2020 in Financial Services

February 26, 2021, Covington Alert

Despite the challenges faced in 2020 and notwithstanding the difficulties of working from home, the UK Courts continued to operate with trials conducted remotely, with a number of significant judgments handed down in the last year. This alert considers some of the key decisions in the financial services sector from the past year, and considers what we might expect in the sector in the year to come.

The Financial Conduct Authority v Arch Insurance (UK) Limited & Ors[1]

One of the biggest cases of 2020 was the Financial Conduct Authority’s (the “FCA”) test case which it brought to try to resolve the legal uncertainty regarding the interpretation of common business interruption policy wording in light of the Covid-19 pandemic. This was the first case brought under the Financial Markets Test Case Scheme, which can be used in Financial List claims which raise issues of general importance on which there is no precedent and immediately relevant authoritative English law guidance is needed, and there need not be a cause of action between the parties.

The FCA commenced the proceedings on behalf of consumers, representing the interests of the policyholders, against 8 defendant insurers. The case started in the High Court in June 2020 - the expedited trial commenced on 20 July 2020, 17 weeks after the UK’s lockdown commenced, and a decision was handed down 7 weeks later. Given the importance of the case, a “leapfrog” appeal directly to the Supreme Court was granted and that appeal was heard in November 2020, and the judgment handed down in January this year.

High Court

The test case considered 21 different sample policy wordings, addressing a sample of non-damage business interruption wordings that had insuring clauses falling into three broad categories:

• Disease clauses, which provide cover for business interruption losses resulting from the occurrence of a notifiable disease (i.e. Covid-19) at, or within a specified distance of, the insured premises;
• Prevention of access clauses, which provide cover for business interruption losses resulting from public authority intervention that prevented or hindered access to or use of the insured premises; and
• Hybrid clauses, which combine the main elements of the disease and prevention of access clauses.

The High Court judgment contains a great amount of detailed analysis on each of the sample wordings considered and for each sample, the Court determined what peril was covered by the policy and specified exclusions. As a general comment the Court’s conclusions were favourable to policy holders’ interest in the majority of the key issues (i.e. the position put forward by the FCA) with the FCA reporting that of the disease clauses considered, “most, but not all” provided cover; and in relation to denial of access clauses, “certain” of the sample policies provided cover.

The insurance companies appealed, and the FCA cross-appealed on certain points also. The matter went straight to the Supreme Court.

Supreme Court

The Supreme Court substantially dismissed the insurers’ appeals against the High Court decision and allowed the FCA’s appeal. In effect, the Supreme Court upheld the High Court’s judgment, albeit based on different reasoning in some important respects.  

Although the judgment is likely to assist many policyholders in their business interruption claims, there are a number of issues that have been left unresolved by the Supreme Court judgment, for instance how a policyholder will establish the presence of one or more Covid-19 cases within the policy’s geographical area and how policies requiring physical damage will be interpreted. We expect these issues will be considered further this year. Also, while the judgment relates to 21 sample policies, affecting several hundreds of thousands of policy holders, there is still uncertainty for those policy holders with similar but different policy wording. Again, these are likely to form the basis of further disputes in the year ahead.  

Full details of the Supreme Court judgment are set out in our alert UK Supreme Court Resolves Test Case on Covid-19 Business Interruption Losses.

Even though this was the first time a test case had been commenced in the five year pilot period, the scheme has now become a permanent feature of the practice directions (see PD63AA). Given the success of the pilot in the FCA’s business interruption insurance case, we expect the process will be used again, particularly by the FCA again looking to bring actions on behalf of consumers.

CFH Clearing Limited v Merrill Lynch International[2]

The judgment is one of a number of recent examples of the English Courts reiterating the importance of certainty and predictability in the interpretation of ISDA Master Agreements more generally. 

CFH Clearing suffered serious losses in a large number of automated FX trades entered into during the “Swiss flash crash” of 2015. Unlike other banking counterparties to the transactions, Merrill Lynch did not agree to limit the CFH Clearing’s losses, but CFH Clearing nonetheless sued to recover the losses it suffered.

The swaps entered into between the two parties were governed by: (i) a 2002 ISDA Master Agreement; (ii) an FX confirmation agreement; and (iii) Merrill Lynch’s terms of business which, relevant to the appeal, provided that all transactions were subject to the market practice of any exchange, market, trading venue and/or clearing house and including the FSA rules. CFH Clearing claimed that through the terms of business, FX market practice was incorporated into the agreement and that Merrill Lynch was in breach of the market practice to adjust or cancel deals when extreme events occurred. Merrill Lynch denied this and argued that “market practice” was a concept too vague and uncertain to be incorporated as a contractual term.

The Court of Appeal strongly rejected CFH Clearing’s claim, finding in favour of Merrill Lynch. The Court of Appeal held that (i) the terms of the specific transaction stated that they took precedence over the general provisions of the terms of business; (ii) even if the specific transaction term could be interpreted to account for market practice, it could not be interpreted as reference to FX market practices in general; and (iii) even if the clause in the terms of business had referenced FX market practice, such a reference would be too vague and uncertain to be incorporated as a contractual term.

Further details of the case can be found in our alert English Court of Appeal Upholds Merrill Lynch’s Reliance on ISDA Standard Terms.

Fine Care Homes Ltd v National Westminster Bank & Ors[3]

This High Court case should provide further comfort that providing general advice on a category of products does not create a duty to advise, or to warn, in relation to a specific transaction.

Claims were brought against National Westminster Bank in relation to the sale of a structured collar to Fine Care Homes. This complex interest rate hedging product was bought by Fine Care Homes in July 2007 for a five year term, which was extended at the option of the bank for a further two years. As a result of interest rates dropping in 2008 following the collapse of Lehman Brothers, the average base rate fell to 0.5%. However, as a result of the terms of the collar, Fine Care Homes was still required to continue to pay the bank 6% interest on its £4 million collar. 

Fine Care Homes commenced proceedings that the bank had mis-sold the structured collar on a number of grounds, in essence claiming that the bank had assumed (and breached) a duty to advise on the transaction, and that it had negligently misrepresented the product to Fine Care Homes. The proceedings were stayed while the then FSA conducted a review into the sale of structured collars more generally, in light of the global financial crisis. Following the review the bank offered a refund of £384,258.50 to Fine Care Homes, but this was rejected and the proceedings continued.

While personnel at the bank had provided general overviews of the benefits and risks of hedging products, it had not suggested a structured collar or provided a specific cost/benefit analysis of any particular products. The Court ultimately held that no advisory duty of care existed. The starting point was the Court of Appeal’s ruling that “a bank negotiating and contracting with another party owes in the first instance no duty to explain the nature or effect of the proposed arrangement to the other party”[4] and this was reinforced by the contractual documents which included an express term that the bank’s role in the transaction was on a non-advisory basis. While an advisory duty may exist in exceptional cases, the Court did not consider it arose in these circumstances, i.e. a complex, yet relatively standard financial product. The Court further dismissed the misstatement and misrepresentation claims.  

Aegean Baltic Bank S.A. v Renzlor Shipping Limited[5]

The Court reiterated that while duties are owed by banks exercising their rights under security documents, such duties can be limited by agreement.

In 2007, Aegean Baltic Bank, a Greek bank, entered into a loan agreement and related security agreements (collectively the “Financing Documents”) providing up to US$ 9 million to finance the costs of repairs and provide liquidity for an oil and chemicals tanker. The Defendants were the corporate owner of the tanker, the company which managed the tanker and its director. The latter two each provided a guarantee as part of the Financing Documents. Following water ingress in 2015, the vessel was abandoned. The owner stopped making repayments under the loan agreement and in 2018 the bank issued a demand and sought full repayment under the Financing Documents. 

Pursuant to the terms of the Financing Documents, upon an event of default, the bank was granted a general assignment of, relevantly, insurances and as a result the bank was conducting certain insurance claims in relation to the water ingress. The Defendants resisted the bank’s claim for repayment in full on the grounds that the bank had breached a duty of care owed to the defendants in exercising its rights under the Financing Documents. Specifically, it was alleged that the bank had failed to recover an appropriate amount in settlement negotiations with insurers in relation to claims for the damage to the vessel under the relevant insurance policies.

The key questions were (i) did the bank own the Defendants any duty or duties as a matter of English Law in the exercise of its rights under the Financing Documents and (ii) if so, did it breach the duty? 

In relation to the first question the Defendants’ case was that the bank owed “duties of care at law and/or equity” towards the Defendants to exercise its rights under the Financing Documents to ensure a fair and reasonable recovery of insurance proceeds. These duties were alleged to arise (a) by way of implied term of the general assignment on the insurance; (b) as a duty of care at common law; and (c) as a duty in equity. The bank denied that any such duties existed.

The Court held that the bank did owe a duty in equity in respect of the relevant rights under the Financing Documents, but not at common law or by way of implied term. The duties owed were to “exercise its powers in good faith and for a proper purpose” and if exercising a power of sale to “take reasonable care to obtain a proper price”. The Court found that pursuant to the terms of the document, the bank had limited its liability to losses caused by the wilful misconduct of its officers and employees. In its findings the Court held that the bank’s position was “akin to that of a mortgagee seeking to exercise its rights over security, and the Bank’s enforcement of the Owner’s claim under the [relevant insurance policies] is analogous to the exercise of a power of sale over a mortgaged property”.

However, having found that a duty did exist, the Court held that there had been no breach of that duty. There was no allegation that the powers had not been exercised in good faith and further, there was no suggestion that there had been wilful misconduct on behalf of the bank.

Looking forward

2021 will of course continue to be dominated by the impact of the global pandemic. A key aspect of this will be the economic and financial repercussions, including a marked increase in fraudulent transactions which may lead to civil actions, and potentially enforcement actions also. 

In this regard, 2021 has already seen the High Court confirm the narrow scope of the duty on banks to prevent fraud, known as the Quincecare duty.[6]  The Quincecare duty requires that banks refrain from executing customers’ orders where they are put on inquiry that the order is an attempt to misappropriate the customer’s funds. However, in the decision of Philipp v Barclays Bank PLC, when giving instruction to transfer her funds, the customer (instructed by the fraudsters and unbeknownst to the bank) gave false explanations to the bank as to why the funds were being transferred to the UAE. In considering whether a Quincecare obligation arose, the Court upheld the narrow applicability of the rule, finding that the Quincecare duty should be understood as ancillary to the primary obligation on banks to act in accordance with their customers’ instructions, and that it would therefore be wrong to extend its application to transactions which have been properly authorised by those customers. Full details of the case can be found in our update English Court Confirms Narrow Scope for Banks’ Fraud Prevention Duty.

The Quincecare duty will likely be considered by the High Court again in the trial of Stanford International Bank Ltd v HSBC Bank plc. HSBC was unsuccessful last year in its strike out and summary judgment applications in relation to SIB’s claim of breach of the Quincecare duty, but the post-trial judgment is likely to give even further guidance for banks on the scope of the Quincecare duty.

Finally, the UK has now officially left the European Union. The fact that the EU-UK Trade & Cooperation Agreement did not address financial services suggests that, in the short-term, notwithstanding the years of planning, disputes are likely to arise in relation to the proper interpretation of contracts, in post-Brexit conditions.  In the longer term, as the impacts of Brexit on the UK’s financial services sector begin to unfold, other issues are almost certain to arise.  But despite the news reporting about Amsterdam having overtaken London as Europe’s share-trading hub, London’s greater size; the sheer diversity of financial services it offers; and the dominance of English common law, mean that, London is unlikely to lose its status as a pre-eminent global financial hub, in which case, the English Courts are likely to remain busy with financial services disputes.

If you have any questions concerning the material discussed in this client alert, please contact the following members of our Commercial Litigation and Financial Services practices.

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[1] [2020] EWHC 2448 (Comm).

[2] [2020] EWCA Civ 1064.

[3] [2020] EWHC 3233 (Ch).

[4] Property Alliance Group v Royal Bank of Scotland Plc [2018] EWCA Civ 355 at ¶66.

[5] [2020] EWHC 2851 (Comm).

[6] Fiona Philipp v Barclays Bank UK PLC [2021] EWHC 10 (Comm).