Caveat emptor - Unreliable assumptions as to good faith in the international capital markets

Introduction

Many institutional investors in the international capital markets will expect that issuers of securities and bank arrangers of complex finance instruments have a duty to act in good faith. Recent decisions in the English courts have re-affirmed that this is likely to be an unfounded expectation. 

In contrast to the approach in many civil law jurisdictions, English law implies a duty of good faith only in very limited circumstances, which would be unlikely to include a duty of good faith as regards disclosure in securities offering documents.

This bulletin summarises the implications for investors who come to believe that material information has been withheld from them in the promotion of a securities offering. The position is now clearly established: if an investor suffers loss on an investment and believes that the loss was caused by matters not disclosed in the offering documents, then it must show clear evidence of a breach of an express or implied representation as to that matter, and also be able to show that it gave "conscious thought" to such representation and placed reliance on it at the time of its original investment decision.

The position in statute. Allianz Funds Multi-Strategy Trust & Ors v Barclays Bank Plc [2024]

In Allianz Funds Multi-Strategy Trust & Ors v Barclays Bank Plc [2024], the Court, at a preliminary hearing, considered whether in the context of a claim for securities misselling brought under inter alia under sections 90A and Schedule 10A of the Financial Services and Markets Act, an allegation of misrepresentation contained in the sales documents would require a claimant to show not only that it had read the relevant statement, but also that it had actually consciously relied on it in making its investment decision.

The claimants were institutional investors who brought claims against Barclays in respect of allegedly false and misleading statements published in its 2011-2014 annual reports, interim results announcements and in a certain prospectus. 

Section 90A/Schedule 10A allows an investor in UK-listed securities to bring a claim against an issuer where (broadly) four limbs are satisfied:

1     that issuer either made an untrue or misleading statement in its published information or omitted a material fact;

2     a “person discharging managerial responsibilities” knew as much (or, in the case of untrue/misleading statements, was reckless);

3     the investor relied upon the statement or omission; and

4     that caused the investor to suffer a loss.

There were 3 categories of claimants: (i) Category A: those claimants who had read, considered and relied on the relevant published information directly; (ii) Category B: those who relied on the relevant published information indirectly through other sources which acted as a conduit for the substantive contents of the published information; and (iii) Category C: those who are alleged to have suffered losses as a consequence of movements in the share price of the Bank or ‘price/market’ reliance (so-called “passive investors”). Barclays applied for strike out and/or summary judgment in respect of 241 of the Claimants’ claims (being, essentially, those of passive investors). 

A key question for the consideration of the court was whether investors who had never read the published information (in this case, chiefly the Category C claimants), could nonetheless have been said to have relied on it.  

In respect of express representations (whether made orally or in writing), the Court held that the test for reliance requires a claimant to “prove that they read or heard the representation, that they understood it in the sense which they allege was false and that it caused them to act in a way which caused them loss”. 

For the Category C claimants to demonstrate reliance, they had to show that either their representatives or third parties who directed or influenced their investment decisions had read and considered the published information. Ultimately, the judge found that these claimants had no real prospect of doing so and granted reverse summary judgment in favour of Barclays.

The judge made clear that the intention of this statute was to identify the purpose of the independent requirement of reliance, namely, to limit recovery to those investors who can prove that they relied on the published information in which the untrue or misleading statement was made, or from which any matter which should have been included in that published information was omitted.  “In my judgment, the test for reliance as it applies to express representations (whether made orally or in writing) requires the claimant to prove that they read or heard the representation, that they understood it in the sense which they allege was false and that it caused them to act in a way which caused them loss.”

Although the judgment relates specifically to passive investors such as tracker or index-linked funds, the rule nevertheless clearly applies equally to 'active' investors who buy directly, or indirectly via a discretionary fund manager (or similar) investing on their behalf.

The common law tort of misrepresentation - innocent or negligent breach of an express or implied term or representation. Loreley Financing (Jersey) No 30 Ltd v Credit Suisse Securities (Europe) Ltd & Ors [2023]

In Loreley Financing (Jersey) No 30 Ltd v Credit Suisse Securities (Europe) Ltd & Ors [2023], the Court was concerned with alleged misrepresentations by the defendant bank, Credit Suisse, in respect of US$100 million Notes (the “Notes”) which formed the basis of a synthetic Collateralised Debt Obligation transaction and which were in turn linked to certain residential mortgage-backed securities, a number of which had been packaged, securitised or underwritten by Credit Suisse and its affiliates. 

The value of the claimant’s investment was lost in full in 2010. It sought to unwind the transaction on the basis that Credit Suisse had made fraudulent implied misrepresentations that induced it to purchase the Notes. It alleged systemic fraud and misconduct in the selling of RMBS, a number of which were directly linked to the credit of the Notes. And it alleged that Credit Suisse had been aware of this fraud and misconduct when selling the Notes, and had fraudulently misrepresented that it was unaware of any such problems.

The judge set out the facts that any investor alleging misrepresentation would need to prove in order to be successful: (i) that the defendant made a false representation; (ii) that the defendant knew the representation to be false, or had no belief in its truth, or was reckless as to whether it was true or false; (iii) that the defendant intended the representation should induce the claimant to enter into the contract; and (iv) that the claimant was induced to enter into the contract by the representation. 

The claimant had alleged a variety of implied representations arising from the content of the sales documents and from the information that various elements within the Credit Suisse group was alleged to possess and that, it was claimed, were material to the claimant’s investment decision.

However, the judge decided that none of those implied representations had in fact been made, but nevertheless went on to consider whether if, on the contrary, any of them had indeed been made, the claimant had relied on them in making its investment decision.

One of the central considerations for the court was whether in such cases, the representee must be aware of the (in this case, “implied”) representation, in the sense that it must be the subject of  "contemporaneous conscious thought" or "actively present to his mind", or whether there was an evidential presumption which infers inducement from the fact of the material misrepresentation having been made and the contract having been entered into. The judge concluded that the law does require that a representation (however made) is received by the representee and that to satisfy the requirements of reliance the representee must be aware of it/have it actively present to their mind when they act on it.

The basic position was summarised in another recent case (Leeds City Council v Barclays Bank PLC [2021]) as follows:  

“The core requirement is to establish that the claimant was materially influenced by the representation. The question of inducement is centrally concerned with establishing a causal link between the conduct of the defendant and the conduct of the claimant. It is a control mechanism: if the defendant told a lie, but that lie had no effect on the claimant’s thought-process or conduct, no remedy will be available. The overarching question is whether the representation operated on the mind of the claimant or materially influenced the claimant.”

However, the rule may also be subject to some degree of nuance. There can be cases where on the particular facts in play reliance is found without any distinct evidence of understanding or awareness being identified.  Such cases bear one of two hallmarks. The first is where the representation is simple and cannot well be missed by the representee. The second (related) is where the representation is one which is at the heart of the transaction. In such cases, it might be said that the fact that is being represented, albeit implied from some other conduct or statement, is so obvious it goes without saying. 

Both of these types of implied representation should be distinguished from cases where the alleged misrepresentation is being said to be capable of being implied despite complex contractual provisions, usually in complex multifaceted transactions.   It is in those cases that there arises a need to see what has, in fact, been registered or understood by the investor.  In the more recent case of Farol Holdings Ltd v Clydesdale Bank plc [2024], this nuanced position was expressed as follows:

“It is essential to keep in mind that in every case it is necessary to show, as a matter of fact, that the claimant's decision to take the action (or refrain from taking action) which caused it loss must have been caused by the representation made by the defendant. The evidence required to satisfy that requirement will differ greatly depending on where on the spectrum the case lies (from "it goes without saying", at one end, to a complex representation said to be implied from conduct and statements, at the other)."

The judgment in Loreley demonstrates clearly the difficulty establishing any implied representations (including those that investors may well consider to be reasonable assumptions as to important behind-the-scenes information) in the sales documents for international capital markets transactions and, indeed, the difficulty in establishing any representations at all - express or implied - in structured finance deals (securitisations, etc) that have a special purpose vehicle (SPV) as issuer.

The position of 'good faith' in European civil law jurisdictions

In matters of disclosure therefore, it should not be assumed that issuers of complex securities or counterparties to complex derivatives transactions are required to disclose all information which may be regarded as material.

In contrast to the English common law which does not impose a general overriding duty to negotiate in good faith, a number of European civil law systems imbibe duties of good faith between parties during the negotiations for a contract. As noted by Bingham LJ in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] Q.B. 433 at p.439: “[i]n many civil law systems, and perhaps in most legal systems outside the common law world, the law of obligations recognises and enforces an overriding principle that in making and carrying out contracts parties should act in good faith”. In particular, it has been noted that in a number of civil law jurisdictions “good faith has provided the basis of some pre-contractual grounds of relief or compensation” including as regards duties of disclosure. 

Some examples of jurisdictions in which a duty of good faith has been recognised in the context of pre-contractual negotiations include: (i) France (Article 1104 of the French Civil Code identifies as a matter of public policy, that contracts must be negotiated, formed and performed in good faith); (ii) Italy (Article 1337 of the Italian Codice Civile); (iii) Germany (s.311(2) of the German Bürgerliches Gesetzbuch) and (iv) Belgium (Articles 5.15 and 5.16  of the Belgian Civil Code).

Conclusion

As can be seen, there are challenges ahead for any investors wishing to bring a misrepresentation claim in English courts. Of key importance will be the need to show that they have read and digested the contents of the selling documents in any new securities issue in order even to start that process.

If you are an institutional investor in the international capital markets and would like to receive further background on this subject, please contact us at the details below.