Supreme Court clarifies requirements for tort of lawful act economic duress

The Supreme Court has dismissed an appeal against a Court of Appeal decision which found that a contract should not be rescinded on the basis of lawful act economic duress, in circumstances where the defendant had threatened to end any contractual relationship with the claimant (as it was entitled to do) unless the claimant waived all claims it might have against the defendant for commission due under a previous contract: Pakistan International Airline Corporation v Times Travel (UK) Ltd [2021] UKSC 40.

The Supreme Court was unanimous in its decision and as to the basic elements for establishing liability for the tort of lawful act economic duress, namely that: (i) the defendant’s threat or pressure must have been illegitimate; (ii) it must have caused the claimant to enter the contract; and (iii) the claimant must have had no reasonable alternative to giving in to the threat or pressure.

The decision will be of interest to financial institutions as it highlights that the court will not lightly conclude that a commercial party has made an illegitimate threat in the context of negotiating a commercial contract, particularly in light of the absence in English law of any doctrine of inequality of bargaining power or any general principle of good faith in contracting. A finding that a commercial contract should be rescinded for lawful act economic duress is therefore likely to be rare.

For a more detailed discussion of the decision, see our litigation blog post.

Supreme Court clarifies proper approach to SAAMCO and to determining scope of duty of care owed by professional advisers

In what is now the leading authority on the application of the decision in South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191 (SAAMCO), the Supreme Court has allowed an appeal by a mutual building society in the context of its claim for damages for economic loss against an auditor for (admitted) negligent advice regarding the accounting treatment of interest rate swaps: Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20. In doing so, the Supreme Court found unanimously that the mutual building society had suffered loss which fell within the scope of the duty of care assumed by the auditor, but that its damages should be reduced by 50% on the basis of its contributory negligence.

The appeal was heard by an expanded constitution of the Supreme Court, in order to provide general guidance regarding the proper approach to determining the scope of duty and the extent of liability of professional advisers in the tort of negligence, including the proper application of the SAAMCO principle. As such, the outcome and reasoning of this decision will be significant for financial institutions faced with claims for economic loss due to alleged negligent advice.

The majority (Lords Hodge, Sales, Reed and Kitchin, and Lady Black) held that the scope of the duty of care assumed by a professional adviser is governed by the purpose of the duty, judged on an objective basis by reference to the purpose for which the advice is being given. In practice, this means that, when looking at the case of negligent advice given by a professional adviser, one looks to see what risk the duty was supposed to guard against and then looks to see whether the loss suffered represented the fruition of that risk. In the view of the majority, this was the point of the mountaineer’s knee example given by Lord Hoffman in SAAMCO.

The majority said the descriptions of “information” case and “advice” case should be dispensed with as terms of art in this area. Cases should not be shoe-horned into one or other of these categories, but rather the focus should be on identifying the purpose to be served by the duty of care assumed by the defendant. In consequence, using a counterfactual test (whereby one asks whether, if the advice or information given by the defendant had in fact been true, the action taken by the claimant would still have resulted in the same loss) should be regarded only as a tool to cross-check the result in most cases, and should not be regarded as replacing the decision which needs to be made as to the scope of duty of care. The majority rejected Lord Leggatt’s emphasis on causation and the counterfactual test, and Lord Burrows’s focus on public policy. However, there was unanimous agreement as to the outcome of the appeal.

In the present case, the majority found that the purpose of the advice given by the auditor was clear: to provide technical accounting advice as to whether the mutual building society could use hedge accounting in order to implement its proposed business model within the constraints of the regulatory environment. As a result of the auditor’s negligent advice, the building society adopted the business model, entered into further swap transactions and was exposed to the risk of loss from having to break the swaps, when it was realised that hedge accounting could not in fact be used and the building society was exposed to regulatory capital requirements which the use of hedge accounting was supposed to avoid. That was a risk which the auditor’s advice was supposed to allow the building society to assess, and which its negligence caused the building society to fail to understand. Accordingly, the losses suffered by the building society when breaking the swaps were within the scope of the duty owed by the auditor.

By focusing on the purpose to be served by the duty of care, the decision may mitigate some of the difficulties which have arisen in practice in categorising “advice” and “information” cases and in applying the correct counterfactual test on the facts of a given case. In future cases, the court is likely to place greater emphasis on understanding the purpose and commercial rationale for which a party has sought advice and identifying the potential risks from which the party was relying on an adviser to protect it. This may lead to an increased evidential burden on the parties, potentially increasing the time and costs of disclosure and witness evidence, where engagements are not documented properly and fully. Accordingly, the decision highlights the importance for financial institutions to ensure, at the outset of a transaction, that there is clear agreement as to how their advice and work will be used by clients, and the impact it could have if it transpires that their advice or work is flawed in some respect.

The decision is considered in more detail below.

Background

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

The High Court’s reasoning is considered in our previous blog post: High Court applies SAAMCO principle to find no assumption of responsibility for losses flowing from market forces.

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 High 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.

Court of Appeal decision

The Court of Appeal’s reasoning is examined in our previous blog post: 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 upheld the decision of the High Court, but did so on different grounds. The Court of Appeal said 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. It said that the correct approach to be taken in cases involving the application of the SAAMCO principle was to consider at the outset whether it is an “advice” or an “information” case, and that in determining which category a case falls within, what matters is the “purpose and effect” of the advice given.

In applying that distinction, the Court of Appeal 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 MBS to prove the counterfactual, that the same loss would not have been suffered if the advice had been correct, i.e. if MBS had not exercised the break clause early and continued to hold the swaps. Here, MBS was unable to prove its loss on the counterfactual 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.

MBS appealed the Court of Appeal’s decision.

Supreme Court decision

The Supreme Court allowed unanimously the appeal, finding that MBS had suffered a loss which fell within the scope of the duty of care assumed by GT, but that damages should be reduced by 50% on the basis of its contributory negligence.

The reasons given for reaching this conclusion differed between the majority (Lord Hodge and Lord Sales, with whom Lord Reed, Lady Black and Lord Kitchin agreed) and the minority judgments of Lord Burrows and Lord Leggatt. The reasoning and key distinctions are discussed further below.

The scope of duty question: how it fits within the tort of negligence

As a preliminary consideration, the majority put the “scope of duty” principle in context within the tort of negligence, setting out a series of questions which will need to be considered in each case.

  • Is the harm (loss, injury and damage) which is the subject matter of the claim actionable in negligence? (the actionability question)
  • What are the risks of harm to the claimant against which the law imposes on the defendant a duty to take care? (the scope of duty question)
  • Did the defendant breach his or her duty by his or her act or omission? (the breach question)
  • Is the loss for which the claimant seeks damages the consequence of the defendant’s act or omission? (the factual causation question)
  • Is there a sufficient nexus between a particular element of the harm for which the claimant seeks damages and the subject matter of the defendant’s duty of care as analysed at stage 2 above? (the duty nexus question)
  • Is a particular element of the harm for which the claimant seeks damages irrecoverable because it is too remote, or because there is a different effective cause (including novus actus interveniens) in relation to it or because the claimant has mitigated his or her loss or has failed to avoid loss which he or she could reasonably have been expected to avoid? (the legal responsibility question)

The central question in the appeal was stage (2), which addresses the discussion in SAAMCO regarding the scope of a defendant’s duty. The majority noted that, depending on the case, this question may be considered either at stage (2) or stage (5). In some cases, the scope of duty question will be relevant to the extent of the losses claimed, and whether they fall within the scope of the duty assumed by the defendant, e.g. in SAAMCO and Hughes-Holland. In such cases, it may be appropriate to identify losses on a simple “but for” basis first and then ask the duty nexus question at stage (5), as a practical approach to working out the implications of the scope of duty concept, which arises (in principle) earlier in the analysis at stage (2).

Lord Burrows departed from the majority view on where the scope of duty question sits within the tort of negligence. He did not consider it necessary or helpful to depart from a more conventional approach to the tort of negligence which begins with the duty of care, treats the SAAMCO principle as being concerned with whether factually caused loss is within the scope of the duty of care, and avoids the novel terminology of the “duty nexus”.

The scope of the duty of care in professional advice cases

The majority underlined that the scope of the duty of care assumed by a professional adviser is governed by the purpose of the duty, judged on an objective basis by reference to the purpose for which the advice is being given.

This was confirmed as the proper approach in SAAMCO itself and in the other leading authorities, including Caparo Industries plc v Dickman [1990] 2 AC 605, Aneco Reinsurance Underwriting Ltd (in liquidation) v Johnson & Higgins Ltd [2001] UKHL 51 and Hughes-Holland v BPE Solicitors [2017] UKSC 21).

In the view of the majority, when looking at the case of negligent advice given by a professional adviser, one looks to see what risk the duty was supposed to guard against and then looks to see whether the loss suffered represented the fruition of that risk. The majority said that this was the point of the mountaineer’s knee example given by Lord Hoffman in SAAMCO, where a doctor is consulted by a mountaineer concerned about his knee, and who negligently pronounces the knee fit. The mountaineer goes on an expedition and suffers an injury which is a foreseeable consequence of mountaineering but has nothing to do with his knee. Lord Hoffman said that the doctor will not be liable, even if the mountaineer would not have gone on the expedition if he had been told the truth, because the injury would have occurred even if the pronouncement as to the state of the knee had been correct. Rather than highlighting the distinction between a duty to provide “information” and a duty to “advise” (which distinction should be avoided following the decision in the present case, as discussed in the following section), the majority suggested that this example supports the purposive approach to determining the scope of the duty of care.

Lord Burrows agreed that the scope of duty principle focuses on the purpose of the advice or information provided by the defendant, but added that this is underpinned by the policy of achieving a fair and reasonable allocation of the risk of the loss that has occurred. The majority did not agree that the analysis should involve reference back to policy.

By contrast, Lord Leggatt held that the scope of duty principle was based upon causation and suggested that the correct approach was to assess whether the loss claimed was caused by the particular matters which made the defendant’s advice incorrect, and not by other matters unrelated to the subject matter of the defendant’s negligence. However, in the view of the majority, the principle can more readily be understood without placing emphasis on causation, which distracts attention from the primary task of identifying the scope of the defendant’s duty.

Distinction between “advice” cases and “information” cases

Lord Leggatt proposed to dispense with the descriptions “information” and “advice” as terms of art in this area.

This was welcomed by the majority, who said the distinction drawn by Lord Hoffmann in SAAMCO had not proved to be satisfactory, agreeing with Lord Sumption in Hughes-Holland that the distinction was too rigid and liable to mislead. They endorsed Lord Sumption’s view that the whole varied range of cases constitutes a spectrum, with pure “advice” cases at one end of the spectrum (where the adviser assumes responsibility for every aspect of a transaction for their client) and, at the other extreme, cases where the professional adviser contributes only a small part of the material on which the client relies in deciding how to act. They also agreed with Lord Sumption’s observation that both “advice” and “information” cases involve the giving of advice.

In the view of the majority, rather than starting with the distinction between “advice” and “information” cases and trying to shoe-horn a particular case into one or other of these categories, the focus should be on identifying the purpose to be served by the duty of care assumed by the defendant. In this context, they emphasised the importance of linking the focus of the analysis of the scope of duty question and the duty nexus question back to the purpose of the duty of care assumed in the case in hand.

Application of SAAMCO-style counterfactual analysis

The majority referred to the use of the counterfactual analysis set out by Lord Hoffman in SAAMCO. This was proposed as a way to assist in identifying the extent of the loss suffered by the claimant which falls within the scope of the defendant’s duty, by asking in an “information” case whether the claimant’s actions would have resulted in the same loss if the advice given by the defendant had been correct, i.e. if the facts or position had in fact been as represented by the defendant. This procedure generates a limit to the damages recoverable which has been called the SAAMCO “cap”.

However, the majority agreed with Lord Burrows that the counterfactual test should be regarded only as a tool to cross-check the result in most cases, and should not be regarded as replacing the decision which needs to be made as to the scope of duty of care. Lord Burrows described this as a policy decision, whereas the majority thought that it reflected more fundamental issues of principle.

In the view of the majority, linking the use of the counterfactual analysis to “information” cases in the “advice” and “information” framework is unhelpful, because of the problems associated with that framework. There was also a danger of manipulation, in argument, of the parameters of the counterfactual world; one therefore had to take care not to allow the counterfactual analysis to drive the outcome in a case. For example, in this case, Lord Burrows expressly noted, the first instance judge and Court of Appeal had not applied the “most helpful counterfactual test”. To continue the use of the counterfactual analysis would create a risk of litigation by way of contest between elaborately constructed worlds advanced by each side, which would become increasingly untethered from reality the further one moved from the relatively simple valuer case addressed in SAAMCO.

By contrast, examination of the purpose of the duty provides an appropriate and refined basis for identifying, out of what may be a wide range of factors which contribute to the claimant’s loss, the factors for which the defendant is responsible.

The scope of the duty of care in the present case

The majority held that MBS had suffered a loss which fell within the scope of the duty of care assumed by GT, having regard to the purpose for which it gave its advice about the use of hedge accounting.

The majority commented that the purpose of the advice given by GT was clear: to advise MBS whether it could employ hedge accounting in order to reduce the volatility on its balance sheet and keep its regulatory capital at a level it could afford in relation to swaps to be held to term on the basis that they were to be matched against mortgages. As a result of GT’s negligent advice, MBS adopted the business model, entered into further swap transactions and was exposed to the risk of loss from having to break the swaps, when it was realised that hedge accounting could not in fact be used and MBS was exposed to regulatory capital requirements which the use of hedge accounting was supposed to avoid. That was a risk which GT’s advice was supposed to allow MBS to assess, and which its negligence caused MBS to fail to understand.

The majority said that for the purposes of analysing whether the losses suffered by MBS fell within the scope of the duty of care assumed by GT, it was important to have regard to the commercial reason (as appreciated by GT) why advice was being sought about whether there was an “effective hedging relationship” between the swaps and mortgages being entered into and why this was fundamental to MBS’s decision to engage in the business of matching swaps and mortgages. That reason was the impact of hedge accounting on MBS’s regulatory capital position. Use of hedge accounting allowed MBS to make the assessment that, in terms of the constraints imposed on it by the regulatory capital requirements to which it was subject, it had the capacity to proceed with that business whereas otherwise it did not. Having regard to this purpose, GT in effect informed MBS in 2006 that hedge accounting could enable it to have sufficient capital resources to carry on the business of matching swaps and mortgages, when in reality it did not.

Reduction for contributory negligence

However, the Supreme Court held, unanimously, that MBS’s damages should be reduced by 50% on the basis of its contributory negligence.

In the Supreme Court’s view, MBS’s contribution to its own loss arose from the mismatching of the mortgages and swaps in what was an overly ambitious application of the business model by MBS’s management. The Supreme Court considered that the trial judge was entitled to make the assessment that MBS’s damages should be reduced by 50% on the basis of its contributory negligence.

Accordingly, the Supreme Court allowed MBS’s appeal. The overall net loss of (approximately) £26.7m was held to be recoverable, subject to a 50% reduction for contributory negligence by MBS.

Simon Clarke
Simon Clarke
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Ceri Morgan
Ceri Morgan
Professional Support Consultant
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Nihar Lovell
Nihar Lovell
Professional Support Lawyer
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CJEU considers issuer liability for prospectuses marketed to both retail and qualified investors

The Court of Justice of the European Union (CJEU) has confirmed that qualified investors (as well as retail investors) can bring an action for damages on the basis of inaccuracies in a prospectus published to the public at large, as a matter of interpretation of Directive 2003/71/EC (the Prospectus Directive): Bankia SA v Unión Mutua Asistencial de Seguros [2021] EUECJ (C 910/19)The CJEU’s decision follows and confirms the opinion of the Advocate General (see our previous blog post: EU Advocate General considers interpretation of Prospectus Directive in relation to an issuer’s liability for a prospectus marketed to both retail and qualified investors).

The relevant provisions considered by the CJEU were Articles 3(2)(a) and 6 of the Prospectus Directive, which were implemented in UK law (before the UK left the EU) by virtue of s.90 of the Financial Services and Markets Act 2000 (FSMA). While the CJEU decision is unsurprising in the context of s.90 FSMA, the ruling provides helpful clarification on an important legislative framework that forms the bedrock of European securities litigation.

Although the UK is no longer a member of the EU, the CJEU decision may still be of relevance to the interpretation of s.90 FSMA claims, which represents “retained EU law” post-Brexit because it is derived from an EU Directive. In interpreting retained EU law, CJEU decisions post-dating the end of the transition period are not binding on UK courts, although the courts may have regard to them so far as relevant (see our litigation blog post on the practical implications of Brexit for disputes).

The CJEU decision is considered in more detail below.

Background

In 2011, the appellant Spanish bank (Bank) issued an offer of shares to the public, for the purpose of becoming listed on the Spanish stock exchange. The offer consisted of two tranches: one for retail investors and the other for qualified investors. A book-building period, in which potential qualified investors could submit subscription bids, took place between June and July 2011. As part of the subscription offer, the Bank contacted the respondent (UMAS), a mutual insurance entity and therefore a qualified investor. UMAS agreed to purchase 160,000 shares at a cost of EUR 600,000. The Bank’s annual financial statements were subsequently revised. This led to the shares losing almost all their value on the secondary market and being suspended from trading.

UMAS issued proceedings in the Spanish court against the Bank seeking to annul the share purchase order, on the grounds that the consent was vitiated by error; or alternatively for a declaration that the Bank was liable on the grounds that the prospectus was misleading. Having lost at first instance, the Bank appealed to the Spanish Provincial Court, which dismissed the action for annulment but upheld the alternative action for damages brought against the Bank on the grounds that the prospectus was inaccurate.

On the Bank’s appeal to the Spanish Supreme Court, the court held that neither the Prospectus Directive nor Spanish law expressly provided that it is possible for qualified investors to hold the issuer liable for an inaccurate prospectus where the offer made to the public to subscribe for securities is addressed to both retail and qualified investors.

The Spanish Supreme Court decided to stay the proceedings and referred two key questions to the CJEU for a preliminary ruling as to the interpretation of Article 6 of the Prospectus Directive.

Opinion of the Advocate General

The Advocate General’s opinion is considered in further detail in our banking litigation blog post.

In summary, the Advocate General concluded that Article 6 of the Prospectus Directive, in the light of Article 3(2)(a), must be interpreted as meaning that, where an offer of shares to the public for subscription is directed at both retail and qualified investors, and a prospectus is issued, an action for damages arising from the prospectus may be brought by qualified investors, although it is not necessary to publish such a document where the offer concerns exclusively such investors.

The Advocate General also concluded that a Member State has the discretion to provide in its legislation or regulations that awareness by a qualified investor of the true situation of the issuer should be taken into account, in the event of an action for damages being brought by a qualified investor on the grounds of an inaccurate prospectus (i.e. that Article 6(2) does not preclude this principle). However, this is subject to the condition that the principles of effectiveness and equivalence are observed.

CJEU decision

We consider below each of the issues addressed by the CJEU.

Issue 1: Inaccurate prospectus as the basis for a qualified investor’s action for damages

The CJEU agreed with the Advocate General that an investor who has participated in an offer of securities where a prospectus has been published, may legitimately rely on the information given in that prospectus, whether or not the prospectus was issued for that investor. On that basis, an investor is entitled to bring an action for damages on the grounds of that information, again whether or not the prospectus was issued for that investor. In reaching this conclusion, the CJEU made the following observations:

  • Context. Interpreting Article 6 of the Prospectus Directive, the court was required to take account of its context and the provisions of EU law as a whole. With this in mind, the CJEU noted that the Prospectus Directive does not identify the investors who may bring an action for damages, but merely identifies the potential defendants.
  • Objectives. Turning to the objectives pursued by the Prospectus Directive, which must also be taken into account in the process of interpretation, the CJEU focused on the objective of investor protection. It emphasised that the publication of a prospectus contributes to the implementation of safeguards designed to meet the objective of protecting the interests of actual and potential investors.
  • Language used. The CJEU noted that Article 3(2) lays down a series of exemptions from the general obligation to publish a prospectus, including an exemption from publishing a prospectus for securities offered exclusively to qualified investors. However, it could not be inferred from this that qualified investors are denied the opportunity to bring an action for damages. In the view of the CJEU, the distinction between retail investors and qualified investors at Article 3 of the Prospectus Directive did not cast doubt on its interpretation of Article 6.

Issue 2: Qualified investor’s awareness of the true situation of the issuer

The CJEU agreed with the Advocate General that Article 6(2) grants a broad discretion to Member States to lay down the rules for bringing an action for damages on the grounds of the information given in the prospectus. Accordingly, that provision must be interpreted as not precluding the qualified investor’s awareness of the true situation of the issuer being taken into consideration, in the event of an action in damages being brought by a qualified investor.

This point is illustrated by the legal framework in the UK, because the awareness of the true position of the issuer is expressly included in the list of potential defences to a s.90 FSMA claim, which appears at Schedule 10. A contrary ruling from the CJEU would, therefore, have contradicted the way in which the UK implemented the Prospectus Directive.

Harry Edwards
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Sarah Hawes
Sarah Hawes
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Ceri Morgan
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Court of Appeal determines that a fiduciary relationship is not a necessary pre-condition to relief in respect of an undisclosed commission paid to an agent

The Court of Appeal has found that a fiduciary relationship is not a necessary pre-condition to relief in respect of an undisclosed commission paid to an agent. Instead, the court should determine whether the agent was obliged to provide information, advice or recommendation on an impartial or disinterested basis, saying that “it is the duty to be honest and impartial that matters”. Where there is such a duty, both the payer and recipient of the undisclosed commission will be liable: Frances Elizabeth Wood v Commercial First Business Limited [2021] EWCA Civ 471.

The Court of Appeal further held that the cases before it involved undisclosed commissions (which give rise to a right to rescind the contract), rather than “half-secret” commissions (where the principal was aware of the payment to its agent, but did not have sufficient information to give informed consent to that payment, with the result that rescission may, but will not necessarily, be available). In the two cases before the court a mortgage broker’s terms provided that they may take a commission from lenders, but that if they did so, it would be disclosed to the borrowers. The court held that in circumstances where no commission was disclosed, the borrowers were not on notice that commission was being paid, and the commissions were therefore secret commissions.

This decision will be of interest to financial institutions as it provides a helpful clarification of the position in relation to secret commissions and indicates that the court will not be required to strain to find a fiduciary duty in order to grant relief in such cases. It further indicates that a general disclosure of potential commissions, of the kind provided to the borrowers in this case, may be insufficient to take cases out of the realm of secret commissions.

For a more detailed discussion of the decision, please see our Civil Fraud and Asset Tracing Notes blog post.

UK post-Brexit reform: Financial Services Act 2021

On 29 April 2021, the Financial Services Act 2021 received royal assent. The Act is a milestone in implementing the UK Government’s wider Future Regulatory Framework initiative and represents the first major step towards HM Government’s objective of maintaining the competitive position of the UK financial services industry whilst capitalising on new opportunities following the end of the Brexit transition period.

This is the first significant piece of UK primary legislation in the financial services sector following the end of the Brexit transition period; it introduces wide-ranging reforms to the current UK regulatory regime which include significant amendments to the Financial Services and Markets Act 2000 and various other ‘onshored’ EU financial services regulation. Many of these provisions are designed to recalibrate the UK regulatory architecture towards a more regulator-led approach and to correct various functional issues with rules introduced under former EU regimes.

For more a detailed overview of the Act and its substantive reforms, please see our briefing.

 

The FCA’s proposed new “Consumer Duty” – what does it mean?

The FCA has published its long-awaited consultation on “duty of care” which has morphed into a proposed package of measures intended to deliver better outcomes for consumers – together a new “Consumer Duty”.

The consultation, which is open until 31 July 2021, proposes:

  • a new Consumer Principle that provides an overarching standard of conduct; and
  • a set of Cross‑cutting Rules and four Outcomes that support the Consumer Principle.

The proposals apply to regulated products and services sold to “retail clients” which would include SMEs.

The proposals from the FCA will add to the range of regulatory tools to address the poor customer outcomes it has identified in retail markets. The FCA has not made any specific proposals on a private right of action. It has, however, said that it would welcome stakeholders’ further views on how a private right of action could support or hinder the success of the proposals and their intended impact on firms, consumers and markets.

It is good to see that a private right of action for Principles breaches is not the focus of the Consultation Paper. In this regard, it is questionable whether a private right of action for Principles breaches would be of real benefit to consumers who already have access to the Financial Ombudsman Service (FOS), which is better suited to dealing with claims from a speed and cost perspective.

For a more detailed analysis of the FCA’s case for change, the proposals and our thoughts on what this may mean for firms, please see our FSR and Corporate Crime blog post.

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

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

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

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

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

Meaning of “advice” in a financial services context

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

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

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

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

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

Impact of “no advice” clause in pension contract

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

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

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

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

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

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

John Corrie
John Corrie
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Ceri Morgan
Ceri Morgan
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Ian Thomas
Ian Thomas
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Nic Patmore
Nic Patmore
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Court of Appeal confirms that the Quincecare duty does not extend to protect creditors

The Court of Appeal has struck out Quincecare duty and dishonest assistance claims brought by the liquidators of a company running a Ponzi scheme against a correspondent bank that operated various accounts for the company. In doing so, the Court of Appeal confirmed that the scope of the Quincecare duty, which may arise in the context of a financial institution processing client payments, is limited to protecting customers of the financial institution, and does not extend to protect the customer’s creditors: Stanford International Bank Ltd v HSBC Bank plc [2021] EWCA Civ 535.

In relation to the Quincecare duty claim, the Court of Appeal found that the company had no claim in damages because it suffered no loss. The way the Ponzi scheme operated, payments made by the bank to genuine investors reduced the company’s assets, but equally discharged the company’s liabilities to those investors by the same amount. The net asset position therefore remained the same in the period between: (a) when the liquidators said the bank should have recognised the “red flags” and stopped processing its customer’s payments, thereby exposing the fraud; and (b) the date upon which the accounts were eventually frozen by the bank.

In reaching this conclusion, the Court of Appeal overturned the decision of the High Court, which had refused to strike out the claim (see our banking litigation blog post). The High Court relied on the company’s state of insolvency as a key factor, finding that if the bank had performed its Quincecare duty, then more cash would have been available to pay other creditors once the company’s insolvency process began (at a later date). However, in the Court of Appeal’s view, the problem with this argument was that it proceeded on the basis that the bank owed a direct duty to the company’s creditors, which it did not. It said the High Court erred in its reasoning by confusing the company’s position before and after the inception of an insolvency process. Before an insolvency process commences (and the statutory insolvency regime is invoked), the fact that a company has slightly lower liabilities is a corresponding benefit to its net asset position, even if the company is in a heavily insolvent position. Having more cash available upon the eventual inception of its insolvency for the liquidators to pursue claims and for distribution to creditors, is a benefit to creditors, but not to the company while it is still trading.

The Court of Appeal upheld the High Court’s decision to strike out the dishonest assistance claim, emphasising that dishonesty and blind-eye knowledge allegations against corporations (large or small) must still be evidenced by the dishonesty of one or more natural persons. Blind-eye knowledge cannot be constituted by a decision not to enquire into an untargeted or speculative suspicion rather than a targeted and specific one; and the liquidators could not hide behind the fact that the defendant bank was a large corporation.

This decision is a reassuring one for financial institutions faced with Quincecare and dishonest assistance claims from liquidators in relation to the processing of payment mandates in connection with customer accounts. The decision limits the scope of the Quincecare duty that is owed by a bank in such circumstances to its customer; it will not extend to the customer’s creditors. It also suggests that claimants may face difficulties in pursuing similar Quincecare claims against banks that have been inadvertently involved in processing the payments of a Ponzi scheme.

Background

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

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

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

The Bank applied to strike out the claim, or obtain reverse summary judgment under CPR Part 24, on the ground that SIB had suffered no loss. For the purpose of the application, the Bank accepted that there was a sufficiently arguable case of breach of the Quincecare duty. The Bank argued that a Quincecare duty claim is a common law claim for damages for breach of a tortious duty (or an implied contractual duty), and so the remedy is damages to compensate for loss suffered. It said that SIB had no claim for damages, because on a net asset basis it was no worse off as a result of the Bank’s actions: the payment of £118 million reduced SIB’s assets by £118 million, but it equally discharged SIB’s liabilities by the same amount. This was because monies paid out by the Bank went (ultimately) to deposit-holders in satisfaction of their contractual rights against SIB.

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

High Court decision

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

In summary, the High Court dismissed the Bank’s application for reverse summary judgment or strike out of the Quincecare loss claim (for the balance over and above the ECB payment). It found that, absent the Bank’s breach of its Quincecare duty, the £80 million in SIB’s accounts as at 1 August 2008 would have been available to pay creditors when insolvency supervened. It agreed with the claimants that, because of SIB’s state of insolvency, SIB had “no net assets”. Accordingly, although the payment of £118 million reduced SIB’s assets by £118 million, the payment did not discharge SIB’s liabilities, because SIB was insolvent and had no assets on any view, but a net liability.

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

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

Court of Appeal decision

The Court of Appeal found in favour of the Bank on both issues.

Issue 1: Quincecare loss claim

As briefly mentioned above, the claimants argued (and the first instance judge found) that SIB’s state of insolvency was a key factor, because if the Bank had performed its Quincecare duty, then SIB would have had (at least) £80 million more in cash, and therefore more cash would have been available to pay other creditors once SIB’s insolvency process began.

In the Court of Appeal’s view, the problem with this argument was that it proceeded on the basis that the Bank owed a direct duty to SIB’s creditors. It noted that while SIB’s directors owed a duty to its creditors as soon as SIB became insolvent (which it had long before 1 August 2008) (as per Liquidator of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30), in contrast, the Bank did not.

The Court of Appeal said that the Bank’s duty was to SIB alone, as explained in the Court of Appeal’s decision in Singularis Holdings Ltd (In Liquidation) v Daiwa Capital Markets Europe Ltd [2018] EWCA Civ 84. Giving the leading judgment in the present case, Sir Geoffrey Vos referred to his own judgment in Singularis, which recorded the parties’ agreement that the Quincecare duty was owed to Singularis (the customer) and not directly to its creditors, even though the company was on the verge of insolvency. He also cited a further paragraph from his judgment in Singularis, which again confirmed that the duty is owed only to the bank’s customer: “…the scope of the Quincecare duty is narrow and well defined. It is to protect a banker’s customer from losing funds held in a bank account with that banker, whilst the circumstances put the banker on inquiry” (emphasis added).

The Court of Appeal also underlined that SIB itself did not lose anything as a result of the payments to discharge creditors: its net asset position at the end of the period was the same as at the beginning.

It said that the High Court had made an error in its reasoning by confusing the company’s position before and after the inception of an insolvency process. In the Court of Appeal’s view, the true distinction is between a company that is trading and a company in respect of which a winding up process has commenced, not between a solvent trading company and an insolvent trading company. For example, if a company is trading (even insolvently) then £100 paid to a creditor reduces its assets, but is offset by a corresponding benefit to the company in reducing its liabilities. The fact that a company has slightly lower liabilities is a corresponding benefit to its net asset position, even if the company is in a heavily insolvent position. Having more cash available upon the eventual inception of its insolvency for the liquidators to pursue claims and for distribution to creditors, is a benefit to creditors, but not to the company while it is trading.

Accordingly, the Court of Appeal allowed the Bank’s appeal on the Quincecare loss claim.

Issue 2: Dishonest assistance claim

SIB argued that the dishonest assistance claim should not have been struck out on the basis that:

  1. A mere failure to identify at the outset the directors, officers or employees who had the relevant state of knowledge does not mean that such an allegation is liable to be struck out if such particulars are given as soon as feasible (as per Sofer v Swissindependent Trustees SA[2020] EWCA Civ 699); and
  2. The test of dishonesty or recklessness for large corporations like the Bank is or should be different to that applicable to individuals.

In relation to (i), the Court of Appeal said that Sofer was a very different case to the present one. SIB suggested that it should be allowed to proceed even if it could never identify any employee or agent of the Bank who was either dishonest or who had blind-eye knowledge of the fraud. The Court of Appeal held that this was not a tenable approach.

In support of its argument on (ii), SIB submitted that the Bank’s senior management dishonestly allowed the Bank to be run in such a way that nobody ever got to the point of realising that SIB was a massive Ponzi scheme. The thrust of its point was that, although human beings must have known that the extensive failures pleaded were recklessly dishonest, SIB may never be able to identify those particular human beings. SIB said that it did not need to so, on the grounds that the only relevant question was whether the Bank’s conduct was objectively dishonest (as per Royal Brunei Airlines Sdn Bhd v Tan [1995] 2 AC 378). Accordingly, the Court of Appeal proceeded to consider the test for dishonesty and its application.

The test for dishonesty

The Court of Appeal said that it was settled law that the touchstone of accessory liability for breach of trust or fiduciary duty is dishonesty as explained in Royal Brunei Airlines. It noted that the basic law of dishonesty was recently restated in this context in Group Seven Ltd v Nasir [2019] EWCA CIV 614 and was not in dispute. The Court of Appeal then highlighted the following key principles that are relevant to the test for dishonesty:

  • Actual state of knowledge or belief. The defendant’s actual state of knowledge or belief as to the facts will form a crucial part of the first stage test.
  • Objective assessment of conduct. Once the relevant facts have been ascertained including the defendant’s state of knowledge or belief as to the facts, the standard of appraisal which must then be applied to those facts is a purely objective one: namely whether the defendant’s conduct was honest or dishonest according to the standards of ordinary decent people.
  • Blind-eye knowledge. As per Manifest Shipping & Co Ltd v. Uni-Polaris Insurance Co Ltd [2003] 1 AC 469, the imputation of blind-eye knowledge requires two conditions to be satisfied: (i) the existence of a suspicion that certain facts may exist; and (ii) a conscious decision to refrain from taking any step to confirm their existence. The suspicion in question must be firmly grounded and targeted on specific facts and, the deliberate decision not to ask questions must be a decision to avoid obtaining confirmation of facts in whose existence the individual has good reason to believe. Blind-eye knowledge cannot be constituted by a decision not to enquire into an untargeted or speculative suspicion (although suspicions falling short of blind-eye knowledge may form part of the overall picture to which the objective standard of dishonesty is applied).
  • Aggregation of knowledge. As per Armstrong v. Strain [1952] KB 232 and Greenridge Luton One Ltd v. Kempton Investments Ltd [2016] EWHC 91 (Ch), it is not possible to aggregate two innocent minds to make a dishonest whole.

Application of the test for dishonesty

The Court of Appeal said that High Court was right to strike out the dishonest assistance claim, finding that SIB’s submissions on this issue were flawed for three principal reasons:

  • SIB was unable to allege that any specific employee was either dishonest or suspected the Ponzi fraud and made a conscious decision to refrain from asking questions.
  • This was a case falling squarely within the strictures of Manifest Shipping and what is required to prove blind-eye knowledge. In the view of the Court of Appeal, if a plea of dishonesty were to be permitted in these circumstances, it would allow blind-eye knowledge to be constituted by a decision not to enquire into an untargeted or speculative suspicion rather than a targeted and specific one.
  • SIB could not hide behind the fact that the Bank was a large corporation. The Court of Appeal maintained that dishonesty and blind-eye knowledge allegations against corporations (large or small) must still be evidenced by the dishonesty of one or more natural persons. The Court of Appeal emphasised that the subjective dishonesty stage of the test must be satisfied (either by the dishonesty of a person within the corporation or the blind-eye knowledge of such a person) in order to proceed to the objective dishonesty stage of the test. It was not possible to avoid the subjective dishonesty stage and move straight to objective dishonesty, as SIB had sought to do.

Accordingly, the Court of Appeal dismissed SIB’s appeal on the dishonest assistance claim. As a result, the only surviving claim is SIB’s claim for breach of the Quincecare duty in relation to the payment made by the Bank to the ECB.

Chris Bushell
Chris Bushell
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Ceri Morgan
Ceri Morgan
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BANKING LITIGATION PODCAST EPISODE 25: SPECIAL EDITION – THE QUINCECARE DUTY OF CARE

In this special edition of our banking litigation podcast, we consider a key risk area for financial institutions handling client payments – the Quincecare duty of care. This episode is hosted by Ceri Morgan, a professional support consultant in our banking litigation team, who is joined by Mark Tanner and Scott Warin. 

Quincecare duty claims typically arise where a bank or deposit holding financial institution has received a payment mandate from an authorised signatory of its customer, and executed the order, in circumstances where (allegedly) there were red flags to suggest that the order was an attempt to misappropriate the funds of the customer. The past few years have witnessed an uptick in such claims, with a proliferation of judgments being handed down in quick succession since the Supreme Court’s decision in Singularis Holdings Ltd v Daiwa Capital Markets Europe Ltd [2019] UKSC 50. In our podcast, we discuss how these judgments have defined both the scope of the duty, and the potential tools in the armoury of banks to defend these claims.

You can also listen on Apple or Spotify and find links to our blog posts on the cases covered in this podcast below:

Please subscribe to the podcast channel here to listen to our regular bite-sized broadcasts covering both litigation and regulatory developments for banks and other financial institutions.

Ceri Morgan
Ceri Morgan
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Mark Tanner
Mark Tanner
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Scott Warin
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Hong Kong court refuses to expand scope of Quincecare duty

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

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

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

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