Welcome to our quarterly update, in which we look at some of the recent highlights and developments in financial services and markets disputes, investigations and financial crime.
Of particular interest are the majority of the Court of Appeal's ruling that an entity can be held responsible in equity for a bribe paid by a third party even if unaware of the payment, and the Supreme Court overturning the much criticised Court of Appeal authority (from 1981) as to the situs of debts under Letters of Credit.
The High Court (Companies Court) has recently provided guidance as to the meaning of material which "evidences" the substance of legal advice for privilege purposes, filling a gap left by the Court of Appeal in Three Rivers.
In a judicial review of the jurisdiction of the Financial Services Ombudsman, the Administrative Court has ruled that the jurisdiction does not extend to complaints about a financial institution's handling of a redress scheme as part of a Skilled Person review under Section 166 FSMA.
Finally, the Supreme Court has changed the test for dishonesty by unanimously ruling that the subjective element under R v Ghosh, namely whether a Defendant appreciates that what he or she has done is dishonest by the objective standards of ordinary decent people, is no longer required.
Bank’s inability to enforce derivative contracts due to unknown bribe
In UBS AG (London branch) and others v Kommunale Wasserwerke Leipzig Gmbh and others,  EWCA Civ 1567, a majority of the Court of Appeal found that the Appellant Bank (the Bank) was responsible for a third party's bribe in equity, despite being completely unaware of the bribe. On the facts, whilst the third party had not been acting as the Bank's agent, the Court of Appeal considered that the Bank had assisted the third party in procuring customers for the Bank. Accordingly, the first instance judge had been right to grant rescission of derivative contracts between the Bank and its customer (the Respondent German municipal water company) on the grounds of bribery and conflict of interests, though not on the basis of agency.
The Respondent had been persuaded to enter into derivative transactions by financial advisers, Value Partners Group AG (VP), assisted by a substantial bribe (USD $3m) paid to one of the Respondent’s managing directors. The Bank had entered into an arrangement to work with VP, whereby VP would advise its clients to enter into such transactions with the Bank, regardless of whether it was in those clients' interests to do so. This arrangement was not disclosed to VP's clients, and was, therefore, likely to generate significant profits for both the Bank and VP.
Importantly, on the evidence, the Bank did not have knowledge of the bribe and having assessed the relationship between the Bank and VP, the Court of Appeal overturned the first instance judge's finding that the bribe was paid by VP as an agent of the Bank. However, the Court of Appeal decided that the Bank had undermined the fiduciary relationship between VP and its clients by virtue of its undisclosed arrangement with VP, and it would be unconscionable for the Bank to be able to enforce the derivative contracts as against the Respondent.
This majority decision has extended the scope of a party’s responsibility for third party bribes, where previously actual knowledge was required. The decision also exemplifies the practice of courts to engage equitable principles in order to avoid what might otherwise be perceived to be an unfair and unjust outcome.
The “intermediate” duty of care owed by banks to retail customers
In Thomas & Another v Triodos Bank NV  EWHC 314 (QB), it was held that banks which voluntarily sign up to a code of conduct can owe an “intermediate” duty of care to their customers. This “intermediate” duty extends beyond the general duty not to misstate or mislead, but is not as wide as the duty of care owed when providing advice.
The Claimants, who were partners in an organic farming business, had taken out two variable rate loans (the Loans) with the Defendant Bank. In the summer of 2008, the Claimants decided to change the variable rate of interest on the Loans to a 10-year fixed rate. Following the sudden drop in interest rates resulting from the 2008 financial crisis, the Claimants found themselves tied to rates that were well above market rates. When they approached the Bank to redeem the Loans early, they learned that the early redemption penalties were far greater than the £10-20,000 which they had understood would be payable, at the time they had taken out the Loans. As a result, the Claimants brought proceedings against the Bank for breach of duty of care and misrepresentation.
Significant to the case was the fact that the Bank had voluntarily signed up to the Business Banking Code (the BBC) which included a “Fairness Commitment” that, if the Bank were asked about a product, it would give the customer a balanced view of the product in plain English, with an explanation of its financial implications.
It was found that, when providing information about its product, the Bank’s duty of care to the Claimants extended beyond the duty not to mislead or misstate facts (see Hedley Byrne & Co Ltd v Heller & Partners Ltd,  AC 465). In the course of arranging the fixed rates of interest, the Claimants enquired about penalties on early redemption of the Loans. The Bank provided information, but failed to provide a full picture of the early redemption penalties payable, leading to a misunderstanding on the part of the Claimants. It was held that the Bank had assumed responsibility for abiding by the BBC principles. Therefore, whilst the Bank was not under a duty to advise about the fixing of the rates, it owed the Claimants an intermediate or “information” duty to explain the financial implications of terminating the fixed interest rates before the end of the term of the Loans, and it failed to discharge that duty.
Supreme Court restores situs of debts under Letters of Credit to place of debtor’s residence
In Taurus Petroleum Limited v State Oil Marketing Company of the Ministry of Oil, Republic of Iraq  UKSC 64, the Supreme Court considered and reversed previous Court of Appeal authority on the situs of a debt under a letter of credit (see Power Curber International Ltd v National Bank of Kuwait SAK  1 WLR 1233). The Supreme Court held unanimously that the situs under English law is the place where the debtor, which is to say the issuer, resides, and not where the debts are due to be paid.
In February 2013, the Claimant Swiss oil company, Taurus Petroleum Limited, received a final arbitral award of USD $8,716,477 against the Defendant, the State Oil Marketing Company of Iraq. The Defendant did not pay its debt. At the same time, Shell was in the process of acquiring two parcels of crude oil from the Defendant, paid for by letters of credit (L/Cs) issued by the London branch of Crédit Agricole. Under the L/Cs, payment was to be made to an account designated the “Oil Proceeds Receipts Account”, held by the Central Bank of Iraq at the Federal Reserve Bank in New York, in favour of the Defendant.
The Claimant applied for a third party debt order in the English Court to recover the funds due to the Defendant under the L/Cs. The Defendant argued that the debt under the L/Cs was situated in New York, where payment was due, and that the English Court had no jurisdiction to hear the claim.
A majority of the Supreme Court held that it is an established principle of English law that the situs of a debt is where the debtor resides (in this case, England), which is also the location where the debt can be enforced. There was no reason to treat a debt owed under a letter of credit differently from any other debt for this purpose. Lord Clarke also noted that the Power Curber decision had been received with “no enthusiasm” by the authors of the relevant practitioners’ text (Dicey & Morris on The Conflict of Laws).
This judgment is a welcome decision which brings consistency and certainty to the question of the situs of debts.
English law purchase agreement provides investor protection in financing under Shari’a Law
In Dana Gas PJSC v Dana Gas Sukuk Limited and others  EWHC 2928 (Comm), concerning the Islamic financing of Dana Gas, the Commercial Court held that a purchase undertaking governed by English law is valid and enforceable even though the other documents constituting the related sukuk certificates (which were governed by UAE law) may be unlawful and unenforceable.
The Claimant had borrowed money through the issue of sukuk certificates by the First Defendant, Dana Gas Sukuk Limited, a special purpose vehicle set up for the financing. Sukuks are widely-used certificates issued where the intention is to raise money for an investment made in a manner compliant with Shari’a law.
The other Defendants included financial institution certificate holders, whose investments were protected in part by a purchase undertaking agreement whereby, on the occurrence of certain specified events, the Claimant undertook to purchase the assets (held by the issuer SPV) that generated funds for the repayments under the certificates. The idea behind the undertaking was to protect the principal value of the certificate holders’ investment.
The Claimant sought a declaration that the purchase undertaking was not enforceable on the basis that it had the effect of guaranteeing to the certificate holders a return from their investment by removing the risk of the loss of capital. This was said to be inconsistent with the prohibition of riba in Shari’a law, to which the law of the UAE gives effect. This argument was rejected by the Court, which held that the purchase undertaking was governed by English law and was prima facie valid, even if it would be regarded as invalid under UAE law.
The outcome of this case will be greeted with relief by many, as it confirms that English law governed Shari'a financing documents can be relied on. The case confirms that sukuk documentation, which is widely used in the market, puts the risks associated with a transaction being ruled impermissible under the Shari'a squarely with the parties seeking finance, not with the investors holding sukuk certificates.
Court clarifies scope of legal advice privilege
In the case of Edwardian Group v Singh  EWHC 2805 (Ch), the High Court (Companies Court) has clarified the scope of legal advice privilege beyond (i) communications containing the legal advice itself, or (ii) documents “reproducing, summarising or paraphrasing” that advice.
In Three Rivers DC v Bank of England (No. 5)  QB 1556, the Court of Appeal made it clear that legal advice privilege also extended to material which “evidences” the substance of legal advice, but did not need to consider this aspect further (at  and , per Longmore LJ).
Departing from the previous High Court authority in Financial Services Compensation Scheme Ltd v Abbey National Treasury Services plc  EWHC 2868, Mr Justice Morgan endorsed the approach in Lyell v Kennedy (No 3) (1884) Ch D 1 and Ventouris v Mountain  1 WLR 607 in finding that documents which would give the other party “a clue to the advice given by the solicitor” or which betray “the trend of the advice” can also attract legal advice privilege. However, he qualified this extension of privilege to cases where there “is a definite and reasonable foundation in the content of the document [to allow] for the suggested inference as to the substance of the legal advice”, rather than mere speculation as to the existence or content of that advice.
On the facts of Singh, an application was made to dispute the heavy redaction of various documents concerning the Petitioners’ attempts to secure a litigation funding agreement. The Respondents’ case was that the redactions prevented them from challenging assertions made by the Petitioners as to their efforts to secure funding. In dismissing the Respondents’ case, Mr Justice Morgan found that the Petitioners’ solicitor had been entitled to make the redactions as the information which had been withheld tended to reveal advice received in relation to “the merits of the case, in relation to strategy and tactics and in relation to the funding itself” (for example, terms as to settlement under the Funding Agreement which may have been useful to the Respondents’ strategy).
In the event of an appeal, the Court of Appeal will be required to provide complete guidance as to the precise scope of legal advice privilege, which may be wider than recent case law suggests.
Compulsory jurisdiction of the Financial Ombudsman Service did not extend to Bank’s handling of a redress scheme for misselling
In R (on the application of Mazarona Properties Ltd) v Financial Ombudsman Service  EWHC 1135 (Admin), it was held that a complaint about a bank’s withdrawal of a redress offer to a customer did not come under the Financial Ombudsman Service’s (FOS) compulsory jurisdiction under Section 226 of the Financial Services and Markets Act 2000 (FSMA). This was because the complaint was not about a redress scheme as defined in Section 404 FSMA, nor was it a complaint about the provision of, or failure to provide, a regulated financial service.
Allied Irish Bank (AIB) entered into three loan agreements with three associated companies (the Claimants). Each loan agreement contained a requirement that the Claimants hedge the full amount of each loan. The Claimants entered into the required interest rate hedging products (IRHPs).
In July 2012, as part of a wider industry exercise mandated by the then Financial Services Authority (FSA), AIB entered into an agreement with the FSA under which AIB agreed to review the sale of IRHPs, and an independent Skilled Person was appointed pursuant to Section 166 FSMA.
AIB subsequently made an initial offer of redress to the Claimants relating to the sale of the three IRHPs, but later withdrew that offer. The Claimants made a complaint to the FOS regarding AIB’s decision to withdraw its offer. The FOS decided that it could not consider the complaint as AIB’s review process did not fall within the scope of its compulsory jurisdiction under Section 226 FSMA. The Claimants sought to challenge that decision by way of judicial review.
The Administrative Court dismissed the claim and upheld the FOS’ decision. In reaching its conclusion, the Court considered the scope of the FOS’ compulsory jurisdiction as contained in Section 226 FSMA and the FCA’s Dispute Resolution: Complaints Sourcebook. The Court drew a distinction between: (i) AIB’s activity in selling the swaps which was a regulated activity and was, therefore, capable of falling within the FOS’ compulsory jurisdiction; and (ii) the review and redress process by AIB which was not a regulated activity and so could not give rise to a freestanding complaint about the manner in which it was conducted. It followed that the Claimants’ complaint to the FOS about the handling of their complaint by AIB was not a complaint about the provision of, or failure to provide, a financial service and, therefore, fell outside the FOS’ compulsory jurisdiction.
This decision makes it clear that where a customer is dissatisfied with the conduct of a review of the sale of IRHPs under one of the many Section 166 reviews by financial institutions instigated by the FCA, the customer cannot complain to the FOS. The customer may only complain about the conduct of the sale of the IRHP(s), regardless of the decision made in the relevant review about that sale.
The evolving role of the compliance function in wholesale banks – FCA report
The FCA has recently published a report on the compliance function in wholesale banks. The report summarises the results of a questionnaire which was sent to a number of banks asking for information about their compliance function.
The FCA observes that a key theme arising from the responses to the questionnaire is that compliance functions need to evolve in response to a changing operating environment. This includes regulatory developments, advances in technology and the expanded range of controls used by the front office.
The report notes that the compliance function is evolving into an independent, second line of defence risk function with higher headcounts and a higher profile within firms (with compliance representatives increasingly being added to boards and governance committees). In order to assist firms in defining the responsibilities of the compliance function, the FCA recommends that firms consider how the function interacts with other second and third line of defence functions.
The report also emphasises the importance of ensuring that compliance functions balance their role as an adviser to the front office with their role of providing challenge to the front office.
The report lists the key questions which the boards and senior management of firms may wish to consider in assessing the extent to which enhancements are required to their compliance function. Firms are not required to take any specific action in response to the publication but the FCA is likely to expect relevant firms to take note of the report and its key observations.
Proposal for new disclosure regime in the Business and Property Courts
A disclosure working group set up last year, chaired by Lady Justice Gloster, has published its proposals for reforms to the rules governing disclosure of documents in English litigation, as a result of concerns within the industry over its excessive costs, scale and complexity. The proposed scheme is expected to be submitted to the Civil Procedure Rules Committee for review and approval in March / April 2018, to be published and commenced as a two-year pilot in the Business and Property Courts thereafter.
After extensive discussion about policy, practice and technology, the working group identified key defects in the current disclosure regime, including: (i) the vast increase over the past 18 years (since the CPR came into force) of the volume of data that may fall to be disclosed; (ii) the lack of use of the broad menu of disclosure options available under the Jackson reforms; (iii) the need for the rules, which were based on paper disclosure, to be updated to cater for electronic data; (iv) the failure of disclosure orders to focus on the issues; (v) the inadequate engagement by the parties before the first CMC in relation to disclosure; and (vi) searches often being far wider than is necessary.
The unanimous view of the group was that a wholesale cultural change is required and that this can only be achieved by the establishment of a completely new regime. In very broad terms, the proposal is that there would be no automatic entitlement to search-based disclosure and the Court would only make an order for what is to be termed “extended disclosure” if there has been full engagement between the parties before the CMC. An order for extended disclosure would be restricted to the issues in the claim. The new approach is designed to be more flexible than the current CPR Part 31 and to reflect developments in technology.
Prior to the review in March / April 2018, further consultation and feedback on the proposals will be sought from the judiciary and professional associations, as well as end user groups in London and the circuits on an open forum basis.
The November 2017 announcement can be accessed here.
35 years after Ghosh: a new dishonesty test in English law
Should a defendant’s failure to comprehend that his or her actions may be objectively dishonest absolve him or her from being judged dishonest in law? In a landmark decision, Ivey v Genting Casinos (2017) UKSC 67, the Supreme Court unanimously decided that the answer is no, it should not, overruling the Court of Appeal’s decision, in R v Ghosh (1982) EWCA Crim 2, which had set a subjective standard for dishonesty in criminal law.
The test under Ghosh had two limbs: (i) whether the conduct complained of was dishonest by the standards of ordinary reasonable and honest people; and (ii) whether the defendant must have realised that ordinary honest people would regard his / her behaviour as dishonest. In Ivey, the Supreme Court did away with the second subjective limb of the Ghosh test, deeming the defendant’s perception of his / her conduct irrelevant.
Lord Hughes, delivering the sole judgment in Ivey, discussed at length case law which had looked at the relationship between the objective-subjective elements of the dishonesty test, and concluded that the second limb of the Ghosh test did not correctly represent the state of the law. Whilst there is a subjective element to the dishonesty test, it is not determinative. The Court must first ascertain, subjectively, the actual state of the defendant’s knowledge or belief as to the facts. This belief need not be reasonable; the question is whether it is genuinely held. However, once his or her actual state of mind as to knowledge or belief as to facts is established, the question whether the defendant’s conduct was honest or dishonest is to be determined by applying the objective standards of ordinary decent people. There is no requirement that the Defendant must appreciate that what he or she has done is, by their standards, dishonest.
The decision in Ivey is to be welcomed, simplifying the test for dishonesty and bringing consistency across the test applied in both civil and criminal law.