BANKING & FINANCE LITIGATION UPDATE

Issue 54

We wish to establish a dialogue with our readers. Please CONTENTS contact us at B&FL Update and let us know which particular areas you are interested in and what you would Domestic Banking ...... 2 find helpful. Domestic General ...... 3 The Banking & Finance Litigation Update is published monthly and covers current developments affecting the European Banking ...... 4 Group's area of practice and its clients during the European General ...... 5 preceding month.

This publication is a general overview and discussion of International Banking...... 5 the subjects dealt with. It should not be used as a International General ...... 5 substitute for taking legal advice in any specific situation. DLA Piper UK LLP accepts no responsibility for any Press Releases ...... 5 actions taken or not taken in reliance on it. Case Law ...... 7 Where references or links (which may not be active links) are made to external publications or websites, the Articles ...... 14 views expressed are those of the authors of those publications or websites which are not necessarily those of DLA Piper UK LLP, and DLA Piper UK LLP accepts no responsibility for the contents or accuracy of those publications or websites.

If you would like further advice, please contact Paula Johnson on 08700 111 111.

DOMESTIC BANKING 7. Barclays has been forced to accept tougher bonus conditions by its shareholders including a cut of 50 per cent in the 2011 £2.7m bonus of CEO Bob BARCLAYS Diamond. 1. Barclays is reported to be considering the sale of its French retail banking business - a network of Financial Times, 20 April 2012 more than 100 branches. HSBC and La Banque Postale are said to be interested. 8. Barclaycard has launched a credit card, PayTag, which will allow its 12 million customers to make Times, 15 May 2012 "wave and pay" purchases from their mobile phones. PayTag will sit on any mobile handset and 2. Barclays has launched an assault on the US is linked to a customer's credit card account, savings market, returning to deposit-taking in the allowing them to make purchases in any States for the first time in years. The bank is "contactless" store, restaurant, and eventually on offering an online savings account to Americans, public transport. The card will be launched to a in a bid to finance its credit card business there select group of Barclays' credit card customers in without relying on capricious wholesale funding May. markets. Guardian, 19 April 2012 Daily Telegraph, 8 May 2012

3. Barclays Natural Resources Investments has HSBC signed a deal with the Qatar Asset Management 9. HSBC has said it might sell its UK retail banking Company to develop natural resource investments. division if new regulations are too arduous Barclays is to locate the company's Middle according to chief executive Stuart Gulliver. Eastern office within the Qatar Financial Centre. Times, 18 May 2012 Daily Telegraph, 1 May 2012 10. HSBC's underlying profit in Q1 was almost $7 4. Over a third of Barclays' investors voted against a billion because of an increase in investment controversial remuneration package for executives banking income and a fall in US bad debts. The which awards chief executive, Bob Diamond, profit was up 25 per cent on the year. £17.7 million. Chairman, Marcus Agius said the bank should have done a better job of Evening Standard, 8 May 2012 communicating its case earlier and more clearly. 11. HSBC is to cut 2000 jobs, mainly in-branch Independent, 30 April 2012 investment advisers and back office administrators. The cuts to investment advisers are 5. Bob Diamond, chief executive of Barclays, and its part of HSBC's reaction to the retail distribution finance director Chris Lucas, have agreed to put review, which puts in place much stricter rules on 50 per cent of their bonuses up against a new the sale of financial products to consumers, return on equity target. The bank's Q1 results diminishing the role of branch advisory staff. suggest that the 50 per cent will be retained by the bank. Daily Telegraph, 26 April 2012

Daily Telegraph, 27 April 2012 12. HSBC is launching a new initiative in partnership with the Telegraph to help UK companies expand 6. Barclays has added £300m to its £1bn provision their business overseas. The Global Connections for payment protection insurance compensation as competition will offer a share of £60m in lending a result of a high-than-expected number of claims. to UK medium-sized businesses, plus the global The move pushed the bank to a £475m statutory expertise of HSBC and the Telegraph Media loss before tax once a reversal in the value of Group's communications know-how. paying back its own debt is included. Telegraph, 23 April 2012 Guardian, 26 April 2012

02 | LLOYDS BANKING GROUP growth. RBS currently has a market capitalisation 13. Chief executive of Lloyds, António Horta-Osório, of £25.6bn. has criticised the claims management firms that Daily Telegraph, 26 April 2012 submit compensation forms for customers, saying that a quarter of the claims submitted by these 20. RBS is proposing a ten-for-one share swap to firms were from customers who did not have reduce the number of its shares and boost their products with the banks against which claims were price according to documents distributed in being made. advance of the bank's annual meeting in May.

Guardian, 1 May 2012 Financial Times, 25 April 2012

14. NBNK will attempt to coax Middle East sovereign 21. Direct Line Group has completed its first bond wealth funds to help them secure the purchase of issue as RBS prepares to float a portion of the 632 Lloyds Banking Group branches. Concerns business later this year. The debt issue raised over the NBNK bid has prompted Lloyds to ask £500 million for the group which owns both for detailed information on the capital strength of Direct Line and Churchill insurance brands. the group and proof of the introduction of tough corporate guidance rules. Times, 23 April 2012 Telegraph, 30 April 2012 STANDARD CHARTERED 15. Lloyds Banking Group has ended its exclusive talks with the Co-operative Group over the sale of 22. Standard Chartered plans to open 50 new branches 632 branches. The Co-op remains their preferred in sub-Saharan Africa in 2012 and increase its bidder but the government-owned bank will also branch staff by about 10 per cent, while also consider alternative bids. investing in credit cards and increasing corporate business headcount. Times, 30 April 2012 Financial Times, 3 May 2012 16. Lloyds took first round bids for its €360m Irish property portfolio on 30 March. The portfolio is a combination of loans that Lloyds took on it when DOMESTIC GENERAL it acquired HBOS and some made through its own 23. The UK is considering a £1 billion capital lending business. The move is in line with the investment into the European Investment Bank as bank's stated intention of withdrawing from the part of an EU-wide growth drive. Irish market. Financial Times, 14 May 2012 Financial Times, 25 April 2012 24. The Chancellor of the Exchequer is to drop some UK objections to the Basel III international accord THE ROYAL BANK OF SCOTLAND on bank capital, allowing a common position to be 17. The Royal Bank of Scotland ("RBS") is to make agreed. extra provision for PPI mis-selling compensation claims by setting aside a further £125m in addition Financial Times, 14 May 2012 to the £1bn already set aside. 25. Sir John Gieve, former head of financial stability Times, 3 May 2012 at the Bank of England, has called on regulators to slow down the introduction of new financial rules, 18. According to outgoing chief executive of RBS clarify the future structure of the banking industry Retail and Wealth, Brian Hartzer, the and tone down attacks on banks to stimulate government's stake in the bank could be sold growth and lending. within the next two years. Daily Telegraph, 10 May 2012 Telegraph, 30 April 2012

19. RBS chief executive, Stephen Hester, has said that the reforms proposed by the Independent Commission on Banking could see £20bn wiped off the bank's market value by restricting its

EVERYTHING MATTERS | 03 26. The Chancellor is expected to concentrate on EUROPEAN BANKING banking reform in his Mansion house speech on 14 June. There will also be a white paper the same day on the International Commission on CREDIT SUISSE Banking's proposals, probably containing details 33. Credit Suisse is planning a flotation of its of proposals to ring-fence retail banking and specialist catastrophe insurance team's closed- setting up a 'depositor preference' scheme. ended funds on the London Stock Exchange.

Guardian, 7 May 2012 Financial Times, 30 April 2012

27. Senior bankers are blaming a slow-down in the 34. Investors' revolts over bonus packages have project finance market on shrinking bank funding spread to Switzerland with 31.6 per cent of and regulatory pressures, jeopardizing the shareholders voting against Credit Suisse's Government's plans to invigorate the economy by remuneration report. injecting private capital. Times, 30 April 2012 Financial Times, 3 May 2012

28. Mervyn King, Governor of the Bank of England, DEUTSCHE BANK has admitted that the Bank failed in its handling of 35. Concerns have been raised over the planned sale the financial crisis and that the Labour by Deutsche Bank of part of its asset management government's actions worsened the situation. He business to Guggenheim Partners. Negotiations has called on the Government to implement the are on-going two weeks after the German bank proposals of the independent Commission on announced a board meeting would be held to Banking. reach a decision about the sale. Both parties claim to be close to a deal. Times, 3 May 2012 Financial Times, 30 April 2012 29. Mobile phone operators are looking at new ways to allow customers to access payment methods 36. Deutsche Bank has reached a deal to sell Actavis using their handsets. to Watson Pharmaceuticals, the US generic drug company. The deal will value the company at Independent on Sunday, 29 April 2012 around €4.5m. 30. Credit card providers are increasing interest rates Financial Times, 25 April 2012 and charges to help boost their profits, some by as much as 50 per cent. According to research from Defaqto, the average rate has increase in the last UBS year from 18.5 per cent to 18.9 per cent, with cash advances increasing from 2.7 per cent to 2.78 per 37. UBS is planning to take bids on commercial real cent. estate-related securities worth $1.5bn. This may have been prompted by the success of a sale of Sunday Times, 29 April 2012 securities in collateralised debt obligations by the Federal Reserve Bank of New York which had an 31. The FSA has requested that banks and financial original face value of $7.5bn and which attracted companies name the person who will be a great deal of interest. responsible for dealing with specific regulatory or enforcement issues. Financial Times, 9 May 2012

Financial Times, 24 April 2012 38. Citigroup, Morgan Stanley, UBS and Wells Fargo have been fined a total of $9.1m (£5.6m) for mis- 32. The alleged mis-selling of interest rate swaps to selling exchange traded funds. The US Financial small businesses by some of the UK's largest Industry Regulatory Authority said the banks did banks will be discussed by a cross-party group of not have a reasonable basis for recommending the MPs. The meeting has been organised to gather products to their clients. political support for an inquiry into how complicated interest hedging products were mis- Daily Telegraph, 2 May 2012 sold to thousands of small business customers.

Sunday Telegraph, 22 April 2012

04 | 39. The FSA has lost its case against former UBS European Banking Authority et al, 15 May 2012 chief executive John Pottage for the improper supervision of his team. Further information can be found on the EBA website: Financial Times, 23 April 2012 http://eba.europa.eu/cebs/media/Publications/ Consultation%20Papers/2012/JC%2001/JC-CP- EUROPEAN GENERAL 2012-01--ESAs-Joint-CP----EC-call-for-advice-on -fundamental-FICOD-review-.pdf 40. According to Fitch Ratings, 29 large European financial institutions (including RBS, Lloyds, 44. Resolution: a progress report Barclays and HSBC) would need to raise an extra £357bn to meet the demands of Basel III. The In a speech to the Institute for Law and Finance ratings agency suggested banks would need to cut Conference, the Bank of England's deputy bonuses and salaries and cut returns by up to a governor for financial stability gave a progress fifth. report on global planning for resolutions regimes aimed at addressing the problem of "too big to Daily Telegraph, 18 May 2012 fail" financial institutions.

Bank of England, 8 May 2012 INTERNATIONAL BANKING Further information can be found on the BoE JPMORGAN CHASE website: 41. JP Morgan racked up $2bn of losses in the six http://www.bankofengland.co.uk/publications/ weeks to the middle of May stemming from a Documents/speeches/2012/speech568.pdf series of complex trades aimed at hedging the bank's overall risk in financial markets. 45. Bank signs lease on a property to house the Prudential Regulation Authority Daily Telegraph, 11 May 2012 The Bank of England has signed contracts on 20 Moorgate until July 2027 in order to house the INTERNATIONAL GENERAL Prudential Regulation Authority, which is expected to be established early in 2013. 42. Major US banks are resisting Federal Reserve plans to limit their exposure to governments and Bank of England, 2 May 2012 individual companies, warning that the plans will cut a combined $1.2 trillion from credit Further information can be found on the BoE commitments at Goldman Sachs, JPMorgan website: Chase, Morgan Stanley, Bank of America and Citigroup. http://www.bankofengland.co.uk/publications/ Pages/news/2012/045.aspx Financial Times, 17 April 2012 46. Developing a Single Rulebook in banking PRESS RELEASES The Chairperson of the EBA, Andrea Enria, gave a speech at the Stakeholder Conference held at the 43. EBA, EIOPA and ESMA's Joint Consultation Central Bank of Ireland on 27 April 2012 on the Paper on its proposed response to the Single Rulebook in banking. Topics which she European Commission's Call for Advice on the discussed included: an overview of the first year Fundamental Review of the Financial of existence of the EBA; the objectives of the new Conglomerates Directive European institutional framework; own funds; and This joint consultation by the European Banking liquidity requirements. Authority (EBA), European Insurance and European Banking Authority, 2 May 2012 Occupational Pensions Authority (EIOPA), and European Securities and Markets Authority Further information can be found on the EBA (ESMA) covers the scope of application; the website: group-wide internal governance requirements and sanctions; and supervisory empowerments under http://www.eba.europa.eu/News-- the Financial Conglomerates Directive. Communications/Speeches/2012/Andrea-Enria-s-- Comments by 13 August 2012. Speech-at-CBI-Dublin---FINAL.aspx

EVERYTHING MATTERS | 05 47. MPs announce terms of reference for corporate 50. EBA Consultation Paper on draft Guidelines governance and remuneration inquiry for assessing the suitability of members of the management body and key function holders of The Treasury Select Committee has published the a credit institution terms of reference for a new inquiry into corporate governance in systemically important This EBA consultation seeks views on draft financial institutions. guidelines on the: assessment of the suitability of members of the management body and key Treasury Committee, 30 April 2012 function holders; the process, criteria and minimum requirements for assessing the Further information can be found on the suitability of those persons; and the criteria for the Committee's website: assessment and documentation requirements for institutions. Comments by July 18, 2012. http://www.parliament.uk/business/committees/ committees-a-z/commons-select/treasury- European Banking Authority, 18 April 2012 committee/news/treasury-committee-announces- terms-of-reference-for-corporate-governance-and- Further information can be found on the EBA remuneration-inquiry/ website:

48. European Central Bank: Annual report 2011 http://www.eba.europa.eu/cebs/media/ Publications/Consultation%20Papers/2012/CP03/ The European Central Bank's (ECB) annual report CP-on-GL-on-the-assessment-of-the-suitability-of 2011 describes the activities of the European -directors-and-key-function-holders.pdf System of Central Banks, reports on the Eurosystem's monetary policy during 2011 and 51. OFT response to European Commission’s includes the annual accounts of the ECB. Green Paper on Card, Internet and Mobile Payments European Central Bank, 24 April 2012 The Office of Fair Trading (OFT) has released a Further information can be found on the ECB response to the European Commission’s green website: paper on card, internet and mobile payments saying they support initiatives to improve http://www.ecb.int/pub/pdf/annrep/ar2011en.pdf payment systems for payers and payees. Their report focuses on competition and consumer 49. Commitment to help consumers agreed at PPI protection. They suggest that regulation for better summit payments systems must consider: At a payment protection insurance (PPI) summit, ■ how it will coexist with competition law; representatives of all major banks and credit card providers, regulators and the Financial ■ how to determine interchange fees in Ombudsman Service promised to help make PPI national card markets and whether it would claims easier and prove that it is not necessary to be uniform across the EU; use a claims management company (CMC). The representatives pledged to standardise complaints ■ who is responsible for the determination; and procedures; improve communication with customers; and call for stricter regulation of ■ whether higher MIF rates would be allowed CMCs. if they provided additional benefits.

British Bankers' Association, 24 April 2012 OFT raises further questions for the EC in relation to related work by other agencies, possible two Further information can be found on the BBA tier payment services provisions affecting the website: consumer and how to classify different forms of e- payments and m-payments. http://www.bba.org.uk/media/article/commitment -to-help-consumers-agreed-at-ppi-summit Office of Fair Trading, 16 April 2012

Further information can be found on the OFT website:

http://www.oft.gov.uk/shared_oft/ consultations/11_04_12_EC.pdf

06 | CASE LAW determine who within HSBC constituted 'the bank' for the purpose of the bank having the 52. Money laundering - clarification of banks' relevant suspicion. obligations Having heard all the evidence, the judge Mr Shah sued HSBC for failing to follow his concluded that as a matter of conduct and practice instructions to process various transactions. a Mr Wigley ("W") acted as nominated officer for HSBC had suspected that funds in Mr Shah's the bank. It was W who was given responsibility account might be the proceeds of crime and had for taking the decision as to whether an external sought the Serious Crime Agency's ("SOCA") Suspicious Activity Report ("SAR") should be consent to the transactions. Pending receipt of made to SOCA. SOCA's consent, it delayed carrying out Mr Shah's instructions. It explained the delays to Mr The judge accepted W's evidence that he Shah by saying that it was "complying with its authorised the submission of the four SARs to UK statutory obligations". SOCA and that in each case the submission was made after he formed his own independent HSBC's delay meant that Mr Shah was unable to suspicion based on the factual information known make a payment to a Mr Kabra, a former to him. W exercised management and control over employee. Mr Shah passed on HSBC's these decisions, had autonomy when making these explanation for the delay to Mr Kabra and this decisions and exercised his judgment lead to rumours being spread in Zimbabwe that independently. Mr Shah was suspected of money laundering. The test for "suspicion" in these circumstances is Mr Shah asked HSBC to disclose details of its a subjective one. There is no legal requirement communications with SOCA but it refused. that there should be reasonable grounds for the suspicion just a requirement that a suspicion is Mr Shah claimed that the Zimbabwean authorities indeed held. became suspicious and that as a result they froze and seized substantial investments belonging to W claimed that seven factors had given rise to his him. This, he alleged, caused him huge losses of suspicion and led to his decision to make a SAR. over US$300 million. These were:

HSBC argued that it could not comply with Mr 1. Someone within the Relationship Team had Shah's instructions without itself committing formed a suspicion which had been offences under the Proceeds of Crime Act 2002 independently considered and confirmed by ("POCA"). It argued that there was an implied the Compliance Department. Such suspicion term in its contract with Mr Shah that it would be lower down the chain would not influence entitled to refuse to process payment instructions him however without his having known the in circumstances where it suspected money primary facts for those suspicions; laundering and SOCA had not granted consent. 2. The movement of funds in and out of the In the event the court found in HSBC's favour. HSBC account was suspicious; The claim fell at every hurdle. The key issues which the court had to determine are set out 3. Mr Shah's explanation for the movement of below. funds was suspicious;

Did the bank suspect that each of the four 4. The size of the first transaction was transactions constituted money laundering? suspicious;

HSBC argued that there was an implied term in 5. There had been previous concerns about its contract with Mr Shah that it could refuse to activity on Mr Shah's account; execute payment instructions in the absence of "appropriate consent" under s.335 POCA where it 6. There was uncertainty as to the original suspected the transaction constituted money sources of the funds; laundering. This was implied by reason of the statutory provisions. 7. Mr Shah's connections with Zimbabwe.

The judge agreed. The judge was persuaded that W had himself taken the decision to make a report to SOCA and Before deciding whether the bank held the that when he submitted that report he honestly and necessary suspicion though, the court had to genuinely suspected that the funds were criminal

EVERYTHING MATTERS | 07 property. He had taken these seven factors into Was the bank obliged/entitled under s.333 (the account when he sent the SAR to SOCA. His 'tipping off' provisions') and or s.342 usual practice amounted to a three-stage process: ('prejudicing an investigation provisions') of he would absorb the information sent to him; he POCA to withhold such information? would investigate it; and he would reflect and decide. That is what the judge found he did. Yes. The bank was obliged to withhold the information sought at all material times. Did the bank's delay in executing any of the payment instructions cause any loss either: (a) Did the failure to provide such information in fact or (b) at law? cause any loss?

The judge found that the HSBC's delay in No. In all probability provision of the information executing the payment instructions did not cause that Mr Shah wanted would not have achieved his any loss. The probability was that the objective of satisfying the Zimbabwean Zimbabwean authorities were already authorities that he had been cleared of any wrong investigating Mr Shah and it was their pre- doing in the UK. existing concerns which led to the seizure of Mr Shah's assets. In so far as the Zimbabwean authorities were troubled by the absence of information from the There were also intervening acts which broke the UK authorities this was not as a result of a failure chain of causation. In particular, Mr Shah could by the bank to provide this information but more have mitigated his loss by paying Mr Kabra from because SOCA had not done so. other funds or sources if he had wanted to. Both this and the conduct of Mr Kabra and the If Mr Shah had succeeded on liability would Zimbabwean authorities also broke the chain of the losses have been recoverable? causation. There were three separate issues here: Was the bank under a duty to inform Mr Shah ■ the effect of exemption clauses; of the details of any reports it made to SOCA and/or the reasons for making the reports? ■ the issue of remoteness; No. The bank was not under any duty to provide ■ the issue of mitigation. Mr Shah with the information sought. First, the bank had sought to rely on exemption Mr Shah had sought to argue that it was part and clauses which excluded or restricted its liability. parcel of the bank's duty as an agent that it would Mr Shah's legal team argued that these clauses keep the customer informed of the reasons why its were unreasonable under the Unfair Contract instructions could not always be complied with. Terms Act 1977 and that the burden of proof lay with the bank to displace the statutory The judge dismissed this argument. It would be most unlikely that banks would be in a position to presumption of the invalidity of its standard terms. know whether their disclosure has triggered an The bank did not call evidence directed at investigation, or might lead to an investigation in establishing the reasonableness of the terms and the future and therefore whether the provision of so had not made out a positive case. In the the information sought might constitute a tipping- circumstances the judge held that the bank had not off offence. The term would be unworkable. It established the reasonableness of the clauses it would cut across the statutory regime, operate as sought to rely on. The exemption clauses were a disincentive to report suspicious activity and therefore unenforceable. undermine the integrity of the reporting regime. Such a term would be unreasonable in light of the On the issue of remoteness the question was number of SARs the banking sector makes. whether the loss was of a type that was within the contemplation of the parties as a "not unlikely" The bank could not be in breach of duty in result of the breach in question. refusing to make a requested disclosure if it would be at risk of criminal liability under s. 333 The losses sustained by Mr Shah through the if such disclosure was made. There has to be an Zimbabwean authorities seizing his assets were implied term that allows the bank to refuse to not foreseeable. It was not foreseeable that if the provide information where the bank in providing Zimbabwean authorities were informed that the that information might contravene duties under bank had not carried out the instructions given by s.333 and s.342 POCA. Mr Shah because it was complying with its UK

08 | statutory obligations, that the Zimbabwean would lead to LBF being similarly in the authorities would seize his assets in Zimbabwe money as against LBIE under the back-to- and take the action that they did. There was no back transaction but expose LBF to no assumption of responsibility by the bank for the adverse consequence if LBIE's client proved losses that occurred. unable to pay);

Finally, Mr Shah was able to, but did not take ■ the close-out of a client transaction would reasonable steps to mitigate or avoid his loss. He not of itself trigger a close-out of the back-to could have paid Mr Kabra from other funds. -back transaction.

Click here to see our client alert on this case. The Side Letter dealt with these risks by providing that: 1(1) Jayesh Shah (2) Shaleetha Mahabeer v HSBC Private Bank (UK) Limited, Queen's Bench ■ the valuation risk was transferred to LBF by Division, 16 May 2012 treating the settlement amount under the back-to-back transaction as identical to the 53. Close-out Amount provisions in 2002 ISDA settlement amount under the client Master Agreement to be valued on same transaction; principles as those in 1992 edition ■ LBIE's obligation to LBF on close-out of the Lehman Brothers International (Europe) ("LBIE") back-to-back transaction was limited to entered into various over-the-counter ("OTC") payment of no more than it actually received derivatives transactions with various from its client; counterparties. The transactions were governed by 1992 ISDA Master Agreements. ■ any early termination of the client transaction would automatically trigger early It was Lehman Group policy that Lehman termination of the back-to -back transaction. Brothers Finance S.A. ("LBF") should manage the risk arising from equity OTC derivatives Unfortunately no consideration was given to the traded by LBIE and that LBF should both enjoy possibility that a back-to-back transaction might the benefits and incur the risks of that trading. be subject to early termination before a client transaction. In order to transfer the risks and benefits from LBIE to LBF, the OTC derivative transactions On 22 November 2007 LBIE and LBF entered were matched by automatically generated equal into a further agreement ("Amendment and opposite back-to-back transactions between Agreement"). The aim of this was to apply LBIE and LBF. Automatic Early Termination to LBF (and not LBIE) for the purposes of section 6(a) of the All the back-to-back transactions were governed Master Agreement. This was done because there by an ISDA Master Agreement dated 18 May was a fear that Swiss Insolvency law might 1992. The back-to-back transactions were not invalidate optional early termination clauses in recorded in separate confirmations but were the event of LBF's insolvency. recorded instead electronically in inter-company accounting entries. On 29 August 2008, LBIE and LBF and many other parties worldwide signed a Close-Out On 24 July 2006 LBIE and LBF signed a side Amount Multinational Agreement ("CAMA") letter ("Side Letter") which supplemented the whereby they agreed common amendments to the terms of the ISDA Master Agreement. The Side 1992 ISDA Master Agreements between them. In Letter was designed to deal with the following general terms this had the effect of replacing the risks not covered by the matching client 1992 provisions for close-out and settlement transactions: amounts on early termination with the provisions of the 2002 edition of the Master Agreement. In ■ valuation risk (where two otherwise broad terms, section 6(e) of the 1992 edition identical ISDA governed derivative allowed the parties to choose between four transactions between different parties could, different bases for determining payments on Early if closed out, lead to significantly different Termination, by adoption of either the First close-out valuations); Method or Second Method, and the use of either Market Quotation or Loss. The 2002 equivalent ■ the credit risk associated with LBIE's substituted a single basis, which broadly equated counterparty (a close-out of a client with Second Method and Loss. transaction which left LBIE in the money

EVERYTHING MATTERS | 09 One effect of the CAMA as between LBIE and "value clean" principle. The Side Letter did not LBF was to amend every existing back-to-back justify a wholly exceptional interpretation and the transaction in this way and to constitute the terms of the ISDA 2002 Master Agreement did amended basis for determining close-out amounts not have the effect of "cutting down the on early termination as the governing regime for importance of the continuity assumption, as the all back-to-back transactions between them. The bedrock of a clean valuation, into a mere shadow result was that all the back-to-back transactions of its former self". The value of the Side Letter were governed thereafter by an amalgam of the formed no part of the process of the determination 1992 and 2002 editions of the ISDA Master of the Close-out Amounts nor should it otherwise Agreement. be included as part of LBIE's loss.

No thought was given as to the effect of the A non-defaulting party should therefore value its CAMA on the Side Letter. In situations where loss on a "clean" basis when calculating a Close- the Side Letter applied it would override the terms out Amount under the 2002 ISDA Master of the close-out agreement. Agreement. This will involve assuming that, if it were not for the termination, the transaction On 15 September 2008 an administration order would have proceeded as planned to maturity and was made in respect of LBIE and on 29 October that the stream of payments and deliveries under 2008 insolvency proceedings in respect of LBF section 2(a)(i) would have run their course. were started in Switzerland. Lehman Brothers International (Europe) v The effect of this was that there was an Event of Lehman Brothers Finance S.A. [2012] EWHC Default which automatically terminated all the 1072 (Ch), Companies Court, 27 April 2012 back-to-back transactions. Although there probably was an Event of Default under the Client 54. Application of section 32(2) of the Limitation Transactions too these did not provide for Act 1980 to breach of fiduciary duty claims Automatic Early Termination in relation to LBIE. This case concerned a claim by a mortgage lender The joint administrators of LBIE against a firm of solicitors for failing to report ("Administrators") sought court guidance as to various matters relating to two sets of transactions whether they should treat the Side Letter as entered into by the borrower client. binding in relation to the back-to-back transactions. The question was extremely The original claim was framed in contract and important as if the Side Letter were binding then negligence only. The issue arose as to whether the the close-out amounts would be determined by lender should be given permission to amend its the actual amounts paid by or to the clients in the case to include allegations of breach of fiduciary client transactions. On the other hand if the Side duty even though the primary limitation period Letter did not apply then a "clean" valuation for bringing such a claim had by then expired. would be used using the Second Method and Loss Would allowing the amendments deprive the calculations. The difference between these two solicitors of a limitation defence? different kinds of valuations amounted to something like US$ 1 billion. Under section 32(1)(b) of the Limitation Act 1980 ("Act") the normal limitation period for bringing a Understandably, the Administrators argued that claim will be postponed if "any fact relevant to the Side Letter should be taken into account. They the plaintiff's right of action has been deliberately argued that the definition of "Close-out Amount" concealed from him by the defendant". Section 32 in the 2002 ISDA Master Agreement assumed (2) further provides that for these purposes that the conditions precedent in section 2(a)(iii) in "deliberate commission" of a breach of duty in relation to "the valuation of payments and "circumstances in which it is unlikely to be deliveries and any other material terms" had been discovered for some time" amounts to deliberate satisfied. The Side Letter, they argued, fell within concealment (emphasis added). the meaning of "any other material terms". The Master hearing the application gave The court ruled that the Side Letter should not be permission to amend. This was on the basis that taken into account. If it were taken into account in he accepted the lender's arguments that the the Close-out Amount calculation this would be a amended case required proof of deliberate breach radical departure from the "value clean" principle of duty. If a deliberate breach was established established by the authorities in relation to the then this would also inevitably establish that the 1992 edition. The 2002 ISDA Master Agreement breach had been deliberately concealed by the could not be construed as having abandoned the solicitors. In such circumstances section 32 of the

10 | Act would prevent the solicitors from running a explore the mental element required in a case of limitation defence. If a deliberate breach was not "actual conflict" as he found that there was no established then the claim would fall away breach of the "actual conflict rule" on the facts of anyway and the limitation point would not arise. the Mothew case.

This initial ruling was appealed. The main issues Conclusions on appeal were whether liability for breach of fiduciary duty can only be committed deliberately The appeal judge accepted that in order to and, if so, whether the element of intentionality establish liability for a breach of "good faith" the required coincides with the state of mind required lender would have to show that the solicitors were to show a "deliberate commission of a breach of conscious of an obligation owed to the lender to duty" for the purposes of section 32 (2). do something (or refrain from doing something), but felt that they were inhibited in complying with Mental element required for s.32(2) that obligation by virtue of the fact that they were also acting for the borrower. Acting in ignorance, Cave v Robinson Jarvis & Rolf [2003] 1 AC 384 even negligent ignorance of any obligation owed clarified the mental element required to amount to to the lender would not be enough. a "deliberate commission of a breach of duty" for the purposes of section 32(2) of the Act. In that Some of the pleaded amendments in the case Lord Millett stated that section 32 deprives a Particulars of Claim however related to defendant of a limitation defence in two allegations of breaches of the "actual conflict rule" situations: and not the "duty to act in good faith".

■ where he takes active steps to conceal his An "actual conflict" arises if the solicitor's own breach of duty after he has become instructions from one client are to do, or not to do, aware of it; something which is contrary to his duty to another client. An actual conflict will not however arise in ■ where he is guilty of deliberate wrongdoing a case where the solicitor has instructions from the and conceals or fails to disclose it in first client that would allow him to perform his circumstances where it is unlikely to be duty to the second, which instructions he fails to discovered for some time. carry out because it would disadvantage the first client. Section 32 does not however deprive a defendant of a limitation defence where he is charged with It was possible to think of circumstances where a negligence if, being unaware of his error or that solicitor could be in breach of the "actual conflict he has failed to take proper care, there has been rule" because of a negligent failure to appreciate nothing for him to disclose. the incompatibility of two sets of instructions. A solicitor might be instructed by a borrower to do A limitation defence will therefore only be something (e.g. to make a particular payment and blocked by section 32(2) of the Act if the not tell the lender about it) but not be aware that to defendant is shown to have been aware at the time do so would be a breach of his obligation to his of the alleged breach of duty that what he did, or lender client because he has negligently failed to omitted to do, amounted to a breach of duty. appreciate that his instructions from the lender required him to tell the lender. In such a case he Is deliberateness required for all kinds of may have failed "to take care not to find himself breach of fiduciary duty? in a position where there is an actual conflict of duty". He will have failed to cease to act in Counsel for the solicitors argued that the circumstances where his duty required him to do authorities were not clear on whether so although he did not appreciate that this was the "deliberateness" is a necessary condition for every case because of his negligent failure to understand actionable breach of fiduciary duty. A contrast the extent of his duty to one of his clients. In such could be drawn between cases involving a breach a case "deliberateness" would not, as a matter of of the fiduciary duty "to act in good faith" and law, be a necessary ingredient. cases involving a breach of the "actual conflict rule".

In Bristol & West Building Society v Mothew [1998] Ch 1 ("Mothew"), Lord Justice Millett stated that in order to establish a breach of the fiduciary duty "to act in good faith" the relevant conduct must be intentional. He did not however

EVERYTHING MATTERS | 11 The Master had therefore been wrong to hold that Having seen the evidence adduced by Transfield there could be no circumstances in which the in support of its summary judgment application, proposed amendments might deprive the Deiulemar abandoned its original allegations and defendant of an arguable limitation defence. The instead sought leave to rely on new allegations appeal was allowed. alleging that:

Mortgage Express (an unlimited company) v ■ Transfield was "insolvent" in the balance Abensons solicitors (a firm), Chancery Division, sheet sense from 1 January 2010 on the basis 20 April 2012 that, by virtue of its indebtedness to Pioneer of over US $8 million it had excess 55. Eurosail test for balance sheet insolvency liabilities over assets at all relevant times applies for purposes of determining whether an after 17 December 2009; event of default has occurred under the 1992 ISDA master agreement ■ Transfield Shipping Inc was a guarantor of most of the agreements and thereby became A dispute arose between Transfield ER Futures a "Credit Support Provider" but was unable Limited ("Transfield") and Deiulemar Shipping to pay its debts as they became due and/or SpA and Deiulemar Compagnia Di Navigazione failed generally to pay its debts as they SpA (collectively "Deiulemar") in relation to six became due. Forward Freight Swap Agreements ("FFAs"). Each FFA was subject to the following It was accepted that if Deiulemar had no real provisions: prospect of succeeding on these new allegations then Transfield would be entitled to judgment on ■ the obligation of any party to make a its counterclaim. payment would be subject to a condition precedent that no Event of Default or Insolvency Potential Event of Default by the other party had occurred and was continuing; Each of the FFAs in this case incorporated, subject to certain specified modifications, the ■ if either party or its "Credit Support provisions of the ISDA Master Agreement. These Provider" became insolvent or unable to pay provide that an Event of Default will occur if a its debts as they became due and/or had party or the Credit Support Provider of that party failed or admitted its inability generally to "becomes insolvent or is unable to pay its debts or pay its debts as they became due this would fails or admits in writing its inability generally to constitute an Event of Default. pay its debts as they become due".

Deiulemar failed to pay sums due under the It was common ground that in this context the FFAs. As a consequence, Transfield served word "insolvent" related to balance sheet Notices of Early Termination relying on solvency rather than cash flow solvency. Deiulemar's failure to pay as the Event of Default. Transfield's Solvency Deiulemar issued proceedings arguing that there had been an Event of Default on Transfield's part. Deiulemar argued that the relevant issue was Initially Deiulemar argued that Transfield was whether, in a commercial sense, Transfield's unable to pay its debts as they became due and/or assets and existing liabilities were such as to had failed to pay its debts as they became due. In make it reasonably certain that the existing and this regard Deiulemar relied on Transfield's probable assets would be insufficient to meet the alleged failure to pay some US $8 million to existing liabilities. Pioneer Freight Futures Company Limited ("Pioneer") under various FFAs when those FFAs In contrast, Transfield referred the judge to BNY had automatically terminated upon the Limited v Eurosail Plc [2011] 1 WLR 2524 appointment of joint provisional liquidators of ("Eurosail"), in which the court of appeal had Pioneer and on Transfield's alleged failure to pay concluded that a company which was unable to sums due to its brokers in respect of FFA trading. pay its debts for the purposes of the Insolvency Act 1986 s.123(2) was a company whose assets Transfield defended the claim and put in a and liabilities, including contingent and future counterclaim. It applied for summary judgment liabilities, were such that it had reached the point against Deiulemar and for judgment on its of no return. Although that case was a decision on counterclaim. the effect of the statutory test of insolvency, the Court of Appeal had in part reached its decision

12 | on the basis of commercial sense as to when a loans were long term, interest free and unsecured. company should be regarded as balance sheet Those factors would have to be taken into account insolvent. rather than simply slavishly applying the full value of the loans. Also the question of The judge concluded that the test for balance Transfield's insolvency fell to be assessed in the sheet insolvency as set out in Eurosail applied for context of the purpose of the contractual the purposes of determining whether an event of provisions. This meant that one would be looking default had occurred under the 1992 ISDA Master for some immediacy in Transfield's financial Agreement. The parties could not sensibly have plight, in the sense of affecting its ability to intended that the mere fact that there was a perform during the currency of the FFAs. balance sheet deficit should trigger an Event of Default. They must have intended that a company The proposed plea that Transfield was insolvent at was only to be regarded as balance sheet insolvent the material times was entirely without substance. when it had reached the point of no return There were no reasonable grounds for believing because of an incurable deficiency in its assets. that a fuller investigation into the facts would change that picture. With regard to contingent liabilities then if, at the time of assessment of the existence of an Event of Was Transfield Shipping Inc a Credit Support Default, a reasonable commercial person would Provider? consider that there were reasonable grounds for disputing the asserted liability, it would fall to be In this case the ISDA Master Agreement had been treated as a contingent liability in respect of incorporated without its Schedule. In those which some assessment would have to be made as circumstances it was up to the parties to stipulate part of the process of deciding whether a party expressly whether Transfield Shipping Inc was to had indeed reached "the point of no return". be treated as a Credit Support Provider.

It would be wholly unrealistic to suggest that the Whilst it would have made sense for the parties to assessment of whether or not a party is insolvent have specified Transfield Shipping Inc as a Credit for the purposes of an Event of Default should be Support Provider, the FFAs did not confer that judged by reference to events which occur after status on Transfield Shipping Inc. The court was the date as to which the question of the existence not prepared to make a bargain for the parties of insolvency falls to be judged. which they could sensibly have made but which they had not. Such is the importance of the status Deiulemar's allegation that Transfield's liability to of a "Credit Support Provider" under the ISDA Pioneer rendered Transfield balance sheet Master Agreement machinery that it was not insolvent had no real prospect of success. Even possible to conclude that the parties must have applying the full US $8 million value to the intended such a specification when they had not Pioneer claim, to describe Transfield as insolvent specified it in their contract. on the basis of the net asset figures at various dates was precisely the approach rejected in There was therefore no real prospect of Deiulemar Eurosail. The net asset figure for Transfield succeeding on their claim on the basis of the fluctuated from month to month. Occasionally it financial state of Transfield Shipping Inc. would fall below the full value of the Pioneer claim. However, to suggest that Transfield had Result reached the "point of no return" was "utterly Deiulemar's application for leave to amend the fanciful". Any reasonable commercial person Particulars of Claim was refused and Transfield's considering Transfield's position would bear in application for summary judgment succeeded. mind that there was at the very least a reasonable Deiulemar's claim was dismissed and Transfield argument for saying that Transfield did not owe any money at all to Pioneer and on that basis the was entitled to judgment on its counterclaims. suggestion that Transfield was insolvent became (1) Deiulemar Shipping SpA (2) Deiulemar even more fanciful. Compagnia Di Navigazione SpA v Transfield ER Futures Limited, Commercial Court, 18 April The existence of shareholder loans (which were not repayable until a long time after the expiry of 2012 the FFAs), to the extent that they created a net Frederick Hui and Nicholas Mallard of DLA Piper asset deficiency on the Financial Statements or Hong Kong and James Watson and Harriet Management Accounts taken at face value, did Farrant of DLA Piper UK acted for Transfield. not provide any basis for saying that Transfield was insolvent or even close to insolvent. The

EVERYTHING MATTERS | 13 ARTICLES This bulletin is intended as a general overview and discussion of the subjects dealt with. It is not intended, 56. Breach of Trust and should not be used, as a substitute for taking legal advice in any specific situation. DLA Piper UK LLP will Rachel Davies and Roger McCourt of DLA Piper accept no responsibility for any actions taken or not consider the Court of Appeal decision in Lloyds taken on the basis of this publication. If you would like TSB Bank Plc v Markandan & Uddin. The further advice, please contact: decision confirmed that lender's solicitors who release mortgage funds having failed to obtain genuine documents or suitable undertakings LEEDS: HUGH EVANS necessary to complete a mortgage transaction act in breach of trust and are liable to repay the entire T 0113 369 2200 mortgage advance to the lender without deduction [email protected] for contributory negligence. LONDON: IOANNIS ALEXOPOULOS "Tried and trusted: liability of solicitors who act in T 020 7796 6897 breach of trust". Journal of International Banking [email protected] & Financial Law, Vol 27 No 5 p 308 MANCHESTER: STEWART PLANT 57. Misrepresentation; undue influence T 0161 235 4544 Looks at the way the courts have treated issues of [email protected] misrepresentation and undue influence when dealing with setting aside a guarantee transaction.

"The convergence and divergence of undue

influence and misrepresentation as grounds for setting aside a guarantee: an uncertain future for misrepresentation in guarantee cases", Journal of International Banking Law & Regulation, Vol 27 No 6, pp 239-249

NB For copyright and/or technological reasons, any internet addresses in the electronic version of this publication may not be active links. This publication is intended as a general overview and discussion of the subjects dealt with. It is not intended to be, and should not be used as, a substitute for taking legal advice in any specific situation. DLA Piper UK LLP and DLA Piper SCOTLAND LLP will accept no responsibility for any actions taken or not taken on the basis of this publication. If you would like further advice, please contact Hugh Evans (Leeds) T: 0113 369 2200, E: [email protected] or Ioannis Alexopoulos (London) T: 020 7796 6897 E: [email protected] or Stewart Plant (Manchester) T: 0161 235 4544, E: [email protected] on 08700 111 111. www.dlapiper.com

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