As the credit crunch continues, financial institutions are likely to face increasing litigation risks. More than 175 subprime-related lawsuits have already been lodged in the US. Given that so many of the world’s banks have capital markets operations in London, what are the risks of similar claims in the UK, and what defences are available?
So far, many of the subprime-related claims in the US are class actions, often brought by shareholders against corporations which have suffered capital market losses and/or their directors and officers. However, the UK is less likely to see claims of this type because its regimes for both class actions and shareholder actions are more restrictive than in the US. The UK is also generally a less claimant-friendly jurisdiction. Civil trials are not decided by juries, punitive damages are not available and the losing litigant has to pay the winner’s costs.
However, there is a much greater risk of UK litigation by market counterparties. To date, most credit crunch-related disputes in the UK have resulted from banks pulling out of acquisition funding deals before completion. Buyers have then tried to enforce the terms of the banks’ commitment letters. Banks have tended to rely on two main lines of defence: first, that commitment letters are only ‘agreements to agree’ and not binding; second, that borrowers cannot anyway obtain ‘specific performance’ of a finance deal, but must instead find replacement finance elsewhere (and then seek damages for any difference in cost). Although the legal merits of these arguments can be unclear, such claims have tended to be settled by a re-negotiation of the financing terms in the banks’ favour.
Mis-selling claims
The credit crunch has also started to lead to mis-selling claims by investors against fund managers and against the arrangers or issuers of collaterised debt obligations (CDOs) and other structured products. Even if, as is often the case, the products are listed or the underlying structures are managed outside the UK, investor claims are likely to be brought in the UK if the business was written by a branch there.
Fund management claims will typically relate to alleged breaches of investment mandate or negligence in portfolio selection. Claims against arrangers and issuers are more complex and are likely to focus on inadequate disclosure or explanation of how the products’ structure allocates risk. Claims based on positive misrepresentations may be hard to prove if the offering documents include the usual risk disclaimers. However, where an offering document qualifies as a ‘prospectus’, investors will be able to rely on omissions from the document, as well as any positive misrepresentations.
This may well give rise to conflict between arrangers/issuers and investors about how the offering documents should reasonably be understood. If investors are successful on that front, they will still have to show that any loss suffered resulted from mis-selling and not just from a fall in the market.
Banks will often perform multiple roles in such structures: for example, acting not only as arranger or issuer but also as counterparty for associated repo agreements and hedging transactions. Investors may claim that the bank owed duties of care to investors in one capacity, breached by serving its own interests in another capacity. Again, defensive wording in documents is likely to assist banks. However, in extreme situations there may be a risk, for example, that a court would find a breach of some unwritten, over-riding duty to act in good faith. Banks should be particularly aware of the risks of taking on additional roles in a structure as other parties drop out.
Only a few disputes in this area have turned into formal claims. However, if underlying asset values deteriorate further, it is possible that many more claims will be brought in the UK by investors in CDOs and other structured products. This will be particularly likely if losses are crystallised early by the activation of default triggers – a risk which banks will have to assess carefully in considering any events of default which they might otherwise wish to call.
Tim Strong is a partner, and Ivan Wilkinson an associate director, in the financial services litigation team at Barlow Lyde & Gilbert.
