Commercial Court grants declaratory relief to bank relating to its rights under the 1992 ISDA Master Agreement

The Commercial Court has granted declaratory relief concerning a bank’s rights under an interest rate hedging arrangement governed by the 1992 ISDA Master Agreement: BNP Paribas SA v Trattamento Rifiuti Metropolitani SPA [2020] EWHC 2436 (Comm).

This is the substantive English trial judgment in the long-running (and cross-jurisdictional) dispute between BNP Paribas S.A. (the Bank) and the Italian public-private partnership, Trattamento Rifiuti Metropolitani S.p.A. (TRM). The dispute relates to a 2008 loan provided by a syndicate of banks (led by the claimant Bank) to TRM, and the associated hedging arrangements, which TRM says the Bank negligently advised it to enter into.

The decision will be welcomed by market participants for providing an abundance of detailed and helpful commentary on key provisions of the ISDA Master Agreement, and more broadly by financial institutions for its analysis of non-reliance clauses, together with guidance for parties seeking declaratory relief. The key takeaways are as follows:

1. Non-reliance clauses in a financial services context

One of the declarations considered by the court tracked the Non-Reliance provisions at Part 5(d)(i) of the Schedule to the ISDA Master Agreement, and asked for a declaration that TRM had “made its own independent decision” to enter into the hedging transaction and was not relying on communications from the Bank as investment advice or as a recommendation to enter into the hedging transaction. A further declaration sought provided that these provisions gave rise to a contractual estoppel, so that TRM was estopped by the ISDA Master Agreement from contending, for example, that it had relied on any representations given by the Bank as investment advice or a recommendation to enter into the hedging transaction.

The court swiftly agreed to grant the declarations tracking the parts of the Schedule, but the question of contractual estoppel gave rise to more detailed analysis. Following Springwell Navigation Corpn v JP Morgan Chase Bank [2010] EWCA Civ 1221, the court confirmed that there is no distinction between: (a) warranties and undertakings (each of which TRM accepted could give rise to an estoppel); and (b) an acknowledgement or a representation (each of which TRM argued could not). The court referred to Leggatt LJ’s commentary suggesting otherwise in First Tower Trustees and another v CDS (Superstores International) Ltd [2018] EWCA Civ 1396, noting that this was obiter. The court also noted that the factual situation in First Tower was very different (since the case concerned the effect of an exclusion clause in a commercial lease and its effect vis à vis pre-contractual enquiries which misrepresented the position as regards asbestos on site). The court specifically noted that Leggatt LJ was not purporting to consider the effect of representations typically made in a financial services context.

The court also rejected TRM’s argument that the Non-Reliance provisions sought to exclude liability for misrepresentation under the Misrepresentation Act 1967, and so were subject to the requirement of reasonableness under section 11(5) of the Unfair Contract Terms Act 1977 (UCTA). This can be contrasted again with the decision in First Tower (which, interestingly, was not cited in the judgment on this point), as considered in our blog post: Court of Appeal finds non-reliance clause sought to exclude liability for misrepresentation and was therefore subject to UCTA reasonableness test.

Although the court considered these arguments in the context of the 1992 ISDA Master Agreement, its findings would also be relevant for a bank relying on the non-reliance language in the 2002 ISDA Master Agreement.

2. Entire Agreement clause in the ISDA Master Agreement

The court rejected TRM’s argument that the standard ISDA entire agreement clause was not effective and that TRM was able to rely on separately negotiated terms of the Financing Agreement as prevailing over the ISDA terms. The court said that the meaning of the entire agreement clause in the ISDA Master Agreement is “clear and unambiguous” on its face, and that TRM’s approach would sit uneasily with, while the Bank’s argument was harmonious with, the dicta in the authorities as to the importance of certainty and clarity in interpreting the ISDA Master Agreement (see for example Lomas v Firth Rixson [2010] EWHC 3372).

3. Guidance for applications for negative declaratory relief

The court provided helpful guidance on the correct approach to applications for negative declaratory relief, which are common in these types of cross-border disputes. As set out in more detail below, the court found that the Bank in this case met the threshold requirements for such relief. In particular, the court noted that in such applications, the touchstone will be whether there is any utility in the claimant obtaining the negative declarations sought. It also noted a number of specific limitations on the grant of declaratory relief, including that the court should not entertain purely hypothetical questions and there must be a real and present dispute between the parties as to the existence or extent of a legal right between them (which need not fall within the jurisdiction of the English court).

A more detailed analysis of these issues and further questions of more general application for financial services institutions, is set out below.

Background

In 2008, a syndicate of banks led by the claimant Bank, entered into a loan agreement (the Financing Agreement) with TRM, an Italian public-private partnership, to fund the building of an energy plant. The Financing Agreement was governed by Italian law and contained a jurisdiction clause in favour of the Italian court.

The Financing Agreement included an obligation for TRM to enter into an interest rate swap with the Bank to hedge the interest rate risks associated with the loan. In 2010, pursuant to that obligation, the parties executed a swap pursuant to a 1992 ISDA Master Agreement (the ISDA Master Agreement). The ISDA Master Agreement contained an exclusive jurisdiction clause in favour of the English court.

In correspondence in July 2016, TRM alleged that the Bank negligently advised TRM to enter into the hedging transactions, which (among other things) TRM said were mismatched with its real hedging requirements, generated a significant negative cash flow, and had a negative mark-to-market value.

In September 2016, the Bank issued proceedings in the English Commercial Court against TRM seeking declarations of non-liability in relation to the hedging transaction, in most cases tracking the wording of the ISDA Master Agreement. In April 2017, TRM sued the Bank before the Italian court and then issued an application in the Commercial Court to challenge its jurisdiction.

Jurisdictional challenge

The Commercial Court found that the proceedings for declaratory relief brought before the English court were governed by the jurisdiction clause in the ISDA Master Agreement, finding that this clause was not displaced or restricted by the apparently competing Italian jurisdiction clause in the Financing Agreement (see the first instance decision). This was despite a provision in the Schedule to the Master Agreement that, in the case of conflict between the terms of the ISDA Master Agreement and those of the Financing Agreement, the latter should “prevail as appropriate”. See our blog post for more detail: High Court holds ISDA jurisdiction clause trumps competing jurisdiction clause in separate but related agreement.

The Court of Appeal agreed (see the Court of Appeal decision), finding that there was no conflict between the jurisdiction clauses, which were found to govern different legal relationships and were therefore complementary, rather than conflicting (such that the conflicts provision was not in fact engaged). The Court of Appeal emphasised that factual overlap between potential claims under the ISDA Master Agreement and the related Financing Agreement did not alter the legal reality that claims under the two agreements related to separate legal relationships. See our blog post for more detail: Court of Appeal finds ISDA jurisdiction clause trumps competing clause in related contract.

Decision

The Bank succeeded on the majority of its claim for declaratory relief, with the court (Mrs Justice Cockerill DBE) granting a significant number of the declarations sought. This blog post provides a summary of the court’s analysis below, focusing on the key points for financial institutions seeking negative declaratory relief and the points of interest in relation to the ISDA Master Agreement.

Preliminary issue: correct approach to applications for negative declaratory relief

Before turning to the substantive issues in dispute, the court considered a preliminary point on the correct approach to applications for negative declaratory relief.

The court noted that its power to grant such relief lay in section 19 of the Senior Courts Act 1981, which appears to be unfettered, but said that the grant of a declaration remains a discretionary remedy (see Zamir & Woolf, The Declaratory Judgment, Fourth Edition at 4-01). While the court acknowledged the authorities indicating that a court should be cautious when asked to grant negative declaratory relief, it was not persuaded by TRM that there should be a reluctance in cases involving foreign proceedings. The court confirmed the following general principles to be applied when considering negative declarations:

  1. The touchstone is whether there is any utility in the claimant obtaining the negative declarations sought.
  2. Negative declarations should be scrutinised by the court and rejected where they would serve no useful purpose.
  3. The prime purpose is to do justice in the particular case, which includes justice to both the claimant and defendant.
  4. The court must consider whether the grant of declaratory relief is the most effective way of resolving the issues raised and consider the alternatives (as per Rolls Royce v Unite the Union [2010] 1 WLR 318).
  5. Limitations on the court include: (i) it should not entertain purely hypothetical questions (see Regina (Al Rawi) v Sec State Foreign & Commonwealth Affairs [2008] QB 289); (ii) there must be a real and present dispute between the parties as to the existence or extent of a legal right between them (see Rolls Royce); and (iii) if the issue in dispute is not based on concrete facts the issue can still be treated as hypothetical. This can be characterised as “the missing element which makes a case hypothetical”.
  6. Factors such as absence of positive evidence of utility and absence of concrete facts to ground the declarations may not be determinative. However, where there is such a lack (in whole or in part) the court should be particularly alert to the dangers of producing something which is not useful and may create confusion.

The court confirmed that it would apply these general principles when considering each of the declarations sought.

Application of general principles for negative declaratory relief

TRM made the overarching submission that the general principles applicable to negative declaratory relief (as outlined above), precluded such relief from being granted in this case. The court found that the application met the threshold requirements for declaratory relief, considering the following two key principles, in particular:

No hypothetical questions / real and present dispute between the parties

TRM argued that the “dispute” on which the Bank relied to bring the claim for negative declarations did not arise in the English court, pointing out that no claims had been brought or intimated by TRM in this jurisdiction, and that the Bank was not able to identify what claims TRM might bring before the English court. Accordingly, it said the “dispute” was purely hypothetical.

The court was not persuaded that it would be appropriate to shut the Bank out from the possibility of declarations based on this ground. In particular, it noted the Bank’s intention to use the declarations sought by way of defence to the Italian claim. Although TRM had brought no claim under the ISDA Master Agreement in the Italian proceedings, the court considered that there was plainly scope for overlap. Moreover, the Bank had specifically pleaded the contractual rights under the ISDA Master Agreement as defences to the Italian claim.

In the court’s view, this was a case that was comfortably on the right side of the hypothetical/actual divide, noting as follows:

“The bottom line is that regardless of where the parts of the debate take place, there is a dispute between the parties as to whether the picture as to TRM’s rights is one which is framed within the [ISDA Master Agreement], or whether, despite the existence of the [ISDA Master Agreement], those rights are different. That is a dispute as to the existence of the rights which the Bank asserts, which is an actual existing dispute. That dispute is not divorced from the facts or based on hypothetical facts. It is plainly not one which has ceased to be of practical significance.”

Utility in obtaining the declarations sought

The court found that at least some of the declarations met the utility threshold requirement. In particular, the court noted that a judgment in England as to the meaning and legal effect as a matter of English law of specific clauses within the ISDA Master Agreement would be enforceable against TRM in Italy under the Brussels Regulation. Given that the ISDA Master Agreement was governed by English law, to the extent the Italian court had to grapple with what the agreement meant, the English court was best placed to decide and the Italian court was likely to be assisted by that determination.

Contractual construction of the ISDA entire agreement clause

Before considering the individual negative declarations sought by the Bank, the court ruled on a question of contractual interpretation of the standard entire agreement clause found in the ISDA Master Agreement.

TRM argued that the Entire Agreement clause was not effective and that it was able to rely on separately negotiated terms of the Financing Agreement prevailing over ISDA Master Agreement (relying on the comments of Lord Millett in The Starsin [2004] 1 AC 715).

The court rejected TRM’s approach, making the following observations, in particular:

  • On its face, the meaning of the ISDA entire agreement clause is “clear and unambiguous”. This was reflected by the decision in Deutsche Bank v Commune di Savona [2018] EWCA Civ 1740 (see our blog post), which said that the ISDA Master Agreement is a “self-contained” agreement, exclusive of prior dealings.
  • The court was not persuaded that TRM’s approach successfully undermined this simple reading of the clause, in particular because it did not identify the specific provisions in the ISDA Master Agreement which were allegedly offensive and which provisions of the Financing Agreement overrode them.
  • While TRM was a party to both the ISDA Master Agreement and to the Financing Agreement, the Bank was a party to the latter as Mandated Lead Arranger (and other roles), not in its capacity as the “Hedging Bank” (even though the Bank was separately defined in the Financing Agreement as fulfilling this role). The court said it would be something of an oddity if the terms of a separate agreement in which the Bank participated with a different hat on, could impact the ISDA Master Agreement.
  • The hedging transaction was entered into “in connection with” the Financing Agreement, highlighting the fact that there were two distinct, albeit connected, agreements.
  • TRM’s approach would sit uneasily with, while the Bank’s argument was harmonious with, the dicta in various authorities as to the importance of certainty and clarity in interpreting the ISDA Master Agreement (most famously in Lomas v Firth Rixson).

Analysis of the individual negative declarations sought

The court then turned to consider the individual negative declarations, granting the majority of them, particularly where those declarations simply tracked the wording of the ISDA Master Agreement, Schedule or Confirmation.

Of the declarations considered by the court, there is one category which has particular significance for financial services contracts. This is the court’s analysis of the effect of the ISDA versions of “no representation” clauses and “non-reliance on representation” clauses, and the application of contractual estoppel to those clauses.

No representation / non-reliance on representation / contractual estoppel

The Bank sought a number of declarations which simply tracked the ISDA documentation:

  • That TRM had “made its own independent decision” to enter into the hedging transaction and was not relying on communications from the Bank as investment advice or as a recommendation to enter into the hedging transaction (the Non-Reliance provisions at Part 5(d)(i) of the Schedule).
  • That TRM was capable of evaluating and understanding the terms, risks etc. of the hedging transaction (Evaluations and Understanding at Part 5(d)(ii) of the Schedule).
  • That TRM was acting as principal and not as agent or in any other capacity, fiduciary or otherwise (Acting as Principal at Part 5(d)(iv) of the Schedule).
  • That TRM had specific competence and expertise to enter into the hedging transaction and in connection with financial instruments (Competence and Expertise at Part 5(e)(i) of the Schedule).
  • That TRM entered into the hedging transaction for hedging purposes and not for speculative purposes (Hedging Purposes at Part 5(e)(ii) of the Schedule).
  • That TRM had full capacity to undertake the obligations under the hedging transaction, the execution of which fell within its institutional functions (Capacity at Part 5(e)(iii) of the Schedule).

In addition, the Bank sought a further declaration that these clauses gave rise to a contractual estoppel, which prevented TRM from contending, for example, that it had relied on any representations given by the Bank as investment advice or a recommendation to enter into the hedging transaction).

The Bank argued that applying accepted principles of contractual interpretation, it was clear that TRM agreed that the Bank did not make any actionable representations to TRM, and that TRM did not rely on any representations in connection with the hedging transaction.

The court swiftly agreed to grant the declarations tracking the parts of the Schedule listed above, but the question of contractual estoppel gave rise to more detailed analysis.

Existence of a contractual estoppel

The court noted that Springwell broadly supported the finding of contractual estoppels arising from such clauses, citing the following comments from Aikens LJ in that case:

“…there is no legal principle that states that parties cannot agree to assume that a certain state of affairs is the case at the time the contract is concluded or has been so in the past, even if that is not the case, so that the contract is made upon the basis that the present or past facts are as stated and agreed by the parties.”

TRM argued that there was a distinction between warranties and undertakings on the one hand (which it accepted could give rise to a contractual estoppel), and an acknowledgement or a representation on the other. In relation to the latter, it said that there was no “agreement”, and therefore an acknowledgement/representation could not create a contractual estoppel. TRM pointed to the judgment of Leggatt LJ in First Tower, in which he questioned whether a clause which simply said that a party “acknowledges” that it has not entered into the contract in reliance on any representation could give rise to a contractual estoppel.

However, the court noted that Springwell itself disagreed with this proposition, with the Court of Appeal finding in that case that Springwell was bound contractually to its statement, or acknowledgement, that no representation or warranty had been made by Chase Manhattan. The court emphasised that Leggatt LJ’s commentary in First Tower was obiter, and did not think he was intending to overrule or qualify Springwell. The court noted that the factual situation in First Tower was very different (since the case concerned the effect of an exclusion clause in a commercial lease and its effect vis à vis pre-contractual enquiries which misrepresented the position as regards asbestos on site). Leggatt LJ was not purporting to consider the effect of representations typically made in a financial services context.

The court also considered obiter comments in Credit Suisse International v Stichting Vestia Groep [2014] EWHC 3103 (Comm), a case concerning the ISDA Master agreement, which TRM suggested drew a distinction generally between warranties and mere representations. Again the court was not persuaded that this authority took matters any further forward, as it was bound by Springwell.

Even if not bound by Springwell, the court considered that the question was whether it could “objectively conclude that by the relevant contractual materials the parties did intend to agree” to the contractual estoppel. It said the question was not dependent on the precise wording (representation vs warranty), but was a question of substance (per Hamblen J in Cassa Di Risparmio Della Repubblica Di San Marino Spa v Barclays Bank Ltd [2011] EWHC 484 (Comm)). This would require the court to discern the intention of the parties, taking into consideration the relevant factual background, including the nature and status of the ISDA Master Agreement. On that basis, even if it had not been bound by Springwell, the court said it would have reached the same conclusion, namely that a contractual estoppel existed.

Effect of the Misrepresentation Act 1967

The court also considered TRM’s argument that the Non-Reliance provisions sought to exclude liability for misrepresentation under the Misrepresentation Act 1967, and so were subject to the requirement of reasonableness under section 11(5) of the Unfair Contract Terms Act 1977 (UCTA).

The court was “entirely unpersuaded” of the merits of this argument. In particular, the court specifically endorsed the decision in Barclays Bank plc v Svizera Holdings BV [2014] EWHC 1020 (Comm), which held that a clause in a mandate letter gave rise to a contractual estoppel against reliance on alleged representations. In that case, the court referred to the consistent judicial recognition of the effectiveness of such clauses giving rise to a contractual estoppel, and said the suggestion that the clause should be struck down as unreasonable under UCTA was “hopeless”. In the present case, the court commented that this conclusion might very well apply here.

The court was critical of TRM’s approach to the argument on the Misrepresentation Act, in particular because it had failed to put its argument formally in issue in the proceedings, cautioning as follows:

“It cannot be acceptable for a party to (as TRM did here) stay absolutely quiet on the subject until the door of the court, and then play their joker in the form of the [Misrepresentation Act], asserting that the burden of proving reasonableness has not been discharged by its opponent.”

The court was also critical of the fact that TRM failed to identify clearly which clauses were said to be exclusion clauses, and the absence of any factual evidence to suggest that the provision should be struck down as unreasonable.

In fact, the court pointed to a number of factors suggesting that the clause was in any event reasonable, including that: this was not a case of a consumer transaction or where there was an inequality of bargaining power; the terms were contained within an ISDA Master Agreement which contains effectively market standard terms; and the bespoke Schedule was agreed between two commercial parties.

The court was therefore prepared to grant the declarations sought relating to representations and contractual estoppel.

Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

Court of Appeal upholds High Court’s decision on the preferred contractual construction of a term in an exclusion clause

The Court of Appeal has upheld the High Court’s decision on a claim involving the legal meaning of ‘goodwill’ and the contractual construction of an exclusion clause excluding liability for lost goodwill: Primus International Holding Co & Ors v Triumph Controls – UK Ltd & Anor [2020] EWCA Civ 1228.

In doing so, the Court of Appeal has confirmed that (unless there are clear words to the contrary in a contract) the ordinary legal meaning of a particular term will be preferred to an unusual, technical or non-legal meaning. The Court of Appeal agreed, in this case, that the ordinary legal meaning of ‘goodwill’ applied to the exclusion clause under consideration as opposed to the technical accounting definition advanced by the defendants; there were no indications otherwise to suggest that the technical definition should be preferred.

This decision will be of broader interest to financial institutions as it underlines the importance of careful drafting, particularly if a contract is to refer to a financial term of art or ‘jargon’. If the parties wish for an unusual, technical or non-legal meaning to be attributed to a particular term rather than the ordinary legal meaning, the approach taken by the Court of Appeal makes it clear that it would be wise to define that particular term clearly.

Background

The Triumph companies (the claimants) entered into discussions with the Primus companies (the defendants) in relation to the potential acquisition of two aerospace manufacturing companies in 2012. As part of the discussions, the defendants provided the claimants with a set of financial forecasts for the target companies extending to 2017. These were known as the “Long Range Plan” (LRP) and predicted that the target companies would be profitable in the future. In 2013, the claimants completed their USD 76.5 million acquisition of the target companies through a SPA. Following completion, the claimants discovered significant operational and business issues at the target companies, which led to a failure to meet their forecasted earnings and their performance did not match that predicted by the LRP.

The claimants subsequently brought a USD 63.5 million damages claim against the defendants alleging that there had been a breach of the warranties given in the SPA, in particular that the LRP had not been “honestly and carefully prepared”.

The defendants sought to rely on certain exclusions of liability in the SPA to defeat that claim. The provision which was relied on and subject to the appeal was an exclusion clause which excluded liability “to the extent that…the matter to which the claim relates…is in respect of lost goodwill”. The defendants argued that the reference to ‘goodwill’ here was a reference to the accounting concept of goodwill, namely an “intangible asset recorded when a company acquires another company and the purchase price is greater than the sum of the fair value of the identifiable tangible and intangible assets acquired and the liabilities that were assumed”.

High Court decision

The High Court found that the defendants were in breach of warranty for failing to prepare the LRP with care. The High Court commented that the LRP failed to take into account key operational and financial assumptions relating to planned transfers of productions lines relating to the target companies. As a result, the LRP overestimated the rate at which production could be transferred and overstated the future profitability of the target companies. The High Court concluded that the purchase price paid by the claimants for the target companies would have been lower if they had been provided with a proper LRP and awarded the claimants damages on that basis.

The High Court rejected the suggestion that the exclusion of claims “in respect of lost goodwill” could be relied upon by the defendant to defeat the claims for breach of warranty as the claims were not for lost goodwill, but rather lost revenues and increased costs. In reaching its decision, the High Court determined that the plain and natural meaning of ‘goodwill’ in a commercial contract is business reputation.

The defendants appealed on a number of matters, but were only granted permission to appeal on the true meaning and effect of the exclusion clause that they had relied upon.

Court of Appeal decision

The Court of Appeal held that the High Court was right to prefer the claimants’ definition of ‘goodwill’ and their construction of the exclusion clause.

The Court of Appeal agreed that the ordinary legal meaning of ‘goodwill’ in a commercial context meant the good name, business reputation and connection of a business, and that the authorities overwhelmingly pointed to this conclusion. The Court of Appeal also examined other parts of the SPA to see how ‘goodwill’ was construed and found that it was used in way that was consistent with its ordinary legal meaning. In the Court of Appeal’s view, there was no reason to depart from the ordinary legal meaning of the word when construing the exclusion clause or to utilise the accounting definition of the term (as suggested by the defendants).

Furthermore, the defendant’s meaning of goodwill was also not a commercially sensible one as it would mean that any claim for breach of warranty not relating to existing assets would be covered by the all-encompassing accounting definition of ‘goodwill’ and therefore be excluded by the exclusion clause; thereby depriving the claimants of most of the force and protection of the warranties in the SPA without any clear words to that effect. In support of its reasoning on this point, the Court of Appeal relied on the view of Briggs LJ in Nobahar Cookson and Another v Hut Group Ltd [2016] EWCA Civ 128: “the parties are not likely to be taken to have intended to cut down the remedies which the law provides for breach of important contractual obligation without using clear words having that effect”.                                                                       

The Court of Appeal therefore dismissed the appeal. On the facts, this was plainly the correct decision. However, parties to financial contracts in particular will want to take note of the observation made in the Court of Appeal’s reasoning that if a contract wishes to include a term which has an unusual, technical or non-legal meaning, that must be spelt out.

Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Nihar Lovell
Nihar Lovell
Senior Associate
+44 20 7466 2529

High Court refuses to strike out Quincecare duty claim against a PSP where its customer was hijacked by fraudsters

The High Court’s judgment in Gareth Hamblin and Marilyn Hamblin v World First Limited and Moorwand NL Limited [2020] EWHC 2383 (Comm) is the first decision to follow the Supreme Court’s ruling in Singularis Holdings Ltd v Daiwa Capital Markets [2019] UKSC 50, considering the so-called Quincecare duty of care (see our banking litigation blog post).

As a reminder, the Quincecare duty arises where a bank or deposit holding financial institution must refrain from processing a payment mandate made by an authorised signatory of its customer for as long as the bank is “put on enquiry” i.e. it has reasonable grounds for believing that the instruction is an attempt to misappropriate funds from the customer. This is an objective test to be judged by the standard of an ordinary prudent banker.

The present decision considered a novel factual scenario not previously analysed by the court in the context of the Quincecare duty, namely whether such a claim can be brought against a financial institution (here, a payment services provider) where the customer was an insolvent shell company, without any directors, which had been hijacked by fraudulent individuals and used for the purpose of a fraud. Even in these extreme circumstances, the court found that a Quincecare claim was realistically arguable. Following Singularis, the court emphasised that the Quincecare duty is owed to the company not to those in control of it, and as such it was possible for the shell company itself to be a “victim” of the fraud.

The court refused to attribute the knowledge of the fraudsters to the shell company, arguably taking a conservative approach to the test for attribution in Singularis. In that case, the Supreme Court confirmed that there is no principle of law that the fraudulent conduct of a director is to be attributed to the company if it is a one-man company. The court applied this principle here, even though on the facts the company was not even a “one-man company” because it had no directors at all, it was in the control of those who were at best de facto directors, all of whom had been intimately involved in the prosecution of the fraudulent scheme. As per Singularis, the court said that the question of attribution in such circumstances is always to be found in consideration of the context and the purpose for which the attribution is relevant.

The decision highlights the creep in the scope of the Quincecare duty first established in Barclays Bank plc v Quincecare Ltd [1992] 4 All ER 343. Quincecare itself considered the duty in the context of a current account, but it has since been extended to depository accounts (JP Morgan Chase Bank, N.A. v The Federal Republic of Nigeria [2019] EWCA Civ 1641, see our banking litigation blog post), investment banks (Singularis) and it is now being considered in the context of a payment service provider in the present case. It is presenting an increasing risk for financial institutions that process client payments, as the spate of recent judgments indicates (see also our recent banking litigation blog post on Stanford International Bank Ltd v HSBC Bank plc [2020] EWHC 2232 (Ch)).

Further, it will be interesting to see the court’s decision on the merits of the claimants’ alternative breach of mandate claim against the bank (for purporting to act on the instructions of an individual whose identity had been stolen by the fraudsters, where in fact there were no registered directors of the company). The court held that the claimants had an arguable case to narrow the established principle that a customer is estopped from claiming damages resulting from its own instruction where the bank has acted in good faith and in the ordinary course of business (see Bank of England v Vagliano Brothers [1891] AC 107). In the court’s view, this principle may need to be refined in the context of a corporate entity controlled by fraudsters, particularly in light of the distinction between where the customer is an individual vs a company, as highlighted in Singularis.

Background

The claim arose out of a sophisticated investment fraud using the second defendant, Moorwand NL Limited (Moorwand NL) as the corporate vehicle by which the fraud was carried into effect by individuals unknown. Those individuals set up an account in the name of Moorwand NL on the application of a Mr Carter, whose identity had been stolen by the fraudsters. At no material time was Mr Carter a director of Moorwand NL, nor did Moorwand NL have any registered directors. Moorwand NL’s account was set up and maintained by the first defendant (against which no allegations of fraud were made), a payment service provider known as World First Limited (WF).

The claimants were persuaded by the fraudsters to open an investment account and transferred £140,000 to Moorwand NL’s account with WF. Subsequently, WF paid out the £140,000 credited to Moorwand NL’s account on instructions apparently received on behalf of Moorwand NL. The sums paid out were misappropriated and the individuals behind the investment fraud were never found.

The claimants commenced proceedings against both WF and Moorwand NL (now in insolvent liquidation) to recover the £140,000 they lost. The claim against WF was brought on the grounds that Moorwand NL was a trustee of the claimants’ funds and that the claimants (as beneficiaries of the trust) had standing to bring representative proceedings (i.e. claims belonging to Moorwand NL) directly against WF.

WF applied for strike out or reverse summary judgment on the grounds that the claims were bound to fail as a matter of law. This blog post focuses on the following issues in the application:

  1. Breach of the Quincecare duty i.e. that WF owed Moorwand NL a duty of care to use reasonable care and skill to not execute a payment instruction in circumstances where a reasonable service provider would be placed on notice that the payments had not been duly authorised.
  2. Breach of mandate because: (i) no authority to pay out from Moorwand NL’s account could have been obtained since Moorwand NL had no directors at any material time and/or (ii) payment out of the account was not authorised by Mr Carter since his identity was stolen and he was not asked nor gave authority for payment out of the account.
  3. The claimants’ right to bring representative proceedings.

For the purpose of the application, WF did not dispute that there was a proper factual basis for alleging that a reasonable service provider ought to have been on notice that the payments out were not duly authorised.

Decision

The High Court (Pelling J) ruled that the claimants had a realistically arguable case against WF for breach of the Quincecare duty and/or breach of mandate, and realistically arguable standing to bring the claim.

Breach of the Quincecare duty

WF submitted that no claim for breach of the Quincecare duty could succeed because:

  1. No loss could be caused by a breach of the Quincecare duty that was within the knowledge of those in control of the customer.
  2. As a matter of policy, the only claim available to a person in the position of the claimants was a claim for dishonest assistance (which was not available on the facts of this case).

Taking each of these arguments in turn, WF argued that the Quincecare duty requires the bank’s customer to have been the victim of the fraud, but here the customer (Moorwand NL) was controlled by fraudsters. Accordingly, any claim for breach of duty brought by Moorwand NL would be bound to be met with an assertion that no loss could be caused by a breach within the knowledge of those in control of Moorwand NL. Any such claim brought by Moorwand NL against WF would give rise to a complete circuity of action, since WF would then be entitled to sue Moorwand NL for fraudulent misrepresentation.

The court highlighted the emphasis given by Lady Hale in Singularis to the fact that the Quincecare duty is owed to the company not to those in control of it. This is because the purpose of the duty is to protect the legally distinct company against the misappropriation of the company’s assets. Taking Moorwand NL as a distinct legal entity, the court held that it was realistically arguable on the facts as they were assumed that Moorwand NL was itself a victim of the fraud.

On the question of whether to attribute the knowledge of the fraudsters to Moorwand NL, the court again cited Singularis, which confirmed that where a company (e.g. Moorwand NL, represented by the claimants) is suing a third party (e.g. WF) for breach of duty, there is no principle of law that the fraudulent conduct of a director is to be attributed to the company if it is a one-man company. In the court’s view, it was at least realistically arguable that this principle would apply here, even though on the facts Moorwand NL was not even a “one-man company” (because it had no directors at all, it was in the control of those who were at best de facto directors, all of whom had been intimately involved in the prosecution of the fraudulent scheme). As per Singularis, the court said that the question of attribution in such circumstances is always to be found in consideration of the context and the purpose for which the attribution is relevant. The court echoed the reasoning in Singularis that to attribute the knowledge of the fraudsters to Moorwand NL so as to defeat the claim would be to denude the Quincecare duty of much of its practical utility.

The court also disagreed with WF’s policy argument, that allowing the claimants to pursue a claim for breach of the Quincecare duty, would be contrary to the deliberate public policy of limiting the claims available to a person in the position of the claimants to a claim for dishonest assistance.

For the above reasons, the court ruled that the claimants had a realistically arguable case for breach of the Quincecare duty by WF.

Breach of mandate

The claim under this head was that WF breached its mandate with Moorwand NL because it purported to act on the instruction of Mr Carter, where Mr Carter could not and did not give any instructions  (because his identity had been stolen by the fraudsters and in fact there were no registered directors).

WF relied on the principle set out in Vagliano Brothers, which held that if a bank acts upon a representation by a customer in good faith and in the ordinary course of business, the customer is estopped from suing the bank for any loss which occurred based on the representation, where that loss would not have occurred if the representation had been true. Accordingly, because the fraudsters (presumably on behalf of Moorwand NL) had impersonated Mr Carter, WF argued that this principle estopped the claimants from bringing the breach of mandate claim.

The claimants argued that the time may have come to review, refine or confine this proposition of law, so as not to apply to a situation where the “customer” was a corporate entity controlled by fraudsters. They said a distinction needed to be drawn between when an individual/partnership of individuals was the customer (as was the case in Vagliano Brothers) and when a company was the customer. In particular, the claimants relied on the following passage from Singularis (emphasis added):

“In Luscombe v Roberts (1962) 106 SJ 373, a solicitor’s claim against his negligent accountants failed because he knew that what he was doing – transferring money from his clients’ account into his firm’s account and using it for his own purposes – was wrong. But companies are different from individuals. They have their own legal existence and personality separate from that of any of the individuals who own or run them. The shareholders own the company. They do not own its assets, and a sole shareholder can steal from his own company.”

The court recognised that Singularis dealt with different facts and a different cause of action, but said that the principle of law was generally stated and well established. On the present application (and in a case where the defence had not been filed nor meaningful disclosure taken place), the court found that the distinction between an individual and a company observed in Singularis was maintainable. Further, the court was not prepared to conclude that Vagliano Brothers provided a certain answer to the claimants’ claim that WF was in breach of mandate, in circumstances where Moorwand NL had no directors and had come under the control of fraudsters who were at best de facto directors of the company.

The court suggested that this would amount to a “modest but incremental” development of the law, but that any development to that effect should be on the basis of facts properly established at trial and not assumed facts as was the case at the interim stage.

Representative proceedings

The final issue considered was whether the claimants had standing to bring the claim at all, which the court found was realistically arguable.

For the purpose of the application, the court found that Moorwand NL was a trustee. In such circumstances, Hayim v Citibank NA [1987] AC 730 (PC) enabled the claimants to bring representative proceedings as a beneficiary where Moorwand NL had committed a breach of trust or “in other exceptional circumstances”. The court found that this requirement was satisfied (at least to the level of realistic argument) where Moorwand NL as the trustee was in insolvent liquidation and there was no dispute that it had been hijacked by fraudulent individuals and used as the means by which a fraud was carried into effect.

The court therefore dismissed the application for strike out or summary judgment.

Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Mannat Sabhikhi
Mannat Sabhikhi
Associate
+44 20 7466 2859

High Court considers Quincecare and dishonest assistance claims against bank in context of Ponzi scheme

The trend of claims against financial institutions alleging breach of the so-called Quincecare duty continues to grow, with the most recent judgment from the High Court refusing to strike out such a claim on the ground that the claimant had suffered no loss because it was an insolvent Ponzi scheme. A parallel claim against the bank for dishonest assistance has, however, been struck out: Stanford International Bank Ltd v HSBC Bank plc [2020] EWHC 2232 (Ch).

In this case, the court considered claims brought by the liquidators of Stanford International Bank Limited (SIB), the infamous Ponzi scheme masterminded by Robert Allen Stanford, the former billionaire who was well known for sponsoring a multi-million pound series of cricket matches with the England and Wales Cricket Board (ECB), before the fraud was exposed and Mr Stanford was convicted in the United States.

The liquidators of SIB have brought proceedings against a correspondent bank (the Bank) that operated various accounts for SIB (which paid out/received deposits to/from investors), arguing that the Quincecare duty required the Bank to have recognised the red flags by 1 August 2008 (at the latest) and to have “sent the balloon up”, freezing the payments to investors out of the accounts and thereby exposing the fraud. The liquidators claim the monies paid out in the period from 1 August 2008 until the accounts were actually frozen in February 2009.

The present judgment relates to a novel application made by the Bank to strike out or seek reverse summary judgment in respect of the Quincecare claim on the basis that SIB has no claim in damages as it suffered no loss. The Bank argued that SIB suffered no loss because its net asset position remained the same during the relevant period: the payments out to investors reduced SIB’s assets, but equally discharged SIB’s liabilities to investors by the same amount.

While the court accepted that the net asset position of a solvent company may remain the same in these circumstances, it found that the position may very well be different for an insolvent individual or company (such as SIB); and said that the counterfactual scenario must be interrogated for the purpose of assessing damages. Here, the court held that if the Bank had frozen the accounts on 1 August 2008, SIB would have had £80 million of assets in its accounts with the Bank. It would have had a very large number of creditors, but it would have had that money in its accounts and available for the liquidators to pursue claims. The court found that SIB did not need to give credit for the fact that it had been saved £80 million of liabilities, because SIB was still just as insolvent, but with a slightly different mix of creditors.

There are a number of Quincecare duty claims progressing through the courts, but still only one finally determined case in which the duty has been found to be owed and breached (see our blog post: Supreme Court upholds first successful claim for breach of the so-called “Quincecare” duty of care). The decision in SIB v HSBC therefore provides a helpful addition to this body of case law, as financial institutions continue to grapple with the emerging litigation risks associated with processing client payments.

The court granted a separate application made by the Bank to strike out the liquidators’ claim for dishonest assistance in relation to breaches of fiduciary duty owed to SIB by Mr Stanford. It held that the allegation of dishonesty was not sufficiently pleaded in the statements of case, clarifying a number of issues in relation to aggregation of knowledge, corporate recklessness and blind-eye knowledge, which are discussed in further detail below.

Background

The underlying claim was brought by the liquidators of the claimant (SIB). SIB was an Antiguan bank, alleged by the liquidators to have been operating a Ponzi scheme fraud since its inception.

The defendant Bank operated various accounts as a correspondent bank for SIB from 2003 onwards. The liquidators claimed that the Bank breached its so-called Quincecare duty of care to take sufficient care that monies paid out from the accounts under its control were being properly paid out. The liquidators argued that the Quincecare duty required the Bank to have reached the conclusion by 1 August 2008 (at the latest) that there was something very wrong and to have frozen payments out of the accounts. Instead, the accounts continued to operate until circa February 2009. The claim was to recover the sums paid out by the Bank during that period, amounting to approximately £118 million (although it is worth noting that the balance in the accounts on 1 August 2008 was £80 million, with the difference between this figure and the amount paid out during the relevant period likely due to new depositors paying into the account).

The payments made by the Bank during this period were made (directly or indirectly) to individual investors holding certificates of deposit who had claims on SIB for the return of their capital and interest, save for one payment to the ECB (which is not considered further in this blog post).

The Bank argued that a Quincecare duty claim is a common law claim for damages for breach of a tortious duty (or an implied contractual duty), and so the remedy is damages to compensate for loss suffered. It said that SIB had no claim for damages, because on a net asset basis it was no worse off as a result of the Bank’s actions: the payment of £118 million reduced SIB’s assets by £118 million, but it equally discharged SIB’s liabilities by the same amount. This was because monies paid out by the Bank went (ultimately) to deposit-holders in satisfaction of their contractual rights against SIB.

The Bank applied to strike out the claim, or obtain reverse summary judgment under CPR Part 24, on the ground that SIB had suffered no loss. For the purpose of the application, the Bank accepted that there was a sufficiently arguable case of breach of the Quincecare duty.

In addition to its Quincecare claim, the liquidators brought a claim against the Bank for dishonest assistance in relation to breaches of fiduciary duty owed to SIB by Mr Stanford, the ultimate beneficial owner of SIB who has now been convicted in the United States. The Bank applied to strike out the dishonest assistance claim on the basis that the allegation of dishonesty was not sufficiently pleaded in the statements of case.

Decision

The court described the Bank’s argument on loss in respect of the Quincecare allegation as “simple and beguiling attractive”, but ultimately refused to strike out or grant summary judgment. The court did strike out the allegation of dishonest assistance.

Quincecare duty

The court acknowledged that it is trite law that (with some exceptions) a party suing for damages arising from an alleged wrongdoing must give credit against the loss claimed for any benefits obtained as a result of the same wrongdoing.

In the case of a solvent company, the court said that paying £100 of its money and discharging £100 of its liabilities, on the one hand reduces its assets but on the other hand is offset by a corresponding benefit to the company by reducing the creditors that have to be paid. Accordingly the net asset position of the solvent company is the same.

However, the claimant’s case was that SIB was always heavily insolvent (somewhere in the region of £4 to 5 billion) and the court accepted that the position may very well be different for an insolvent individual or company.  Taking the example above, the court said that if the company is insolvent, then paying £100 on the one hand reduces its assets, but that is not offset by a corresponding benefit to the company and a reduction in its liabilities, as it still does not have enough to pay them all, and it still has no net assets at all.

In a case such as this, where the claimant is insolvent, the court said that the counterfactual scenario must be interrogated for the purpose of assessing damages. The relevant counterfactual scenario in this case was described by the court as follows:

  • As at 1 August 2008, SIB had the sum of £80 million in its accounts with the Bank.
  • If the Bank had frozen the accounts on that date, the Ponzi scheme would have been uncovered and SIB would have collapsed into insolvent liquidation on or around that date.
  • In that scenario, SIB would have had £80 million of assets available to it. It would have had a very large number of creditors, but it would have that money in its accounts with the Bank.
  • Had SIB had the £80 million, it would have had that money available for the liquidators to pursue such claims as they thought they could usefully pursue and for distribution to its creditors.

As a result of what actually happened, SIB did not have the £80 million. Assuming (for the purpose of the application) that the Bank breached its Quincecare duty, the court said that effect of the breach was to deprive SIB of the opportunity to use the £80 million as described above. The court held that this was a real loss and it was contrary to “instinctive and common sense reaction to the facts” to describe SIB as currently being in exactly the same financial position as it would have been on 1 August 2008.

The claimant’s argument on the “no net assets” point (with which the court agreed), was put concisely as follows:

“…once your liabilities vastly exceed your assets, it really is a matter of indifference to you whether you have £5bn of liabilities or £6bn of liabilities. If your assets are only in the hundreds of millions, on any view you are hopelessly and irredeemably insolvent. You therefore have no net assets on any view, but a net liability, and if that net liability is only £5bn instead of £6bn (or £5.118bn), that does not make any difference to you – you still have no net assets.”

In the court’s view, SIB did not need to give credit for the fact that it had been saved £80 million of liabilities, because it did not make SIB any better off, it was still just as insolvent as it was, but with a slightly different mix of creditors.

The Bank argued that the position of SIB as the company (as opposed to the creditors) was no worse off by having £80 million of its assets wrongfully extracted from its bank accounts, given that there would be nothing left over for the company or its shareholders on any view. In this context, the Bank pointed out that the Quincecare duty is only owed to the company and not to its creditors. However, the court rejected this argument, because under the counterfactual scenario, SIB would have had £80 million in the bank, rather than nothing.

Accordingly, the court dismissed the application for reverse summary judgment or strike out of the Quincecare loss claim (for the balance over and above the ECB payment). The court was not asked decide the point on a final basis in favour of the claimant, and so it will technically be open to the Bank to continue to run these arguments at trial.

Dishonest assistance

In respect of the dishonest assistance claim, the only point argued before the court was whether there was a sufficient plea of dishonesty against the Bank to survive the strike out application. The court held that there was not, and the key themes of its analysis are considered further below.

Aggregation of knowledge

Counsel for the claimant acknowledged that he was unwilling to plead dishonesty against any particular individual at the Bank, because he did not have the material to do so at that stage of the proceedings. The claimant therefore pleaded a case of dishonesty against the Bank collectively, on the basis that if disclosure revealed a case that could be properly pleaded against individuals at the Bank, the claimant would seek to amend to do so.

The court noted that it is a thoroughly well-established principle of English law that one cannot aggregate two innocent minds to make a dishonest whole: see Armstrong v Strain [1952] KB 232. As such, the court held that no case could be made against the Bank that relied on aggregating knowledge held by different people at the Bank if none of those individuals was alleged to be dishonest.

Corporate recklessness

In the alternative, the claimant argued that the Bank acted with “corporate recklessness. The court considered the question of whether corporate recklessness is sufficient to amount to dishonesty in the context of a dishonest assistance claim.

The claimant submitted that recklessness could amount to dishonesty, as per the statement by Lord Herschell in Derry v Peek (1889) 14 App Cas 337. In this case Lord Herschell explained the meaning of “fraud” in the context of a claim for deceit, saying said that fraud is proved where it is shown that a false representation has been made: (1) knowingly; or (2) without belief in its truth; or (3) recklessly, careless whether it be true or false.

The claimant built on the analysis in Derry v Peek to allege a case of corporate recklessness against the Bank for not knowing or caring whether SIB was being run properly not, or was a fraud on its investors, saying this was sufficient to amount to dishonesty in a dishonest assistance claim.

The court disagreed. It held that the words of Lord Herschell cannot be transposed into a generalised allegation that if one does not know or care about something one is dishonest in relation to it. Lord Herschell was dealing specifically with a claim in deceit (a tort that depends on fraudulent misrepresentation) and the court in this case said the claimant’s argument was an attempt to stretch his words beyond their proper application. One could not simply say that companies that act recklessly in the sense of not knowing and not caring are therefore dishonest.

The court considered the sharp distinction between honesty and dishonesty discussed in Agip (Africa) Ltd) v Jackson [1990] Ch 265 at 293E. The court said that this was relevant when considering why the Bank did not ask questions that would have revealed the nature of SIB’s business as a fraud. If questions were not asked because the Bank/its employees did not suspect wrongdoing, then they were not dishonest, even if they ignored the Bank’s own policies, and it did not assist to say that they had developed an ingrained culture of failing to obtain knowledge.

Blind-eye knowledge

The claimant also alleged that the Bank turned a blind eye as to whether SIB was being run dishonestly.

On the question of what will amount to blind-eye knowledge, the court considered the speech of Lord Scott in Twinsectra v Yardley [2002] UKHL 12, which was also referred to by the Court of Appeal in Group Seven Ltd v Nasir [2019] EWCA Civ 614. In summary, this confirms that blind-eye knowledge requires targeted suspicion and a deliberate decision not to look.

Absent an allegation of targeted suspicion and of a deliberate decision not to look (which did not appear in the claimant’s statements of case), the court found that the allegations made against the Bank could not be characterised as allegations of dishonesty.

Strike out

Accordingly, the court struck out the dishonest assistance claim. It noted that, by striking out  the claim rather than granting summary judgment, the claimant would preserve the opportunity to seek to re-plead a case of dishonesty following disclosure, if it could properly do so.

Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

Judgment handed down in FCA’s COVID-19 business interruption insurance test case

The High Court has today handed down judgment in the COVID-19 Business Interruption insurance test case of The Financial Conduct Authority v Arch and Others. Herbert Smith Freehills represented the FCA (who was advancing the claim for policyholders) in the case, which considered 21 lead sample wordings from eight insurers. Following expedited proceedings, the judgment brings highly-anticipated guidance on the proper operation of cover under certain non-damage business interruption insurance extensions.

While different conclusions were reached in respect of each wording, the court found in favour of the FCA on the majority of the key issues, in particular in respect of coverage triggers under most disease and ‘hybrid’ clauses, certain denial of access/public authority clauses, as well as causation and ‘trends’ clauses. The judgment should therefore bring welcome news for a significant number of the thousands of policyholders impacted by COVID-related business interruption losses.

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

High Court finds proceedings properly served on process agent appointed by lender under credit agreement

In a recent decision, the High Court confirmed that proceedings had been properly served on a borrower where it had failed to comply with its contractual obligations to appoint a process agent and so the lender had appointed an agent on its behalf as permitted by the credit agreement: Banco San Juan Internacional Inc v Petroleos De Venezuela Sa [2020] EWHC 2145 (Comm).

This decision will be welcomed by lenders, demonstrating the willingness of the court to construe service clauses in accordance with their clear and intended purpose, which is to ensure proceedings can be brought efficiently and in a timely manner. 

Background

A dispute arose between the claimant bank and the defendant state-owned oil company under the terms of two credit agreements. Under those agreements the defendant was required to appoint a process agent for service of proceedings in England, which it failed to do. The credit agreements both contained provisions permitting the bank to make such appointment on behalf of the defendant if it failed to do so.

The defendant had failed to appoint a process agent at all under one credit agreement (the 2017 agreement), and under the other (the 2016 agreement) the agent’s appointment had expired and had not been renewed. The bank therefore relied on the contractual provisions to appoint a process agent for the defendant, and served two sets of proceedings on it.

The defendant subsequently challenged whether it had been properly served with the claims.

Decision

The High Court (Foxton J) held that the proceedings had been properly served on the defendant.

The court noted that the general efficacy of clauses permitting service on a process agent had been recognised by a long line of first instance authorities, but that each clause depended on its own particular language. The court described the structure of the relevant clauses in the two credit agreements as follows:

(i) PDVSA is obliged forthwith to appoint a process agent to be an authorised agent for service of proceedings in England.

(iii) If for any reason the process agent ceases to be such an agent, then PDVSA must forthwith appoint a new agent and notify that appointment within 30 days of the previous agent ceasing to be agent.

(iii) If PDVSA fails to comply with its obligation to appoint a new agent for the service of process, the lender may appoint an agent for service of process on PDVSA.

The court said that “authorised” agent must mean authorised under the terms of the credit agreement, and therefore rejected the defendant’s argument that the bank’s appointment could not be an appointment of the defendant’s “authorised” agent for service as required by (i) above. If the bank appointed an agent on behalf of the defendant following its own failure to do so, then by definition that agent was the “authorised” agent of the defendant. To construe the clause otherwise would render the bank’s right to appoint a replacement agent “entirely nugatory and purposeless”.

The defendant tried to argue that it was “unfair” for it to be encumbered with an agent not of its choosing. The court found there was no unfairness, saying:

“if the defendant did not want to be at risk of an agent being appointed who it does not like [or] on terms of appointment that it did not like, all it need do is comply with its contractual obligation to appoint an agent in the first place”.

In relation to the 2017 credit agreement, where the defendant had not appointed a process agent at all, the court noted that the language of (iii) above”might be said to pre-suppose that PDVSA had at one stage appointed a process agent and failed to replace it”, including because of the reference to a “new” agent. However, adopting an “appropriately purposive construction”, that was not how the clause should be construed.

If the defendant’s construction were adopted, it would allow the defendant to frustrate the operation of the clause in the first place by failing to appoint an original process agent. The court said it was:

“clear from the authorities that the courts construe these clauses, so far as possible, in the light of their acknowledged purpose of allowing a speedy and certain means of service, and they seek to avoid a construction which allows the party to be served to deprive the clause of its intended benefit”.

In the court’s view, the better construction was that the bank’s ability to appoint a “new” agent did not require the defendant to have previously appointed an agent. The court likened the situation to one where: “Someone who has never owned a coat may still be said to buy a new coat, notwithstanding the fact that it is not a replacement…”

Rupert Lewis
Rupert Lewis
Partner
+44 20 7466 2517
Antonia Brindle
Antonia Brindle
Associate

Court of Appeal upholds High Court decision to grant summary judgment in FX de-pegging case

The Court of Appeal has upheld the High Court’s decision to grant summary judgment in favour of a bank defending a claim brought by a foreign exchange (FX) broker seeking to recover losses incurred on FX spot transactions during the 2015 “Swiss Flash Crash”: CFH Clearing Ltd v MLI [2020] EWCA Civ 1064.

In doing so, the Court of Appeal has confirmed that the bank’s terms and conditions of business (TOB) did not import into the FX transactions a contractual obligation to comply with “market practice”, so as to require the bank to re-price the transactions, or otherwise cancel them.

This decision will be of broader interest to financial institutions in that it provides reassurance that English courts are prepared to determine decisively, at the summary judgment stage, that the express terms of market standard master agreements will be enforceable and will not readily incorporate vague concepts of market practices into such contracts. This will be the case even if the claimant can point to its loss arising from unusual or important market events – a sophisticated claimant investor will be held to the consequences of an agreement in which they have failed to provide for market disruption.

Background

This case concerned FX transactions which the claimant broker entered into with the defendant bank on 15 January 2015, in which the claimant bought Swiss francs and sold euros, and were documented by a 2002 ISDA Master Agreement (the ISDA Agreement) together with an electronic confirmation. The FX transactions took place on the same day (and shortly before) the Swiss National Bank ‘de-pegged’ the Swiss franc from the euro, by removing the currency floor with respect to the value of the Swiss franc against the euro. This led to severe fluctuations in the foreign exchange market in those currencies. The extreme rates triggered automatic liquidation of certain client positions of the claimant at prices below the official low set by the e-trading platform for Swiss franc interbank trades, known as the Electronic Broking Service (EBS). Later that day, other banks amended the pricing of trades which they had executed with the claimant to prices at or above the official EBS low. The bank agreed to improve the pricing of its trades, but to a level below the EBS low.

The claimant’s case was that since the FX transactions were entered into at a time of severe market disruption, the bank was obliged to make a retrospective adjustment to the price of those transactions (e.g. to adjust the price to a rate to the EBS low, in accordance with alleged market practice), or to cancel them, in accordance with its express or implied contractual obligations and/or pursuant to a duty of care in tort.

The bank applied for strike out and/or summary judgment.

High Court decision

The High Court granted summary judgment in respect of all claims, holding there was no real prospect of the claim succeeding and that there was no other compelling reason for the claim to proceed to a trial. 

The High Court’s reasoning is summarised in our previous blog post here.

The claimant appealed.

Court of Appeal decision

The claimant contended that the effect of the bank’s TOB imported into the FX transactions a contractual obligation to comply with “market practice”, so as to require the bank to re-price the transactions at the EBS low, or otherwise cancel them. This was on the basis that the bank’s TOB provided that:

“All transactions are subject to all applicable laws, rules, regulations howsoever applying and, where relevant, the market practice of any exchange, market, trading venue and/or any clearing house and including the FSA Rules (together the “applicable rules”). In the event of any conflict between these Terms and any applicable rules, the applicable rules shall prevail…”

The Court of Appeal dismissed the appeal, finding that there was no arguable basis for holding that such an agreement had been made by the parties. The words “subject to” did not incorporate “market practice” into the contract; rather it meant that neither party was required to act contrary to such market practice (in which case it would be relieved of its contractual obligations).

The starting point for the contractual analysis was that the parties had agreed that their FX transactions would be governed by a standard ISDA Master Agreement, had negotiated the specific terms of the Schedule and had incorporated the 1998 FX Definitions, which would have permitted them to provide for market disruption. The transactions were therefore governed by a detailed contract which on industry standard terms reflected market practice and was tailored by the parties for their specific business relationship. The Court of Appeal also referred to the well-known observation of Briggs J in Lomas & Ors v JFB Firth Rixson Inc & Ors [2010] EWHC 3372 that the ISDA Master Agreement is probably the most important standard market agreement used in the financial world and that it was obvious that it should be interpreted in a manner that met the objectives of clarity, certainty, and predictability, so that the very large number of parties using it should know where they stand. The suggestion that the parties had agreed to incorporate “market practice” generally, even though not reflected in the ISDA Agreement and, indeed, overriding its provisions, therefore must be treated with considerable caution.

In the Court of Appeal’s view, it was also difficult to see how a “market practice” overriding the ISDA Agreement’s standard terms could be derived from the International Code of Conduct and Practice for the Financial Markets (the Code). Indeed, the Code itself recognised that Master Agreements should be entered into to reflect market practices and to provide for exceptional circumstances. The claimant in its arguments had focused on only one provision of the Code whilst ignoring the more fundamental recognition in the Code that legal certainty, including as to market practices and exceptional circumstances, should be ensured by adopting a Master Agreement.

Furthermore, the Court of Appeal considered that the alleged “market practice” was far too vague and uncertain to be incorporated as a contract term. It was not clear precisely what obligation was said to have arisen with regard to re-pricing (there being no reference in the Code to the “authenticated market price” or the “official low”), and when a party must re-price and when it must cancel. In the Court of Appeal’s opinion, the inclusion of those two very different routes would give rise, at best, to an unenforceable agreement to agree. The fact that the other liquidity providers “readily” complied with the alleged practice was deemed by the Court of Appeal to be rationalisation after the event, in circumstances where the terms of the relevant contracts with those counterparties were unknown to the court.

Finally, the Court of Appeal also firmly rejected the suggestion that the unusual and important nature of the market events was itself a compelling reason that the matter should be allowed to proceed to trial. The Court of Appeal remarked that there was no reason why the claimant should not be held to its bargain on the basis that it: (a) was a sophisticated commercial party who had entered into automatic transactions at the next available price without specifying a limit; and (b) had negotiated and agreed with the bank the ISDA Agreement, an agreement in which it could have but did not provide for market disruption.

Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Nihar Lovell
Nihar Lovell
Senior Associate
+44 20 7466 2529

High Court refuses to grant summary judgment based on contractual interpretation of Argentinian government bonds

The High Court’s recent judgment in Palladian Partners LP & Ors v The Republic of Argentina & Anor [2020] EWHC 1946 (Comm) is an interesting and high profile addition to the body of case law on the interpretation of complex financial instruments, here the terms and conditions applicable to euro-denominated government bonds issued by the Republic of Argentina in 2005 and 2010, as part of a restructuring which gave creditors of the Republic 25-35% of what they were originally owed.

The underlying dispute centres on a claim brought by three investment funds against the Republic on the basis that the Argentinian government allegedly improperly changed the baseline of the securities (referenced to the Republic’s GDP) used to calculate the amount due to the holders of the securities and declared that the relevant performance condition for payment was not met.

Applying established principles of contractual construction, the court refused to grant the Republic reverse summary judgment on the effect of two payment provisions in the terms and conditions applicable to the securities. The Republic contended that these clauses meant that the holders of the securities were bound by all calculations performed by the Argentinian Ministry of Economy in determining payment, and the claimants were therefore bound by its determination that the relevant performance condition for payment was not met.

The court did not accept that the Republic had the better of the arguments on the merits of the simple construction exercise, and stated that – in any event – this was not a case where the court could grasp the nettle and grant judgment in the Republic’s favour. It is a reminder that, while the court is willing to consider questions of contractual interpretation without the need for a full trial in an appropriate case; certain factors will make cases less likely to be suitable for summary determination, such as where the construction argument is hinged on commercial purpose for success.

Background

The claimants are holders of the Republic’s euro-denominated securities. As per the terms and conditions applicable to the securities, the Republic is required to pay to the holders annually an amount linked to the Republic’s GDP, subject to certain conditions being satisfied. The claimants brought a claim against the Republic alleging that in 2013 the Republic had incorrectly decided that no payment was due to the holders because one of the conditions for payment under the terms and conditions, that the actual GDP growth in that year is higher than the base case GDP growth (the “Performance Condition”), had not been satisfied.

The claimants allege that when the Republic rebased the securities in 2013 and changed the baseline of the securities from 1993 to 2004, it failed to adjust the base case GDP (calculated based on 1993 prices and a factor in determining if the Performance Condition is met) by the fraction set out in the terms and conditions (the “Adjustment Provision”). The claimants’ case is that if the Republic had applied the Adjustment Provision to the base case GDP, then the Performance Condition would have been satisfied, which consequently would have required the Republic to calculate the amount due to the holders of the securities (the “Payment Amount”). The claimants allege that this would have resulted in a payment of €525-€645 million to them.

In connection with the above litigation, the Republic made the following two applications –

  1. For summary judgment – the Republic’s contention was that on the proper construction of the terms and conditions, the Ministry of Economy’s determination that no payment was due to the holders of the securities in 2013 is binding on the claimants, unless they have properly pleaded and can prove bad faith, wilful misconduct or manifest error on the part of the Ministry of Economy. Therefore, if the court agreed with the Republic that under the terms and conditions the claimants were bound by the determination made by the Ministry of Economy that the Performance Condition was not met, then the claimants’ underlying claim (including in relation to the application of the Adjustment Provision to the base case GDP) falls away.
  2. To strike out the claim – the Republic’s argument was that the claimants’ secondary allegation of bad faith, wilful misconduct and / or manifest error is not properly pleaded and is therefore defective.

Decision

The High Court (Cockerill J) dismissed both applications.

(1) Application for summary judgment

The Republic’s application for summary judgment turned on the proper construction of two instances of what were termed as the “Binding Effect Provisions” in the terms and conditions. The first instance is in the definition of Payment Amount (emphasis added):

All calculations made by the Ministry of Economy hereunder shall be binding on … all Holders absent bad faith, wilful misconduct or manifest error on the part of the Ministry of Economy”.

The other instance is in the definition of Excess GDP (a form of GDP used in the calculation of the Payment Amount) which provides that:

All calculations necessary to determine Excess GDP … will be performed by the Ministry of Economy … and such calculations shall be binding on … all Holders of this Security, absent bad faith, wilful misconduct or manifest error on the part of the Ministry of Economy”.

The Republic argued that the Binding Effect Provisions applied to all the calculations made by the Ministry of Economy in determining the Payment Amount (including the base case GDP and the Performance Condition) and not just the calculations found in the definitions of Payment Amount and Excess GDP.

The court did not accept that the Republic had the better of the arguments on the merits of the construction exercise, and stated that – in any event – this was not a case where the court could grasp the nettle and grant judgment in the Republic’s favour. In refusing summary judgment, the key observations made by the court on the question of contractual construction of the terms and conditions of the securities were as follows:

  • The court held that on a simple reading of the Binding Effect Provisions, they are intended to cover only the calculations described in the Payment Amount and Excess GDP provisions as they are not free-standing provisions but tail-end the respective definitions. The court noted that if sophisticated legally-advised parties intended the Binding Effect Provisions to have general effect, they would have included them as a separate provision. This was further bolstered by the fact that the terms and conditions included provisions that were meant to have general effect as stand-alone provisions, for instance, general limitation of liability provisions.
  • In terms of the wider context, the court considered there to be a real distinction between the wording in relation to the satisfaction of the conditions and the calculation of the Payment Amount, which further weakened the Republic’s argument. The Payment Amount is expressly stated to be subject to the conditions. The conditions are then presented separately and are expressed in terms of entitlement and conditionality, not calculation.
  • Further, though not considered in detail given the conclusions reached in the previous paragraphs, the court preferred the claimants’ argument that the Binding Effect Provisions used classical words of exception, and would therefore need to be subject to a strict approach to construction.
  • The court also considered that the Republic’s commercial purpose argument, that a comprehensive Binding Effect Provision was required to promote certainty against a background where many of the holders had bought the securities long after they were issued and where the determination of the Payment Amount requires a number of calculations, was not one which was suitable for a summary determination.

Accordingly, the court found that the claimants had the better of the arguments in relation to the interpretation of the Binding Effect Provisions and dismissed the Republic’s summary judgment application.

(2) Application to strike out the claim

The Republic’s strike out application fell away as it was contingent on the court’s ruling on the summary judgment application. However, the court still considered the application briefly. In summary, the court did not accept the Republic’s contention that at the pleading stage, reference to a specific person who made an error or acted in bad faith or engaged in wilful misconduct is necessary. In the context of fraud, the court relied on the authorities to state that at the pleading stage what is required is not a pleaded set of facts which lacks any other possible explanation than fraud, but rather the pleading of facts which, if proved at trial, tilt the balance towards justifying a plea of fraud.

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High Court finds no duty of care owed for late execution of orders due to unforeseen market turbulence

The High Court has dismissed a claim brought by an investment company against a foreign exchange trading platform seeking to recover losses it suffered as a result of the late execution of stop loss orders (SLOs) at disadvantageous exchange rates, following the de-pegging of the Swiss Franc from the Euro in 2015: Target Rich International Limited v Forex Capital Markets Limited [2020] EWHC 1544 (Comm).

This decision will be of interest to financial institutions as it provides another helpful example of the courts taking a robust approach to resisting claims for losses caused by unforeseen market volatility.

The court held that there was no express or alternatively implied duty on the defendant to execute the SLOs at the stop loss price. The defendant was no more than an intermediary between liquidity providers and its clients. The existence of the SLOs did not impose an obligation on the defendant to take its own position at the stop loss price and so engage in a substantively different sort of business, namely as a market maker, whether or not the corresponding price was available in the market.

The court also made it clear that parties could only incorporate a set of regulatory rules (such as the Conduct of Business Sourcebook (COBS)) by “express and obvious words of incorporation” and emphasised that it was already well-established in English case law that regulatory obligations do not automatically translate into the direct creation of private law rights. The court further clarified that the mere existence of the COBS rules did not give rise to a concurrent duty of care in tort.

Despite this issue not strictly arising for determination, the court also held that if the defendant had owed the relevant obligations, there would have been no breach due to the existence of a force majeure clause in the agreement. This is especially significant given the current COVID-19 context. 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 claimant traded various currency pairs through the defendant’s platform from 2012. This trading included a number of open trades on the Euro/Swiss Franc (the Trades) aimed at making a profit from the appreciation of the Euro against the Swiss Franc. However, in order to protect itself against future losses (in particular, the depreciation of the Euro against the Swiss Franc) the claimant also had a series of SLOs in place. Under the SLOs, the Trades would be automatically closed out and executed at market price if the Euro/Swiss Franc rate reached 1.17911. At the time of the Trades, the Swiss National Bank (SNB) maintained a cap on the value of the Swiss Franc as against the Euro at 1 Euro to 1.20 Swiss Franc.

On 15 January 2015, the SNB announced the removal of the cap with immediate effect, which appears to have taken the market by surprise and resulted in an immediate period of great volatility (known as the Swiss Flash Crash). The SLOs’ limit was surpassed shortly after the SNB’s announcement, but the defendant’s system circuit breakers (SCBs) triggered immediately thereafter prevented the automatic execution of the SLOs. The SCBs temporarily suspended both pricing and trading on the defendant’s platform. Later in the day, the defendant lifted the SCBs (on the basis that sufficient pricing stability had returned) in order to execute the backlog of orders, including the claimant’s SLOs. The SLOs were executed at rates of around 1.03, but all the Trades were loss-making.

The claimant’s case was that the defendant acted in breach of contract and negligently in failing to execute the SLOs when they were triggered shortly after the SNB’s announcement.

Decision

The court dismissed the claimant’s case.

The key issues which are likely to be of broader interest to financial institutions are summarised below.

Issue 1: Express or alternatively implied term to execute stop loss orders

The claimant argued that the Terms of Business (the Agreement) incorporated (i) the specific instructions in relation to the SLOs given by the claimant to the defendant, and therefore contained an express term to execute the SLOs at the stop loss price; or alternatively incorporated (ii) the defendant’s Order Execution Policy (OEP), and therefore contained an express or alternatively implied term to execute the SLOs at the stop loss price.

The court dismissed the claimant’s arguments.

Specific instructions

The court held that there was no express or implied term requiring the defendant to comply with the SLOs at the stop loss price. The court noted that the Agreement contained an express term to the effect that an instruction would not constitute a binding contract until that instruction was executed and confirmed through the trading platform. The Agreement further provided that the acceptance of an instruction did not constitute any agreement or representation that the defendant would execute the instruction. The court also commented that in a market such as a foreign exchange where the defendant acts an intermediary, rather than market maker, it is of commercial importance that there be clarity as to the creation, nature and scope of legal obligation. In this case, the Agreement clearly determined the scope of the legal obligations between the parties and the meaning and effect of the relevant terms were not susceptible to any real doubt.

The court remarked that, even leaving aside the relevant provisions of the Agreement, it would reject the argument that the Agreement incorporated the specific instructions in relation to the SLOs on the basis that the defendant was no more than an intermediary between liquidity providers and its clients. It would not have been known at the time of placing the SLOs whether any liquidity provider would make an offer at the precise level of the SLOs and the defendant was under no obligation to take its own position at the stop loss price.

The court also stated that even if the claimant had established there was a binding contractual obligation on the defendant to execute the SLOs once triggered, there still would have been no breach of duty. The losses were incurred as result of the SCBs, which were market standard and intended for consumer protection.

Order Execution Policy

The court held that the OEP did not form part of the Agreement. There was an express provision in the Agreement to this effect and this was reinforced by an entire agreement provision. The court also noted that an obligation in the COBS rules to provide information on the OEP did not mean that the OEP became a term of the contract.

Issue 2: Express or alternatively implied best execution terms from the COBS rules

The claimant submitted that the Agreement also incorporated, as express or alternatively implied best execution terms, the relevant provisions of the COBS rules on the following grounds:

  • the COBS rules were implied into the Agreement as a matter of law and that this was necessary to give effect to the Markets in Financial Instructions Directive 2004/39/EC (MiFID) under European law;
  • the COBS rules were expressly incorporated by reference into the Agreement; or
  • the COBS rules were implied into the Agreement as a matter of fact as it was necessary to do so in order to meet the “officious bystander test”, especially as it was incomplete.

The court rejected all of the claimant’s submissions.

Implication as a matter of law

The court held that the COBS rules were not mandatorily implied into every agreement of every authorised entity conducting investment business.

The court noted that there was a consistent series of court decisions providing that there is no direct right of action for breach of the COBS rules other than through s.150/138D FSMA. Also, MiFID did not require member states to provide protection for consumers by means of a direct right of action against an authorised person. The court also commented that it was incorrect to assert that the implementation of MiFID had not been sufficient to render “effective” the enforcement of rights for breach of its obligations. There were several routes to regulatory enforcement of MiFID. Even if this were not the case and the implementation of MiFID had been “ineffective”, this would not translate into the direct creation of private law rights.

Incorporation by reference

The court held that there were no express and obvious words of incorporation. This indicated that there was no contractual intention to do so. The court found that the references in the Agreement to the defendant “acting in compliance with MiFID” or to the claimant being afforded “regulatory protections” were insufficient.

The court also held that there was no incorporation by assumption. The COBS rules were binding as regulatory obligations but this did not mean that they become binding by way of contractual obligation.

Implication as a matter of fact

The court held that the implication of the COBS rules was neither necessary nor obvious. The Agreement was perfectly workable without the implication of the rules.

Issue 3: Concurrent duty of care to comply with COBS rules

The claimant submitted that it was mandatory that the COBS rules were implied into the Agreement as a matter of European law and that every authorised entity conducting investment business owed duties of care in tort to the like effect.

The court rejected this submission.

The court held there was no concurrent duty of care to comply with the COBS rules. The court noted that the mere existence of the COBS rules does not give rise to a co-extensive duty of care. To do so would be contrary to Parliament’s intention to confer a limited cause of action for a limited class of persons (Green & Rowley v The Royal Bank of Scotland plc [2013] EWCA Civ 1197 followed; see our blog post on this decision).

Issue 4: Effect of the force majeure clause

Although the claimant’s case had failed for the reasons outlined above, the court considered whether the force majeure clause in the Agreement would have been engaged as a result of the Swiss Flash Crash. The force majeure clause in the Agreement provided that: (i) an Exceptional Market Event would constitute a Force Majeure Event; and (ii) such a Force Majeure Event would immediately suspend the defendant’s obligations for the duration of the Force Majeure Event. The Agreement defined Exceptional Market Event as:

“the suspension, closure, regulation, imposition of limits, special or unusual terms, excessive movements, volatility or loss of liquidity in any relevant market or underlying instrument, or where the Company reasonably believes that any of the above circumstances are about to occur.”

The court accepted that: (i) the excessive volatility and excessive loss of liquidity of the Swiss Flash Crash constituted an Exceptional Market Event within the definition in the Agreement; and (ii) the force majeure clause satisfied the reasonableness test under the Unfair Contract Terms Act 1977.

On the basis of the above, the court commented that if the defendant had owed the relevant obligations as argued by the claimant, the force majeure clause would have suspended those obligations. In that event, no breach would have been committed in any case by the defendant.

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Court of Appeal confirms borrower’s right to withhold payment under English law Tier 2 Capital facility agreement where risk of US secondary sanctions

In a recent decision, the Court of Appeal has confirmed that the terms of an English law facility agreement in respect of Tier 2 Capital, 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. In the view of the Court of Appeal, this result effectively balanced the competing interests of the lender to be paid timeously against the borrower’s ability to delay making a payment where it would be illegal (in a broad sense of the word, and under a different system of law to the facility agreement) and therefore affect the borrower’s ability to conduct its ordinary business: Lamesa Investments Limited v Cynergy Bank Limited [2020] EWCA Civ 821.

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, parties can contract out of this general rule, which is what happened in this case. Clause 9.1 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”.

At first instance, the High Court, applying the usual principles of contractual interpretation, 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 (read our previous banking litigation blog post).

The Court of Appeal agreed with the High Court’s outcome but adopted different reasoning. In particular, the Court of Appeal emphasised that the relevant clause was a standard term and the factual background therefore had a much more limited role to play in the interpretation than that ascribed by the High Court. Whereas the High Court focused on the specific intentions of the parties to the facility agreement in question, the Court of Appeal focused on the more general context of agreements for the provision of Tier 2 Capital within the EU.

While the High Court decision could be seen as limited to the specific facts of the case, the Court of Appeal’s conclusion that “the balance between the interests of the parties to this type of facility agreement in respect of Tier 2 Capital favours the application of the proviso to clause 9.1 to the standard form of US secondary sanctions legislation” potentially has broader implications for the interpretation of similar clauses in similar agreements. The decision emphasises the need for parties to consider the potential impact of extraterritorial sanctions regimes on the performance of their obligations, to include a clear contractual allocation of risk in this regard and to pay close attention to any standard form clauses which might affect the allocation of this risk.

Many sanctions practitioners were surprised with the first instance decision in this case – and in particular the proposition that secondary sanctions (which may be imposed on a discretionary basis under a legal system which is not applicable to the parties or the contract) amount to a “mandatory provision of law” with which “compliance” is required. Whilst the case turned on the construction of a particular contract, it raised new uncertainty as to the ability of parties to avoid contractual performance in light of secondary sanctions risk, in the absence of clear wording to that effect. In this context, the Court of Appeal judgment is broadly helpful by focusing on the particular backdrop of EU Tier 2 capital requirements – although, as noted above, the emphasis on the fact that this was a standard clause means the case has read-across value in respect of similar agreements.

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 as Tier 2 Capital for a term of 10 years, with interest payable 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 to 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. Under a particular provision of US legislation, namely 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.

High Court decision

The High 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 High Court reiterated 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. The High Court found that it did.

The High Court’s reasoning is summarised in our previous blog post here.

Court of Appeal decision

The lender appealed against the High Court’s decision on the basis that:

  1. The relevant US legislation contained no express legal prohibition on payment and the borrower could not say that it refused to pay “in order to comply with [a] mandatory provision of law”, when the relevant legislation did not even purport to bind the borrower to act or not act in a particular way.
  2. The High Court was wrong to construe clause 9.1 as if it were a one-off negotiated provision when it was in fact a standard form clause.

The Court of Appeal dismissed the appeal. Sir Geoffrey Vos (with whom Males LJ and Arnold LJ agreed) held that the High Court had made the correct order, but the Court of Appeal did not agree entirely with the reasons given at first instance.

The Court of Appeal set out the usual principles of contractual interpretation and noted a number of additional relevant factors that the High Court may have overlooked.

  • Clause 9.1 of the facility agreement was a standard term in common usage at the time. The Court of Appeal referred to previous authority emphasising that standard form agreements should, as far as possible, be interpreted in a way that achieves clarity, certainty and predictability so that the large number of parties who use the standard forms know where they stand. A standard form is not context specific and evidence of the particular factual background or matrix has a much more limited, if any, part to play in the interpretation. The focus is ultimately on the words used, which should be taken to have been selected after considerable thought and with the benefit of the input and continuing review of users of the standard forms and knowledge of the market (Re Lehman Brothers (No 8) [2016] EWHC 2417 (Ch)).
  • The Court of Appeal said that consideration of the context of the facility agreement that led to the inclusion of the standard term, had to be against the background of two more general considerations: (i) that it would take clear words to abrogate a repayment obligation in a loan agreement; and (ii) that, in construing a commercial contract, the court must always take into account the commercial interests of both parties. The Court of Appeal noted that there were indications in the High Court’s decision that it was more focused on the commercial interests of the borrower than those of the lender.
  • The process of interpretation is a unitary exercise. The court starts with the words and relevant context and moves to an iterative process, checking each suggested interpretation against the provisions of the contract and its commercial consequences. The court must consider the contract as a whole and give more or less weight to elements of the wider context in reaching its view as to its objective meaning.

The Court of Appeal went on to consider the relevant context to the facility agreement.

  • This was a standard provision in a loan agreement used for the provision of Tier 2 Capital to an international bank. The capital was required under the Capital Regulations including CRD IV (Directive 2013/36/EU). The non-payment provisions in this type of loan are different to ordinary loan agreements. The loan is subordinated and can only be enforced by winding up the borrower and repayment events are controlled.
  • The High Court seemed to have lost sight of the fact that clause 9.1 was drafted to deal with possible future events that went far beyond sanctions in general and US sanctions in particular. The High Court seemed to have treated clause 9.1 as if it had been inserted to deal only with prospective possible US sanctions affecting the lender.
  • It was important that clause 9.1 did not extinguish the borrower’s repayment obligation entirely. It merely abrogated any default so that the lender could not enforce payment by presenting a winding-up petition. The argument was therefore about the timing of the payments rather than about whether those payments would ever be made.
  • The Court of Appeal concluded that the context to clause 9.1 was a balance between the desire of the lender to be paid timeously and the desire of the borrower not to infringe mandatory provisions of law, regulation or court orders.

The Court of Appeal then considered the competing meanings of the clause. In particular, whether the wording of clause 9.1 meant that the reason for non-payment must be:

  1. To comply with a statute that binds the borrower and directly requires the borrower not to pay the sums in question (the lender’s argument); or
  2. To comply with an actual or implied prohibition on making such payments in legislation (or regulation or order) that affects the borrower (the borrower’s argument).

The Court of Appeal followed the unitary process to determine the correct interpretation, accepting that the wording of the clause was ambiguous and it was therefore relevant to consider the admissible context and commercial common sense.

There were three aspects of admissible context that the Court of Appeal considered were of great importance:

  • The terms of the EU Blocking Regulation that must have been known to the parties and the drafters of the standard clause. The EU Blocking Regulation does not apply to the US/Russia sanctions, but in the context of other US secondary sanctions measures (notably in relation to Iran and Cuba) it regards specified US secondary sanctions legislation as imposing, in the court’s view, a “requirement or prohibition” with which EU parties are required to “comply”. The EU Blocking Regulation therefore uses similar language to clause 9.1.
  • The fact that clause 9.1 was a standard clause.
  • US secondary sanctions would have been at the relevant time one (but not the only) potential problem affecting parties to agreements for the provision of Tier 2 Capital within the EU. The drafter of the clause must have intended the borrower to be capable of obtaining relief from default if its reason for non-payment was to “comply” with a foreign statute that would otherwise be triggered.

Taking this context into consideration, the Court of Appeal reflected on the rival meanings of clause 9.1 as follows:

  • The lender’s main argument was that, once one accepted that the clause was ambiguous, the wording could not be clear enough to excuse something so crucial to the agreement as non-payment. That, however, assumed that payment would be abrogated rather than delayed. Adopting the unitary approach, it also needed to be considered that the utility of clause 9.1 would be badly dented if the lender’s interpretation was correct.
  • If a “mandatory provision of law” only referred to one that directly bound the borrower not to pay, it would have almost no possibility of taking effect.
  • While the US legislation cannot, and does not purport to, prohibit a payment by the borrower to the lender, its effect is clearly one of prohibition.
  • As noted above, a compelling argument in favour of the borrower’s interpretation was the drafting of the EU Blocking Regulation. Interestingly, the court dismissed an argument that the wider drafting of the Blocking Regulation was a distinguishing feature (the Regulation refers to persons “[complying]…with any requirement or prohibition, based on or resulting, directly or indirectly, from the laws specified in the Annex…”, rather than persons complying with the laws themselves).
  • It was not certain that payment under the facility agreement would attract the imposition of a sanction on the borrower, but it was clear that (as a matter of US law) the imposition of a sanction would be mandatory, subject to the payment not being deemed “significant” or the President otherwise deciding that it was not in US interests to impose the sanction. There seems to have been little weight ascribed to the practical experience of secondary sanctions enforcement, with the court observing that “what matters here is [the borrower’s] reason for the non-payment, not whether [the borrower] is certain or only likely to be sanctioned if it makes the payment”.
  • The Court of Appeal noted that the competing interests of the parties to a Tier 2 Capital facility agreement including clause 9.1 are the lender’s interest in being paid timeously and the borrower’s interest in being able delay payment if, put broadly, payment would be illegal, not only under English law but under any system of law which would affect the borrower’s ability to conduct its ordinary business. Overall, the balance between the interests of the parties to this type of facility agreement favours the application of clause 9.1 to US secondary sanctions legislation.

The Court of Appeal therefore dismissed the appeal.

Conclusion

It is clear from this decision that parties should consider the potential impact of extraterritorial sanctions regimes on the performance of their obligations, to include a clear contractual allocation of risk in this regard and to pay close attention to any standard form clauses which might affect the allocation of this risk.

The case also raises an interesting Blocking Regulation point. Particularly following the revisions to the Blocking Regulation arising from the US withdrawal from the Joint Comprehensive Plan of Action (JCPOA), EU businesses wishing to contract on terms that require performance not to be conducted in a way which is secondarily sanctionable, have been struggling with how to ensure that such contractual language is “Blocking Regulation compliant”. There is a concern that contracting on such terms (by either party) may amount to compliance with a requirement or prohibition which is based on the Blocked Laws. Here, the relevant sanctions regime was the US/Russia regime, and accordingly the Blocking Regulation was inapplicable. However, the court appears to have considered that a contractual provision that required compliance with US secondary sanctions as well as potentially other foreign law – which must logically include the Blocked Laws under the Blocking Regulation, as well as the US/Russia sanctions – did not itself constitute an infringement of the Blocking Regulation. The enforceability of the clause would no doubt have been impacted if it had been relied upon in the context of the Iran or Cuba secondary sanctions, but it does not appear to have been argued that the clause itself was unlawful because of its implicit coverage of, inter alia, the Blocked Laws. It does not appear that this point was argued, and accordingly one would need to be cautious about placing undue weight upon it, but it adds to the incrementally growing body of judicial observations that will be relevant to the interpretation of the Blocking Regulation, if and when it is finally considered directly in a dispute or enforcement action.

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