Summary and implications

On 5 November 2012 judgment was given by the Federal Court of Australia in favour of 12 local councils, who sought to recover losses suffered after investing in complex financial products called constant debt proportion obligations (CDPOs). One of the defendants was Standard & Poor’s, the credit rating agency, which had given the CDPOs an AAA rating.

This is the first time that a credit ratings agency has been held liable for the rating that it gives to a product or security and the funder that backed the litigation in Australia, IMF (Australia) Limited, is reportedly seeking to back similar claims in other jurisdictions. The facts of this case, however, are unusual and it is unlikely to be the harbinger of similar findings in the UK.

Similar findings are unlikely in the UK

There are several reasons why funders would struggle to find willing litigants in our opinion.

First, claims for economic loss resulting from a statement (or rating), such as this, are difficult to prosecute. It is the issuer of a product that engages a rating agency, so there is no contractual liability to investors who subsequently rely on the rating. Therefore, and in order to bring a negligence claim, it must be established that a duty of care is owed by the rating agency to potential investors. Given the stringent test that UK courts apply, including the existence of a special relationship, it is questionable whether a duty of care would be found to exist.

The extensive disclaimers given by ratings agencies are probably sufficient to negate a duty of care. The presence of a disclaimer would reduce the likelihood of there being a special relationship and also reduce the ability of an investor to be entitled to rely on a rating.

Next, one of the important features of this case was that the claimants were local authorities, who the court held did not have the expertise to perform due diligence on the CDPOs themselves. This is in stark contrast with most cases of this nature, when the prospective claimants are sophisticated investors who have, or should have, the expertise to evaluate the strength of the products in which they invest.

If that expertise is not exercised then it will be at least contributory negligence (reducing damages) or, more likely, a break in the chain of causation. This argument was rejected in this case because of the “grotesquely complicated” nature of the CDPOs and because it was reasonable for the councils not have the in-house expertise.

Not only should investors have the expertise, but they will also have a duty and/or obligation to their own investors to ensure that they perform the requisite due diligence. To bring a claim of this nature, therefore, would be both an admission of breach of that duty and an embarrassing acknowledgment of the failure to analyse the risks.

Unless there is strong evidence of “negligent misrepresentations” or the rating is “misleading and deceptive”, as the Federal Court of Australia found, claims against ratings agencies will be difficult to bring in the UK.