COVID-19 market disclosures and managing the associated litigation risks

Herbert Smith Freehills have published an article in the Journal of International Banking Law and Regulation: COVID-19 market disclosures and managing the associated litigation risks.

Since the start of the pandemic many listed companies have sought to strengthen their balance sheet by raising additional capital from shareholders. This article considers the types of disclosures relating to COVID-19 that have been made to the market when doing so, the potential litigation risks that may be faced in the context of increased securities class actions activity in this jurisdiction, and how those risks may be appropriately managed.

The article can be found here: COVID-19 market disclosures and managing the associated litigation risks. This material was first published by Thomson Reuters, trading as Sweet & Maxwell, 5 Canada Square, Canary Wharf, London, E14 5AQ, in the September 2021 edition of JIBLR and is reproduced by agreement with the publishers.

Alternatively, please contact Nihar Lovell if you would like to request a copy of the full article.

Rupert Lewis
Rupert Lewis
Partner, Head of Banking Litigation
+44 20 7466 2517
Michael Jacobs
Michael Jacobs
Partner
+44 20 7466 2463
Daniel May
Daniel May
Senior Associate
+44 20 7466 7608
Sarah Ries-Coward
Sarah Ries-Coward
Senior Associate
+44 20 7466 2268

Privy Council confirms that the so-called “reflective loss” principle applies to ex-shareholders

The Board of the Privy Council has allowed an appeal in relation to the application of the so-called “reflective loss” principle, confirming that the rule falls to be assessed as at the point in time when a claimant suffers loss and not at the time proceedings are brought Primeo Fund v Bank of Bermuda (Cayman) Ltd & Anor (Cayman Islands) [2021] UKPC 22.

As a reminder, the Supreme Court in Sevilleja v Marex Financial Ltd [2020] UKSC 31 confirmed (by a 4-3 majority) that the reflective loss principle is a bright line legal rule, which prevents only shareholders from bringing a claim based on any fall in the value of their shares or distributions, which is the consequence of loss sustained by the company, where the company has a cause of action against the same wrongdoer (see our blog post: Untangling, but not killing off, the Japanese knotweed: Supreme Court confirms existence and scope of “reflective loss” rule).

On the facts of the present case, the claimant suffered loss arising from a breach of obligation by a wrongdoer before it became a shareholder in a company. However, by the time the claimant brought its claims, it had become a member of the relevant company, which had its own claim for the same loss against the same wrongdoer. It was common ground that if the company succeeded in its claims, it would fully restore the value of the shares in the company held by the claimant. However, the Board found that the claimant’s claims were not barred by the reflective loss principle. It emphasised that the reflective loss rule is not a procedural rule, concerned only with the avoidance of double recovery, but must be applied as a substantive rule of law, focusing on the nature of the loss, which must be assessed at the time the loss is suffered.

This is a helpful clarification of the correct approach to the issue of timing. Since Marex, there have been conflicting decisions as to whether the rule against reflective loss will apply to a former shareholder, who is no longer a shareholder in the relevant entity at the time the claim is commenced. In particular, there has been a lot of focus in some quarters on a decision by Flaux LJ as a single judge of the Court of Appeal in relation to an application for permission to appeal in Nectrus Ltd v UCP plc [2021] EWCA Civ 57. In Nectrus, Flaux LJ held that the claim of an ex-shareholder was not barred by the reflective loss principle, finding that the rule should be assessed when the claim is made.

The decision of the Board in Primeo Fund has put this question beyond doubt, expressly confirming that a shareholder which suffers a loss in the form of a diminution in value of its shareholding which is not recoverable as a result of the application of the reflective loss rule, cannot later convert that loss into one which is recoverable simply by selling its shareholding. The Board said that to find otherwise would lead to very “odd results”. While decisions of the Privy Council are not binding on English courts, they are regarded as having great weight and persuasive value (unless inconsistent with a decision that would otherwise be binding on the lower court). Given the questionable precedent value of Nectrus  and the constitution of the Board of the Privy Council in Primeo Fund, it is highly likely that the decision in Primeo Fund will be followed by the Court of Appeal the next time this issue arises in an English case.

The decision is considered in further detail below.

Background

The appellant (Primeo), was an open-ended mutual investment fund set up in 1994 and registered in the Cayman Islands, but now in liquidation. The respondents acted as Primeo’s custodian and administrator from 1993.

From inception, Primeo placed a proportion of funds raised from investors with Bernard L Madoff Investment Securities LLC (BLMIS) for investment. Over time, Primeo increased the proportion of its fund which invested with BLIMIS until, by 1 May 2001, the whole of its fund was invested in this way either directly, or indirectly through two feeder funds called Herald Fund SPC (Herald) and Alpha Prime Fund Limited (Alpha).

On 1 May 2007, Primeo’s direct investments with BLMIS were transferred to Herald, in consideration for new shares in Herald (the Herald Transfer). From that date, Primeo no longer had any direct investments with BLMIS, all investments were held indirectly via Herald or Alpha.

On 11 December 2008, the Ponzi scheme operated by Mr Madoff and BLMIS collapsed. Mr Madoff surrendered to the authorities in the United States and was charged with fraudulently operating a multi-billion dollar Ponzi scheme. Primeo was placed into voluntary liquidation on 23 January 2009.

Primeo brought claims in the Cayman Islands against its administrators and custodians, alleging breaches of duty.

Decisions of the Grand Court and Court of Appeal of the Cayman Islands

The Grand Court held that the administrators and custodians owed relevant duties to Primeo and breached those duties. However, the Grand Court dismissed Primeo’s claims on the grounds that they infringed the reflective loss rule, on the basis that Herald and Alpha also had claims against the same defendants which covered the same loss, and if they made recovery on those claims that would eliminate any loss suffered by Primeo.

Each side appealed to the Court of Appeal of the Cayman Islands (on various issues), which dismissed Primeo’s appeal against the Grand Court’s finding that its claims were barred by the reflective loss rule.

Appeal to the Privy Council

The Board of the Privy Council gave directions to hear and determine the discrete issue as to the operation of the reflective loss rule (with another hearing to follow, dealing with other issues on appeal). The parties were agreed that Cayman Islands law regarding the reflective loss rule, was the same as English law.

The specific issues for the Board of the Privy Council to determine were as follows:

  1. What is the relevant time to determine whether the reflective loss rule applies? Is it the time when the relevant claimant (here, Primeo) issued proceedings (by which time Primeo was a shareholder in Herald), or is it the time when the claimant acquired its causes of action (when Primeo was not a shareholder in Herald)?
  2. If the time to determine whether the reflective loss applies is when the claimant acquired its causes of action, did Primeo nonetheless lose its right to claim for the losses it suffered and become subject to the reflective loss rule by reason of the Herald Transfer, by which it ceased to be a direct investor in BLMIS and became an indirect investor via its replacement shareholding in Herald?
  3. The reflective loss rule operates where there is a common wrongdoer whose actions have affected both the claimant shareholder (Primeo) and the company (Herald/Alpha) – must the claims against the common wrongdoer be direct claims, and what degree of overlap between the claims of the shareholder and the company is required?
  4. Were the Grand Court and Court of Appeal correct to say that the reflective loss rule is brought into operation where the company has a realistic prospect of success, as opposed to being likely to succeed on the balance of probabilities?

Decision of the Board of the Privy Council

The Board of the Privy Council concluded that Primeo’s appeal in relation to the application of the reflective loss rule should be allowed. Each of the issues considered by the Board are discussed further below.

1. The timing issue

The Board confirmed that the reflective loss rule falls to be assessed as at the point in time when the claimant suffers loss arising from some relevant breach of obligation by the relevant wrongdoer, and not at the time proceedings are brought. On the facts of the present case, at the time Primeo suffered loss, it was not a shareholder in Herald and therefore its claim was not barred by the reflective loss principle.

The Board emphasised that the reflective loss rule is not a procedural rule, concerned only with the avoidance of double recovery, and must be applied as a substantive rule of law. In this context, the majority in Marex said that the focus of the reflective loss rule is on the nature of the loss, which involves consideration of the capacity in which the claimant suffered the loss and the form of the loss. The Board concluded that the issue is one of the characterisation of the loss, which depends on its status (i.e. whether or not it is recognised by the law) at the time it is suffered.

In the Board’s view, Nectrus Ltd v UCP plc [2021] EWCA Civ 57 was wrongly decided. In Nectrus, Flaux LJ presided as a single judge of the Court of Appeal over an application for permission to appeal. Flaux LJ held that the claim of an ex-shareholder was not barred by the reflective loss principle, finding that the rule should be assessed when the claim is made, at a time when the loss claimed has crystallised.

As a consequence of its decision, the Board confirmed that a shareholder which suffers a loss in the form of a diminution in value of its shareholding which is not recoverable as a result of the application of the reflective loss rule, cannot later convert that loss into one which is recoverable simply by selling its shareholding. The Board said that to find otherwise would lead to very “odd results”.

2. The Herald Transfer issue

Having found that the reflective loss principle was not engaged following analysis of the timing issue above, the Board considered whether the outcome was affected by the Herald Transfer.

In Marex, Lord Reed and Lord Hodge explained the justification for the reflective loss rule as based on the fact that, by becoming a member of the company, the shareholder agrees to “follow the fortunes of the company” in relation to losses suffered by it as a result of wrongs done to the company, and agrees that the company will have the right to decide whether claims should be brought in respect of such wrongs.

The question then was whether the Herald Transfer precluded Primeo from pursuing the causes of action it had already acquired before the Herald Transfer, because of the “follow the fortunes” bargain.

The Board considered that this argument was unsustainable, because the “follow the fortunes” bargain is forward-looking, not backward-looking. It is directed to characterisation of loss suffered by a claimant after they become a shareholder in the company (and they then suffer loss of the requisite type arising as a consequence of a wrong done to the company), and is directed to limiting the ability of a shareholder to acquire a right of action from that time on.

In the Board’s view, to apply the reflective loss rule to preclude a new shareholder from enforcing rights of action which had already accrued to them before they became a member of the company would be an unwarranted extension of the reflective loss rule. The Board noted that the issue of possible double recovery by Primeo on the one hand, and Herald and Alpha on the other, would have to be managed by a procedural mechanism.

3. The common wrongdoer issue

Primeo submitted that the Court of Appeal was wrong to apply the reflective loss rule in respect of claims against its former administrator, because neither Herald nor Alpha had any claim against the same corporate entity (different entities in the same group were involved in the provision of administration and custody services over the years to the various parties). Primeo made the same argument in relation to certain claims against its former custodian.

The Board agreed with Primeo, saying that it is an inherent part of the reflective loss rule that it only applies to exclude a claim by a shareholder where what is in issue is a wrong committed by a person who is a wrongdoer both as against the shareholder and as against the company. It noted that the separate legal identity of the administrator and custodian were of critical importance in the application of the reflective loss rule. The Board commented that to extend the reflective loss rule in these circumstances would be contrary to the decision in Marex, which was directed to keeping the operation of the rule within narrow parameters.

4. The merits issue

Given the Board’s other findings, it was not necessary to decide whether the Grand Court and Court of Appeal were correct to say that the reflective loss rule is brought into operation where the company has a realistic prospect of success, as opposed to being likely to succeed on the balance of probabilities.

However, the Board observed that those judgments were reached without the benefit of the decision in Marex, and adopting a materially different approach to the Supreme Court in that case. Accordingly, the Board warned that what the Grand Court and Court of Appeal said about this issue should not be treated as authoritative.

Julian Copeman
Julian Copeman
Partner
+44 20 7466 2168
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

HMT reform of prospectus regime: the potential impact on securities litigation

HM Treasury (HMT) has published an initial consultation on fundamental reforms promising the biggest shake up of the prospectus regime since 2005. The consultation follows the conclusions of the Hill Review of the UK listing regime published in March 2021.

In this blog post, we consider HMT’s consultation paper through a securities litigation lens, highlighting the potential impact on claims under s.90 of the Financial Services and Markets Act 2000 (FSMA) for liability for prospectuses and listing particulars.

For an overview of all the key proposals in HMT’s consultation paper, please see our Capital Markets team’s briefing paper: UK Prospectus Regime review – bold reform ahead?

1) Liability for forward-looking information in a prospectus

The most important reform to highlight in the context of s.90 FSMA claims is the proposed new statutory standard of liability for forward-looking information published in a prospectus.

We examine below the rationale behind this proposal, the current standard of liability for information published in a prospectus, HMT’s proposed approach to liability standards and also consider what this will mean for issuers in terms of litigation risk for claims under s.90 FSMA.

The rationale

In Lord Hill’s view, the existing prospectus regime deters issuers from including forward-looking information in their prospectuses. This is due to the level of liability attached to a prospectus under the current legislative framework in respect of untrue or misleading statements or omissions relating to both past and future events. Issuers have some certainty over past events, but less so when considering their future plans and trajectory. As a consequence, issuers typically provide very little forward-looking information directly to investors. In order to improve the quality of information that investors receive directly, Lord Hill recommended an adjustment to the current statutory standard of liability for forward-looking information in a prospectus.

The current standard of liability

The current standard of liability under s.90 FSMA for information published in a prospectus is, essentially, a negligence standard with a reverse burden of proof. S.90 FSMA provides that any person responsible for the document is liable to pay compensation to a person who has suffered loss as a result of any untrue or misleading statement in the document, or any omission from the document of “necessary information” (see section (3) below in relation to this disclosure requirement and the proposed reforms to it). Schedule 10 FSMA sets out exemptions to liability under s.90, including that liability does not arise where a person reasonably believed that the statement was true and not misleading or that the omission was properly made. It is generally accepted that it is for Claimants to prove that they have suffered loss as a result of the untrue or misleading statement, or omission, but it is for Defendants to prove the reasonableness of their belief. [1]

By way of contrast, the fault standard under s.90A FSMA, for untrue or misleading statements in information published by an issuer via a recognised information service, is one of recklessness: there is liability where the relevant person (a PDMR or “person discharging managerial responsibilities”) within the issuer either knows the statement to be untrue or misleading or is reckless as to whether it is untrue or misleading. In respect of omissions of a matter which is required to be included in information published by an issuer, the fault standard is effectively one of dishonesty: the PDMR must know the omission to be a dishonest concealment of a material fact. It is generally accepted that the burden of proof is on Claimants to prove recklessness or dishonesty. The same liability standard as under s.90A FSMA also applies under s.463 of the Companies Act 2006 (CA 2006) to directors of companies in respect of their potential liability towards the company for untrue or misleading statements in, or omissions from, the directors’ report and certain other reports and statements included in a company’s annual report.

HMT’s proposed standard of liability

HMT is minded to apply the same recklessness standard of liability to forward-looking information in, and to omissions from, prospectuses.

HMT’s view is that this standard of liability should only apply in respect of statements in a prospectus which project or predict a future state of affairs. It would not be applicable to statements of fact (e.g. any statement on the state of affairs at the date of the documents or any statement of historic fact), or the working capital statements in a prospectus. An issuer who wishes to be subject to the proposed lower standard of liability for forward-looking information will be required to identify that information explicitly.

Impact on s.90 FSMA litigation risk

Recklessness is a higher fault standard than negligence. Therefore, if the proposals are introduced, it will be more difficult for an investor to bring a successful claim for breach of s.90 FSMA on the basis of alleged untrue or misleading statements in or omissions of necessary information from a prospectus, where those allegations arise in relation to forward-looking statements. The practical impact (and the rationale underpinning the change, as discussed above) is that this should encourage greater disclosure of forward-looking information in prospectuses.

HMT’s proposals are yet to have legislative force, but they indicate the likely direction of travel in respect of liability for forward-looking statements in prospectuses for issuers. It will be important for issuers to continue to monitor regulatory developments. It appears, at this stage, that there will be a further Government consultation and a review and consultation by the FCA.

2) Threshold for when a prospectus will be required

The Government consultation suggests a number of other bold reforms, which may lead to a reduction in the number of prospectuses published in the UK. Although prospectuses will remain a key feature of an IPO in the UK, the Government suggests that a prospectus may not be needed in all instances where an admission occurs, such as during a secondary issuance of new securities. The consultation proposes to grant the FCA discretion as to when a prospectus is needed for the admission of securities to a UK regulated market. At present, the FCA cannot amend the UK Prospectus Regulation which governs the requirement to produce a prospectus, and its format and contents – only Parliament can. The consultation proposes to put those powers back into the hands of the FCA (which held them prior to the implementation of the EU Prospectus Directive in the UK in 2005).

A reduction in the number of prospectuses published would result in fewer opportunities for claims under s.90 FSMA. However, this would not remove the securities litigation risk for a prospectus-exempt issuance altogether, since s.90A claims may be available for any untrue or misleading statements made to the market, or omissions or delays in publishing required information.

3) Disclosure requirement

The general disclosure requirement for prospectuses in the UK is the “necessary information” test, which includes an express materiality standard and is found currently at Article 6(1) of the UK Prospectus Regulation: “…a prospectus shall contain the necessary information which is material to an investor for making an informed assessment of: (a) the assets and liabilities, profits and losses, financial position, and prospects of the issuer and of any guarantor; (b) the rights attaching to the securities; and (c) the reasons for the issuance and its impact on the issuer.”

The consultation suggests that, for now, the substance of the necessary information test should be retained, thus maintaining the overall disclosure standard for prospectuses. From a litigation perspective, this preserves the status quo for s.90 FSMA claims.

However, the consultation identifies two potential future changes:

  • The Government is considering amending the test to better accommodate further issues and non-equity securities. At present, a simplified prospectus content regime exists for secondary offerings contained in Article 14 of the UK Prospectus Regulation. This simplified regime sets out a separate standard with reduced information requirements. The consultation asks for feedback as to whether this revised separate standard has clarified matters. The Government is proposing not to include a separate test for secondary issuances but instead to make clear that a factor considered will be whether an issuer’s securities are already admitted to the market.
  • The consultation proposes to give the FCA responsibility for making detailed rules on the contents of a prospectus, where one is still required. Theoretically this could mean a change to the general disclosure requirement at some later date, if the rules are altered by the FCA using its new powers.

If either of these changes are implemented, there may be a corresponding impact on s.90 FSMA claims. For example, if the FCA believes that the level of detail required by the current regime is too high, it could downgrade the disclosure threshold, leading to a reduction in the volume of disclosure, which may limit the scope for s.90 FSMA claims.

For more information

Our Capital Markets colleagues have prepared an overview of all the key proposals in HMT’s consultation paper.

If you have any specific queries in relation to the impact of the proposals on s.90 FSMA claims, please get in touch with one of the contacts below or your usual HSF contact.

[1] It is also worth noting that the need to show reasonableness applies to the Defendant’s specific belief and whether that belief was based on reasonable enquiries rather than a broad assessment of the Defendant’s conduct as a whole.

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7374 2529
Sarah Penfold
Sarah Penfold
Senior Associate
+44 20 7466 2619

Court of Appeal provides guidance on the “reflective loss” principle and its interaction with the Contracts (Rights of Third Parties) Act 1999

The Court of Appeal has held that the so-called “reflective loss” principle will not bar the claim of a shareholder, who is also a contractual promisee/beneficiary, in circumstances where the company in which the shares are owned has acquired the right to bring a claim in respect of the same contract against the same wrongdoer pursuant to s.1 of the Contracts (Rights of Third Parties) Act 1999 (1999 Act): Broadcasting Investment Group Ltd & Ors v Smith & Anr [2021] EWCA Civ 912.

In reaching its decision, the Court of Appeal overturned the High Court’s judgment striking out the contractual promisee’s claim (see our banking litigation blog post). The High Court had ruled that the company (of which the contractual promisee was a shareholder) acquired a right to enforce the contract in question pursuant to s.1 of the 1999 Act. Consequently, the promisee’s claim, as a shareholder of the company, was barred by the rule in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 (often referred to as the reflective loss principle). The High Court found that s.4 of the 1999 Act, which preserves the rights of a promisee to enforce a contract, was subject to generally applicable legal principles including the rule in Prudential.

The Court of Appeal disagreed with the High Court’s interpretation of s.4 of the 1999 Act. It held that, since the company’s right to enforce the contract was conferred by the 1999 Act, it was subject to the terms and limitations imposed by that statute. Since the rule in Prudential was only engaged because of s.1 of the 1999 Act, it could not bar the promisee’s right to enforce the contract as prescribed by s.4 of the 1999 Act. In the Court of Appeal’s view, to interpret the rule in Prudential independently of the 1999 Act was entirely artificial, would sidestep the limitations imposed by s.4 designed to protect the rights of the promisee, and would effectively extinguish the promisee’s right to enforce the contract, which was impermissible by statute.

This decision will be of interest for financial institutions following developments to the reflective loss principle, which was confirmed by the Supreme Court last year in Sevilleja v Marex Financial Ltd [2020] UKSC 31 (see our banking litigation blog post: Untangling, but not killing off, the Japanese knotweed: Supreme Court confirms existence and scope of “reflective loss” rule). The reflective loss rule plays an important part in the defence of claims brought against banks by shareholders (aside from claims brought under section 90 and 90A of the Financial Services and Markets Act 2000, which provide a statutory exemption).

Given that the outcome in the present case is to allow the concurrent claims of a shareholder and company against the same third party wrongdoer, some might argue that it has narrowed the scope of the reflective loss principle. However, the rationale supporting the decision is based on the effect of the 1999 Act and its very specific wording, and does not have wider application. Accordingly, the decision is unlikely to impact the scope of the reflective loss principle in a general sense, and is likely to be limited to the (unusual) fact pattern of cases where the company only has a claim as a result of s.1 of the 1999 Act, and the shareholder is a contractual promisee.

In addition, financial institutions are likely to welcome the helpful obiter comments from the Court of Appeal on the question of whether the reflective loss principle should bar the claim of an “indirect” shareholder, i.e. where there is a chain of shareholder ownership. On this point, the concurring judgment of Arnold LJ considered it “well arguable” that the rule in Prudential can apply to indirect shareholders in appropriate circumstances.

Background

The underlying facts of the dispute are complex, but relate to the development of a start-up company in the technology sector. In summary, in October 2012 an alleged oral joint venture agreement (JV Agreement) was entered into by the claimants, the first defendant (Mr Smith), the second defendant (Mr Finch) and certain other parties. Under the terms of the JV Agreement, it was intended (among other things) that a joint venture vehicle would be set up, called Simplestream Group plc (SS plc), and that Mr Smith’s shares in two existing software companies would be transferred to SS plc.

SS plc was subsequently formed and its shareholders were Mr Smith, Mr Finch and the first claimant, Broadcasting Investment Group Limited (BIG). In alleged breach of the JV Agreement, the relevant shares were not transferred to SS plc, and SS plc subsequently entered creditors’ voluntary liquidation.

BIG brought a claim against Mr Smith and Mr Finch (and others) for breach of the JV Agreement, claiming specific performance as regards the transfer of shares to SS plc, or damages in lieu of specific performance. Alternatively, BIG claimed that it had suffered loss by reason of the consequent diminution in the value of its shareholding in SS plc and loss of dividend income from SS plc.

The second claimant (VIIL) was the majority shareholder of BIG and the third claimant (Mr Burgess) was, in turn, the majority shareholder of VIIL. Mr Burgess brought parallel claims to those brought by BIG, on the basis that both BIG and Mr Burgess personally were alleged to be parties to, and therefore prima facie entitled to enforce, the JV Agreement.

Mr Smith applied for strike out / reverse summary judgment on the basis that the claims of BIG and Mr Burgess were barred by the rule against reflective loss, as recently affirmed by the Supreme Court in Marex.

The liquidator of SS plc has, thus far, not indicated any intention to pursue any claims which SS plc might have in relation to the JV Agreement.

High Court decision

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

In summary, the High Court struck out BIG’s claims for both damages and specific performance in relation to the JV Agreement because the court found that BIG’s claim was a paradigm example of a claim within the scope of the reflective loss principle, and therefore should be barred.

The High Court found that SS plc had a right to enforce the JV Agreement pursuant to s.1(1)(b) of the 1999 Act and therefore SS plc and BIG had concurrent claims. The High Court held that BIG’s claim as a direct shareholder in SS plc fell within the scope of the rule in Prudential and was consequently barred. Further, the High Court held that s.4 of the 1999 Act, which states that s.1 of the 1999 Act does not affect any right of the promisee to enforce the terms of the contract, is subject to generally applicable legal principles and consequently, does not override the rule in Prudential.

The High Court ruled that Mr Burgess’s claim to enforce the JV Agreement was not barred by the rule in Prudential and could proceed to trial, because he was an indirect or quasi-shareholder in SS plc, rather than a direct shareholder (aptly referred to as the “Russian Doll” argument). In the view of the High Court, Marex emphasised that the reflective loss principle bars only shareholders in the loss-suffering company and is a “highly specific exception of no wider ambit”.

BIG appealed the High Court’s decision to strike out its claims on two grounds: (i) the High Court’s interpretation of both s.4 of the 1999 Act and Prudential; and (ii) whether Prudential bars claims for specific performance. In addition, Mr Smith cross-appealed the High Court’s refusal to strike out Mr Burgess’s claims in respect of the JV Agreement (i.e. the Russian Doll argument).

Court of Appeal decision

The Court of Appeal allowed BIG’s appeal on the interpretation of the 1999 Act and held that the rule in Prudential was not engaged to bar its claim.

Given its primary ruling, the Court of Appeal did not consider in detail either BIG’s alternative ground of appeal on the question of whether the rule in Prudential applies to claims for specific performance, or the cross-appeal.

Interpretation of the 1999 Act and Prudential

There was no dispute that SS plc acquired a right to enforce the JV Agreement pursuant to s.1(1)(b) the 1999 Act, with the result that both SS plc and BIG had concurrent claims for breach of contract against Mr Smith. Nor was it in dispute that BIG was a “contractual promisee” under the JV Agreement.

The question for the Court of Appeal was whether s.4 of the 1999 Act preserved BIG’s right to enforce the JV Agreement, notwithstanding the concurrent claim of SS plc, because it provides that the contractual promisee’s right to enforce the contract is not “affected” by s.1. In other words, did the creation of a right in SS plc under s.1 of the 1999 Act, destroy BIG’s rights as contractual promisee because of the operation of the rule in Prudential?

BIG argued that if the right acquired by SS plc by virtue of s.1, prevented BIG as a shareholder of SS plc from pursuing its cause of action for breach of the JV Agreement because of the rule in Prudential, then the situation was analogous to a parasite killing its host. Conversely, Mr Smith submitted that s.4 of the 1999 Act could not be construed to mean that it abrogates the rule in Prudential and, as a result, subverts the principle of the autonomy of the company in Foss v Harbottle.

In the Court of Appeal’s view it was clear from the natural meaning of the words in s.4 of the 1999 Act that the rights conferred on third parties by virtue of s.1 of the 1999 Act are in addition to any right the contractual promisee has to enforce th e contract (and that such a construction is consistent with the Explanatory Notes to the 1999 Act). This interpretation is consistent with the 1999 Act as a whole, which created only a limited and tightly constrained incursion into the rule of privity of contract. The legislation created rights and took “nothing away”.

The Court of Appeal focused on the use of the word “affect” in s.4 of the 1999 Act, which provides that s.1 must not “affect” the promisee’s right to enforce the contract. The Court of Appeal held that the proximate cause for BIG’s rights being extinguished was s.1 of the 1999 Act, and not the rule in Prudential. The rule in Prudential was only engaged when s.1 of the 1999 Act enabled SS plc to enforce the JV Agreement. Treating the rule in Prudential as if it were independent to the right conferred by s.1 of the 1999 Act was entirely artificial and would effectively sidestep the limitations imposed by s.4, which protect the rights of the promisee. This interpretation would not only affect BIG’s right to enforce the JV Agreement, but extinguish it completely – which it considered to be impermissible as a matter of statute. The Court of Appeal held that it would be a nonsense to interpret s. 4 of the 1999 Act in any other way.

The Court of Appeal also disagreed with the High Court’s reasoning that s.4 of the 1999 Act was subject to “generally applicable legal principles, including (where applicable) the rule in Prudential“, as this interpretation would defeat the purpose of s.4 of the 1999 Act. In this context, the Court of Appeal observed that SS plc’s right to enforce the JV Agreement was conferred purely by statute and is therefore subject to the terms and limitations imposed by that statute.

It therefore concluded that BIG’s claims under the JV Agreement were not barred by the rule in Prudential and were, to the contrary, expressly protected by s.4 of the 1999 Act.

Specific performance

The Court of Appeal did not consider this ground in detail given that it had allowed BIG’s appeal on the grounds discussed above.

The Court of Appeal said that a “superficial consideration” of Lord Reed’s reference in Marex to a shareholder being unable to bring an action against a wrongdoer to recover damages “or secure other relief for an injury done to the company”, might lead to the conclusion that claims for specific performance also fall within the rule in Prudential. However, Asplin LJ highlighted that the matter was complex and was best left to a case where it was necessary to decide this issue.

The cross-appeal (the “Russian Doll” argument)

Again, the Court of Appeal did not need to consider the cross-appeal given its finding that the rule in Prudential was not engaged in the current case.

However, in a short concurring judgment given by Arnold LJ, he disagreed with the High Court’s conclusion that the rule in Prudential was not engaged in relation to indirect shareholders (e.g. to prevent the claims of shareholders in a corporate shareholder).

Arnold LJ observed that it was “well arguable”, in appropriate circumstances, that the rule in Prudential can apply to indirect shareholders. Although his comments on this point are obiter, and therefore not binding, Arnold LJ suggested that it was difficult to see why the rule in Prudential should not apply in such a scenario.

Julian Copeman
Julian Copeman
Partner
+44 20 7466 2168
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Mannat Sabhikhi
Mannat Sabhikhi
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Court of Appeal clarifies proper approach to assessing damages for fraudulent misrepresentation

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
Harry Edwards
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Ceri Morgan
Ceri Morgan
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Nihar Lovell
Nihar Lovell
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Herbert Smith Freehills contributes chapter to The Securities Litigation Review (7th Edition)

Herbert Smith Freehills have contributed the England and Wales chapter of The Securities Litigation Review. Now in its seventh edition, The Securities Litigation Review is a guided introduction to the class action regimes for securities claims in the key jurisdictions across the globe, providing a valuable resource for corporates and financial institutions who might face such claims.

Download chapter

Reproduced with permission from Law Business Research Ltd. This article was first published in June 2021. For further information please contact Nick.Barette@thelawreviews.co.uk.

Previous Editions:

6th edition 2020

5th edition, 2019

4th edition, 2018

3rd edition, 2017

Harry Edwards
Harry Edwards
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Jon Ford
Jon Ford
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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
Harry Edwards
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Sarah Hawes
Sarah Hawes
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Ceri Morgan
Ceri Morgan
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Intermediated securities in a securities class action context

Herbert Smith Freehills LLP have published an article in Butterworths Journal of International Banking and Financial Law on intermediated securities in a securities class action context.

The majority of investors in the UK hold their interests through an intermediated chain of securities. The relationships between the investors in the chain are governed by the contracts they have entered into, and the system is largely operated on a “no look through” basis, meaning investors only have rights against their own counterparties. The Law Commission has considered whether to reform the law in this area, in order to give greater rights to ultimate investors. Any amendments to the current law may impact upon securities class actions. If the law is reformed to provide additional protections to ultimate investors, this could result in greater litigation risk for issuers, as well as an increased practical and administrative burden. However, there may also be some benefits to issuers from reform in this area; if ultimate investors are easier to identify, this can provide clarity to the issuer in relation to who might bring a claim against it, and enable the issuer to quantify any claims which it is facing more readily.

In our article we examine: what intermediated securities are, the legal consequences of holding intermediated securities, the Law Commission’s proposed reform of the existing law on intermediated securities, the potential solutions proposed by the Law Commission to reform the current law relating to intermediated securities, and the impact of the proposed reforms upon listed issuers.

The article can be found here: Intermediated securities in a securities class action context. This article first appeared in the April 2021 edition of JIBFL.

Simon Clarke
Simon Clarke
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Harry Edwards
Harry Edwards
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Sarah Penfold
Sarah Penfold
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High Court determines that reliance issues in context of a s.90A FSMA claim should be heard at first trial

At a recent case management conference where a split trial was proposed by the parties in relation to a section 90A Financial Services and Markets Act 2000 (FSMA) claim, the High Court has held that reliance issues should be heard at the first trial rather than held over to the second trial: Allianz Global Investors GmbH & 76 Ors v RSA Insurance Group plc [2021] EWHC 570 (Ch).

Trial structure tends to be a key case management battleground in securities class actions. For strategic and practical reasons, claimants often seek to postpone issues involving reliance, causation and quantum (i.e. issues which concern the conduct of the claimants) to the second trial and render issues surrounding the issuer’s alleged liability the sole focus of the first trial (see our banking litigation blog post on The Tesco Litigation: lessons learned from split trial orders in the context of securities class actions for further details).

The judgment therefore provides noteworthy and helpful guidance to issuers faced with securities claims in advocating for a trial structure with a fairer allocation of the burden of preparing for trial. The court referred to various factors which influenced its decision that reliance issues should be heard at the first trial. In summary, the court was of the view that an early determination on reliance may increase the chance of a settlement, and that since questions concerning reliance are primarily factual, these should be determined as early as possible during the trial process, particularly where the claimants had issued proceedings deep into the limitation period.

There are two particular points of note from the judgment:

  1. the court acknowledged the claimants’ argument that the inclusion of reliance issues could lead to a longer first trial; however, the court found that this was not a telling factor in a claim of this size and significance, and that the claimants who had brought the claim “must be ready to take part in it fully” especially as litigation funding had been arranged; and
  2. the allocation of the litigation burden between the parties was one of the factors which had a bearing on the court’s decision. The court noted that the claimants who brought the claim “should be prepared to undertake substantial work in ensuring the expeditious progress of the proceedings to resolution”.

The additional implication of these points is that further securities class actions may be more costly or practically burdensome for claimants to pursue, as they may need to invest more time and costs in anticipation of being required to participate more fully throughout the proceedings from the outset.

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

Background

In late 2013, RSA Insurance Group plc (RSA) made public announcements in respect of certain misconduct and accounting irregularities which had occurred in its Irish subsidiary (RSA Ireland) during the period of 2009-2013. Following the 2013 market announcements, a reduction was observed in RSA’s share price.

A claimant group of institutional investors subsequently brought proceedings under section 90A and Schedule 10A FSMA against RSA on the basis that:

  • the misconduct within RSA Ireland meant RSA’s published information during 2009-2013 contained alleged false/misleading statements and/or omissions, and/or RSA had dishonestly delayed the publication of relevant information; and
  • they had suffered loss as a result of acquiring/continuing to hold RSA shares during 2009-2013 in reasonable reliance on the alleged false/misleading statements and/or omissions and/or dishonest delay of relevant information.

RSA denies the allegations and is robustly defending the s.90A FSMA claim being brought against it.

One of the main issues the parties asked the court to consider during the case’s first CMC was how the trial should be structured. It was common ground that there should be a split trial; however, the parties disagreed as to where that spilt should lie.

The parties framed the debate by reference to an agreed list of issues. It was agreed between the parties that issues relating to whether RSA is liable under section 90A FSMA (the RSA Issues) and issues relating to quantum should be heard in the first and second trial respectively. The dispute arose in relation to issues relating to reliance and causation which are issues which concern the actions of the claimants (the Claimant Issues) and in which trial such issues should be heard.

The claimants submitted that the first trial should deal solely with the RSA Issues only, leaving the reliance and causation issues to the second trial; whereas RSA submitted that in addition to the RSA Issues, the court should also determine issues of reliance in the first trial, and that as an alternative fall-back position, the court might also determine causation issues in the first trial.

Decision

The court found in favour of RSA and held that it was appropriate that issues of reliance should be included in the first trial for the reasons set out below:

  1. Settlement – The court noted that it was preferable, on balance, for more issues rather than fewer to be tried at the first trial, and that a determination on both the RSA Issues as well as the reliance issues at that juncture was more likely to bring about a settlement of the remaining issues.
  2. Timing for the determination of the reliance issues – The court was of the view that the timeline produced by RSA’s proposed split would lead to a faster determination of the factual issues concerning reliance. The potential difference between the parties’ suggested timelines amounted to approximately a year. The court was not persuaded by the claimants’ submission that such a difference was marginal and that a year or so of delay should be avoided if possible. The court agreed with RSA that the claimants had chosen to bring the claim late in the limitation period, and the more time which passed, the more difficult it would be for the parties and the court to establish what had happened on a true factual basis.
  3. First trial length – The court noted that there was some force in the claimants’ argument that their proposed spilt would lead to a shorter first trial. However, the court commented that in a case of this scale and importance, this ought not to be a particularly telling factor. The claimants who brought this claim “must be ready to take part in it fully”, even if it resulted in a longer first trial. The court further noted that it did not think a trial of 25-30 court days to be excessively onerous for parties who were as well funded as the claimants (who had secured litigation funding).
  4. Overlap between causation and reliance – Whilst the court recognised that there was some force in the claimants’ argument concerning the potential overlap between reliance and causation issues, and noted that in an ideal world it would be preferable to have a spilt trial structure which cleanly separated the Claimant Issues from the RSA Issues; however, the court did not deem such a division to be pragmatic in the present case. It further noted that it did not consider it likely for the potential overlap in reliance and causation evidence to lead to a serious risk of inconsistencies in the evidence or the court’s findings. The court acknowledged it may be unsatisfactory for the same witness to be called to provide evidence twice (once in the first trial for reliance, and another time in the second trial for causation); however, it was of the view that the process of taking causation evidence should be fairly short and self-contained in the second trial.
  5. Expert evidence – The court agreed with RSA that it was possible that no expert evidence would be required for issues of reliance. The proposition advanced by the claimants was that the price of securities on the London Stock Exchange was influenced by published information. The court’s initial view was that such an argument was self-evident and required no expert evidence. Nonetheless, the court noted that should expert evidence be required, it did not expect the process to be a long one.
  6. Possibility of appeals – Overall, the court noted that there was some force in RSA’s argument that if there were to be appeals following the first trial, it would be better for the appellate court to hear as many issues as possible at the same time. The court also regarded there to be a real risk that the determination of reliance issues could be further postponed, in the scenario where such issues are put off to the second trial and an appeal occurs after the first trial. As per the reasons above, the court deemed this to be unsatisfactory since reliance questions are essentially factual and should be dealt with sooner rather than later.
  7. Litigation burden – On the allocation of the litigation burden between the parties, the court agreed with RSA that the claimants’ proposed split effectively meant that the claimants’ burden would be postponed to the second trial and almost all the work for the first trial would rest solely with RSA. The court noted that both parties should be entitled to scrutinise each other’s case, and that there may be times where the litigation burden between the parties is lopsided by the nature of the litigation; however, that was not the case here – as such an imbalance would be created by the claimants’ proposals for a split trial. In its consideration, the court also underlined that the claimants, having brought the claim, “should be prepared to undertake substantial work in ensuring the expeditious progress of the proceedings to resolution”. This includes providing disclosure, preparing witness statements and being prepared to provide evidence at trial. The court was of the view that RSA’s proposal represented a fairer allocation of the litigation burden between the parties, which although not a determining factor by itself did however have some bearing.

Herbert Smith Freehills LLP acts for the defendant, RSA, in this matter. 

Ceri Morgan
Ceri Morgan
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Nihar Lovell
Nihar Lovell
Professional Support Lawyer
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Karen Wu
Karen Wu
Associate
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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 Advocate General (AG) of the Court of Justice of the European Union (CJEU) has handed down an unsurprising opinion on the interpretation of Directive 2003/71/EC (the Prospectus Directive), considering the liability of issuers to qualified investors in respect of inaccuracies in a prospectus: Bankia SA v UMAS (Case C-910/19) EU:C:2021:119 (11 February 2021), (Advocate General Richard de la Tour).

The referral was made by the Spanish Supreme Court on the interpretation of Article 3(2)(a) and Article 6 of the Prospective Directive, which (before its repeal – as discussed further below) provided the framework for a “single passport” for prospectuses throughout the EU. As an EU Directive, it required further implementation measures by EU Member States to be effective. In the UK, the relevant provisions considered by the AG are found at s.90 of the Financial Services and Markets Act 2000 (FSMA).

The context for the referral was the relatively commonplace scenario in a securities issuance, where an issuer publishes a prospectus to the public at large, and as a consequence it is received by qualified investors as well as retail investors (e.g. where there is a combined offer). The question for the AG was whether the issuer could be liable (under Article 6 of the Prospectus Directive) to qualified investors (as well as retail investors) for any inaccuracies in the prospectus in circumstances where, if the offer had been directed solely at qualified investors, the issuer would have been exempt from publishing the prospectus under Article 3(2)(a) of the Prospectus Directive. If the qualified investor is entitled to bring a claim in these circumstances, the AG was asked if the qualified investor’s awareness of the true situation of the issuer could be taken into consideration.

In response to these questions, the AG’s opinion (which is non-binding but influential on the CJEU) concluded as follows:

  1. Article 6 of the Prospectus Directive, in 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.
  2. Article 6(2) of the Prospectus Directive must be interpreted as not precluding, in the event of an action in damages being brought by a qualified investor on grounds of an inaccurate prospectus, that investor’s awareness of the true situation of the issuer being taken into consideration besides the inaccurate or incomplete terms of the prospectus, since such awareness may also be taken into account in similar actions for damages and taking it into account does not in practice have the effect of making it impossible or excessively difficult to bring that action, which is a matter for the referring court to determine.

From a UK perspective (and as prefaced above), this is an unsurprising outcome in the context of s.90 FSMA. In particular, because the second point (awareness of the true position of the issuer) is expressly included in the Schedule 10 defences to a s.90 claim.

Securities lawyers will immediately question the impact of the AG’s opinion in the light of the Prospectus Regulation (EU) 2017/1129 and Brexit.  Although the Prospectus Regulation repealed and replaced the Prospectus Directive (see our banking litigation blog post), the substance of the Articles considered by the AG have been carried forward into the equivalent Prospectus Regulation provisions.

As to Brexit, although the UK is no longer a member of the EU (following the end of the Brexit transition period on 31 December 2020), the AG’s opinion may still be of relevance to the interpretation of s.90 FSMA claims. S.90 FSMA 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). As noted above, AG opinions are not binding in any event, but this will be the status of the CJEU decision when finally handed down.

The AG’s opinion 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 ECJ for a preliminary ruling:

  • When an offer of shares to the public for subscription is directed at both retail and qualified investors, and a prospectus is issued for the retail investors, is an action for damages arising from the prospectus available to both kinds of investor or only to retail investors?
  • In the event that an action for damages arising from the prospectus is also available to qualified investors, is it possible to assess the extent to which they were aware of the economic situation of the issuer of the offer of shares to the public for subscription otherwise than through the prospectus, on the basis of their legal and commercial relations with that issuer (e.g. being shareholders of the issuer or members of its management bodies etc)?

Decision

We consider below each of the issues addressed by the AG in his opinion.

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

The AG 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.

In the AG’s view, this interpretation was supported by both a literal/systematic interpretation of the Prospectus Directive, and a teleological interpretation (paying attention to the aim and purpose of EU law).

Before considering each approach to interpretation below, and by way of reminder, Article 3(2)(a) of the Prospectus Directive contains an exemption from the obligation to publish a prospectus where the offer is limited to qualified investors. However, the publication of a prospectus is mandatory where there is a combined offer to the public (i.e. both non-qualified and qualified investors) (Article 3(1)); or in the event of an issue of shares for trading on a regulated market (Article 3(3)).

Literal/systematic interpretation

Considering first the linguistic interpretation of the words used, the AG noted that Article 6 establishes a principle of liability in respect of inaccurate/incomplete prospectuses, but does not provide for an exception to that principle based on the nature of the combined offer, whether it is offered solely to the public or is intended for trading on a regulated market.

The AG contrasted the approach in other provisions of the Prospectus Directive, which do provide for exemptions from the obligation to publish a prospectus, based either on the person to whom the offer is addressed (Article 3(2)(a)), the number of shares or total offer issues (Article 3(2)), or on the nature of the shares issued (Article 4). However, those exemptions from the publication obligation do not prohibit voluntary publication of a prospectus by an issuer who will then benefit from the “single passport” if the shares are issued on a regulated market.

From a systematic perspective, the AG pointed out that the effect of the exemptions was to create circumstances in which qualified investors will receive a prospectus, even if they would not have received one if the offer had been directed solely at qualified investors. For example, where there is a combined offer (as in the present case) or where the prospectus is published voluntarily to benefit from the “single passport”.

The AG commented that the referring court appeared to start from the premise that, since the prospectus was intended solely to protect and inform retail investors, qualified investors could not rely on the inaccuracy of the prospectus in order to bring an action for damages. In the AG’s view, a literal and systematic interpretation of the Prospectus Directive cast doubt on the idea that a prospectus is produced merely in order to protect non-qualified investors.

Teleological interpretation (looking at the aim and purpose of EU law)

The AG said the interpretation of Article 6 of the Prospectus Directive must have regard to and balance two objectives: (i) the completion of a single securities market through the development of access to financial markets; and (ii) the protection of investors whilst taking account of the different requirements for the protection of the various categories of investors and their level of expertise.

Again, in the AG’s view, the presence of exemptions in Articles 3 and 4 versus the lack of any exemptions in Article 6, must lead to an interpretation that where a prospectus exists it must be possible to bring an action for damages on the basis of the inaccuracy of that prospectus irrespective of the type of investor.

The AG also commented that if it were accepted that each Member State could determine itself whether or not qualified investors may bring an action for damages in the event of an inaccurate prospectus, that would lead to possible distortions occurring among Member States that would undermine, disproportionately, the objective of completing the single securities market. A uniform interpretation of Article 6 is required, therefore, concerning persons who may bring proceedings against the issuer in connection with an offer.

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

The AG 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.

The AG said that the extent of liability for inaccuracies in a prospectus is a matter for Member States (in terms of whether to take account of the contributory fault of the investor and questions of causation). Accepting that Member States may factor in the awareness of a qualified investor in their legislation, the AG drew an analogy with the reasoning of the CJEU’s decision in Hirmann C‑174/12, EU:C:2013:856. In Hirmann, the court accepted that a Member State may limit the civil liability of the issuer by limiting the amount of compensation by reference to the date on which the share price is determined for the compensation (although again, the Member State must observe the principles of equivalence and effectiveness).

In terms of observing those principles of equivalence and effectiveness, the AG emphasised the need to take the investor’s awareness into consideration specifically in a given situation, which will require the courts of Member States to assess the evidence of such awareness and of the extent to which that awareness has been taken into consideration.

Harry Edwards
Harry Edwards
Partner
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Sarah Hawes
Sarah Hawes
Head of Corporate Knowledge, UK
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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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