JP Morgan Chase v Springwell Navigation Corporation

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1 slaughter and may Companies Briefing Paper Act 2006 July 2008 JP Morgan Chase v Springwell Navigation Corporation When does a bank assume responsibility for financial advice that it gives to its clients? The High Court in London gives helpful guidance on the scope of a bank s advisory duties. There are points to note for banks in the Court s judgment and important implications for banks engagement letters, especially where advice may be given to a client. 1. Background to the case After an unsuccessful action in the United States in 1999 (dismissed on jurisdictional grounds), and a six month trial in London, a sophisticated investor has lost its action in the High Court against a bank for investment losses to its portfolio of Russian bonds, including GKO-linked notes (a type of Russian debt security), following the Russian government debt default in The bank was Chase and the sophisticated investor was Springwell, the investment vehicle of the Polemis family, owners of a Greek shipping fleet. The essence of the claim was that: > Chase had breached an alleged contractual, tortious or fiduciary duty to advise Springwell as to what investments were appropriate, having regard both to the particular characteristics of the individual investments and to the balance of the portfolio as a whole; and > Chase could not rely on contractual disclaimers because the duty pre-dated the disclaimer and/ or was not effective to exclude Chase s fiduciary duties. A secondary claim was that even if Chase had no advisory duty, it misrepresented to Springwell the characteristics of the GKO-linked notes and other Russian investments. In addition, Springwell claimed an account of, and equitable compensation for, alleged excessive profits made by Chase in its dealings with Springwell. There were also some additional claims for shipping losses, conduct after the Russian government debt default and interest. The Honourable Mrs Justice Gloster DBE, in a lengthy judgment, found for the bank on all points. She concluded that none of the relevant Chase entities owed contractual or tortious obligations to Springwell to advise it as to appropriate investments, or as to the structure of the portfolio. Since the judge found there was no contractual or tortious duty to advise, she saw nothing in what was essentially a commercial banking relationship that could give rise to a fiduciary obligation. Although much of this judgment is specific to the facts, and the judge found the main witness for Springwell unreliable, there is much that banks can take from the decision.

2 Of particular interest is the fact that she found that the salesman did in fact give recommendations or advice, but in the context (and bearing in mind the other relevant factors) this did not impose a duty of care on the bank, and that even if (contrary to her decision) it did, the contractual terms were effective to relieve Chase of liability. The bank s terms of business were standard in the market at the time (1998) and included provisions that the bank s duty was non-advisory, that Springwell was acting independently and without reliance on Chase, and that Springwell took its own decisions to acquire investments and did not expect Chase to be responsible for advising it as to the merits of those investments. The terms provided that no representations were made, that the bank took no responsibility for statements, statements made had not been independently verified, and that in placing an order Springwell represented it was a sophisticated investor and entered into investment contracts independently and without reliance on Chase. There were also some general exclusion clauses. In relation to the Unfair Contract Terms Act 1977 (UCTA), the judge said that terms which simply define the basis on which services will be rendered are not subject to section 2 of UCTA. Recognising that UCTA is of limited application in the case of commercial contracts between commercial counterparties, she added that even where the contractual provisions fell within the scope of UCTA, in the context of the dealings between the parties, the terms of business were not unreasonable - On the contrary, they were reasonable. On the misrepresentation claim, the judge said that a reasonable person, operating in the markets in which Springwell was engaged, and on the same contractual terms, would not have assumed that the salesman s statements were actionable, or that his expressions of opinion were anything other than a trader s opinion from the trading floor. The judge added that there was no duty to the bank to account to Springwell for excessive profits because there was no fiduciary duty owed to Springwell, and even if there would otherwise have been such a duty, the contractual provisions were effective to preclude it. Profits were simply made from sale and purchase transactions between the two parties and if Springwell was unhappy with the price that it was paying for instruments, it could have negotiated further with Chase. The remainder of this briefing considers some important implications of the decision in Springwell. 2. Duty of care The Court in Springwell considered whether (leaving aside the effect of the contractual documentation) the facts could of themselves have given rise to a duty of care falling on the bank. The following factors influenced the judge in holding that no such duty arose: > The absence of any advisory agreement or advisory fee structure was a strong pointer against the existence of any free-standing duty of care to give appropriate investment advice. > Even if there was reliance by Springwell on the advice and recommendations of the bank s salesman in making investment decisions, such reliance on its own does not necessarily give rise to an advisory relationship, with consequential duties of care. Nor is it relevant whether a salesman s recommendations are advice or investment advice, in a loose or strict sense. The key point is whether there is an assumption of responsibility on the part of the bank: My conclusion is simply that, in the circumstances of this case, the fact that [the salesman] may have been giving advice upon which Springwell relied in reaching its decisions, does not amount to an assumption of responsibility on the part of [the bank], so as to bring into play the full range of 2 slaugh ter and may

3 obligations of an investment advisor, as contended for by Springwell. The function of a salesman giving advice, recommendations and information and, in that sense, in providing a value-added service to the clients, who will then make their own decisions as to whether and what to buy and sell, is entirely consistent with the role not only of an emerging markets bond salesman in the financial world, but, indeed, with that of any salesman in ordinary life. > There were no factual grounds for Springwell having a reasonable belief that it was entitled to rely on the bank to be giving it wide ranging investment advice. It is important to note that Springwell was classified as a non-private customer under what were then the rules of the Securities and Futures Authority (the then relevant regulator of the bank), one of the effects of which was to exclude a regulatory duty of suitability in giving advice. Had Springwell been a private customer, a finding that the salesman gave investment advice (amounting to a regulated activity) may have led to a significantly different outcome. The judge, in any event, upheld the efficacy of the contractual documents in preventing any duty of care arising. In doing so she made some interesting points about the position where the relationship between parties in fact differs from that described by the contractual documents. This is considered next. 3. Contractual estoppel Contractual estoppel is the legal rule most clearly set out by the Court of Appeal in Peekay Intermark v ANZ Banking Group and quoted by the judge in Springwell: There is no reason in principle why parties to a contract should not agree that a certain state of affairs should form the basis for the transaction, whether it be the case or not. For example, it may be desirable to settle a disagreement as to an existing state of affairs in order to establish a clear basis for the contract itself and its subsequent performance. Where parties express an agreement of that kind in a contractual document neither can subsequently deny the existence of the facts and the matters upon which they have agreed, at least so far as concerns those aspects of their relationship to which the agreement was directed. The contract itself gives rise to an estoppel. In the hands of the judge in Springwell, this rule has been fashioned into a formidable weapon (of defence) for the use of those, such as investment banks, who seek to rely on contractual provisions setting out the nature of the relationship between a firm and its customer, notwithstanding that the actual facts concerning that relationship are to an extent at variance with the contract. Thus, the fact that a bank s salesman did in fact give advice to the customer and the fact that the customer took account of that advice was not sufficient to render ineffective the contractual provision that the bank was not giving investment advice, because the parties had agreed that their relationship was to proceed on the basis that there was no advisory relationship. The Court distinguished the situation where an agreement merely records a statement as to past facts which is known to the parties to be false (such as in the leading case of Lowe v Lombank, where a hire purchase agreement purported to record, falsely, that the hirer had not made known the purpose for which she required a car bought on hire purchase). The Court also distinguished the situation where an agreement amounts to a sham (see Snook v London & West Riding Investments) where parties dress up their true agreement in false legal clothing. 3 slaugh ter and may

4 It may in practice be a hard line to draw in some cases. In the Springwell case, the Court clearly felt that there was no sham given especially that: > the customer was in fact a sophisticated investor which ultimately relied on its own judgement, even taking account of the "advice" given by the bank's salesman; and > it is to be expected that a salesman will inevitably express his opinions to customers; but it does not follow that a sophisticated customer is thereby justified in arguing that the true relationship is an advisory one, notwithstanding the terms of the written contract. Each case will turn on its own facts. For example, a course of dealings with a bank, or a relationship with an inexperienced private investor, which showed that it was the mutual understanding of the parties that the customer was reliant upon the firm's advice may well lead a court to conclude differently. 4. Fiduciary duty The judge inevitably went on to hold that in the absence of any contractual agreement for [the bank] to provide investment advisory services to Springwell, or any common law acceptance of an obligation to do so I do not see how what was essentially a commercial banking relationship could give rise to the extensive fiduciary obligations contended for by Springwell. In the same paragraph of her judgment, the judge observed: the mere fact that one party to a commercial relationship trusts the other does not predicate a fiduciary relationship. The word trust, like the work advice has a variety of meanings. The judge went on to quote Lord Mustill s speech in Re Goldcorp: Many commercial relationships involve a reliance by one party on the other [honestly and conscientiously to do what it had by contract promised to do] and to introduce the whole new dimension into such relationships which would flow from giving them a fiduciary character would have adverse consequences. It is possible without misuse of language to say that the customers put faith in the company, and that their trust has not been repaid. But the vocabulary is misleading; high expectations do not necessarily lead to equitable remedies. In summary, the contractual documentation in the Springwell case did not undermine or modify an existing fiduciary relationship for the very good reason that there was no pre- or co-existing fiduciary relationship to undermine or modify. The purpose of the documentation was to define and delineate the basis of the relationship, and the relationship thus defined was neither a fiduciary one nor one which gave rise to a duty of care to advise. 5. Would MiFID have altered the result? Suitability duties The Court held that investment advice (under one description or another) had been given by the bank s salesman. Under the pre-mifid regime, this would only have triggered a suitability obligation in the case of advice to a private customer. The position is now different. COBS 9.2 applies to professional clients given a personal recommendation. This is defined as: a recommendation that is [given to an investor on the merits of buying, selling etc a particular investment] and is presented as suitable for the person to whom it is made, or is based on a consideration of the circumstances of that person. 4 slaugh ter and may

5 So the first question would be whether the advice tendered by the salesman would as a matter of fact have fallen within this definition had the case concerned events and circumstances after the implementation of MiFID. If so, then the obligation under COBS 9.2.1R is to take reasonable steps to ensure that the recommendation is suitable for the client, based on the firm s obtaining the necessary information regarding the client s: (a) knowledge and experience in the investment field relevant to the specific type of designated investment or service; (b) (c) financial situation; and investment objectives. This obligation is further refined in COBS 9.2.2R: (1) a firm must obtain from the client such information as is necessary for the firm to understand the essential facts about him and have a reasonable basis for believing, giving due consideration to the nature and extent of the service provided, that the specific transaction to be recommended, or entered into in the course of managing: (a) (b) (c) meets his investment objectives; is such that he is able financially to bear any related investment risks consistent with his investment objectives; and is such that he has the necessary experience and knowledge in order to understand the risks involved in the transaction or in the management of his portfolio. In the case of professional clients (as one of which, given the facts found by the Court, Springwell would presumably have been classified had MiFID applied) a firm is entitled to assume that, in relation to the products, transactions and services for which the professional client is so classified, the client has the necessary level of experience and knowledge for the purposes of [(c)] above. Further, if Springwell could be said to be a per se professional client under COBS then a firm would be entitled to assume that it would be able financially to bear any related investment risks consistent with its investment objectives. Although it is unlikely that Springwell would have been a per se professional client (unless it could be considered to fall within the category of other institutional investors who are such clients - see COBS 3.5.2R(1)(i)), it was certainly a finding of the Court that Springwell had, or had at its disposal, substantial family assets; so it may well have been the case that the bank could have demonstrated that there were adequate financial resources even if it was not permitted to assume that. Accordingly, the MiFID suitability obligation would, in practice, have involved the salesman having to have a reasonable basis for believing the transactions he was recommending met Springwell s investment objectives. There was no finding in the Springwell case which suggests that the bank would have been in breach of this obligation. 5 slaugh ter and may

6 6. Implications for banks and their clients Banks The Springwell judgment is very fact-based and it is by no means certain that the Court would reach the same conclusion in a case on different facts. In particular, and as noted above, it might be expected that the result would have been different had the investor been unsophisticated and, of course, if the bank s engagement letter had provided for advice to be given. From the banks perspective, the principal lessons to be learned post-springwell when dealing with sophisticated clients are as follows: > Despite the fact that the events to which the Springwell case related took place in the 1990s, much of the judgment remains relevant today. > It remains important for a bank: - to describe clearly in its terms of business and engagement letters the scope of its duty; and - to state clearly in its terms of business and engagement letters that: it is not giving advice if the bank does not wish to take responsibility for any advice actually given; no personal recommendations will be given to the client unless specifically agreed between the bank and the client at the time they are given. Procedures are required to determine how any such agreement will be recorded to avoid disputes later; if no advice is to be given, the bank is not making representations and that the client is not relying on any statements made by the bank; and the bank owes no fiduciary duty to the client if such is to be the case. The effectiveness of this exclusion remains open to debate although it ought to be otiose if there is nothing else in the contractual terms that gives rise to a fiduciary relationship. > A statement that no advice is to be given could be undermined if the fee structure agreed with the client includes fees referenced to advice or the outcome of steps taken or not taken in reliance on advice given. > Compliance with the rules and guidance of the relevant regulator is likely to assist a bank s defence of a claim based on tortious liability, misrepresentation or breach of fiduciary duty. However, it remains unhelpful for banks to undertake in terms of business or engagement letters to comply with FSA rules and guidance. > The Springwell judgment does not give banks carte blanche to rely on their terms of business where the actual services provided differ radically from those described in the terms of business. A degree of such reliance is permitted but where the client requests services which amount to a significant departure from the original terms of engagement, the bank should revisit those terms and reconsider its duties. 6 slaugh ter and may

7 > Bank personnel should consider their obligations and duties under the FSA rules. > Regardless of the bank s liability to the client, problems may arise in practice if a salesman is knowledgeable about the investments concerned but is not best placed to advise the client about alternative investment options. Clients The most important point arising from the Springwell case from the client s perspective is the importance of ensuring that if the client wishes to rely on advice given by the bank, the bank s terms of engagement or engagement letter provide for this. If the scope of a bank s activities drifts away from that originally envisaged then it is important from the client s perspective that steps are taken to record the new scope of the bank s engagement in writing. Slaughter and May London One Bunhill Row, London EC1Y 8YY, United Kingdom T +44 (0) F +44 (0) Paris 130 rue du Faubourg Saint-Honoré, Paris, France T +33 (0) F +33 (0) Hong Kong 47th Floor, Jardine House, One Connaught Place, Central, Hong Kong T F Brussels Square de Meeûs Brussels Belgium T +32 (0) F +32 (0) Please note that this Briefing Paper is published to provide general information and not as legal advice. For further information please contact your usual adviser at Slaughter and May. yc3.indd708

misrepresentations were made about the nature of the instruments she traded; and

misrepresentations were made about the nature of the instruments she traded; and slaughter and may Short shrift for sophisticated clients: Bank Leumi (UK) PLC v. Wachner BRIEFING april 2011 The High Court case of Bank Leumi 1 is another in a line of cases dealing with attempts by relatively