High Court finds in favour of novel duty of care on employers (or quasi-employers) to protect against economic loss by providing an “ethically safe” work environment

In a recent decision, the High Court has awarded a former partner of Ernst & Young (EY) damages exceeding $11 million, broadly equating to past and future earnings for the rest of his career: Rihan v Ernst & Young (Global) Ltd [2020] EWHC 901 (QB). The claimant, Mr Rihan, was a whistle-blower who publicly disclosed suspected irregularities arising out of an audit for a client for whom he was the audit engagement partner, and unilaterally left EY.

While the facts of the case arose in an audit and accounting context, the decision will be of interest to financial services firms more generally. In particular, the duty of care found to have been owed by EY to Mr Rihan was to protect against economic loss (in the form of loss of future employment opportunity), by providing an “ethically safe” work environment, free from professional misconduct. Further, although Mr Rihan was a partner in EY working in Dubai, the court found that this duty was owed (and breached) by four UK-based EY entities.

The decision has a number of unusual features, not least that: Mr Rihan had no contractual relationship with any of the defendant entities; his public disclosure was a criminal offence under local UAE law; the award of damages was the product of an exercise in judicial creativity involving the identification of a novel duty of care, albeit limited in ambit; and finally, the reasoning for the identification of this duty owed a considerable amount to features of UK employment law and yet Mr Rihan was not employed by any EY entity, being a partner.

EY is reported to be seeking permission to appeal. If the decision survives an appeal, it remains to be seen how widespread its effect will be as the court stressed the exceptional nature of the relevant facts which had given rise to the duty.

Background

The complex facts in the case, as found by the trial judge (Kerr J), can be summarised as follows:

  1. The claimant was a partner in EY working in Dubai. He was the audit engagement partner for a Dubai corporate client, Kaloti Jewellery International (Kaloti), which is Dubai’s biggest gold refiner, and had been tasked with providing an “assurance audit” of Kaloti. This would provide an independent view on the quality and propriety of Kaloti’s business practices. He discovered irregularities in Kaloti’s business concerning the suspected unlawful smuggling of gold bullion coated in silver out of Morocco and into Dubai. Indeed it was common ground that this gave rise to a reasonable suspicion that Kaloti was involved in money laundering.
  2. The claimant reported his concerns within EY, but EY failed to act on the claimant’s concerns and sanitised the findings of the report. The claimant refused to sign the sanitised report and was replaced by an accountant who “improperly [lent EY’s] name to a flagrantly misleading assurance reporting process”.
  3. The claimant became concerned for his personal safety and that of his family, and fled to England. Ultimately, the claimant resigned from EY and made public his allegations which subsequently featured in a Panorama programme.
  4. The claimant brought claims in the High Court – not against the entity of which he was a partner (EY MENA Limited), but against various UK-based entities. The claimant alleged that the UK defendants had acted together in such a way as to breach duties of care owed to him in the conduct of the audit and had failed to protect him as a bona fide whistle-blower.
  5. Specifically, the claimant alleged that EY owed him two duties of care, both expressed as duties not to cause him financial loss:
    1. a “safety duty” – a duty to take reasonable steps to prevent the claimant from suffering loss of earnings as a result of his reasonably apprehended concerns for his safety and that of his family if he were to return to Dubai; and
    2. an “audit duty” – a duty to take reasonable steps to prevent the claimant from suffering loss of earnings by reason of EY’s failure to conduct the Kaloti audit in an ethical and professional manner.

Decision

It was common ground that the claimant was not able to seek a remedy under the UK whistle-blower legislation: firstly, because he was not a worker at any of the defendant entities; and secondly, because he lived and worked outside the UK. Yet the court observed that if this had been a “conventional whistle-blower case”, the claimant would have had a strong claim. Although the claimant (as a partner) was not an employee of any EY entity, Kerr J (perhaps because of his employment law background and the fact that he also sits in the Employment Appeal Tribunal) invoked a number of analogies with employees or those in a “quasi-employment relationship”. Indeed there is no discussion in the judgment of the claimant’s rights as a partner of EY.

In deciding whether either duty of care identified by the claimant should be recognised, the court recognised first that there was no general duty to protect an employee against economic loss suffered after the end of his employment.

The court proceeded to consider each of the alleged duties in turn, applying the three classic tests used to determine the existence of a tortious duty of care in respect of economic loss: (1) assumption of responsibility; (2) the three-fold test in Caparo Industries plc v Dickman [1990] 2 AC 605 (foreseeability, proximity and whether it is “fair, just and reasonable” to impose a duty); and (3) the incremental test (whether the addition to existing categories of duty would be incremental rather than indefinable).

Safety duty

The court rejected the existence of the safety duty, finding that it would be an illegitimate extension of the law to make the leap from the standard employer’s duty to safeguard its employees against personal injury, to a broad duty to safeguard them against pure economic loss incurred as a result of the claimant’s need to cease working to avoid a threat to his physical safety.

The court held that EY had not assumed responsibility for such a duty and the threefold Caparo test was not met. Even if it was assumed that the claimant’s losses were foreseeable and that a sufficient relationship of proximity existed between the defendants and the claimant, in the court’s view it was not “fair, just and reasonable to impose on the defendants a duty of such width as to go far beyond the conventional duty to safeguard an employee against personal injury and loss of earnings consequent on such injury”.

Audit duty

The court found that, on the facts of the present case, the audit duty of care did not fit the “assumption of responsibility” analysis favoured in the paradigm cases where a person provides services or advice to another in circumstances where there is no contract but the provider knows or should know that the other will rely on the professional care, skill and judgment.

Having found that the proposed audit duty was novel, the court proceeded to consider whether the duty should exist by adopting an incremental approach to development of the law, by analogy with decided cases (see Lord Mance in Robinson v Chief Constable of West Yorkshire [2018] 2 WLR 595). On the other hand, however, the court also invoked the dictum of Lord Steyn in Williams v Natural Life Health Foods Ltd [ 1988] 1 WLR 830 that “the law of tort, as the general law, has to fulfil an essentially gap filling role”.

The court set out nine legally significant features drawn from analogous cases to decide whether they provided a sufficient basis to recognise the duty of care identified by the claimant, applying the threefold test set out in Caparo.

Foreseeability

In the court’s view, it was readily foreseeable that the claimant would suffer financial loss if the audit was conducted and concluded in a manner the claimant considered unethical and unacceptable.

As to whether the loss was foreseeable by the four EY defendants specifically, the court was “not especially concerned with the precise contractual position of the claimant within the EY organisation”. Although the claimant had what the court described as “a partnership contract” with EY MENA Limited, he owed duties to the EY organisation far beyond those owed to EY MENA Limited. Similarly, the claimant regarded the EY organisation as “acting in concert with and through its various subordinate associated bodies” which all dealt closely with each other. The court regarded the knowledge and perceptions of EY global and regional leaders as attributable to all four defendants.

Proximity

The court found that the requirement of proximity was met in relation to the audit of Kaloti and rejected arguments against this on the basis of EY’s corporate structure. It took comfort in this regard from recent appellate decisions including Vedanta Resources plc v Lungowe [2019] UKSC 20 and Chandler v Cape plc [2012] EWCA Civ 525 in which parent companies had (on an arguable basis only in the case of Vedanta, which arose in the context of a jurisdiction challenge) been found to owe duties to third parties/employees of their subsidiaries in circumstances where they exercised a high degree of influence in the business of the latter. This step in his reasoning was important because it enabled him to circumvent the fact that the claimant had no contractual relationship with any of the defendant entities.

Fair, just and reasonable

Turning to the final “policy” element in the test, the court found that it was fair, just and reasonable for the law to impose the audit duty on EY. In reaching this conclusion, the court highlighted the following points in particular:

  • The court felt that the claimant, who had otherwise been denied a remedy as a “conventional whistle-blower”, should have a remedy: “professionals like accountants should not be pressured to act unethically”.
  • In the court’s judgment, conceptually it was not a huge leap from imposing a duty of care to protect against physical injury and consequent financial loss by providing a physically safe work environment, to imposing a duty of care to protect against economic loss (in the form of loss of future employment opportunity) by providing an ethically safe work environment, free from professional misconduct.
  • The court reviewed a number of previous authorities including Scally v Southern Health Board [1992] 1 AC 294 and Spring v Guardian Assurance [1995] 2 AC 296, in which the courts had held that employers were obliged to take reasonable steps to protect the post-employment economic interests of their employees, but found that “the cases do not differentiate sharply” between those featuring employees/former employees and what the court termed “quasi employees”. Interesting in this connection are the references throughout the judgment to employment law analogies and references which the court applied in relation to the facts of this case (eg the rights of whistle-blowers, the implied duty of trust and confidence and the concept of constructive dismissal). However, it must be doubtful whether a partnership relationship can really be termed one of “quasi employment”. Further, while members of limited liability partnerships (and possibly partners) are now recognised as falling within the ambit of the UK whistle-blowing legislation, the other two concepts do not apply to a partnership relationship under UK law.
  • On policy grounds, the court said it would not have recognised the audit duty had it cut across any UK statutory rights of the claimant (in a nod to the decision in Johnson v Unisys Ltd [2003] 1 AC 518). Here, the court found that the duty sat alongside the UK whistle-blower legislation and, duly fulfilling its “gap filling” role, the court did not engage with the question of whether Parliament deliberately decided that these rights should not be available to those living and working abroad.

Finding in favour of the audit duty, the court was clear that the scope of the duty would have limited application. Specifically, it imposes a new duty of care on employers – and other quasi employers including partnerships and LLPs – to protect against economic loss to an employee/quasi employee’s loss of future job opportunity by providing an ethically safe work environment, free from professional misconduct in a professional setting. However, the court said the ambit of the duty would extend only to the team members in the Kaloti audit in the present case. More generally, the decision would apply only to “a small class of exceptional cases” and was “an outlier with a factual basis that will rarely if ever recur”.

Having found that the audit duty was owed by EY, the court was satisfied that it had been breached and awarded the claimant damages for loss of past and future earnings.

DISPUTES CONTACTS:

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Maura McIntosh
Maura McIntosh
Professional Support Consultant
+44 20 7466 2608
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

 

 

 

 

 

 

 

 

EMPLOYMENT CONTACTS:

Peter Frost
Peter Frost
Consultant
+44 20 7466 2325
Anna Henderson
Anna Henderson
Professional Support Consultant
+44 20 7466 2819

What does Lloyds/HBOS tell us about sections 90 and 90A of FSMA?

Herbert Smith Freehills LLP have published an article in Butterworths Journal of International Banking and Financial Law considering how the findings in Sharp v Blank [2019] EWHC 3078 (Ch) (also known as The Lloyds/HBOS litigation) may be of assistance in interpreting sections 90 and 90A of the Financial Services and Markets Act 2000.

Lloyds/HBOS is the only securities class action to have reached trial in England and Wales to date. While this case considered the common law duty not to negligently misstate and equitable duty to provide shareholders with sufficient information, there are parallels between these duties and the bases for shareholder claims found in the statutory regime under sections 90 and 90A FSMA.

The article can be found here: What does Lloyds/HBOS tell us about sections 90 and 90A of FSMA? This article first appeared in the February 2020 edition of JIBFL.

Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Sarah Penfold
Sarah Penfold
Associate
+44 20 7466 2619
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948

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

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

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

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

The decision is considered in further detail below.

Background

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

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

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

Claims

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

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

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

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

Decision

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

Duty to exercise reasonable skill and care in providing lending services

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

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

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

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

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

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

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

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

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

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

Alleged intimidation and economic duress

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

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

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

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

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

Accordingly, the court dismissed the claim in full.

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

High Court strikes out claim against banks in their capacity as lenders to investors of a tax deferral scheme

The High Court has struck out claims brought by former investors in the Ingenious Media tax deferral schemes against lending banks who advanced sums to the investors for the purpose of investing in the scheme: Mr Anthony Barness & Ors v Ingenious Media Limited & Ors [2019] EWHC 3299 (Ch).

In the context of the current wave of tax deferral scheme litigation (including in respect of the film financing schemes Samarkand, Proteus, Imagine and Timeless Releasing), the interlocutory decision in Barness provides reassurance to banks which acted as lenders to the investors in those schemes. This is particularly welcome in circumstances where investors are increasingly pursuing claims against such lenders where the independent financial advisers (“IFA”) and promoters who provided advice to investors directly have either collapsed or do not have sufficiently deep pockets.

The most important aspects of the case which are likely to be of relevance to similar claims, and more generally to financial institutions selling products on an execution-only basis, are as follows:

  1. The claimant investors in Barness sought to establish that their relationship with the banks went above and beyond a standard lending relationship, and that they were owed duties (both in contract and in tort) by their lenders relating to the suitability of the investment for which the loan was advanced. The court firmly rejected this avenue of reasoning, referring to the decision of the Court of Appeal in Green v The Royal Bank of Scotland plc [2013] EWCA Civ 1197 and of the High Court in Carney v N M Rothschild & Sons Ltd [2018] EWHC 958 (Comm) that there is no general obligation on a lending bank to give advice about the prudence or otherwise of the transaction which the loan is intended to fund.
  2. For claims based on implied contractual terms or duties of care to succeed, it remains paramount for claimants to point to very specific words or conduct. In this case, it was asserted by the investors that the lending banks had agreed (or acquiesced) to the investors’ IFA “packaging” together the investment proposition with available financing. The court found that – even if this assertion was accepted – it was insufficient to establish an implied term as to the suitability of the investment, or to find that the banks had assumed a similar duty of care in tort or had otherwise endorsed the investment.
  3. The court was unconvinced by the argument that there existed an implied “umbrella contract” based on the “private banking and wealth management relationship” between the claimants and the lenders. We have previously considered a similar (unsuccessful) attempt at such an argument advanced in Standish v RBS [2018] EWHC 1829 (Ch) in our blog post. There has been a noticeable uptick in claimants asserting the existence of an implied umbrella or overarching agreement as a vehicle by which to advance arguments based on implied contractual terms. The court’s robust rejection of such claims in this case and Standish will be welcomed by financial institutions.
  4. The court also rejected a claim that the IFA promoting the scheme had acted as the lending banks’ agent, and that the banks were therefore vicariously liable for its negligent advice. The court held that the IFA and the banks had conducted their separate businesses throughout (of providing financial advice and financing respectively), such that the activities of the financial adviser could not be said to have been an integral part of the banks’ business. Evidence regarding the close relationship between the financial adviser and the banks was submitted to no avail. Again, the court’s robust rejection of this line of argument is helpful not only in the context of other tax deferral scheme litigation, but more generally where banks act on an execution-only basis alongside an IFA.

We consider the decision in more detail below.

Background

From 2002 to 2007 a number of tax schemes were promoted under the name “Ingenious” as tax-efficient vehicles through which investors could contribute funds to a limited liability partnership (“LLP”) for investing in films/video games and set off their share of the LLP’s losses against other taxable income. HMRC did not accept that the schemes worked as intended and, following a series of appeals, the outcome for the individual investors was that they lost both the sums invested in the schemes and the anticipated tax relief (and may be exposed to claims by HMRC for arrears of tax with interest and penalties). A number of the investors have issued claims to seek to recover their losses from a range of defendants, including claims against the banks which advanced the funds to cover some (or all) of the investors’ capital contribution to the relevant LLP.

The present claims were brought by investors who borrowed sums from Coutts & Co and National Westminster Bank plc (the “Banks”). All of the claimants received independent advice on their investments in the Ingenious schemes from the same IFA.

The claims against the Banks are part of a much larger litigation brought against financial and tax advisers, the promoters of the scheme and lenders. In relation to their claims against the lender Banks, the claimants relied on three separate causes of action:

  1. Claims for breach of contract, based on terms said to be implied into contracts between the claimants and the relevant Bank. In particular, an implied term relating to the suitability of the loans (i.e. that the Banks would not provide loan finance, introduce products or allow a loan to be packaged with an investment product, unless they were suitable for the claimants having regard to their financial position, needs, objectives and attitude to risk).
  2. Claims for negligence, predicated on duties of care of a similar nature to the (alleged) implied suitability terms, owed both (a) concurrently with the implied contractual duties; and (b) in tort arising from a non-contractual assumption of responsibility.
  3. Claims alleging that the Banks were vicariously liable for breaches of duty by the IFA, on the basis that the IFA acted as the Banks’ agent.

Decision

The court struck out the contractual and tortious claims pursuant to CPR 3.4(2)(a) and granted reverse summary judgment on the vicarious liability claims pursuant to CPR 24.2. The court’s analysis is considered in further detail below.

1. Breach of contract

The claimants asserted that the term relating to the suitability of the loan (and a number of other terms) were implied into either: (a) an unwritten umbrella or overarching contract on the basis that the claimants and the relevant Bank had entered into a “private banking and wealth management relationship”; or (b) the existing loan documentation.

Umbrella contract

As to whether there was a wider umbrella agreement, the Banks submitted that the claimants had failed to comply with CPR Practice Direction 16, which requires that claims based on oral agreements and conduct must specify the words spoken and conduct in sufficient detail. The court agreed that no facts had been pleaded which supported the existence of an umbrella contract between the claimants and either of the Banks.

Having noted that not every breach of Practice Direction 16 would lead to a claim being struck out, the court considered the claimants’ argument that the umbrella contract arose on the basis of the Banks’ conduct, specifically in offering the “package” presentation of the investment and loans. In the court’s view, this did not provide the requisite support for the umbrella contract. It said there was no logical connection between the alleged “packaging” of the loans and investments, and the suggestion that the Banks offered to undertake an overarching responsibility for management of the claimants’ wealth which was over and above the particular services provided by the Banks (loans and current accounts etc.). The court likewise held that statements in one of the Bank’s internal documents that the claimants had a “full banking relationship” did not suggest that the Bank had entered into an umbrella contract to provide not only banking but also wealth management services.

The court concluded that there was no pleaded basis for the suitability terms to be implied into an umbrella contract and this was sufficient to justify strike out in the circumstances, noting that it would have alternatively granted reverse summary judgment.

Loan documentation

The court paraphrased the test for implying terms into a contract (clarified in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Limited and another [2015] UKSC 72, although without citation in the judgment). It found that the alleged contractual duty on the Banks not to package loans with an unsuitable investment was neither so obvious as to go without saying, nor necessary to give business efficacy to the contract.

The court accepted that it was well established that a bank which sells a product to its customer is not under a (tortious) duty to advise as to the nature of the risks inherent in the transaction (Green v RBS). In those circumstances, the court could not see any sustainable case pleaded (or that could realistically be pleaded) that the suitability terms were to be implied into the contracts of loans between the Banks and the claimants.

The court therefore struck out the claims (and noted it would have alternatively awarded reverse summary judgment).

2. Negligence

As noted above, the allegation that the Banks owed the claimants a duty of care in tort was argued firstly on the basis that it was concurrent with a like duty in contract. This duty was not considered further, given the court’s rejection of the contractual claims.

Accordingly, the court proceeded to consider whether the relevant Bank assumed responsibility towards each of the claimants giving rise to a duty of care in tort of a similar nature to the (alleged) implied suitability terms. The court accepted that to find a duty of care in tort required some communication between the Banks and the claimants to the effect that the Banks were assuming responsibility for the tasks in question; and reliance by the claimants.

The claimants could not point to anything in terms of advice that crossed the line between the Banks and the claimants, but relied – once again – on the “packaging” of the loans with the investments to give rise to the duty of care. Without more, the court found this was insufficient to give rise to a duty of care. The court noted that a bank does not “assume an advisory role simply because it agrees to lend to the customer for a particular purpose” (Carney) and could not, therefore, be said to have assumed an advisory role simply because it agreed to its loans being “packaged” together with an investment. This was particularly so where there was an IFA advising the customer.

The court rejected the claimants’ attempts to draw comparisons with cases in which a duty of care had been found and reliance was not required, such as White v Jones [1995] 2 AC 207 (where a solicitor instructed by a testator was held to have owed duties of care in tort to the intended legatees). The court distinguished such cases on the basis that they related to whether an established contractual duty of reasonable skill and care can be said to be owed not only to a client of the defendant, but also to the person intended to benefit from the defendant’s advice. That was different to the present case, in which the question was whether there was a relevant duty of care at all, rather than widening the class of people who can sue for breach of duty.

The court therefore found that there were no reasonable grounds for bringing the claims and ordered strike out, noting that it would equally have granted reverse summary judgment.

3. Vicarious liability

The claimants alleged that the IFA had acted as the Banks’ agent in “introducing, explaining and advising upon the packaged investment”. The court said that the relevant question was whether the IFA was acting on behalf of the Banks, which required them to have either:

  1. told the claimants that the IFA was advising on their behalf, or otherwise held the IFA out as doing so (which was not the case, due to the fact that the loan documentation explicitly stated that the claimants were not relying on advice provided by the Banks); or
  2. used the IFA to discharge a duty to advise owed to the claimants (and the court found that there was no such duty to advise). In relation to the final claim based on vicarious liability, the court therefore granted reverse summary judgment in favour of the Banks.

An argument based on the rule in Cox v Ministry of Justice [2016] UKSC 10 which was advanced by the claimants also failed. This test expands the scope of agency to situations in which a person carries on activities as an integral part of the business activities of the principal and for its benefit. The court found that the business activities of the IFA in providing financial advice were neither an integral part of the business of the Banks, nor were they for their benefit. Despite the close commercial relationship between the IFA and the Banks, the commission paid by the former to the latter and the “packaged” presentation of the investment and the loan, each party was carrying out its own business, namely that of providing financial advice and providing banking and lending services respectively.

In relation to the final claim based on vicarious liability, the court therefore granted reverse summary judgment in favour of the Banks.

Julian Copeman
Julian Copeman
Partner
+44 20 7466 2168
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948
Kevin Kilgour
Kevin Kilgour
Senior Associate
+44 20 7466 2584
Michael Hunt
Michael Hunt
Senior Associate
+44 20 7466 2796

Upcoming webinar – Class actions in England and Wales: Shareholder actions – The Lloyds/HBOS litigation

On Monday 9 December (1-2pm UK time), Harry EdwardsCeri Morgan and Sarah Penfold will deliver a webinar for Herbert Smith Freehills clients and contacts looking at the judgment in the Lloyds/HBOS litigation, Sharp v Blank [2019] EWHC 3078 (Ch), which was handed down by the High Court on 15 November. Herbert Smith Freehills acted for the successful defendants to the action.

This was the first judgment in a shareholder class action in England & Wales and will have important ramifications for listed companies, and their advisers, in the UK. In rejecting the claim brought by a group of shareholders against Lloyds relating to its acquisition of HBOS in 2008, the decision of the High Court provides clarity on some of the most important battlegrounds which arise in shareholder class actions as well as guidance for listed companies and their directors on various key aspects of capital markets and M&A transactions.

This webinar is part of our series of HSF webinars, which are designed to update clients and contacts on the latest developments without having to leave their desks. The webinars can be accessed “live”, with a facility to send in questions by e-mail, or the archived version can be accessed after the event. Please click here to register.

The webinar is a follow-up to our webinar earlier this year discussing shareholder class actions more generally, as part of our series of webinars on class actions in England and Wales. If you would like to access the archived version of that webinar, or other webinars from the class actions series, please click here. Or click here to access our series of short guides on class actions related topics.

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

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

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

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

In the present case, breach of the Quincecare duty was established at first instance and not appealed. The issue for the Supreme Court was whether the fraudulent state of mind of the authorised signatory could be attributed to the company which had been defrauded and, if so, whether the claim for breach of the Quincecare duty could be defeated by the defence of illegality (and certain other grounds of defence). The Supreme Court found against the bank in respect of both points.

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

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

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

We consider the decision in more detail below.

Background

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

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

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

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

High Court decision

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

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

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

Court of Appeal decision

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

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

The Bank appealed to the Supreme Court.

Supreme Court decision

Two broad issues arose for the Supreme Court to consider:

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

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

The Bank’s defences

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

Defence of illegality

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

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

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

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

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

(a) Purpose of the prohibition:

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

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

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

(b) Relevant public policy:

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

(c) Proportionality:

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

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

Defence of causation

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

Countervailing claim in deceit

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

Attribution of knowledge and conduct

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

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

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

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

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

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

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

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

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

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

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

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

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

The Quincecare duty arises in the context of a deposit holding financial institution receiving and processing a payment mandate in relation to a customer’s account, where that mandate was made by an authorised signatory of its customer, but where the instructions turn out to have been made fraudulently and to the detriment of the customer. It is the duty imposed on the bank to refrain from executing the order if (and for as long as) it is “put on inquiry” in the sense that it has reasonable grounds (although not necessarily proof) for believing that the order is an attempt to misappropriate the funds of its customer. This is an objective test, judged by the standard of an ordinary prudent banker.

In the present case, the Court of Appeal refused an application made by the defendant bank for reverse summary judgment/strike out on the basis that there was no Quincecare duty of care applicable on the facts because such a duty was inconsistent with, or was excluded by, the express terms governing the claimant’s depository account with the bank. In doing so, the Court of Appeal upheld the decision of the High Court (given by the now Lord Burrows, who recently received a leapfrog promotion to the Supreme Court): The Federal Republic of Nigeria v JPMorgan Chase Bank, N.A. [2019] EWHC 347 (Comm).

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

  1. Scope of the Quincecare duty of care:

The Court of Appeal has arguably expanded the scope of the Quincecare duty of care. The judgment states that, in most cases, the Quincecare duty will require “something more” from the bank than simply pausing and refusing to pay out on the mandate when put on enquiry that the order is an attempt to misappropriate funds. It commented that the question of what a bank should do will vary according to the particular facts of the case. In the present case, the Court of Appeal said that the trial judge will be in a better position to determine what the bank should have done if it had decided not to execute the instructions it was given to transfer funds.

The effect is that the Quincecare duty comprises both:

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

In the Court of Appeal’s view, these negative and positive duties carry equal weight, and neither is separate or subsidiary or additional to the other. In the High Court, the judge inclined to the view that the positive duty was a duty of enquiry. However, the Court of Appeal’s formulation of the positive duty is not limited to one of enquiry or investigation and for that reason it has arguably expanded the scope of the Quincecare duty.

Further, the Court of Appeal consciously avoided identifying factors which might be relevant to assessing what the “something more” is or might consist of, thus offering banks little practical guidance; it will depend on the facts of the case in question.

  1. Exclusion of the Quincecare duty is possible

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

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

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

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

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

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

Background

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

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

Claim

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

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

The Bank applied for reverse summary judgment and/or strike out on various grounds, including that there was no Quincecare duty of care applicable on the facts because such a duty was inconsistent with, or was excluded by, the express terms of the depository agreement. The judgments considered below relate to that application.

High Court decision

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

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

Scope of the Quincecare duty

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

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

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

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

Express clauses of the depository agreement

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

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

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

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

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

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

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

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

The Bank appealed.

Court of Appeal decision

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

1. Scope of Quincecare duty

As to the scope of the Quincecare duty, the Court of Appeal said that, in most cases, the duty will require “something more” from the bank than simply pausing and refusing to pay out on the mandate when put on enquiry that the order is an attempt to misappropriate funds. It commented that the question of what a bank should do will vary according to the particular facts of the case. In the present case, the Court of Appeal said that the trial judge will be in a better position to determine what the Bank should have done if it had decided not to execute the instructions it was given to transfer funds. It did not think it would be helpful to give an indication as to what factors are likely to be relevant to the trial judge’s overall assessment of what the Bank should have done.

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

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

2. Exclusion of the Quincecare duty is possible

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

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

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

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

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

Simon Clarke
Simon Clarke
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Harry Edwards
Harry Edwards
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Chris Bushell
Chris Bushell
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Ceri Morgan
Ceri Morgan
Professional Support Lawyer
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Commercial Court grants summary judgment in favour of defendant bank in FX de-pegging case

The Commercial Court has granted summary judgment in favour of a bank defending a claim brought by a foreign exchange (“FX“) broker seeking to recover losses it suffered when the Swiss franc was de-pegged from the euro in 2015: CFH Clearing Limited v MLI [2019] EWHC 963 (Comm).

The decision represents a robust approach by the court in response to an attempt to shift losses caused by market forces to the defendant bank, through a suite of alleged express/implied contractual obligations and tortious duties. It is an example of how the court will be prepared – in appropriate cases – to summarily determine claims, without the need for a full trial and all the time and costs involved. As such, the decision should be welcomed by financial institutions.

In the present case, the broker argued that since its FX transactions with the bank were entered into at a time of severe market disruption, the bank was obliged to make a retrospective adjustment to the price of those transactions (which the broker said were automatically liquidated at a price below the official low), or to cancel them. In particular, the broker relied upon: (i) an alleged express/implied contractual obligation to follow market practice; (ii) the alleged incorporation of a contractual term based on the bank’s own best execution policy; and (iii) an alleged tortious duty to take reasonable care to ensure that transactions were priced correctly and, in circumstances where orders were wrongly priced due to market turbulence, to retrospectively re-price them.

The Commercial Court rejected all of the alleged contractual/tortious duties and granted summary judgment in favour of the defendant bank. In doing so, it emphasised the significance of the ISDA Master Agreement governing the specific FX transactions, which it said prevailed over the bank’s standard terms and conditions (rejecting the broker’s submission that the standard terms should be regarded as having primacy). The court held that the ISDA Master Agreement did not incorporate any express provisions relating to market practice/disruption, and pointed against the incorporation of an implied term to that effect and the alleged tortious duty.

Background

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

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

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

Decision

The court granted summary judgment in respect of all claims, holding there was no real prospect of the claim succeeding/no other compelling reason for a trial. The key issues which are likely to be of broader interest to financial institutions are summarised below.

1. Express term as to market practice

To establish an express term as to market practice, the claimant relied on clause 7 of the bank’s terms and conditions, as follows:

All transactions are subject to all applicable laws, rules, regulations howsoever applying and, where relevant, the market practice of any exchange, market, trading venue and/or any clearing house and including the FSA Rules (together, the “applicable rules”). In the event of any conflict between these Terms and applicable rules, the applicable rules shall prevail subject that nothing in this preceding clause shall affect our rights under clause 15.” (Emphasis added)

The claimant alleged that the effect of the words “subject to” was to incorporate all applicable laws rules and regulations (and market practice) into the contract. It said that this imposed a number of obligations on the bank. In particular, in the case of extreme events where deals took place outside of the market range (i.e. those shown on the EBS platform), to immediately adjust the deal within the EBS range or to cancel it. The claimant alleged that the bank was in breach of clause 7 because it did not act in accordance with good market practice, by failing to rebook the relevant trades within the EBS range at the time or cancel the trades.

Applying established principles of contractual interpretation, the court held that the objective meaning of the language of clause 7, was that market practice was not imported into the contract as an express term of the contract giving rise to contractual obligations. Rather, clause 7 was intended to relieve a party of contractual obligations that would otherwise place it in breach of its contract, where it was unable to perform its obligations by reason of relevant market practice.

One of the key factors influencing the court’s decision was that the standard terms stated they were subject to any specific transaction documentation, which the court held clearly included the ISDA Master Agreement governing the FX transactions. The court held that the ISDA Master Agreement prevailed over the standard terms (rejecting the claimant’s submission that the standard terms should be regarded as having primacy), and added that the ISDA Master Agreement was the appropriate place for the parties to have specified express provisions dealing with market disruption, and they had not done so in this case.

In the court’s view, this was not a case where there were reasonable grounds for believing that a fuller investigation into the facts would add to or alter the evidence on the issue of the express term. Accordingly, the court was prepared to “grasp the nettle” and decide the point finally on the application.

2. Implied term as to market practice

In the alternative, the claimant asserted that it was an implied term of the contracts relevant to the FX transactions that the parties would act in accordance with market practice.

Applying the test for implied terms in Marks & Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] UKSC 72, the court held that there was no real prospect of the claimant establishing the implied term as alleged. In particular, the court noted that in circumstances where the parties had entered into an ISDA Master Agreement, which contained extensive and comprehensive provisions used widely in the market, it could not be said that a general implied term for the incorporation of relevant market practice was either necessary for business efficacy or so obvious that it went without saying.

3. Contractual term based on the bank’s best execution policy

The claimant also alleged that the bank’s best execution policy was incorporated into the standard terms and conditions. It relied again upon clause 7, which stated (in addition to the part of the clause quoted above in relation to an alleged implied term as to market practice):

“Your orders will be executed in accordance with our order execution policy (as amended from time to time), a summary of which will, where applicable, be provided to you separately…”

The court held that the fact that the bank was obliged to follow the best execution policy did not mean that it was incorporated as a contractual term. In particular, the court highlighted that the best execution policy derived from the regulatory rules and emphasised that it was clear from the authorities that obligations on banks to comply with the Conduct of Business rules did not confer direct rights on their clients except and to the extent that the statute expressly provided. Further, given that only a summary of the best execution policy was provided to the claimant, this supported the bank’s submission that the best execution policy was not intended by the language of clause 7 to be incorporated into the standard terms and conditions as a contractual term. In the court’s view, even if the best execution policy was incorporated as a contractual term, there was no real prospect that it would extend to a requirement to retrospectively adjust the pricing of the trades, or to cancel them, where the price of the trades was affected by market turbulence.

4. Duty of care in relation to execution and settlement of orders

The claimant alleged that the bank assumed a duty to take reasonable care to ensure that transactions were priced correctly and, in circumstances where orders were wrongly priced due to market turbulence, to retrospectively re-price them.

The court found that there was no real prospect of the claimant establishing such a duty of care in the circumstances, given that both parties were professionals dealing at arm’s length. The court relied in particular on the terms of the ISDA Master Agreement and the standard terms and conditions, which expressly provided that the bank was not acting as a fiduciary. In the court’s view, the duty alleged had not been breached in any event.

Accordingly, the court granted the bank’s application for summary judgment, holding that there was no real prospect of the claim succeeding and no other compelling reason to allow the claim to proceed.

Donny Surtani
Donny Surtani
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Ceri Morgan
Ceri Morgan
Professional Support Lawyer
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Vicky Man
Vicky Man
Senior Associate (Hong Kong)
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Court of Appeal decision in Manchester Building Society v Grant Thornton: clarification of “advice” vs “information” distinction when applying the SAAMCO principle

The Court of Appeal has dismissed the claimant’s appeal in Manchester Building Society v Grant Thornton UK LLP [2019] EWCA Civ 40, an important decision on the application of the decision in South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191 (SAAMCO) to cases involving an adviser’s negligence. The decision will be of interest to financial institutions and professional advisers generally, including auditors (the subject of the instant decision).

As explained in our banking litigation e-bulletin on the first instance decision, the case concerned an auditor’s liability for (admitted) negligent advice regarding the accounting treatment of interest rate swaps. When the auditor’s error came to light, the client had to break the swaps early, incurring mark-to-market break costs of £32.7m. The Court of Appeal upheld the decision of the High Court, but did so on different grounds.

The judgment provides a number of helpful points of clarification on the approach to be taken in such cases involving the application of the SAAMCO principle as expanded upon in Hughes-Holland v BPE Solicitors [2017] UKSC 21:

  1. In particular, the Court of Appeal clarified that the correct approach in such cases is to consider at the outset whether it is an “advice” or an “information” case. The court emphasised that although there may be a descriptive inadequacy to these labels (so that a dispute involving negligent advice can still fall within the “information” case category), this should not undermine the fact that there is a clear and important distinction between the two categories of case.
  2. In determining whether a case falls within the “information” or “advice” category, what matters is the “purpose and effect” of the advice given. If that advice does not involve responsibility for “guiding the whole decision making process” or where the adviser’s duty does not extend to “consider all relevant matters and not only specific matters” – the case should fall within the “information” case category.
  3. For “information” cases, the adviser will be responsible only for the foreseeable consequences of the advice being wrong. This will require the claimant (who has the burden of proof) to prove the counter-factual, namely that loss would not have been suffered if the advice had been correct. Applying the relevant counter-factual scenario so as to determine which, if any, losses are recoverable will remain a complex exercise in many cases.

In the instant case, the Court of Appeal held that the High Court had erred in approaching the issue of liability by asking in general terms whether the auditor had assumed a responsibility for the mark-to-market losses and found that the present case was an “information” case, and so the auditor was responsible only for the foreseeable consequences of the accounting advice being wrong. This required the claimant to prove the counter-factual, that the same loss would not have been suffered if the advice had been correct, i.e. if the claimant had not exercised the break clause early and continued to hold the swaps. Here, the client was unable to prove its loss on the counter-factual as the discovery of the negligent advice merely crystallised mark-to-market losses on swaps which would have been suffered anyway if the swaps had been held to term.

The fact that the Court of Appeal came to its conclusion by virtue of a completely different analysis highlights that this remains a difficult area of the law, particularly in its application to the facts. Professional advisers can seek to avoid the uncertainty, and the time and cost associated with complex disputes, by ensuring that the scope of their role is clear from the terms of their retainer and, where appropriate, by excluding liability for particular categories of loss.

Background

The background to the dispute is set out in detail in our e-bulletin on the High Court decision. Broadly, however, the case involved a claim brought by Manchester Building Society (“MBS“) against its auditor, Grant Thornton (“GT“), arising out of negligent advice given by GT regarding the accounting treatment of interest rate swaps relating to its lifetime mortgage portfolio.

GT had negligently advised MBS in 2006 that it would be able to make use of an accounting treatment known as “hedge accounting” which would allow it to reduce the volatility of the mark-to-market value of the swaps on MBS’s balance sheet. In reliance on that advice, MBS acquired and issued lifetime mortgages and entered into swap transactions in order to hedge its interest rate risk.

In 2013, MBS discovered that GT’s advice had been incorrect and it could not in fact make use of hedge accounting. This meant that MBS’s balance sheet was exposed to volatility as a result of changes in the value of the swaps and, in particular, to the full losses suffered on the swaps following the fall in interest rates in the aftermath of the 2008 financial crisis. Once MBS’s accounts were corrected, it no longer held sufficient regulatory capital and was required to close out the swaps. In doing so, MBS incurred a mark-to-market loss of £32.7m.

High Court decision

At first instance, the High Court concluded that MBS had established causation both in fact and in law in respect of the break costs i.e. (a) but for the negligent advice, MBS would not have bought the swaps; and (b) if GT’s advice had been correct, it would not have needed to break the swaps in 2013. However, GT escaped liability because the High Court found it had not assumed responsibility for MBS being “out of the money” on the swaps. Rather, the mark-to-market losses suffered by MBS for terminating the swaps flowed from market forces. The court held that only the sum of circa £300,000 was recoverable (reflecting the transaction costs of breaking the swaps and certain other costs).

MBS appealed the High Court’s decision.

Grounds of appeal

The principal grounds of MBS’s appeal considered by the Court of Appeal were as follows:

  1. The judge erred in law in approaching the issue of liability on the basis of assumption of responsibility rather than by following the approach set out in SAAMCO and Hughes-Holland of considering whether this was an “advice” or “information” case.
  2. The correct analysis was that GT provided advice to MBS about whether it could apply hedge accounting and this was an “advice” case.
  3. Even if this was an “information” case, the judge’s decision was wrong because it failed to hold GT liable for the reasonably foreseeable consequences of the information being wrong (which should include the mark-to-market losses on the swaps).

Court of Appeal decision

The appeal was dismissed. The Court of Appeal’s conclusions for each of the principal grounds of appeal are set out further below.

1. Assumption of responsibility or “advice” vs “information” – which approach is correct?

Having considered the authorities discussing the SAAMCO principle (and in particular the clarification provided by Lord Sumption in Hughes-Holland), the Court of Appeal concluded that the High Court had been wrong to analyse the question of whether GT was liable for the mark-to-market losses by asking in general terms whether GT had assumed a responsibility for mark-to-market losses on the swaps. The right approach was to consider whether the case was an “advice” case or an “information” case.

The High Court did not take this approach, largely because of Lord Sumption’s reference to the descriptive inadequacy of the labels in Hughes-Holland. However, the Court of Appeal commented that the descriptive inadequacy of the labels used did not undermine the fact that there was a clear and important distinction between the two categories of case.

In summary, the Court of Appeal said that a case will be an “advice” case if it is left to the adviser to consider what matters should be taken into account in deciding whether to proceed with a particular transaction, i.e. the adviser is “responsible for guiding the whole decision making process” and “his duty is to consider all relevant matters and not only specific matters“. In such cases, the adviser will be liable for all the foreseeable losses flowing from entering into the transaction.

It continued that, if a case is not an “advice” case, it will by definition be an “information” case. In “information” cases, the adviser will not have assumed responsibility for the client’s decision as to whether to proceed with the transaction (the decision itself remains the responsibility of the client). In “information” cases, the adviser will only be responsible for the foreseeable financial consequences of the advice being wrong. Those consequences can be identified by considering what losses would have been suffered if the advice had been correct. Put differently, the adviser can only be liable for losses which would not have been suffered if its advice had been correct.

2. Was this an advice case?

The Court of Appeal concluded, uncontroversially we think, that this was not an “advice” case. In particular:

  • While it was true that GT provided accounting advice, GT was not involved in MBS’s decision to enter into the swaps. That remained a matter for MBS to decide, taking into account all relevant considerations (not only the information or advice from GT).
  • What mattered was not whether advice was given, but the purpose and effect of the advice given.
  • In the Court of Appeal’s view, GT’s accounting advice manifestly did not involve responsibility for “guiding the whole decision making process” and it was plain that “GT’s responsibility was limited to the giving of accounting advice, and never came close to extending to responsibility for the entire lifetime mortgage/swaps business“.
  • The Court of Appeal distinguished Main v Giambrone [2018] PNLR 17 (in which the adviser was found to have assumed the role of “guiding the whole decision making process“) from the instant case, in which GT played no such role.

It followed that the analysis applicable to “information” cases needed to be applied.

3. If this was an “information” case, was GT liable for the mark-to-market losses?

On the basis that this was an “information” case and applying the SAAMCO principle, the Court of Appeal concluded that GT was responsible only for the foreseeable consequences of the information being wrong.

MBS contended that this meant it was entitled to recover losses which would not have been incurred if GT’s information in relation to hedge accounting had been correct. It referred to the High Court’s findings in this hypothetical scenario, that MBS would not have “broken the swaps in 2013 and so would not at that time have incurred the loss which in fact it did”, in which case MBS’s case would be made out.

However, in the Court of Appeal’s judgment, it was a “striking feature” of the case that MBS’s claim for damages consisted of the “fair value” of the swaps, and receiving fair value does not ordinarily give rise to any loss. Indeed, if the swaps had been “in the money” when GT’s error had been discovered, MBS would still have needed to close them out to remove the resulting accounting volatility and, in those circumstances, they would have sustained no financial loss.

The Court of Appeal therefore proceeded to determine what the proper counter-factual should be. In this context, it held:

  • MBS had to do more than establish the fact of the mark-to-market losses in order to prove that it would not have suffered those losses if GT’s advice had been correct.
  • The Court of Appeal emphasised that the mark-to-market losses reflected market forces. It noted this was supported by the High Court’s reasoning (paragraph 179). In particular: “the fact that the swaps were heavily ‘out of the money’ at the beginning of June 2013 was the result of market forces. The closing out of the swaps at fair value on 6 and 7 June 2013 crystallised the loss resulting from the swaps being ‘out of the money’, but it did not create that loss“.
  • The counter-factual that MBS had to prove was that loss would not have been suffered had it continued to hold the swaps. The Court of Appeal noted that this was an aspect of proof of loss.
  • MBS failed to prove its loss in this counter-factual scenario.

The Court of Appeal commented that the position might have been different if MBS could show that, had it had not been forced to close out the swaps in 2013, it would have closed them out a later and more advantageous time. That was not, however, MBS’s case.

The Court of Appeal therefore concluded that MBS had not proved that the mark-to-market losses would not have been incurred had GT’s advice been correct. Accordingly, although the High Court’s approach was not correct in law, it reached the correct overall decision and therefore the appeal was dismissed.

Simon Clarke
Simon Clarke
Partner
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Catherine Emanuel
Catherine Emanuel
Senior Associate
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Eliot Leggo
Eliot Leggo
Associate
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Ceri Morgan
Ceri Morgan
Professional Support Lawyer
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Do we need a new duty of care in financial services?

On 17 July 2018, the FCA published a paper on its Approach to Consumers (the Approach), accompanied by a discussion paper DP18/5 (the DP) on the possible introduction of a new duty of care and other alternative approaches (a New Duty).
The Approach sets the FCA’s vision for well-functioning markets that work for consumers, and builds on the November 2017 consultation on its Future Approach to Consumers. The aim is to provide greater transparency on when and how the FCA will act to protect consumers, its policy positions on key issues, and its strategy for ensuring that it advances its consumer protection objective with the greatest impact.
The key question raised by the November 2017 consultation, one of immediate interest to firms and other stakeholders, was whether there was a need to introduce a New Duty.
Some stakeholders suggested that the current regulatory framework was insufficient, was not applied effectively to prevent harm to consumers and did not provide appropriate levels of protection. Some thought the introduction of a New Duty could foster long term cultural change within firms and avoid conflicts of interest. Others by contrast felt that existing FCA rules and common and statute law, complemented by the Senior Managers & Certification Regime collectively represent in practice the same requirements on firms as a duty of care.
The FCA’s objective is therefore to open broader discussion on the merits of a New Duty and understand what outcomes a New Duty may achieve to enhance behaviours in the financial services sector.
To that end, the FCA seeks views on:
  • whether there is a gap in the existing legal and regulatory framework, or the way the FCA regulates, that could be addressed by introducing a New Duty;
  • whether change is desirable and if so, the form it should take;
  • what a New Duty for financial services firms might do to enhance positive behaviour and conduct from firms in the financial services market, and incentivise good consumer outcomes;
  • how the New Duty might increase the FCA’s effectiveness in preventing and tackling harm and achieving good outcomes for consumers;
  • whether breaches of a New Duty or of the FCA’s Principles for Businesses should give rise to a private right of action for damages in court; and
  • whether a New Duty would be more effective in preventing harm (by, for example, enhancing good conduct and culture within firms) and therefore lead to less reliance on redress.
The DP deliberately leaves open for discussion the nature of any duty, i.e. whether it would be more akin to a ‘duty of care’ or to a fiduciary duty, the former being more of a positive obligation than the latter which is, largely, a prohibition (e.g. a firm must not put its own interests above those of the client).

Assessment of the current legal and regulatory framework

The DP reviews the current legal and regulatory framework and notes that it could be said that the current Principles for Businesses (Principles), amplified by detailed rules, address many of the issues cited for introducing the New Duty.

The FCA identifies the following as the most relevant Principles:

  • Principle 2 – a firm must conduct its business with due skill, care and diligence
  • Principle 6 – a firm must pay due regard to the interests of its customers and treat them fairly
  • Principle 7 – a firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading
  • Principle 8 – a firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client, and
  • Principle 9 – a firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment.

The FCA also points to the client’s ‘best interests’ rule, whilst highlighting that there is no equivalent rule applicable to accepting of deposits and carrying out contracts of insurance, and obligations on firms to take reasonable care in undertaking certain activities.

These are supplemented by the Consumer Rights Act 2015 (the CRA), which implies a term requiring those providing services to consumers to act with reasonable care and skill, and the FCA’s power to enforce breaches of certain consumer protection laws (including the CRA).

The FCA has also concurrent competition powers to investigate and intervene in respect of markets where competition may not be working well, and to enforce against breaches of the competition law prohibitions.

Finally, the FCA is extending its Senior Managers and Certification Regime (SM&CR) to all FSMA authorised firms: this will impose on most employees of financial services firms five conduct rules, including in particular the requirement to act with due care, skill and diligence, and to pay due regard to the interests of customers and treat them fairly. The FCA believes these additional obligations on individuals could help address some of the key cultural and governance concerns which underlie calls for a New Duty.

Proposals for the New Duty

As well as seeking views on the merits, practicalities and consequences of introducing a New Duty, the FCA will consider a range of possible alternatives to address stakeholders’ concerns:

  1. making a rule introducing a New Duty, through the use of FSMA rule-making powers. This approach would require clarification through the issue of guidance and consideration as to how it would sit within the regime, and in particular its relationship to the Principles.
  2. by the introduction of a statutory duty (through a change in primary legislation in Parliament) and supplemented by FCA rules and guidance. A statutory duty would have greater status than the Principles, going further than the requirements of s1C(2)(e) FSMA¹.
  3. the extension of the client’s best interest rule. This would only apply to regulated activities and may require some amendment to some of the Principles.
  4. enhancements to the Principles through the introduction of detailed new rules or guidance, for example through the guidance expected to be published next year on the identification and treatment of vulnerable customers.

Consumer outcomes and redress

While being clear that the best consumer outcome is to prevent harm from occurring in the first place, the FCA addresses the mechanisms available to a consumer when seeking redress when things go wrong.

It is in that regard, the FCA raises what will no doubt be a controversial question as to whether a breach of a New Duty or of the Principles should give rise to private right of damages. The latter reopening a debate had in the context of a 1998 consultation that originally introduced the Principles.

Any extension of private rights of action in respect of breach of the Principles would need to be considered in conjunction with the FCA’s recent discussion of a proposed extension of Principle 5 to unregulated activities, which the FCA may revisit in the future. Such an extension of Principle 5, together with the recognition of a range of industry codes relating to unregulated activities, would assume a wholly different complexion if private rights of action were also added to the mix.

Reflection

The call for duty of care in financial services regulation is not a new one and, as well as having been a priority for the Financial Services Consumer Panel for some time, was considered by the Parliamentary Commission on Banking Standards as well as the Law Commission.

It is not clear from the DP that there is in fact an obvious gap in the existing legal and regulatory framework to be filled – that itself being an open question in the DP. That is, rationally, the fundamental starting point – proceeding to discuss the nature or form of a New Duty, including the potential for the Principles to be actionable, is premature before the underlying problem or gap is properly identified. Clearly there continue to be conduct issues in the market that need to be addressed but rushing to introduce new rules or guidance is not necessarily the best answer.

 

¹ In meeting its objective of securing appropriate degree of protection for consumers the FCA is currently required by s1C(2)(e) FSMA to have regard to “the general principle that those providing regulated financial services should be expected to provide consumers with a level of care that is appropriate having regard to the degree of risk involved in relation to the investment or other transaction and the capabilities of the consumers in question”

Jenny Stainsby
Jenny Stainsby
Partner
+44 20 7466 2995
 
Karen Anderson
Karen Anderson
Partner
+44 20 7466 2404
 
Jon Ford
Jon Ford
Senior Associate
+44 20 7466 2539