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

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

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

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

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

First securities class action judgment in Australia

The Australian Federal Court has recently handed down judgment in the first securities class action in Australia to reach trial: TPT Patrol Pty Ltd as trustee for Amies Superannuation Fund v Myer Holdings Limited [2019] FCA 1747.

The decision is likely to be of interest from a UK securities litigation perspective. A briefing paper setting out the observations and insights of our Australian colleagues is now available to download: Myer Shareholder Class Action: Briefing Paper (October 2019).

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Harry Edwards
Harry Edwards
Partner
+44 20 7466 2221
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948
Sarah Penfold
Sarah Penfold
Associate
+44 20 7466 2619

High Court refuses Tesco’s strike out application in s.90A FSMA group shareholder action

In an important decision for securities litigation in the UK, the High Court has dismissed a strike out application made by Tesco plc in the group litigation brought by its shareholders under section 90A Financial Services and Markets Act 2000 (“FSMA”), relating to the false and misleading statements made by Tesco regarding its commercial income and trading profits in 2014: SL Claimants v Tesco plc [2019] EWHC 2858 (Ch).

In summary, Tesco asserted that it was not liable for any untrue or misleading statement in its published information under section 90A and schedule 10A FSMA to any claimants who held the shares in a custody chain with more than one intermediary. While Tesco accepted that its construction would render the FSMA regime ineffective in relation to claims by holders of intermediated securities, it contended that these consequences flowed from a failure of the law to keep pace with the development of a dematerialised market, where transfers in certified securities are replaced with share dealing in computerised form (i.e. through CREST).

The court considered two technical questions of statutory construction in relation to section 90A and schedule 10A FSMA, namely whether claimants who held their shares through CREST:

  1. Had an “interest in securities” within the meaning of paragraph 8(3) of schedule 10A FSMA.
  2. Acquired, continued to hold or disposed of” any interest in securities (even if, contrary to Tesco’s first submission, they had one).

The court answered both questions in the affirmative, dismissing Tesco’s strike out application.

The decision is significant, because the vast majority of transactions in publicly held shares in companies listed in an exchange in the UK are held in dematerialised form through CREST, and the position of the claimants was entirely typical of the dematerialised securities market. If Tesco had been correct in its submissions, the effect would have been to expose a fundamental hole in the FSMA regime. Indeed, the court recognised that, had Tesco been successful, the likely consequence would have been to undermine the legislative scheme implemented by Parliament to reflect in domestic law the European Transparency Directive with a view to encouraging accurate and timely disclosure by issuers and promoting investor protection. The court held that it:

…must proceed on the basis that the draftsman and legislature did understand the market in intermediated securities, did not intend to strip away the rights of investors who chose that mode of holding their investment, and must have been persuaded that the words they used were appropriate to preserve and enhance those rights.”

Background

The underlying claim arose out of false and misleading statements made by Tesco to the market in the context of reporting its commercial income and trading profits in 2014. Two claimant groups have brought proceedings against Tesco under section 90A FSMA alleging that they suffered loss as a result of those misleading statements.

The instant judgment relates to Tesco’s application to strike out the claims on the basis that the remedies available under section 90A and schedule 10A FSMA for untrue or misleading statements were not available to the claimants because of the nature of how they acquired, held and (in some cases) disposed of their interests in the securities. In particular because:

  • The shares in Tesco were, like most listed companies in the UK, held in dematerialised form (i.e. on a computer-based system with no paper certificates) through CREST.
  • The shares were registered in the name of the financial institution providing custodian services to the claimants, so none of the claimants ever directly acquired, held or disposed of a legal interest in any of the shares.
  • Most of the shares in Tesco were held in a custody chain (with custodians in turn using sub-custodians).

Tesco’s position was that the consequence of this was:

  1. That the interest of the claimants in such a custody chain was not an “interest in securities” within the meaning of paragraph 8(3) of schedule 10A FSMA.
  2. In any event, none of the claimants could properly be said to have “acquired, continued to hold or disposed of” any interest in securities (even if, contrary to Tesco’s first submission, they had one).

Decision

The court held that neither of the two limbs of Tesco’s argument was sustainable, and therefore the strike-out application was dismissed.

1. Did the claimants have an “interest in securities” within the meaning of paragraph 8(3) of schedule 10A FSMA?

The court started its analysis with section 90A FSMA, which sets out the liability of issuers of securities to pay compensation to: “persons who have suffered loss as a result of (a) a misleading statement or dishonest omission in certain published information relating to the securities.”

Paragraph 3(1) of schedule 10A provides for compensation to be paid: “to a person who acquires, continues to hold or disposes of securities in reliance on published information to which this schedule applies” and who has suffered loss as a result of any untrue or misleading statement in it (or omission of any matter required to be included in it).

Paragraph 8 contains rules of interpretation which apply to schedule 10A. The court noted that of central importance to the present application was the definition given in paragraph 8(3) (emphasis added):

References in this schedule to the acquisition or disposal of securities include:

(a) acquisition or disposal of any interest in securities, or

(b) contracting to acquire or dispose of securities or of any interest in securities,

except where what is acquired or disposed of (or contracted to be acquired or disposed of) is a depositary receipt, derivative instrument or other financial instrument representing securities.

The question under the first limb of Tesco’s argument was therefore whether the claimants had an “interest in securities” sufficient to enable them to maintain proceedings for the purposes of section 90A and schedule 10A FSMA. Finding that they did have such an interest, the court made a number of key observations:

  • It readily accepted that where there is a chain of intermediaries, the investor at the end of the chain does not have any direct proprietary interest in the underlying security, nor can it enforce any rights held in the chain of sub-trusts directly against the issuer (referring to the Lehman Rascals case: re Lehman Brothers International (Europe) [2010] EWHC 2914 (Ch)).
  • The court also accepted that the concept of an or “any interest in securities” must denote something more than a contractual right or economic interest in such securities for the ‘custody chains’ to have legal sustainability.
  • The court acknowledged that it would be wrong to treat sub-trusts as if they were a contrivance which could be looked through for the purpose of identifying the true interest held by the ultimate investor.

However, in the court’s judgment, the ‘right to the right’ which the investor had via the custody chain was, or could be equated to, an equitable property right in respect of the securities, and this was sufficient to qualify as “any interest in securities” for the purpose of schedule 10A FSMA. The court noted that this conclusion was supported by the court’s explanation in: In the matter of Lehman Brothers International (Europe) [2012] EWHC 2997 (Ch):

It is an essential part of the English law analysis of the ownership of dematerialised securities that the interests of the ultimate beneficial owner is an equitable interest, held under a series of trusts and sub-trusts between it, any intermediaries and the depository in which the legal title is vested: see paragraph [226] of my judgment in the RASCALS case.”

2. Did the claimants “acquire, continue to hold or dispose of” any interest in securities?

Tesco’s second limb of argument was that – even if the claimants had an “interest in securities” – none of the claimants could sue because none could be said to have “acquired” or “disposed of” their interest in Tesco shares within the meaning of paragraph 8(3) of schedule 10A FSMA.

Tesco’s construction of paragraph 8(3) depended upon the proposition that there could only be an “acquisition” or “disposal” of an interest in securities if there was a transfer of, or dealing in, that particular interest (as distinct from some other interest). On Tesco’s case, at the very most, all the ultimate investors had was a beneficial interest. It said that a purchase or sale by the legal owner of legal title would not constitute a purchase or sale of the beneficial interest, because the beneficial interest could be created or extinguished, but could not be acquired or disposed of.

The court noted that Tesco’s argument depended upon a narrow interpretation of the expressions “acquisition” and “disposal” as used in schedule 10A, and confining them to the very interest in which the claimant has or had.

The court was mindful that ordinary principles of statutory construction required it to ensure that the statutory purpose (here of the relevant provisions of FSMA) were not thwarted, unless the wording was without any semantic doubt entirely deficient to apply.

With this in mind, the court referred to the Supreme Court’s recognition that in other contexts the word “disposition” was capable of encompassing the destruction or termination of an interest (see Akers v Samba Financial Group [2017] AC 424). It seemed to the court plain and obvious that the expressions “holding” and “acquisition” must in logic be given broad corresponding remit. It said there was every reason to give the expressions such meaning here, to ensure the achievement, rather than the negation, of the statutory purpose.

The court concluded:

Accordingly, I consider that any process whereby, in a transaction or transactions on CREST, the ultimate beneficial ownership of securities that are, with the consent of the issuer, admitted to trading on a securities market in accordance with paragraph 1 of schedule 10A, comes to be vested in or ceases to be vested in a person constitutes (respectively) ‘the acquisition or disposal of any interest in securities’.”

The court therefore dismissed the strike-out application.

 

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Harry Edwards
Harry Edwards
Partner
+44 20 7466 2221
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948
Sarah Penfold
Sarah Penfold
Associate
+44 20 7466 2619

High Court finds in favour of Lehman administrator in respect of US $7 million trade error and implies term into otherwise “unworkable” debt security trade agreement

A recent High Court decision has found that it was necessary to imply a term into an otherwise unworkable debt security trade agreement: Lehman Brothers International (Europe) (In Administration) v Exotix Partners LLP [2019] EWHC 2380 (Ch). The approach of the court towards implying terms into a contract is highly restrictive (see our litigation blog post) and implied terms are particularly unusual in the securities market, so this decision will likely be of interest to financial institutions.

In the present case, following a “colloquial” and “imprecise” oral agreement, both parties were mistaken as to the nature and value of the securities being traded. Having considered the contractual interpretation of the trade agreement, the court found that the correct interpretation required an implied term in order for performance to take place. Without this implied term, the trade would have been impossible to fulfil.

The court found that the implied term was not “obvious, because the implication of the term would have alerted the parties to their mutual misunderstanding. The term was instead implied solely on the basis that, without the term, the contract would lack commercial or practical coherence. In the court’s view, this included “workability”. This conclusion was not reached without some (understandable) hesitation from the court, in particular because – if the parties had been asked at the time of the transaction – they would likely have realised the shared misapprehension and dissolved the trade.

One of the most interesting points arising from the judgment is the legal gymnastics undertaken by the court in order to reach an ostensibly fair decision. The court notably criticised the defendant’s failure to notify its counterparty when it discovered the significant trading error. Indeed, the court found the defendant’s “commercial morality” to be “frail” at best. Against this backdrop, the court appears to have been motivated to claw back the defendant’s windfall gain of circa US $7 million.

It is worth noting that, had the agreement been made in writing as opposed to orally over a recorded line, the difficulties experienced by the court could have been avoided because rectification would have been a possible remedy. The Court of Appeal’s recent decision in FSHC Group Holdings Ltd v GLAS Trust Corporation Ltd [2019] EWCA Civ 1361 sets out the test for rectifying terms following common mistake and further consideration of the case can be found in our banking litigation blog post. However, rectification is not possible for oral agreements and therefore was not available here.

Background

In early 2014, Lehman Brothers International (Europe) (In Administration) (“LBIE”) entered into a trade of Peruvian Government Global Depository Notes (“GDN”) with Exotix Partners LLP via an oral trade agreement. A GDN is a debt instrument created and issued by a depository bank evidencing ownership of a local currency-dominated debt security (in this case, Peruvian government-issued bonds). Each GDN provided for payment of principal and interest in US dollars (unlike the underlying bonds, which were issued in Peruvian Nuevo Sol, or “PEN”).

The oral agreement was colloquial and imprecise. Both parties were mistaken as to the value of the trade. Indeed, each party was under the misapprehension that they were trading “scraps” worth approximately US $7,000 when in fact LBIE’s holding was worth over US $7 million. LBIE delivered its holding to Exotix which, upon the receipt of a larger than expected coupon payment, identified the error and, following some internal discussions, sold on the GDNs and pocketed the windfall without notifying LBIE.

Decision

The principal dispute was the true meaning and effect of the bargain struck further to the oral agreement, focusing on the contractual construction of that oral agreement and whether or not it contained an implied term.

Contractual construction

Applying the now well-established principles of contractual construction, the court considered the objective intention of the parties as to the subject of the trade and price. The key question was whether the parties had agreed to the sale and delivery of: (a) a specific number of GDNs (Exotix’s case); or (b) the number of GDNs equating to a face value in PEN (LBIE’s case).

The court found that the most likely meaning was (b) above, with the face value in PEN equating to approximately US $7,000. Accordingly, the performance (namely transferring a holding worth approximately US $7 million as opposed to US $7,000) was not in accordance with the objective interpretation of the trade agreement given the facts known at the time and the words used in the trade.

However, this interpretation presented a problem, because it required LBIE to deliver a non-integer quantity of GDNs. LBIE sought to cure this by way of an implied term.

Implied term

LBIE argued that as (i) fractions of the GDNs could not be transferred in practice and (ii) both parties were aware of the approximate trade value of US $7,000, the agreement must include an implied term which provided for and enabled delivery of a fraction of a GDN.

Finding in favour of LBIE, the High Court held that in order for the contract to be workable, a term must be implied into the trade agreement in respect of transferring fractions of GDNs.

In doing so, the court made the following key observations:

  • The court noted that the case of Crema v Cenkos Securities plc [2011] 1 WLR 2066 is the leading modern authority on the implication of terms based on clear trade practice. However, it held that there was not enough evidential basis to establish an “invariable, certain and notorious” practice relating to the delivery of a non-integer number of GDNs, and therefore this test was not satisfied. Even equating GDNs with bonds (for which it was accepted by both sides’ experts that trades might give rise to a fractional entitlement), the court could not properly extrapolate an implied term from the evidence when the issue of fractions of bonds is not common.
  • The court referred to the leading authority of Marks & Spencer plc v BNP Paribas [2015] UKSC 72 on the question of whether the pleaded implied term should be read into the trade on some other basis, in particular that it was obvious and necessary to provide commercial and practical coherence to the agreement and (in other words) to give the trade business efficacy.
  • The court noted that the difficulty in this case with saying that the term was so obvious as to go without saying, was the likelihood that knowledge of the term at the time of entering into the trade would have “jolted [the parties] into recognising the real problem”. So the implication of the term would have saved the contract from a misunderstanding rather than an obvious omission.
  • However, the court held that did not exclude the possibility of implying a term to ensure the workability of the agreement, i.e. that the implied term was necessary. The court emphasised that terms may be implied on the alternative bases of being obvious or necessary, and that although the outcome of either approach will usually be the same, that is not invariably the case. On this point, the court relied upon Nazir Ali v Petroleum Company of Trinidad and Tobago [2017] UKPC 2, which confirmed that a term may be implied if, without the term, the contract would lack commercial or practical coherence. In the court’s view, this included workability: a term may be implied if it is necessary to ensure that an agreement is workable.
  • Given the court’s conclusions on contractual construction, and the obligation to deliver a fraction of a GDN, the court stated that the only way in which the trade agreement could then be made to work was by implying a term for settlement of the fractional entitlement in cash, which was the implied term sought by LBIE.
  • The court acknowledged its hesitation in reaching this conclusion. It noted that, if the parties had been asked at the time, they likely would have made enquiries that revealed a shared misapprehension as to the nature of GDNs and dissolved the trade (this was intended to be a deal for scraps). However, the court stated that the law usually stops short of dissolving an agreement, preferring instead to give effect to what the parties appear ostensibly to have agreed (although the court considered LBIE’s argument that the contract was impossible to perform in the absence of the implied term, discussed further below).

Relief

The parties agreed that if LBIE succeeded in its primary case in respect of the contractual interpretation of the trade agreement and the implied term on fractions of GDNs, it would be entitled to restitutionary relief on the basis that Exotix would have been unjustly enriched by the over delivery of GDNs and coupon payments made on that amount.

The court held that the appropriate remedy for LBIE was monetary and this was the correct means of restitution (reference was made to Menelaou v Bank of Cyprus UK Ltd [2016] AC 176 (SC)).

In the event an implied term was not found, the court stated that the natural consequence would be that the contract was impossible to perform. It held that, in this event, LBIE would have been entitled to restitutionary relief on the basis there was a failure of consideration which would make the agreement void and unenforceable.

Harry Edwards
Harry Edwards
Partner
+44 20 7466 2221
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948
Elizabeth Court
Elizabeth Court
Associate
+44 20 7466 2238

What securities litigators need to know about the new Prospectus Regulation

The new EU Prospectus Regulation (EU/2017/1129) (the “PR”) entered into full force and effect on 21 July 2019 across EU Member States. It replaces, in its entirety, the Prospectus Directive (the “PD”) regime and therefore represents the most significant overhaul of European securities law since the PD came into force in 2005.

A number of the changes will have a direct impact on claims under s.90 Financial Services and Markets Act 2000 (“FSMA”) for liability for prospectuses and listing particulars published after the relevant change took effect (some of the PR’s provisions came into force prior to 21 July 2019). We highlight below some of the key changes introduced by the PR which are likely to be of most interest from a securities litigation perspective.

Key changes from a securities litigation perspective

Disclosure requirement

The general disclosure requirement for prospectuses under the PR remains broadly the same as under the PD. It remains, fundamentally, the ‘necessary information’ test, but now helpfully includes an express materiality standard: “the necessary information which is material to an investor for making an informed assessment of” various matters including assets, liabilities, profits and losses of the issuer, the rights attaching to securities and the reasons for the issuance and its impact on the issuer (Article 6(3) PR, emphasis added).

From a litigation perspective, s.90 FSMA has been amended by the PR to import the materiality threshold in the context of such claims. In the absence of judicial guidance, it had generally been assumed that there was a materiality standard, and that a trivial omission or misstatement would not give rise to issuer liability. However, this clarification will be welcomed by issuers.

It is perhaps regrettable that the European Commission has not taken this opportunity to clarify the meaning of an ‘investor’. It therefore remains the case that it is unclear what characteristics, knowledge and experience the hypothetical investor should be imbued with for the purpose of the ‘necessary information’ test; or whether the application of that test is affected if the prospectus was targeted at institutional investors rather than including a retail offering.

Risk factors

One of the main changes brought in by the PR regime concerns the presentation of risk factors, the most relevant of which from a disputes perspective being in relation to specificity, materiality and mitigation:

  • Specificity: Article 16(1) PR requires that risk factors in prospectuses must not be general in nature, but instead be specific to the issuer or the securities covered by the prospectus.
  • Materiality: Article 16(1) PR further specifies that the issuer must “assess the materiality of the risk factors based on the probability of their occurrence and expected magnitude of their negative impact…” to allow investors to understand the relative weights which should be attached to those risks. The PR provides that the issuer has the option to rate the relevant risk as low, medium or high (although our expectation is that issuers will avoid making a qualitative assessment in this way given the obvious increase in the risk of liability).
  • Mitigation: Article 16(4) required ESMA to develop guidelines on risk factors, which contain an interesting description of the balance between overuse of mitigation at the risk of underplaying the risk (on the one hand) and underplaying the mitigants which are in place, at the risk of overstating the risks and discouraging investment (on the other).

Risk factors invariably play an important role in any subsequent litigation, particularly where risks that have been identified have come to pass after the publication of the prospectus in question. The key battleground will often be whether the risk factors were sufficiently specific to have alerted investors.

For more information

Our Capital Markets colleagues have prepared a short and helpful webinar to highlight the key changes to the PR regime, which you can access via the link. This webinar is part of a series considering the developments in this area.

If you would like more detail on any of the above, or more generally about the key changes introduced by the PR, then please see below links to six short briefings prepared by our Capital Markets team. The briefings cover:

If you have any specific queries, please get in touch with one of the contacts below or your usual HSF contact.

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Harry Edwards
Harry Edwards
Partner
+44 20 7466 2221
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948

Herbert Smith Freehills contributes chapter to The Securities Litigation Review (5th Edition)

Herbert Smith Freehills have contributed the England and Wales chapter of The Securities Litigation Review. Now in its fifth edition, The Securities Litigation Review, edited by William Savitt of Wachtell, Lipton, Rosen & Katz, 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. Partners from our Australian offices have also contributed.

Harry Edwards leads our class actions practice in the UK. Feel free to contact him to learn more about our team.

Download Chapter

Reproduced with permission from Law Business Research Ltd.This article was first published in July 2019. For further information please contact Nick.Barette@thelawreviews.co.uk.

Previous Editions:

4th edition, 2018

3rd edition, 2017

Harry Edwards
Harry Edwards
Partner
+44 20 7466 2221

Shareholder class actions – new webinar and “handy client guide”

Herbert Smith Freehills has today released the third in our series of webinars on class actions in England and Wales, looking at shareholder class actions. In the presentation Simon ClarkeHarry Edwards and Kirsten Massey discuss the outlook for shareholder group actions in England and Wales, the types of claims (eg under sections 90 and 90A FSMA) and remedies likely to be pursued by shareholder group claimants, and some challenges in bringing and defending these actions. Clients and contacts of the firm can register to access the archived version by contacting Prudence Heidemans.

The webinar is accompanied by the fourth in our series of short guides to class actions in England and Wales, Shareholder class actions, which has been published here (together with our first three editions: (i) Overview of class actions in the English courts; (ii) Group Litigation Orders; and (iii) Data breach class actions).

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Harry Edwards
Harry Edwards
Partner
+44 20 7466 2221
 
Kirsten Massey
Kirsten Massey
Partner
+44 20 7466 2218

High Court orders Tesco to disclose SFO documents in s.90A FSMA shareholder class action

In a recent decision, the High Court has ordered that documents provided to Tesco plc (“Tesco“) by the SFO for the purpose of negotiating a deferred prosecution agreement (“DPA“) must be disclosed by Tesco in the separate civil action relating to the same subject matter, brought by its shareholders under s.90A of the Financial Services and Markets Act 2000 (“FSMA“): Omers Administration Corporation & Ors v Tesco plc [2019] EWHC 109 (Ch). The court reached this conclusion notwithstanding the fact that these documents were obtained by the SFO from third parties using its powers to compel the production of information/documents under s.2 of the Criminal Justice Act 1987 (“CJA“), and provided to Tesco during the DPA process on the understanding between the SFO and Tesco that the information they contain would be kept confidential.

This decision will be of significance to listed companies. It highlights the possibility that documents provided by third parties to the SFO (for example in connection with a criminal/regulatory investigation into false/misleading financial information published by a listed company), will become disclosable in any subsequent civil shareholder action. One can readily see the likelihood of follow-on civil proceedings in such circumstances.  There may also be read across value for documents produced to other regulatory or enforcement bodies in similar circumstances; although depending on the agency concerned there may be additional statutory restrictions on the disclosure or use of documents which come into play (for example s.348 FSMA in the context of an FCA investigation).

Where a live criminal investigation/prosecution is on foot, there may also be additional considerations relating to whether disclosure of documents could prejudice that investigation – in Omers, the court considered that a confidentiality club order, protecting the documents from entering the public domain until after the conclusion of the civil proceedings was sufficient to address the risk of prejudice to the criminal proceedings, but this may not always be the case.

Third parties who are compelled to provide documents to criminal/regulatory authorities should also take note of this decision and understand the potential for wider disclosure of such documents.

The judgment follows the recent decision in R (On The Application Of KBR Inc) v The Director of the Serious Fraud Office [2018] EWHC 2368 (Admin) in which the High Court held that the SFO was able to compel a foreign company to produce documents located outside the jurisdiction (see our banking litigation e-bulletin). Taken together, these cases suggest that the scope of documents obtained in regulatory and criminal investigations which may be obtainable by claimants in civil litigation may be increasing.

One risk arising from this decision is that, conscious that their evidence may no longer be truly confidential, people being interviewed may be less willing to speak freely and openly to investigators. Of course, where an interview is compelled then there will be no choice but to answer questions, but there is the potential for a chilling effect on witnesses, on voluntary interviews and on the provision of witness statements.  Preservation of confidentiality in regulatory investigations and criminal proceedings has long been viewed as being in the public interest and this decision calls those policy objectives into question.

Background

This judgment arises out of proceedings brought against Tesco by two groups of shareholders seeking compensation under s.90A FSMA in respect of losses allegedly suffered as a result of false and misleading statements made by Tesco to the market in the context of reporting its commercial income and trading profits (the “Shareholder Action“).

The same circumstances also led the SFO to pursue a criminal investigation into Tesco, its subsidiary Tesco Stores Limited (“TSL“) and certain individuals. This resulted in the DPA between the SFO and TSL in 2017.  Three individuals were also prosecuted, but later acquitted on all counts (see our corporate crime e-briefing on the DPA).

During its investigation, the SFO obtained documents, transcripts of interviews and witness statements from third parties (the “SFO Documents“). This material was obtained by the SFO by the use or prospective use of its powers to compel the production of information/documents under s.2 CJA.

The SFO provided these documents to Tesco for the purpose of negotiating the DPA, stipulating that they were provided “in confidence for the purpose only of providing legal advice in relation to the criminal investigation being conducted by the [SFO]“. The SFO Documents were therefore in Tesco’s possession and control for the purpose of disclosure in the Shareholder Action, and (as Tesco accepted) were caught by the test for standard disclosure in those proceedings.

Tesco was thus caught by two potentially conflicting obligations: the obligation of confidentiality to the SFO on the one hand, and the obligation to give disclosure in the Shareholder Action on the other.

The question before the court was:

  1. whether these documents should be disclosed to the claimants in the Shareholder Action, having regard to (i) the terms on which the SFO obtained the SFO Documents and (ii) the terms on which the SFO provided the SFO Documents to Tesco; and
  2. if so, whether any restrictions should be stipulated as to their retention and use.

The court heard submissions from the claimants, Tesco and the SFO, the latter acting in effect as a self-appointed amicus curiae in addressing the relevant legal principles. The court also had the benefit of a number of objections to disclosure of the SFO Documents received by the SFO from third party objectors (“TPOs“) from whom the documents were originally obtained.

Decision

The court held that the SFO Documents did fall to be disclosed in the Shareholder Action, notwithstanding the fact that these documents were obtained by the SFO from third parties using its powers to compel the production of information/documents under s.2 CJA, and provided to Tesco during the DPA process on the understanding between the SFO and Tesco that the information they contain would be kept confidential.

In reaching this decision the court considered: (a) the potential application of various provisions of CPR Part 31; (b) the corresponding test for disclosure under each provision; (c) the potentially different application of these tests between cases of private vs public confidentiality; (d) the balancing exercise to be carried out by the court; and (e) taking all of this into account, its conclusions on the facts of the instant case.

Applicable provisions of the CPR

The court noted that CPR Part 31 provides for (at least) three different circumstances:

  1. the position as between parties to the litigation (CPR 31.6 and 31.12 being of particular note);
  2. the position where third parties hold documents relevant to the litigation (CPR 31.17); and
  3. the position regarding the usage of documents disclosed in the litigation outside of those proceedings, also known as the ‘collateral purpose rule’ (CPR 31.22).

The court held that the instant case fell within category (1) above as the documents were in the possession or control of Tesco, so disclosure and production were sought from an existing party to the proceedings. As such, it held that CPR 31.22 and CPR 31.17 were not engaged.

Party to party disclosure

The court noted that in cases of party to party disclosure, “relevance is the prima facie test“.

In the court’s view, relevance was not of itself enough to override public or private interests in maintaining confidentiality, and confidentiality must always be assessed when considering an application for production of documents where a duty of confidentiality is owed to a third party. The court accepted that “[n]othing in the CPR overrides or dilutes the Court’s obligation to consider fairly … the strength and value of the interest in preserving confidentiality and the damage which may be caused by breaking it” (quoting from Science Research Council v Nassé [1980] AC 1028 at page 1067B-D). However, the court added that confidentiality in and of itself offers no ground for protection and the relevant question is “whether the overriding objective of dealing with the case justly and at proportionate cost can be secured without production of the relevant documents“.

In answering this question, the court made the following key points:

  • Although the court stated that the ‘necessity test’ (i.e. whether disclosure is necessary for disposing fairly of the proceedings in question) did not expressly apply to CPR 31.6 or 31.12, it accepted that the court may properly have regard to this test following the Court of Appeal decision in National Crime Agency v Abacha and others [2016] 1 WLR 4375. However, as per Abacha, the court noted that the ‘necessity test’ in this context was not a free-standing or exclusively determinative test but may be a relevant factor in striking a just balance.
  • Other factors to be considered include whether the same information is available from another source and whether a restricted form of disclosure would be sufficient.
  • If disclosure/non-disclosure of a document would likely be of litigious advantage/disadvantage to either of the parties, that may well outweigh or take precedence over other considerations.

Private vs public interest confidentiality

Having decided the relevant test to be applied in these circumstances, as outlined above, the court then explored the difference between where the confidentiality asserted is purely private (in which case it said the argument for disclosure is almost certain to take precedence) and where there is a wider public interest in the maintenance of confidentiality.

It was acknowledged that in relation to the facts of this case, “[i]mportant policy objectives are in play in the context of the use that may be made of documents obtained pursuant to the exercise by the relevant authorised body of powers of compulsion for the purpose of a regulatory investigation and/or criminal prosecution“. The court referred to the judgments in Rawlinson & Hunter Trustees v SFO [2014] EWCA Civ 1409 (Tchenguiz No 2) and Real Estate Opportunities v Aberdeen Asset Managers Jersey Ltd [2007] EWCA Civ 197, both of which highlighted the importance of preserving confidentiality in such circumstances.

Discretion of the court

The court emphasised that there is a difficult exercise in judicial judgment where confidentiality is asserted, because confidentiality (and the damage which may be caused by breaking it) and the objective to dispose fairly of a case are not commensurable.

However, it suggested that in the case of party to party disclosure – in cases where it is accepted that the documents are relevant – the balance is “very likely” to favour production (unless the same information is available from another source without disproportionate difficulty). That said, the court will seek to impose protections where appropriate to do so.

Exercise of discretion in the present case

The court was firmly of the view that it would not be just to deny the claimants production of the SFO Documents. The court considered separately the issues of public interest confidentiality in the context of documents obtained/created under compulsion, and private confidentiality.

(a) Public interest confidentiality

The court stated that the SFO Documents were “undoubtedly likely to contain material necessary for the fair disposal of the action” and that in such circumstances the public interest in confidentiality, “though usually of particular weight in the context of documents obtained by compulsion, must yield to the public interest in ensuring … as far as possible the courts try civil claims on the basis of all the relevant material and thus have the best prospect of reaching a fair and just result“.

The court noted the following points which it regarded as relevant in this context:

  • The SFO was entitled, even obliged, to release the SFO Documents to Tesco.
  • The duty of confidentiality imposed on Tesco by the SFO was expressed to be subject to a situation where Tesco was compelled by law or the court to provide disclosure.
  • The fact that the documents were only brought into existence because of the criminal proceedings and in the possession of Tesco through a “windfall” disclosure via the DPA process was irrelevant to the question of whether their disclosure was “necessary” for the fair disposition of the proceedings.
  • The SFO Documents were undoubtedly likely to contain material “necessary for the fair disposal of the action” and the claimants were likely to gain a litigious advantage by their production. The court expanded on this point, highlighting that the documents were likely to contain more, and more contemporaneous, evidence than would otherwise be available to the claimants and the court.
  • The SFO Documents formed part of an entire investigative process that should be looked at as a whole.

(b) Private interest confidentiality

Notwithstanding its finding that the SFO documents were disclosable, the court did acknowledge the objections raised by certain TPOs that some documents contained information that was private and confidential and irrelevant to the matters in issue. The court considered that it should be left to the relevant TPOs to identify what they regarded as truly private, confidential passages that could be redacted without undermining the substantive content of the document in terms of the issues in the proceedings. It allowed additional time to enable these TPOs to identify the discrete parts to be redacted.

The court considered separately the objections of the whistle-blower whose actions led to Tesco’s profit overstatements being revealed to the market. The SFO confirmed to the court that there were no special confidentiality protections for whistle-blowers in such a position. The court was minded to accept that safeguarding a whistle-blower’s privacy and confidentiality was a particularly “weighty” factor when exercising its discretion, but found that this did not prevent disclosure in the present case (where the identity of the whistle-blower was no secret and the argument that his evidence should be protected by confidentiality had been considerably eroded by his previous evidence in court).

Further restrictions

The court also asked for further submissions from the parties as to how the adverse consequences of disclosing the SFO documents could be mitigated by further restrictions (noting the restrictions applied in Frankson v Home Office [2003] 1 WLR 1952, such as a strict limitation on the persons to whom copies of the transcripts could be provided).

Harry Edwards
Harry Edwards
Partner
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Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948
 
Frances Furnivall
Frances Furnivall
Senior Associate
+44 20 7466 2405

High Court refuses declarations sought by trustee of unsecured notes as to amounts due and payable by issuer

In Part 8 proceedings brought by the trustee of certain unsecured notes, the High Court has refused to exercise its discretion to grant declarations as to the amounts due and payable by the issuer of the notes: The Bank of New York Mellon, London Branch v Essar Steel India Ltd [2018] EWHC 3177 (Ch). The court reached this conclusion notwithstanding the fact that the issuer was clearly in default under the notes, did not take any steps in the proceedings and was not represented before the court.

The decision offers some cautionary guidance as to the steps that those exercising corporate trustee functions might consider taking when applying for declaratory relief in relation to non-payment by the issuer of notes or other debt instruments. In particular, the court in this case found that:

  • In the absence of any evidence to confirm that other proceedings involving the issuer (an insolvency process in India) would not be affected by declarations made by the English court, the potential for those foreign proceedings to be affected was a factor that pointed clearly against the making of the declarations.
  • In circumstances where a third party who might be affected by the declarations (the insolvency professional in India) was not before the court and had been unable to make submissions, granting the declarations would amount to an “improper interference” in a foreign process being conducted by another party if the declarations were to affect the foreign process.

To the extent that the court appears to have taken a strict approach to the exercise of its discretion in this case, this may be explained by the court’s decision to adopt a “conservative mindset” against granting the declaration, because of the issuer’s non-participation in the proceedings. It is noteworthy that the court adopted this approach even though the issuer’s non-participation was not the fault of the claimant, and the claim was made under Part 8 and therefore did not turn on a factual dispute.

Background

The defendant (the “Issuer”) issued certain US Dollar 0.25% unsecured notes (the “Notes”), which were constituted under the terms of a trust deed dated 5 December 2003 (the “Trust Deed”). The claimant was the trustee (the “Trustee”) of the Notes.

The Trustee issued a Part 8 Claim in July 2018 seeking declarations against the Issuer as to the amounts due and payable in respect of the Notes. The Issuer took no step in the proceedings and was not represented at the hearing.

To determine whether the declarations sought should be made, the court said there were three questions to resolve:

  1. Did the Trustee have standing to bring the claim?
  2. Was the Defendant properly before the court, so that it could properly determine the substance of the Part 8 Claim?
  3. Was it appropriate to make the declarations sought by the Trustee?

Decision

Having found that the Trustee had standing to bring the claim and the Issuer was properly before the court (by service of the claim form on a service agent appointed under the Trust Deed), the court held that it would be inappropriate to make the declarations sought by the Trustee.

The court noted that the power to grant declaratory relief is discretionary (Rolls Royce plc v Unite the Union [2009] EWCA Civ 387). In exercising that discretion, the court said it was required to take into account justice to the claimant, justice to the defendant, whether the declaration would serve a useful purpose and whether there were other special reasons why or why not the court should grant the declaration (Finance Services Authority v Rourke  [2002] CP Rep 14).

The key reasons given by the court for finding that the declarations sought by the Trustee should not be made were as follows:

Both sides of the argument will not be put

The court said it was required to ensure that all those affected were either before the court or would have their arguments put before the court (Rolls Royce at [120](6)).

The court accepted that it would be “invidious and wrong” to allow a defendant’s non-participation in proceedings to prevent the making of declarations (particularly where this was not the fault of the claimant, and where the claim was made under Part 8 and did not turn on substantial disputes of fact – as here). However, where the defendant was absent, the court considered that it was required to approach the exercise of its discretion with “something of a conservative mindset against the granting of a declaration“.

Potential effect on a third party not before the court

The court noted that the Issuer was the subject of an insolvency process in India, but the effect of the instant proceedings on that insolvency process (and on the insolvency professional appointed in India) was unclear. There was no Indian law before the court to confirm the position.

The court found that the possibility of the insolvency professional being affected by declarations made in English court proceedings to which he/she was not a party was a factor that pointed clearly against the making of declarations.

The existence of a real and present dispute and the potential for interference in a foreign process

The court emphasised the need for a real and present dispute between the parties, which would be resolved by the making of the declaration.

The court found that it was “difficult to identify such a dispute as between the Trustee and the [d]efendant“, because although the Issuer was in default under the Notes, there was not a discernible dispute as to terms of the Notes or the Issuer’s obligations and it was not a case where the Issuer would pay if the declarations sought were made. It appeared to be a case where the Issuer simply could not pay and the granting of a declaration would not resolve the position in respect of the Issuer.

Further, the court understood that there were some points of dispute between the insolvency professional in India and the Trustee. As noted above, the court did not have evidence as to whether the declarations sought would affect the Indian insolvency process. However, if they did, then in the court’s view such declarations would amount to an “improper interference” in a foreign process being conducted by a party (the insolvency professional in India) who was not before the court and had been unable to make submissions. The court said this was not cured by the fact that the Indian insolvency process did not preclude claims for declaratory relief; and/or that the insolvency proceedings had not been recognised in this jurisdiction.

In light of the above, the court considered that it would be inappropriate to make the declarations sought by the Trustee and declined to do so.

 

Simon Clarke
Simon Clarke
Partner
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Ceri Morgan
Ceri Morgan
Professional Support Lawyer
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High Court finds duty of care owed by arranger of capital markets transaction to investors

Golden Belt 1 Sukuk Company BSC(c) v BNP Paribas [2017] EWHC 3182 (Comm)

In a decision which will cause concern to many who work in capital markets, the High Court has found that a bank arranging a publicly listed issue of debt securities owed a tortious duty of care to investors and that it breached that duty. The bank acted as the arranger of a sukuk (an asset-based Islamic financing transaction) and the duty found to exist was to ensure that a transactional document providing certificate holders with a claim against the underlying obligor (in the event of default by the obligor) was properly executed.

The imposition of the duty in this case was said to have been justified by the court on the basis that it was limited and specific, and because it was imposed following the application of established principles to the specific facts of the instant case. In that sense, the decision is capable of being distinguished in future cases or confined to its particular facts, and so it does not necessarily follow that it will provide a proper or firm basis on which to bring proceedings which require the imposition of a broader duty of care.

However, there is a risk that the judgment represents a novel extension of the law in the context of capital markets transactions. Until now, those advising on capital markets transactions have operated on the basis that – while there was a risk that an arranging bank may owe tortious duties to investors (which has typically been addressed by appropriately worded disclaimers) – this risk was relatively low in the absence of a precedent holding that such a duty existed.

The High Court has granted permission for the bank to appeal the decision. This is unsurprising, particularly given the novel duty of care established.

Although the decision is subject to an appeal, there are a number of immediate implications for financial institutions to consider:

  1. Disclaimers: Arranging banks might consider seeking the inclusion of an express disclaimer in offering circulars in relation to issues in certain jurisdictions negating any responsibility to ensure that transaction documents more generally are properly executed (as well as other more mechanical tasks), in addition to existing disclaimers.
  2. Risk and compliance: Arranging banks may look to take practical steps to minimise risk in relation to the execution of transaction documents – these may include physical signing meetings, insisting on the arranging bank’s international or local counsel being physically present at signing meetings, or perhaps the use of technology to provide virtual attendance at signings. However, there are likely to be difficulties in striking a balance, which can be applied on a consistent basis across different markets and jurisdictions, between efficient practice and over-engineered signing procedures, particularly where it is reasonable for arranging banks to assume that issuers and their representatives are acting in good faith.
  3. Coordination between an arranging bank, its local counsel and its international counsel: The case highlights the need for close coordination between these parties. Parties might additionally consider appointing separate international and local counsel for the issuer and the arranging bank to assist in the scrutiny of execution procedures, particularly under local laws (and thereby seek to protect against a finding of any breach of duty, if found to have been owed). In this case, it appears that neither the issuer nor the delegate had separate legal representation to the arranging bank and, while it is speculative to suggest so, it is possible that this may have influenced the court’s approach in attributing duties to the arranging bank, in the absence of separate issuer’s counsel.
  4. Mandate letters: Arranging banks may wish to consider changes to their standard engagement terms to define expressly their responsibilities to assist an issuer, and perhaps affirm that the responsibility for creating legal, valid and binding documents lies with the issuer (as it represents in the subsequent underwriting / subscription / purchase agreement) and, more generally, to review the allocation of responsibilities between arranging banks (and their counsel) and issuers (and their counsel).
  5. Condition Precedent Waiver: Arranging banks may wish to ensure that there is no discretion to waive the condition precedent that the documents have been duly executed.

It may be prudent for a financial institution performing the role of arranger for distressed credits to carry out a risk evaluation of its functions, to identify any functions on which investors might place reliance. This would include a review of the offering circular and any other documents in which the arranging bank is specifically named and have been made available to potential investors.

For a detailed analysis of the case and its implications, read our e-briefing.