Court of Appeal decision in Adams v Options: the meaning of “advice” and potential implications for financial product mis-selling claims

In the context of an investor’s claim against the provider of his self-invested personal pension (SIPP) under s.27 of the Financial Services and Markets Act 2000 (FSMA), the Court of Appeal has provided guidance on the question of what constitutes “advice” on investments for the purpose of article 53 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO), which will be of broader interest to the financial services sector, beyond pensions-related disputes: Adams v Options UK Personal Pensions LLP [2021] EWCA Civ 474.

The underlying claim involved a pensions scheme operated by an unregulated intermediary (CLP), which persuaded the investor, Mr Adams, to cash out his existing pension fund and invest in “storepods” via a SIPP operated by Options UK Personal Pensions LLP (formerly Carey Pensions UK LLP). The Court of Appeal found that Mr Adams only agreed to transfer his pension fund into the Carey SIPP in consequence of things said and done by CLP in contravention of the general prohibition imposed by s.19 FSMA (which bars anyone except an authorised/exempt person from carrying on a regulated activity in the United Kingdom). Despite the fact that Carey had no knowledge that CLP was carrying out regulated activities, the Court of Appeal held that Mr Adams was entitled to recover his investment from Carey pursuant to s.27 FSMA.

The decision provides some interesting commentary on the meaning of “advice” in a financial services context, and the operation of the “no advice” clause in the pension contract between Carey and Mr Adams. These issues are considered below, although for a more detailed analysis of the decision, please see our Pensions Notes blog post.

Carey has applied to the Supreme Court for permission to appeal.

Meaning of “advice” in a financial services context

Central to the Court of Appeal’s decision on the s.27 FSMA claim, was its conclusion that CLP carried on a regulated activity by providing “advice” on investments to Mr Adams within the meaning of article 53 of the RAO. The Court of Appeal cited with approval the key authorities considering what constitutes “advice” in this context: Walker v Inter-Alliance Group plc [2007] EWHC 1858 (Ch) and Rubenstein v HSBC Bank plc [2011] EWHC 2304 (QB) and confirmed the following general principles:

  • The simple giving of information without any comment will not normally amount to “advice”.
  • However, the provision of information which is itself the product of a process of selection involving a value judgment so that the information will tend to influence the decision of the recipient is capable of constituting “advice”.
  • Any element of comparison or evaluation or persuasion is likely to cross the dividing line.
  • “Advice on the merits” need not include or be accompanied by information about the relevant transaction. A communication to the effect that the recipient ought, say, to buy a specific investment can amount to “advice on the merits” without elaboration on the features or advantages of the investment.

It is important to recognise the different contexts in which the meaning of “advice” has been considered in the cases cited:

  1. As explained above, in Adams v Options, the court looked at this question to determine whether or not the activity of an unregulated entity was a specified type of regulated activity under the RAO.
  2. In Rubenstein (and more recently in Ramesh Parmar & Anor v Barclays Bank plc [2018] EWHC 1027 (Ch), see our blog post), the court considered whether a sale was advised or non-advised for the purpose of the Conduct of Business Rules (COB) (since replaced by the Conduct of Business Sourcebook (COBS)). In these cases, the question of whether the sale was advised/non-advised underpinned the relevant claimant’s case that the bank was liable under s.138D (formerly s.150) FSMA for breach of COB/COBS rules.
  3. The court has also been asked to consider whether a sale was advised or non-advised for the purpose of establishing whether a bank owed a duty to use reasonable skill and care in giving advice and/or making recommendations about the suitability of a financial product. These questions formed part of the claim in Rubenstein, which included claims for breach of contract and in negligence, and were also considered in Crestsign Ltd v National Westminster Bank Plc & Anor [2014] EWHC 3043 (Ch).

It is unclear whether the general principles confirmed in Adams v Options as to the meaning of “advice” will apply to all of the scenarios identified above, or if they will be confined to the court’s interpretation of the RAO. The court appears to have cited the authorities interchangeably between these cases, but there may be a tension between the ordinary English meaning of the word “advice” (e.g. for the purpose of considering a breach of contract or tortious claim) and “advice” for the purpose of the regulatory regime.

Impact of “no advice” clause in pension contract

Given its conclusion in respect of s.27 FSMA that Mr Adams had been advised, the court held that Mr Adams was entitled to recover money and other property transferred under his pension contract with Carey, unless the court was prepared to exercise its powers under s.28(3) FSMA to enforce the contractual agreement between the parties. Section 28 FSMA empowers the court to allow an agreement to which s.27 applies to be enforced or money/property transferred under the agreement to be retained, if it is just and equitable to do so. In considering whether to take such a course in a case arising under s.27, the court must have regard to “whether the provider knew that the third party was (in carrying on the regulated activity) contravening the general prohibition”.

Although Carey was not aware that the introducer (CLP) was carrying on unauthorised activities, the Court of Appeal rejected Carey’s argument that the pension contract should be enforced.

This outcome raises an interesting issue as to the contractual allocation of risk in the pension contract between Mr Adams and Carey, which expressly provided that Carey was instructed on an execution-only basis. As summarised by Lady Justice Andrews:

“There is nothing to prevent a regulated SIPP provider such as Carey from accepting instructions from clients recommended to it by an unregulated person, and from doing so on an “execution only” basis. But the basis on which they contract with their clients will only go so far to protect them from liability. If they accept business from the likes of CLP, they run the risk of being exposed to liability under s.27 of the FSMA.”

Accordingly, the practical effect of the Court of Appeal’s decision was to sidestep the provisions of the pension contract that defined the relationship as “non-advisory“ and expose Carey to specific risks associated with CLP’s (unauthorised) business model. It is clear that the court’s approach was driven by the very specific exercise of its discretion under s.28 FSMA, in particular to promote the key aim of FSMA to protect consumers, and to reflect the appropriate allocation of risk to authorised persons who have accepted introductions from unregulated sources.

This can be contrasted with the approach adopted by the court to no advice clauses in the context of civil mis-selling claims for breach of contractual and/or tortious duty in advising a customer as to the suitability of a particular financial product. The court has recently confirmed in Fine Care Homes Limited v National Westminster Bank plc & Anor [2020] EWHC 3233 (Ch) (see our blog post) that clauses stating that a bank is providing general dealing services on an execution-only basis and not providing advice on the merits of a particular transaction, are enforceable and are not subject to the requirement of reasonableness in the Unfair Contract Terms Act 1977 (UCTA) when relied upon in the context of a breach of advisory duty claim.

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Hong Kong court refuses to expand scope of Quincecare duty

The Hong Kong Court of First Instance has dismissed a claim for breach of the so-called Quincecare duty of care on the basis that the duty could only arise in circumstances where misappropriation of a customer’s funds occurred by an authorised or trusted agent of the customer, rather than where the customer itself instructed payment as a result of being tricked or defrauded by a third party: Luk Wing Yan v CMB Wing Lung Bank Ltd [2021] HKCFI 279.

As discussed in our previous blog posts, the Quincecare duty of care is a key risk area for financial institutions handling client payments, given the proliferation of claims relying on the duty and an expansion in the scope of the duty in recent judgments. As a reminder, the duty arises where a bank has received a payment mandate from an authorised signatory of its customer, and executed the order, in circumstances where (allegedly) there were red flags to suggest that the order was an attempt to misappropriate the funds of the customer.

The recent decision of the Hong Kong court highlights the global nature of the Quincecare duty risk and illustrates the strict parameters of who the duty can be owed to. In summary, the Hong Kong court reached the same conclusion as the English High Court in Philipp v Barclays Bank UK plc [2021] EWHC 10 (Comm) (see our banking litigation blog post) and refused to broaden the scope of the duty to protect an individual customer who had instructed the bank to make the relevant payment directly, confirming that existing authorities limit the Quincecare duty to protect corporate customers or unincorporated associations such as partnerships.

For further information, please see our Asia Disputes blog post.

High Court finds alleged frustration of contract due to COVID-19 pandemic is not sufficiently arguable to grant injunction restraining demand under letter of credit  

The High Court has dismissed an application for an injunction to prevent an airline group from making demands under bank-confirmed standby letters of credit (SBLCs), securing aircraft leases granted to the claimant (a budget passenger airline), on the basis that it was not sufficiently arguable that the leases were frustrated due to the effects of the COVID-19 pandemic: Salam Air SAOC v Latam Airlines Group SA [2020] EWHC 2414 (Comm).

The court’s decision confirms the established position on the law of frustration, which requires a multi-factorial approach as per Edwinton Commercial Corporation v Tsavliris Russ (Worldwide Salvage and Towage) Ltd (The Sea Angel) [2007] 1 CLC 876. The decision highlights the importance that the nature of the contract and its terms may play when applying the multi-factorial approach. Here, the claimant had agreed to provide the SBLCs as an alternative to paying a cash deposit for the aircraft, and the SBLCs were commercially and legally intended to be equivalent to cash. The terms of the leases also expressly placed on the claimant the full risk of any disruption whatsoever to their airline business; they had been drafted to make it clear that the claimant’s obligation to pay continued in almost any conceivable circumstances. Taking these factors into account, the court found that the claimant’s frustration case was “far too weak” to justify the step of interfering with the operation of the SBLCs.

It is a noteworthy decision for financial institutions because of the obvious increased risk of frustration arguments relating to the ongoing COVID-19 pandemic. There have been relatively few decisions on frustration in recent years, most notably: Canary Wharf (BP4) T1 Ltd & Ors v European Medicines Agency [2019] EWHC 335 (Ch) (see our litigation blog post). While decisions applying the doctrine will depend on their precise facts, it is helpful to see recent authority confirming the established principles, in particular when considering the specific context of the COVID-19 pandemic. 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. Please also see our COVID-19 Contract Disputes Guide.

In addition, the decision will be a reassuring one for financial institutions as credit-providers under letters of credit and other similar instruments, providing certainty and clarity as to the high bar for any interference with their operation. In particular, it confirms that the enhanced merits standard for obtaining interim relief against the credit-provider applies equally to any injunction applications seeking to restrain the beneficiary from making a demand, i.e. that in either scenario, the claimant must establish that the case is “seriously arguable”.

Background

In 2017, the claimant budget passenger airline entered into three aircraft leases with the defendant airline group. The claimant leased the aircrafts with a view to operating domestic flights within Oman initially. The leases included an obligation on the claimant to: (a) pay rent and make other payments, which was “absolute and unconditional irrespective of any contingency whatsoever”; and (b) as an alternative to paying a deposit of three months’ rent, provide irrevocable and bank-confirmed SBLCs, under which the defendant would be entitled to withdraw all or part of the amount of the SBLCs and apply this in the same way as it would apply the deposit.

In March 2020, in response to the COVID-19 pandemic, the Oman Civil Aviation Authority introduced strict travel restrictions, notably the prohibition of all flights to or from Oman airports (with few exceptions such as cargo flights). The claimant stopped paying rent under the leases in March 2020, redelivered the aircrafts to the defendant in June 2020 and subsequently gave notice to terminate the leases.

The claimant made a without notice application to the court for an injunction to restrain the defendant from making a demand under the SBLCs, on the basis that the purpose of the leases was frustrated by the effects of the COVID-19 pandemic, in particular the strict travel restrictions introduced by the Omani authorities.

Decision

The court said that the application raised two threshold issues:

  • Whether it would be appropriate for the court to interfere with the operation of the SBLCs by injuncting the defendant (the beneficiary of the SBLCs) from making a demand under them.
  • If so, whether the claimant could demonstrate a sufficiently arguable case that the leases were frustrated by the effects of the COVID-19 pandemic.

The court found that the claimant failed to satisfy either of the threshold issues with the result that it was not entitled to the injunction it sought. The two issues are considered in further detail below.

Issue 1: Injunction against the credit-provider or beneficiary

The court considered whether it would be appropriate to interfere with the operation of the SBLC via injunctive relief, noting that the court will only intervene by injunctive relief in the operation of irrevocable letters of credit and similar instruments in “exceptional circumstances” because they are intended to be “the equivalent of cash”.

The court noted that for these reasons, the circumstances in which an applicant can obtain an injunction restraining the credit-provider from paying out under the instrument are limited to where the instrument itself is invalid or where the bank knows the demand for payment is fraudulent. The strength of case which the applicant is required to establish for the purpose of an injunction is an enhanced one (as per Alternative Power Solution Ltd v Central Electricity Board [2015] 1 WLR 697). The case must be “seriously arguable” and the American Cyanamid Co v Ethicon Ltd [1975] AC 396 principles on the granting of interim injunctions do not apply.

The claimant did not challenge the validity of the SBLCs, or suggest that any demand made by the defendant under them would be fraudulent. Rather, it alleged that the substantive and evidential obstacles which apply to an application for an injunction restraining a credit-provider (as set out above) do not apply to an applicant seeking an injunction restraining a beneficiary from making a demand (as in the present case).

The court accepted that it was bound by the decision in Themehelpe v West [1996] WB 84, in which the court found that in some circumstances an injunction to prevent the beneficiary from making a demand under an irrevocable letter of credit (and similar instruments) can be obtained even though the applicant is unable to satisfy the requirements of the fraud exception. However, given the criticism of that case in subsequent authorities and legal commentary, the court was not willing to give the decision any broader application than it strictly required. In the court’s view, that involved at least the following limitations:

  1. The applicant’s underlying claim against the beneficiary must include an allegation of fraud;
  2. The injunction must be sought “well before” the right to call on the instrument has arisen (although the court noted some hesitation in respect of this limitation); and
  3. The enhanced merits standard for obtaining interim relief against the credit-provider apply equally to any injunctions to restrain the beneficiary from making a demand.

Considering these limitations, the court repeated that the claimant did not contend that there was any fraud by the defendant in relation to the aircraft leases (nor did it argue that any term of the aircraft leases meant that the defendant was not permitted to make a demand). Further, the court stated that this was not a case in which the claimant sought an injunction “well before” the right to claim under the SBLCs arose.

Accordingly, the court concluded that the claimant was not entitled to the injunction sought.

Issue 2: Frustration

Notwithstanding its conclusions on the first issue, the court proceeded to consider whether the claimant was able to make out its frustration case to the requisite degree of arguability. As noted above, this required the claimant to establish a strong rather than merely arguable case. The court found that the claimant’s frustration case was “far too weak” and not sufficiently arguable to justify the step of interfering with the operation of the SBLCs.

Test for frustration

The court noted that the authorities on frustration had recently been reviewed in detail in Canary Wharf v EMA and pointed to the formulation of the test for frustration set out in National Carriers v Panalpina [1981] AC 675:

“Would outstanding performance in accordance with the literal terms of the contract differ so significantly from what the parties reasonably contemplated at the time of execution that it would be unjust to insist on compliance with those literal terms.”

On the application of that test, the court cited the leading authority of The Sea Angel, which confirms that the doctrine of frustration requires a multi-factorial approach, with the factors to be considered being:

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

The Sea Angel also confirms that the doctrine is not to be lightly invoked (mere expense, delay or a more onerous obligation are not sufficient) and the purpose of the doctrine is to do justice (and so considerations of justice are important factors to bear in mind). Part of that calculation is the consideration that the frustration of a contract may well mean that the contractual allocation of risk is reversed.

The parties agreed that the question for the court to consider was whether there had been “frustration of purpose” (i.e. that the frustrating event had transformed performance of the contract into something so radically different from the intended purpose that it would be unfair to hold the parties to their obligation), as opposed to the event of frustration making the contract physically or commercially impossible or illegal to perform.

Application of the test for frustration

In considering whether there was, in fact, frustration of the purpose of the contract, the court considered the nature of the contract and its terms, making the following observations:

  • Shared purpose. The court noted that the “frustration of purpose” doctrine had seldom been applied since it first emerged in the Coronation cases at the start of the last century, and in particular in Krell v Henry [1903] 2 KB 740. The Court of Appeal in that case emphasised that viewing the coronation procession was a “state of things assumed by both contracting parties as the foundation of the contract”, in finding that a contract to hire a flat in Pall Mall was frustrated when the coronation was postponed. In contrast, on the facts of the present case, there was nothing in the leases to suggest that the claimant’s use of the aircrafts was a shared purpose of both parties to the leases as opposed to a matter with which the claimant was alone concerned.
  • Allocation of risk. The leases expressly placed on the claimant the full risk of any disruption whatsoever to their business. The leases were drafted to make it clear that the claimant’s obligation to pay rent continued in almost any conceivable circumstances (i.e. a “hell or highwater” basis as per Bitumen Invest AS v Richmond Mercantile Ltd FZC [2016] EWHC 2957). The obligation to pay rent was expressed to be “absolute and unconditional irrespective of any contingency whatsoever”. In the court’s view, such clauses were fundamentally inconsistent with any suggestion that the existing Omani travel restrictions (for so long as they remained in force) or any other long-term suppression of air travel preventing the claimant from using the aircrafts to earn revenue through passenger flights with an Omani terminus had the effect of terminating the leases and freeing the claimant of its obligation to pay rent.
  • Right to terminate. The claimant had the option of terminating the leases on six months’ notice from a date on or after 4 years of the delivery date of the aircrafts if it ceased to carry on the business of air transport. But in the court’s view there was nothing on the facts to suggest that this contingency had arisen. The leases still had 3 years left to run on them at the time that it was alleged the inability to operate passenger flights frustrated them.

For these reasons, the court refused the claimant’s application.

Julian Copeman
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Natasha Johnson
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Maura McIntosh
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Ceri Morgan
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Court of Appeal rejects all claims relating to transfer of property portfolio to lender’s restructuring unit following borrower default

The Court of Appeal has upheld the High Court’s decision to reject all claims arising from the transfer of a defaulting borrower’s property portfolio to his lending bank’s restructuring unit during the global financial crisis. Dismissing the appeal in full, the Court of Appeal refused to imply any contractual terms into the mortgage, and did not accept claims that the bank owed a general duty to act in good faith in relation to the negotiation of the restructuring, or that the bank’s actions amounted to intimidation or economic duress: Morley (t/a Morley Estates) v The Royal Bank of Scotland plc [2021] EWCA Civ 338.

This decision is a reassuring one for financial institutions where borrower default has led to a restructuring and the bank is faced with attempts to rescind, especially where there has been significant market turmoil (such as the global financial crisis or the current COVID-19 pandemic). It highlights the difficulties for claimants bringing claims of this nature in circumstances where the bank’s exercise of its powers under a facility agreement are in line with its commercial interests and the negotiation of the relevant restructuring is between commercial parties with the benefit of legal advice.

The key points decided by the Court of Appeal that are likely to be of broader interest are as follows:

  • Duty to provide services with reasonable skill and care. The Court of Appeal rejected the implication of a contractual term into the original loan agreement under section 13 of the Supply of Goods and Services Act 1982 (the Act). It did not accept that the bank was under any implied contractual duty to exercise reasonable skill and care in negotiating the restructuring with the claimant after his default on the original loan; by then the parties’ relationship was governed by the express terms of the loan and the equitable principles applicable to that relationship. Even if owed, the Court of Appeal commented that this duty was not breached on the facts.
  • Duty to act in good faith. The Court of Appeal did not accept that the bank was subject to an implied contractual duty under the loan to act in good faith in its negotiations with the claimant. All the bank’s actions in any case, in the court’s view, were rationally connected to its commercial interests.  
  • Intimidation and economic duress. The Court of Appeal underlined that the bank had not committed the tort of intimidation and that the restructuring agreement between the bank and claimant was therefore not voidable for economic duress. In its view, the restructuring agreement concluded was the result of a robust negotiation between commercial parties, each of which had legal advice and was well able to look after itself in that negotiation. Also, it was notable that the restructuring agreement concluded was one that the claimant had wanted and had originally proposed.

The decision is considered in further detail below.

Background

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

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

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

The claimant brought proceedings against the Bank on the basis that in concluding this Restructuring Agreement, the Bank acted in breach of a duty owed to him pursuant to section 13 of the Act to provide banking services with reasonable care and skill and in breach of a duty of good faith, and seeking damages for breach of these duties. The claimant also contended that he was coerced into concluding the Restructuring Agreement by unlawful pressure placed upon him by the Bank, and that as a result of this coercion, the Bank committed the tort of intimidation and the Restructuring Agreement was voidable for economic duress.

High Court decision

The High Court dismissed the claim in full. The High Court’s reasoning is summarised in our previous blog post here. The claimant appealed.

Court of Appeal decision

The Court of Appeal found in favour of the Bank and upheld the High Court’s decision to dismiss the claimant’s claim. We consider below some of key issues considered by the court.

Issue 1: Duty to exercise reasonable skill and care in providing lending services

The claimant argued that the Bank was: (i) subject to a duty under the Act to provide lending services with reasonable care and skill (such a duty operated as an implied term of the original Loan Agreement); and (ii) in breach of duty because, in negotiating for the transfer of the properties to West Register, the Bank was acting as a buyer (i.e. seeking to obtain the properties with a view to medium or long term capital gain) rather than as a lender (i.e. seeking to recover the money which it had lent).

The Court of Appeal did not accept that the Bank was under any implied contractual duty to exercise reasonable skill and care in negotiating the Restructuring Agreement with the claimant after his default on the original Loan Agreement in December 2009. The Court of Appeal underlined that by then the parties’ relationship was governed by the express terms of the Loan Agreement and the equitable principles applicable to that relationship; an implied term in the original Loan Agreement therefore did not have any part to play in the parties’ relationship in the circumstances.

The Court of Appeal commented that even if the Bank did owe a relevant duty under the Act, it had committed no breach of duty; throughout the Bank’s only objective was to recover as much as possible of the amount which it had loaned to the claimant, but even if the Bank had mixed motives that would have made no difference – it was unnecessary that a mortgagee should have “purity of purpose”, i.e. that its only motive is to recover in whole or part the debt secured by the mortgage.

Issue 2: Duty to act in good faith

The claimant argued that the Bank was under an implied contractual duty under the original Loan Agreement to act in good faith, or not to act vexatiously or contrary to its “legitimate commercial interests”.

The Court of Appeal did not accept that the Bank was subject to such a duty in its negotiations with the claimant and noted that all the Bank’s actions in any case were rationally connected to its commercial interests.

The Court of Appeal highlighted that the High Court had already made a factual finding rejecting that the manner in which the negotiations were conducted were acts done in order to vex the claimant maliciously.

Issue 3: Intimidation and economic duress

The claimant argued that the High Court’s finding that he had not been coerced was wrong.

The Court of Appeal disagreed and highlighted that, on the facts of the case, there had been no coercion. The Court of Appeal said that the Restructuring Agreement concluded was the result of a robust negotiation between commercial parties, each of which had legal advice and was well able to look after itself in that negotiation. The Court of Appeal noted that the claimant: (a) was not above making threats (such as walking away from the properties to cause serious damage to the Bank’s security); (b) was prepared to exert political and public relations pressure on the Bank (by enlisting his MP and by engaging public relations consultations); and (c) was prepared to threaten an emergency application to a court for an injunction.

The Court of Appeal also commented that the claimant did not submit to the Bank’s demand and that the Restructuring Agreement concluded was one that the claimant had wanted and had originally proposed; it was the claimant’s successful persistence in the negotiations (e.g. in not being coerced) which enabled him to achieve his object and he therefore had entered into the Restructuring Agreement with the Bank of his own free will. The Court of Appeal said the fact that claimant did not take any steps to set the Restructuring Agreement aside until 5 years later was significant, as it not only demonstrated his affirmation of the Restructuring Agreement but also negated any finding of coercion. The Court of Appeal underlined that any doubt was dispelled by a submission document prepared by the claimant or on his behalf in August 2010 for a separate bank, in which the virtues of the deal with the Bank was extolled and described as a consensual deal which was driven by the claimant.

Accordingly, the Court of Appeal dismissed the appeal in full.

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High Court confirms current scope of Quincecare duty is limited to protecting corporate customers and does not extend to individuals

In a recent decision, the High Court has granted reverse summary judgment in favour of a defendant bank on the basis that the so-called Quincecare duty of care did not operate in the context of an authorised push payment (APP) fraud, where a third party fraudster tricked the bank’s customer willingly to instruct the bank to transfer large sums out of her account, which were then misappropriated: Philipp v Barclays Bank UK plc [2021] EWHC 10 (Comm).

The judgment is the latest in a line of judgments concerning the parameters of the Quincecare duty, which arises where a bank has received a payment mandate from an authorised signatory of its customer, and executed the order, in circumstances where (allegedly) there were red flags to suggest that the order was an attempt to misappropriate the funds of the customer. This recent decision is important and helpful for financial institutions, because it confirms that existing authorities limit the Quincecare duty to protect corporate customers or unincorporated associations such as partnerships (i.e. where the instruction to the bank has been given by a trusted agent of the customer). The decision confirms that the Quincecare duty does not currently extend to individual customers. On the facts of the present case, the court was not persuaded to extend the Quincecare duty to protect an individual customer in the context of an APP fraud, saying to do so would be contrary to the principles underpinning the duty.

There has been an unfortunate proliferation of APP frauds over recent years which has seen a staggering increase in the accompanying sums that individuals are therefore out of pocket. While this decision closes one avenue by which banks were said to be liable for compensating victims, it will only be of relevance when the circumstances of the fraud cause it to fall outside of the voluntary Contingent Reimbursement Model Code, which seeks to compensate victims of APP frauds and is funded by banks for this purpose.

Background

In March 2018, the claimant was the victim of an APP fraud. As part of an elaborate deception by a third party fraudster, the claimant transferred £700,000 in two separate tranches from her account with the defendant bank (Bank) to international bank accounts, in the belief that the money would be safe and that she was assisting an investigation by the Financial Conduct Authority (FCA) and the National Crime Agency (NCA).

The claimant brought a claim against the Bank to recover damages for the loss she suffered by making the two payments, alleging that the Bank owed and breached a duty of care to protect her from the consequences of the payments. In this context, the claimant relied upon the Quincecare duty of care (first established in Barclays Bank plc v Quincecare Ltd [1992] 4 All ER 343), saying that the extent of protection afforded to a customer through a bank’s observance of the Quincecare duty, required the Bank to have certain policies and procedures in place by March 2018 for the purpose of:

  • Detecting potential APP fraud;
  • Preventing potential APP fraud;
  • Stopping potential APP fraud; and
  • Stopping or reversing or reclaiming monies the subject of a potential APP fraud.

The claimant brought an alternative case based upon loss of a chance, on the basis that if the international transfers had at least been delayed by the Bank, she would have had the chance of recovering the monies before they reached the hands of the fraudster.

The Bank denied the claim and brought an application for strike out / reverse summary judgment, arguing that it did not owe a legal duty of the kind alleged by the claimant and that (even if such a duty was owed and breached) the claimant’s case on causation was fanciful.

Decision

The court held that that Bank did not owe the claimant a duty of care in respect of the APP fraud and granted summary judgment in favour of the Bank.

Suitability for summary judgment

The application turned upon the interpretation of the Bank’s alleged duty of care, i.e. whether or not the Bank should, in March 2018, have had in place a system for detecting and preventing the APP fraud perpetrated upon the claimant. The court was satisfied that this was a case giving rise to a short point of law or construction, and that the factual platform was sufficiently clear and stable, to enable it to grasp the nettle and decide the matter before the costs of the litigation increased further (applying the seventh proposition in EasyAir Ltd v Opal Telecom Ltd [2009] EWHC 339 (Ch)).

Scope and nature of the Quincecare duty of care

The difference between the parties arose from the extent of protection afforded to a customer through a bank’s observance of the Quincecare duty. This duty was first encapsulated in the decision from Steyn J in the case of the same name, in which he said as follows:

“…a banker must refrain from executing an order if and for so long as the banker is “put on inquiry” in the sense that he has reasonable grounds (although not necessarily proof) for believing that the order is an attempt to misappropriate funds of the company…And the external standard of the likely perception of the ordinary prudent banker is the governing one.”

The question for the court was whether or not the Quincecare duty owed by the Bank required it to have in place the policies and procedures alleged in the particulars of claim, for the purpose of detecting and preventing the APP fraud or for recovering any monies transferred by the claimant as a result of it.

In this context, the court made three important observations about the nature of the Quincecare duty from previous authorities including Quincecare itself, Lipkin Gorman v Karpnale Ltd  [1987] 1 WLR 987 and Singularis Holdings Ltd (In Official Liquidation) v Daiwa Capital Markets Europe Ltd [2019] UKSC 50, as follows:

  1. The purpose of the Quincecare duty is to protect a bank’s customer from the misappropriation of funds, carried out by a trusted agent of the customer who is authorised to withdraw its money from the account.
  2. The Quincecare duty is subordinate to the bank’s contractual duty to act upon a valid instruction (whether the payment of cheques, acting on oral/written instructions to transfer monies, or automated bank payment methods). The Quincecare duty is both ancillary and subject to that primary duty.
  3. The operative standard of the ordinary prudent banker enables a claimant customer to hold a defendant bank to objective (or industry) standards of honesty; it is not a test based on subjective dishonesty or “lack of probity” on the bank’s part (see Singularis).

The court found that it was clear from all three previous authorities that the particulars of claim amounted to an invitation to the court to extend the scope of the Quincecare duty beyond its established boundaries. Central to this conclusion was the court’s acceptance that the existing authorities limited the Quincecare duty to cases of attempted misappropriation by an agent of the customer. It emphasised that the present case concerned an authorised push payment fraud, i.e. the claimant herself gave authorisation for the international payments to be made and so there was no agent involved.

Suggested extension of the Quincecare duty

The case therefore raised a novel point of law, as to whether the Quincecare duty should be extended in the context of APP fraud.

The court adopted the approach in Gorham v British Telecommunications plc [2000] 1 W.L.R 2129, considering whether the alleged duty could be established through a process of appropriate incremental development of the common law by reference to circumstances not addressed in earlier cases considering the duty. The court confirmed that it would approach the question of incremental development of the Quincecare duty as follows:

  • While expert evidence might be required to assist the court in deciding whether the Bank fell short in the performance of its duties to the claimant, the court would not be assisted by expert evidence on the question of what those duties were – expert evidence was therefore irrelevant to the Bank’s application.
  • Various materials were published in relation to APP fraud prior to March 2018, but these materials did not support the conclusion that the Bank owed the claimant the duties alleged.
  • The decision as to the true scope and nature of the Quincecare duty turned, therefore, upon an analysis of the principles underpinning it.

Accordingly, the court proceeded to consider the principles underpinning the Quincecare duty, as articulated at numbered paragraphs 1-3 in the scope of duty section above.

(i) Purpose of the duty: corporate customers vs individuals

In the court’s view, the observations of Lady Hale in Singularis (in particular on corporate attribution and causation) about the purpose of the duty, did not sit comfortably with the extension of the Quincecare duty to an individual customer. The Supreme Court said nothing about a bank protecting an individual customer (and her monies) from her own intentional decision. Considering the factual context of Singularis, the court observed that “even a sole shareholder can steal from the company for whom he is a signatory at the bank” but the claimant in this case “could not steal from herself”.

It commented that, where the bank’s customer is an individual (and not a corporation or unincorporated association which is dependent upon individual representatives and signatories who have the potential to go rogue), the customer’s authority to make the payment is not only apparent but must also be taken by the bank to be real and genuine. As between the individual and the bank, the payment instruction will be no less real and genuine in relation to the intended destination of the customer’s funds because it has been induced by deceit.

The court highlighted another contrast between the position of an individual vs corporate customer, considering the effect on how legal title passes. In the present case, the claimant gave valid instructions to the Bank to make the transfers (albeit those instructions were procured by fraud), and therefore they remained valid in legally passing title to the monies to the fraudster. In contrast, where an agent of the bank’s customer misappropriates the customer’s monies, then a constructive trust will be deemed to have arisen at the moment of receipt (provided legal title to the funds can be asserted).

(ii) Duty subordinate/ancillary to primary duty to act on customer’s instruction

Concerning the interaction between a bank’s mandate to comply with customer instructions and its Quincecare duty, the court held that it should resist the claimant’s attempt to elevate the Quincecare duty to a position where it ceased to be ancillary or subordinate to a bank’s primary duty of acting upon its customer’s instructions. To do so, would “emasculate the primary duty”, by a supposedly subordinate duty assuming a heightened set of obligations. The court said that such an outcome should be avoided as it would “involve the triumph of unduly onerous and commercially unrealistic policing obligations over the bank’s basic obligation to act upon its customer’s instructions”.

The court further noted that banks “cannot be expected to carry out such urgent detective work, or treated as a gatekeeper or guardian in relation to the commercial wisdom of the customer’s decision and the payment instructions which result”.

(iii) No clear framework for extended duty to operate within

Additionally, the court considered that no clear framework existed by which such an extended duty could in practice sensibly operate. It noted that the Quincecare duty concerns the general concept that a bank will adhere to the “standards of honest and reasonable conduct in being alive to suspected fraud”, which Steyn J himself noted was not “too high a standard”.

The court held that the Quincecare duty is inherently a creature shaped by the conception of knowledge (actual or constructive) and not a negligent failure to adhere to an amorphous “code” of which the terms are not clearly defined. If the duty was to be extended beyond that general concept, it would have to be by reference to: “industry-recognised rules from which a bank could identify the particular circumstances in which it should not act (or act immediately) upon its customer’s genuine instructions”.

Loss of a chance

Given the court’s finding that the legal duty asserted did not arise, it was not necessary to consider the claimant’s anterior arguments, including her claim for loss of a chance in recovering the monies from the UAE; one which the court accepted could not have been determined summarily.

Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Scott Warin
Scott Warin
Associate
+44 20 7466 2479

Supreme Court hands down judgment in FCA’s Covid-19 Business Interruption Test Case

The Supreme 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 acted for the FCA who advanced the claim for policyholders.

The Supreme Court unanimously dismissed Insurers’ appeals and allowed all four of the FCA’s appeals (in two cases on a qualified basis), bringing positive news to policyholders across the country that have suffered business interruption losses as a result of the Covid-19 pandemic.

At first instance the FCA had been successful on many of the issues, and now the Supreme Court has substantially allowed the FCA’s appeal on the issues it chose to appeal. The practical effect is that all of the insuring clauses which were in issue on the appeal will provide cover for the business interruption caused by Covid-19.

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

High Court considers entitlement of investment firm to terminate Bitcoin trading account due to alleged money laundering concerns

The High Court has found in favour of a claimant investor in a dispute arising from the termination of her Bitcoin trading account with an online trading platform and concurrent cancellation of open trades (as a result of an alleged money laundering risk): Ang v Reliantco Investments Ltd [2020] EWHC 3242 (Comm). Although the claim relates to an account used to trade Bitcoin futures, the decision will be of broader interest to financial institutions, given the potential application to other types of trading accounts and accounts more generally.

The judgment is noteworthy for the court’s analysis of the defendant’s contractual termination rights in relation to the account and open trades. While the Customer Agreement provided the defendant with the right to terminate the account, the court found that the defendant remained under an obligation to return money deposited in the account (which was held under a Quistclose trust). As to the related open trades, the court found that the defendant only had a contractual right to close out the trades rather than to cancel them (or alternatively, the court said that the same result would be required under the Consumer Rights Act 2015 (the Act), as the investor was a “consumer” for the purposes of the Act).

The decision illustrates the risks for financial institutions seeking to terminate relationships with their customers, particularly in circumstances where there are money laundering or other regulatory compliance concerns. Often accounts may need to be closed without notice (as per N v The Royal Bank of Scotland plc [2019] EWHC 1770; see our banking litigation blog post). Claims against banks by customers in this type of scenario can be significant, and not limited to claims for money deposited in the account, extending to gains on outstanding trades and the loss of future investment returns but for the termination of the account. In the present case, the court found that the claimant was entitled to recover the loss on her investment returns, as it was deemed to be within the reasonable contemplation of the parties when they contracted that, if the defendant failed to repay the claimant sums which she had invested, she might lose the opportunity of investing in similar products.

In order to manage the litigation risks, it may be prudent for financial institutions to review the relevant contractual documentation associated with trading accounts to ensure that it: (i) allows for termination of the account in the relevant circumstances at the absolute discretion of the bank; and (ii) confers an appropriate contractual right to deal with any deposits and open trades. This is particularly the case where the customer is a consumer for the purposes of s.62 of the Act, as there will be a risk that any term in the contract consequently deemed unfair will not be binding on the customer.

Background

In early 2017, the claimant individual opened an account with an online trading platform (UFX), owned by the defendant investment firm. Through this account, the claimant traded in Bitcoin futures. The claimant’s husband (a specialist computer scientist and researcher with cybersecurity and blockchain expertise, and alleged inventor of Bitcoin) also opened accounts on UFX; however, these were blocked when the defendant identified though its compliance checks that he had previously been accused of fraud in 2015.

The claimant made substantial profits trading Bitcoin futures, which were then withdrawn from the UFX account. In late 2017, the defendant terminated the claimant’s UFX account and cancelled all related open transactions, apparently as a result of an alleged money laundering risk.

The claimant subsequently brought a claim alleging that the defendant did so wrongfully and seeking to recover: (i) the remaining funds in the account; (ii) the increase in the value of her open Bitcoin positions; and (iii) the sums from her proposed reinvestment of those funds.

The defendant sought to resist the claim primarily on the basis that the account had actually been operated by the claimant’s husband rather than the claimant and the claimant had provided inaccurate information to the defendant in her “Source of Wealth” documentation.

Decision

The claim succeeded and the key issues decided by the court were as follows.

Issue 1: Entitlement of defendant to terminate UFX account

The defendant argued that it was entitled to terminate the UFX account because: (i) there was a breach of certain clauses of the Customer Agreement relating to access to the UFX account – there had been misrepresentations during the course of the existence of the claimant’s account; and (ii) the claimant had made misrepresentations in her “Source of Wealth” form and documents – this constituted a breach of a warranty the claimant had given as to the accuracy of information she had given to the defendant.

The court held that the defendant was contractually entitled to terminate the UFX account on the basis that the claimant’s husband did have some access to the account, which must have involved breaches of the Customer Agreement.

However, the court found that the statements made by the claimant in the “Source of Wealth” documentation were not untrue or inaccurate. The court said that the alleged misrepresentations in relation to: (i) the “Source of Wealth” form was not pre-contractual and could not have induced the making of the Customer Agreement; and (ii) access to the UFX account failed on the facts – the UFX account did not belong to and was not solely or predominantly operated by the claimant’s husband.

Issue 2: Sums deposited in the UFX account

The defendant accepted that there was the equivalent of a Quistclose trust in respect of these amounts and that it did have an obligation to return them.

The court held that even if there was no Quistclose trust, the defendant was obliged to return the amounts in any case pursuant to the terms and conditions (incorporated into the Customer Agreement between the claimant and the defendant) and that there was no suggestion that any amount needed to be withheld from those amounts in respect of future liabilities.

Issue 3: Unrealised gains on the claimant’s open Bitcoin positions

The court highlighted that the terms of the Customer Agreement obliged the defendant to close out (rather than “cancel”) the open positions, realise the unrealised gain on the Bitcoin futures and pay the balance to the claimant.

However, the court added that if this construction of the Customer Agreement was wrong and the defendant did have discretion to “annul or cancel” open positions, then the relevant clauses would be unfair, as they would cause a significant imbalance in the parties’ rights and obligations to the detriment of the consumer, contrary to the requirement of good faith. In the court’s view such clauses would have the effect of permitting the defendant to deprive the claimant of what might be very significant gains for trivial breaches. The clauses therefore would not be binding on the claimant by reason of s.62 of the Act.

Issue 4: Loss of investment returns

The claimant argued that she was entitled to claim what she would have earned had the monies to which she was entitled been paid to her upon the termination of her account.

The court held that the claimant was entitled to succeed on this aspect of her claim as the defendant had breached the Customer Agreement by not closing the open positions, realising the gain and paying the balance to the claimant. In the court’s view, remoteness of damage was not an issue as it was plainly within the reasonable contemplation of the parties when they contracted that if the defendant failed to pay the claimant sums which she had invested in (and/or made from investing in) Bitcoin futures, she might lose the amount which she might gain from investing in similar products.

Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Nihar Lovell
Nihar Lovell
Senior Associate
+44 20 7466 2529
Claire Nicholas
Claire Nicholas
Senior Associate
+44 20 7466 2058

High Court provides further insights on the risks of Quincecare claims against banks

The High Court has recently handed down another interesting decision on the so-called Quincecare duty: Roberts v The Royal Bank of Scotland plc [2020] EWHC 3141 (Comm).

Quincecare duty claims typically arise where a bank received a payment mandate from an authorised signatory of its customer, and executed the order, in circumstances where (allegedly) there were red flags to suggest that the order was an attempt to misappropriate the funds of the customer. The recent uptick in Quincecare duty claims against financial institutions is striking, perhaps a culmination of years of increased regulation which has raised the expectation of firms to identify potentially fraudulent activity. Accordingly, insights from the court on the risks associated with processing client payments will be welcomed by the sector. You can find our blog posts on previous Quincecare decisions here.

Roberts involved a classic breach of Quincecare duty (and breach of mandate) claim, in respect of which the court granted the defendant bank’s application for reverse summary judgment on the basis that the claims were time-barred under the Limitation Act 1980. It highlights the court’s approach to a limitation defence to resist claims alleging breach of Quincecare duty and breach of mandate claims. The decision confirms that the court will (in appropriate cases) take a robust approach in dismissing such claims which on the facts are clearly time-barred; this will especially be the case where the necessary facts required to plead a prima facie case of breach were within the claimant’s knowledge at an earlier date than contended.

However, in doing so the court concluded that a prima facie case for breach of the Quincecare duty could be pleaded by the claimants from inference, i.e. simply being inferred from the fact of payment. While this was helpful in the context of the bank’s limitation defence, it is potentially less helpful to the extent that it suggests a low threshold applies to the pleading requirements in Quincecare cases.

We examine the decision in more detail below.

Background

In early 2006, an advertising company set up a business account with the defendant bank (Bank). The Bank was authorised to accept instructions from any two signatories as set out on the authorised signatories sheet attached to an original mandate.

In mid-2006, the company hired a temporary accounts clerk. Shortly thereafter, a form was sent to the Bank apparently authorising that clerk as a full and additional signatory of the company’s business accounts. Between 2006 and 2007 the Bank paid cheques presented to it (totalling £265,000), which had the clerk’s signature and which were in favour of the company’s majority shareholder. In 2008, the company went into administration and was subsequently placed into compulsory liquidation.

In late 2015, the liquidators assigned the company’s claims to the claimant individual who issued a claim in 2019 (more than 12 years after the last cheque had been paid), alleging that the company’s administration and compulsory liquidation was a consequence of the Bank honouring the cheques presented to it. The claimant’s case was that the Bank had breached its Quincecare duty and the mandate in place between the Bank and the company.

The bank applied for reverse summary judgment and/or strike out of the claims made against it on the basis that the claims were time-barred and that the claimant had no real prospect of establishing that the limitation period had been extended under section 32 of the Limitation Act 1980.

Decision

The court rejected the claimant’s arguments and granted the Bank’s application for reverse summary judgment.

The claimant argued that the limitation period did not start running until late 2017 as it was only then that certain facts were discovered, having been deliberately concealed by the Bank until then. The facts relied on by claimant included, in respect of the breach of the: (a) Quincecare duty claim, “the knowledge whether the defendant conducted an inquiry on any of the cheque payments and if it did not why”; and (b) mandate claim, certain paperwork such as that relating to the mandate and the authorised signatory form.

The court noted that section 32(1)(b) of the Act does allow for the postponement of the commencement of the relevant period of limitation where “any fact relevant to the plaintiff’s right of action has been deliberately concealed from him by the defendant”. That postponement will be until the time when “the plaintiff has discovered the fraud, concealment or mistake or could with reasonable diligence have discovered it”. However, the court said that (as per Arcadia Group Brands Limited and others v Visa Inc and others [2014] EWHC 3561) not every broadly relevant fact would qualify; the only facts that would count for this purpose would be those facts which the claimant would need to plead in a statement of case to plead a prima facie case.

In the present case, the court said that what really mattered was whether there was knowledge sufficient to plead that the Bank had reasonable grounds for believing that the payment was part of a scheme to defraud the company such that the Bank came under a duty to refrain from making the payment. The court concluded “without hesitation” that a prima facie case of breach could be pleaded by inference from the fact of payment, if the prior steps could be pleaded (i.e. that the company was a customer of the Bank, that the authorised signatory instructed the Bank to make payment etc.). The court noted that this was, in fact, the way the claimant had pleaded the case.

The court held that the facts giving rise to the claims were plainly within the company’s knowledge at a very early stage – far earlier than six years ago, therefore there could be no deliberate concealment which has a real as opposed to a fanciful prospect of success. The claims were therefore time-barred and the court granted reverse summary judgment in favour of the Bank.

Harry Edwards
Harry Edwards
Partner
+44 20 7466 2221
Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Nihar Lovell
Nihar Lovell
Senior Associate
+44 20 7466 2529

High Court finds no breach of duty by bank in exercise of enforcement rights under finance agreements

The High Court has granted a claim brought by a bank against two companies (and the managing director of one of them) to recover outstanding sums due under a USD 9 million loan agreement and related security agreements (the Finance Agreements): Aegean Baltic Bank SA v Renzlor Shipping Ltd & Ors [2020] EWHC 2851 (Comm).

In doing so, the court confirmed that the bank owed an equitable duty in exercising its enforcement rights under the Finance Agreements. However, that duty was capable of amendment and constriction by contractual agreement and, on the facts, there had been no breach by the bank of its equitable duty.

In light particularly of the complex impact of the current COVID-19 pandemic on borrowers including the likely increase in default and therefore enforcement, this decision will be of significance to financial institutions considering the exercise of contractual rights. The decision provides a helpful reminder of the extent to which: (a) a duty can be imposed on a bank in respect of the exercise of its enforcement rights under various finance agreements; and (b) certain actions linked to the exercise of enforcement rights will not be considered to be in breach of such a duty. Please also see our previous blog post on a related decision considering whether a bank would have a duty of care akin to that which a mortgagee would have when exercising a power of sale over its security.

Background

The claimant bank entered into Finance Agreements with two shipping companies and the managing director of one of the shipping companies (together, the defendants). The purpose of the Finance Agreements was to enable the financing of repairs and provide liquidity for a shipping vessel.

Following damage to the vessel – which was abandoned – in 2015 the defendants ceased to make repayments due under the loan agreement. In 2018, the bank subsequently sent a notice of default and acceleration notice demanding full repayment under the Finance Agreements. The bank also issued a claim for outstanding indebtedness under the Finance Agreements.

The defendants sought to resist the claim on the basis that the bank had acted negligently or otherwise in breach of duty in its conduct of certain insurance claims following damage to the shipping vessel in 2015.

Decision

The court granted the bank’s claim.

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

Issue 1: Was a duty owed when exercising rights under the Finance Agreements?

The defendants argued that the bank owed duties of care at law and/or equity towards the defendants to exercise its rights under the Finance Agreements to ensure a fair and reasonable recovery of insurance proceeds. The defendants said these duties arose: (a) by way of implied term; (b) as a duty of care at common law; and (c) as a duty in equity.

The court held that the bank did owe a duty in equity (as a matter of law and by reason of its status as security holder) in respect of the exercise of its relevant rights under the Finance Agreements, though not at common law or by way of implied term.

In the court’s view, the position of the bank under the security documents was akin to that of a mortgagee seeking to exercise its rights over security, and the bank’s enforcement of the defendants’ claim under the relevant insurance policy was analogous to the exercise of a power of sale over a mortgaged property. This gave rise to an equitable duty.

The court remarked that the equitable duty was owed to the defendants. As per Downsview Nominees Ltd v First City Corporation Ltd [1993] AC 295, such an equitable duty would involve: (a) the exercise of powers in good faith and for a proper purpose; and (b) if exercising a power of sale, taking reasonable care to obtain a proper price.

However, the court underlined that such a duty was capable of amendment and constriction by contractual agreement. The court held that on the facts of the present case the parties by contract had restricted the bank’s liability for any breach of duty in the exercise of its rights under the security agreement to losses caused by the wilful misconduct of its officers and employees.

Issue 2: Was there a breach of duty?

The defendants argued that the bank had breached its equitable duty as it had entered into a wholly unreasonable settlement with an Italian insurance company on the basis that it was for less than 50% of the constructive total loss value notwithstanding that a full and proper recovery was possible. Additionally, the defendants argued that the settlement contained false and unreasonable admissions, the bank had failed to make a recovery within a reasonable time, and the bank had excluded the defendants from participation in negotiations with the insurers.

The court rejected the defendants’ submissions and held that the bank had not breached the equitable duty it owed to the defendants.

In reaching its conclusion, the court cited the following factors, amongst others, as influential in its decision on this particular issue:

  • there was no allegation that the bank did not exercise its powers in good faith;
  • there was no allegation that the bank acted with wilful misconduct;
  • although a creditor must exercise its powers in good faith and for a proper purpose, it does not owe a duty as to when to exercise its powers, even if the timing of the exercise or non-exercise may occasion loss and damage to the mortgagor (as per China and South Sea Bank Ltd v Tan Soon Gin [1990] 1 AC 536);
  • compliance with an equitable duty did not require the bank to engage in litigation at its own financial risk, i.e. it was entitled to look after its own interests (as per General Mediterranean Holding SA SPF v Qucomhaps Holdings Ltd [2018] EWCA Civ 2416, in which the Court of Appeal observed that a creditor would not be obliged to incur any sizeable expenditure or to run any significant risk to preserve or maintain a security); and
  • there was nothing in the Finance Agreements requiring the bank to call for, or permit, the active participation of the defendants in any negotiations it chose to conduct, nor was there any evidence to suggest that the defendants’ participation would have had a beneficial effect in influencing the Italian insurance company in relation to the constructive total loss claim.

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.

Natasha Johnson
Natasha Johnson
Partner
+44 20 7466 2981
Nihar Lovell
Nihar Lovell
Senior Associate
+44 20 7466 2529

US Sanctions and the right of borrowers to withhold repayment: Commercial Court signals return to orthodoxy

The Commercial Court has granted summary judgment in favour of a bank seeking to recover payments under Credit Agreements entered into with the Venezuelan state-owned oil and gas company, Petroleos De Venezuela SA (PDVSA), finding that the defaulting borrower had no real prospect of successfully defending the claims on the basis of certain US Sanctions imposed on Venezuela which post-dated the execution of the Credit Agreements: Banco San Juan Internacional Inc v Petroleos De Venezuela SA [2020] EWHC 2937 (Comm).

The court rejected all of the arguments put forward by PDVSA as to why it was prevented from making repayments as a result of the imposition of US sanctions (PDVSA is now a US Specially Designated National (“SDN”)). In particular, the court made the following findings, which will be of broader interest to global lenders with exposure to borrowers facing sanctions risk:

  1. No “normal course” to suspend payment obligations where there is a risk of US Sanctions

In interpreting the sanctions clause in the Credit Agreements, the court rejected the suggestion that the Court of Appeal’s recent decision in Lamesa Investments Limited v Cynergy Bank Limited [2020] EWCA Civ 821 demonstrated that it is perfectly normal and sensible in commercial agreements to suspend payment obligations where payment would otherwise be in breach of US sanctions (see our banking litigation blog post). It found that this authority (and others) were simply decisions on their (very different) facts. On the facts of the present case, the court concluded that the relevant clause provided no basis for a suspension of the repayment obligations (and in any case it was not clear that it would in fact be a breach of sanctions for PDVSA to make payment).

This represents a move back to orthodoxy in cases of this kind, emphasising the importance of the contractual construction of the particular wording of the clause in each case. Lamesa v Cynergy was a surprising decision in part because the party with the payment obligation in that case was (if payment was made) only at risk pursuant to US secondary sanctions. Here, US primary sanctions were in play to some extent, given that the payment was to be made in US dollars and to a US account. Nonetheless, the court found that PDVSA’s payment obligation was not suspended. As such, it appears that the outcome in Lamesa v Cynergy does not have broader application – instead, as the court itself observed in Lamesa, each case will turn on the  interpretation of the particular contract in question.

2. Impossibility vs impracticability of repayment

On an obiter basis, the court expressed the view that it was merely impracticable and not illegal for PDVSA to make payments in USD to a US bank account, because: (i) it was not illegal for PDVSA (a non-US entity based outside the US) to initiate payment; and (ii) it was possible for the parties to vary the Credit Agreements and make payment in euros to a bank outside the US. Accordingly, the court doubted that PDVSA could rely on the “very narrow gateway” in Ralli Bros v Compania Naviera Sota y Aznar [1920] 2 KB 287 (providing that English law governed contracts are unenforceable where performance is prohibited in the place of performance).

3. Burden of proving that US Sanctions prevent contractual performance

Even if the US Sanctions prima facie rendered the performance of PDVSA’s payment obligations necessarily illegal at the place of performance, the court found that PDVSA had an obligation under the Credit Agreements to apply for a licence from the US Office of Foreign Assets Control (OFAC) in order to make the payments, which it had failed to discharge. As an important point of general application, the court stated that (absent any contractual provision to the contrary or a statutory reversal), the legal burden to obtain the necessary licence to effect the repayments was on PDVSA (as the debtor and the party bound to perform).

The decision is considered in more detail below.

Background

PDVSA is a Venezuelan state-owned oil and gas company, exclusively operating the Venezuelan oil and gas reserves, which are among the largest in the world. In 2016 and 2017, PDVSA borrowed sums under two Credit Agreements that it entered into with the Puerto Rican bank, Banco San Juan Internacional Inc (the Bank). On PDVSA’s case, this was part of a broad trend by which Venezuelan business interests were moved away from the mainland US financial system to Puerto Rico (an unincorporated territory of the US) as a result of political pressure from the US on Venezuela.

PDVSA defaulted on payments under both Credit Agreements, which contained English law and exclusive jurisdiction clauses in favour of the courts of England and Wales.

The claims

The Bank brought two claims in debt against PDVSA in this jurisdiction:

  1. 2016 Credit Agreement: A claim for US$48 million comprising overdue principal and accrued default interest and costs; and
  2. 2017 Credit Agreement: A claim for US$38 million comprising the loss of anticipated profits under the agreement, accrued default interest and costs. By way of brief explanation, following PDVSA’s payment defaults under this agreement, the loan was accelerated on 3 December 2018 and monies in certain trust accounts were used to discharge the overdue principal and interest then owed under the agreement. The liability under this agreement therefore rested on Clause 3.04(c) of the 2017 Credit Agreement to compensate the Bank for “the loss of anticipated profits equal to the Present Value of all fees and interest payable to [the Bank] through the Final Maturity Date of each Loan“.

The Bank applied for summary judgment on both claims. PDVSA argued that it had a real prospect of successfully defending the claims, primarily because of the effect of certain US Sanctions imposed on Venezuela which post-dated the execution of the Credit Agreements (in particular Executive Order 13850 and Executive Order 13884, detailed below). In the alternative, PDVSA argued that the sum claimed under the 2017 Credit Agreement was a disproportionate penalty, and that the sums claimed by way of costs and expenses under the terms of the Credit Agreements were not reasonable and within the scope of the indemnity.

Decision

The court granted summary judgment in favour of the Bank on both claims. We consider below the principal grounds of defence rejected by the court that are likely to have broader application.

Imposition of US Sanctions

PDVSA said that it wanted (and had the funds) to repay the Bank under the Credit Agreements, but that this was not possible because of the US Sanctions imposed on Venezuela.

PDVSA relied in particular on Executive Order 13850 (issued by President Trump on 1 November 2018, implementing blocking sanctions against persons operating in the gold sector of the Venezuelan economy, and creating an executive power for further sectors of the Venezuelan economy also to be blocked in due course) and Executive Order 13884 (issued by President Trump on 5 August 2019, a general blocking sanction freezing all property held by the Venezuelan government, including PDVSA).

As a consequence of the US Sanctions, PDVSA argued as follows (set out together with the court’s response):

1. The terms of the Credit Agreements, properly construed, suspended PDVSA’s payment obligations

The issue here was whether the sanctions clause in the Credit Agreements operated as a condition precedent to PDVSA’s liability (such that, if it was triggered, it would suspend PDVSA’s payment obligations – PDVSA’s case), or whether it was a negative covenant for the Bank’s benefit, but did not impact PDVSA’s liability to make payment (the Bank’s case). PDVSA relied on the decisions in Mamancochet Mining Limited v Aegis Managing Agency Limited [2018] EWHC 2643 (Comm) and Lamesa v Cynergy to argue that it is perfectly normal and sensible in commercial agreements to suspend payment obligations where payment would otherwise be in breach of unilateral US Sanctions.

The court found that these authorities were simply decisions on their (very different) facts.

The specific clause of the Credit Agreements relied on by PDVSA (Section 7.03), stated as follows:

“Sanctions. [PDVSA] will not repay Loans with the proceeds of

(a) business activities that are or which become subject to sanctions, restrictions or embargoes imposed by the Office of Foreign Asset Control of the U.S. Treasury Department, the United Nations Security Council and the U.S. Department of Commerce, the U.S. Department of State [sic] (collectively, ‘Sanctions’); or

(b) business activities in/with a country or territory that is the subject of Sanctions (including, without limitation, Cuba, Iran, North Korea, Sudan and Syria) (‘Sanctioned Country’)”.

This clause was contrasted with the relevant clause in Lamesa, which expressly provided for non-payment and was part of the payment obligation in the contract (unlike the present case, where there was no express mention of non-payment and the relevant clause was under the “Sanctions” heading). The court also noted that in Lamesa, the court of Appeal found good reasons for the existence of the non-payment provision.

Having found that the authorities did not suggest that it was a normal course for parties to contract to suspend payment obligations where there is a risk of US Sanctions, the court proceeded to consider the debate between the parties as to whether the clause was a condition precedent or a negative covenant. The court agreed with the Bank that the construction of the clause as a negative covenant was clear, in particular from the express wording of the clause and the structure of the agreement (under the “Sanctions” heading and separate from the payment obligations). The fact that the clause did not mention suspending the payment obligation was a notable contrast with another explicit suspension mechanism in the contract (in favour the Bank) and consistent with this construction.

The court therefore concluded that Section 7.03 provided no basis for a suspension of the repayment obligations by the terms of the Credit Agreements.

The court also went on to say that there were considerable doubts as to whether the relevant US Sanctions activated Section 7.03 at all (although it did not need to decide the point, given its primary finding). This will be interesting for those who wish to draft sanctions clauses which will be triggered by payment by a party who becomes an SDN. The doubt expressed by the court was on the basis that (a) the US sanctions against Venezuela were not country-wide; (b) the US sanctions were not such that PDVSA’s “business activities” were “subject to sanctions”, and (c) PDVSA had historical assets derived from its activities before the sanctions came into effect, held outside the US, and Section 7.03(a) would not apply to such assets.

2. By reason of the rule in Ralli Bros, English law governed contracts are unenforceable where performance is prohibited in the place of performance, which in this case was the US

PDVSA relied on the rule in Ralli Bros to assert that it could not perform the Credit Agreements in accordance with US law. Primarily, this was because PDVSA said it could not pay and the Bank could not receive funds into the “Stipulated Account”, which was located in the US. However, even if they could, PDVSA highlighted that the payments under the Credit Agreements were required to be made in USD, and a significant USD transaction would need to clear the US financial system (via a correspondent bank), from which PDVSA was excluded.

The court found that – even if the US Sanctions prima facie rendered the performance of PDVSA’s payment obligations necessarily illegal at the place of performance – PDVSA had no reasonable prospects of success on this ground of defence. This was because the prohibitions in the US Sanctions were qualified and PDVSA could have applied for a licence from OFAC in order to make the payment into the Stipulated Account. The court found that (absent any provision to the contrary in the Credit Agreements, or a statutory reversal), the legal burden to obtain the necessary licence to effect the repayments was on PDVSA (as the debtor and the party bound to perform). Further, in this case the court found that the Credit Agreements explicitly put the burden on PDVSA. However, PDVSA failed to show that it had discharged its obligation to apply for a licence, or that (had it applied) the application would have failed.

Although unnecessary given its finding on the licence issue, the court considered (obiter) whether making payments into the Stipulated Account would have been illegal, and therefore engaged the Ralli Bros doctrine. In this context, the court noted that the rule in Ralli Bros operates as a limited exception to the general rule that illegality under foreign law does not frustrate or otherwise relive a party from performance of an English law contract (see for example, Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 (Ch) and our litigation blog post). The court emphasised that the doctrine offers a narrow gateway: the performance of the contract must necessarily involve the performance of an act illegal at the place of performance and will not apply where the contract could be performed some other way which is legal, or if the illegal act has to be performed somewhere else.

In contrast to these requirements, the court said the issue of making payment to the Stipulated Account in the US was not one of illegality, but rather impracticability: it was not illegal for PDVSA (a non-US entity based outside the US) to initiate a payment, and it was not clear that it was illegal for the Bank to receive it (if the funds were then blocked). In any event, in the court’s view there was plainly a possibility of payment being made in euros to a bank outside the US, by variation of the Credit Agreements, to which the Bank would have been amenable. Accordingly, the court doubted that the “very narrow gateway” of Ralli Bros was engaged.

3. Article 9(3) of Rome I (Regulation No 593/2008/EC) confers a discretion on the court to apply mandatory overriding provisions of the law of the place of performance (here, US law) to a contract governed by another law (English law) and that this discretion should be exercised in this case

The court concluded that there was no real prospect of success on this argument, particularly in circumstances where the Ralli Bros defence covered similar ground to Article 9(3), but operated without any discretionary element.

Penalty argument

PDVSA argued that the sum claimed under the 2017 Credit Agreement was a disproportionate penalty, imposed for breach of the primary sums due under the 2017 Credit Agreement, and despite the fact that the primary sums have already been recovered in full.

The court had no difficulty at all in concluding that the clause was not a penalty and that PDVSA’s argument had no real prospect of success. As this was in essence a question of construction, the court found it was an appropriate issue on which to come to a final conclusion on a summary judgment application.

It was common ground that the leading authority on penalty clauses is Makdessi v Cavendish Square Holding BV [2015] UKSC 67 (see our litigation blog post), which provides that to find that a provision is an unenforceable penalty, it must be: (i) a secondary obligation; (ii) triggered on breach of contract; which (iii) imposes a disproportionate detriment on the contract breaker.

In this case, the court said that the three limbs of the Makdessi test were intertwined. Looking at the contract as providing an overall agreement for a particular return over the lifetime of the contract, the court commented that “…not only does the mathematics inexorably drive the conclusion that the sum involved is in no way disproportionate, but also suggests that the obligation is a primary one and not a sum due (even in substance) on breach.”

The court therefore found that the clause was not a penalty and granted summary judgment in favour of the Bank on both the 2016 and 2017 Credit Agreements.

Susannah Cogman
Susannah Cogman
Partner
+44 20 7466 2580
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948