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02 Feb 2018

Bank liable to investors for "dropping the ball" in its role as arranger in securities offering

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In the landmark judgment Golden Belt v BNP Paribas [2017] EWHC 3182 (Comm) the Commercial Court found, for the first time, that an arranging bank owed a limited duty of care to investors (including those in the secondary market) in a capital market offering.

The case highlights the need to articulate clearly the scope of a bank's responsibilities and corresponding disclaimers in offering documentation.

Background

The 'Golden Belt' case is part of the myriad of global litigation that emerged from the collapse of Saad Group, a major Saudi Arabian conglomerate, in 2009. This claim concerned a Sukuk, an Islamic financing instrument substantially similar to a bond, which was issued by Golden Belt, a Bahraini SPV. BNP Paribas (BNP) was arranger, sole bookrunner and one of the lead managers in the offering, which was intended to raise US$650 million for Saad, as ultimate borrower.

The primary means of enforcing rights under the Sukuk was a promissory note issued by Saad in favour of Golden Belt. Golden Belt's rights under the transaction documents (including the promissory note) were held on trust for investors.  In a default situation, it was envisaged that investors could require Golden Belt to invoke its rights under the promissory note, thereby giving investors a relatively straightforward remedy against Saad. However, following default under the Sukuk, it emerged that the promissory note had not been properly executed and was therefore worthless.

BNP was sued in negligence by Golden Belt and distressed debt funds that invested in the Sukuk in the secondary market. Crucially, the funds invested in the secondary market after it became clear that Saad was in financial difficulty but before it emerged that the promissory note had not been properly executed. The existence of the promissory note was a major consideration in their decision to invest.

Should a tortious duty of care be imposed on the Arranger?

BNP was identified on the front cover of the Offering Circular as "Arranger and Sole Bookrunner" but the document was silent as to BNP's role and responsibilities in those capacities. There was therefore no express contractual duty of care to investors in respect of BNP's acts as arranger and sole bookrunner. An important notice in the Offering Circular made clear that the "Lead Managers" (including BNP) made no representation or warranty and accepted no responsibility as to the accuracy or completeness of its contents. However, the risks outlined in the Offering Circular did not include any reference to the possibility of Saad not executing transaction documents properly.

One of the main issues before the Court was whether BNP owed a tortious (i.e. non-contractual) duty of care to Golden Belt and investors to exercise reasonable care and skill to ensure that the transaction documents were properly executed. The Courts have developed several established tests (which Judges have noted are easier to recite than apply) in order to determine whether a tortious duty of care exists:

  • The first is whether the defendant assumed responsibility for what he said and did as against the claimant, or is to be treated by the law as having done so. This test is to be applied objectively.
  • The second is known as the 'threefold' test: (i) whether loss to the claimant was a reasonably foreseeable consequence of what the defendant did or failed to do; (ii) whether the relationship between the parties was one of sufficient proximity; and (iii) whether in all the circumstances it is fair, just and reasonable (as a matter of policy) to impose a duty of care on the defendant towards the claimant.
  • Third is the 'incremental' test, which is that the law should develop novel categories of negligence incrementally and by analogy with established categories (it is of little value as a test in itself).

Key findings of the Court

  1. The promissory note only had one purpose – to provide investors with a straightforward claim against Saad in an event of default. For that to work, it was vital that it was properly executed. The task of ensuring that the promissory note was properly executed was something that was carried out entirely for the benefit of investors.
     
  2. The Offering Circular made it very clear that there was no guarantee of recovery and that investors would have to accept a whole range of risks, but there was no hint that investors were expected to take the risk that the promissory note might turn out to be invalid because care had not been taken to ensure that it was properly executed. Nor was this within the scope of the disclaimer. This was an entirely different kind of risk from those about which investors were warned in the Offering Circular.
     
  3. BNP ensured that it was prominently described as the "Arranger and Sole Bookrunner". While BNP argued that there was no communications which "crossed the line" (passed) between itself and investors, the Offering Circular (drafted and approved by BNP) was one such communication. It was provided for the benefit of both initial investors and investors on the secondary market, which it was intended would develop. As the functions of an arranger invariably include responsibility for arranging the execution of transaction documents, BNP, in holding itself out as arranger, was effectively telling prospective investors that it would arrange (or had arranged) the execution of the promissory note. There was no one else for investors to rely on in that regard. All those considerations meant that investors would rely on BNP to ensure that the promissory note was properly executed and it was reasonable for them to do so.
     
  4. In the circumstances, BNP assumed responsibility to investors to exercise reasonable care in ensuring the promissory note was properly executed under both the objective and threefold test. The judge rejected BNP's submission that the incremental test was not satisfied.
     
  5. There was a material difference in the positions of Golden Belt and the investors. It was the investors that would suffer loss if the promissory note was not executed properly. Golden Belt was just a "brass plate" with no economic interest of its own in the validity of the promissory note. BNP therefore did not owe the alleged duty to Golden Belt.
     
  6. The Judge accepted that it is open to an arranging bank to include an express disclaimer of any responsibility to ensure that an important document for the protection of investors is properly executed. However, "A bank which wishes to disclaim such responsibility and thereby to cast upon investors the risk that they are purchasing worthless documents ought to do so in clear terms, accepting the consequences for the success or otherwise of the issue that such a disclaimer might involve".
     
  7. The Judge went on to find that BNP breached its duty to the investors and that caused loss. As to measure of loss:
     
    a) The correct measure would be the difference between (i) the recovery, if any, which the investors would have made if the promissory note had been valid and (ii) the recovery, if any, which they will in fact achieve from Saad. Those damages are to be assessed at a further trial but, on BNP's case, they amount to zero because the investors would not have recovered anything if the promissory note had been properly executed in light of Saad's insolvency. If the judgment stands and that argument prevails on assessment, the judgment would likely prove a hollow victory for the investors.
     
    b) In reaching his conclusion as to the measure of damages, the Judge rejected the investors' argument that they should be entitled to the difference between the value of their investments (i) with the benefit of a valid promissory note and (ii) if the invalidity of the promissory note had been known in the market at the time of their investment (such difference in value amounting to some 97.5% of the price paid by the investors). The Judge found that measuring damages on that basis would risk an undeserved windfall. In particular, it would not properly take into account the numerous other risks (mainly as to enforcement challenges arising from Saad's insolvency) that the investors had clearly taken on when deciding to purchase on the secondary market.

Conclusion

The Judge viewed his decision as an application of established negligence principles and not as any major extension of the law. He recognised that this was the first English case where a duty of care was found to be owed to investors by a bank assisting a borrower to arrange a publicly listed securities issue but, in his view, it had never been the law that an arranging bank cannot owe a duty to investors. The duty found to exist was limited and specific to execution of transaction documents. Moreover, the Judge was clear in his rejection of the suggestion by the investors' banking expert that an arranger owes a nebulous "commercial duty" to look after the interests of investors. Nonetheless, the decision will have caused considerable disquiet in the capital markets community, not least because of the Judge's perhaps bolder finding that arrangers could hold duties of care to purchasers in the secondary market.  We understand that BNP is appealing the decision.

In the meantime, the case highlights the need for care by banks and their lawyers to ensure that offering documentation fully describes the scope of the role that the bank agrees to perform in the transaction and the need to draft disclaimers to encompass acts and omissions in carrying out all the constituent elements of that role. Should concerns arise that comprehensive disclaimers risk prejudicing investor appetite in a particular offering, banks involved in that offering should consider whether the risks of potential investor claims are factored into their participation fees.

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