High Court takes robust approach to personal guarantees: potential impact for accredited lenders under the Coronavirus Business Interruption Loan Schemes

The High Court has held that personal guarantees signed by the chairman and sole shareholder of a borrower company were enforceable, dismissing arguments that emailing scanned signature pages was insufficient to constitute “delivery”, or that the doctrine of promissory estoppel was engaged to prevent the lender from calling on the guarantees where certain alleged assurances were given: Umrish Ltd & Ors v Gill [2020] EWHC 1513 (Ch).

The decision demonstrates the court’s willingness to take a robust approach to personal guarantors’ attempts to deny liability. This will be of particular interest for accredited lenders under the Coronavirus Business Interruption Loans Schemes, which were introduced as part of the government’s response to the effects of COVID-19 on businesses. Under these schemes, loans are partially guaranteed by the government. However, banks are permitted (and in some situations expected), to take security or personal guarantees for large facilities to cover the risk of default on the remaining balance. This decision provides comfort that the court will take a pragmatic approach to mechanisms for recovery under personal guarantees.

Background

The defendant approached the claimants seeking investment by way of four loans totalling £1.5 million in Swisspro Asset Management AG (Swisspro), for which he was the chairman and sole shareholder.

Mr Venkatesh, on behalf of the claimant companies, indicated that personal guarantees from the defendant would be required to cover repayment in the event of default. The defendant was reluctant to provide a personal guarantee, but Mr Venkatesh gave certain assurances to the defendant, the precise formulation of which was an issue at trial. Following these conversations, the defendant signed and emailed a scan of the signature pages of the personal guarantees to the claimants.

Swisspro subsequently fell behind on its payments and the claimants sought to rely on the personal guarantees to recover the outstanding balance. The defendant argued that the guarantees were unenforceable. He alleged that no formal delivery had taken place, as only the signature pages were sent electronically, and that under the doctrine of promissory estoppel it was inequitable for the claimants to call on the guarantees due to the assurances given by Mr Venkatesh at the time of signing.

Decision

The court upheld the enforceability of the personal guarantees.

Delivery

The court held that, on an objective assessment of the defendant’s actions in signing and scanning the signature page of the guarantees, a reasonable recipient in the position of the claimants would understand that the defendant had delivered the guarantees effectively and unconditionally.

The court rejected the defendant’s argument that it would be expected that he would not be bound by the terms until he delivered the complete contract with an original signature. Both parties identified the documents sent as being the personal guarantees in question. By signing and transmitting the signature pages to the claimants, the defendant indicated an intention to be bound by the terms of those documents. On the facts, there was no context that would indicate that this was conditional. The fact that a “completion meeting” was proposed to sign the originals did not impose a condition on the delivery.

The court noted that, in the age of instant communication, emailing a scanned signature page of an identified document is (absent any contrary context) sufficient for delivery and it would be unreasonable to expect a greater degree of formality.

Promissory estoppel

The court found that the assurances given by Mr Venkatesh prior to the defendant signing the personal guarantees did not make it inequitable under the doctrine of promissory estoppel for the claimants to later call on the guarantees.

The court made certain findings of fact that Mr Venkatesh did not give any assurances that the guarantees would be unenforceable. The court found that he may have said the guarantees would “give comfort” and would be used as a “sleeping pill”, meaning they would not be called on for minor infractions. It held that these statements were not sufficiently clear and unequivocal to engage the doctrine of promissory estoppel. It was therefore not inequitable for the claimants to claim under the guarantees.

Although not necessary given its primary finding of fact above, the court grappled with the question of whether promissory estoppel can arise outside of the context of an existing legal relationship. In this case, the defendant said he relied on the alleged promise not to enforce certain terms to enter into the very legal relationship that the promise was said to have varied (i.e. there was no pre-existing legal relationship). The court considered the authorities and concluded, obiter, that case law strongly suggests promissory estoppel does require the pre-existence of a legal relationship between promisor and promisee (in particular, obiter dictum in Harvey v Dunbar Assets plc [2017] EWCA Civ 60).

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High Court gives guidance on availability of summary judgment and frustration in contractual disputes

A recent High Court decision is a good example of the court’s willingness to deal with questions of contractual interpretation on a summary basis in an appropriate case, without the need for a full trial. However, it also highlights the difficulties that will be faced in successfully striking out a defence based on the common law doctrine of frustration, which is likely to be of particular interest to financial institutions in the context of the COVID-19 pandemic: Natixis & Anor v Famfa Oil Ltd [2020] 2 WLUK 330.

The court found, on a summary judgment and strike out application, that the sums claimed by the claimant investment banks had fallen due for payment as a matter of construction of the relevant contracts. While parties often seek to determine contractual construction disputes at full trial or by trial of preliminary issues, the decision is a helpful reminder that summary judgment is also available to achieve early determination of such matters, in an appropriate case. The following factors (in particular) were highlighted as making the present case suitable for determination by summary judgment: the claim involved a short point of contractual construction; the factual matrix was not in dispute; the agreements were sophisticated, complex and drafted by skilled professionals; and it was appropriate to interpret the contracts principally by a textual analysis.

Summary judgment may provide a quicker route to early determination as parties can apply as soon as statements of case are served. Trials of preliminary issues, on the other hand, require a party to apply for (and obtain) an order for a trial of preliminary issues before those issues can be heard. In the Commercial Court, applications for a trial of preliminary issues are normally considered at the first Case Management Conference which can cause further delay in obtaining early determination.

However, the court was not prepared to summarily strike out a defence based on the doctrine of frustration. Having regard to the need to take a multi-factorial approach to this question, the court held that the relevant factors (including the parties’ knowledge and expectations at the time of entering into the contract, in particular as to risk) could only properly be investigated at trial following disclosure and the exploration of oral evidence in cross-examination.

Interestingly, the court found that the frustration defence was realistically arguable where the event relied on created a “real risk” that the relevant financing contracts would become incapable of being performed or that the obligations would be rendered radically different. In other words, the defendant did not need to wait for the risk of frustration to materialise for the defence to be realistically arguable. Whether the contracts were actually frustrated on the facts of the case is yet to be established at trial. However, for parties facing disputes arising from the impact of the current COVID-19 pandemic on commercial contracts, the decision may provide helpful guidance on when frustration might be available. For further legal analysis and insights in relation to COVID-19, and how we expect the crisis to operate as a catalyst for change, please visit our Catalyst Hub.

Background

The defendant (a private company incorporated in Nigeria) entered into a series of contracts with the claimants (the Banks) and others for the provision of, inter alia, a $1.2 billion syndicated term loan and underwriting services. The facility was to enable the defendant to bid for and purchase a company known as Petrogas Oil and Gas PV (Petrogas). The parties intended that the defendant would service the facility by using revenue generated from the defendant’s participating interest in part of the Agbami oil field in Nigeria (known as OML 127).

However, after executing the finance documents and submitting its binding offer for Petrogas, the defendant received a letter from the Department of Petroleum Resources of the Federal Republic of Nigeria (the DPR) suggesting that the Federal Government of Nigeria intended to acquire the defendant’s interest in OML 127 (which would risk its ability to service the facility).

The defendant alleged that the DPR’s letter created an unquantifiable and material risk that outweighed any potential upside from winning the bid to purchase Petrogas. The defendant withdrew from the purchase process and the finance agreements were terminated in accordance with their respective terms.

The Banks subsequently demanded fees allegedly due under: (i) a mandate letter in relation to the underwriting; and (ii) a fee letter in relation to the arrangement of a substitute facility for Petrogas (Petrogas had an existing borrowing facility that was subject to a change of control provision, and this agreement was to guard against the risk of existing lenders refusing to consent to the change of control). The Banks commenced proceedings to recover the payments allegedly due. They subsequently applied to strike out part of the defendant’s defence and for partial summary judgment on some of the issues in dispute.

Decision

Among the issues to be determined by the court were:

  1. whether, as a matter of construction, the defendant had a realistically arguable defence to the sums claimed under the mandate letter and fee letter; and
  2. whether the defendant had a realistically arguable defence based on either frustration and/or common mistake.

Contractual interpretation claims

The court was satisfied that the issues were short points of contractual construction that could properly be determined on a summary judgment application. In particular, there was no realistically arguable relevant factual matrix evidence in dispute; and the agreements were sophisticated and signed by parties who had the benefit of extensive legal advice. Accordingly, the true meaning and effect of the agreements was dependant on the language used by the parties when read in the proper context (i.e. adopting a textual analysis).

Applying the well-established principles of contractual construction, the court held that the drafting of the relevant contracts was clear and that the sums demanded by the Banks were due even though they had not actually provided any underwriting or arranged substitute financing for Petrogas (which the defendant argued were pre-conditions for the payments).

Defences of frustration and common mistake

The court declined to strike out the defences based on frustration and/or common mistake, finding that these could only properly be investigated at trial following disclosure and the exploration of oral evidence in cross-examination.

In relation to frustration, the court provided a helpful summary of the current state of the law, as summarised in Canary Wharf (BP4) T1 Ltd & Ors v European Medicines Agency [2019] EWHC 335 (Ch). This case confirms that the court is required to take a multi-factorial approach, and the factors to consider include:

“…the terms of the contract itself, its matrix or context, the parties’ knowledge, expectations, assumptions and contemplations, in particular as to risk, as at the time of the contract, at any rate so far as these can be ascribed neutrally and objectively, and then the nature of the supervening event and the parties’ reasonable and objectively ascertainable calculation as to the possibilities of future performance in the new circumstances.”

The court held that it was close to impossible on a strike out application, having regard to the need to take a multi-factorial approach, to conclude that the frustration defence was unreal. Before such a conclusion can he reached, it will be necessary to determine the parties’ knowledge, expectations, assumptions and contemplations in particular as to risk.

The court acknowledged the Banks’ argument that the DPR’s correspondence did not actually expropriate the defendant’s interest. It was also uncertain that any negotiations with DPR would necessarily lead to the defendant losing its interest in OML 127. However, the court noted that the defendant could realistically argue that the effect of the DPR’s correspondence was:

“…to create a real risk that such would occur so as to put at risk its ability to repay the loan and therefore to participate successfully. Given the terms as to repayment and the unconditional nature of the offer that had to be made for the shares, it is realistically arguable that the threat was sufficiently great to enable the defendant to allege that the correspondence was a frustrating event.

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Court of Appeal upholds High Court contractual construction of CLO transaction

The Court of Appeal has upheld the High Court’s decision that no incentive fee was payable to a collateral manager in a collateralised loan obligation (CLO) transaction following the exercise of a right of early redemption by the holders of the equity notes: Barings (UK) Ltd v Deutsche Trustee Company Ltd & Ors (Rev 1) [2020] EWCA Civ 521.

While the Court of Appeal conducted the necessary iterative process of comparing the rival constructions and their commercial consequences, it was prepared to deal with the appellant’s various arguments in a robust but short form judgment. It will be interesting to see if the Court of Appeal’s willingness to do so leads to a trend of greater reluctance in giving permission to appeal contractual interpretation judgments than we have seen over the last few years. The decision is also noteworthy for emphasising that in a complex negotiated transaction, the contractual documents reflect the negotiated trade-offs agreed by the parties.

You can read our previous blog post on the High Court decision here: High Court applies contractual interpretation principles in collateralised loan obligation transaction.

Background

The parties entered into a CLO securitisation transaction in August 2006 pursuant to which Duchess VI CLO B.V. (the Issuer) issued various classes of notes (the Transaction). Deutsche Bank Trustee Company Limited acted as trustee (the Trustee). Napier Park Global Capital Limited held Class F Notes (the equity tranche of the CLO). Barings (U.K.) Limited acted as the collateral manager (the Collateral Manager).

The Collateral Manager was appointed pursuant to a collateral management agreement (the CMA), under which it was responsible for the investment decisions which determined the performance of the Transaction as a whole. In addition to receiving an ongoing base collateral management fee, a separate incentive collateral management fee (the ICM Fee) was payable, in certain circumstances, to the Collateral Manager to incentivise its management of the portfolio.

The Transaction did not perform as hoped, at least in part due to the 2008 global financial crisis. In January 2018, the Class F Noteholders exercised their right to an Optional Redemption under Condition 7 of the Conditions of the Notes, requiring the Collateral Manager to liquidate the portfolio and make a distribution of principal according to the applicable waterfall (set out at Condition 11).

The Collateral Manager duly liquidated the portfolio, but it also claimed that an ICM Fee was due on redemption of the principal, which was said to have triggered the threshold of return which would lead to the ICM Fee being payable.

The Trustee, who took a neutral position, brought proceedings under CPR Part 8 which focused on the entitlement of Collateral Manager to payment of an ICM Fee in relation to the redemption.

High Court decision

The High Court dismissed the Collateral Manager’s claim to the ICM Fee.

Applying well-established principles (as set out in, in particular, Rainy Sky v Kookmin Bank [2011] 1 W.L.R. 2900Arnold v Britton [2015] A.C. 1619 and Wood v Capita Insurance Services Limited [2017] 2 WLR 1095), the High Court compared the rival contractual constructions put forward and considered their commercial consequences. In interpreting the Transaction documents, the court found that the Collateral Manager was not entitled to the ICM Fee in an Optional Redemption scenario.

The Collateral Manager appealed.

Court of Appeal decision

The Court of Appeal considered the principal issue of whether the ICM Fee was payable in an Optional Redemption scenario under Conditions 7 and 11 of the Notes.

The Court of Appeal dismissed the appeal in a short-form judgment, the key points of which are summarised below.

The Court of Appeal noted that the definition of the ICM Fee did not refer to Condition 7 (providing the right of Optional Redemption) or Condition 11 (setting out the payment waterfall to apply in the event of an Optional Redemption). Rather, the definition of the ICM Fee stated expressly that it would be payable in accordance with Condition 3 (setting out how regular Interest and Principal Proceeds should be applied), which did not apply in an Optional Redemption scenario. The Court of Appeal considered that the Collateral Manager’s attempts to read in references to Conditions 7 and 11 into the definition of ICM Fee would “…not be re-interpreting but re-writing” the definition, which it was not prepared to do. Nor was it prepared to infer that was the drafter’s intention from the approach taken to other provisions.

Similarly, the Court of Appeal rejected the Collateral Manager’s attempts to trace through various related provisions to demonstrate that the ICM Fee was payable in an Optional Redemption scenario. It held that the “convoluted exercise of interpretation and implication” which the Collateral Manager had put forward was inconsistent with the express wording of the definition of ICM Fee, and incorrectly assumed that the drafter was not conscious of the difference in the payment waterfalls applicable under Condition 3 and in an Optional Redemption scenario under Conditions 7 and 11.

In the Court of Appeal’s view, the Transaction documents, including the CMA and related documents (read as a whole), showed that the drafter “had well in mind, and made careful choices between” the waterfalls applicable to Optional Redemption and those applicable in other circumstances.

It was, therefore, not in accordance with the definition of the ICM Fee for it to be paid on an Optional Redemption under Conditions 7 and 11.

The Court of Appeal said that it was “impossible” in the circumstances of this case to say that this interpretation was “so patently inconsistent with business common sense…that it undermines that interpretation being the correct one”. In this context, the Collateral Manager had made an overarching submission that it would lack business sense for the ICM Fee – as a performance fee – to be calculated without taking into account capital distributions to the Class F Noteholders on the Redemption Date itself where the redemption was triggered on Optional Redemption.

In rejecting the business sense argument put forward by the Collateral Manager, the Court of Appeal recognised that “In this highly complex set of agreements it is plain that there are negotiated trade-offs”, and there were other examples in the transaction documents which provided enhanced protection to the Collateral Manager.

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Commercial Court dismisses challenge to exercise of options in swap confirmations incorporating 2000 ISDA Definitions

The Commercial Court has dismissed a challenge to the exercise of options contained in five extendable interest rate swaps which incorporated the 2000 ISDA Definitions: Alfred Street Properties Ltd v National Asset Management Agency [2020] EWHC 397. The challenge was brought on the basis that notice was either not given by a contractually prescribed method or at all, despite the resultant swap transactions having been performed to term without challenge by either party.

The decision provides some helpful guidance on the approach to contractual interpretation of the ISDA Master Agreement and the 2000 Definitions. The court noted that while a strict approach, favouring clarity, certainty and predictability is required in interpreting the terms of standard market agreements, any questions as to incorporation and variation of such provisions should be interpreted according to the recognised principles of general contractual interpretation as confirmed by the Supreme Court, e.g. in Wood (Respondent) v Capita Insurance Services Limited (Appellant) [2017] UKSC 24 (see our litigation blog post).

Adopting a “unitary” approach, which involves an iterative process by which rival interpretations are checked against the provisions of the contract and the commercial consequences investigated, the court considered (in particular) Article 10 of the 2000 Definitions (which sets out the definitions of “Option Transaction” and “Swaption”). The court held that there is no requirement under Article 10 for parties to use the precise name or label “Option Transaction” or “Swaption” in the confirmation evidencing the swap transaction. It is sufficient for a transaction to be identifiable as such, e.g. by defining or describing either the transaction or its operation, in terms which “make it clear that it falls within the provisions dealing with those transactions”.

The key parts of the decision are considered below.

Background

Alfred Street Properties Limited (“ASPL”) entered into facilities totalling £111.5 million with Anglo Irish Banking Corporation, together with five extendable interest rate swaps to hedge its interest rate exposure under the facilities (the “Swaps”). The National Asset Management Agency (“NAMA”) subsequently acquired the bank’s interests in the loans and the Swaps. For convenience, in this blog post the bank’s rights and obligations under these documents are referred to as belonging to NAMA.

Each of the confirmations relating to the Swaps (each a “Confirmation”) incorporated the 2000 ISDA Definitions and was governed by the 1992 ISDA Master Agreement (Multicurrency-Cross Border) (the “ISDA MA”).

The Confirmations provided, amongst other things, that NAMA had the right, but not the obligation, to extend the Swaps by 11.00am (London time) on 2 April 2012 (the “Options”). In the event that NAMA exercised that right by the specified time and date, the Swaps would be extended on the same terms for a further three years, save that ASPL would pay an increased fixed rate.

NAMA sought to exercise the Options (via its agent) on 2 April 2012 at 9.15am by telephone (the “Notice Call”). Thereafter, ASPL made quarterly payments to NAMA on the assumption that the Swaps had been duly extended, totalling £4,778,289.56 (the “Swap Payments”).

The claim

A year after the term of the Swaps expired, ASPL alleged that NAMA’s exercise of the Options was invalid and sought restitution of the Swap Payments plus interest. Proceedings were commenced in January 2017 in which ASPL claimed that:

  1. NAMA was not entitled under the terms of the Confirmations to notify ASPL of the exercise of the Options by telephone. Whilst, s.12.2 of the 2000 Definitions allowed for notice of the exercise of Options to be provided orally, including by telephone, ASPL argued that the s.12.2 procedure was not engaged because the Confirmations did not expressly identify (using capitalised terms) that the transactions in question were “Option Transactions” or “Swaptions”. Instead, ASPL asserted that NAMA should have given notice in accordance with s.12(a) of the ISDA MA, which did not allow for notice by telephone. Alternatively, ASPL argued that, even if the s.12.2 procedure in the 2000 Definitions was engaged, exercise of the Options by telephone was not permissible as the Confirmations did not include a telephone contact number for ASPL, only a postal address (the “Notice Issue”); and
  2. NAMA’s agent did not actually exercise the Options on the Notice Call but merely indicated NAMA’s intention to exercise the Options (the “Intention Issue”).

Decision

The court dismissed the claim in its entirety.

The Notice Issue

The court noted that while a strict approach, favouring clarity, certainty and predictability is required in interpreting the terms of standard market agreements such as the ISDA MA or 2000 Definitions, any question as to incorporation and variation of such provisions should be interpreted according to the recognised principles of general contractual interpretation. It cited the Supreme Court’s decisions in Rainy Sky SA v Kookmin Bank [2011] 1 UKSC 50, Arnold v Britton [2015] UKSC 36 and Wood v Capita. The court emphasised the “unitary” approach to contractual interpretation in Rainy Sky and Arnold, which involves an iterative process by which rival interpretations are checked against the provisions of the contract and the commercial consequences investigated.

Applying this approach, the court rejected ASPL’s arguments, finding that NAMA was entitled to give notice to ASPL by telephone under s.12.2 of the 2000 Definitions. The key reasons given by the court were as follows:

  1. The court held that Article 10 of the 2000 Definitions, which sets out the definitions of “Option Transaction” and “Swaption”, simply requires that a transaction be identifiable as such in the confirmation evidencing the swap transaction (e.g. by defining or describing either the transaction or its operation, in terms which “make it clear that it falls within the provisions dealing with those transactions”). It said there was no requirement to use the precise name or label “Option Transaction” or “Swaption”. The court found that the terms of the Swaps set out in the Confirmations “clearly and obviously” showed the transactions were “Option Transactions” because of how they were described – even though the defined (capitalised) terms were not used. Accordingly, s.12.2 of the 2000 Definitions was the correct procedure for NAMA’s exercise of the Options.
  2. The court considered, obiter, the alternative scenario if its conclusion at point (1) above was wrong, namely whether the s.12.2 procedure could still apply, or whether notice had to be given in accordance with s.12(a) of the ISDA MA which did not allow for notice to be given orally. The court commented that a textual analysis of the Confirmations suggested the s.12.2 procedure could still apply because:
    1. Even if the Options were not identified as “Option Transactions”, the s.12.2 procedure had been incorporated into the Confirmations – in particular because the Options and their terms were structured solely by reference to terms defined in Articles 11 and 12 of the 2000 Definitions.
    2. For the s.12(a) ISDA MA method to apply, the parties would need to have set out contact details in a Schedule to the Confirmations which they had not done. In the absence of contact details, only the s.12.2 procedure was workable.
    3. The broader business context of the Confirmations also supported the conclusion that the parties had chosen to adopt the s.12.2 procedure. The decision to exercise an option by 11am on a particular day, would be highly sensitive to market movements and may be made at the last minute; that meant NAMA’s ability to exercise the Options orally made far more business sense than the alternative which would have required notice by post.
  3. The court also rejected ASPL’s argument that, as the Confirmations only specified a postal address and not a telephone number, notice by post was the only method permitted under the s.12.2 procedure. The parties could use the s.12.2 procedure irrespective of whether telephone contact details had been provided. S.12.2 expressly permitted oral notification, so the inclusion of a postal address did not implicitly exclude the other notice methods to which s.12.2 referred. In any event, the court found that the postal address had been included as an address for the Confirmation to be sent, rather than as an address for notice under s.12.2.

The Intention Issue

The court considered that, to decide whether the Options had actually been exercised on the Notice Call, the test was whether a reasonable person in the position of ASPL’s Head of Finance (ASPL’s representative on the Notice Call), with knowledge of the relevant circumstances, would have understood during the Notice Call, that NAMA was exercising the Options.

As the transcript of the Notice Call showed, NAMA’s agent stated that NAMA would be exercising the Options; identified the Swaps in question (but not discussed the terms relevant to the extension); and stated that he would follow up with a formal confirmation.

The court found that NAMA’s agent’s words were “exactly what would be expected of a party…exercising an option in a trade…”. The context, including the fact that the call took place during the limited window when the Options could be exercised, and the wording of a confirmation email sent by NAMA’s agent to ASPL’s Head of Finance after the Notice Call, also supported the argument that a reasonable person in the position of ASPL’s Head of Finance would have understood that the Options were being exercised.

Conclusion

Accordingly, the court found that the Options had been validly exercised and the Swaps extended. The court further found on an obiter basis that – in the absence of the Options having been validly exercised – NAMA would have had defences of estoppel by convention or by conduct, or change of position, given the parties’ performance of the Swaps to term.

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High Court finds no implied contractual duties in connection with past business review

Since 2015 there has been a series of judgments in which claimant customers have (ultimately unsuccessfully) sought to impose contractual and tortious duties on financial institutions relating to the institution’s conduct of the 2012 past business review into the alleged mis-selling of interest rate hedging products (the “PBR”). The latest decision from the High Court represents good news for financial institutions in this context, finding that a bank owed no implied contractual duties to assess or compensate consequential loss claims under the PBR: Norham Holdings Group Ltd v Lloyds Bank plc [2019] EWHC 3744. The judgment, which was handed down in June 2019 but has only recently been made publicly available, demonstrates the robust approach the court is prepared to take to novel claimant arguments of this type.

In summary, the claimant alleged that a settlement agreement under the PBR in respect of direct losses, which expressly carved out claims for consequential loss from the scope of the settlement, should be construed as giving rise to an implied contractual duty on the bank to assess or compensate consequential loss claims under the PBR. The court rejected this contention, finding not only that the claimant’s construction of the particular language of the settlement was unnatural, but also that the imposition of such a duty would cut across the regulatory regime under which the PBR was established. The court also rejected an argument that the bank was estopped from contesting whether the swap was mis-sold in civil proceedings as a result of its assessment that redress was due under the PBR.

The latest decision is in line with two important previous authorities. In CGL Group Limited & Ors v Royal Bank of Scotland plc & Ors [2017] EWCA Civ 1073 (see our blog post), the Court of Appeal confirmed that the banks did not owe tortious duties to customers to conduct the PBR with reasonable skill and care, resolving previous inconsistent first instance decisions. Similarly, in Elite Property Holdings & Anor v Barclays Bank plc [2018] EWCA Civ 1688 (see our blog post), the Court of Appeal rejected the argument that a settlement agreement in respect of direct losses gave rise to implied contractual duties to carry out a detailed assessment of consequential loss and pay fair and reasonable redress if the claims were well founded. In both decisions, the Court of Appeal considered (among other matters) that it would undermine the regulatory and statutory regime to impose private law rights in such circumstances and there would need to be a clear expression of intention by the banks to undertake such duties – which there was not on the facts.

Given this previous higher authority, it is unsurprising that the claimant was unsuccessful in the present case, particularly as it bore close similarities to the claims rejected in Elite Property. However, the latest judgment serves to reiterate that the court will be reluctant to find that firms undertook any private law duties in the context of the PBR, absent clear expression of intention to do so. Furthermore, the court’s reasoning may apply to other formal past business reviews entered into voluntarily by agreement with the FCA and to section 404 of the Financial Services and Markets Act 2000 consumer redress schemes. Nevertheless, it would be prudent for firms to expressly exclude contractual and tortious duties when communicating with customers in respect of such reviews/schemes.

The court’s finding on estoppel will also be welcomed by banks, as it demonstrates that a bank’s offer of redress under the PBR will not (absent exceptional circumstances) prevent it from contesting mis-selling allegations in any subsequent litigation.

Background

The claimant, a property investment company, entered into a LIBOR interest rate swap in February 2008 with Lloyds Bank (the “Bank”). The claimant suffered losses under the swap as interest rates fell substantially following the financial crisis.

In June 2012, the Bank, along with a number of other banks, entered into an agreement with the FSA (now FCA) to conduct the PBR. The PBR terms required it to review past sales of interest rate hedging products in order to determine whether there had been any breach of regulatory requirements, and to compensate direct losses (referred to as basic redress”) where appropriate, as well as any consequential losses evidenced by customers (such as overdraft charges and additional borrowing costs).

In January 2014, the Bank concluded that there was insufficient evidence on file in relation to the swap to demonstrate compliance with regulatory requirements and offered a basic redress award to compensate direct losses (plus 8% interest) on the basis that the claimant should have been sold an alternative swap with different terms that would have incurred less losses (the counterfactual swap). The claimant accepted the basic redress award and elected that the Bank should also consider claims that it had suffered consequential losses. The parties signed a settlement agreement (the “Settlement”) to settle any claims for direct losses. The Settlement contained a broad full and final settlement clause covering all claims in respect of the swap except any claims for consequential loss.

In October 2016, the Bank offered a consequential loss award to the claimant for only part of the sums claimed by the claimant. This offer was rejected by the claimant, which subsequently issued proceedings in May 2017 alleging mis-selling of the swap and seeking consequential losses.

Preliminary issues

The instant judgment relates to the trial of two preliminary issues, being the claimant’s allegations that:

  1. Contractual entitlement. The claimant had a contractual entitlement to consequential loss assessed in accordance with the PBR basic redress findings, subject to proof of causation. This was on the basis that the Settlement should be construed as settling all pre-settlement causes of action in respect of the swap (including claims for consequential loss based on pre-settlement causes of action) – but carved out claims for consequential loss within the PBR.
  2. Estoppel. The Bank was estopped by convention from disputing that the swap was mis-sold (with the consequence that the court need only determine the amount of consequential loss), because it was assumed by the parties that the Settlement amounted to acceptance on the Bank’s part that the swap was mis-sold.

Decision

The court found in favour of the Bank on both of the preliminary issues.

Issue 1: Contractual entitlement

The court rejected the claimant’s argument that the Settlement created a contractual entitlement to consequential loss, for a number of reasons, including:

  • The claimant’s construction of the Settlement wording did not accord with the ordinary and natural meaning of the words (per Arnold v Britton [2015] UKSC 36). It required reading the exclusion of claims for consequential loss as relating solely to consequential loss claims considered within the PBR (rather than all causes of action in respect of consequential losses). The court rejected this construction and found that, if the Settlement had been intended to exclude solely PBR consequential loss claims, it would have said so expressly.
  • The alleged contractual duty owed to the claimant would cut across the regulatory regime and would be entirely at odds with the gratuitous nature of the PBR. The court drew support from the Court of Appeal’s reasoning in Elite Property in this regard.
  • Any purported contractual cause of action requiring the Bank to assess consequential loss in accordance with the PBR findings would merely replicate the Bank’s existing obligations to the FCA and would therefore fail for want of consideration.
  • The claimant’s argument undermined the commercial purpose of the PBR and the Settlement, as it implied that customers would be forced to abandon existing causes of action in respect of consequential loss, in order to accept a basic redress award. This would restrict customers that issue litigation to accepting the counterfactual findings of the PBR (in the claimant’s case, the counterfactual swap) and would prevent them from alleging fraud (which can obviate the need for losses to be foreseeable).

Issue 2: Estoppel

The court rejected the claimant’s estoppel by convention argument, as there was no unequivocal assumption by the parties that the Bank would not defend civil proceedings. The PBR made a much more limited finding that, on the limited information available to it, there had been insufficient evidence to demonstrate compliance with regulatory requirements. This was of no benefit to the claimant, as it had no cause of action based on breach of regulatory requirements, and in any event further information would be available in litigation.

Julian Copeman
Julian Copeman
Partner
+44 20 7466 2168
Dan Eziefula
Dan Eziefula
Senior Associate
+44 20 7466 2182
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948

Is coronavirus likely to be a valid basis for avoiding contractual obligations?

With the continuing rise in the number of cases of novel coronavirus worldwide, in addition to obvious implications of the outbreak for individuals, businesses are likely to be exposed to a heightened risk of legal implications arising across their supply chain.

In this briefingNatasha JohnsonRobert Moore and Yasmin Mitha consider the scope for parties to rely on coronavirus as a basis to delay and/or avoid their contractual obligations, or terminate their contracts, under English law. For further information and publications, see our hub page on navigating the COVID-19 outbreak.

 

High Court upholds financial institution restructuring unit’s exercise of its powers under facility agreement following borrower default, finding there was no “relational contract” and rejecting claims for intimidation and economic duress

The High Court has dismissed the most recent claim to reach trial arising from the actions taken by a lending bank’s restructuring unit following a borrower’s default under a facility agreement during the global financial crisis. The court rejected all claims that the bank failed to discharge its duty to provide lending services with reasonable skill and care; that it owed a general duty to act in good faith; or that the bank’s actions amounted to intimidation or economic duress: Oliver Morley v The Royal Bank of Scotland plc [2020] EWHC 88 (Ch).

Overall, this decision will provide reassurance for financial institutions seeking to enforce their rights against defaulting borrowers. It is the latest in a helpful trend of recent cases in which the courts have upheld the exercise by financial institutions of their contractual rights and discretions when providing banking and lending services (for example, N v The Royal Bank of Scotland plc [2019] EWHC 1770 – see our previous blog post). The following points decided by the court are likely to be of broader interest to lending banks:

  1. So-called “relational contracts”. The court found that the loan agreement was not a long term relational contract incorporating an implied obligation of good faith (as per the formulation in Yam Seng Pte Ltd v International Trade Corp Ltd [2013] EWHC 111 (QB)). Rather, the court said it was “an ordinary facility loan agreement”, reflecting a similar approach to UTB LLC v Sheffield United Ltd [2019] EWHC 2322 (Ch) that “not all long term contracts that involve an enduring but undefined, cooperative relationship between the parties…will, as a matter of law, involve an obligation of good faith”. Together with Standish & Ors v The Royal Bank of Scotland plc & Anor [2018] EWHC 1829 (Ch) (see our previous blog post), it suggests that the initial traction which relational contracts gained through judicial statements has been curbed in more recent authorities, which have emphasised the high threshold which must be met before the court is willing to imply the existence of a contract or term.
  2. Limited fetter on the bank’s contractual discretion. Accordingly, the only fetter on the bank’s exercise of power (in this case, to obtain a revaluation of the assets charged under the loan agreement and to charge a higher, default interest rate) was the requirement to exercise these powers for a proper purpose connected to the bank’s commercial interests and not in order to vex the claimant maliciously (as per Property Alliance Group Ltd v Royal Bank of Scotland plc [2018] EWCA Civ 355). The court found that the bank exercised its discretion appropriately.
  3. Scope of the duty to provide banking service with reasonable skill and care. The court helpfully confirmed that while compliance with regulatory standards is relevant to whether a bank has satisfied this duty, compliance with the bank’s internal policies and procedures is not to be treated in the same way as compliance with rules setting professional standards across a trade or profession.
  4. Intimidation and economic duress claims. The court’s approach to these claims is noteworthy. The claims arose from a statement made by the bank at a meeting with the customer that the bank would enforce its security by appointing a receiver to transfer the customer’s secured assets (a property portfolio) to the bank’s subsidiary. Ultimately this did not happen as a matter of fact, but the claimant relied upon the statement itself to found claims in intimidation and economic duress. In particular, the court found:
    • There was no suggestion by the customer of bad faith (because the bank believed it had the right to appoint the receiver). In the absence of bad faith, the court confirmed there could be no lawful act duress, approving the approach in Times Travel (UK) Ltd v. Pakistan International Airlines Corporation [2019] 3 WLR 445.
    • Having established that duress could only be made out if the bank’s threat to appoint a receiver to sell the properties amounted to an unlawful act, the court went on to consider whether the threat to appoint the receiver was indeed unlawful.
    • The court was not satisfied that appointing a receiver to transfer the properties to the bank’s subsidiary would have been an unlawful act; rather it was an assertion that the bank would “do an act which might or might not turn out to be unlawful and was part of “the rough and tumble of the pressures of normal commercial bargaining”.
    • In reaching this conclusion, the court considered the outcome of a hypothetical injunction application by the customer to restrain the appointment of a receiver by the bank. The court found that there were various fact-specific reasons why such an application might have been refused.

The decision is considered in further detail below.

Background

The claimant was a commercial property developer with a portfolio in the north of England. In December 2006, he entered into a three year, £75 million loan with RBS (“the Bank”). The Bank took legal charges over all 21 properties in the claimant’s portfolio, but had no recourse to the claimant personally. During 2008 the parties discussed restructuring the loan, after the claimant failed to make interest payments, but did not reach agreement. In January 2009, the Bank obtained an updated valuation valuing the portfolio at approximately £59 million (the “2009 valuation”). On the basis of the 2009 valuation, the Bank: 1) notified the claimant of a breach of a loan to value (“LTV”) covenant; and 2) served a separate notice exercising its right to charge interest at an increased default rate of 3%.

In mid-2009, the Bank’s Global Restructuring Group (the “GRG”) took over the relationship with the claimant. Negotiations continued between the GRG and the claimant into 2010 (primarily focused on a discounted redemption of the loan by the claimant, on the basis that the value of the portfolio had dropped sharply in turbulent times) and the loan expiry date was extended several times, but the claimant was unable to raise sufficient funds.

At a meeting on Thursday 8 July 2010, the GRG sought the claimant’s consent to transfer the entire portfolio voluntarily to the Bank’s subsidiary, West Register (Property Investments) Limited (“West Register”). The GRG’s representative warned that if the claimant refused, the Bank would do a pre-pack insolvency and appoint a receiver on Monday 12 July 2010 (“the statement”). The claimant did not agree to transfer his portfolio, but continued to negotiate. A few weeks later, the claimant’s solicitors wrote to the GRG threatening injunction proceedings if the appointment of a receiver went ahead. In August 2010, the parties executed agreements under which the claimant repurchased five of the properties for £20.5 million and surrendered the rest to West Register and in return the Bank released its security and the claimant was released from his obligations under the loan agreement (the “2010 Agreements”).

Claims

The claimant brought proceedings against the Bank alleging that it had acted in breach of the following duties:

  1. A duty (in tort and in contract) to exercise reasonable skill and care in providing lending services;
  2. A duty owed in contract to act in good faith and not for an ulterior purpose unrelated to the Bank’s commercial interests.
  3. A duty as a mortgagee to sell mortgaged assets in good faith and to take reasonable steps to obtain the best price reasonably obtainable.

The claimant also asserted that the 2010 Agreements were procured by threats amounting to the tort of intimidation or were entered into under economic duress.

The claimant sought rescission of the 2010 Agreements (on the ground of economic duress); or damages in lieu of rescission; or alternatively damages for the tort of intimidation or for breach of the various duties, to compensate him for the loss of the properties he surrendered to West Register.

Decision

The court dismissed the claim in full, for the reasons set out below.

Duty to exercise reasonable skill and care in providing lending services

The court started by considering the scope of the duty to exercise reasonable skill and care in providing lending services. It held that it was not controversial that compliance with regulatory standards would be relevant to whether the Bank had breached this duty. However, the court rejected the claimant’s suggestion that compliance with the Bank’s internal policies and procedures was to be treated in the same way as rules setting professional standards across a trade or profession

The court considered breach of this duty together with the second duty, discussed below.

Alleged duty to act in good faith and not for an ulterior purpose unrelated to the Bank’s commercial interests

The court paraphrased this duty as a “duty to act honestly and in good faith”.

The court rejected the claimant’s argument that the loan facility agreement was a “relational contract” requiring a high degree of co-operation, communication and confidence between the parties (as per Yam Seng), finding instead that it was “an ordinary facility loan agreement”.

The court agreed with the Bank that it had an absolute right to call in the loan and held that the Bank had two relevant contractual discretions: its power to obtain a revaluation and its power to charge an interest rate of 3% following an event of default. These discretions, the court found, had to be exercised in the manner identified by the court in Property Alliance Group, i.e. “for purposes rationally connected to the bank’s commercial interests and not so as to vex the claimant maliciously”.

The court then considered whether the Bank had breached either of the first and second duties and held that it had not, for the following reasons:

  • The Bank was not bound to protect the claimant against the consequences of breaching the LTV covenant by refraining from exercising its contractual rights in response (i.e. its rights to obtain a valuation and to increase the interest rate to the default rate).
  • The Bank was not at fault for how it had conducted the restructuring negotiations, particularly given that the claimant “needed no lessons in commercial negotiation”.
  • There was no attempt by the Bank to manufacture a breach of the LTV covenant or an event of default so that it could seize the claimant’s property portfolio, as the claimant alleged. In obtaining the 2009 valuation, the Bank had properly exercised one of its contractual discretions in a way that was rationally connected to the Bank’s commercial interests. Furthermore, whilst the 2009 valuation evidenced the breach of the LTV covenant, it did not cause that breach.
  • The Bank’s decision to raise the interest rate to the default rate was also rationally connected to its commercial interests.
  • The Bank was entitled, as a matter of commercial judgment, to reject various offers made by the claimant during the negotiations in 2010.

Duty as a mortgagee to sell mortgaged assets in good faith and to take reasonable steps to obtain the best price reasonably obtainable

The claimant alleged that the Bank breached or threatened to breach this duty, on the basis of the Bank’s statement that it would do a pre-pack insolvency and appoint a receiver on 12 July 2010 if the claimant refused the offer made by the Bank. The court considered this duty as relevant to the claims based on the tort of intimidation and economic duress, which are considered further below.

Alleged intimidation and economic duress

The question for the court was whether the statement amounted to an actual or threatened breach of the Bank’s duty as mortgagee (as above), amounting to “illegitimate” conduct forming the basis for a claim in the torts of intimidation and/or economic duress. The court rejected both of these claims.

There was no suggestion by the claimant that the GRG representative who made the statement had acted in bad faith. In the absence of bad faith, the court confirmed there could be no lawful act duress, approving the approach in Times Travel.

The statement therefore needed to be an assertion that the Bank would do an unlawful act in order for there to be intimidation or duress and the court was not satisfied that it was; rather it was an assertion that the Bank would “do an act which might or might not turn out to be unlawful”. In reaching this conclusion, the court made the following observations:

  • On a conventional analysis, the court noted that there was no real separation or arm’s length negotiation between the Bank and West Register and it was unclear whether or how there would be a transfer of real value to the receiver or the Bank from West Register.
  • However, the court considered that there were two reasons why the conventional analysis may not be appropriate, which could be illustrated by looking at the hypothetical situation in which the claimant applied for an injunction, following the meeting at which the statement was made, to restrain the appointment of a receiver:
    • West Register could have undertaken to sell the properties onwards on the open market, meaning that the Bank’s duty as mortgagee would be “unperformed, but not yet incapable of lawful performance”.
    • More importantly, the claimant might have been found to lack standing to challenge the receivership. The negative equity position was such that, even if the properties were sold on the open market for full market value, the claimant would gain nothing. Also, the claimant, as mortgagor, could not be made to pay back the debt personally. Therefore, any sale at an undervalue would not prejudice or otherwise affect him personally.
  • It was difficult to predict what the outcome of a hypothetical injunction application would have been, but in the circumstances, the statement was “not to do an act that was, unequivocally, unlawful” but was what the court in DSND Subsea Ltd v Petroleum Geoservices ASA [2000] BLR 530 at [131]) called part of “the rough and tumble of the pressures of normal commercial bargaining” (at [268] of the judgment).

The court also found that the remaining elements of intimidation and economic duress were not made out. The claimant retained a practical choice to resist the statement and he did resist it, obtaining a better outcome than transferring his whole portfolio to the Bank. He also retained the choice to litigate, which he did not, in the end, pursue. Finally, the claimant had also affirmed the 2010 Agreements, since he had acted in accordance with them and had taken no steps to have them set aside until five years later.

Accordingly, the court dismissed the claim in full.

Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948
Harriet Tolkien
Harriet Tolkien
Associate
+44 20 7466 6328

Supreme Court upholds first successful claim for breach of the so-called “Quincecare” duty of care

The Supreme Court has upheld the first successful claim for breach of the so-called Quincecare duty of care: Singularis Holdings Ltd (In Official Liquidation) (A Company Incorporated in the Cayman Islands) v Daiwa Capital Markets Europe Ltd [2019] UKSC 50.

The Supreme Court’s judgment in this case follows hot on the heels of the Court of Appeal’s refusal to strike out a Quincecare duty claim in JPMorgan Chase Bank, N.A. v The Federal Republic of Nigeria [2019] EWCA Civ 1641 (see our banking litigation blog post). The judicial attention that this cause of action is currently receiving highlights the litigation risks of inadequate safeguards/processes governing payment processing at financial institutions, and the recent decision is therefore likely to be of significant interest to the sector.

A brief recap on the Quincecare duty. The duty arises in the context of a deposit holding financial institution processing a payment mandate in relation to a customer’s account, where that mandate was made by an authorised signatory of its customer, but where the instructions turn out to have been made fraudulently and to the detriment of the customer. It is the duty imposed on the bank to refrain from executing the order if (and for as long as) it is “put on inquiry” that the order is an attempt to misappropriate its customer’s funds. This is an objective test, judged by the standard of an ordinary prudent banker.

In the present case, breach of the Quincecare duty was established at first instance and not appealed. The issue for the Supreme Court was 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 bank in respect of both points.

In reaching this conclusion, the Supreme Court clarified a number of important implications, including:

  1. Test for attribution: Declaring that the often criticised decision in Stone & Rolls Ltd v Moore Stephens [2009] UKHL 39 can “finally be laid to rest”, the Supreme Court restated and clarified the test for attribution. It confirmed that whether 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. The Supreme Court expressly stated that there is no principle of law that, in any proceedings where the company is suing a third party for breach of a duty owed to it by that third party, the fraudulent conduct of a director is to be attributed to the company if it is a one-man company.
  2. Illegality defence in response to a Quincecare claim: In the present case the Supreme Court found that the bank did not meet the test for a successful illegality defence laid down in Patel v Mirza [2016] UKSC 42. While this will be fact specific in any given case, the reasoning given by the court highlights the challenges which financial institutions may face to make good such a defence. In particular, as a matter of public policy, the Supreme Court said that denial of the claim would have a material impact upon the growing reliance on banks and other financial institutions to play an important part in reducing and uncovering financial crime and money laundering. If a regulated entity could escape from the consequences of failing to identify and prevent financial crime by casting on the customer the illegal conduct of its employees that policy would be undermined.

In combination with the JPMorgan v Nigeria decision, this judgment suggests that it may be prudent for financial institutions to review safeguards governing payment processing, to review protocols in place for what steps must be taken in the event that a red flag is raised, and also to consider reviewing the standard form wording of client account agreements seeking to exclude the Quincecare duty.

We consider the decision in more detail below.

Background

For further detail on the background to the claim, please see our blog post on the Court of Appeal’s decision.

In summary, Singularis Holdings Limited (“Singularis”) held sums on deposit with Daiwa Capital Markets Europe Limited (the “Bank”). In 2009, the Bank was instructed by an authorised signatory on the account (Mr Al Sanea) to make payments out of Singularis’s account. Mr Al Sanea was the sole shareholder, a director and also chairman, president and treasurer of Singularis. There were six other directors, who were reputable people, but did not exercise any influence over the management of Singularis. Very extensive powers were delegated to Mr Al Sanea to take decisions on behalf of Singularis, including signing powers over the company’s bank accounts.

The Bank approved and completed the transfers notwithstanding “many obvious, even glaring, signs that Mr Al Sanea was perpetrating a fraud on the company” and that Mr Al Sanea “was clearly using the funds for his own purposes and not for the purpose of benefiting Singularis”. It was common ground at trial that Mr Al Sanea was acting fraudulently when he instigated the transfers.

In 2014, Singularis (acting by its joint official liquidators) issued a claim against the Bank for US$204m, the total of the sums transferred in 2009. There were two bases for the claim: (1) dishonest assistance in Mr Al Sanea’s breach of fiduciary duty in misapplying Singularis’ funds; and (2) breach of the Quincecare duty of care owed by the Bank to Singularis by giving effect to the payment instructions.

High Court decision

The High Court held that the claim of dishonest assistance failed, but that the Bank did act in breach of its Quincecare duty by making the payments in question without proper inquiry, finding that any reasonable banker would have noticed the signs that Mr Al Sanea was perpetrating a fraud on Singularis and that there was a failure at every level within the Bank: Singularis Holdings Ltd v Daiwa Capital Markets Europe Ltd [2017] EWHC 257 (Ch).

The Bank advanced an illegality defence relying on the legal doctrine of ex turpi causa, which prevents a claimant from pursuing a civil claim if the claim arises in connection with some illegal act on the part of the claimant. In this instance, the claim against the Bank for breach of duty was brought by Singularis, but the illegal acts were carried out by Mr Al Sanea. The focus of the argument before the High Court on the illegality defence was therefore whether Mr Al Sanea’s dishonest conduct should be attributed to Singularis. However, this (and the Bank’s other defences) was rejected. The court reduced the damages payable by 25% to account for Singularis’s contributory negligence.

The Bank appealed. The grounds of appeal did not include an appeal against the finding of the Quincecare duty of care, or breach of that duty. The grounds related to the illegality defence and other defences, or alternatively (if remaining unsuccessful on those defences), the amount by which Singularis’s damages should be reduced for contributory negligence.

Court of Appeal decision

The Court of Appeal unanimously dismissed the appeal: Singularis Holdings Ltd v Daiwa Capital Markets Europe Ltd [2018] EWCA Civ 84 (see our banking litigation blog post for more detail).

It upheld the High Court’s finding that Mr Al Sanea’s fraudulent state of mind could not be attributed to Singularis. However, the Court of Appeal held that, even if the Bank had been successful on attribution, the claim for breach of the Quincecare duty would still have been successful and not defeated by any of the Bank’s defences, and that the finding of 25% contributory negligence was a reasonable one.

The Bank appealed to the Supreme Court.

Supreme Court decision

Two broad issues arose for the Supreme Court to consider:

  1. When can the actions of a dominant personality, such as Mr Al Sanea, who owns and controls a company, even though there are other directors, be attributed to the company?
  2. If such actions are attributed to the company, is the claim defeated (i) by illegality; (ii) by lack of causation; or (iii) by an equal and countervailing claim in deceit?

We consider the Supreme Court’s response to these issues below (in reverse order).

The Bank’s defences

The Supreme Court rejected all three of the Bank’s defences, based on illegality, causation and a countervailing claim in deceit.

Defence of illegality

Both the High Court and Court of Appeal rejected the illegality defence raised by the Bank on two grounds: (1) that Mr Al Sanea’s fraud could not be attributed to Singularis (in other words, his fraud could not be held to be the company’s fraud) – considered below; and (2) in any event, the Bank did not meet the test for a successful illegality defence laid down in Patel v Mirza.

An illegality defence will operate in an appropriate case to prevent a claimant from pursuing a civil claim if the claim arises in connection with some illegal act on the part of the claimant. In this case, the illegality relied on was Mr Al Sanea’s provision of documents which he knew to be false and his breach of his fiduciary duty towards Singularis. The Bank argued that these illegal acts by Mr Al Sanea (attributed to Singularis) defeated the breach of Quincecare duty claim.

Looking at the test for a successful illegality defence, the Supreme Court noted that Patel v Mirza rejected a test which depended on whether or not the claimant had to plead the illegal agreement in order to succeed. Instead the Supreme Court in that case adopted an approach based on whether enforcing the claim would be harmful to the integrity of the legal system and therefore contrary to the public interest. It set out a three-fold test to assess whether the public interest would be harmed in that way:

“…it is necessary (a) to consider the underlying purpose of the prohibition which has been transgressed and whether that purpose will be enhanced by denial of the claim, (b) to consider any other relevant public policy on which the denial of the claim may have an impact and (c) to consider whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts.”

The Supreme Court considered each element of the test, agreeing with the conclusions of the first instance judge and finding against the Bank in respect of each element.

(a) Purpose of the prohibition:

Prohibition against breach of fiduciary duty by Mr Al Sanea: The Supreme Court held this prohibition was to protect Singularis from becoming the victim of the wrongful exercise of power by officers of Singularis. That purpose would not be enhanced by preventing Singularis from getting back the money which had been wrongfully removed from its account.

Prohibition against false statements made by Mr Al Sanea: The Supreme Court held this prohibition was both to protect the Bank from being deceived and Singularis from having its funds misappropriated. That purpose would be achieved by ensuring that the Bank was only liable to repay the money if the Quincecare duty was breached: that duty struck a careful balance between the interests of the customer and the interests of the Bank.

Accordingly, the first limb of the Patel v Mirza test was not satisfied by the Bank, because denial of the Quincecare duty claim would not enhance the purpose of the relevant prohibitions (i.e. the prohibitions against breach of fiduciary duty or making false statements).

(b) Relevant public policy:

The Supreme Court said that denial of the claim would have a material impact upon the growing reliance on banks and other financial institutions to play an important part in reducing and uncovering financial crime and money laundering. If a regulated entity could escape from the consequences of failing to identify and prevent financial crime by casting on the customer the illegal conduct of its employees that policy would be undermined.

(c) Proportionality:

In the opinion of the Supreme Court, denial of the claim would be an unfair and disproportionate response to any wrongdoing on the part of Singularis. The possibility of making a deduction for contributory negligence on the customer’s part enables the court to make a more appropriate adjustment than the rather blunt instrument of the illegality defence.

Accordingly, the Supreme Court held that – even if the acts of Mr Al Sanea could be attributed to Singularis – the claim for breach of the Quincecare duty could not be defeated by the defence of illegality.

Defence of causation

The Bank argued that, if the fraud was attributed to the company, the company’s loss was caused by its own fault and not the Bank’s. The Supreme Court recognised that there is a there is a difference between protecting people against harm caused by third parties and protecting them against self-inflicted harm. However, the present case was one of the rare cases in which the Bank had a duty to protect against self-inflicted harm. That is the purpose of the Quincecare duty: to protect a bank’s customers from harm caused by those for whom the customer is, one way or another, responsible.

Countervailing claim in deceit

The Bank argued that, because it would have an equal and countervailing claim in deceit against the company, the company’s claim in negligence should fail for circularity. The Supreme Court dismissed this argument in brief terms, citing the Court of Appeal’s reasoning that, since the fraud was a precondition for the claim for breach of the Quincecare duty, it would be a surprising result if the Bank could escape liability by placing reliance on the existence of that same fraud.

Attribution of knowledge and conduct

The Bank argued that, as Singularis was effectively a one-man company and Mr Al Sanea was its controlling mind and will, his fraud should be attributed to Singularis.

In seeking to establish attribution in this case, the Bank relied on the decision in Stone & Rolls, in which the House of Lords held that the knowledge of the fraudulent activities of the beneficial owner and “directing mind and will” of a company was attributable to that company. In Stone & Rolls, this meant that the defrauded company (which was by that stage in liquidation) could not bring a claim against its auditors for failing to detect the fraud. The decision has been much criticised, in particular because it deprived the company’s creditors of a remedy.

The Supreme Court noted that Stone & Rolls was a case between a company and a third party, but a similar argument was subsequently considered in the context of a case brought by a company against its directors and others who were alleged to have dishonestly assisted the directors in a conspiracy to defraud the company: Bilta (UK) Ltd v Nazir (No 2) [2015] UKSC 23. The Supreme Court in Bilta confirmed that the key to any question of attribution was always to be found in considerations of the context and the purpose for which the attribution was relevant.

However, the Supreme Court in the present case recognised that because of certain comments made by the majority in Bilta, the case has been treated as if it established a rule of law that the dishonesty of the controlling mind in a “one man company” could be attributed to the company whatever the context and purpose of the attribution in question.

Taking all of the above into consideration, the Supreme Court made two important findings:

  1. It confirmed that whether 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 (emphasis added). The Supreme Court expressly stated that there is no principle of law that in any proceedings where the company is suing a third party for breach of a duty owed to it by that third party, the fraudulent conduct of a director is to be attributed to the company if it is a one-man company. Accordingly, Stone & Rolls can “finally be laid to rest”.
  2. In any event, the Supreme Court held that Singularis was not a one-man company in the sense used in Stone & Rolls and Bilta because:
    • Singularis had a board of reputable people and a substantial business.
    • There was no evidence to show that the other directors were involved in or aware of Mr Al Sanea’s actions.
    • There was no reason why the other directors should have been complicit in this misappropriation of the money.

Having confirmed the test for attribution at point (1) above, the Supreme Court proceeded to consider the context and purpose for which the attribution was relevant in the present case.

It said the context was the breach by Bank of its Quincecare duty of care towards Singularis. The purpose of that duty was to protect Singularis against the misappropriation of its funds by a trusted agent of the company who was authorised to withdraw its money from the account. In these circumstances, the Supreme Court held that the fraud of Mr Al Sanea could not be attributed to Singularis, commenting:

To attribute the fraud of that person to the company would be, as the judge put it, to “denude the duty of any value in cases where it is most needed” (para 184). If the appellant’s argument were to be accepted in a case such as this, there would in reality be no Quincecare duty of care or its breach would cease to have consequences. This would be a retrograde step.”

Having found that the Bank’s defences failed, and that the fraudulent state of mind of Mr Al Sanea could not be attributed to Singularis in any event, the Supreme Court dismissed the Bank’s appeal.

Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Maura McIntosh
Maura McIntosh
Professional Support Consultant
+44 20 7466 2608
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948

COURT OF APPEAL JUDGMENT ON SCOPE AND EXCLUSION OF ‘QUINCECARE’ DUTY OF CARE

The Court of Appeal has recently handed down an important judgment considering the so-called Quincecare duty of care: JPMorgan Chase Bank, N.A. v The Federal Republic of Nigeria [2019] EWCA Civ 1641.

The Quincecare duty arises in the context of a deposit holding financial institution receiving and processing a payment mandate in relation to a customer’s account, where that mandate was made by an authorised signatory of its customer, but where the instructions turn out to have been made fraudulently and to the detriment of the customer. It is the duty imposed on the bank to refrain from executing the 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.

In the present case, the Court of Appeal refused an application made by the defendant bank for reverse summary judgment/strike out on the basis 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 governing the claimant’s depository account with the bank. In doing so, the Court of Appeal upheld the decision of the High Court (given by the now Lord Burrows, who recently received a leapfrog promotion to the Supreme Court): The Federal Republic of Nigeria v JPMorgan Chase Bank, N.A. [2019] EWHC 347 (Comm).

There are three significant points arising from the Court of Appeal’s judgment:

  1. Scope of the Quincecare duty of care:

The Court of Appeal has arguably expanded the scope of the Quincecare duty of care. The judgment states 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. It commented that the question of what a bank should do will vary according to the particular facts of the case. In the present case, the Court of Appeal said that the trial judge will be in a better position to determine what the bank should have done if it had decided not to execute the instructions it was given to transfer funds.

The effect is that the Quincecare duty comprises both:

    • A negative duty to refrain from making payment; and
    • A positive duty on the bank to proactively do “something more“.

In the Court of Appeal’s view, these negative and positive duties carry equal weight, and neither is separate or subsidiary or 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 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.

Further, the Court of Appeal 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 depend on the facts of the case in question.

  1. Exclusion of the Quincecare duty is possible

The Court of Appeal endorsed the High Court’s view that it is possible for a bank and its client to agree to exclude the Quincecare duty (subject to any statutory restrictions, such as the clause being reasonable under the Unfair Contract Terms Act 1977). However, both the High Court and Court of Appeal emphasised that such an exclusion would have to be sufficiently clear (which was not the position on the facts of the present case). While an exclusion in such clear terms is therefore possible, it may be commercially unpalatable.

  1. Whether the Quincecare duty was inconsistent with express terms of the depository agreement

The Quincecare duty either arises by operation of an implied term of the contract governing the customer’s account, or under the tort of negligence. In the present case, the bank argued that there were certain express terms of the contract which meant that the Quincecare duty could not arise by operation of an implied term (because an implied term cannot be inconsistent with an express term), nor could it arise in tort (because the tortious duty is shaped, and can be excluded by, contractual terms). The bank argued that the express terms directly conflicted with what the Quincecare duty would seek to impose, and therefore the duty did not arise.

However, both the High Court and the Court of Appeal read references in express terms to there being no duty to “enquire” or “investigate” as meaning that there was no duty of care to enquire or investigate prior to the point at which the bank had the relevant reasonable grounds for belief. It therefore held such clauses were consistent with the Quincecare duty, even if it imposes an additional positive duty to enquire/investigate along with the negative duty not to pay.

There have been a number of recent cases shining a spotlight on the Quincecare duty of care. We previously considered the Court of Appeal’s decision in Singularis Holdings Ltd v Daiwa Capital Markets Europe Ltd [2018] EWCA Civ 84, in which the court rejected a bank’s attempt to defeat a Quincecare duty claim with a defence of illegality (see our banking litigation blog post). Earlier this year, the Supreme Court heard the bank’s appeal in that case and judgment is currently awaited.

The Singularis case remains the first and only case in which a bank has been found liable for breach of its Quincecare duty of care. However, the number of cases in which the duty is being argued highlights this as a risk area for financial institutions handling client payments. In particular given the potential expansion of what is encompassed within the Quincecare duty, it may be prudent for financial instructions to review safeguards governing payment processing, and also review the protocol in place for what steps must be taken in the event that a red flag is raised, not limited to refraining from making the payment, but extending to positive steps of investigation and the record-keeping of those steps. Financial institutions may also wish to consider reviewing the standard form wording of client account agreements.

Background

In 2011, the Federal Republic of Nigeria (the “FRN”) opened a depository account in its name with JPMorgan Chase Bank, N.A. (the “Bank”). The account was opened following a long-running dispute about the rights to exploit an offshore Nigerian oilfield, in which there were competing ownership claims from a company called Malabu Oil and Gas Nigeria Ltd and a subsidiary of the oil company Shell. These disputes were settled pursuant to various settlement agreements. Under the terms of settlement, Shell was required to pay US$ 1 billion into a depository account in the name of the FRN, which would then be used by the FRN to pay Malabu.

The Bank subsequently paid out the whole of the deposited sum on the instruction of authorised signatories of the FRN under the terms governing the operation of the depository account. However, the FRN asserts that these requested transfers were part of a corrupt scheme by which the FRN was defrauded, and the money transferred out of the depository account was used to pay off corrupt former and contemporary Nigerian government officials and/or their proxies and used to make other illegitimate payments.

Claim

The FRN brought a claim against the Bank to recover the sums held in the depository account on the basis that the payments were made in breach of the Quincecare duty of care, named after the case of Barclays Bank plc v Quincecare Ltd [1992] 4 All ER 363 in which this duty of care was first described.

It was alleged by the FRN that the fraudulent and corrupt scheme of which these payments were part reached the very highest levels in the Nigerian state. There was no allegation that the Bank knew about or was in any way involved in the alleged fraud, but it was said that the Bank should have realised that it could not trust the senior Nigerian officials from whom it took instructions. The FRN claimed that the Bank should not have made the payments it was instructed to make and is therefore liable to pay damages to the FRN in the same sum as the payments that were made.

The Bank applied for reverse summary judgment and/or 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 judgments considered below relate to that application.

High Court decision

The High Court held that the express terms of the depository agreement between the Bank and the FRN did not exclude, and were not inconsistent with, the imposition of the Quincecare duty. The High Court also refused the application on various further ancillary grounds which are beyond the scope of this blog post.

The High Court summarised the relevant law on the Quincecare duty before considering the interpretation of certain clauses of the depository agreement.

Scope of the Quincecare duty

The High Court noted that the Quincecare duty of care was very carefully formulated and explained in Barclays v Quincecare as a duty on a bank to refrain from executing a customer’s order if, and for so long as, the bank is “put on inquiry” in the sense that the bank has reasonable grounds for believing – assessed according to the standards of an ordinary prudent banker – that the order is an attempt to defraud the customer. In the present case, the High Court said it is an aspect of the bank’s duty of reasonable skill and care in or about executing the customer’s orders and therefore arises by reason of an implied term of the contract or under a coextensive duty of care in the tort of negligence. Although Quincecare considered the duty in the context of a current account, in the High Court’s view, there was no good reason of principle or policy why a Quincecare duty of care should be confined to current accounts and not apply to depository accounts.

In terms of the scope of the duty, the High Court held that the core of the Quincecare duty was the negative duty on a bank to refrain from making a payment (despite an instruction on behalf of its customer to do so) where it has reasonable grounds for believing that that payment is part of a scheme to defraud the customer. The High Court inclined to the view that, in addition to this core negative duty, there was a positive duty on the bank to make reasonable enquiries so as to ascertain whether or not there is substance to those reasonable grounds.

The High Court said that this would not be an “unduly onerous” duty, because it would always be limited by what an ordinary prudent banker would regard as reasonable enquiries in a situation where there are reasonable grounds for believing that the customer is being defrauded. There was no discussion of what these enquiries might be on the facts of the case or more generally, although the word “enquiry” was used interchangeably with “investigation”.

The High Court noted that it did not need to decide finally the point on whether the scope of the Quincecare duty included an additional positive duty, because of its conclusions on the interpretation of the depository agreement (below), and therefore these comments were made on an obiter basis.

Express clauses of the depository agreement

The High Court applied the now well-established principles of contractual interpretation to consider the terms of the depository agreement, finding that none of the clauses expressly excluded the Quincecare duty of care, either under the entire agreement clause or exemption clauses in the depository agreement. In particular, the High Court noted that clear words were required to exclude a valuable right such as the Quincecare duty, and there were no such clear words on the facts of this case.

The Bank also argued that certain clauses of the depository agreement were inconsistent with a Quincecare duty of care. The High Court said that it is trite common law that an implied term cannot be inconsistent with an express term, and similarly a duty of care in tort may be shaped by, and can be excluded by, contractual terms. Given that the Quincecare duty arises by way of either an implied contractual term or concurrent tortious duty, the High Court proceeded to consider whether the clauses identified by the Bank were inconsistent with the Quincecare duty (in which case it would have supported the Bank’s argument that no Quincecare duty arose).

The most important express terms which the Bank relied on as being inconsistent with the duty were clauses 7.2 and 7.4:

7.2 The Depository shall be under no duty to enquire into or investigate the validity, accuracy or content of any instruction or other communication…

7.4 The Depository need not act upon instructions which it reasonably believes to be contrary to law, regulation or market practice but is under no duty to investigate whether any instructions comply with any applicable law, regulation or market practice.

The High Court held that these clauses were consistent with (at least) the core of the Quincecare duty of care (i.e. the negative duty to refrain from making payment where it has reasonable grounds for believing that the payment is part of a scheme to defraud the customer).

It held that the correct interpretation of clauses 7.2 and 7.4 was that – apart from the opening part of clause 7.4 (which it said was plainly consistent with a Quincecare duty of care) – they did not apply at all where the Bank had reasonable grounds for believing that the customer was being defrauded. In other words, the references to there being no duty to enquire or investigate were making clear that there was no duty of care to enquire or investigate prior to the point at which the Bank had the relevant reasonable grounds for belief. It therefore found that clauses 7.2 and 7.4 were consistent with the Quincecare duty even if it imposes an additional positive duty to enquire/investigate along with the core negative duty not to pay.

Although this was an interlocutory application, the High Court heard full legal argument and decided this issue finally (and not on the basis of whether the claimant had a realistic prospect of success). It was common ground between the parties that the High Court should “grasp the nettle” and decide this point on the application rather than at trial, because the issue was concerned with questions of law as to the contractual interpretation of the depository agreement and the nature of a Quincecare duty of care.

The Bank appealed.

Court of Appeal decision

The Court of Appeal upheld the High Court’s decision. There are three particularly significant points arising from the judgment, discussed below.

1. Scope of Quincecare duty

As to the scope of the Quincecare duty, the Court of Appeal said that, in most cases, the 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. It commented that the question of what a bank should do will vary according to the particular facts of the case. In the present case, the Court of Appeal said that the trial judge will be in a better position to determine what the Bank should have done if it had decided not to execute the instructions it was given to transfer funds. It did not think it would be helpful to give an indication as to what factors are likely to be relevant to the trial judge’s overall assessment of what the Bank should have done.

In contrast to the High Court, the Court of Appeal did not find it useful to describe some parts of the Quincecare duty as being core and some parts of it as being separate of subsidiary or additional.

It is worth noting that the Court of Appeal’s comments on the scope of the Quincecare duty were obiter, because it held that this was an issue for the trial judge, and arose on an issue which both the High Court and Court of Appeal found did need to be resolved in order for to dispose of the application.

2. Exclusion of the Quincecare duty is possible

The Court of Appeal endorsed the High Court’s view that it is possible for a bank and its client to agree to exclude the Quincecare duty (subject to any statutory restrictions, such as the clause being reasonable under Unfair Contract Terms Act 1977). However, both the High Court and Court of Appeal emphasised that such an exclusion would have to be sufficiently clear (which was not the position on the facts of the present case). In the Court of Appeal’s words, the clause must make clear:

“…that the bank should be entitled to pay out on instruction of the authorised signatory even if it suspects the payment is in furtherance of a fraud which that signatory is seeking to perpetrate on its client.”

3. Whether the Quincecare duty was inconsistent with express terms of the depository agreement

The Court of Appeal found that, as a matter of contractual interpretation, clauses 7.2 and 7.4 were not inconsistent with the existence of the Quincecare duty, agreeing with the reasons given by the High Court.

The Court of Appeal therefore found that the High Court was right to dismiss the summary judgment application and refused the Bank’s appeal.

Simon Clarke
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High Court finds terms of English law Facility Agreement allowed borrower to withhold interest payments given risk of US “secondary” sanctions

In a recent decision, the High Court has found that the terms of a Facility Agreement governed by English law allowed the borrower to withhold payment of interest instalments where there was a risk of secondary sanctions being imposed on the borrower under US law, notwithstanding that the Facility Agreement had no connection with the US: Lamesa Investments Limited v Cynergy Bank Limited [2019] EWHC 1877 (Comm).

At first sight the decision is surprising because English law does not generally excuse contractual performance by reference to a foreign law unless it is the law of the contract or the place of performance (and these exceptions did not apply here). However, the court noted that parties can contract out of this general rule, which is precisely what happened in this case. The relevant clause of the Facility Agreement permitted the borrower to withhold payment of interest instalments “in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction”.

Applying the usual principles of contractual interpretation, the court found that the clause covered the relevant US legislation even though it only gave rise to the possibility of secondary sanctions being imposed on the borrower, rather than expressly prohibiting the borrower from transacting with the lender. Specifically, the court held that the parties intended that:

  • The phrase “mandatory provision of law had no territorial qualification, it included the laws of any country (not just English law).
  • The word “mandatory in this context meant a provision of law that the parties could not vary or dis-apply.
  • The effect of the words “in order to comply with a mandatory provision of law, applied whenever a party refrained from acting in a manner that would otherwise attract the possible imposition of a sanction or penalty by operation of a statute.

The most striking aspect of the judgment is the approach to interpretation of the phrase “in order to comply. The conclusion reached by the court accords with the ‘in practice’ position of parties faced with secondary sanctions risk (i.e. that, in effect, they have to ‘comply’ with non-applicable US law). However, it is not an obvious construction of the phrase given the legal nature of secondary sanctions.

This was a decision based on the interpretation of the terms of a particular contract, and so the outcome is therefore specific to the facts of this case rather than being more broadly applicable. However, the decision emphasises the need for parties to consider the potential impact of extraterritorial sanctions regimes on the performance of their obligations and to include a clear contractual allocation of risk in this regard. In this case, but for the relevant clause, the borrower would have been left with a choice between defaulting on its interest payments under the Facility Agreement or paying the sums due and facing potentially ruinous sanctions.

The drafting of the clause in this case was not entirely clear and the parties had to rely on the court to determine the correct interpretation. In order to avoid uncertainty, in many cases it will be prudent for parties to include a detailed definition of terms such as “comply and “mandatory provision of law which expressly state whether such terms are: (a) intended to be limited to the laws of any particular jurisdiction; and (b) intended to include laws which do not expressly require a party to refuse to make payment (or otherwise perform its obligations) but which may result in the party being subjected to secondary sanctions if it does so. However, where the risk being mitigated includes secondary sanctions risk arising under US laws which are subject to the so-called Blocking Regulation (EU Regulation 2271/96) (in particular in relation to Iran and Cuba), parties who are EU persons will also need to consider whether the language they wish to use would itself give rise to risk under the Blocking Regulation.

Background

The claimant, Lamesa Investments Limited, is a Cypriot company whose ultimate beneficial owner is Mr Viktor Vekselberg. On 19 December 2017, the claimant entered into a Facility Agreement with the defendant, Cynergy Bank Limited, an English company.

Under the Facility Agreement, the claimant lent £30 million to the defendant, which was required to make interest payments on 21 June and 21 December of each year throughout the term of the loan. Clause 9.1 of the Facility Agreement provided that the borrower would not be in default if sums due were not paid “in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction. The Facility Agreement was governed by English law.

On 6 April 2018, the US placed Mr Vekselberg on the list of “Specially Designated Nationals (“SDNs“), pursuant to Executive Order 13662 (made under the International Emergency Economic Powers Act). As a result, the lender became a “Blocked Person by reason of its indirect ownership by Mr Vekselberg.

The US sanctions on Russia (in common with a small number of other US sanctions regimes, including for example the regime applicable to Iran), contain so-called ‘secondary sanctions’ provisions. By contrast to traditional ‘primary sanctions’, which apply to US persons and conduct within the territorial jurisdiction of the US, secondary sanctions seek to target non-US persons who engage in certain specified activities that have no US jurisdictional nexus. A non-US party that engages in the specified activities can itself be subjected to retaliatory measures by the US government. For example, pursuant to US/Russian sanctions, knowingly facilitating a “significant transaction with a SDN is secondarily sanctionable.

This meant that if the borrower knowingly facilitated a significant financial transaction on behalf of the lender, then the borrower could be subjected to secondary sanctions. In particular, under Section 5 of the Ukraine Freedom Support Act 2014 the borrower could be blocked from opening or maintaining a correspondent account in the US or have strict conditions imposed on the maintaining of such an account.

A significant part of the borrower’s business was denominated in US dollars, and US dollars deposited by its retail customers were deposited in a correspondent account maintained by the borrower with JP Morgan in the US. As a result of the significant risk to its business, the borrower relied on clause 9.1 of the Facility Agreement to withhold payment of £3.6 million of interest instalments that had fallen due (although it had ring-fenced the funds).

The lender sought a declaration that the borrower was obliged to continue making the payments under the Facility Agreement notwithstanding the risk that it would be subjected to secondary sanctions.

The decision

The court held that the borrower was entitled to rely on clause 9.1 of the Facility Agreement for as long as Mr Vekselberg remained a SDN and the lender remained a Blocked Person by reason of it being owned by Mr Vekselberg.

The court re-iterated the general position that, unless the contract provides otherwise, English law will not excuse contractual performance by reference to foreign law, unless that law is the law of the contract or the law of the place of performance. The Facility Agreement was not governed by US law and the US was not the place of performance. The sole issue was therefore whether, on its true construction, clause 9.1 of the Facility Agreement excused performance by reference to the relevant provisions of US law. There were three key battlegrounds on contractual construction, each of which is considered further below.

Territorial qualification

The court rejected the lender’s argument that the phrase “mandatory provision of law should be construed to include a territorial qualification. It based its decision on the relevant documentary context. In particular:

  • Clause 9.1 also referred to regulations and orders of any court of competent jurisdiction. The definition of the term “regulationwas not subject to any territorial qualification.
  • The reference to “any court of competent jurisdiction suggested that the parties did not intend to impose a territorial qualification.

In the court’s view, it would therefore be inconsistent to construe the term “mandatory provision of law as being confined to English law. The court also noted that if the parties had intended to include a territorial qualification then they could have done so easily enough, but they chose not to do so.

Meaning of “mandatory” provision of law

The court did not accept that the natural understanding of English lawyers at the date of the Facility Agreement would have been that a “mandatory rule of law was one that expressly required compliance. It said that all provisions of the law by definition have to be complied with unless the parties dis-apply them to the extent possible. Accordingly, the court found that the word “mandatory in this context meant a provision of law that the parties cannot vary or dis-apply.

Meaning of “in order to comply

The court considered that the real issue concerned the effect of the words “in order to comply.

This is an interesting phrase in the context of secondary sanctions. On the one hand, there is an argument that technically such provisions do not require non-US persons to take or refrain from taking any particular steps; they do not ‘apply’ outside the US, and non-US parties are not required to ‘comply’ with them. Rather, they specify conduct which, if taken, could on a discretionary basis give rise to various forms of retaliatory action. On the other hand, in practice their effect is that non-US persons consider themselves required to ‘comply’, given the severe repercussions if secondary sanctions are imposed.

The court noted three possible permutations of the phrase “in order to comply:

  • The first was that it only applied to a statute that expressly prohibits payment on pain of the imposition of a sanction or penalty.
  • The second was that it applied whenever a party refrains from acting in a manner that would otherwise attract a sanction or penalty imposed by statute.
  • The third was that it applied whenever a party refrains from acting in a manner that would otherwise attract the possible imposition of a sanction or penalty by operation of a statute.

The court found that there was no reason why clause 9.1 should be confined to the first of these permutations (express prohibition). It emphasised that it has long been recognised in context of whether a contract is void for illegality that if a statute imposes a penalty that will be treated as an implied prohibition (see Phoenix General Insurance Co of Greece SA v Halvanon Insurance Company Limited [1988] 1 QB 216). In the court’s view, a party who acts so as to avoid the imposition of a penalty is complying with the implied prohibition just as much as a party who acts so as to comply with an express prohibition. (The court did not address the point that the imposition of secondary sanctions is not per se a ‘penalty’ imposed for breach of an applicable law).

The court further found that the factual and commercial context suggested that it was highly unlikely that the parties intended the clause to be limited to the first and second but not the third permutations. In particular:

  • The parties were aware in December 2017 that it was possible that US sanctions would be imposed on the lender, albeit this was not considered likely. It was known to the parties that the risk was that the borrower would be exposed to secondary sanctions, not primary sanctions. Neither party could have thought that there was any question of primary sanctions arising if the lender became a Blocked Person because there was nothing in the Facility Agreement that required payment to be made in US dollars or to a US bank account, neither of the parties were US entities, and the agreement did not involve any conduct in the US.
  • The way that clause 9.1 addressed the risk was by prospectively excusing payment by the borrower. It did not provide any recourse after the event if the borrower made a payment and a sanction was then imposed after an unsuccessful attempt by the borrower to persuade the US authorities not to impose a sanction. If clause 9.1 were limited to the first and second permutations this would not adequately address the risk because the borrower would be required to make the payment and would have no recourse if a sanction was then imposed.
  • It was all the more unlikely that the parties intended to exclude the third permutation (possible imposition of a sanction/penalty) because even though the imposition of sanctions was theoretically only ‘possible’ if the borrower made payment to a Blocked Person, in reality sanctions were the default position. As such the clause would have no effect if limited in this way. The court took that view in light of guidance from the relevant US authorities, and the limited exceptions in the US legislation itself; the fact that secondary sanctions have in practice been imposed only infrequently did not feature in the judgment.

Accordingly, the court found that the borrower was entitled to rely upon clause 9.1 of the Finance Agreement for as long as Mr Vekselberg remained a SDN and the lender remained a Blocked Party, and was entitled to a declaration to that effect.

Blocking Regulation

One final point of interest to sanctions practitioners is a brief appearance in the judgment of reference to the so-called Blocking Regulation (EU Regulation 2271/96). Cynergy had argued that relieving Lamesa of its obligation to perform the contract would be contrary to the UK’s policy of not giving extra-territorial effect to US secondary sanctions programmes. The court rejected that argument, on the basis that its ruling was based on contractual construction, and “[u]nless there is a mandatory rule of English law that precludes parties to a contract from including a provision to the effect alleged I do not consider the alleged policy is material. The court found that since the Appendix to the Blocking Regulation did not include the US/Russia secondary sanctions, the parties were free, through the terms of their agreement, to manage secondary sanctions risk.

This leaves open the possibility (albeit this was not relevant on the facts of the case), that the same approach would not pertain if the secondary sanctions in question were the blocked laws which appear in the Appendix to the Blocking Regulation (relating principally to Iran and Cuba). Set against this, but in a slightly different context, there are obiter comments in Mamancochet Mining Limited v Aegis Managing Agency Limited & Ors [2018] EWHC 2643 to the effect that there was “considerable force in an argument that the EU Blocking Regulation was not engaged where an insurer’s liability to pay an Iran-related claim was suspended under a sanctions clause in an insurance policy (see our insurance blog post).

In short, the impact of the Blocking Regulation in these sorts of claims has yet to be fully explored, but it is interesting to see the courts begin to grapple with its potential impact; and as the US turns more often to secondary sanctions as a policy tool, it seems reasonable to anticipate more cases in which it will feature.

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