Partner Elaina Bailes and Associate Aleks Valkov have prepared the global overview to the first Lexology Getting The Deal Through (GTDT) guide to financial services litigation.

Introduction

Predicting litigation trends is notoriously tricky. Disputes arise from unique, random or bizarre events and (for most clients) litigation is, by its nature, outside the course of ‘business as usual’. It is, therefore, difficult for litigators to look at market trends in their clients’ sectors and draw conclusions. The coronavirus crisis has added a further curveball into the landscape for 2020.

Having said that, financial services is an area where litigation patterns can be more easily recognised than in other fields. One reason for this is the size of the sector: in 2018, the financial services sector made up 6.9 per cent of total economic output and contributed £132 billion to the UK economy. At that scale, when things go wrong, they go wrong more than once. Other features of the sector that lend themselves to the potential for disputes include:

• the use of standard form agreements, leading to disputes involving the interpretation of their terms;
• the unequal relationship between financial institutions and retail customers who are dealing outside their area of expertise, leading to disputes regarding whether banks, etc, have treated customers fairly and whether they have discharged any duties of care that apply; and
• the difficulties faced by regulators attempting to enforce fair practices in an industry driven by profit that has long had an issue with a culture that rewards ruthless behaviour; disputes arise where the line between sharp practice and fraudulent or misleading conduct becomes blurred.

In this article, we set out our predictions for the growth areas in financial services disputes over the next 12 months and the decade ahead. More than 10 years has passed since the last great financial crisis, but the English courts are still dealing with the tail end of its fallout. It is, therefore, likely that the downturn caused by the covid-19 pandemic, plus the other trends we identify, will leave financial services litigators busy for many years to come.

Brexit

Brexit is an event that seemed certain to dominate the 2020 agenda until the covid-19 pandemic hit. The UK financial services industry has already felt its impact as firms have begun to move offices and people away from London, fearing that the United Kingdom will lose its passporting rights to free access to EU markets. Recent events suggest that the deal between the United Kingdom and the European Union is far from sealed, meaning that the uncertainty for the industry will continue for some time. Given the global nature of the financial services business, the uncertainty about the ceasing of EU law application in the United Kingdom is likely to give rise to disputes in the sector. One could speculate ad fininitum, but currently, the obvious key area that may affect financial services is jurisdiction and enforcement of UK judgments.

The United Kingdom stopped being a member of the European Union on 31 January 2020. At this point, as a result of the EU–UK Withdrawal Agreement, the United Kingdom ceased to apply the current EU regime concerning whether EU member state courts have jurisdiction to hear a dispute (found in Regulation (EU) No. 1215/2012 of the European Parliament and of the Council of 12 December 2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (the Recast Regulation). Currently, the Lugano Convention on jurisdiction and the enforcement of judgments in civil and commercial matters signed in Lugano on 30 October 2007 applies during the transition period (which will end on 31 December 2020, unless extended). The Lugano Convention’s provisions on jurisdiction clauses are similar to the regime currently in force. That said, some significant differences could lead to complications.

On 8 April 2020, the United Kingdom applied to become a signatory of the 2007 Lugano Convention after the transition period comes to an end. However, there has been some indication that this might not happen. If this is the case, the common law rules on jurisdiction will take precedent, meaning the enforcement of English judgments in the European Union becomes less straightforward.

There has been much speculation on whether Brexit will mean a loss of business for the English courts compared to European rivals who can provide justice within the EU framework. This remains a risk, but our view is that the English courts’ reputation for sophistication and their long experience in dealing in financial services litigation will mean that the jurisdiction will remain the preferred choice for many parties in the financial services sector. The existence of the Financial List since 2015, a specialist list within the Commercial and Chancery Divisions, has seen the High Court upping its game in the efficient disposal of suitable financial cases by specially selected judges. Although other European jurisdictions are starting to promote international business courts, equipped to deal with cases governed by foreign law, our view is that this cannot replace the English courts’ experience in this field. Sir Geoffrey Vos, the Chancellor of the High Court, agrees. In a speech in May 2019, he said he did not expect Brexit to have the ‘dramatic effect’ on financial services litigation that some have suggested.

The end of LIBOR

The London Inter-bank Offered Rate (LIBOR) has been a hotly debated (and litigated) issue in the wave of claims from the 2008 global financial crisis. Claimants have had limited success when bringing misrepresentation claims based on the manipulation of LIBOR. The Court of Appeal, in Property Alliance Group Ltd v The Royal Bank of Scotland plc [2018] EWCA Civ 355, dismissed the appeal against the first instance decision that the bank, on the facts, was not liable for misrepresentation despite being involved in manipulating LIBOR. That said, the Court also reaffirmed the first instance judge’s conclusion that a bank could assume responsibilities to a client in a particular factual context in respect of a particular transaction or a relationship. This seems to have precluded at least some of the possible LIBOR claims.

However, a new stream of claims is possible as a result of the announcement by the Financial Conduct Authority (FCA) in 2017 that banks would not be asked to contribute to the rate after 2021, making it highly likely that LIBOR will be discontinued. The main issue is that a vast number of financial contracts that will mature after 2021 that are referenced to LIBOR will no longer exist. It has been decided that LIBOR will be replaced by the risk-free rates (eg, in the United Kingdom, the Sterling Overnight Index Average (SONIA), or in the United States, the Secured Overnight Financing Rate). However, the main issue with this replacement is that LIBOR is numerically bigger than SONIA. As such, the new rate will have to be SONIA plus a credit spread adjustment. The Bank of England has been working on establishing and codifying that extra spread, but this has been subject to disagreement between stakeholders.

That said, the English court (see Sudbrook Trading Estate Ltd v Eggleton [1983] 1 AC 444) has long ago established that:

where an agreement which would otherwise be unenforceable for want of certainty or finality in an essential stipulation has been partly performed so that the intervention of the court is necessary for the aid of a grant that has already taken effect, the court will strain to the utmost to supply the want of certainty even to the extent of providing substitute machinery.

As such, it has the tools to substitute whatever rate justice requires to ensure that agreements between parties are enforceable. This is very much an uncharted territory that could potentially become a highly litigious one as courts establish principles for determining the substitute rate. Moreover, as a result of the pervasiveness of LIBOR, there may be diverging judgments from different jurisdictions that could complicate matters even further.

International sanctions

Where international sanctions operate as a restriction on supply chains, disputes can arise in many different sectors, but since all businesses need access to finance, this has a knock-on impact on the financial services sector. For example, if new sanctions are imposed in a customer’s jurisdiction, a financial institution may decide to cancel lending facilities in breach of contract; the risk to the lender of being penalised by sanctions authorities or excluded from the relevant jurisdiction is greater than that of breaching their contract.

In recent years, there have been several disputes arising from investment in the United Kingdom and Europe by investors from politically unstable jurisdictions where sanctions are now in place (such as Iran and Libya). As this instability shows no signs of disappearing, we expect disputes to continue.

Crypto-assets

Litigation involving crypto-assets is expected to grow. Currently, most crypto-investments are not specified investments under the Financial Services and Markets Act 2000 (the FSMA 2000), so customers do not benefit from statutory or regulatory protections.

In 2019, the English courts saw a raft of cases tackling issues such as contractual terms, whether crypto-assets are property and appropriate remedies (including confirming that freezing injunctions can be sought over crypto-assets).

As the digital asset class grows in value, the market will expand and lead to disputes. On the consumer side, a similar phenomenon could be seen to the trend seen pre-2008 of retail customers being sold unsuitable complex interest rate products they did not fully understand, leading to mis-selling claims. The FCA recommended that retail customers not be sold derivatives based on cryptocurrencies, but crypto mis-selling claims may yet still appear. The English judiciary has taken steps to ensure its courts are fully equipped to deal with legal issues arising from crypto-assets. In November 2019, the Chancellor of the High Court, Sir Geoffrey Vos, launched the Legal Statement on Crypto-assets and Smart Contracts, which aimed to bring clarity on the ‘likely’ status of crypto-assets under English law. This is an unprecedented step in a common law jurisdiction of anticipating how future cases may be decided and shows how the judiciary sees this as a future growth litigation area.

Shareholder claims

In recent years, UK investors have become a lot more active, following in the footsteps of their American brethren. This has resulted in several claims brought before the English courts against financial institutions and businesses by their shareholders based on section 90 and section 90A of the FSMA 2000.

Section 90 of the FSMA 2000 imposes liability on listed companies for untrue and misleading statements (or omission of particular matters) in the listing prospectus. The Royal Bank of Scotland (RBS) Rights Issue litigation, commenced in 2013, was the first group action of its kind in England in which a large number of shareholders sued the Royal Bank of Scotland under section 90 of the FSMA 2000 because the prospectus for the bank’s 2008 rights issue of shares was untrue and misleading. Although the case settled in 2016 before trial, it established some procedural guidance concerning when a group litigation order can be made and that where there is a large discrepancy in the values of claimant’s claims, the court may depart from the usual rule of apportioning claimant common costs on an equal basis.

Section 90A (and Schedule 10A) of the FSMA 2000, in turn, covers a wide range of publications made by a listed company and imposes liability for any statement that is untrue or misleading or for an omission in a statement that was dishonest concealment of a material fact. Unlike section 90, for a section 90A claim, the claimant must show that he or she relied on the misleading statement. The Tesco shareholder action (due to go to trial later in 2020) is the first claim under section 90A. The background to the proceedings is that on 22 September 2014, Tesco Plc admitted to overstating its profits for the half-year of 2014–15 by £250 million. This resulted in a huge drop in the share price and a significant loss for shareholders.

Tesco recently applied to have the claim struck out and lost, which resulted in a landmark judgment clarifying section 90A of the FMSA 2000. The vast majority of the claimants in the proceedings held their shares in ‘dematerialised form’ through the CREST system via a chain of custodians or sub-custodians in whose name the shares were registered. Tesco Plc argued that this meant that the claimants did not have an interest in the securities or could not be properly said to have ‘acquired, continued to hold or disposed of’ any interest in securities. Both of these are a necessary prerequisite for a section 90A claim (see Omers Administration Corporation & Ors v Tesco Plc [2019] EWHC 2858 (Ch)). Mr Justice Hildyard observed the fundamental importance of this issue given the prevalence of custody chains in the dematerialised securities market and the underlying purpose of section 90A of the FSMA 2000. If Tesco was correct on its construction in respect of the nature of the claimants’ ‘interest in securities’ under Schedule 10A of the FSMA 2000, the statute would be unfit for purpose and require further consideration and amendment. However, ultimately, the judge dismissed both of Tesco plc’s arguments. This is an important decision for potential securities actions claimants, confirming that section 90A has teeth. As a result, we expect to see an increase in securities actions over the next few years; unfortunately, the economic crisis sparked by the covid-19 pandemic may lead to institutions in financial difficulty to mislead their investors.

The coronavirus crisis

The covid-19 pandemic has had a tremendous impact on all businesses around the world. Despite the lockdown restrictions, the High Court (and, in particular, the Financial List) has continued operating by way of virtual hearings and is now slowly starting to phase in hybrid hearings (which include some of the participants being physically present).

Shortly after the UK lockdown began, the Court remotely heard the case of National Bank of Kazakhstan and another v The Bank of New York Mellon and ors [2020] EWHC 916 (Comm), which was a claim for about US$530 million. Pre-pandemic, the English courts had made attempts to modernise their digital offering, partly in response to Brexit concerns, but the lockdown has accelerated this process. This is a welcome development for parties (and potential parties) to financial services litigation, showing the English courts’ commitment to providing efficient justice.

The insolvency of many businesses as a result of the crisis may trigger defaults in financial documents, which financial institutions will no doubt wish to pursue. However, the recent Corporate Insolvency and Governance Act 2020, enacted in response to the crisis, brings in sweeping reforms to the existing insolvency rules, making the regime much more business-friendly (as opposed to debtor-friendly). This means financial institutions might not be able to bring insolvency proceedings against debtors (see, for example, Schedule 10 of the Act) and could lead to disputes regarding the interpretation of contracts entered into historically.

Much has been said about force majeure disputes as a result of the covid-19 pandemic. Whether these disputes will see significant litigation remains to be seen, but the 2002 International Swaps and Derivatives Association Master Agreement’s force majeure clause is a potential target. The clause applies to ‘force majeure or acts of state’ that prevent the office of the party from making a payment or delivery in respect of a transaction under the agreement. Whether the clause is engaged or not would be a fact-specific exercise.

Conclusion

We believe that the next few years will see a more diverse range of financial services disputes than what was seen in the wake of the 2008 global financial crisis. Then, litigation was focused around several key causes of action available to customers arising from a pattern of behaviour of financial institutions across the board. It was easier to point blame and ask for regulatory reform. There were extreme examples, such as in the case of RBS, where problems pervaded every aspect of the business, leading to shareholder claims being brought.

However, in the current climate, financial institutions face litigation risk on several different fronts, not of their own doing. Political (in the form of Brexit and sanctions); technological (in the form of legal uncertainty of crypto-assets and the new social distancing norms); and economic, but this time as a result of a health crisis not directly related to the industry itself. For the judiciary and litigators, it will be predictably fascinating, in unpredictable ways.

The full article can be viewed here.

Reproduced with permission from Law Business Research Ltd. This article was first published in July, 2020. For further information please contact editorial@gettingthedealthrough.com