High Court refuses customer’s interim mandatory injunction application to unfreeze bank account

In the context of a breach of contract claim brought by a customer against a bank for freezing their account on the basis of suspected fraud or criminal activity, the High Court has dismissed an application by the claimant for an interim mandatory injunction to compel the defendant to unfreeze their bank account: Harvey v Santander UK plc [2023] EWHC 2947 (KB).

This decision will be of interest to financial institutions as it continues the trend that the court will uphold a bank’s decision to exercise its contractual rights to freeze a customer’s account without notice in circumstances where it suspects fraud or criminal activity (see our previous blog posts here and here).

The decision considers the common law principles that the court will take into account in considering whether to grant an interim mandatory injunction application brought under CPR Part 25 by a customer against a bank. The court will generally approach these injunctions with caution and they are typically granted only in clear-cut cases where the court has a high degree of assurance that the party seeking the injunction will succeed at trial. This is because mandatory injunctions can significantly alter the status quo and may impose substantial burdens or obligations on the party against whom they are issued.

In the present case, the court was not satisfied that this was a case in which an interlocutory mandatory injunction should be granted because it did not feel a high degree of assurance that the customer would succeed in satisfying a court at trial that the bank had not been exercising its contractual rights to freeze the account, to close it and to decline to execute the customer’s instructions. Further, the court was concerned that if it were to grant the injunction and at trial it was proved that it was wrong to do so, then damages would be an inadequate remedy for the bank because it may face regulatory and/or criminal sanctions and/or potential actions from third parties who might claim the funds were misapplied.

We consider the decision in more detail below.

Background

The claimant customer had a business account with the defendant bank, which was subject to the bank’s general terms and conditions (the T&Cs). These provided that the bank could refuse any withdrawal or payment from the customer’s account if: (a) it may place the bank in breach of any legislation or law or the bank reasonably suspected it may result in any regulatory action against it in any jurisdiction; or (b) the bank reasonably suspected it related to fraud or any other criminal act. The T&Cs also contained conditions that the customer must not misuse their account or act in any way which gave rise to a reasonable suspicion of fraud or other criminal activities, and that if the customer breached these conditions that the bank could suspend or close the customer’s account immediately without prior notice.

In 2022, a large payment into the customer’s account created an alert on one of the bank’s monitoring systems. Discussions with the claimant and subsequent investigations led to the bank suspect the payments related to fraud or another criminal act because of their origin, stated purpose and amount. The bank concluded that the account ought to be closed and immediately froze the account. The customer discovered that the account had been frozen and asked the bank for an explanation, but was not satisfied with the lack of information provided by the bank.

The customer subsequently brought a breach of contract claim against the bank and applied for an interim mandatory injunction to compel the bank to unfreeze their bank account. The bank opposed this application on the basis that it was contractually entitled to act as it did given its suspicions that the bank account was being used for potential fraud or criminal activity, and the need to guard against any potential regulatory and legal risks.

Decision

The High Court found in favour of the bank and dismissed the customer’s application.

The court rejected the bank’s suggestion that the application should be refused because it was not an urgent matter, emphasising that while ongoing police inquiries (which cannot be revealed to their customers under criminal legislation) may put banks in a difficult position, banks should explain to their customers the contractual reasons for their conduct.

The bank submitted that, in any event, it was not appropriate to grant an interim mandatory injunction, relying in particular on the following bases:

  • It was highly inappropriate for a mandatory injunction to be granted which would render a bank at risk of committing a criminal offence, thus an injunction should be refused as a matter of discretion, as per K Ltd v National Westminster Bank Plc [2006] EWCA Civ 1039.
  • A bank must be entitled to rely on its contractual rights to refuse to carry out a transaction if it reasonably thinks that one or more of its conditions to do so is satisfied, as per Becker & Fellowes v Lloyds TSB Bank Plc [2013] EWHC 3000.
  • For an interim mandatory injunction to be granted, which would have the practical effect of putting an end to the action, a court is required to factor-in the degree of likelihood of the claimant succeeding in the action if it had gone to trial, as per NWL Ltd v Woods [1979] 1 WLR 1294.
  • For a mandatory injunction a court must feel a high degree of assurance that at trial it will appear that the injunction was rightly granted – a higher standard than for a probatory injunction, as per Shepherd Holmes Ltd v Sandham [1971] 1 Ch 340.
  • An application for an interlocutory mandatory injunction should be approached with caution and the relief granted only in a clear case, as per Locabail International Finance Ltd v Agroexport [1986] 1 WLR 657.

The court was not satisfied that this was a case in which an interlocutory mandatory injunction should be granted because it did not feel a high degree of assurance that the customer would succeed in satisfying a court at trial that the bank had not been exercising its contractual rights under the T&Cs to freeze the account, to close it and to decline to execute the customer’s instructions.

This was due to the lack of any documentary evidential support provided by the customer to provide any assurance that the deposited monies were not the proceeds of crime and that certain proposed transactions were not an attempt to money-launder them. Also, none of the customer’s own explanations satisfactorily dealt with the legitimacy of the source of the monies, nor provided any evidential support for it.

The court emphasised that if it were to grant the injunction and at trial it was proved that it was wrong to do so, then damages would be an inadequate remedy for the bank because it may face regulatory and/or criminal sanctions and/or potential actions from third parties who might claim the funds were misapplied. In the court’s view, the customer was not someone who would have the resources to meet those damages. Also, the court said that the customer’s limited means were such that cross-undertaking in damages would not be of any value.

Further, the court believed the balance of convenience favoured the maintenance of the status quo at this stage of the proceedings.

Finally, the court commented that a court should be cautious in granting the discretionary remedy of an interim mandatory injunction in anything other than a clear-cut case. The court said it found itself unable to conclude that it had the necessary high degree of assurance that this was such a case.

Accordingly, the court found in favour of the bank and dismissed the customer’s application for an interim mandatory injunction.

Rupert Lewis
Rupert Lewis
Partner
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Ceri Morgan
Ceri Morgan
Professional Support Consultant
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Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7374 2529

High Court considers enforcement of security by way of appropriation under the Financial Collateral Arrangements (No 2) Regulations 2003 (FCARs)

The High Court has dismissed a claim made by a borrower that a lender’s appropriation of certain shares secured by a charge, upon default in a loan arrangement, was invalid and that the valuation of the appropriated shares was commercially unreasonable: ABT Auto Investments Ltd v Aapico Investment PTE Ltd & Ors [2022] EWHC 2839 (Comm).

The decision is interesting for two reasons:

  • It considers the validity of the appropriation of shares in a private company under the Financial Collateral Arrangements (No 2) Regulations 2003 (the FCARs) and their valuation; and
  • It is an addition to the growing body of case law considering the threshold to be satisfied when exercising contractual discretions in the context of a borrower’s default. You can find our previous blog posts considering similar issues here.

The FCARs introduced the concept of a “security financial collateral arrangement” into UK law, which in the context of security arrangements disapplies various formalities and provisions of UK insolvency law in relation to the taking and enforcing of security over cash, financial instruments and credit claims, where such arrangements are made between entities other than individuals. They also provide for remedies on security enforcement which are different from those usually seen in UK law, including, most notably, the enforcement technique of appropriation.  They are most frequently used in the financial markets, and there are relatively few cases on their application. There is some long-running academic debate on various aspects of the FCARs, including their scope of application to certain categories of parties and assets.

In the present case, the court considered the validity of the appropriation of the shares by the lender (which is a relatively novel self-help remedy in UK law), and their valuation in a “commercially reasonable manner” as required by Regulations 17 and 18 (respectively) of the FCARs.  The court was satisfied both that the appropriation was valid, and that the valuation of the appropriated shares had been made in accordance with the FCARs.

The court underlined that the FCARs imported an objective standard in valuing the shares. In the current context, the word “commercially” indicated that the standard to be applied was that of reasonable participants in the relevant financial market. In other contexts, the manner of valuation must be one which conforms in that context to “the reasonable expectations of sensible businessmen”.  However, it specifically did not have to consider the effect of the special value that the shares in a joint venture (JV) company would have to one of the JV partners as part of the overall valuation.

We consider the decision in more detail below.

Background

In 2017, the claimant company (ABT), through one of its subsidiaries, set up a JV with the defendant companies (Aapico). The JV was funded by Aapico and the arrangements between the parties were set out in a suite of documents which included loan agreements made in 2017 and 2018 (the Loan Agreements). As security for the loans, ABT gave guarantees and a charge over its shares in the JV (the Share Charge).

In 2019, the JV defaulted on certain payments due under the Loan Agreements. Aapico sent four notices of default to the JV and notices of acceleration to ABT declaring both loans to be repayable on demand. Aapico then made further demands to the JV for immediate repayment of the loans and to ABT for repayment of the debt under its guarantees. No payments were made by either the JV or ABT. Aapico consequently gave notice purporting to exercise the power under a specific clause in the Share Charge to appropriate the charged shares. In that notice, Aapico ascribed a value of USD 27 million to the charged shares. That figure was based on a valuation carried out in 2019 of ABT’s shareholding in the JV (the FTI Valuation) at Aapico’s request by FTI Consulting (FTI).

ABT subsequently brought proceedings against Aapico challenging the validity of Aapico’s appropriation of the charged shares and of the value which Aapico had subscribed to them. ABT’s case was that the specific clause relied on in the Share Charge was not effective to confer a legally valid power of appropriation since the method of valuation for which it provided was not commercially reasonable. Further, the appropriation which Aapico purported to carry out was in any event legally ineffective because the valuation of the charged shares had not been carried out in a commercially reasonable manner.

Aapico denied the claim.

Decision

The High Court found in favour of Aapico and dismissed the claim. The key issues of interest are examined below.

(1) The validity of the appropriation

The court held that there had been a legally valid appropriation by Aapico. The specific clause of the Share Charge relied on by Aapico was effective to confer on Aapico a legally valid power of appropriation.  Appropriation is a relatively novel but very useful self-help remedy in English law: it allows a collateral taker to effectively acquire the financial collateral itself without an order from the courts, when self-dealing by a mortgagee is usually prohibited, and on that acquisition, the equity of redemption of the collateral provider is extinguished (as per Çukurova Finance International Limited v Alfa Telecom Turkey Limited [2009] UKPC 19).  The court held here that appropriation would therefore only be available in accordance with the FCARs, that is where there is a security financial collateral arrangement that includes a power of appropriation and there is a provision for valuation.

Regulation 18 of the FCARs

The court noted that the specific clause of the Share Charge relied on by Aapico expressly stated that Aapico’s right to appropriate the charged shares was subject always to Regulation 18 of the FCARs, which requires that the methods of valuation are “commercially reasonable”. However, the FCARs do not contain any description of what constitutes a “commercially reasonable manner” of realisation or valuation. Nor is there any express indication in the FCARs about whether a “commercially reasonable manner” of valuation should reflect any special value of the collateral to the collateral taker.

The drafting of the Share Charge

The court commented that the specific clause of the Share Charge relied on by Aapico on its face gave the collateral taker a discretion as to the method of valuation if no public index or independent valuation was “available or reasonably practicable given the then current circumstances”. However, it did not follow that the collateral taker was thereby permitted to act in an arbitrary or unreasonable manner. In the court’s view, when the clause was read as a whole it was implicit that the valuation methods permitted in this case, were methods conforming to the requirements of Regulation 18(1). On that basis, no further restrictive implication was necessary.

Even if the court was wrong on that point, then on the true interpretation of the clause the collateral taker’s contractual discretion as to the method of valuation would be “limited, as a matter of necessary implication, by…the need for the absence of arbitrariness, capriciousness, perversity and irrationality” (as per Socimer International Bank Ltd (In Liquidation) v Standard Bank London Ltd (No.2) [2008] EWCA Civ 116).

(2) Were the charged shares valued in a commercially reasonable manner?

The court held that the valuation had been made in accordance with the terms of the arrangement and in any event in a commercially reasonable manner. It was satisfied that both Aapico and FTI complied with the requirements of the specific clause relied upon by Aapico in the Share Charge and of Regulation 18(1).

Commercially reasonable manner

The court highlighted the following key legal principles from the authorities:

In the court’s view, each case emphasised the need to consider the particular words of the relevant provision in the particular context (both contextual and commercial) in which they are used, and the danger of interpreting one provision in a particular context by reference to a different provision in a different context.

The FCARs context

The court noted that the relevant context in this case was that of the FCARs. In giving effect to Regulation 18(1), the court’s task was to review, after the event, a valuation of financial collateral carried out by the collateral taker in the context of the “rapid and non-formalistic enforcement procedures” provided for in the FCARs, in order to ensure for “the protection of the collateral provider and third parties” and that the valuation has been conducted in a commercially reasonable manner.

Having regard to that context and to the wording of the FCARs, the court drew a number of conclusions about what Regulation 18(1) requires. In particular:

  • The clear words of Regulation 18(1) place the duty of valuation on the collateral-taker, even if it has used a third-party valuer.
  • It is the way in which the valuation is made which must be commercially reasonable. It does not necessarily follow that the result itself must be a commercially reasonable one. Nevertheless, if the value produced is less than what could reasonably be expected, that may of itself be evidence that the manner of valuation has not been commercially reasonable.
  • The requirement for the valuation to be made in a commercially reasonable manner imports an objective standard. The subjective view of the collateral taker (or of its third party valuer) about what is commercially reasonable is irrelevant. The word “commercially” indicates that the standard to be applied is that of reasonable participants in the relevant financial market. In other contexts, the manner of valuation must be one which conforms in that context to “the reasonable expectations of sensible businessmen” (as per G Percy Trentham Ltd v Archital Luxfer Ltd [1993] 1 Lloyd’s Rep 25 and First Energy (UK) Ltd v Hungarian International Bank Ltd [1993] 2 Lloyd’s Rep 194).
  • The question of what, in any given case, is commercially reasonable is fact-sensitive. Depending upon the nature of the collateral and the circumstances of the case, there may perhaps be only one commercially reasonable manner of valuation.
  • In the context of the valuation required to be made on appropriation, there is no separate and independent requirement for the collateral taker to act in good faith, and no room for the implication of any of the equitable or other duties associated with the law of mortgage in English law.
  • The process of valuation is not one in which it will normally be commercially reasonable for the valuing party to have primary regard to its own commercial interests. The valuation of financial collateral for these purposes is essentially an objective exercise.

The present case

Failure to provide information

The court noted that there was simply no evidence that anyone at Aapico had placed any limits on the information and documents which FTI could request, and no suggestion in the FTI Valuation itself that any important requests for information made by FTI were refused. There was, however, positive evidence that certain employees at Aapico were instructed to provide FTI with whatever they asked for.

The court also said that Aapico’s omission to provide FTI with certain financial statements, or the supporting documents, or with particular DCF valuations, did not either establish or indicate that the valuation was not done in a commercially reasonable manner. Further, the court stated that Aapico’s omission to make arrangements for FTI to have discussions with the management of certain companies did not itself establish or indicate that the valuation was not done in a commercially reasonable manner.

Instructing and/or encouraging FTI to arrive at the lowest possible result

In the court’s view, FTI were keen to produce a valuation which was as well reasoned and as well supported as possible. The court concluded that there was nothing in Aapico’s conduct in relation to the valuation exercise which would properly be characterised as commercially unreasonable.

FTI’s valuation methodology

The court accepted that the information that FTI had was sufficient to perform a valuation of the charged shares. None of the documents identified by ABT Auto that were not provided to FTI included new information that a reasonable valuer would have considered to have a material impact on the valuation FTI undertook.

Special value of the collateral to a collateral taker

For various procedural reasons, the court specifically did not have to consider the effect on the valuation of the special value that shares in a JV company might have to one of the JV partners.  Accordingly, for all the reasons above, the court found in favour of Aapico and dismissed the claim.

Nick May
Nick May
Partner
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Ceri Morgan
Ceri Morgan
Professional Support Consultant
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Emily Barry
Emily Barry
Professional Support Consultant
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Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7466 2529

High Court finds lender’s exercise of absolute contractual right is not subject to implied Braganza duty

The High Court (Chancery Appeals Division) has allowed a lender’s appeal of a District Judge’s decision to set aside statutory demands made against two guarantors, following a borrower’s default under a loan facility: Sibner Capital Ltd v Jarvis [2022] EWHC 3273 (Ch).

This decision will be of interest to financial institutions seeking to exercise a contractual discretion or right following an event of default. The decision highlights that a financial institution’s exercise of its discretion/right will not necessarily be subject to an implied duty to act in good faith or to refrain from acting in a way which was arbitrary, capricious or irrational (as per Braganza v BP Shipping Ltd [2015] UKSC 17), particularly where the documentation confers an absolute contractual right in favour of the financial institution. This is the latest in a recent line of decisions considering the exercise of contractual discretions in a financial services context (see our previous blog posts here).

In the present case, the court was satisfied that there was no realistic prospect of the guarantors establishing that the lender was under some sort of duty of good faith or other Braganza style duty in deciding whether or not to accept payment of less than the full amount of a tranche on the due date. The court underlined that the relevant clause in the facility agreement contained no qualification, and indeed went out of its way to say that the lender had an absolute right whether or not to accept less than it was entitled to.

We consider the decision in more detail below.

Background

The claimant lender agreed to provide loans to the borrower company in relation to the development of a property. The loan facility was guaranteed by two individuals. A joint venture agreement (the JV Agreement) was also entered into on the same day by the lender, the borrower, the guarantors and the owner of the property which was to be developed.

The loan facility agreement provided that “The lender may in its absolute discretion accept a sum less than the Tranche A commitment plus interest on the Tranche A Repayment Date in satisfaction of the Borrower’s obligation to repay the Tranche A Facility on that Date…”.

The JV Agreement required the parties to act in good faith. However, the JV Agreement also provided that this requirement did not prejudice or restrict the lender’s rights under the finance documents including any rights which may arise following an event of default.

In 2020, the lender and the guarantors agreed that a certain sum would be accepted as part settlement of Tranche A on the following basis: (a) the agreed sum would be paid by 22 December 2020; (b) the lender would release its security over property when the repayment was made; and (c) the balance of the amount due would be paid by 31 January 2021. The agreement also included an undertaking by the guarantors that their guarantees would remain in force and that they would not object to any enforcement action in respect of the outstanding amount, including any statutory demand or bankruptcy petition. The part repayment was made on 22 December 2020, but the balance was not paid by 31 January 2021. Consequently, the lender served statutory demands on the guarantors.

The guarantors denied the claim and made an application to set aside the statutory demands.

District Judge’s decision

The District Judge found in favour of the guarantors and set aside the statutory demands.

The District Judge said the guarantors had a realistic prospect of demonstrating that there was an implied duty to act in good faith or to refrain from acting in a way which was arbitrary, capricious or irrational (as per Braganza). The District Judge also said that the lender had failed to exclude extraneous considerations in exercising its discretion under the facility agreement and had therefore called in the loan and called on the guarantees in reliance on its breach of duty.

The lender appealed, on the basis that its discretion under the facility agreement was absolute and was not restricted by the Braganza duty or any implied duty of good faith.

High Court (Chancery Appeals Division) decision

The court found in favour of the lender and upheld the statutory demands. The key issues which may be of interest to financial institutions are examined below.

The facility agreement

The court said that on the face of the facility agreement, the lender had an absolute discretion whether to agree to accept less than full repayment of Tranche A. The discretion was not expressly qualified in any way. Given that the lender would, in exercising the discretion, be accepting less than it would otherwise be entitled to, it might perhaps be surprising if it were under any obligation to consider anything other than its own interests.

Implied duty of good faith/Braganza duty

The court reviewed the authorities and highlighted the following key legal principles:

  • A contractual discretion does not involve a simple decision whether or not to exercise an absolute right. Rather, a discretion involves making an assessment or choosing from a range of options, taking into account the interest of both parties (as per Mid-Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd (t/a Medirest) [2013] EWCA Civ 200).
  • When a contract gives one of the parties an absolute right, a court will not usually imply any restrictions on it, even restrictions preventing the right from being exercised in an arbitrary, capricious or irrational manner (as per Greenclose Limited v National Westminster Bank Plc [2014] EWHC 1156 (Ch)).
  • The court will refuse to imply a term that an unqualified right to terminate a contract should be exercised in good faith, even where there is an express clause requiring the parties to work together in a spirit of trust, fairness, and mutual co-operation (as per TSG Building Services v South Anglia Housing Ltd [2013] EWHC 1151 (TCC)).
  • The expression “absolute contractual right” is the result of a process of construction which takes account of the characteristics of the parties, the terms of the contract as whole and the contractual context. It is only possible to say whether a term conferring a contractual choice on one party represents an absolute contractual right after that process of construction has been undertaken (as per Equitas Insurance Ltd v Municipal Mutual Insurance Ltd [2019] EWCA 718).
  • Absolute rights conferred by professionally drawn or standard form contracts (including but not limited to absolute rights to terminate relationships and roles within relationships) are an everyday feature of the contracts that govern commercial relationships. Extending Braganza to such provisions would be an unwarranted interference in the freedom of parties to contract on the terms they choose (as per TAQA Bratani Ltd v Rockrose [2020] EWHC 58 (Comm)).
  • Even if a contracting party has a discretion to bring the contract to an end, and that such discretion should not be exercised capriciously or arbitrarily, it by no means follows that the same considerations apply to allowing the contract to continue, which does not require any positive act on the part of the non-defaulting party (as per Lomas v JFB Firth Rixson [2012] EWCA 419).

The present case

The court concluded that there was no realistic prospect of the guarantors establishing that the lender was under some sort of duty of good faith or other Braganza style duty in exercising its discretion whether or not to accept payment of less than the full amount of Tranche A on the due date in accordance with the facility agreement.

In the court’s view, this was a commercial contract drawn up with legal assistance between experienced commercial parties. On the face of it, the relevant clause contained no qualification and indeed went out of its way to say that the lender had an absolute discretion whether or not to accept less than it was entitled to even though it was known that a new mortgage was being discussed and that a decision, in principle, had been made by the lender.

The court said that it was also relevant that the JV Agreement, whilst containing an obligation for the parties to act in good faith, specifically provided that this obligation should not affect the lender’s rights under the finance agreement. Another important consideration was that the documents were clear that Tranche A was to be repaid in full before any other steps were to take place.

In the court’s view, looking at the characteristics of the parties, the terms of the contract as a whole, and the contractual context, there was no doubt that this was not the sort of provision where it would be appropriate to imply an obligation of good faith. Accordingly, there were no substantial grounds for disputing the debt on this basis.

For all the reasons set out above, the court found in favour of the lender and upheld the statutory demands.

Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7466 2529

High Court considers application of COBS and Braganza duty to close out of trading account

The High Court found in favour of an online spread betting company in a claim for £1.3 million in unpaid debts against a real estate tycoon following the close-out of a trading position on an online spread betting platform in March 2020: CMC Spreadbet plc v Tchenguiz [2022] EWHC 1640 (Comm).

The decision will be of interest to financial services providers in relation the nature of obligations under the Financial Conduct Authority’s Conduct of Business Sourcebook (COBS) Rules, including in relation to the duty to act in the best interests of a client when closing out a trading account which has a negative balance. The case is also a helpful example of how the court will grapple with whether a contractual discretion to close out has been exercised in a manner that is reasonable and not irrational, arbitrary or capricious, in accordance with the Supreme Court’s decision in Braganza v BP Shipping Ltd [2015] UKSC 17.

Spread betting is a form of contract for differences, in which investors speculate about the price movement of financial markets (for example) without owning any underlying asset. In the present case, the defendant had elected to be treated as a professional client when opening his spread betting account with the claimant spread betting firm. The court found that the claimant had rightly treated the defendant as a professional client and that he had waived the rights given to retail investors. As such, the claimant firm had not failed to comply with its COBS obligations to warn the defendant about the loss of protection as a retail investor.

The court also held that the claimant’s decision to close out the account, which had accrued a significant negative balance, had not breached the implied Braganza duty to act rationally and in good faith, nor had it breached the COBS rule to act in the client’s best interests.

We consider the decision in more detail below.

Background

Mr Tchenguiz opened a spread betting account in 2019 with the claimant, CMC Spreadbet plc (CMC). While the account opened by CMC for Mr Tchenguiz was initially on retail terms, Mr Tchenguiz completed a request form to elect to be treated as a “professional client”. At the time, Mr Tchenguiz also held positions with a number of spread betting firms as an elective professional client. The request form notified Mr Tchenguiz of the protections he would lose by his reclassification.

His classification as a professional client allowed Mr Tchenguiz to being able to trade on a high leveraged basis and operate his account with a negative balance. This was subject to CMC’s entitlement in accordance with its terms of business to close out any positions where the balances fell below an applicable “close-out level” and to recover any deficit on the account. Retail clients on the other hand enjoy “negative balance protection” (NBP), which limits their losses to the level of their investment.

Mr Tchenguiz subsequently traded on his CMC account, opening substantial trading positions in December and January 2020 in relation to the shares of First Group plc (First Group), a transport operator which runs the Great Western Railway, South Western Railway and the TransPennine Express. However, in March 2020 the value of First Group’s shares plummeted as a result of the outbreak of the coronavirus pandemic, resulting in a significant deficit on Mr Tchenguiz’s account.

CMC closed out the positions on Mr Tchenguiz’s account and sought recovery of the deficit. When Mr Tchenguiz failed to repay these amounts, CMC brought a claim against him in the English High Court for recovery of the debt.

Mr Tchenguiz relied on two principal defences:

  1. Firstly, Mr Tchenguiz contended that he should not have been treated as an elective professional client as CMC had breached the COBS Rules by failing adequately to warn Mr Tchenguiz about the loss of protection he would have enjoyed as a retail investor, including NBP. Mr Tchenguiz asserted that, had he not been treated as a professional client, he would not have been allowed to operate his account at a deficit, and as such he would not have been liable for the losses beyond his initial investment as claimed by CMC.
  2. Secondly, Mr Tchenguiz contended that in closing out his account, either:
    1. CMC breached its duty under COBS 2.1.1R, to act honestly, fairly and professionally in accordance with the best interests of its client; or
    2. CMC had the discretion to delay close-out for a reasonable time in order to request payment into the account, and by failing to exercise this discretion, it acted in an irrational manner contrary to an implied Braganza duty.

Decision

The High Court (Mr David Elvin QC sitting as a Deputy High Court Judge) rejected Mr Tchenguiz’s arguments and held in CMC’s favour on all issues.

(1) Treatment of Mr Tchenguiz as a professional client

The court considered the rules relating to the classification of Mr Tchenguiz as a professional client and CMC’s obligations to warn Mr Tchenguiz about the loss of his rights as a retail investor.

The court found that Mr Tchenguiz was well aware and understood the effect of being classified as a professional client prior to opening his account with CMC. The court noted that CMC had provided warnings about loss of NBP, including in CMC’s terms of business and the terms of the agreement which Mr Tchenguiz had signed in electing to be a professional client. In cross examination it became apparent that at the time when Mr Tchenguiz received the warnings about the loss of his rights, he did not consider them significant, and he had fully understood the risks of being categorised as a professional client.

In addition, Mr Tchenguiz had opened his spread betting account with CMC because another firm, with whom Mr Tchenguiz held share equivalents of 18 million, considered its exposure to risk was too great. Mr Tchenguiz therefore reduced his position with that firm, which led to his request to open an account with CMC. Had Mr Tchenguiz not been allowed to open an account as a professional with CMC, it was likely he would have done so with another spread betting firm.

The court went on to note that Mr Tchenguiz had accepted candidly that he knew he would gain certain advantages by being classified as a professional client (such as being able to trade on a high leveraged basis), and that he would lose NBP as a result. This was the case with other spread betting firms with whom Mr Tchenguiz had accounts; these firms had also given Mr Tchenguiz similar warnings. CMC had therefore complied with its obligations to give clear written warnings concerning the loss of NBP, including with regard to the circumstances, knowledge and experience of Mr Tchenguiz.

Accordingly, the court found that Mr Tchenguiz was categorised lawfully as a professional client and CMC did not fail to comply with the duty in COBS to give appropriate warnings with regard to the loss of protections and rights which are enjoyed by retail clients, but not professional clients. The court noted that Mr Tchenguiz was aware of the terms applicable to professional clients, in particular because he had the same classification with other spread betting platforms.

(2) Duties in relation to close out of Mr Tchenguiz’s positions with CMC including Braganza Duty and COBS 2.1.1R

The court rejected Mr Tchenguiz’s contentions that in closing out his account CMC had breached its Braganza duty or failed to comply with COBS 2.1.1R, being the duty to act in the best interests of its client.

CMC’s business terms contained provisions to ensure that the account remained above the relevant close-out level, though the management team had discretion to delay close-out to request payment into the account within a reasonable time in certain cases. Mr Tchenguiz submitted that CMC breached its Braganza duty in reaching its close-out decision, notwithstanding the significant deficit on Mr Tchenguiz’s account, in circumstances where it should have delayed its close-out decision and agreed to proposals put forward by Mr Tchenguiz to resolve his outstanding balances.

It was not in dispute that the CMC had an implied Braganza duty to act in a manner that was reasonable and not irrational, arbitrary or capricious. However, the court held that CMC’s decision to close out the account was not irrational, in particular because:

  • CMC had agreed to Mr Tchenguiz’s request for a short period of time to try to find a funding solution. CMC was not required to further delay closing out Mr Tchenguiz’s account as it had already given him an opportunity to suggest a funding solution, especially in the significantly deteriorating market conditions.
  • CMC’s actions in exercising its discretion or not had to be judged in the context of Mr Tchenguiz’s contractual obligations to clear negative balances promptly. Mr Tchenguiz had only suggested vague forms of security which were not sufficient to meet his contractual obligations to keep the account above close-out level.
  • Taking into account the difficult circumstances in late March 2020 and the fact that all the other spread betting firms with which Mr Tchenguiz had taken out positions were looking to close out and were not cooperating to provide a global solution.
  • The fact that the spread betting market is a volatile one in which the spread better inevitably takes risks, as the various warnings given to Mr Tchenguiz by CMC emphasised.
  • The court rejected the submission that CMC took irrelevant factors into account, such as CMC’s own hedge position and the impact of the falling market conditions on that position. It accepted CMC’s evidence that the focus was on compliance with the contractual obligations and on taking reasonable steps to protect both Mr Tchenguiz and CMC.

Under COBS 2.1.1R, there is a general duty to act in the client’s best interests. The court found that CMC had not breached this duty, relying on a number of factors, including taking into account Mr Tchenguiz’s considerable experience in spread betting, and that CMC had not acted significantly differently from other spread betting firms with whom Mr Tchenguiz had opened accounts.

As CMC succeeded on its claims, and the court rejected Mr Tchenguiz’s defences, the court found that Mr Tchenguiz owed CMC a sum of £1.31 million plus interest. Mr Tchenguiz has indicated an intention to appeal the decision.

Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Gayatri Gogoi
Gayatri Gogoi
Associate
+44 20 7466 2663

High Court considers termination and enforcement of security rights in context of default on loan agreement

The High Court has found in favour of a lender in its claim against a dissolved airline business for sums due under a loan facility agreement (which was secured by an aircraft mortgage): Lombard North Central plc v European Skyjets Ltd [2022] EWHC 728 (QB).

This decision will be of broader interest to financial institutions seeking to accelerate a loan and enforce security. It is a useful reminder that a creditor’s conduct, for example by accepting late payments or offering more time for outstanding payments to be made, may be held to waive an event of default.

In the present case, the lender was found to have waived its right to rely on the borrower’s payment default (because of conduct outlined above), despite the inclusion of a “no waiver” clause in the loan agreement, and the use of reservation of rights language in communications with the borrower. While the lender’s acceleration notice under the loan agreement referred to the payment default only (in respect of which the right to terminate had been waived), the court held that – on the construction of the loan agreement in question – the notice was valid because of an alternative event of default which had occurred (including a subjective material adverse change). Neither the loan agreement nor the mortgage (as drafted) required the relevant event of default to be specified in the notice, and such a requirement could not be implied in the circumstances of this case.

The court also confirmed that the lender’s right to accelerate the loan was not subject to the so-called Braganza duty, derived from the Supreme Court’s decision in Braganza v BP Shipping Ltd [2015] UKSC 17, i.e. the lender’s discretion was not required to be exercised in a way which was not arbitrary, capricious or irrational in the public law sense.

We consider the decision in more detail below.

Background

In 2008, Lombard North Central Plc (the Lender) lent approximately USD 8.8 million to European Skyjets Limited (the Borrower) for the purchase of an aircraft, pursuant to a loan agreement (the Loan Agreement). The loan was to be repaid in monthly instalments. By way of security, the Lender acquired a first priority legal charge over the aircraft.

In October 2009, the Borrower failed to make the first payment due under the Loan Agreement. Between October 2009 and October 2011, there were a series of further payment related defaults. However, during that time, the Borrower also periodically cleared the payment arrears, although it subsequently went into payment default again at various points. After lengthy restructuring related discussions, which included the Lender obtaining third party advice from an accounting firm, the Loan Agreement was terminated and the loan accelerated by the Lender serving a notice (the Notice) in November 2012. The Borrower subsequently went into administration.

In due course, the Lender brought a claim against the Borrower for the outstanding balance of some USD 5.8 million. The Lender’s case was that it had validly terminated the Loan Agreement, and thereafter validly enforced its security over the aircraft by selling it for USD 3.1 million.

The Borrower denied the claim. The Borrower’s case was that the Lender had no entitlement to terminate the Loan Agreement or to sell the aircraft, and that in any event the Lender had breached its duties as mortgagee when selling the aircraft. The Borrower brought a counterclaim for damages in the sum of GBP 26 million for breach of contract and/or conversion.

Decision

The court found in favour of the Lender, holding that the Lender had validly accelerated and terminated the Loan Agreement and thereby became entitled to enforce the security in respect of the outstanding balance of the loan. There also had been no breach by the Lender of its equitable duty to obtain the best price reasonably obtainable for the aircraft.

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

Termination

1) Did the Lender waive its right to rely on the Borrower’s default in the payment of principal or interest or any other sum payable as an event of default so as to terminate the Loan Agreement?

The court found that the Lender had waived its right to rely on this event of default through its conduct, notwithstanding the inclusion of common contractual “no waiver” language and the use of reservation of rights language in communications with the borrower.

The court noted that as a matter of construction, the relevant provisions in the Loan Agreement did not require the relevant event of default to be continuing; instead, an event of default simply had to have occurred in order for the loan to be accelerated (as per Mardorf Peach & Co Ltd v Attica Sea Carriers Corporation of Liberia (The Laconia) [1977] AC 850). However, the court acknowledged that its finding on the absence of a need for a continuing default could give rise to a relatively severe effect on parties in the position of the Borrower. Namely, a creditor might sit on the right of termination arising from an instalment which was paid late, only to exercise its right of termination much later.

The court commented that this could be addressed by the doctrine of waiver (or estoppel). In cases of waiver, the conduct of the creditor in the period after receipt of the late payment may be held to have waived any right to terminate on account of that late payment. In the present case, the court found that the Lender’s conduct and statements, in accepting late payment of various instalments, offering further time for the balance of the outstanding payment to be paid by a specific date and adding late payment charges to the amounts said to be due from the Borrower, was consistent with the Lender having waived its right to terminate the Loan Agreement based on the event of default by that date.

The court also considered the effect of a “no waiver” clause in the Loan Agreement, and also a statement in an e-mail sent by a representative of the Lender to the Borrower purporting to reserve its rights in relation to the event of default. The “no waiver” clause provided that a failure or delay in exercising a right on the part of the Lender would not operate as a waiver, and the reservation of rights wording indicated that the Lender’s rights were generally reserved in relation to identified breaches of the Loan Agreement.

Here, it was not the failure or delay to exercise a right which resulted in a waiver, but the positive assertions said to arise from the late payments in which the Lender had indicated that it would not enforce the event of default if payments were subsequently brought up to date. As to the reservation of rights, as per SK Shipping Europe Plc v Capital VLCC 3 Corp [2020] EWHC 3448 (Comm), the court noted that a statement in an email reserving rights could not prevent an affirmatory act, which would amount to a waiver and thereby effectively trump the reservation of rights. That was the case here.

2) Could the Lender rely on another event of default not specified in the Notice?

The court found that although the Notice did not specify the correct events of default, this did not impugn the notice, and it had been validly given.

The court noted that the Loan Agreement required that the Notice must (i) be sent after the occurrence of an event of default and (ii) cancel the facility and require the Borrower to immediately repay the loan together with the accrued interest and all other sums payable under the Loan Agreement. The related mortgage had a similar provision which required notice to be given after the occurrence of an event of default.

As per Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] UKHL 19, a party exercising its contractual right of termination by notice must strictly comply with any conditions relating to the exercise of that right. Neither the Loan Agreement nor the mortgage required the relevant event of default to be specified in the Notice, and such a requirement ought not to be implied. This was not a case where there was a cure period, such that it could be said the borrower needed to know what the default was to address it. Furthermore, as per Boston Deep Sea Fishing v Ansell (1888) 39 Ch D 352, 364, it was possible to terminate an agreement without identifying (or correctly identifying) the breaches justifying termination. Similarly, the court said there was ample authority, as per Byblos Bank SAL v Al-Khudhairy [1986] 2 BCC 99,548 and Brampton Manor (Leisure) Ltd v McLean [2007] BCC 640, that a bank was able to accelerate a debt and appoint a receiver where it relied on a default which had not been invoked prior to the appointment.

3) Was there a material adverse effect on the Borrower’s position giving rise to an event of default?

The court found there had been a subjective material adverse change which gave rise to an event of default.

The court noted that the Loan Agreement provided that there would be an event of default if “in the opinion of the Lender, a material adverse change occurs in the business, assets, condition, operations or prospects of any Group Company or any Credit Support Provider.

The court accepted that for the purposes of that clause it was necessary for the court to be satisfied that the Lender formed the requisite opinion at the time (and that the opinion was honest and rational) but unnecessary objectively for the event of circumstance relied upon to have had an adverse effect (as per Cukurova Finance International Ltd v Alfa Telecom Turkey Ltd [2013] UKPC 2). This would need to be the case at the time it served the Notice (as per Plantation Holdings (FZ) LLC v Dubai Islamic Bank PJSC [2017] EWHC 520 (Comm)).

The court highlighted that the Lender had previously been told by the principal of the Borrower’s group, that it required a certain level of net revenue to break even and meet the loan repayments over 10 years, it had recently achieved net profits and was forecasting to do the same and that the principal had substantial net assets.

However, the court said the evidence (from the relevant account manager at the Lender) showed that the Lender honestly believed at the time the Notice was served that there had been a material adverse change in the Borrower’s position, and this was objectively an entirely reasonable position. The account manager had raised the need for an investigation into the position of the Borrower. The investigation by a third-party accounting firm revealed that the Borrower’s management accounts showed trading losses for four months, the performance of the Borrower’s group was far below budget performance and that the business was insolvent on a cash flow basis. Following receipt of that report, the account manager had also made clear in an internal communication that he endorsed that assessment and that the short- and long-term forecasts had shown that the Borrower’s group was not viable at that time and would in the future be unable to service its facilities.

4) Was the Lender precluded from terminating by a contractual duty of good faith?

The court highlighted that the occurrence of an event of default giving the Lender a right of termination was not a contractual discretion to which the Braganza duties applied.

The court noted that, as per TAQA Bratani Limited v Rockrose UKCS8 LLC [2020] EWHC 58 (Comm), that the Lender’s right of termination was an absolute one, which could be exercised by the Lender for its own purposes as it saw fit (and therefore was not subject to a Braganza style fetter).

Sale of aircraft

The court found that there had been no breach by the Lender of its equitable duty to obtain the best price reasonably obtainable for the aircraft.

The court acknowledged that, as per Silven Properties v Royal Bank of Scotland [2003] EWCA Civ 1409 and Cuckmere Brick Co Ltd v Mutual Finance Ltd [1971] EWCA Civ 9, the Lender owed the Borrower an equitable duty to obtain the best price reasonably obtainable for the aircraft, that this involved the exercise of an informed judgment and that provided that the Lender as mortgagee went about the exercise of its judgment in a reasonable way it would not be held to be in breach of duty.

The court said that it was not persuaded that the Lender had breached its duty as mortgagee by: (i) keeping the aircraft in situ (rather than flying it to a cheaper location to store or where there would have been less risk of corrosion): and (ii) acting as it did in the sales process of the aircraft, e.g. by appointing a certain sales broker to conduct the process, not advertising the aircraft in trade journals, and refusing to deal with intermediaries seeking commission.

Further, the court said that even if there had been a breach of duty to take reasonable steps to realise the best value of the aircraft it was persuaded that, when it had regard to the fact that aircraft was being sold by a mortgagee in possession after a lengthy period on the market, the sale price fell within the range of reasonable market values.

Accordingly, for all the reasons above, the court found in favour of the lender.

Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Emily Barry
Emily Barry
Professional Support Consultant
+44 20 7466 2546
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7466 2529
Nic Patmore
Nic Patmore
Senior Associate
+44 20 7466 2298

High Court considers exercise of contractual discretion to close out a customer’s position

The High Court has dismissed claims brought by a customer against a spread betting services provider alleging breach of contract, breach of fiduciary duty, misrepresentation and breach of the Conduct of Business Sourcebook (COBS) rules in relation to the close out of certain positions on his account when it fell into default: De Boinville v I G Index Ltd [2021] EWHC 3326 (Comm).

Although set in the context of spread betting services, the decision will be of broader interest to financial institutions given its potential application to other types of trading accounts. In particular, the court held that the customer was not owed a duty obliging the services provider to close out Mr de Boinville’s positions within a certain timescale or at all (either pursuant to the customer agreement or statutory duty). The court noted that the customer agreement conferred an “absolute discretion” to the services provider to close all or part of any bet where there had been a failure to provide margin amounting to an event of default, which gave rise to an entitlement to the services provider, rather than obligation.

The decision contains some interesting analysis of established legal principles relating to contractual discretion and duties owed in the context of conducting a close out for a customer in default (see our previous blog posts here).

We consider the decision in more detail below.

Background

In January 2012, the claimant (Mr de Boinville) opened an account with the defendant (IGI), a provider of execution-only spread betting services. The account was governed by a customer agreement. Mr de Boinville used the account to open and close spread bets.

In June 2012, Mr de Boinville placed several spread bets online. However, the account was flagged by IGI as being in significant default. The market also moved against Mr de Boinville’s positions around the same time. IGI, in reliance on its contractual discretion to do so under the customer agreement, subsequently closed out all of the spread bets linked to Mr de Boinville’s account.

In 2018, Mr de Boinville commenced legal proceedings against IGI, which included a claim for: (i) losses arising from a transfer of funds out of his spread betting account (to his debit account) and the subsequent closure of his open positions (the Transfer Claim), which had been subject to a settlement agreement between the parties and which Mr de Boinville sought to rescind on the grounds of negligent misrepresentations by IGI; (ii) losses arising from occasions when IGI was alleged to have failed in its regulatory duties under COBS when closing his positions by delaying or allowing a delay in executing his order, leading to losses caused by adverse market movement (the Best Execution Claim); and (iii) losses arising from alleged misrepresentations made by IGI’s compliance department to the FOS (the FOS Claim).

IGI denied the claim and brought a counterclaim against Mr de Boinville for sums paid under the settlement agreement and extra losses in relation to certain spread bet positions.

Decision

The court found in favour of IGI and dismissed Mr de Boinville’s claims.

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

1) The Transfer Claim

The court highlighted that in order to succeed in a claim for misrepresentation, a claimant has to show: (i) the alleged representations were made; (ii) those representations were false; and (iii) they relied upon the representations in the sense that they operated on their mind and caused them, or helped to cause to them, to act as they did. Further, the burden of proof was on the representee.

The court held that the Transfer Claim fell at the second hurdle for establishing misrepresentation, as the representations made by IGI were not false and IGI was not negligent in making them. The position as represented to Mr de Boinville was accurate on the facts. Accordingly, the settlement agreement was not set aside, and the counterclaim was not engaged.

In reaching its conclusion, the court examined the representations made by IGI to the effect that the closure of the positions was a result of data being released to the market which had caused an adverse movement, rather than as a direct result of the transfer of funds out of Mr de Boinville’s account such that there was insufficient collateral to keep the positions open. In the court’s view, none of the representations amounted to a misrepresentation.

The court also noted that Mr de Boinville had been aware of the true position from his discussions with IGI and entered into the settlement agreement on that basis.

2) The Best Execution Claim

In its analysis as to whether IGI owed Mr de Boinville a duty of best execution, the court highlighted the following key legal principles:

  • Where a customer agreement includes the words “You acknowledge that” at the beginning of a provision, this does not mean it is a provision for the benefit of the customer. It will instead be construed as the customer acknowledging what follows is a provision for the protection of the respondent rather than the customer (as per Ehrentreu v IG Index [2015] EWCA (Civ) 79; see our blog post).
  • The duty of best execution has to do with the mechanics of acquiring or selling securities, not the merits or otherwise of the trade. It applies only on the execution of a client order. It has nothing to do with the underlying investment decision (as per Första AP-fonden v Bank of New York Mellon SA/NV [2013] EWHC 3127).
  • A person exercising its right to close out positions in the event of default has a duty to act rationally, i.e. honestly, in good faith and not arbitrarily, capriciously, perversely or irrationally (as per Euroption Strategic Fund Limited v Skandinaviska Enskilda Banken AB [2012] EWHC 584 (Comm); see our blog post).
  • There is no room for the imposition of a tortious duty of care, which is more extensive than that which is provided for under a mandate (as per Euroption).

In reaching its conclusion that the Best Execution Claim failed, the court considered three questions:

  • Whether, in the event of default, IGI was obliged by any contractual provision in the customer agreement, statutory duty or other duty to close out Mr de Boinville’s positions within a certain timescale (or at all)?
  • In closing positions as a result of an act of default, whether IGI was subject to the duties of best execution set out in COBS or any other duty?
  • If IGI was subject to any duty, whether it was in breach of the duty?

Contractual duty to close out positions

The court found that there was no contractual provision obliging IGI to close out Mr de Boinville’s positions when he went into default or at any particular time thereafter.

The court noted that the customer agreement: (i) conferred an entitlement rather than obligation within the exercise of IGI’s “absolute discretion” to close all or part of any bet where there had been a failure to provide margin amounting to an event of default; (ii) conferred a contractual reasonable discretion to keep a bet open where there had been a failure to meet demand for margin; and (iii) included a provision that stated “you acknowledge and agree that, if we agree to allow you to continue to place Bets or to allow your open Bets to remain open [where a margin demand has not been met], this may result in your incurring further losses…”, which following Ehrentreu, was not for the benefit of the customer, but rather to protect IGI.

The court rejected the plea that there was an implied term that IGI would exercise its discretion fairly and in the best interest of Mr de Boinville, on the basis that the customer agreement set out the circumstances and ways in which IGI could exercise its discretion. It was therefore not necessary to imply such terms in order to give business efficacy to that agreement. However, the court said that the exercise of the absolute discretion would be subject to an implied term that it will not be exercised in a manner which is irrational, perverse, capricious or arbitrary (as per Euroption).

There was no plea that IGI’s exercise of its discretion was irrational, perverse, capricious or arbitrary, and in the court’s view, nor could there be. Mr de Boinville had accepted that IGI’s internal system flagged accounts for a dealer to investigate, and if there were closures to be made to work out what order to close the various positions. That would take time.

Statutory duty to close out positions

The court found that there was no duty, statutory or otherwise, on IGI to close out a customer’s position either immediately that customer becomes in default, or immediately he becomes in significant default or at any particular time thereafter.

COBS/Fiduciary/Common law duty of best execution

In the court’s view, there had been no breach of COBS. The court said that, following Första, IGI’s best execution policy related to the mechanics of acquiring or selling securities, rather than the anterior decision as to whether or not Mr de Boinville’s positions should be closed.

As to the existence of any fiduciary duties, the court commented that as IGI provided services on an execution-only basis, all the duties it owed Mr de Boinville were fully contained in the customer agreement and certain statutory regulations.

Further, the court highlighted that, following Euroption, it did not accept that the common law duties contended for by Mr de Boinville, in particular that there were duties at common law, akin to those imposed by statute, or that there was any additional obligation at common law imposed upon IGI, given that it was operating an execution-only service. In the court’s opinion, IGI had not assumed responsibility for the management of Mr de Boinville’s money and its obligations in relation to Mr de Boinville’s money were set out in the customer agreement and certain statutory regulations.

The court noted that, had such fiduciary or common law duties existed, it would not have found any breach for the same reasons that there was no breach of contractual or statutory duty by IGI.

Breach of duties

The court commented that even if IGI were subjected to the duties contended by Mr de Boinville, there had been no breach of them.

The court noted that there was insufficient evidence to establish that the conduct of IGI was unreasonable, in light of Mr de Boinville’s acceptance that IGI’s internal system flagged accounts for a dealer to investigate, and if there were closures to be made to work out what order to close the various positions.

Further, the court said that Mr de Boinville himself could have taken active steps to close out the positions, having failed to provide sufficient margin and, with one exception, did not do so.

3) The FOS Claim

The court said that having found that the Best Execution claim failed, it followed that the FOS reached the correct decision. That decision was not based on incorrect statements from IGI, and therefore there was no breach of any duty, contractual, statutory or any other duty and as a result no loss had been suffered by Mr de Boinville.

Accordingly, for all the reasons above, the court found in favour of IGI and dismissed Mr de Boinville’s claims.

Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7466 2529
Catherine Bagge
Catherine Bagge
Associate
+44 20 7466 7499

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

Commercial Court considers contractual discretion of bank to close customer account without notice where there is suspicion of money laundering

In a recent decision, the Commercial Court has upheld a financial institution’s decision to exercise its contractual right to close a customer’s accounts and terminate its relationship without notice, where the financial institution had a suspicion that its customer’s accounts were being used for money laundering purposes: N v The Royal Bank of Scotland plc [2019] EWHC 1770. The decision will be welcomed by financial institutions seeking to take action to prevent financial crime occurring through use of accounts provided to customers, under tight time pressure and notwithstanding that the consequences of the bank’s action for the business in question could be severe.

This is not the first case in which a financial institution has successfully defended a breach of contract claim brought by its customer in the context of a money laundering suspicion. In Shah & Anor v HSBC Private Bank (UK) Ltd [2012] EWHC 1283 (QB) (see our corporate crime e-briefing), the court firmly rejected the customers’ claim that the bank was in breach of contract by refusing to process payment instructions while awaiting consent from the Serious Organised Crime Agency (now the National Crime Agency, “NCA”) in respect of a Suspicious Activity Report (“SAR”). In that case (in the absence of an express term) the court implied a term into the contract. The implied term permitted the bank to refuse to execute payment instructions in the absence of “appropriate consent” under the Proceeds of Crime Act 2002 (“POCA”), where it suspected a transaction constituted money laundering. Pursuant to the POCA ‘consent regime’, once a bank makes a SAR, it will not be able to process payments in relation to the relevant account until “appropriate consent” (now known by the NCA as “DAML”) has been given by the NCA. In Shah, the defendant bank was then put to proof that it had the requisite suspicion of money laundering in order to rely upon the implied term (which the bank satisfied).

However, in the instant case, the bank was assisted by express contractual provisions giving the bank discretion to close the customer’s account and delay/refuse to process payments in certain circumstances. As such, the test applied by the court was different to previous authorities (including Shah), because it derived from the wording of the contract itself and the contractual discretion expressly provided for.

While the terms governing accounts will vary between institutions and account type, a number of the court’s findings may be of general assistance to banks considering AML compliance procedures and assessing the risk of exposure to account-holder claims. In particular:

  • Interestingly, the court did not find it necessary to grapple with the question of the standard which the bank was required to meet in the exercise of its contractual discretion to close the account, i.e. whether the bank’s discretion was required to be exercised in a way which was not arbitrary, capricious or irrational in the public law sense (the so-called Braganza duty); or if the bank was required to meet the higher standard of objective reasonableness. This was because, even applying the higher threshold, the court found that the standard had been met by the bank and the decision to close the account did not breach the bank’s contractual terms. The applicable standard is important because contractual discretions are subject to increased judicial scrutiny if the latter standard applies (see previous blog post: High Court applies public law standard to the exercise of discretion by a financial institution under a receivables finance agreement). It may be prudent for those drafting the bank’s account terms to consider expressly incorporating the lower threshold where appropriate.
  • The court reached its conclusion notwithstanding the absence of any suspicion that the customer (a money service business (MSB), whose accounts received funds from its underlying clients) was implicated in its clients’ suspected criminality. This was because the end result of the customer’s poor AML due diligence and regulatory compliance was similar to the result of deliberate action on its part.
  • The court expressly stated that the bank was entitled to consider the impact (on the bank itself) of not freezing and terminating the customer’s accounts – here the bank could not countenance a risk that it would be money laundering and this was a relevant factor to take into account in the exercise of the bank’s discretion.
  • The court specifically rejected the customer’s broad contention that unless complicity/fraud is proven, closing an account without notice “could never rationally be adopted by a bank” (emphasis added). The court confirmed this will depend upon the wording of the contractual terms governing the account. In this case, the contract provided that the bank could take action where it considered there to be exceptional circumstances, not just where there is established complicity or proven fraud.

Regrettably, the court chose not to grapple with a number of other areas of interest from an AML compliance perspective which are raised by the case. Foremost among these is the question of co-mingling and ring-fencing (and in particular the circumstances in which ring-fencing might be a permissible approach, within the framework of POCA, as an alternative to freezing an account). This is a perennial debate, and the recent Law Commission consultation on reform of the SARS regime included an interesting discussion on the question of ring-fencing and fungibility (that money is considered to be an asset capable of mutual substitution, i.e. one £5 note can be substituted for any other £5 note). The Law Commission’s final report recommended an amendment to POCA to create additional clarity in this area. In the meantime, while the position taken by the court in N v RBS was helpful to the bank, the correct legal analysis as to the nature of the criminal property in play when funds are mixed remains open to debate.

Background

The claimant (“N”) was an authorised payment institution providing foreign exchange and payment services to its customers. N held several main accounts and client sub-accounts with the defendant, The Royal Bank of Scotland plc (the “Bank”).

Pursuant to the terms which governed the operation of N’s accounts, the Bank:

  • was under a duty to give N written notice to close an account, unless it considered there were exceptional circumstances; and
  • could delay or refuse to proceed with processing a payment if, in its reasonable opinion, it would be prudent to do so in the interests of crime prevention or in compliance with laws.

In September 2015, the Bank suspected that several of N’s clients were involved in “boiler room” scams, and that victims had paid money into N’s accounts held with the Bank. The Bank froze several client sub-accounts, and identified there had been “co-mingling” (i.e. mixing) between sub-accounts and the main accounts. On 8 October 2015, after the sub-accounts had been frozen, an attempted payment was made from the main account (the “Attempted Payment”), arousing the Bank’s suspicion that some of N’s clients were attempting to circumvent the freeze on the sub-accounts.

On 9 October 2015, the Bank froze the main accounts and terminated its relationship with N immediately. N commenced proceedings challenging the lawfulness of the Bank’s actions, alleging breach of contract and negligence.

Decision

The High Court found the Bank was entitled to terminate its relationship without notice in the circumstances.

Standard of contractual discretion

The court undertook a detailed assessment of the factual evidence presented, and found that the decision to terminate the relationship was taken on 9 October 2015. It then considered whether the Bank exercised its discretion to close the accounts (and therefore refuse to process payments) in accordance with the contractual terms governing the account.

In the court’s view, the case did not turn on the differences between the parties’ rival contentions as to the meaning of the contractual terms and it did not consider those questions further. In this regard, N argued that the Bank was required to meet the standard of objective reasonableness in the exercise of its contractual discretion to close the accounts. The court held that, even applying this standard (which is higher than the rationality threshold), the standard was met by the Bank.

Alleged failure by the Bank to exercise discretion in reasonable manner

The court considered various challenges made by N to the exercise of the Bank’s discretion. The key challenges which are likely to be of broader interest are explored further below.

  1. N’s primary challenge to the exercise of the Bank’s discretion was that there was no suspicion that N was implicated in money laundering. However, the court found that N’s poor control environment meant, in effect, whether N was implicated in the fraud or not was irrelevant to the Bank’s exercise of its discretion. In this regard it is noteworthy that the experts on both sides agreed that there were numerous failures in N’s due diligence and regulatory compliance, which the court held were “serious”.
  2. N argued that because there was no suspicion that it was complicit/implicated in the underlying frauds of its clients, the co-mingling issue “was not insurmountable”. However, the court considered and rejected the various ways suggested by N (ex post) as to how freezing N’s sterling pooled client account (one of the accounts in question) could have been avoided. In particular:
    • The court rejected N’s contention that the Bank could have ring-fenced suspected funds as the Bank had tried this by initially freezing the suspect sub-accounts. The success of this option had already been compromised by the co-mingling of accounts and the Attempted Payment. The court said the position was the same in relation to N’s separate contention that the Bank could have broken the account (if necessary with NCA consent), and commented that the Bank also had (and was entitled) to consider its obligations as to the prevention of crime, separate to the view of the NCA.
    • The court rejected N’s proposal that the Bank could have manually operated the account or sought consent on a daily basis by way of an ‘omnibus’ SAR. These two proposals were impractical, in light of the volume of transactions and the challenges posed by investigating each one, and of engaging with the NCA.
    • The court rejected N’s assertion that the Bank could have prevented further credits to the account or could have adopted a cooperative approach to the exit of the relationship by working with N over the suspect accounts. The court commented that the Bank was entitled to conclude that things had gone too far for this suggestion to be workable, and the proposal as to further credits did not address the position as to existing balances in the accounts.
  3. The court rejected N’s contention that the absence of suspicion in relation to N’s involvement in evasion in relation to the Attempted Payment was relevant – it was the evasion itself which was the problem for the Bank.
  4. The court also concluded that as co-mingling had been identified in the accounts, this fact could be taken into account by the decision-maker at the Bank, even without further investigation.
  5. N argued that the decision to terminate the relationship without notice did not take account of the potentially significant consequences for N’s business. As a matter of fact, the court found this was incorrect. The court also helpfully commented that the impact on the Bank of not freezing and terminating must be part of the consideration – here the Bank could not countenance a risk that it would be money laundering and this was a relevant factor to take into account in the exercise of the Bank’s discretion.
  6. The court specifically rejected N’s broad contention that unless complicity/fraud is proved, closing an account without notice “could never rationally be adopted by a bank” (emphasis added). The court noted that the contract provided for a right to close an account without notice where the Bank considers there are “exceptional circumstances”, not “where there is established complicity or proven fraud”.

The court recognised there were a range of honest, rational and reasonable decisions which could have been taken. However, it did not mean that the decision-maker’s chosen course was incorrect; it was within the realm of reasonable decisions. Accordingly, the court held that the decision taken by the Bank on 9 October 2015 was not in breach of the Bank’s terms (nor a breach of any tortious duty, for the same reasons).

Section 338(4A) POCA

The court found it unnecessary to consider s.338(4A) POCA, the post-Shah provision which was introduced into POCA with a view to assisting firms who are alleged to have caused loss to customers or counterparties by making authorised disclosures (typically, if there is a delay in a transaction while consent/DAML is sought). The provision did not assist the Bank, since the basis of the customer’s claim was the decision to terminate the account relationship, rather than a loss arising from the seeking of consent.

Susannah Cogman
Susannah Cogman
Partner
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Harry Edwards
Harry Edwards
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Ceri Morgan
Ceri Morgan
Professional Support Lawyer
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Nic Patmore
Nic Patmore
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Important High Court guidance on the limits of determining party’s discretion when calculating Loss under the 1992 ISDA Master Agreement

The High Court has provided important guidance on the application of the standard to which a determining party’s calculation of Loss under the 1992 ISDA Master Agreement will be held in Lehman Brothers Finance AG (in liquidation) v (1) Klaus Tschira Stiftung GmbH & Anor [2019] EWHC 379 (Ch).

Upon an Event of Default under the 1992 ISDA, the standard to which the determining party is held in calculating Loss (if elected) under the 1992 ISDA has previously been confirmed in Fondazione Enasarco v Lehman Brothers Finance SA [2015] EWHC 1307 (read our summary here). The test is one of rationality, rather than objective reasonableness (in contrast to the position under the 2002 version of the ISDA Master Agreement). This gives the determining party greater latitude, with the result that the amounts can be determined quickly and with only limited basis for challenge. In the classical formulation of the test, the defaulting party can challenge the determination if it is irrational, capricious or arbitrary.

The Tschira decision provides additional clarification of the limitations on the determining party’s discretion to determine Loss, illustrating that the width of the discretion does not mean that the determination can only be challenged if it can be shown that “no reasonable Non-defaulting Party acting in good faith could have come to the same result“. In particular:

  1. Whilst an administrative-law style assessment would consider whether the determining party took into account all relevant factors and ignored all irrelevant factors, that does not mean that the determining party has the freedom to determine what the definition of Loss in the 1992 ISDA actually means. In other words, the determining party cannot apply its own interpretation of Loss and the court will scrutinise whether the correct interpretation has been applied.
  2. The definition of Loss in the 1992 ISDA did not provide a de facto indemnity against all losses suffered as a result of the Event of Default. Accordingly, common law principles of remoteness applied and it was necessary for the court therefore to consider whether all of the losses incorporated into the determination were in the reasonable contemplation of the parties.
  3. Whilst the determining party is plainly able to use indicative quotations obtained from market participants for the purpose of its calculation of Loss, care must be taken:
  • Only in limited circumstances will it be appropriate to rely on indicative quotations as at a later date than the Event of Default.
  • Whilst Enasarco established that the replacement trade to which the quotation applies need not be identical to the trade being valued, where the differences would obviously produce a substantially different result there is a real risk that use of such quotations to determine Loss would be deemed irrational.
  • It is clear that the determining party need not in fact enter into the replacement trade in order to be able to use the indicative quotation for the determination of Loss. However, in order for use of an indicative quotation to be rational, it may need to have been possible for the determining party to have been able to enter into it.

Background

The defendants were two German entities established by one of the founders of SAP. Since their principal assets consisted of shares in SAP, they had each entered into a number of single stock derivative transactions with Lehman Brothers Finance AG (the “Bank“), a Swiss entity which was part of the Lehman Brothers group, to hedge against significant falls in the price of SAP shares. The hedging transactions were governed by the 1992 version of the ISDA Master Agreement. Given the poor credit quality of the defendants, the terms of the transactions required the SAP shares they held to be placed as collateral with the UK subsidiary of the Lehman Brothers group (“LBIE“).

The collapse of Lehman Brothers on 15 September 2008 caused an Event of Default on the hedges triggering the need for the defendants to determine the close-out payments (on the basis of Loss, which the parties had elected as the methodology to apply in the 1992 ISDA). Soon after the Event of Default, the defendants sought indicative quotations from Goldman Sachs and Mediobanca, Banca di Credito Finanziario SpA (“Mediobanca“) for replacement hedges on the basis that they would be collateralised in a similar way to the original trades.

However, the defendants later learnt that the SAP shares held by LBIE as collateral would be dealt with as part of its administration, raising the prospect of them being unavailable to the defendants for use in any replacement trade for the foreseeable future. As a result, Mediobanca and Goldman Sachs were asked to provide revised indicative quotations for replacement trades on an uncollateralised basis. Unsurprisingly, these quotations were substantially higher than the earlier quotations which had been obtained on a collateralised basis (reflecting, amongst other things, the significantly greater credit risk to which the counterparty would be exposed).

The defendants ultimately served a determination of Loss based on Mediobanca’s quotation for an uncollateralised replacement trade. Accordingly, the determination of Loss which it sought to recover from the Bank (over €511m) was far higher than it would have been had it been determined on the basis of the earlier quotations which were based on a collateralised replacement trade (which were €28.22m and €17.46m).

The Bank challenged the calculation of Loss.

Decision

The court held that the determination of Loss by the defendants was invalid. First, it had not been performed in accordance with the definition of Loss. In any event, it was found to have been irrational.

Application of the rationality standard

It is well established by the authorities (for example, Enasarco) that the relevant standard which applies to the determining party’s calculation of Loss under the 1992 ISDA is one of rationality, reflecting the test of Wednesbury reasonableness of an administrative decision. However, it was noted that this did not resolve all uncertainties as to the standard to which the determining party will be held. In particular, it was unclear whether this test imported into the court’s assessment of all the elements of a review of an administrative decision, including the process by which the determination was reached.

The court held that the 1992 ISDA did not import a requirement that the court undertake a detailed assessment of whether the determining party took into account all relevant factors and ignored irrelevant factors. To allow such an expanded basis for challenge would undermine the desire for speed and commercial certainty which is clearly one of the driving principles of the Loss definition. However, the determining party does not have free rein to determine for itself not only the method it will adopt to determine Loss, but also the actual meaning of Loss. Accordingly, the Bank was not limited only to being able to challenge the determination of Loss on the basis that the method chosen was irrational (or in bad faith), for which the defendants had a large measure of latitude. It could also challenge the determination on the basis that the defendants had interpreted the definition of Loss incorrectly.

Remoteness test in the meaning of Loss

The court held that the correct meaning of Loss incorporated usual common law principles applicable to the assessment of contractual damages, including remoteness. The key question, therefore, was whether all of the Loss claimed was of a type that was in the reasonable contemplation of the parties. Applying this test, the court found that it was not within the reasonable contemplation of the parties that the defendants would be able to recover the additional financial consequences of having to enter into an uncollateralised replacement trade as a result of being unable to retrieve the collateral from LBIE.

The court noted that this conclusion was consistent with the ‘value clean’ principle, pursuant to which the loss of bargain within the Loss calculation must be valued on the assumption that “but for termination, the transaction would have proceeded to a conclusion, and that all conditions to its full performance by both sides would have been satisfied, however improbable that assumption may be in the real world“. Applying the ‘value clean’ principle in this case, the provision of the collateral by the defendants was a condition precedent for the trades. Accordingly, the assumption should be made for the replacement trades that this condition would be satisfied, notwithstanding that this was not possible in the real world. This meant that any quotations for replacement transactions should have been on a collateralised basis.

Appropriate date for determining Loss

The court also considered a criticism made that the quotations used for the defendants’ determination should have been ‘as of’ the Early Termination Date. The Bank argued that, whilst the Loss definition permitted (for practical reasons) some flexibility in the use of a firm quotation obtained after the Early Termination Date, it did not allow an indicative quotation to be used other than as of the Early Termination Date. The rationale for this was that it should always be possible to obtain an indicative quotation as at the earlier date (on a retrospective basis).

The court did not agree with such a restrictive interpretation of Loss, which would have the effect of requiring, rather than permitting, the Non-defaulting Party to use firm quotations rather than any other method in circumstances where, for whatever reason, it was unable to obtain quotations at the time of the Early Termination Date (for instance where it did not learn of the Event of Default until a later point in time or where there was no available market as at the Early Termination Date). However, it noted that this flexibility would only apply in those sorts of limited circumstances.

Rationality

The court also found that it was, in any event, irrational for the defendants to use the uncollateralised replacement transactions as a basis for the calculation of Loss.

First, whilst the existence of some differences between the terms of the trade and the terms of the replacement trade may not invalidate the determination of Loss (as illustrated in the Enasarco case), there were limits to that latitude. In this case, seeking quotations for replacement trades on an uncollateralised basis would obviously, and did, produce a substantial difference when compared to seeking quotations on a collateralised basis. This meant that they were not a reliable guide as to the value of what had been lost, and to use this as a basis for the calculation of Loss was irrational.

Second, the method of using quotations or valuations of the cost of a replacement trade to measure loss depends on the replacement being one that the party could enter into in an available market (albeit that they need not actually enter into the replacement trade). Having made a finding of fact that the defendants, given their poor credit risk, could not have entered into a replacement hedge on an uncollateralised basis, it was irrational to use a quotation for such a transaction as a method of determining its Loss.

The court’s calculation of Loss

Having found that the determination was invalid, the task for the court was to determine what Loss determination would have been arrived at by the defendants acting reasonably and in good faith. It therefore substituted the defendants’ invalid determination with its own calculation, using the initial quotations which had in fact been obtained by the defendants (on a collateralised basis). Whilst there were criticisms made of aspects of those quotations by the Bank’s expert, these were characterised by the court as differences of methodology, rather than fundamental errors that would lead to a substantially different price.

The court’s approach emphasised the potential importance of all contemporaneous quotations received by the Non-defaulting Party. Whilst it is clear from previous case law (see our e-bulletin on National Power) that the determining party gets only one bite at the cherry, the steps taken to obtain other quotations at or around the time of the Event of Default are likely to provide important evidence for the court to use in its own calculation of Loss.

It is noteworthy, also, that in this aspect of the judgment the court left open the question of whether the determining party could validly favour its own interests in the selection of which quotation to use in its determination, or whether choosing the one which was most favourable would necessarily be irrational. The court adopted the pragmatic approach of averaging the two quotations which the defendants received on the basis that the defendants had, as a matter of fact, used that average when providing a ‘without prejudice’ informal calculation of Loss in the initial days after the Event of Default. However, in doing so, it has left the question to be determined in future litigation.

Harry Edwards
Harry Edwards
Partner
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Amel Fenghour
Amel Fenghour
Associate
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Ceri Morgan
Ceri Morgan
Professional Support Lawyer
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High Court finds bank unreasonably withheld consent to sale of secured property where sale would not have satisfied the secured liability in full

Paul Crowther & Anor v Arbuthnot Latham & Co Ltd[2018] EWHC 504 (Comm) provides an interesting example of how the High Court applied the test of objective reasonableness to the exercise of a bank’s discretion to consent to the sale of a secured property. In reaching this conclusion, the court refused to apply the so-called Braganza duty to the exercise of the contractual discretion, i.e. whether it was exercised in a way which was not arbitrary, capricious or irrational in the public law sense. Central to the court’s decision was its conclusion that the wording of the clause in the instant case (that the bank’s consent should not be “unreasonably withheld or delayed“) was “essentially the same” as the wording of a clause in a landlord and tenant case in which the Court of Appeal applied the objective test of reasonableness: Straudley Investments Ltd v Mount Eden Land Ltd [1996] EWCA Civ 673(citation corrected from the judgment).

Applying this objective test, the court held that the bank’s refusal was unreasonable. The bank’s position was that any consent to sell was conditional on the provision by the claimants of further security, because the proceeds of the sale would not discharge the outstanding debt in full. However, the court emphasised that at the time the relevant agreement was entered into, the estimated value of the property was “very considerably less” than the outstanding indebtedness, and so the position had not really changed. Essentially, the court took the view that the bank should have sought further security (in excess of the value of the secured property) at the outset, if it wished to have security for the full amount of the outstanding debt.

This decision will be of interest to lenders, particularly those considering the exercise of a contractual veto to prevent the sale of secured property, although each case will turn on its own facts and the express wording of the clause.  One way in which the interpretation of a similarly worded clause might be distinguished in the future is where (at the time the relevant agreement was executed) the full outstanding liability was secured by the property in question. The instant decision is also vulnerable to criticism that the principles applied were specific to the landlord and tenant context and attempts to transfer such principles outside of that sector are inappropriate. In particular, the court failed to address the fact that the analysis of the requirement not to unreasonably withhold or delay consent in Mount Eden, on which much emphasis was placed, was (at least in part) informed by the requirements of the Landlord and Tenant Act 1988 which also uses the same wording.

However, if this decision is followed, it may increase the risk for lenders who withhold consent to the sale of secured property in circumstances where there is an express provision that such consent should not be withheld unreasonably. This is because the application of an objective test (as opposed to one based on rationality) will arguably make it more difficult for a lender to prove that consent has been withheld legitimately.

Factual background 

In December 2001 the claimants issued proceedings against Arbuthnot Latham & Co Ltd (the “Bank“) before the Brighton County Court alleging that, as a result of a number of loan facilities entered into between them, an unfair relationship within the context of the Consumer Credit Act 1974 arose. These loans were secured by a charge over the claimants’ property in France (the “Property“). The proceedings were subsequently transferred to the High Court, and the claim was settled in September 2013 by a Tomlin order, with settlement terms included in a schedule to that order (the “Settlement Agreement“). Further to the Settlement Agreement, the charge and only one facility (with approximately €5.9 million outstanding) remained in place and their original terms were superseded by those included in the Settlement Agreement.

Over the years the claimants tried to sell the secured Property to reduce their indebtedness and towards the end of 2016 they received an offer of €4.5 million, which was in line or slightly over the market valuations at the time and was considered by the Bank as “an agreeable offer“.  However, the sale would have left the Bank with a considerable shortfall (€1.7 million) and no security. The Bank was prepared to agree to the sale on the condition that further security was provided by the claimants. Since no further security was provided, the sale was lost. The claimants did not accept that the Bank’s requirement for further security as a condition of consent was a legitimate or reasonable basis for its refusal.

The current dispute between the parties concerned the construction of the following clause of the Settlement Agreement (the “Clause“): “If with the prior approval of the bank (such approval not to be unreasonably withheld or delayed) the property is sold, you shall immediately repay to the bank the net proceeds of sale“. The claimants sought a declaration that the Bank had unreasonably withheld its consent to the sale of the Property.

Decision

The court held that the Bank’s refusal to consent to the sale was unreasonable, granting declaratory relief against the Bank. The key question considered by the court was the proper scope of the Bank’s discretion to consent to the sale, in other words, the proper purpose of the Clause.

The court first referred to Mount Eden, a landlord and tenant case  where the wording of the landlord’s veto clause was essentially the same as the Clause in the instant case, i.e. that consent should not be unreasonably withheld. The landlord was only prepared to give consent for its tenant to sublet, subject to a condition which would improve the landlord’s own security position, whereby the deposit from the new subtenant was required to be held in a joint account. The court held that the landlord’s consent to the subletting was unreasonably withheld, stating that it would not normally be reasonable for a landlord to seek to impose a condition which was designed to increase or enhance the rights that he enjoyed under the headlease (i.e. retaining a security interest in the deposit to which only the tenant would normally be beneficially entitled). In the instant case, the court said that the decision in Mount Eden was of assistance in two ways:

  • Mount Eden stated that it was not necessary for a landlord to prove that the conclusions which led him to refuse consent were justified, if they were conclusions which might be reached by a reasonable man in the circumstances. This suggested that the test for reasonableness was an objective assessment.
  • Mount Eden stated that a landlord is not entitled to refuse his consent to an assignment on grounds which have nothing to do with the relationship of landlord and tenant in regard to the subject matter of the lease, referring to a recent example of a case where the landlord’s consent was unreasonably withheld because the refusal was designed to achieve a “collateral purpose” unconnected with the terms of the lease. As such, a “collateral purpose” would include where a party withholding consent does so in order to obtain rights he did not otherwise have.

It is noted that Mount Eden appears to have been decided (at least in part) on the requirements of the Landlord and Tenant Act 1988, rather than purely on the basis of a landlord’s veto clause in the head lease. The implications of this are discussed in the introduction.

The court distinguished Barclays Bank Plc v Unicredit Bank AG (formerly Bayerische Hypo-und Vereinsbank AG) [2014] EWCA Civ 302, in which the fact that the bank had only regarded its own commercial interests in refusing consent to an early termination of derivative transactions was found to be reasonable. In Unicredit, the clause required consent to be determined in a “commercially reasonable manner” and the nature of the reasonableness test was by reference to Wednesbury unreasonableness or a form of Braganzaduty, i.e. a test of rationality as opposed to the common law, reasonable person test. The key points of distinction made were as follows:

  • In the instant case, the court saw no basis for a Wednesbury reasonableness test, given that the wording of the Clause followed the landlord and tenant-type clause (per Mount Eden, which applied a reasonable person test) and was different to the wording of the clause in Unicredit.
  • Further, the court noted that the discretion considered by the Court of Appeal in Unicredit concerned the process or manner of the determination of whether to consent to the early termination, by contrast to the Clause in this case, which was about outcome.

The court noted that the Clause did not qualify or define its object or target in respect of the reasonableness of the refusal in any way, but stated it was “very hard to see why the scope of the [Clause] should go any further than a concern which [sic] the aim of permitting disposal of the [Property] at a proper price“. In this context, the court held that the Bank’s reasons for refusing the sale had no connection with the aim of getting a sale at a proper value at all. Although the proposed sale would have left a shortfall, the court noted that the value of the Property at the time of the Settlement Agreement was “very considerably” less than the outstanding indebtedness. As such there was no expectation at that time that a potential sale of the Property would pay off the entirety of the outstanding loan and so the position had not really changed. The court commented that, although the Bank’s desire for more security was about the loan and its relationship with its debtors, that did not stop it from being a collateral purpose as the decision in Mount Eden made clear.

Accordingly, the court held that the disputed Clause should be construed so that the reasonableness of the discretion exercised by the Bank was determined by reference to whether the proposed sale was “at fair market value and at arm’s length“. The court did not accept that the reasonableness criteria in that context was limited to ensuring that the Bank acted in a Wednesbury reasonable or rational way in reaching its decision. Consequently, upon the facts of the case, the Bank’s refusal to the sale was deemed unreasonable.

 

Rupert Lewis
Rupert Lewis
Partner
+44 20 7466 2517
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948