It is inevitable that in such a dramatic, and fast changing, economic landscape, commercial counterparties are urgently considering whether and how they can protect their rights by litigation. Some of the issues arising will be considered by the Courts for the first time. Much of the documentation which is currently giving rise to issues has never been "stress-tested" and the circumstances in which it is now required to respond were never envisaged at the time the particular transactions were written. It is equally inevitable that the scope, nature and scale of contentious issues is developing and changing fast, and this will continue to be the case over the next several months at least.

To give an indication of the breadth of issues which are currently giving rise to claims:

Prime brokerage agreements

The key question for prime brokerage clients (and indeed other banks) in relation to commingling is whether the client retains title to assets lodged with the bank as security for ongoing transactions. Given that a major part of the bank's revenue from offering prime brokerage services is derived from lending the securities which they held on behalf of clients, clients either had to take a credit risk on the bank, or retain title to the assets. The effect of such agreements, and the practicalities of seeking the return of affected assets is bound to be considered in several claims. RAB Capital was quick to launch proceedings in the High Court, though disappointed that the Court declined to consider the claim on an urgent basis, indicating that it fell to be dealt with in the ordinary course of the administration of Lehman Brothers. For a fuller briefing on this important case, please click here.

Return of Collateral

In New York, Texas billionaire T. Boone Pickens sued Lehman Brothers Holdings Inc for $59.9 million alleging that he was owed collateral provided in respect of derivative transactions terminated as a result of the Lehmans bankruptcy. Bank of America Corp has brought claims against various Lehman companies claiming $500 million on the same basis.

Material Adverse Change

Hexion Specialty Chemicals Inc had sued in the Delaware Courts to be released from a $10.6 billion deal to buy Huntsman Corporation. Relying on Huntsman's increased net debt and lower-than-expected earnings, Hexion argued that it was not liable for any damages or break-up fee because there had been a material adverse change at Huntsman, and that the capital structure contemplated in the merger would leave the combined entity insolvent, making lenders for the deal unlikely to fund it. . Though not particularly new, the decision raised a number of points:

  • Corporate acquirers are assumed to be purchasing as part of a long term strategy (absent evidence to the contrary). 
  • The burden of proving material adverse effect rests on the party seeking to excuse performance under the contract (in the absence of clear language to the contrary). 
  • EBITDA is a better benchmark than earnings per share because it is independent of capital structure 
  • The agreement disclaimed any representation as to performance save as to performance between signing and closing 
  • Under the terms of the merger agreement, material adverse effect was to be determined based on an examination of Huntsman as a whole (poor performance in two divisions representing no more than 25% of Huntsman's EBITDA did not materially change Huntsman's business as a whole). 

The Court's order required specific performance of all Hexion's covenants and obligations under the merger agreement, other than the obligation to close. If all other conditions to closing are met, Huntsman must then call on the lending banks to perform their funding obligations, and at that point, the banks will either fund or refuse to fund the merger. If the banks agree to fund, Hexion will have to decide whether to close, or to refuse to close, and subject itself to an additional finding of knowing and intentional breach of contract and uncapped damages. The Court took the view that any determination of solvency is only relevant at or as of closing, and declined to resolve the question of whether the combined entity would be solvent or not.

Injunctive relief

Citigroup sought to prevent Wells Fargo from acquiring Wachovia, basing its claim on Wells Fargo's alleged interference in a deal which had been struck by Citigroup and which Wells Fargo then sought to better. On 4 October, Citigroup obtained an order blocking the deal pending a hearing on 10 October; Wells Fargo then persuaded a Federal District Court judge to hold a hearing on 7 October, and an appellate court judge to overturn the initial restraining order. Fed officials intervened to help mediate the matter, and Citigroup ultimately agreed to walk away from the deal.

Meanwhile, the Huntsman Corporation sought temporary and permanent injunctive relief against the lending banks which had agreed to provide the financing for Hexion's proposed merger with Huntsman. The court granted a temporary injunction, requiring the banks to forebear from any action that could reasonably be expected to materially impair, delay, terminate, or prevent consummation of the financing contemplated by the agreement between the banks and Hexion. 

Misrepresentation and Negligent Advice

It was completely predictable that with the economic downturn and investments proving to be far less profitable than had been hoped, claims for misrepresentation and negligent advice would follow. Cassa di Risparmio dell Repubblica di San Marino SpA, a long established bank in San Marino, has sued Barclays Bank plc and others in London claiming that Barclays owed it a duty to advise and that it induced it to purchase notes "including a highly complex and opaque CDO component" by various misrepresentations. We have said before that the fact that claimants are able to plead claims such as these is in no sense an indication that they will succeed. There are many complex factual and legal issues which will have to be played out. Moreover, since all such litigation is heavily fact dependent, early decisions in some claims, whilst helpful overall in terms of precedent, are unlikely to be determinative.

Icelandic issues

On 8 October 2008, powers granted to the Treasury under the Anti-Terrorism, Crime and Security Act 2001 (the "Act") were used to freeze certain assets under the Landsbanki Freezing Order 2008 (the "Order"). Despite its title, the Act covers a range of provisions and allows the Treasury to make a freezing order if action has been or is likely to be taken to the detriment of the UK economy by a government and/or a resident of a country outside the UK. The Treasury argued that the proposed nationalisation of Landsbanki was likely to be to the detriment of the UK economy. .It remains to be seen whether the governments' use of these powers will be challenged.

In the wake of the Order¹, consideration is being given to the other options available to local authorities to reclaim sums placed on deposit in Icelandic banks. For example, if the initial deposit had been made ultra vires, the contracts between the local authorities and the banks would be void ab initio and would potentially allow both parties to such contract to rely on the doctrine of restitution to recover sums. However, leading cases in this area such as Hazell v Hammersmith and Fulham LBC [1991] involved entry into unusual transactions such as swaps arrangements, whereas the local authorities in the present case simply appear to have placed sums on deposit. Unless the decision to invest in these institutions could be shown to be perverse, it is very unlikely to be ultra vires. In any event, it is not obvious how a judgment in the present circumstances could assist the councils in terms of their priority as a creditor in any insolvency.

On the hand, councils could, in theory at least, face claims for damages on the basis of their improper conduct. LGA spokesman Edward Welsh indicated that the councils had been told by the Government that the Icelandic banks had been given a "double A" rating. If this was an accurate rating at the time the investments were made, there seems unlikely that the councils acted improperly by placing the monies on deposit. In any event, by 27 March 2008 the credit default swap market priced the cost of insuring Icelandic bank debt at a level that suggested imminent and/or unavoidable bankruptcy. It might be argued that local authorities should have recognised the increased risk and withdrawn funds at this time (as various individual investors did in the wake of adverse publicity). If the councils have acted improperly in making or maintaining the deposits, this might give rise to claims against local authorities or local authority employees by council taxpayers on the basis (for example) of an increase in council tax resulting from the lost sums. Council tax payers would however need to show that a duty of care was owed to them or that there was a breach of any fiduciary duty which might be owed - this would not be straightforward. In any event, the end result of any such claims could be circular - damages payable by the local authorities might ultimately be reclaimed again through an increase in council tax, unless there were insurance arrangements in place which covered such claims.