Partner Abdulali Jiwaji and Associate Rory Spillman discuss misselling claims in financial derivatives in Financier Worldwide.
The approach taken by the courts in misselling claims to date generally favours those selling derivative products. In particular, the principle of contractual estoppel is potentially an effective line of defence to a claim of misselling, unless there are fraudulent aspects to the way the product was sold. Are misselling claims now dead in the water, or is there scope for argument in the right type of case? The courts are willing to review carefully all of the facts and the particular wording of the contractual documentation between the parties and appear to be reluctant to deal with these issues summarily. As discussed below, on the right set of facts, a claimant may find a way through.
Development of contractual estoppel
Contractual estoppel in misselling cases has developed from the seminal cases of Springwell Navigation Corporation v JP Morgan Chase Bank & Ors EWCA Civ 1221 and Peekay Intermark Ltd v Australia and New Zealand Banking Group Ltd 2 Lloyd’s Rep 511.
In Peekay the Court of Appeal established that where commercial parties agree to enter into contractual terms on an expressed basis, then they will be precluded from later claiming that this basis was not in fact the reality. Therefore, where an investor has accepted within the contractual terms that it has not relied on any representations made by the bank, it will not then be open to the investor to claim an advisory relationship, even if this was closer to reality.
The principle which underlies the position taken by the courts is that of contractual certainty between commercial parties. In Peekay it was said that: “There is no reason in principle why parties to a contract should not agree that a certain state of affairs should form the basis for the transaction, whether it be the case or not”.
In Springwell Gloster J (with the Court of Appeal agreeing) confirmed and built upon the principles established in Peekay. The court found that the bank had not assumed responsibility. Springwell had knowledge of the particular investments and had ultimately relied on the bank’s advice, but had made its own decisions. In addition, like Peekay, it had expressly agreed that the bank had not made any representations. Springwell was therefore precluded from claiming misrepresentation or negligent misstatement.
The following factors were considered by the Court in Springwell when determining that no duty was owed: (i) sophistication of the investor – the fact that the investor had some knowledge and experience of the products through similar dealings with other banks would suggest that there was no advisory relationship and that the contractual terms were read and understood by the investor; (ii) evidence of advisory relationship – the lack of a written advisory agreement was crucial; and (iii) contractual terms agreed between the parties – the contractual terms agreed between the parties estopped Springwell from claiming that certain representations had been made by the bank.
In seeking to uphold the underlying principle of contractual certainty, the courts have upheld contractual estoppel with vigour. So, what room remains for investors to establish that a duty was owed and breached notwithstanding the existence of inconsistent contractual terms?
Basis terms, exclusion clauses and the elusive unsophisticated investor
A key question is whether the contractual terms relied on to raise a contractual estoppel are basis terms or exclusion clauses, with the latter being subject to statutory reasonableness tests (Unfair Contract Terms Act 1977 and s.3 Misrepresentation Act 1967).
In the case of Raiffeisen Zentralbank Osterreich AG v Royal Bank of Scotland plc  EWHC 1392 (Comm) Clark J commented that there was an obvious advantage to allowing “commercial parties of equal bargaining power” to agree what responsibility they are taking (or not taking) towards each other. If “sophisticated commercial parties” agree, in clear terms, to regulate their future relationship by defining the basis on which they will be dealing, then a suitably drafted clause may properly be regarded as establishing that no representations are being made or are intended to be relied upon.
Clark J also noted that financial institutions may attempt to hide behind these principles by carefully drafting terms in order to avoid liability when it and the investor knew that it had advised the investor and that the investor had relied heavily upon that advice. Therefore, in determining whether the contractual terms were “basis terms” or “exclusion clauses”, Clark J found that: “… the key question, as it seems to me, is whether the clause attempts to rewrite history or parts company with reality. … to tell the man in the street that the car you are selling him is perfect and then agree that the basis of your contract is that no representations have been made or relied on, may be nothing more than an attempt retrospectively to alter the character and effect of what has gone before, and in substance an attempt to exclude or restrict liability.” (emphasis added)
It would, therefore, seem that clauses are more likely to be considered exclusion clauses and to be unreasonable where the claim is by an unsophisticated investor. However, how imbalanced are the bargaining positions required to be before an investor is considered unsophisticated?
This point was considered in the recent case of Crestsign Ltd v National Westminster Bank plc and Royal Bank of Scotland plc  EWHC 3043 (Ch).
In 2008 Crestsign, a small family-run private company, entered into an interest-only facility along with an interest rate swap which had a longer term than that of the loan facility. It was found that the director had not understood that the swap contract was a separate and independent contract from the underlying loan facility and that its duration was longer than that loan facility. Interest rates fell, leaving Crestsign obliged to pay 5.65 percent, even after the loan facility had come to an end. Crestsign pursed a claim for misselling.
A number of documents that were supplied to Crestsign included the banks’ standard terms, which included that: (i) Crestsign would determine whether the transactions were suitable, placed no reliance on RBS for advice or recommendations of any sort, should make its own assessment of any transaction and not rely on any opinion provided by the banks; and (ii) the banks would not advise on the merits of a transaction or provide any personal recommendations.
The Court found that the banks’ standard terms defined the basis of the parties’ relationship as a non-advisory one and therefore Crestsign was estopped from asserting a duty of care. As the standard terms did not attempt to “rewrite history” and did not depart from reality (referring to Clark J’s analysis in Raiffeisen); they were found to be effective “basis terms” and not “exclusion clauses”. The Judge indicated that when determining this question: “…you look at the words used to see whether, understood in their proper context from the perspective of an impartial and reasonable observer (i.e. the court), they prevent a representation from having been made, or whether, by contrast, they exclude liability for making it…No violence is done to history or reality by construing the documents as meaning what they say”.
Notably, the Judge commented that although Crestsign was not a large sophisticated commercial party, it was not in a position akin to the buyer of a second hand car. The banks’ standard terms were “unequivocal” and were clearly drawn to Crestsign’s attention before the swap was concluded. However, the Judge went on to say that if the clauses were found to be exclusion clauses, then they would have been found to be unreasonable in the circumstances.
The case-law to date has tended to involve “sophisticated” investors, as cases involving “unsophisticated” investors are likely to settle at an early stage (and note the possibility of regulatory redress discussed below) but no doubt this point will fall to be considered by the courts again.
The regulatory approach
The 2008/09 financial crisis, particularly the dramatic fall in interest rates, led to the increased scrutiny of the practice of selling derivative products and in 2012, the FCA identified failings in the way that some financial institutions sold interest rate hedging products. A number of institutions involved agreed to review their sales of these products to unsophisticated customers dating back to 2001. According to the FCA around 10,000 customers have accepted a redress offer and £1.5bn is being paid out.
It is interesting to look at how the FCA has delineated matters in the redress scheme. For these purposes the FCA considers anyone that satisfied at least two of the following three criteria when the sale was completed to be “sophisticated”: (i) a turnover of more than £6.5m; (ii) a balance sheet total of more than £3.26m; or (iii) more than 50 employees.
Alternatively, if the firm can demonstrate that at the time of the sale the investor had the necessary experience and knowledge to understand the service to be provided and the type of product or transaction envisaged, then they will also be considered “sophisticated”.
The regulatory approach would clearly not be determinative for a court, but the court would certainly be interested in the knowledge and expertise of those dealing with the financial institutions and the complexity of the product.
While there are hurdles to be cleared in pursuing a misselling claim, the courts have made it clear that each case will depend on its facts – the particular things said and done by both parties, their sophistication and relationship and the particular terms agreed between them. The recent case of UBS AG (London Branch) and Anor v Kommunale Wasserwerke Leipzig GMBH  EWHC 3615 confirmed that not all non-reliance and entire agreement clauses will successfully preclude claims of misrepresentation. One has to look at each clause’s particular wording and the exclusion of liability for misrepresentation has to be clearly stated.
Further, other avenues may be open to some investors – such as claiming that the financial institution has breached an information duty or that the particular transactions were ultra vires for lack of capacity. Note that the principle of contractual estoppel extends to cases such as this, potentially preventing parties from challenging the validity of the contract. In the case of Credit Suisse International v Stichting Vestia Groep  EWHC 3103 (COMM) the court found that the “Additional Representations” made in the Schedule to an ISDA Master Agreement were contractual undertakings of future conduct precluding the investor from denying that it had capacity to enter into certain transactions, even in circumstances where the Judge had found that the investor did not have such capacity.
We anticipate that there will be further clarification of the case law in 2015 (a number of cases are set to be heard by the Court of Appeal) and potentially regulatory measures to redress the balance in the future. In the meantime, misselling claims are likely to continue to trouble financial institutions. It will, therefore, be critical for them to carefully consider the practices adopted in the sale of the products, monitor relationships with clients and keep their standard terms under constant review.
Read the original article in Financier Worldwide here.