Partner Abdulali Jiwaji and Associate Nils de Wolff examine the duty to explain in financial product misselling claims.
A version of this article has been published in Compliance Monitor on 7 February 2017, and can be found here.
The duty to explain in financial product misselling claims: fact or fiction?
Financial product misselling continues to be an issue that has become particularly rife in the wake of the financial crisis. Misselling claims broadly relate to breach of statutory duty, misrepresentations, and in contract or in tort relating to the advice itself.
Claims for breach of a contractual or tortious duty to advise are often defended on the basis that the contract between the parties includes sweeping disclaimer wording. Less onerous than the duty to advise (and not dependent on a party being an advisor) is the bare common law duty not to misstate or mislead. However, this can be relatively straightforward to comply with. It is no surprise then that claimants have sought to advance a “mezzanine duty” (less onerous than a duty to advise, but more onerous than the conventional duty not to misstate) – namely, a duty on financial institutions to provide a full and accurate explanation of the products being sold (referred to as the duty to explain).
The duty to explain – judicial scrutiny
The duty to explain is said to derive from the Court of Appeal decision in Cornish v Midland Bank  3 All ER 513, where a bank manager had taken it upon himself to advise a wife on the effect of a second mortgage transaction in favour of her husband. The court held that the bank would have discharged that duty by either (a) advising the customer to seek independent advice, or (b) explaining the matter fully. In the circumstances the bank had failed to do so. Specifically, the bank described the mortgage as being “just like a building society mortgage” (normally only used to secure a loan for a specific purpose), meaning that the customer was believing she was merely securing a temporary loan when in fact the mortgage would secure any future borrowing that the bank might allow her husband to make, a fact that the bank manager had omitted to convey to the wife.
Further support comes from Bankers Trust International v PT Dharmala Sakti Sejahter  CLC 518, in the context of derivatives transactions (swaps) involving sophisticated investors. In that case, the claimants alleged that the duty extended to explaining fully and properly the operation and effect of the proposed swaps and the risks and financial consequences of accepting them. The court held that: “in the first instance [a bank owes] no duty to explain the nature or effect of the proposed arrangement to that other party. However, if the bank does give an explanation or tender advice, then it owes a duty to give that explanation or tender that advice fully, accurately and properly. How far that duty goes must once again depend on the precise nature of the circumstances”. On the facts of the case, the court held there was no corresponding broader duty to explain. In reaching its decision the court highlighted some relevant factors to consider, including the parties’ respective skill and knowledge, the commerciality of the relationship, whether the parties were entitled to expect the bank to act as their advisers generally and any written statements setting out the bank’s role.
In the more recent decision in Crestsign v National Westminster Bank plc and Royal Bank of Scotland plc  EWHC 3043 (Ch), in the context of a swap transaction, the bank had again chosen to volunteer information to the customer. It was found there was no duty to explain the whole range of products that might be available. The duty was to explain fully only those products which the bank had wished to sell to the customer. As to the content of the duty, the judge observed that it would require the bank to explain the effect of swaps accurately, without misleading, but did not extend as far as a “duty to educate” in the sense of giving a comprehensive “tutorial”. There was no duty to ensure that the information provided was properly understood, and it was sufficient for the bank to provide short summaries of the essential attributes of each of the four products it had described, provided the descriptions were not factually wrong or misleading. The duty, it said, would extend to correcting any obvious misunderstandings and answering reasonable questions. In relation to break costs specifically, in the context of structured interest rate derivatives, the judge found that the duty had been satisfied where the bank had described them as “substantial”. However, the judge acknowledged that “in this respect the bank came closest to breaching the duty it owed in respect of the provision of information”. Crestsign appealed the first instance decision (the appeal was due to be heard in April 2016), but the case settled on a confidential basis in February 2016.
Crestsign seems to suggest that there can be a positive duty to explain even in the absence of an advisory duty. Nonetheless, that duty is fact sensitive and there is some onus on the customer to make further enquiries, in circumstances where the information provided is brief and generic (albeit not factually inaccurate and misleading).
In the first instance decision of Thornbridge v Barclays  EWHC 3430 (QB) (an appeal is outstanding), the court found that there is a sharp distinction between advised and non-advised sales. In the absence of an advisory relationship, it was unwilling to recognise a broad duty to provide information. It noted that if Crestsign did intend the existence of a more general duty to explain products fully, then it had erred in doing so. Each case must depend on its facts. The court also observed there was no obligation on banks to warn of unexpected risks, such as movements in interest rates.
On 21 December 2016, Asplin J handed down judgment in Property Alliance Group (“PAG“) v Royal Bank of Scotland (“RBS“)  EWHC 3342 (Ch). PAG was claiming against RBS for amongst other things, the misselling of interest rate swaps. The Court was reluctant to recognise a wider duty to “explain fully” outside an advisory relationship. However, it recognised a potential “broader duty of care”, which is “fact dependent” and “contemplated as a duty falling on the advisory spectrum.” On the facts, it was found that no duty existed, given that PAG (i) was not an unsophisticated party, (ii) had a series of banking advisers who were aware of the potential costs, (iii) never sought the relevant information complained of and (iv) was under no time pressure (unlike the claimant in Crestsign). It was also not considered market practice to give information about potential break costs at the outset and in any event the Court observed that the explanations given were more extensive than in Bankers Trust.
At present the issue remains open for argument. The starting point is that banks owe no duty to explain the nature and effect of a proposed transaction. However, if they choose to volunteer information, then that may give rise to a duty to explain – a question of fact in each case. The scope of any duty to explain will be highly fact sensitive and depend on the context and on enquiries made by the customer.
Given the importance of relevant factual circumstances, and the outstanding appeal in Thornbridge, the scope of a bank’s explanation duty is likely to be explored further, with significant consequences for future misselling claims.