Court of Appeal rejects novel duty of care on banks to protect employees from economic loss arising from a criminal conviction in the performance of duties

March 7, 2023

The Court of Appeal has dismissed the appeal of a bank employee, finding that the bank did not owe a novel duty to take reasonable care to avoid the risk of the employee being convicted, and that there was no implied term of the employment contract that the bank would indemnify the employee against loss of future earnings suffered as a result of his conviction: Benyatov v Credit Suisse (Securities) Europe Ltd [2023] EWCA Civ 140. In doing so, the Court of Appeal upheld the decision of the High Court for essentially the same reasons.

The Court of Appeal refused to draw an analogy with the audit duty found in Rihan v Ernst & Young Global Ltd [2020] EWHC 901 (QB) (see our banking litigation blog post). In Rihan, the established duty on the defendant auditor was to conduct the audit ethically and without misconduct. In the view of the Court of Appeal, this had no application to the circumstances of the present case, where the duty alleged had nothing to do with the bank avoiding wrongdoing, but was an alleged duty to protect the claimant against the wrongdoing/unjust acts of another third party.

The decision demonstrates the court’s conservative approach to establishing a novel duty of care, providing some helpful analysis on the correct approach in law. The Court of Appeal applied well-established principles, taking the incremental approach endorsed in Robinson v Chief Constable of West Yorkshire Police [2018] UKSC 4. This will involve consideration of the three-stage Caparo test (namely, (i) foreseeability, (ii) proximity, and (iii) fairness, justice and reasonableness) to the extent that those factors are in issue. The Court of Appeal acknowledged that assumption of responsibility may be a useful analytical tool, but its usefulness will depend on the issues in the particular case. The most decisive factor in the present case was foreseeability, and assumption of responsibility added nothing, because the bank could not have assumed responsibility for risks that were not reasonably foreseeable.

In relation to the contractual indemnity argument, it was common ground that it was an implied term of the claimant’s employment contract that the bank would indemnify him against some forms of harm suffered in doing his job. However, in the Court of Appeal’s view, there was no support in the English authorities for a general principle that if a person acts on the instruction of another, they are entitled to be indemnified against all losses, of any kind, suffered as a result of doing so, irrespective of any fault on the part of the employer. It commented that a general indemnity of this kind would “wholly subvert the way in which both the common law and legislation have addressed the issue of the obligations of employers”.

We consider the decision in more detail below.

Background

The claimant joined the defendant bank (Bank) in 1997, and from 2005 he worked on a project advising a company about the purchase of a state-owned electricity company in Romania. In 2006, while he was on a visit to Romania, the claimant was arrested on suspicion of criminal wrongdoing in connection with the privatisation, subsequently charged and found guilty by the Romanian court in 2013. The claimant made a partially successful appeal to the Romanian Appeal Court and subsequently applied to the European Court of Human Rights, where he is still awaiting an admissibility decision.

It was common ground that the Romanian conviction was, in practice, an insuperable obstacle to the claimant’s ability to work as a regulated financial professional either in the UK or elsewhere. The claimant’s employment by the Bank was terminated in 2015.

In 2018, the claimant issued proceedings against the Bank, claiming that the Bank was liable to compensate him for the loss of earnings that he has suffered as a result of his conviction. He originally estimated that loss at over £66 million and proceeded on two alternatives bases:

  1. That it was an implied term of his contract of employment that the Bank would indemnify him against a loss of the kind suffered (the indemnity claim); and
  2. That the Bank was in breach of a duty to take reasonable care to avoid the risk of him being convicted, and that he is entitled to damages for that breach (the negligence claim).

The proceedings were conducted throughout by both parties on the basis that the claimant was indeed wrongfully convicted (save for in relation to one point, which was ultimately rejected by the court and is not considered further in this blog post).

High Court decision

The High Court dismissed the claim in its entirety.

Negligence claim

The claimant argued he was owed a duty of care not to expose him to criminal conviction in the performance of his duties for the Bank. In particular, the claimant argued that the Bank had a continuing duty to take reasonable care to protect him from criminal conviction, and the resulting losses in the performance of his duties.

The High Court approached the case as a “novel situation” (i.e. one where the existence of a duty of care has not been recognised in previous authority), with the result being that the High Court should proceed incrementally and by analogy with established authority, identifying the legally significant features of the situations (per Caparo Industries plc v Dickman [1990] 2 AC 605, as explained further in Robinson).

The High Court found that the claimant was unable to prove the basis of the pleaded duty, and failed to prove that (in the circumstances of the case) it was reasonably foreseeable that he would be exposed to a conviction in the performance of his duties for the Bank. The High Court took a number of factors into account in reaching this conclusion, including the facts showing that (during the relevant period) Romania was not regarded as a high-risk country, and that the privatisation transaction was not regarded as a high-risk transaction.

The High Court’s conclusion that the Bank did not owe the claimant the alleged duty meant that there was no need to consider the issue of breach. In any event, the High Court found that the claim was brought outside of the statutory limitation period.

Contractual indemnity claim

The claimant submitted that various terms were implied into the claimant’s employment contract as a matter of law, fact or business efficacy, including that (at all material times) the Bank owed to the claimant a duty to indemnify him in respect of “all losses, costs, expenses and claims he has suffered arising from or in consequence of faithfully, diligently or properly performing his duties on its behalf” (referred to as the “general indemnity”).

Considering implication as a matter of law, the High Court rejected the claimant’s claim that the general indemnity was a necessary incident of the employment relationship. It disagreed with the suggestion that there was a general principle that if a person acts on the instruction of another they are entitled to be indemnified against all losses, of any kind, suffered as a result of doing so. Bearing in mind that the loss (allegedly) suffered by the claimant in this case was predominantly loss of future earnings, the High Court commented that:

“… there is not a single case in which an indemnity implied into an agency or employment contract has permitted the agent or employee to recover lost income. Rather, in every reported case where an indemnity was ordered it was for payments that the agent or employee had made, or was liable to make, to a third party.”

The High Court also rejected the implication of the indemnity as a matter of fact, i.e. because of the particular circumstances of the case, such as the allegedly high-risk nature of the claimant’s work. The High Court’s findings in relation to the negligence claim meant that none of the risk factors relied on had been established, and so the alleged indemnity was not made out.

The claimant appealed this decision.

Court of Appeal decision

The appeal was dismissed unanimously by the Court of Appeal, with Underhill LJ giving the leading judgment and Bean LJ and Singh LJ in agreement.

Negligence claim

The claimant challenged the dismissal of his negligence claim on three grounds:

  1. Errors of law. The High Court took the wrong approach in law to the question of whether the alleged duties of care arose.
  2. Errors of fact. A challenge to the High Court’s decision on the facts relied on as establishing a duty of care, alleging that the High Court failed to take into account relevant evidence and/or reached a perverse conclusion on the basis of the evidence adduced.
  3. Limitation.

All three grounds were dismissed. In this blog post, we focus on the Court of Appeal’s reasoning in respect of the alleged errors of law, which is most likely to be of interest and application in future cases.

In summary, the Court of Appeal found that there was no error of law in the approach taken by the High Court to the question of whether a duty of care arose. The claimant’s criticisms fell broadly into three categories, although there was some degree of overlap, each of which is considered further below.

(a) Reliance on the Bank’s subjective understanding

The claimant submitted that the High Court applied the wrong test, by focusing on the subjective understanding of the defendant Bank as to whether there was a reasonable foreseeability of the claimant being exposed to criminal conviction. He said that the correct approach in law required an objective determination of whether the Bank had an implied assumption of responsibility.

In the view of the Court of Appeal, the High Court had correctly adopted an objective approach to the foreseeability of the risk to the claimant, considering the information “reasonably available” to the Bank at the time of the alleged negligence – that is, not only what the Bank actually knew, but what it should have known.

(b) Assumption of responsibility

The claimant suggested that the High Court’s analysis was “fundamentally flawed” because it did not approach it “through the lens” of the concept of assumption of responsibility.

The Court of Appeal confirmed that the correct course to assessing whether a duty of care should be recognised in a novel situation is to take the incremental approach endorsed in Robinson. That will involve consideration of the three-stage Caparo test (namely, (i) foreseeability, (ii) proximity, and (iii) fairness, justice and reasonableness), to the extent that those factors are in issue. The Court of Appeal said that the question of assumption of responsibility may be a useful analytical tool, particularly in considering the factors of proximity and/or fairness, justice and reasonableness, but its usefulness will depend on the issues in the particular case.

Applying that approach in the present case, the Court of Appeal found that it was quite unnecessary for the High Court to make any reference to the concept of assumption of responsibility, as the main point that was decisive in the High Court’s reasoning was foreseeability. Reference to assumption of responsibility added nothing on that question: the Bank could not have assumed responsibility for risks that were not reasonably foreseeable.

(c) Rihan v Ernst & Young Global Ltd

Finally, the claimant submitted that the High Court erred in failing to draw an analogy from the audit duty found in Rihan. In that case, the court found that there was a duty on Ernst & Young to take reasonable steps to prevent the claimant suffering financial loss by reason of their failure to conduct the audit ethically and without professional misconduct, and that the duty had been breached.

In the view of the Court of Appeal, the reasoning in Rihan had no application to the circumstances of the present case. In the first place, the court in Rihan found that the loss complained of by the claimant was foreseeable, whereas, the High Court in this case made the opposite factual finding. Secondly, the essence of the duty found in Rihan was that Ernst & Young should conduct the audit ethically and without misconduct. The duty alleged in the present case had nothing to do with the Bank avoiding wrongdoing – it was a duty to protect the claimant against the wrongdoing/unjust acts of others. That being so, the complaint that the High Court in the present case failed to “draw an analogy” with the finding of the audit duty in Rihan was misconceived.

As a matter of prudence, the Court of Appeal made it clear that it expressed no view either way about the correctness of the decision in Rihan about the audit duty (where permission to appeal was given but an appeal was not in the event pursued).

Accordingly, the Court of Appeal upheld the High Court’s dismissal of the negligence claim.

Contractual indemnity claim

It was common ground that it was an implied term of the claimant’s employment contract that the Bank would indemnify him against some forms of harm suffered in doing his job. The issue raised by the appeal was whether the forms of harm covered by the indemnity extended to a loss of earnings caused by the acts of a third party, and without the need to establish any fault on the part of the Bank.

Following a “regrettably prolonged trawl through the case law”, the Court of Appeal reached the view that there was no support in the English authorities for a general principle, reflected in the agency and employment cases, that if a person acts on the instruction of another they are entitled to be indemnified against all losses, of any kind, suffered as a result of doing so. This was the same conclusion as the High Court.

Notwithstanding the absence of authority, the Court of Appeal considered whether the general indemnity should – as a matter of principle – extend to cover all losses, of any kind, suffered by an employee as a result of doing their job, and more particularly, a loss of earnings of the kind suffered in this case, irrespective of any fault on the part of the employer.

The Court of Appeal concluded that the implication of this sort of indemnity would not be reasonable or fair, nor would it balance the competing policy considerations. The Court of Appeal went further and said that a general indemnity of the kind contended for would “wholly subvert the way in which both the common law and legislation have addressed the issue of the obligations of employers”. lt emphasised that an employer should not be liable simply because a serious misfortune or injustice at the hands of a third party has occurred in consequence of an employee doing their job, noting that the court is wary of imposing liability in the absence of fault.

The Court of Appeal also rejected the claimant’s challenge based on implication of the general indemnity as a matter of fact.

Accordingly, the Court of Appeal also upheld the High Court’s dismissal of the contractual indemnity claim, dismissing the appeal in full.

Ajay Malhotra
Ajay Malhotra
Partner
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Anna Henderson
Anna Henderson
Professional Support Consultant
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Ceri Morgan
Ceri Morgan
Professional Support Consultant
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Supreme Court decision gives further clarity on claims by distressed companies against directors

March 2, 2023

We recently published a blog post on the Supreme Court’s judgment in Stanford International Bank Ltd (In Liquidation) v HSBC Bank plc [2022] UKSC 34, in which the Supreme Court upheld the Court of Appeal’s decision to strike out a claim brought by the liquidators of a Ponzi scheme against its correspondent bank, alleging that the bank breached its so-called Quincecare duty to take sufficient care that monies paid out from the accounts under its control were being paid out properly.

The judgment also provides further clarity on the circumstances in which a distressed or insolvent company may seek to make claims against its directors, which colleagues in our RTI team have considered in further detail.

The key aspects affecting directors’ liabilities presented in the Supreme Court ruling are that:

  1. At least where unlawful preference rules are not engaged, loss to the company is a necessary element of the company’s claims against its directors for misappropriation of the company’s assets; and
  2. Building on the principles considered in BTI 2014 LLC v Sequana SA & Ors [2022] UKSC 25, a company’s losses for these purposes are not one and the same as those suffered by its creditors.

This means that, where other remedies are not available to recover sums paid out to third parties in breach of duty, insolvency practitioners and creditors alike should not assume that recourse will lie against defaulting directors to increase the amounts distributable upon liquidation.

This is the first reported judgment to consider the landmark BTI v Sequana decision which clarified the duties owed by directors of distressed and insolvent companies and was the subject of a recent briefing paper produced by our restructuring team.

For a more detailed analysis of this decision relating to claims against directors of distressed companies, please see our Restructuring, Turnaround and Insolvency Legal Briefing.

Andrew Cooke
Andrew Cooke
Partner
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Richard Mendoza
Richard Mendoza
Senior Associate
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High Court finds lender’s exercise of absolute contractual right is not subject to implied Braganza duty

February 1, 2023

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
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Supreme Court strikes out Quincecare claim where no loss suffered by insolvent Ponzi scheme

January 23, 2023

The Supreme Court has upheld the Court of Appeal’s decision to strike out a claim brought by the liquidators of a Ponzi scheme against its correspondent bank, alleging that the bank breached its so-called Quincecare duty to take sufficient care that monies paid out from the accounts under its control were being paid out properly: Stanford International Bank Ltd (In Liquidation) v HSBC Bank PLC [2022] UKSC 34.

This is the second case considering the Quincecare duty to reach the Supreme Court, the first being Singularis Holdings v Daiwa Capital Markets [2019] UKSC 50 (see our blog post). While the present Supreme Court judgment did not consider the scope of the Quincecare duty expressly, it highlights that the court will consider the question of whether any pecuniary loss has been suffered in such cases with a critical eye. It also demonstrates that the court is prepared to deal with Quincecare claims on a summary basis where appropriate, in contrast with some recent unsuccessful applications (see our blog posts here and here). Finally, the judgment places heavy emphasis on retaining the narrow boundaries of the Quincecare duty, so that it does not unduly interfere with commercial certainty and the ability of a bank to act upon the payment instructions given to it by its customer promptly and without fear.

The appeal concerned £116m paid to genuine investors (directly or indirectly) from the bank’s account, in the period between when the claimants said the bank should have recognised the “red flags” and stopped processing its customer’s payments (thereby exposing the fraud), and the date upon which the accounts were eventually frozen by the bank. The precise scope and content of the Quincecare duty was not critical for the present appeal. Assuming (for the purpose of the strike out application) that the bank owed and breached the duty, the appeal considered whether that breach gave rise to any recoverable loss suffered by the claimant. The claimant argued that it had lost the chance of discharging the debts owed to investors who were wise or lucky enough to redeem their investment early, for a few pence in the pound, rather than those investors being paid out in full.

By a majority of 4:1 (Lord Sales dissenting), the Supreme Court held that the claimant had no claim in damages because it suffered no loss. The Supreme Court considered the nature of the chance that the claimant had lost. In the counterfactual scenario where the bank had complied with its Quincecare duty and disobeyed the claimant’s instructions, the claimant would have had an extra £116m to its credit. However, even if this meant that all the customers received the same dividend (i.e. there was no longer any distinction between those investors who redeemed their investment early and those who did not), no additional customer indebtedness would be paid off.

The dissenting judgment of Lord Sales provided some interesting (obiter) commentary on the Quincecare duty, suggesting that (in principle) the formulation of the duty covers payments made to creditors where a company is in a situation of “hopeless insolvency”, just as much as any other kind of misappropriation. However, this is likely to have limited impact since banks are not expected to police the solvency of their customers, and the test of “hopeless insolvency” is such a stringent one that examples in practice will be rare.

We consider the decision in further detail below.

Background

The underlying claim was brought by the liquidators of the claimant (SIB). SIB was a company incorporated in Antigua and Barbuda, which operated a Ponzi scheme fraud until its collapse in 2009.

The defendant bank (Bank) provided correspondent banking services for SIB from 2003 onwards. Those accounts were frozen on 17 February 2009, following news that the beneficial owner and controller of SIB (Mr Robert Allen Stanford) had been charged by the US Securities and Exchange Commission.

The liquidators claimed that the Bank breached its so-called Quincecare duty of care to take sufficient care that monies paid out from the accounts under its control were being properly paid out. The liquidators argued that the Quincecare duty required the Bank to have reached the conclusion by 1 August 2008 (at the latest) that there was something very wrong and to have frozen payments out of the accounts. The claim was to recover the sums paid out by the Bank during the period from 1 August 2008 and 17 February 2009. The claim concerned £116m paid to customers (directly or indirectly) from the Bank’s accounts. There was no consequential loss claimed by SIB.

The Bank applied to strike out the claim, or obtain reverse summary judgment under CPR Part 24, on the ground that SIB had suffered no loss. For the purpose of the application, the Bank accepted that there was a sufficiently arguable case of breach of the Quincecare duty. The Bank argued that a Quincecare duty claim is a common law claim for damages for breach of a tortious duty (or an implied contractual duty), and so the remedy is damages to compensate for loss suffered. It said that SIB had no claim for damages, because on a net asset basis it was no worse off as a result of the Bank’s actions: the payment of £116 million reduced SIB’s assets by £116 million, but it equally discharged SIB’s liabilities by the same amount. This was because monies paid out by the Bank went (ultimately) to deposit-holders in satisfaction of their contractual rights against SIB.

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

By way of background and context, in separate but related proceedings brought by the liquidators in Antigua and pursued on appeal to the Privy Council, it was held that there was no possibility of recovering the money from the customers who had been wise or lucky enough to redeem their investment and be paid out in full: see In re Stanford International Bank Ltd [2019] UKPC 45; [2020] 1 BCLC 446.

High Court decision

The High Court’s reasoning is discussed in our previous banking litigation blog post.

In summary, the High Court dismissed the Bank’s application for reverse summary judgment or strike out of the Quincecare loss claim. It found that, absent the Bank’s breach of its Quincecare duty, the funds sitting in SIB’s accounts as at 1 August 2008 (£80 million) would have been available to pay creditors when insolvency supervened. It agreed with the claimants that, because of SIB’s state of insolvency, SIB had “no net assets”. Accordingly, although the payment of £116 million reduced SIB’s assets by £116 million, the payment did not discharge SIB’s liabilities, because SIB was insolvent and had no assets on any view, but a net liability.

The High Court did strike out the allegation of dishonest assistance, finding that the plea of dishonesty against the Bank was insufficient.

The Bank appealed against the High Court’s refusal to strike out the Quincecare loss claim or to grant reverse summary judgment, whereas SIB appealed against the High Court’s strike out of the allegation of dishonest assistance.

Court of Appeal decision

The Court of Appeal’s reasoning is discussed in our previous banking litigation blog post.

The Court of Appeal overturned the decision of the High Court on the Quincecare duty, finding that SIB had no claim in damages because it suffered no loss. The way the Ponzi scheme operated, payments made by the Bank to genuine investors reduced the company’s assets, but equally discharged the company’s liabilities to those investors by the same amount. The net asset position therefore remained the same in the period between 1 August 2008 and 17 February 2009.

The Court of Appeal said that the High Court erred in its reasoning by proceeding on the basis that the bank owed a direct duty to the company’s creditors, which it did not. The High Court had confused the company’s position before and after the inception of an insolvency process. Before an insolvency process commences (and the statutory insolvency regime is invoked), the fact that a company has slightly lower liabilities is a corresponding benefit to its net asset position, even if the company is in a heavily insolvent position. Having more cash available upon the eventual inception of its insolvency for the liquidators to pursue claims and for distribution to creditors, is a benefit to creditors, but not to the company while it is still trading.

The Court of Appeal upheld the High Court’s decision to strike out the dishonest assistance claim, emphasising that dishonesty and blind-eye knowledge allegations against corporations (large or small) must still be evidenced by the dishonesty of one or more natural persons.

SIB appealed to the Supreme Court in respect of the Quincecare duty claim only.

Supreme Court decision

By a majority of 4:1, the Supreme Court dismissed SIB’s appeal and upheld the Court of Appeal’s decision to strike out the Quincecare claim, thus dismissing the claim in full.

The appeal proceeded on the basis of two critical assumptions: (1) that there had been a breach by the Bank of the Quincecare duty; and (2) that the Quincecare duty may be breached where there is nothing wrong with the transaction itself but where the bank is put on notice of some background fraudulent activity being carried on by the person purporting to authorise the payment from the customer’s account.

During the course of the appeal, SIB accepted that the net asset point which formed the basis of the Court of Appeal’s decision was a good one. SIB recognised that the £116m payments out relieved it of £116m debt that it owed under contracts with its customers, and so there was no depletion of the company’s net assets in the amount paid away. Accordingly, SIB put its allegations on an alternative basis, arguing that the damage it suffered was the loss of a chance, as per Chaplin v Hicks [1911] 2 KB 786 and Allied Maples Group Ltd v Simmons & Simmons [1995] EWCA Civ 17. The Supreme Court’s analysis of the loss of a chance case is considered in further detail below.

Loss of a chance case

SIB said that at the time the disputed payments were made, SIB was hopelessly insolvent and it has since gone into liquidation. It argued that if the Bank had not made the payments, those debts would still have been owed to the customers who withdrew their funds in full and escaped without loss (the “early investors”). Those early investors would then have to prove their debts in the liquidation and would be likely to receive a dividend of only a few pence in the pound. SIB’s loss was, therefore, the loss of the chance of discharging those debts owed to the early investors for a few pence in the pound.

In the leading judgment given by Lady Rose (with whom Lord Hodge and Lord Kitchin agreed), the Supreme Court considered the nature of the chance that SIB had lost. In the counterfactual scenario where the Bank had complied with its Quincecare duty and disobeyed Mr Stanford’s instruction to pay out SIB’s money, SIB would have had an extra £116m to its credit. However, even if this meant that all the customers received the same dividend (i.e. there was no longer any distinction between early and late investors), no additional customer indebtedness would be paid off.

SIB argued that the chance lost was a chance for SIB to act more fairly as between customers, by making sure that the early investors did not benefit at the expense of the late investors. However, Lady Rose concluded that SIB had not suffered the loss of a chance that had any pecuniary value to it and so there was nothing recoverable on its pleaded case.

The concurring judgment of Lord Leggatt reached the same conclusion: that the amount that SIB “lost” by paying the early investors in full was offset by the equal amount that SIB “gained” by paying the late investors less than they would otherwise have received. In Lord Leggatt’s judgment, SIB’s argument was flawed because it disregarded the net loss rule (as per British Westinghouse Electric & Manufacturing Co Ltd v Underground Electric Railways Co of London Ltd [1912] AC 673).

The “breach date rule”

As part of Lord Leggatt’s discussion of how the court should address the value of the chance that was lost when the Bank made the payments, he gave some commentary on the “breach date rule”.

In summary, the Bank argued that, as a matter of law, loss caused by breach of a duty owed under a contract or in tort is generally to be assessed as at the date of breach. However, SIB submitted that the court could take account of a contingent event at the date of breach of contract, which has since arisen, i.e. the court could have regard to the fact that the chance of a liquidation as at 1 August has turned into an actual liquidation. SIB said that, when assessing the chance that it lost when the payments were made, the value should be calculated by taking the likelihood of the liquidation happening as 100%.

In the view of Lord Leggatt, this was “unnecessarily complicated and involves a misunderstanding of the relevant legal principles”. He said that there is no such rule of law that loss caused by a breach of duty is generally assessed as at the date of the breach (as per Bunge SA v Nidera BV (formerly Nidera Handelscompagnie BV) [2015] UKSC 43).

Limits of the Quincecare duty

While the scope of the Quincecare duty was not an issue in this appeal, the dissenting judgment of Lord Sales gave some interesting (obiter) commentary on the coherence of the law and the limits of the duty.

He emphasised that the Quincecare duty should be kept within narrow bounds, so that it does not unduly interfere with the conduct of commerce. In ordinary circumstances, a bank should be able to act upon the payment instructions given to it by its customer promptly and without fear. The Quincecare duty qualifies that position, balancing commercial certainty for the bank against the need for some reassurance that the payment instruction was legitimate. The impact of the Quincecare duty should be kept within bounds by a strict approach governing when it applies, and by careful analysis of the scope of the duty.

In the view of Lord Sales, the formulation of the Quincecare duty covers the situation where the order is an attempt to misappropriate the funds of a company by using them to make full payments which ought not to be made to creditors in a situation of “hopeless insolvency”, just as much as any other kind of misappropriation. He said that the company suffers a loss in both situations because its own funds are misappropriated. However, since the test of hopeless insolvency is such a stringent one, it will only be in a rare case that a bank will be found to have knowledge of this or to be on notice of it to the requisite standard. Banks are not expected to police the solvency of their customers as an ordinary incident of the service they provide.

Director’s duties owed to a company on the verge of insolvency

Lord Leggatt and Lord Sales considered, in some detail, the nature of the fiduciary duty owed by a director to a company on the verge of going into insolvent liquidation. Their observations will be of interest to insolvency practitioners, in particular the analysis of the recent decision of the Supreme Court in BTI 2014 LLC v Sequana SA [2022] UKSC 25 (see this briefing prepared by our Restructuring, Turnaround and Insolvency team).

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

Contractual duties of good faith: Court of Appeal confirms context is king

November 29, 2022

The Court of Appeal has allowed an appeal in a case which provides important clarification around the scope and construction of contractual provisions obliging the parties to act in good faith: Re Compound Photonics Group Ltd; Faulkner v Vollin Holdings Ltd [2022] EWCA Civ 1371.

Although set in a non-financial context, the decision will be of interest to financial institutions as it emphasises that good faith clauses must be interpreted by close reference to the particular context in which they appear, and that authorities interpreting similar clauses in other legal or commercial contexts cannot be straightforwardly applied to other situations.

In particular, the Court of Appeal rejected the proposition that it was possible or appropriate to divine from the case law a set of minimum standards that would apply in every case in which a duty of good faith is inserted into a contract, beyond the “very obvious” point that the core meaning of an obligation of good faith is an obligation to act honestly – though it also rejected the argument that a good faith obligation cannot be breached other than by acting dishonestly.

On a practical level, this case serves as a reminder that parties proposing to include an express duty of good faith should define the scope of the duty as clearly as possible within the agreement, including, where feasible to do so, identifying actions that are (or are not) required to satisfy it.

For more information on the decision, see our Litigation Notes blog.

Green credentials: walking an advertising tightrope

November 10, 2022

In October 2022, the Advertising Standards Authority (the ASA) ruled for the first time that a bank had misrepresented its green credentials and engaged in so-called “greenwashing“. In this blog post, we consider how banks and financial services institutions can fall within the remit of the ASA’s advertising codes and the potential risks associated with making “environmental” claims.

The ASA’s role

In the UK, the UK Code of Non-broadcast Advertising and Direct & Promotional Marketing (the CAP Code) is the rule book for non-broadcast marketing adverts (i.e. marketing communications other than TV or radio adverts). The CAP Code applies to all adverts aimed at “consumers“, anyone who is likely to see a given marketing communication (whether in the course of business or not). The central principle for all marketing communications under the CAP Code “is that they should be legal, decent, honest and truthful” (Rule 1.1).

While banks and financial services institutions may not see themselves as “marketers“, to the extent that they produce any marketing communications, including adverts in newspapers and marketing on their websites, they fall within the scope of the CAP Code. One notable exception is that the CAP Code does not apply to “investor relations” material, information addressed to members of the financial community who might be interested in the company’s stock or financial stability.

The CAP Code is designed to be self-regulatory, but the ASA is the independent body that endorses and administers it to ensure that the self-regulatory system works in the public interest. The ASA, therefore, investigates and rules on complaints from consumers or businesses under the CAP Code.

Environmental claims

Environmental claims are a particular focus area for the ASA currently, particularly since the development of its Environment and Climate Change Project. The ASA notes that the project “sends a clear signal that the ASA will be shining a brighter regulatory spotlight on advertising issues that relate to climate change and the environment in the coming months and years“.

Specific requirements for environmental claims are set out at Rule 11 of the CAP Code. In particular:

  • The basis of environmental claims must be clear. Unqualified claims could mislead if they omit significant information (Rule 11.1).
  • The meaning of all terms used in marketing communications must be clear to consumers (Rule 11.2).
  • Absolute claims must be supported by a high level of substantiation. Comparative claims such as “greener” or “friendlier” can be justified, for example, if the advertised product provides a total environmental benefit over that of the marketer’s previous product or competitor products and the basis of the comparison is clear (Rule 11.3).

However, marketers should also be aware of the general prohibitions on misleading advertising, which are equally applicable to environmental claims.

Similar provisions are also contained in the UK Code of Broadcast Advertising, which applies to adverts on radio and television series, but environmental claims have so far most commonly been brought under the CAP Code.

Misleading advertising

Rule 3 of the CAP Code generally considers the potential for marketing communications to mislead consumers. Importantly, the ASA takes into account the impression created by marketing communications, as well as specific claims and rules on the basis of the likely effect on consumers, as opposed to the marketer’s intentions. Particular rules that may be relevant to environmental claims include:

  • Marketing communications must not materially mislead or be likely to do so (Rule 3.1).
  • Marketing communications must not mislead the consumer by omitting material information. They must not mislead by hiding material information or presenting it in an unclear, unintelligible, ambiguous or untimely manner (Rule 3.3).
  • Marketing communications must state significant limitations and qualifications. Qualifications may clarify but must not contradict the claims that they qualify (Rule 3.9).

Implications of non-compliance

If the ASA considers there may be a breach of the CAP Code, it gives the marketer an opportunity to respond (usually in writing). The burden of proof is on the marketer to show that its claims comply with the CAP Code.

The ASA cannot impose legally binding penalties, but its findings are published on its website and often attract a lot of press attention. A negative finding can therefore be a strong deterrent to marketers, particularly in the field of environmental claims as banks face increased public pressure to reduce or halt their financing of oil and gas production.

ASA’s ruling against a bank

The ASA’s recent ruling centred on two adverts which ran on high streets in October 2021, in the run‑up to COP26. The adverts highlighted how the bank in question had invested $1 trillion in financing and investment globally to help its clients hit climate targets and how the bank was helping to plant two million trees. Complainants argued that the adverts omitted significant information about the bank’s contribution to carbon dioxide and greenhouse gas emissions through its other financing commitments.

The ASA upheld the complaint on the basis of CAP Code Rules 3.1 and 3.3 (misleading advertising) and Rule 11.1 (the basis of environmental claims must be clear). The ASA considered that consumers would understand the claims to mean that the bank was making a positive overall environmental contribution as a company and was committed to ensuring its business and lending model would help support businesses’ transition to models which supported net zero targets. Notably, the ASA found that the use of imagery from the natural world, including the image of waves crashing on a beach, contributed to that impression. However, the ASA referred to the bank’s annual reports to demonstrate the bank’s current financed emissions and continuing commitment to financing thermal coal mining, which it did not consider consumers would know. This was found to be “material information that was likely to affect consumers’ understanding of the ads’ overall message“.

Key takeaways

Banks have faced increasing scrutiny over the last year in relation to their climate commitments. Earlier this year, ShareAction accused 24 banks in the Net Zero Banking Alliance of pumping billions of dollars into new oil and gas production despite being part of a green banking group and Adfree Cities (one of the complainants in the ASA case) said it has made similar greenwashing-by-omission complaints against two further banks’ social media adverts.

While banks and financial service institutions will be keen to advertise their long-term commitments to net zero and their financing of projects assisting in the transition to a lower-carbon economy, there is a difficult balance to be struck in respect of their marketing communications to avoid complaints that they are misleading consumers. In particular, thought needs to be given to any necessary qualifications or disclosures (admittedly not what the ad man or woman wants to be concentrating on when devising their advertising concept), and clearly it is dangerous to seek to impute any general knowledge to consumers as to what existing customers or positions banks may have on their books. In this case, the ASA ruled that any future adverts featuring environmental claims must be adequately qualified and must not omit material information about the bank’s contribution to carbon dioxide and greenhouse gas emissions. This ruling is likely to have read-across implications for other banks which are contemplating advertising their green credentials.

So far, the adverts in question are consumer issues, but any negative press around a company’s climate impact will likely concern shareholders particularly as many banks have now passed climate change resolutions. Negative press may therefore lead to an increased risk of activist claims or shareholder reaction.

Simon Clarke
Simon Clarke
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Neil Blake
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Andrew Lidbetter
Andrew Lidbetter
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Abigail West
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Key Supreme Court insolvency ruling clarifies stance on creditor duties

October 18, 2022

A much-anticipated Supreme Court judgment has confirmed the position as to when directors owe obligations to consider the interests of creditors, dismissing an appeal against the Court of Appeal decision in this case: BTI v Sequana [2022] UKSC 25.

This decision will be of interest to financial institutions involved in turnarounds and restructurings as a majority of the Supreme Court have:

  • affirmed the existence of the duty to consider the interests of creditors;
  • clarified that it is engaged where the directors know, or ought to know, that the company is insolvent or bordering on insolvency or that an insolvent liquidation or administration is probable;
  • explained that where interests of creditors are engaged and diverge from those of shareholders:
    • liquidation is inevitable, creditors’ interests are paramount; and
    • prior to that, there will be a fact sensitive balancing exercise to weigh up the competing interests by reference to the degree of distress.

For more information on the decision and its practical implications, see this briefing prepared by our Restructuring, Turnaround and Insolvency team.

COURT OF APPEAL CONSIDERS WHEN DIRECTOR LIABLE AS ACCESSORY TO A TORT COMMITTED BY A COMPANY

August 31, 2022

The Court of Appeal has held that a director was not personally liable as an accessory to a tort committed by a company and has given guidance on the applicable principles: Barclay-Watt v Alpha Panareti Public Ltd [2022] EWCA Civ 1169.

In good news for the directors/senior managers of financial institutions, the decision suggests that it may be difficult to establish accessory tort liability against a director or senior manager outside of the circumstances where such liability has traditionally been found to exist (although every case will turn on its own facts).

For a director or senior manager to be held personally liable as an accessory to a tort committed by a company requires that person to have assisted the company in the commission of a tortious act pursuant to a common design. Whether the test is satisfied can be a difficult, or elusive, question, requiring the balancing of competing principles, and statements of legal principle must be understood in the context in which they are made.

The competing principles are that individuals are entitled to limit their liability by incorporating a company while, on the other hand, a person should be liable for their tortious acts and should not escape liability merely because they are a director of a company. So far as the context is concerned, consideration needs to be given to the nature of the tort in any particular case. Statements of principle which have been made in the context of strict liability torts (such as certain intellectual property torts, trespass and conversion) and deceit are not necessarily directly applicable to other torts – such as in this case, where the company’s liability was dependent on its assumption of a duty to the claimants in circumstances where the director had no direct dealings with those claimants and had not assumed any duty to them.

To establish that a director is liable as an accessory, something more will be needed than the director controlling or being closely involved in the actions of the company. This will be particularly so where the tort consists of a negligent failure to take a step as opposed to a deliberate act or omission, as in those circumstances it will be difficult to demonstrate a common design to do what makes the conduct tortious.

For a more detailed analysis of this decision, please see our Litigation Notes blog post.

FCA confirms final rules for new Consumer Duty

July 28, 2022

The FCA has published the final rules and guidance and accompanying non-Handbook guidance relating to the new Consumer Duty (the Duty).

While the nature and scope of the Duty remains largely unchanged in most areas, the final rules and guidance contain some significant changes and clarifications relating to how the Duty will apply in relation to distribution chains, closed books, wholesale markets and funds and asset managers and where firms provide products or services to occupational pension schemes. Helpfully, firms have been given more time to implement the changes needed to comply with the Duty.

From a disputes perspective, the FCA kept its powder dry on the possibility of a private right of action for breaches of any part of the Duty, saying that the possibility was being kept under review following the initial consultation. Financial services firms will welcome confirmation that no private right of action has been incorporated in the final rules. Firms will still be accountable for any breach of the Duty through the Financial Ombudsman Service framework (which is now subject to increased award limits).

For a more detailed analysis of the final rules and timeframe for compliance, please see our FSR Notes blog post.

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

July 15, 2022

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

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

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

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

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