special definition under Sch 10A (although s.90A contained no such special definition), which represents a statutory codification of the common law test for dishonesty laid down in R v Ghosh [1982] 1 QB 1053 (although in a common law context, that test has been revised by Ivey v Genting Casinos (UK) Ltd [2018] AC 391). Under the Sch 10A definition, a person’s conduct is regarded as dishonest only if:

“(a) it is regarded as dishonest by persons who regularly trade on the securities market in question, and (b) the person was aware (or must be taken to have been aware) that it was so regarded.”

    • Any advice given to the company and its directors from professionals will be relevant to the question of dishonesty (see below).
  • Impact of advice given by professionals on the subjective test
    • The court emphasised that, where a PDMR receives guidance from the company’s auditors that a certain fact does not need to be included in the company’s published information, then the omission of that fact on the basis of the advice is unlikely to amount to a dishonest concealment of a material fact (even if the disclosure was in fact required).
    • Similarly, where a PDMR has been advised by auditors that a particular statement included in the accounts was a fair description (as required by the relevant accountancy standards), it may be unlikely that the PDMR had knowledge that the statement was untrue/misleading or was reckless as to its truth (unless the auditor was misled).
    • However, in the court’s view, directors are likely to be (and should be) in a better position than an auditor to assess the likely impact on their shareholders of what is reported, and (for example) to assess what shareholders will make of possibly ambiguous statements. Accordingly, the court said “on matters within the directors’ proper province, the view of the company’s auditors cannot be regarded as a litmus test nor a ‘safe harbour’: auditors may prompt but they cannot keep the directors’ conscience”.
    • Accordingly, narrative “front-end” reports and presentations of business activities cannot be delegated by directors, as their purpose/objective is to reflect the directors’ (not the auditors’) view of the business and require directors to provide an accurate account according to their own conscience and understanding.
  • Subjective test to be applied in respect of each false statement. The court confirmed that liability is only engaged in respect of statements known to be untrue. If a company’s annual report contains ten misstatements, each of them relied on by a person acquiring the company, but it can only be shown that a PDMR knew about one of those misstatements, the company will only be liable in respect of that one, not the other nine.

Reliance

Reasonable reliance is another necessary precondition to liability under s.90A and Sch 10A, although the precise requirements of reliance are not defined in those provisions. In the Autonomy judgment, the court considered the question of reliance in further detail, providing the following guidance:

  • Reliance by whom? The court held that reliance must be by the person acquiring the securities, and not by some other person.
  • Individual statements vs published information. The court held that reliance must be upon a statement or omission, rather than, in some generalised sense, on a piece of published information (e.g. the annual report for a given year).
  • Express statements vs impression. The court suggested that statements and omissions may in combination create an impression which no single one imparts and, if that impression is false, that may found a claim (subject to the “awareness” requirement below).
  • Awareness requirement. The court held that, in order to demonstrate reliance upon a statement or omission, a claimant will have to demonstrate that they were consciously aware of the statement or omission in question, and that it induced them to enter into the transaction. The requirement for reliance upon a piece of information will not be satisfied if the claimant cannot demonstrate that they reviewed or considered the information: “it cannot have been intended to give an acquirer of shares a cause of action based on a misstatement that he never even looked at, merely because it is contained, for example, in an annual report, some other part of which he relied on”. Further, the relevant statement “must have been present to the claimant’s mind at the time he took the action on which he bases his claim”, i.e. made his investment decision.
  • Standard of reliance. The court held that a claimant must show that the fraudulent representation had an “impact on their mind” or an “influence on their judgement” in relation to the investment decision.
  • Presumption of inducement. The court held that the so-called “presumption of inducement” applies in the context of a FSMA claim to the same extent as it does in other cases of deceit. This is a presumption that the claimant was induced by a fraudulent misrepresentation to act in a certain way, which will assist the claimant when proving reliance. The presumption is an inference of fact which is rebuttable on the facts. In addition, for the purposes of s.90A and Sch 10A, any reliance must be “reasonable”, and that reasonableness requirement mitigates the effect of the presumption by introducing an additional test for the claimant to satisfy. The court also made clear that the presumption of inducement is subject to the “awareness” requirement above, i.e. the presumption of inducement will not arise if the claimant was not consciously aware of the representation.
  • When is reliance reasonable? The court held that “the test of reasonableness is not further defined, but is plainly to be applied by reference to the conditions at the time when the representee claimant relied on it. Circumstances, caveats or conditions which qualify the apparent reliability of the statement relied on by the claimant are all to be taken into account. The question of when reliance is reasonable is fact-sensitive.”

Loss in the context of FSMA claims

The court expressed its provisional view on some “novel and difficult issues” in the context of loss. In particular, it said that it is for the court to decide, and not for the defrauded party to make an election, as to whether “inflation” damages (i.e. if the truth had been known the claimant would have acquired the shares at a lower price) or “no transaction” damages (i.e. if the truth had been known, the claimant would not have purchased the shares in question) are available. The court will return to this question when addressing issues of quantum (the present judgment considered liability only).

Future use of s.90A / Sch 10A claims in M&A disputes

In the present case, the alleged liability of Autonomy under s.90A/Sch 10A was used as a stepping-stone to a claim against the defendants. This was described by the court as a “dog leg claim” because Autonomy (now under the control of HP) accepted full liability to its shareholder, and Autonomy sought to recover in turn from the defendants as PDMRs of Autonomy at the relevant time. The court said that there was no conceptual impediment to this, but that it was right to bear in mind that in interpreting the provisions and conditions of liability, the relevant question was whether the issuer itself should be liable.

This may open the door for future M&A disputes to be brought by way of a s.90A FSMA claim by disgruntled purchasers against the target company in order – ultimately – to pursue a claim against former directors of the target company (i.e. the vendors), based on breach of their duties owed to the target company.

Simon Clarke
Simon Clarke
Partner
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Ceri Morgan
Ceri Morgan
Professional Support Consultant
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Rupert Lewis
Rupert Lewis
Partner
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Chris Bushell
Chris Bushell
Partner
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High Court clarifies meaning of “PDMR” in s.90A FSMA claims

May 30, 2022

The High Court has clarified what is meant by “person discharging managerial responsibilities” (PDMR) in the context of Section 90A and Schedule 10A of the Financial Services and Markets Act 2000 (FSMA), a key element of the test for statutory liability for statements made by UK listed companies in periodic publications: Various Investors v G4S Limited (formerly known as G4S plc) [2022] EWHC 1081 (Ch).

The statutory regime

Pursuant to Schedule 10A FSMA, paragraph 3(1), an issuer will be liable to pay compensation to a person who acquires, continues to hold or disposes of securities in reliance upon published information and suffers loss as a result of any untrue or misleading statement in (or omission of a “matter required to be included” from) that published information. An issuer will also be liable to pay compensation to a person who acquires, continues to hold or disposes of the securities and suffers loss in respect of the securities as a result of delay by the issuer in publishing information (paragraph 5(1)).

An issuer will only, however, be liable in the following circumstances:

  • in respect of an untrue or misleading statement, if a PDMR within the issuer knew the statement to be untrue or misleading or was reckless as to whether it was untrue or misleading (paragraph 3(2));
  • in respect of omissions, if a PDMR within the issuer knew the omission to be a dishonest concealment of a material fact (paragraph 3(3)); and
  • in respect of delays, if a PDMR within the issuer acted dishonestly in delaying the publication of the information (paragraph 5(2)).

Paragraph 8(5) defines PDMR for the purposes of Schedule 10A as follows:

  1. any director of the issuer (or person occupying the position of director, by whatever name called);
  2. in the case of an issuer whose affairs are managed by its members, any member of the issuer;
  3. in the case of an issuer that has no persons within paragraph (a) or (b), any senior executive of the issuer having responsibilities in relation to the information in question or its publication.

The meaning of “director”

In the case of G4S, which is a company with directors, it was common ground that the relevant paragraph was 8(5)(a), and that only directors of G4S would constitute PDMRs. However, the parties differed in relation to what was meant by “director”.

The claimants contended that terms such as “director” take colour from their context and that the term should be interpreted broadly for the purposes of paragraph 8(5)(a). They highlighted the use of the term PDMR in EU market abuse legislation, and the broader definition that applies there:

“…a person within an issuer…who is (a) a member of the administrative, management or supervisory body of that entity; or (b) a senior executive who is not a member of the bodies referred to in point (a), who has regular access to inside information relating directly or indirectly to that entity and power to take managerial decisions affecting the future developments and business prospects of that entity”.

The claimants suggested that the term “director” in paragraph 8(5)(a) ought to be interpreted so as to align the Schedule 10A definition with the market abuse definition, extending the concept of “director” beyond the three currently recognised categories in English law (i.e. de jure, de facto and shadow directors), to also include “senior executives with control over substantial business units, or who were responsible for managerial decisions affecting the future developments and business prospects of the issuer and/or those business units”.

By way of contrast, the defendant contended that the statutory definition of PDMR in Schedule 10A was clear and unambiguous. The term “director” is well-known and established in UK law. The drafter used recognised concepts of domestic company law and there is no reason to adopt another meaning.

The court rejected the claimants’ argument, holding that Schedule 10A clearly stipulates that where an issuer has directors the PDMRs are the directors (including persons occupying the position of director, by whatever name called), and that the term “director” in that context should be given its usual, well-established legal meaning.

De facto directors

For the purposes of this application, the defendant did not contest the claimants’ position that a de facto director might constitute a PDMR for the purposes of paragraph 8(5)(a). The defendant did, however, contest that, if de facto directors can be PDMRs for the purposes of paragraph 8(5)(a), this had been properly pleaded by the claimants. Mr Justice Miles held that the claimants had pleaded that the individuals they alleged to be PDMRs were de facto directors of G4S. However, he encouraged the claimants to do so more fully, holding that “it is to my mind undesirable for the pleadings to be left in their somewhat ambiguous and uncertain state.”

Chris Bushell
Chris Bushell
Partner
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Sarah Penfold
Sarah Penfold
Senior Associate
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Holly McCann
Holly McCann
Associate
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CAT ruling in FX litigation: class action should be opt-in, not opt-out

April 21, 2022

In a recent ruling in the FX litigation, the UK Competition Appeal Tribunal (CAT) has ruled for the first time that collective proceedings can only proceed on an opt-in basis, rather than the opt-out basis sought by the class applicants: Michael O’Higgins FX Class Representative Limited v Barclays Bank PLC and Others; and Mr Phillip Evans v Barclays Bank PLC and Others [2022] CAT 16.

The decision highlights that collective proceedings order (CPO) applicants are not guaranteed the ability to bring opt-out proceedings by pointing to the impracticability of opt-in proceedings. It may disrupt the trend towards opt-out, which was emerging from recent certification judgments where the classes were made up of a large number of consumers, on the basis that very few individuals would likely seek to opt-in. It may dampen the anticipated growth of the CPO regime following the Supreme Court’s ruling in Mastercard Incorporated & Ors v Merricks [2020] UKSC 51 and could reduce the litigation risks for the financial services sector, as discussed in our recent article: Merricks v Mastercard: the litigation risks for the financial services sector.

As reminder, unlike most other class actions in the English courts, competition class actions in the CAT can be brought on an “opt out” basis, subject to the CAT certifying the proceedings by granting a CPO. An “opt-out” claim means that a claim can be brought on behalf of all those who suffered loss as a result of the relevant conduct, without individual claimants having to come forward and be named in the action.

In the present case, the CAT noted that the class was comprised of mostly sophisticated businesses with potentially large claims on average – for whom opting into a claim would be practicable. The CAT underlined that the relevant question was whether opt-in proceedings would be practicable from the standpoint of the members of the class, rather than from the standpoint of the applicant. The CAT consequently ordered that both applications for a CPO be stayed and that the applicants be given permission to submit a revised application for certification on an opt-in basis within a three-month period.

For more information see this post on our Competition Notes blog.

High Court strikes out shareholders’ claim barred by the reflective loss rule

March 23, 2022

The High Court has struck out a claim by the former shareholders of a dissolved company against an investor on the basis that all the losses claimed were barred by the reflective loss principle: Burnford & Ors v Automobile Association Developments Ltd [2022] EWHC 368 (Ch).

As a reminder, the Supreme Court in Sevilleja v Marex Financial Ltd [2020] UKSC 31 confirmed (by a 4-3 majority) that the reflective loss principle is a bright line legal rule, which prevents only shareholders from bringing a claim based on any fall in the value of their shares or distributions, which is the consequence of loss sustained by the company, in respect of which the company has a cause of action against the same wrongdoer (see our blog post).

Although the company in the present case had been dissolved, the High Court found that the claimants’ claim fell within the ambit of the reflective loss principle.

The decision is of interest because of the High Court’s consideration of the question as to the time at which the reflective loss rule falls to be assessed. In Nectrus Ltd v UCP plc [2021] EWCA Civ 57, Flaux LJ (as he then was) sitting as a single judge of the Court of Appeal refused permission to appeal and in doing so held that the claim of an ex-shareholder was not barred by the reflective loss principle, finding that the rule should be assessed at the time the claim is made. However, in Primeo Fund v Bank of Bermuda (Cayman) Ltd [2021] UKPC 22 the Board of the Privy Council (comprising five of the seven judges who had heard the Supreme Court appeal in Marex) concluded that Nectrus was wrongly decided. The Board confirmed that the rule falls to be assessed as at the point in time when a claimant suffers loss and not at the time proceedings are brought (see our blog post).

Notwithstanding the ruling of the Board of the Privy Council in Primeo, the High Court in the present case considered that it was bound by the decision in Nectrus, even though Flaux LJ’s decision in Nectrus was made as a single member of the Court of Appeal on an application for permission to appeal, and would therefore not normally have any precedent value.

In spite of this, the High Court then concluded that the present case was distinguishable on its facts from Nectrus and did, therefore, follow the Board of the Privy Council’s decision in Primeo. As such, even though the company in the present case was dissolved, the claimants’ claims were barred because their losses were suffered in the capacity of shareholders, in the form of a diminution in the value of their shareholdings, which was the consequence of loss sustained by the company in respect of which the company had a cause of action against the same wrongdoer.

This case suggests a judicial reluctance to follow Nectrus, which is not surprising given its uncertain precedent value and the Privy Council’s comments in Primeo. This may lead to further attempts to distinguish Nectrus in future cases, until the Court of Appeal has the opportunity to reconsider the issue properly.

We consider the decision in more detail below.

Background

The claimants were former shareholders in a company called Motoriety (UK) Ltd (Motoriety), whose business was the exploitation of two software-based products for the motoring industry. In 2015, Motoriety wished to expand its customer base and entered into negotiations with Automobile Association plc (better known as “the AA”), on the basis that the AA could invest in the company. Motoriety and the claimants subsequently entered into an investment agreement with the defendant subsidiary company of the AA. The defendant agreed to subscribe for 50% of the share capital of Motoriety and the defendant had a call option for the remaining 50%, for consideration produced by a formula contained in the agreement. On the same day, Motoriety granted the defendant a licence to use its software and associated intellectual property rights. In 2017, Motoriety went into administration and was bought from its administrators by another company in the AA group.

The claimants subsequently brought a claim against the defendant for fraudulent or negligent misrepresentation and/or for breach of contract. The claimants alleged that they had entered into the investment agreement and the licence agreement in reliance on false representations by the defendant. The claimants also alleged that the defendant breached implied terms of the investment agreement by pursuing a course of conduct that undermined the basis of the arrangements between the claimants, Motoriety and the defendant. The claimants alleged that this led to Motoriety going into administration. The claimants also pleaded an alternative breach of contract claim that, had it not been for the defendant’s breach of contract, the defendant would have exercised the call option and paid the consideration due.

The claimants sought damages for losses incurred as a result of the fraudulent/negligent misrepresentation and/or breach of contract. On the claimants’ misrepresentation claim, losses were claimed on the basis that, had the alleged misrepresentations not been made, the claimants and Motoriety would not have done the deal with the defendant, but would have entered into a venture with a third party company and the value of the claimants’ shareholdings would have increased accordingly. Similarly, in relation to the original breach of contract claim, the claimants claimed that if the contract had been properly performed, Motoriety would have thrived and the value of the claimants’ shareholdings would have increased. Alternatively, had it not been for the defendant’s breach of contract, the defendant would have exercised its call option, so that the claimants would have been entitled to the consideration provided for by that option. Three of the claimants also claimed for the loss of their initial investments in Motoriety.

The defendant denied the claim and brought an application to strike out the claim or for reverse summary judgment on the basis that all the losses claimed by the claimants were barred by the reflective loss principle.

Decision

The High Court found in favour of the defendant and granted its application to strike out the claim.

The key issues which may be of interest to financial institutions are set out below.

Developing area of the law

The claimants argued that it was inappropriate to deal with the reflective loss principle in a strike out application because this is a “fiendishly complex area of the law” which is “uncertain and developing”. However, the High Court did not accept this and, on the contrary, considered that Marex had restated and recast the principle. Even the “timing issue” (referred to below) which was raised by the decision in Nectrus was quickly resolved by the Privy Council in Primeo.

The High Court stated that Lord Reed’s judgment in Marex had made clear that claims by shareholders against third parties fell foul of the reflective loss rule where (and only where):

  • The shareholder suffers loss,
  • in the capacity of shareholder,
  • in the form of a diminution in share value or in distributions,
  • which is the consequence of loss sustained by the company,
  • in respect of which the company has a cause of action,
  • against the same wrongdoer.

All of these conditions needed to be satisfied for a claim to be barred by the reflective loss rule and, conversely, if any of them were not satisfied, the claim was not barred.

Independent wrongs

The claimants argued that their losses were caused by independent wrongs committed against them by the defendant. Their losses did not simply follow on from the loss of the company, reflected through their shareholdings in it. The representations were made to them personally and they were separate parties to the contract, such that they had “separate and distinct” losses from that of Motoriety.

However, the High Court noted that, as per Prudential Assurance Co v Newman Industries Ltd [1982] 1 Ch 204, shareholders may not recover a loss caused to the company by breach of the duty owed to the company. To allow otherwise, would subvert the rule that no shareholder can bring a claim on behalf of the company (as per Foss v Harbottle (1843) 2 Hare 461). With the above in mind, the High Court considered that the claimants had to show that Motoriety had not suffered the same loss. In fact, the claimants’ alleged losses were entirely derived from the claimed losses of Motoriety. They may have had a direct claim, but they only had an indirect loss.

The “timing” point

The claimants argued that the reflective loss rule did not apply because Motoriety had been dissolved before the commencement of the claim, and therefore they were no longer shareholders in it. In the claimants’ view, the reflective loss rule must be applied by reference to the time when the claims commenced, and not when the loss was suffered. The claimants relied on Nectrus in which Flaux LJ (as he then was) sitting as a single judge of the Court of Appeal, refused permission to appeal. In doing so, he held that the claim of an ex-shareholder was not barred by the reflective loss principle, finding that the rule should be assessed at the time the claim is made. The claimants argued that, although the Board of the Privy Council in Primeo (comprising five of the seven judges who had heard the Supreme Court appeal in Marex) found that Nectrus was wrongly decided and confirmed that the rule falls to be assessed as at the point in time when a claimant suffers loss and not at the time proceedings are brought, this decision was not binding on the High Court. Conversely, the defendant argued that Nectrus was not binding on the High Court and was distinguishable in any event.

The High Court highlighted that Flaux LJ’s decision in relation to permission to appeal in Nectrus contained no express statement that it was establishing a new principle or extending the current law. It should therefore not ordinarily be cited before a court or bind another court. However, in Allianz Global Investors GmbH v Barclays Bank plc [2021] EWHC 399 (Comm), Sir Nigel Teare (sitting as a High Court judge) while acknowledging that remarks made when refusing (or granting) permission to appeal are ordinarily of no weight, stated that he had been informed that Flaux LJ’s intention was that his ruling may be cited. As such, the High Court in the present case proceeded on the basis that that was correct and therefore Flaux LJ’s decision was binding.

The High Court noted that, as per Willers v Joyce, it was obliged to follow an otherwise binding decision of the Court of Appeal in preference to a decision of the Privy Council. The High Court considered whether the “timing” point was merely obiter dicta and therefore not strictly binding, but concluded that Flaux LJ’s decision in Nectrus was based on four separate grounds which were all part of the binding ratio decidendi. One of the grounds was that it was “unarguable” that the reflective loss rule applied to a claimant who had ceased to be a shareholder at the date of the claim and the High Court was therefore bound by this part of the decision unless it could be distinguished.

The High Court did, however, find that Nectrus was distinguishable. In that case the shareholder had sold its shareholding at a reduced price, which meant that the company’s loss had in effect been “passed on” (pro rata) to the shareholder so the company could no longer claim that share of the loss. As per Allianz, it was clear that in such circumstances there was no risk of: (a) the rule in Foss v Harbottle being subverted as there would be no concurrent claims; and (b) double recovery. In the present case, there had been no sale of the shares at a reduced price, and no “passing on” of any part of the loss of the company. If Motoriety was restored to the register, the loss would still be in the company. As such, the High Court determined that it was not bound to follow Nectrus and was free to follow the decision in Primeo in finding that the reflective loss principle did bar the claimants’ misrepresentation and original breach of contract claim.

Alternative claim for breach of contract

The claimants argued that the alternative breach of contract claim fell outside the scope of the reflective loss rule because the loss consisted of the formula set out in the investment agreement to calculate the consideration due under the call option and because only the claimants, not Motoriety, had rights to the consideration under the call option. Therefore Motoriety never had a cause of action to claim compensation in respect of this head of loss.

The High Court found that this claim was also barred by the reflective loss rule. The claim satisfied all six of the conditions set out in Lord Reed’s judgment in Marex. The fact that the measure of the claimants’ loss was by reference to a contractual formula and different to the measure of the loss of the company was beside the point.

The initial investments claim

The claimants who claimed for the loss of their initial investments in Motoriety argued that this head of loss fell outside of the reflective loss rule because it did not reflect a diminution in the value of their shares.

The High Court agreed with the defendant’s argument that this was simply a “less ambitious” version of the same claim. Instead of claiming the difference between what the values of their shareholdings should have been and what they now were, the claimants were claiming the much smaller difference between what they paid for their shareholdings and what they now had. The High Court found that even though the claims were limited to the amounts paid for the shares, the loss suffered by the claimants was still the loss of their value and the loss of their value was still reflective of the loss to Motoriety.

Accordingly, for all the reasons above, the High Court found in favour of the defendant and granted its application to strike out the claim.

Julian Copeman
Julian Copeman
Partner
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Ceri Morgan
Ceri Morgan
Professional Support Consultant
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Nihar Lovell
Nihar Lovell
Professional Support Lawyer
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Claire Nicholas
Claire Nicholas
Senior Associate
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