This article sets out a summary of some of the key, recent court cases relating to institutional financial services, looks at some of the themes emerging and gives a view on the outlook for disputes in the sector.
It is no surprise that, as a result of the financial crisis, many investors and counterparties of institutional financial services businesses have found themselves with significant losses arising from the investments that they made in products such as complex financial instruments. It is also no surprise that the reaction of many of those investors has been to blame the financial institutions that created and sold those products and claim that they have been the victims of mis-selling.
Empirical data available from the High Court and the major arbitral bodies confirms that there is an increase in claims issued in the years following a recession. While the period following the market disruption in 2007/08 has been no different, the general consensus among practitioners is, first, that the increase in contentious activity in the UK has not been as dramatic as anticipated and predicted in the heady climate in the months following the collapse of Lehman Brothers in September 2008, and, secondly, that since the limitation periods for many potential claims have still yet to expire, it is unlikely that the level of contentious activity following 2007/08 will have reached its peak.
One reason for this is likely to be the decisions that have been issued in the relatively few major claims arising from failed investments that have been considered by the appellate courts in the past two years. This article sets out a summary of some of the most significant cases relating to losses suffered as a result of the 2007/08 financial market crisis and the possible consequences of those decisions for future claims.
Prior to considering those cases, it is worth mentioning two important recent Court of Appeal cases that have set the scene for the latest claims made by investors: Springwell Navigation Corporation v JP Morgan Chase Bank & ors  and Peekay Intermark Ltd & anor v Australia and New Zealand Banking Group Ltd .
While the claims in Springwell and Peekay arose from investment in Russian government bonds that defaulted in 1998 rather than from the events of 2007/08, the decisions are timely and they have become important precedents for the subsequent claims relating to losses suffered in structured products as a result of the financial market crisis.
In both cases, the court decided firmly in favour of the financial institution. The cases have very detailed decisions and have been the subject of a great deal of analysis. For the purposes of this article, it is sufficient to summarise some of the key principles that emerge:
- The court will be reluctant to find that banks and other financial institutions have a duty to provide financial advice to their clients, unless the client in question has specifically asked for that service and is prepared to pay for it.
- It will be more difficult for sophisticated investors in commercial transactions to succeed in a claim against a financial institution from which they purchased investment products. The court is likely to adopt a caveat emptor approach with the starting point being that sophisticated investors know and understand the risks that they are taking. In the words of Gloster J in the first instance Springwell decision referring to trading in sophisticated financial instruments: ‘Such markets are not for the uninitiated or the faint hearted.’
- A well-drafted non-reliance clause may mean that a party is contractually estopped from contending that actionable representations were made by another party to the contract. If the contractual documents say that the investor has not relied on any pre-contractual representations and that they have understood the risks of the investment, the scope for the investor to argue otherwise at a later date will be limited.
- The existence and scope of an advisory duty of care in tort is a pragmatic question and each case should be decided on its specific facts.
- Causation will play an important part in the overall analysis of any claim. In particular, consideration must be given to whether the claimant would have behaved differently if the correct advice had been given.
The remainder of this article looks at four of the most significant cases arising out of the financial markets crisis relating to failed investments. The first two cases concern claims of mis-selling of financial products and were determined very clearly in the light of the principles arising from Springwell and Peekay. The other two cases reflect two other current trends in litigation: disputes about priority of payment in failed structured investment vehicles (SIVs) and disputes where one party seeks to invoke the common law principle of unenforceable penalty clauses as a means to avoid a contractual obligation to make payment.
RECENT CASES CONCERNING FAILED INVESTMENTS
Titan Steel Wheels Ltd v The Royal Bank of Scotland (RBS) plc 
Titan was a claim for mis-selling brought post-Springwell. Titan executed a treasury mandate with RBS in December 1997, under which it originally purchased vanilla foreign currency contracts before moving on to purchasing structured products. In February 2004 RBS sent Titan new terms of business, which included provisions:
- stipulating that RBS was not providing advisory services and was providing an execution-only service;
- requiring Titan to take independent advice to ensure that it understood, among other things, the financial effects and risks of any transactions RBS undertook with or for it; and
- excluding RBS from liability, except for gross negligence, wilful default or fraud, for any decline in the value of investments purchased on Titan’s behalf or any errors of judgment.
The alleged mis-selling related to two currency swap products purchased by Titan in June and September 2007, the former of which was intended to replace three earlier products bought in February and March 2007 under which Titan had suffered losses.
The court considered three initial issues and found in favour of the bank on all three. Titan was not able to bring itself within the meaning of ‘Private Person’ within the Financial Services and Markets Act (FSMA) 2000 (Rights of Action) Regulations so as to bring a claim under s150 of FSMA 2000. It was unlikely that any corporate entity involved in financial trading could be a ‘Private Person’ and Titan’s business depended on some degree of currency trading. Further, RBS was not acting as an adviser to Titan, which purchased similar products from other banks, without classifying those relationships as advisory or advising RBS of the existence of the other products, which would enable it to provide informed advice. Titan’s financial controller had over ten years’ experience of sophisticated products and Titan was considered equally as sophisticated as RBS for the purposes of the transactions. Lastly, the non-reliance term in the revised terms did not breach the Unfair Contract Terms Act 1977. While non-reliance clauses, following Springwell, are capable of being exclusion clauses, in this instance the clause merely set out the parties’ respective responsibilities.
Cassa Di Risparmio Della Repubblica Di San Marino Spa v Barclays Bank Ltd plc 
In the most recent mis-selling claim to have been brought and lost by an investor against a bank, Cassa Di Risparmio Della Repubblica Di San Marino (CRSM) alleged Barclays had made fraudulent misrepresentations in selling certain Notes to it and in a subsequent restructuring of those Notes, and sought damages of €92m.
The Notes were described as AAA in accordance with the rating from an independent ratings agency. However, Barclays’ internal model indicated that the collaterised debt obligation (CDO) underlying the Notes had a greater probability of defaulting. When CRSM raised concerns about the credit risk of the Notes, Barclays agreed to restructure them at zero cost.
CRSM alleged that Barclays had misrepresented the rating of the Notes, the criteria for the restructuring and that they would make no profit from the restructuring. In addition to denying all of the claims outright on the facts, Barclays also relied on the non-reliance clauses in the contract and the inherent nature of CDO structures that the reference names populating the portfolio will have higher credit spreads relative to the coupon on any AAA tranche, as well as the standard industry practice of favouring higher spread names.
CRSM’s claims were comprehensively dismissed. The AAA rating relied on by CRSM was that provided by the ratings agency, which was prepared for different purposes than Barclays’ own internal rating. Further, the practices complained of were the basis of the CDO business. The statement that the restructuring was to be at zero cost meant only that CRSM would not have to pay any additional charge and it was unreasonable to expect Barclays not to make a profit. Barclays were also able to rely on the disclaimer whereby CRSM stated that it was capable of assessing and understanding the merits and risks associated with the Notes as preventing CRSM from bringing any such claim.
Re Sigma Finance Corporation 
Sigma relates to the order in which investors in a SIV could be paid out following the insolvency of the SIV under the terms of its repayment provisions. Sigma was an SIV established to invest in asset-backed securities and its assets were secured under a security trust deed. Under that deed, on the occurrence of an enforcement event, the assets were to be divided into short-term and long-term pools aimed at matching the amounts of Sigma’s short and long-term liabilities with assets of corresponding amounts, maturity and payment dates. If the assets were insufficient, then the pools were to be reduced proportionately and payments made pari passu. The deed also provided that, during the 60-day period for establishing the pools, any short-term liabilities falling due were to be discharged so far as possible using available assets.
In September 2008 Sigma became unable to honour the calls made on it and was put into receivership. The receivers applied to the court for determination of the correct application of the security trust deed with four interested parties representing classes of creditors in the insolvency. The major point of dispute was whether the clause providing for payment of short-term liabilities during the realisation period for the pools required those liabilities to be met from assets before the assets were split into pools, such that the amount of assets in each pool was reduced and effectively exhausted, or only from the short-term pool after the division had occurred.
The High Court and Court of Appeal both held that, although the outcome appeared unusual, the deed required the short-term liabilities falling due in the 60 days to be paid in full, reducing the pot for all other liabilities. The Supreme Court in only its second decision overruled the lower courts. Looking at the clause within the agreement as a whole, it was apparent that the scheme intended for distributions to be made pari passu in respect of each pool.
In effect, the court looked behind the apparent effect of contractual provisions to ensure that the position upheld was the one intended by the parties. It is also one of the few cases where any investors can be said to have prevailed in the courts in recent times, although it should be noted that any victory was at the expense of other investors and was somewhat pyrrhic given the proportion of the pari passu distributions to investments made.
BNP Paribas v Wockhardt EU Operations (Swiss) AG 
In April 2008 BNP Paribas (BNPP) and Wockhardt entered into several transactions subject to the International Swaps and Derivatives Association (ISDA) Master Agreement. These included a series of foreign exchange target redemption forwards, whereby Wochkardt agreed to buy from BNPP a certain amount of euros or dollars at a certain rate on a certain date. Wockhardt were due to make payments under these transactions on 30 December 2008 and 28 January 2009 but failed to do so. These payments were also not made in accordance with the notice to remedy given on 17 February 2009. Therefore, in accordance with the terms of the ISDA Master Agreement, BNPP called for the early termination of all outstanding transactions. BNPP demanded immediate payment of the early termination amount, comprising the amounts outstanding, default interest thereon and a close-out payment.
BNPP issued proceedings, which Wockhardt defended on the grounds that the early termination and close out provisions in the ISDA Master Agreement were penalties and as such unenforceable.
The court concluded that the provisions were not penal; the relevant clauses did not stipulate a specific amount to be paid to the non-defaulting party on termination, rather they provided a method of calculating what amount was payable and to whom. This could have resulted in a payment to the defaulting party (although it did not in this instance). The provisions ensured the parties received the appropriate benefit (or burden) on termination and not a windfall. Further, the parties had agreed that time was of the essence in relation to the payments to be made, making Wockhardt’s failure to pay in a timely manner a breach of a condition. The breach in this instance was therefore one serious enough to justify the early termination payment provisions to be relied on.
Had Wockhardt been successful in establishing that the provisions in the ISDA Master Agreement were penalties, the implications would have been vast and far reaching. As it is, this is simply another example of the court closing off avenues of claim for investors.
OUTLOOK FOR THE FUTURE
The cases considered above all demonstrate that the English courts will lean towards the concept of caveat emptor and will be reluctant to interfere with contractual bargains struck between commercial parties. Since the key decisions are at either Court of Appeal or Supreme Court level, it is reasonable to assume that this approach will not change in England. For an investor who has suffered loss to succeed in a claim, it will need to establish a set of circumstances that would take it out of the scope of the cases referred to above, such as fraud, a clear misrepresentation (knowingly made and relied on), negligence or breach of contract.
This article only sets out the approach of the courts of England and Wales exercising English law. The courts of other jurisdictions (particularly civil law jurisdictions) have, on occasions, adopted a more sympathetic approach towards investors. To the extent that an investor has the scope to select a forum, it is unlikely that it will exercise that choice in favour of the courts of England and Wales.
That said, even where an investor is restricted to English law and jurisdiction, in view of the scale of losses suffered following 2007/08, it is inevitable that claimants will continue to advance their claims and pursue creative arguments to distinguish their position from that in unfavourable precedents. While commercial factors will always come into play in driving settlement, in view of the binding authorities developing in the appellate courts, banks are likely to be emboldened and will defend claims where their in-house and external advisers take the view that they would, on balance, succeed at trial. In other words, product providers will be more inclined to call the bluff of an investor with a dubious claim.