In keeping with recent litigation trends, many of the important banking cases that reached the courts in 2013 concerned allegations that investors had been mis-sold financial products.
In Graiseley Properties Ltd v Barclays Bank Plc and Deutsche Bank AG v Unitech Global Limited and Deutsche Bank AG v Unitech Limited the Court of Appeal gave permission to two parties in two separate mis-selling cases (which were conjoined on appeal) to amend their pleadings to include allegations that implied representations had been made by the banks as to the accuracy of the London Interbank Offered Rate (Libor). Both Barclays and Deutsche Bank are on the panel of banks that make submissions used in the calculation of Libor ( EWCA Civ 1372)).
In the first of the cases conjoined on appeal, Graiseley claimed that it had been mis-sold an interest rate swap which it had been required to enter into as a condition of obtaining lending from Barclays. The interest rate swap referenced Libor. After regulatory sanctions had been imposed on Barclays for its role in the manipulation of Libor, Graiseley applied to amend its particulars of claim to allege implied representations by the bank in respect of the accuracy and non-manipulation of Libor. The judge at first instance allowed the amendment to be made and Barclays appealed this decision ( EWHC 3093 (Comm)).
In the second of the cases conjoined on appeal, Deutsche Bank had brought a claim against Unitech for payments owed under a credit facility and an interest rate swap. This interest rate swap also referenced Libor. After having filed its defence, Unitech had applied for permission to amend its defence and counterclaim to include implied representations by the bank about Libor. The judge at first instance refused to allow Unitech to amend as he considered that Unitech's pleas had no prospect of success since no representation had been made as to how the Libor figure was calculated ( EWHC 471 (Comm)). Unitech appealed this decision.
The Court of Appeal unanimously considered that, in both cases, the proposed amendments were at least sufficiently arguable as to have a reasonable prospect of success at trial. Consequently both appellant parties were granted permission to amend their pleadings to include allegations that the banks had made implied representations as to the accuracy and non-manipulation of Libor. In reaching its decision, the Court of Appeal held that, since the banks had proposed Libor as the reference for the swaps, it was at least sufficiently arguable that they had represented that their participation in Libor was honest.
In the absence of a successful appeal to the Supreme Court, the banks will be required to respond at trial to allegations that they had in fact made implied misrepresentations about the accuracy of Libor. While it will be for the judges in the respective trials to decide whether the allegations have merit, the case will be of significance for all Libor-submitting institutions given that the implied representations were allowed to be included in the pleadings without limitation.
Conduct of business rules
During 2013 the Commercial Court and the Court of Appeal handed down judgments in three mis-selling cases that concerned the application of the rules in respect of suitability of investment advice contained in the FSA's conduct of business rules. Although the cases before the Court of Appeal concerned the Conduct of Business (COB) rules which are no longer in force (having been replaced in 2007 by the Conduct of Business Sourcebook (COBS), those decisions are nonetheless likely to signal the approach that the courts will take in respect of suitability cases under the new regulatory regime.
In Zaki and ors v Credit Suisse (UK) Ltd, the Court of Appeal upheld the trial judge's finding that the sale of 10 structured notes to a wealthy investor was suitable despite the significant amount of leverage used. The trial judge had concluded that the recommendations to invest in the first seven structured notes were suitable under COB 5.3.5R (the judge found that the final three notes were not suitable but as the investor would have bought them anyway there would have been no causative link between sale and the investor's losses). The claimants appealed in respect of the first seven notes alleging that the bank had breached the requirements under COB 7.9.3R to assess the investor's financial standing and to take reasonable steps to ensure that any lending was suitable. The claimants alleged that these requirements were in addition to that under COB 5.3.5R to take reasonable steps to ensure that recommendations on the transaction as a whole were suitable.
The Court of Appeal held that the suitability tests in COB 5.3.5 and COB 7.9.3 were not the same, but found that the COB 7.9.3 test was effectively encompassed within the wider COB 5.35 test. The Court of Appeal rejected the notion that any failure of process or breach of COB would automatically render the bank liable for all losses. The obligation on banks in these circumstances is to take reasonable steps to ensure the suitability of recommendations, not an absolute requirement to ensure suitability ( EWCA Civ 14).
In Green and Rowley v Royal Bank of Scotland Plc, the Court of Appeal found that the fact that the COB rules existed did not, in the case of non-advised transactions, create a co-extensive duty of care at common law. The Court of Appeal rejected the appellants' attempts to widen the category of the claimants who can bring a private claim for breach of COB (and by extension COBS).
Green and Rowley had appealed the trial judge's dismissal of their claim that RBS had breached its duty of care in respect of an interest rate swap hedge. The appellants were time-barred from bringing an action for contravention of COB under Section 150 FSMA 2000 (now s.138D) and instead argued that a breach of statutory duty was actionable as a breach of a concurrent duty of care under common law in circumstances where the purpose of the statute was to provide protection to a class of individuals.
The Court of Appeal dismissed the appeal and held that it was not justifiable to impose a common law duty of care on the bank to advise about the nature of the risks inherent in the transaction, as this would impose duties beyond the intention of the legislation ( EWCA Civ 1197). The position in respect to advised sales is left unaffected by this judgment which was made in relation to a non-advised transaction. Although not entirely clear, it seems likely that in the context of an advised sale, even if common law and regulatory standards are not co-extensive, the courts will construe the common law duty of care in tort by reference to the relevant regulatory standards.
In Al Sulaiman v (i) Credit Suisse Securities (Europe) Ltd and another the Commercial Court dismissed a high value mis-selling claim brought by a wealthy individual for losses arising from leveraged investments in structured products. The court found that the investor had failed to prove that she had not been informed of the risks involved in investing in structured notes using leverage and that since the investor had ignored her adviser's recommendation to meet the margin call, she was unable to establish causation.
In common with the facts in Zaki v Credit Suisse (discussed above), the investor had suffered losses arising from a margin call made by the bank in October 2008 which resulted in a forced sale of the investor's structured notes. The investor had alleged that her losses had been caused by, among other things, breaches of the explanation of risk and suitability requirements under the conduct of business rules.
On the facts the court found that there was no breach of statutory duty by the bank which had provided adequate explanations of the risks associated with leverage and had taken reasonable steps to ensure that these were understood by the investor. Following the approach in Zaki v Credit Suisse, the court held that if an investment is in fact suitable for an investor, then it does not follow that this can be rendered unsuitable under the conduct of business rules merely because there has been a failure of process ( EWHC 400 (Comm)).
In one of the largest claims in the Commercial Court's history, Deutsche Bank AG v Sebastian Holdings Inc, the court provided useful guidance on the nature of FX prime brokerage and the services to be provided by a prime broker. The bank had brought a claim for FX and equities trading debts of Sebastian, an entity controlled and owned by a Norwegian billionaire. Sebastian counterclaimed for loss-making FX transactions placed through the bank's prime brokerage platform and for losses arising from FX positions placed on Sebastian's behalf by its owner. In addition, Sebastian counterclaimed for $8 billion in consequential losses.
The judge held that, in the absence of a contractual agreement to the contrary, the prime brokerage function did not involve the giving of advice and was essentially a clearing function providing basic information for reconciling trades. The judge refused to imply a term into the prime brokerage agreement that a prime broker owed a duty to use reasonable skill and care to ensure that each transaction was booked, valued and recorded accurately. Sebastian has applied for permission to appeal ( EWHC 3463).
In Torre Asset Funding Ltd v Royal Bank of Scotland Plc the court provided guidance that will be of interest to financial institutions that act as agent in lending transactions. The court was asked to rule on the scope of the duties of an agent bank in a structured finance transaction involving a property investment portfolio.
Torre Asset had argued that RBS was under a duty to provide it with information (including notifications of events of default) which may have allowed it to understand the financial difficulties facing the company RBS was acting as agent for. On the facts, the court found that the limited duties of the agent were as defined in the transaction documents ( EWHC 2670).
The judgment handed down by the Commercial Court in Första AP-Fonden v Bank of New York Mellon SA/NV and ors will be of interest to the securities lending industry as, in that case, a bank was found to have been negligent in its duties as a securities lending agent.
Första, a Swedish pension fund whose securities lending programme was managed by BNY Mellon, suffered large losses in relation to a $35.5 million investment in medium term notes issues by Sigma Finance Inc. Sigma was a $27 million structured investment vehicle that collapsed in September 2008 during the financial crisis. Under the securities lending agreement, BNY Mellon had contracted to provide a "fair view" of the risk of default and loss and also of the alternatives to holding the securities until their maturity ( EWHC 3127 (Comm)).
The court found that BNY Mellon had not provided a "fair view" when it told Första that it remained confident that the medium term notes would be paid in full on maturity, as the bank's analysis at the time in fact showed that there was a likelihood of default. This communication was a negligent misstatement and misrepresentation which breached the bank's duty of care under the securities agreement.
In 2014 the courts look set to continue to be called upon to clarify the scope of the duties and responsibilities of financial institutions in relation to the sale of financial products.