High Court clarifies meaning of “PDMR” in s.90A FSMA claims

May 30, 2022

The High Court has clarified what is meant by “person discharging managerial responsibilities” (PDMR) in the context of Section 90A and Schedule 10A of the Financial Services and Markets Act 2000 (FSMA), a key element of the test for statutory liability for statements made by UK listed companies in periodic publications: Various Investors v G4S Limited (formerly known as G4S plc) [2022] EWHC 1081 (Ch).

The statutory regime

Pursuant to Schedule 10A FSMA, paragraph 3(1), an issuer will be liable to pay compensation to a person who acquires, continues to hold or disposes of securities in reliance upon published information and suffers loss as a result of any untrue or misleading statement in (or omission of a “matter required to be included” from) that published information. An issuer will also be liable to pay compensation to a person who acquires, continues to hold or disposes of the securities and suffers loss in respect of the securities as a result of delay by the issuer in publishing information (paragraph 5(1)).

An issuer will only, however, be liable in the following circumstances:

  • in respect of an untrue or misleading statement, if a PDMR within the issuer knew the statement to be untrue or misleading or was reckless as to whether it was untrue or misleading (paragraph 3(2));
  • in respect of omissions, if a PDMR within the issuer knew the omission to be a dishonest concealment of a material fact (paragraph 3(3)); and
  • in respect of delays, if a PDMR within the issuer acted dishonestly in delaying the publication of the information (paragraph 5(2)).

Paragraph 8(5) defines PDMR for the purposes of Schedule 10A as follows:

  1. any director of the issuer (or person occupying the position of director, by whatever name called);
  2. in the case of an issuer whose affairs are managed by its members, any member of the issuer;
  3. in the case of an issuer that has no persons within paragraph (a) or (b), any senior executive of the issuer having responsibilities in relation to the information in question or its publication.

The meaning of “director”

In the case of G4S, which is a company with directors, it was common ground that the relevant paragraph was 8(5)(a), and that only directors of G4S would constitute PDMRs. However, the parties differed in relation to what was meant by “director”.

The claimants contended that terms such as “director” take colour from their context and that the term should be interpreted broadly for the purposes of paragraph 8(5)(a). They highlighted the use of the term PDMR in EU market abuse legislation, and the broader definition that applies there:

“…a person within an issuer…who is (a) a member of the administrative, management or supervisory body of that entity; or (b) a senior executive who is not a member of the bodies referred to in point (a), who has regular access to inside information relating directly or indirectly to that entity and power to take managerial decisions affecting the future developments and business prospects of that entity”.

The claimants suggested that the term “director” in paragraph 8(5)(a) ought to be interpreted so as to align the Schedule 10A definition with the market abuse definition, extending the concept of “director” beyond the three currently recognised categories in English law (i.e. de jure, de facto and shadow directors), to also include “senior executives with control over substantial business units, or who were responsible for managerial decisions affecting the future developments and business prospects of the issuer and/or those business units”.

By way of contrast, the defendant contended that the statutory definition of PDMR in Schedule 10A was clear and unambiguous. The term “director” is well-known and established in UK law. The drafter used recognised concepts of domestic company law and there is no reason to adopt another meaning.

The court rejected the claimants’ argument, holding that Schedule 10A clearly stipulates that where an issuer has directors the PDMRs are the directors (including persons occupying the position of director, by whatever name called), and that the term “director” in that context should be given its usual, well-established legal meaning.

De facto directors

For the purposes of this application, the defendant did not contest the claimants’ position that a de facto director might constitute a PDMR for the purposes of paragraph 8(5)(a). The defendant did, however, contest that, if de facto directors can be PDMRs for the purposes of paragraph 8(5)(a), this had been properly pleaded by the claimants. Mr Justice Miles held that the claimants had pleaded that the individuals they alleged to be PDMRs were de facto directors of G4S. However, he encouraged the claimants to do so more fully, holding that “it is to my mind undesirable for the pleadings to be left in their somewhat ambiguous and uncertain state.”

Chris Bushell
Chris Bushell
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Sarah Penfold
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High Court dismisses claim against banks involving allegations of front running/trading ahead on stop-loss orders on limitation grounds

December 20, 2021

The High Court has dismissed a claim by a currency debt management firm against three banks in a banking group, which included allegations of front running and/or trading ahead in relation to the execution of certain stop-loss orders (SLOs) in 2006. In doing so, the court found that the claim was time-barred as the claimant failed to show that it had not discovered or could not with reasonable diligence have discovered the claim in the same year that the SLOs were triggered: ECU Group plc v HSBC Bank plc & Ors [2021] EWHC 2875 (Comm).

The decision highlights the difficult threshold for claimants to meet in proving that a bank has engaged in this type of market abuse (although this will always be fact-specific), and demonstrates how such claims may be effectively barred by the Limitation Act 1980 (LA 1980) in appropriate circumstances.

In the present case, the court was satisfied that in the year that the disputed SLOs were triggered, a senior officer of the claimant believed that the SLOs had been deliberately triggered by the banks and that this amounted to market abuse and front running. The court also considered that at the time, the claimant could with “reasonable diligence” have discovered the other claims now alleged (within the meaning of section 32 LA 1980), if it had pursued an application for pre-disclosure or the issue of a claim related to front running and/or trading ahead.

Even if the claim had not been time-barred, the court found (on an obiter basis) that the allegation of front running was not made out. In the court’s view, the claimant had not established that it was more likely than not that the banks had intended to trigger the SLOs. While the court’s finding on this aspect of the judgment does not have precedent value and is not binding, it may be persuasive in future cases with similar facts.

We consider the decision in more detail below.

Background

A currency debt management firm (the Firm) managed multi-currency loans for its customers. This involved placing large SLOs with a number of banks, including the second defendant, as a form of currency-damage limitation for the Firm and its clients to manage the risk of foreign exchange rates for a particular pair of currencies rising above an expected level. The second defendant would pass those orders on to entities within the same banking group. For simplicity, the defendant banks are referred to together as “the Banks” in this blog post.

If the relevant currencies rose above the expected level, then the stop-loss would be triggered and the Banks would buy/sell that currency pair to avoid further losses. If the relevant currencies did not rise above the predetermined ceiling, then no action would be taken on the order.

In January 2006, the Firm placed three SLOs. Each of these orders was triggered very shortly after they were placed. The Firm found this surprising, and expressed its concern to the Banks.  The Firm queried whether there had been front-running on those orders (i.e. whether the Banks had manipulated the markets by their own buying and selling activities in respect of the currencies so as to artificially push the relevant rates up causing the SLOs to trigger). The Banks conducted an internal investigation and responded that they had not found evidence of front-running or wrongdoing but rather that the currency movements were simply due to general market activity.

In February 2019, the Firm brought a claim against the Banks in connection with the loans and/or handling and execution of the SLOs. The Firm’s case was that:

  • the Banks had breached their contractual, tortious and equitable duties as they had engaged in the fraudulent front running of the SLOs, or some of them, to the detriment of both the Firm and the Firm’s customers; or
  • alternatively, the Banks had: (i) made misrepresentations to the Firm in connection with the SLOs; or (ii) failed to execute the SLOs in accordance with the duties that they owed to the Firm and in accordance with the Firm’s instructions.

The Firm also sought to rely on the postponement of the primary limitation period under section 32 of the LA 1980 on the basis that the Banks’ breaches of duty had been committed in circumstances where they were unlikely to be discovered for some time. Alternatively, the facts relevant to the Firm’s right of action had deliberately been concealed from it by the Banks.

The Banks denied the claim. The Banks’ case was that the claim was time-barred given that the material events had taken place between 13 to 15 years prior to the issue of the claim. The Banks also contended that there had been no front running or misuse of confidential information: any trading ahead of the SLOs that may have taken place was simply pre-hedging; this did not constitute a breach of confidence and was a legitimate order management technique that the Banks were entitled to adopt when executing the SLOs.

Decision

The court found in the Banks’ favour and dismissed the claim.

The key issues which may be of broader interest to financial institutions are examined below.

1. Limitation

Limitation legal principles

In its consideration as to whether the claim was statute barred, the court reviewed the authorities and highlighted the following key principles:

  • Under section 32 LA 1980, the limitation period on fraud or concealment does not begin until the claimant has discovered the fraud or concealment or could, with reasonable diligence, have discovered it.
  • One of the main reasons for the statute of limitation is to require claims to be put before the court at a time when the evidence necessary for their fair adjudication is likely to remain available (as per AB v Ministry of Defence [2013] 1 AC 78).
  • The test for discovery of the fraud or the concealment is the “statement of claim” test (as per OT Computers v Infineon Technologies [2021] EWCA Civ 501). This is met if the claimant has sufficient knowledge to plead the claim.
  • For the fraud to be known or discoverable by a claimant under section 32 LA 1980 (such that time will start running against them), it is not necessary that the claimant knows or could have discovered each and every piece of evidence which it later decides to plead (as per Libyan Investment Authority v JP Morgan [2019] EWHC 1452).
  • What reasonable diligence requires in any situation must depend on the circumstances. The question is not whether the claimants should have discovered the fraud sooner, but whether they could with reasonable diligence have done so. The question may have to be asked at two distinct stages: (1) whether there is anything to put a claimant on notice of a need to investigate; and (2) what a reasonably diligent investigation would then reveal. However, it is a single statutory issue, i.e. whether the claimant could with reasonable diligence have discovered the concealment (as per OT Computers).

Application of the limitation principles to the present case

The court held that the claim was time barred as the Firm had failed to show that it had not discovered or could not with reasonable diligence have discovered the claim in 2006.

In respect of the allegations of front running and trading ahead, the court commented that for the purposes of section 32 LA 1980, the Firm had sufficient knowledge in 2006 to plead the claim in relation to the SLOs. The court noted that it was satisfied that in 2006 a senior officer of the Firm believed that the SLOs had deliberately been triggered by the Banks and that this amounted to market abuse and front running. The court also said that, as far as knowledge was concerned, the knowledge of the senior officer could be attributed to the Firm and it was not necessary for the board of directors to have shared his belief for the Firm to have knowledge for the purpose of limitation. The evidence also showed that it was unlikely that the Banks’ response in 2006 would have been a barrier to concluding that there was credible evidence enabling a claim to be pleaded.

As to the remainder of the allegations, the court noted that the Firm had not shown in the circumstances that the exercise of reasonable diligence did not extend either to issuing proceedings for the claim in front running and/or trading ahead, or to making an application for pre-action disclosure. Had the Firm taken either of those routes, the Firm could with reasonable diligence have discovered the other claims now alleged within the meaning of section 32 LA 1980. In the court’s view, if the Firm had wanted to know what had happened and exercised reasonable diligence, it would have sought legal advice and taken steps to pursue the claims for trading ahead and front running, yet the Firm decided not to take any further steps in response to the Banks’ response in 2006 that there was no evidence of front running or wrongdoing. The court also noted that the Firm was a sophisticated commercial player with access to lawyers and there was no evidence that it would not have had the resources or the staff to pursue the claims.

2. Front running/misuse of confidential information

Front running/misuse of confidential information principles

In the event that the front running claim had not been time barred, the court in its consideration as to whether there had been front running noted the following key principles:

  • Front running involves a claimant establishing on a balance of probabilities that: (i) for the relevant trade there was trading ahead of the order which was not legitimate; and (ii) the trader(s) involved intended by trading ahead to trigger the SLO.
  • The court had to consider whether it was satisfied on the balance of the probabilities in relation to the individual trades in issue that: (i) trading ahead of the SLO occurred; (ii) such trading was not for legitimate purposes; (iii) such trading had a material effect on the triggering of the order; and (iv) the trader intended to trigger the order by trading ahead.
  • There was a distinction between a trader taking a position ahead of an order (pre-hedging) and front running. The latter would be trading behaviour that was deliberately intended to trigger the stop-loss to the detriment of the client.
  • The experts were agreed that even if there had been a valid instruction to a bank not to trade ahead, trading to fill customers’ orders or to adjust the trader’s own position was legitimate.
  • It was common ground that if the trading ahead had been deliberately intended to trigger the SLOs that would amount to a misuse of confidential information.

Application of front running/misuse of confidential information principles to the present case

The court said that the Firm had not established that it was more likely than not that the Banks had intended to trigger the SLOs and thus the allegation of front running was not made out.

The court noted that there was no trading data and no evidence that the Banks traded ahead. Even if the Banks had traded ahead, there was no evidence as to why such trading ahead occurred, its impact on the market or the motive of the trader. Any such trading ahead could have been to reduce slippage or for other legitimate purposes.

The court commented that the guidance in the regulatory code at the time (relied upon by the Firm in support of its case that there had been illegal front running), the Non-Investment Products Code on FX trading, was aspirational and did not represent actual best practice at the time.

The court also rejected the submission that an adverse inference as to widespread misconduct and systemic failures in the Banks’ FX business should be drawn from subsequent regulatory findings/foreign proceedings in relation to the misconduct of a particular rogue trader.

Finally, the court said that in any case any alleged front running or trading ahead did not affect the rate at which the SLOs were executed since the rate was specified by the Firm when it gave the orders to the Banks and remained a constant; it only affected the time when the SLOs were triggered. In addition, the Firm could not prove that any wrongdoing would have changed the subsequent trajectory of the market for the relevant currency pair.

The court also noted that there was no fiduciary relationship between the Firm and the Banks or between the loan customers and the Banks, so any comparison that the Firm sought to draw with cases concerning the misuse of trust property was inapposite.

Accordingly, for the reasons given above, the court dismissed the claim.

Rupert Lewis
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Karen Anderson
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High Court dismisses fraudulent misrepresentation claim relating to loan notes investment on limitation grounds

December 1, 2021

The High Court has dismissed a claim by the assignee of an investment fund against a financial advisory firm (and associated parties) for losses arising out of alleged fraudulent misrepresentations made in relation to the financial position and prospects of a business which had induced the investment fund to subscribe for £11 million in loan notes in 2011 and to later make a follow-on investment of £4.25 million: European Real Estate Debt Fund v Treon [2021] EWHC 2866 (Ch).

The decision will be of interest to financial institutions faced with fraudulent misrepresentation claims in relation to certain investments which: (i) have been brought more than 6 years after the date of the disputed investment; and (ii) seek to postpone the start of the statutory limitation period. It highlights the difficulties for claimants in pursuing fraudulent misrepresentation claims where they do not satisfy the requirements of section 32(1) Limitation Act 1980 (LA 1980), especially where it is clear that the claimant discovered the fraud or could with reasonable diligence have discovered it before the expiry of the statutory limitation period.

In the present case, the court found that the claim was statute-barred. The court highlighted that although it is well known that fraudsters cannot avoid liability for fraud by pleading that their victim failed to take reasonable care to detect the fraud, this did not necessarily mean that claims based on fraud brought outside the primary limitation period were entitled to invoke the special statutory postponement of the limitation period. If a claimant could reasonably have discovered the fraud by virtue of events and circumstances occurring before it actually suffered a loss, there was no principled rationale for allowing it the indulgence of more than the normal six years’ period to bring its claim. The court said that a reasonably diligent investor, such as one in the position of the investment fund’s adviser, in reviewing the financial information provided to it before the investment was made, would have been put sufficiently on inquiry to ask some basic questions and demand further information. The court also noted that if the investment fund’s advisers had asked the further questions it would have discovered sufficient facts to enable the investment fund to plead a statement of claim within the primary limitation period of six years.

We consider the court’s decision in more detail below.

Background

In 2011, an investment fund (the Fund) made a principal investment of £11 million in a care homes business. The Fund’s advisers then discovered in early March 2012 that the financial information about the business and its prospects that had been provided as part of the discussions leading up to the investment was false and misleading. In July 2012, in order to mitigate its losses, the Fund made a follow-on investment of £4.25 million in the business. The business went into administration in 2014 and the Fund lost the entire value of its investment.

Subsequently, the assignee of the Fund (the claimant) brought a damages claim against the founder of the business, a financial advisory firm, and a director of the financial advisory firm (together, the defendants). The claimant alleged that the defendants had fraudulently misrepresented the financial position of business and had induced the Fund to subscribe for £11 million in loan notes in June 2011. The claimant’s case was that the Fund and its advisers had relied on certain trading numbers and projections as accurate and current, and that defendants conspired to mislead the Fund. In addition, the claimant also alleged that the business’ founder was responsible for various representations made by the issuer of the notes in a loan note agreement of June 2011. The claimant also relied on section 32(1) LA 1980 in seeking to postpone the start of the limitation period for its claim.

The defendants denied all liability and in addition said that the action was statute-barred given that it had been commenced more than six years after the date of the principal investment.

Decision

The High Court found in favour of the defendant and dismissed the claim for the reasons explained below.

Limitation legal principles

In its consideration as to whether the claim was statute barred the court noted that section 32(1) LA 1980 had been considered in a number of cases which were reviewed in OT Computers Limited v Infineon Technologies AF [2021] EWCA Civ 501 and highlighted the following key principles:

  • The state of knowledge which a claimant must have in order for it to have discovered the concealment has for the most part been regarded as the knowledge sufficient to enable it to plead a claim. This is known as the statement of claim test. Test Claimants in FII Group Litigation v Revenue and Customs Commissioners [2020] UKSC 47 suggested a more liberal test in that time should begin to run from the (possibly earlier) point when the claimant knows, or could with reasonable diligence know, about the mistake with sufficient confidence to justify embarking on the preliminaries to the issue of proceedings.
  • As per Paragon Finance Plc v DB Thakerar [1999] 1 ALL ER 400 the question is not whether the claimant should have discovered the fraud sooner but whether they could have done so with reasonable diligence. The claimant must therefore establish that they could not have discovered the fraud without undertaking exceptional measures, which they could not reasonably have been expected to take. In considering what would constitute exceptional measures, the court will consider how a person carrying on a business of the relevant kind would act if they had adequate but not unlimited staff and resources and were motivated by a reasonable but not excessive sense of urgency.
  • As per OT Computers, the question of what reasonable diligence requires may have to be asked at two distinct stages: (i) whether there is anything to put the claimant on notice of a need to investigate; and (ii) what a reasonably diligent investigation would then reveal. However, there is a single statutory issue, which is whether the claimant could with reasonable diligence have discovered the concealment.
  • Section 32(1) LA 1980 is only relevant once there is a complete cause of action because that is when the primary limitation period would commence, and the purpose of that section is to postpone that period. However, it does not follow that the court investigating the claimant’s state of mind must ignore events, communications or things known to the claimant before then. There may be cases where the claimant is aware (or could with reasonable diligence have been aware) of facts before it suffered any loss which would have enabled it to write a letter before action. Consequently, the court must examine all of the facts and should not artificially restrict itself to events or circumstances arising only after the cause of action had completely accrued. As per OT Computers, the ultimate question under the section is whether the claimant has or could have “discovered” the fraud and that may turn on events before as well as after loss was suffered.
  • It is well known that a fraudster is not entitled to plead that his victim failed to take reasonable care to detect the fraud (as per Redgrave v Hurd (1881) 20 Ch.D.1.). However, the question under section 32(1) LA 1980 is not whether the claim is defeated by the careless failure of the claimant to spot the fraud. It is quite the distinct issue of whether the claimant who brings his claim outside the primary limitation period for a fraud claim (6 years) is entitled to invoke the special statutory postponement of the limitation period. Such postponement is available to a defrauded claimant who could not normally have discovered the facts, but it is not available to all victims of fraud, however careless they may be in attending to and asserting their rights. If a claimant could reasonably have discovered the fraud by virtue of events and circumstances occurring before it actually suffered a loss, there is no principled rationale for allowing it the indulgence of more than the normal six years’ period to bring its claim.

Application of the limitation principles to the present case

The court held that the claim was statute-barred as the claimant had failed to satisfy the requirements of section 32(1) LA 1980 to postpone the start of the limitation period.

In its analysis, the court commented that in approaching the exercise under section 32(1) LA 1980, it had to be careful to avoid the dangers of hindsight and to examine events as they would have appeared at the time and in their proper context and sequence. The court also noted that a reasonable investor in the Fund’s adviser’s position could reasonably be expected to approach potential investments with a careful eye and appropriate degree of professional care, i.e. it could be expected to undertake professional due diligence.

The court then examined the financial information that had been provided to the Fund’s adviser (whose knowledge was considered to be the same as the Fund) by the business, keeping in mind the two stage test in OT Computers.

With respect to whether there was anything to put the Fund’s advisers on notice of a need to investigate, the court’s view was that a reasonably diligent investor, when it reviewed the financial information provided to it before the investment, would have been put sufficiently on inquiry to ask some basic questions and demand further information. The court disagreed that there was nothing in the financial information provided to the Fund’s advisers to trigger these questions or requests for further information on the basis that these basic questions would have been prompted by the information provided to the Fund’s advisers and by the passage of time. Seeking this further information would not have been an exceptional measure which a reasonably diligent investor could not be expected to take. It would have been a routine part of due diligence.

The court then considered what would have happened if the Fund’s advisers had raised further questions with the defendants. It concluded that if the Fund’s adviser had asked the further questions it would have discovered sufficient facts to enable the Fund to plead a statement of claim within the primary limitation period of six years.

Accordingly, the court dismissed the claim.

Natasha Johnson
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Court of Appeal clarifies proper approach to assessing damages for fraudulent misrepresentation

July 5, 2021

The Court of Appeal has allowed an appeal by a purchaser in the context of its claim for damages for fraudulent misrepresentation against the sellers of certain business assets that it had acquired. In doing so, the Court of Appeal held that damages for fraudulent misrepresentation should, as a general rule, be assessed by ascertaining the actual value of the assets bought at the relevant date and deducting that figure from the price paid: Glossop Cartons and Print Ltd and others v Contact (Print & Packaging) Ltd and others [2021] EWCA Civ 639.

The Court of Appeal found that the High Court was incorrect to apply the “deduction method” to calculate the market value of the business assets as at the transaction date. The approach adopted by the High Court involved deducting from the purchase price the cost of every flaw or defect that the claimant had not itself factored into its calculation of the price. The Court of Appeal said that, in a normal case for fraudulent misrepresentation, this method is wrong in principle, unduly complex and inappropriately requires the court to consider what subjectively the claimant factored into its calculation of the purchase price. These matters are irrelevant to the calculation of direct loss for fraudulent misrepresentation, which merely requires the court to ascertain the actual value of the assets bought at the relevant date and to deduct that figure from the price paid (as per Smith New Court Securities Ltd v Scrimgeour Vickers (Asset Management) Ltd [1997] AC 254). In Smith New Court Securities, the House of Lords emphasised that the general rule for the measure of damages in deceit claims should not be “mechanistically applied”. However, the Court of Appeal’s decision in the present case suggests that these general principles will be the norm and that there is a threshold question as to when an alternative measure of damages may be applied.

The decision is noteworthy for financial institutions faced with claims founded in the tort of deceit, particularly in the context of mis-selling disputes and shareholder claims. In securities litigation, the judgment is relevant to claims based on alleged fraudulent misrepresentation at common law. It may also be relevant to claims brought under section 90A of the Financial Services and Markets Act 2000, although currently it remains unclear whether the appropriate measure is as for the tort of deceit or the tort of negligent misstatement (and of course there are many additional, complicating factors in measuring damages in securities litigation, not least the impact of “harmed” investors both buying and selling securities during the period in which the misrepresentation is alleged to have endured).

In the context of a shareholder claim based on a false representation, the general rule in Smith New Court Securities means that damages will be assessed on the date on which the securities were purchased (the transaction date). Accordingly, the amount will be calculated as the difference between the price paid for the shares and their actual/true value as at the transaction date. As a result of the Court of Appeal’s decision in Glossop, claimants may face additional challenges where they try to depart from the general rule, for example by seeking to recover the difference between the price paid for the shares and the amount realised on disposal of the shares, which is often one of the methods by which damages are calculated by claimants in such claims. This may be an attractive option for claimants where there has been a later fall in value of the shares due to some separate event.

The extent to which falls in the share price may be claimed by shareholders is an important battleground in securities litigation, and there is a clear (although complex) inter-relationship between the measure of damages (in cases such as Smith New Court Securities and Glossop) and the application of the principle in South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191 (SAAMCO).

The SAAMCO principle confirms that a claimant can only recover loss that falls within the scope of the duty of care assumed by the defendant issuer, and was recently considered by the Supreme Court in Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20 (see our banking litigation blog post). In Manchester Building Society, the Supreme Court said that cases should not be shoe-horned into the categories of “information” cases or “advice” cases, and confirmed 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. Whether or not a claimant can recover an unrelated stock price drop during the period between acquisition and disposal of the shares will usually depend upon whether the defendant’s responsibility extended to the decision to purchase the shares in the first place. This will present a further hurdle for claimants seeking to depart from the general rule as to the measure of damages in such cases.

The case is considered in more detail below.

Background

A packaging manufacturer (Glossop), entered into an asset sale agreement and lease sale agreements (together, the agreements) to buy the business assets of a print company, and the lease of a property owned by Mr Smith and a pension company. The print company was a loss-making company which was ultimately owned and controlled by Mr Smith.

Glossop subsequently issued proceedings against the print company, Mr Smith and the pension company (together, Carton), claiming that it had been induced to enter into the agreements by Mr Smith’s fraudulent misrepresentations about the property.

High Court decision

The High Court found in Glossop’s favour, but held that a claimant in a deceit claim could not recover for losses which directly flowed from the relevant transaction if those losses were the product of the claimant’s own commercial misjudgement.

In attempting to ascertain the market value of the business assets sold, the High Court applied the “deduction method”, deducting from the purchase price the cost of every flaw or defect that Glossop had not itself factored into its calculation of the price. Following this approach, the High Court found that certain crucial flaws or defects could not be deducted from the purchase price, for example where Glossop had appreciated certain risks and had factored them into the purchase price.

Glossop appealed the High Court’s decision, arguing that the deduction method was not an appropriate way to assess damages. It argued that the High Court had failed to award damages for the direct loss caused by the fraudulent misrepresentations: the difference between the actual market value of the business assets sold and the price paid. Glossop argued that the difference was £300,000, which was the sum Glossop claimed it had paid for goodwill.

Court of Appeal decision

The Court of Appeal allowed Glossop’s appeal. It held that the High Court was incorrect to apply the deduction method, and that the direct loss here was simply the difference between the price paid and the market value.

The Court of Appeal referred back to the basic rules applicable where claimants (as in this case) have been induced by fraudulent misrepresentations to buy property, as per Smith New Court Securities. In that case, where the claimant acquired shares in reliance on fraudulent misrepresentations made by the defendants, the House of Lords held that a defendant is liable for all losses directly flowing from a fraudulently induced transaction even if they were unforeseeable. The House of Lords re-stated the general rule for the assessment of damages, which is that damages for tort or breach of contract are assessed at the date of the breach. In a shareholder claim based on a false representation, the House of Lords confirmed the general rule that this would be the date on which the securities were purchased (the transaction date). The amount would be calculated as the difference between the price paid for the shares and their actual/true value as at the transaction date.

In assessing the direct loss for fraudulent misrepresentation, in the Court of Appeal’s view the deduction method is wrong in principle. It is unduly complex and inappropriately requires the court to consider what subjectively the claimant had factored into its calculation of the purchase price. These matters are irrelevant to the calculation of direct loss for fraudulent misrepresentation in a normal case, which merely requires the court to ascertain the actual value of the assets bought at the relevant date and to deduct that figure from the price paid.

The Court of Appeal emphasised that a claimant is entitled to the difference between the price paid and the market value, whatever miscalculations it may have made in entering into the transaction. Claimants may, therefore, be compensated for making (or notwithstanding that they made) a bad bargain, even if they knew or ought to have known about defects before entering into the transaction. The purchaser’s commercial judgements and misjudgements are irrelevant to the evaluation of what direct loss it suffered.

On the facts of the present case, the Court of Appeal held that an alternative “broad brush” approach was appropriate. Glossop was entitled to recover, by way of direct loss, the difference between the price it paid and the market value of the assets purchased at the relevant date. That difference was best represented by the sum of £300,000 which Glossop paid for goodwill (mostly for business contracts) that had no real value and it was hard to see how there could be any goodwill in a loss-making business.

Harry Edwards
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