article
FSFocus
13 January 2009
Inevitably, as the impact of the global recession reverberates
throughout the financial services sector, we will see a rise in the
number of litigation cases, according to Nichola Evans, a partner
with law firm Browne Jacobson. Here, she looks at the increase in
cases involving financial advisers, banks, brokers and insurers and
provides some advice for those considering court action.
Statistics show that business litigation is rising. Whilst the
number of cases being issued in the Commercial Court fell between
1999 and 2005, they rose again significantly in 2006. The Ministry
of Justice Judicial Statistics show that in 2005 49,442 cases were
issued whereas in 2006 61,691 cases were issued. That trend
continued in 2007 and although current figures are hard to come by,
it’s inevitable that the number of litigation cases has continued
during 2008.
As companies face more and more financial pressure, they are
forced to look at their bottom line. This leads to debts being
chased more effectively, but one further consequence is that
companies will look to their advisers and analyse the quality of
the advice which has been given.
The sub prime mortgage crisis has led to what one newspaper
called a “tsunami of lawsuits”. So far the bulk of the litigation
has been brought in the United States, much of it by way of class
action. Part of this is due to the fact that in the US one has the
ability to claim punitive damages and also the Claimant is not
responsible for the Defendant’s costs.
There have been various forms of claim:
- Investors v banks – this can relate to allegations of negligent
misstatement, the purchase of asset-backed securities based on bad
loans or for improper accounting.
- Businesses v banks – in particular pension funds companies who
have assessed how much money has been lost on the back of sub prime
investments.
- Banks v banks – for instance Barclays Bank who sued Bear
Stearns over its management of a hedge fund.
- Businesses v lawyers and accountants with a whole variety of
claims being made.
Whilst these matters make good headlines, let’s look at what is
required if one is to make a claim. The purpose of this article is
to look at the common law position and not to look at issues of
corporate governance or the FSA position.
In the past banks and professional advisers have been seen as
easy targets to make a claim against and there may well have been
good practical, commercial reasons for settling claims. However,
banks and their lawyers have indicated that in the present economic
climate claims are likely to be defended aggressively. Again with
the insurance market hardening that trend is going to extend there
too.
Should a company wish to bring a claim, there are a number of
hoops through which it would have to jump.
The first step is to look at the relationship between the
parties and in particular the scope of that relationship. There is
a considerable amount of case law devoted to this area. However,
let us focus on two cases that can provide valuable lessons for
others in the financial services sector.
The first is the case of Football League Limited v Edge Ellison.
Edge Ellison, a firm of solicitors, was sued by their former
client. Edge Ellison had been engaged by Football League Limited to
advise on the licencing of television rights to a broadcasting
company. A three year agreement was negotiated by Edge Ellison for
the sum of £315,000,000. However, after a short period of time the
broadcasters went into liquidation leaving a substantial sum of
money unpaid. Football League Limited alleged that Edge Ellison was
negligent in that it ought to have sought guarantees from the
broadcaster’s parent company for performance of the payment
obligations.
The court took a different view having reviewed the factual
matrix. It held that a solicitor was not employed to take a general
overview of the commercial considerations and to take part in the
commercial decision making process. It looked at the fact that the
people involved in the decision making process at Football League
Limited were experienced businessmen and would have been well aware
of an insolvency risk.
The lesson from this case is to look at the precise terms of the
retainer between the parties and see what it is agreed that the
professional will do. It is generally accepted that there is no
such thing as a ‘general retainer’ imposing a duty to consider all
issues relating to a client’s interest. However, it is accepted
that a duty may arise if the client is inexperienced and that
advice may have to be proffered where it would not if the client
were more experienced.
This complex issue has been judicially considered recently in
the case of J P Morgan Bank (formerly Chase Manhattan Bank) v
Springwell Navigation Corp. In this case Springwell sued J P Morgan
in relation to an alleged failure to advise in relation to emerging
market investments. Springwell was investing heavily in a certain
type of derivative instrument referenced to bonds. When the issuer
of the bond defaulted, the portfolio collapsed in value. Springwell
claimed damages alleging that J P Morgan should have advised that
this was not an appropriate investment.
This claim was dismissed. The court found that no advisory
relationship existed and that the obligations of an investment
manager or asset manager were not imposed.
In reaching this decision the court took account of how the
business between the parties was conducted. In addition, the court
reviewed the contractual documentation which existed between the
parties and this showed that the parties contracted on the basis of
a trading and banking relationship and this also meant that no
general advisory duty came into existence. This issue had also been
examined in a number of similar cases.
After looking at the scope of the duty owed by an adviser, one
has to look at the advice given and analyse in what respect is it
alleged that the Defendant did not exercise the requisite degree of
skill and care that one would reasonably expect of a professional
in that position.
Following on from that, the next test is to establish what would
have been the correct advice. Furthermore, if the correct advice
had been given, what difference would that have made to the action
taken by the Claimant? If one looks at the unsuccessful litigation
brought by Equitable Life against Ernst & Young, one of the
biggest problems faced by Equitable Life was showing the court that
if their auditors had given correct advice that they would have
acted any differently.
The damages which the court awards will be based upon the view
it takes as to how it believes that the Claimant would have behaved
had the correct advice been given.
If this sounds difficult enough, then the following factors also
need to be taken into account.
Claims like these are notoriously expensive to bring. It was
widely reported that the legal costs incurred by Equitable Life in
pursuing its claim against its former auditors Ernst and Young was
£45 million. Clearly, most cases will not reach this level of costs
but Claimants either need “deep pockets”, some kind of legal
expenses insurance policy or to find a lawyer who will take the
case on a “no win no fee” arrangement. However even with this kind
of agreement most lawyers would recommend the taking out of an
insurance policy in respect of the other side costs to provide for
the possible ruinous consequences of an unsuccessful action. Such
policies tend to be a fair sized proportion of the likely costs in
any event.
In addition, in order to succeed in an action, a Claimant would
need to bring in expert witnesses, again at cost, to support the
claim. For instance, expert evidence will often be needed to show
what the correct advice should have been. Expert evidence will also
generally be required to look at the quantification of loss.
Claimants tend to underestimate how much time and effort they
need to put into the preparation of a case, from instructing a
solicitor to locating documents and dealing with the burden of
disclosure through to the preparation of witness statements and
attendance at trial itself. No compensation or costs are available
in relation to this time. Realistically, can a senior director
afford to spend this time away from the business, particularly a
business which possibly has cash flow problems?
In the light of these facts, it is fair to conclude that looking
forward to the rest of 2009, insurers and large institutions are
likely to vigorously defend professional negligence claims.
It is extremely difficult to bring a claim and there are a
number of hoops through which a potential Claimant will need to
leap. Businesses may naturally think that if an investment goes
wrong, that someone is to blame. In practice, that is not
necessarily the case. Indeed the investigation into whether there
has been bad advice may cost thousands of pounds to
investigate.
Therefore in the UK it is envisaged only the most committed and
those who have been advised that they have excellent prospects of
success (and by this one means those with prospects in excess of
65%) will actually bring a claim as opposed to making noises about
the same.
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