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15 Apr 2014

Finance litigation LegalEye Spring 2014


An overview of recent developments

In this issue:

* The Court of Appeal considers whether a final determination by the Financial Services Ombudsman is the end of the matter

* Construction of legal charge

* What is commercially reasonable

* The risks associated with entering into swap transactions with foreign public bodies


The Court of Appeal considers whether a final determination by the Financial Services Ombudsman is the end of the matter

In Clark & Another v In Focus Asset Management & Tax Solutions Limited [ 2014 ] EWCA Civ 118, the Court of Appeal considered whether it is open to parties, having accepted a determination of the Financial Services Ombudsman, later to bring Court proceedings for damages to recover the balance of their claimed losses. 

In our March 2013 edition of Legal Eye, we considered the High Court decision in Clark & Clark v In Focus Asset Management & Tax Solutions Limited [ 2012 ] EWHC 3669 (QB). We explained that there were conflicting High Court decisions and that the defendant, In Focus Asset Management & Tax Solutions Limited ("In Focus"), was expected to appeal the decision. That appeal has now been heard by the Court of Appeal and, as a result, the High Court decision in Clark has been overturned. The position remains as it was prior to the High Court decision in Clark, in line with the previous High Court decision in Andrews v SBJ Benefit Consultants Ltd [ 2010 ] EWHC 2875 (HC).

The claimants (and respondents to In Focus' appeal to the Court of Appeal), Mr and Mrs Clark ("the Clarks"), received financial advice from In Focus in 2004. The Clarks' contention was that as a result of inappropriate investment advice from In Focus they had lost in excess of £500,000. In November 2008, the Clarks complained to the Financial Services Ombudsman (the "Ombudsman" or "FOS"). The Ombudsman upheld the complaint and awarded the Clarks compensation up to the then maximum that he could award - £100,000. He also recommended, as part of his award, that In Focus pay the Clarks an amount representing their full loss. The Clarks accepted the determination of the Ombudsman (meaning that it became binding on the Clarks and In Focus) and In Focus subsequently paid them £100,000 in settlement of the complaint.

In June 2010, the Clarks began proceedings against In Focus in the County Court claiming damages for loss resulting from negligent financial advice given to them by In Focus. The claim gave credit for the sum of £100,000 paid to the Clarks by In Focus following the determination by FOS. The County Court granted an application by In Focus for the Clarks' claim to be struck out on the basis that the causes of action in the claim were precisely the same as considered by FOS and so the doctrine of merger applied so as to bar the Clarks from litigating (the County Court regarded itself as bound by the High Court decision in Andrews v SBJ Benefit). The doctrine of merger provides that a person who has obtained a final judgment in a tribunal of competent jurisdiction is precluded from later recovering in court a second judgment for the same relief in respect of the same subject matter; the cause of action which the claimant first advanced merges which the judgment so that there is no cause of action to pursue on the second occasion.

The High Court reviewed the decision of the County Court and concluded (contrary to the decision in Andrews v SBJ Benefit) that the doctrine of merger does not apply to determinations of the Ombudsman and that the Clarks were not precluded from claiming damages from In Focus for an amount in excess of that recovered through a complaint to the Ombudsman. The primary reasons for this decision were that (i) FOS considers complaints, not causes of action, and that (ii) FOS is not a tribunal for the purposes of the doctrine of merger as its functions differ from those of a typical tribunal. The Court viewed it as perfectly proper for a complainant to use an award by the Ombudsman of £100,000 to finance the legal costs of bringing Court proceedings for a greater amount.

The Court of Appeal decision

The Court of Appeal has now considered the appeal. It is worth noting that the case was argued before the Court of Appeal on the basis of res judicata and not on the basis of the doctrine of merger as it was in the courts below. Res judicata means that where a court or tribunal has already adjudicated on the matter, a party is precluded from bringing another set of proceedings.

The Court of Appeal made two key determinations that meant that the appeal was allowed and the Clarks were precluded from pursuing their claim against In Focus to "top up" their compensation.

First, the Court concluded that acceptance by a complainant of an Ombudsman's award would preclude that complainant from starting legal proceedings to pursue complaints which had already been submitted to (and decided by) the Ombudsman by operation of the common law doctrine of res judicata. As part of the decision, the court found that an Ombudsman's award is a judicial decision for the purposes of res judicata. This is consistent with a previous decision in R (Heather Moor & Edgecomb Ltd v Financial Ombudsman Service [ 2008 ] Bus LR 1486) that the Ombudsman has judicial status for the purposes of Article 6 (right to a fair trial) of the European Convention on Human Rights. The Court made it clear that the burden of showing that the requirements of res judicata are made out on the facts of any given case will fall to the respondent to the complaint.

Second, the Court of Appeal found that the relevant provisions of the Financial Services and Markets Act 2000 setting up the FOS do not exclude the operation of the common law doctrine of res judicata.

The Court of Appeal noted as part of its decision that in future cases the relevant court would need to determine whether the claim before it was the same as the complaint submitted to the Ombudsman and, if so, whether the Ombudsman had already determined the issue. The complainant is to have the benefit of any doubt in this regard.

Practical implications

As a result of this decision, complainants will now have to choose whether to make a complaint to FOS (accepting the limited compensation available) or make a civil claim (taking on the potential risks and costs that that involves). An important caveat to this is that if a complainant does not accept the decision of the Ombudsman (whether it is in their favour or not) then that complainant is free to bring a claim in the courts without the doctrine of res judicata operating so as to prevent them from doing so. In such circumstances, it is not clear to what extent the Ombudsman's decision would be admissible in the court proceedings.

This decision of the Court of Appeal has been welcomed by the financial services industry and has been criticised by others as being unfair to consumers. However, Lady Justice Arden pointed out in her judgment that enabling consumers to commence proceedings for more compensation than that awarded by the FOS could lead to them losing their claims in the courts (which take a more robust, legal approach than the FOS) and becoming subject to adverse costs orders (almost equalling or even surpassing the amount of their original compensation). This plainly would not be a sensible state of affairs. In any event, the resolution by the Court of Appeal of the conflicting High Court case law is to be welcomed.

Construction of legal charge

In Fons HF (in liquidation) v (1) Corporal Limited (2) Pillar Securitisation S.A.R.L [ 2014 ] EWCA Civ 304 the Court of Appeal held that, on the proper construction of a legal charge between a company and a bank, a first legal mortgage over shares owned by the company extended to its rights under two shareholder loan agreements. The agreements amounted to "other securities" or "debentures" so as to fall within the definition of "shares" over which the charge had effect.

Fons HF ("Fons") provided business funding, by way of unsecured loans, to Corporal Limited ("Corporal"), a company in which Fons held shares, pursuant to two shareholder loan agreements dated 17 October 2007 and 15 February 2008 ("the SLAs").

As at June 2008, Fons owed a substantial sum of money to Kaupthing Bank Luxembourg S.A ("Kaupthing") on an unsecured basis. As a result of Fons coming under pressure from Kaupthing to provide security for its indebtedness, Fons and Kaupthing entered into a Legal Charge dated 29 September 2008 ("the Charge") pursuant to which Fons provided Kaupthing with a first mortgage over "all shares (if any) specified in Schedule 1 (shares) [ of the Charge ], and also all other stocks, shares, debentures, bonds, warrants, coupons or other securities now or in the future owned by [ Fons ] in Corporal from time to time or any in which it had an interest" ("the Shares").

Fons and Kaupthing subsequently went into liquidation and the benefit of the Charge vested in Pillar Securitisation S.A.R.L ("Pillar"). The issue that arose for determination before the Court at first instance was whether the first mortgage over the Shares provided by the Charge extended to Fons' rights under the SLAs. Pillar argued that the wording of the definition of "Shares" was sufficiently wide to catch Fons' rights under the SLAs on the basis that those rights fell within the meaning of "other securities" and/or "debentures". Fons submitted that neither the words "other securities" nor the word "debentures" ought to be so widely construed as extending to documents such as the SLAs, which merely concerned the terms for the making of unsecured loans. The Court was required to determine the proper construction of the definition clause in the Charge.

The Judge held that as a matter of true construction of the definition of "Shares", it did not extend to include Fons' rights under the SLAs which were not therefore caught by the Charge. The Judge held that a reasonable objective observer, looking at the wording of the definition of "Shares" taken as a whole, would not understand the parties to have intended the reference to "other securities", or the reference to "debentures", as extending to documents such as the SLAs, or the unsecured liabilities arising thereunder. In the present context, the words "other securities" and "debentures" bore an ordinary meaning quite different from a mere loan agreement.

Pillar successfully appealed the Judge's decision. The Court of Appeal made a declaration that the rights of Fons under the two SLAs were included within the Charge.

Lord Justice Patten, delivering the leading judgment, observed that the construction of the Charge was an objective exercise to be carried out by the Court through the eyes of a notional reasonable man who is credited with all the background information which would reasonably have been available to the parties at the time of the contract: see Investors Compensation Scheme Ltd v West Bromwich Building Society [ 1998 ] 1 WLR 896. The background information includes anything which would have affected the way in which the reasonable man would understand the words used but does not extend to the negotiations or to evidence of the parties' subjective intent. The task of the Court is to determine what the parties meant by the language which they used. Consistent with that objective, the Court will seek to give the words their natural and ordinary meaning derived from the context of the agreement and all other relevant facts indicating the nature and purpose of the transaction.

Although there was no precise definition of the term "debenture" in the authorities which were considered, the Court of Appeal could see no reason why it should be limited to a meaning which would exclude the SLAs in this case. Once it was clear from a reading of the Charge that they did not have to include a charge over Corporal's assets, the Court of Appeal thought that the reasonable observer would have read the term "debenture" as having its ordinary meaning of an acknowledgement of debt recorded in a written document. There was nothing in the wording of the Charge or in the relevant contextual background to require or suggest that the word "debenture" was to be given a narrower meaning and the Judge had not suggested any alternative meaning which would have been obvious from the admissible background. On this basis, the SLAs were debentures, comprising in each case a written instrument which creates and thereby acknowledges the relevant debts owed by Corporal.


This case provides a useful summary of the various considerations that must be borne in mind when interpreting legal documents. It also gives helpful guidance on how the Courts will interpret the words "debentures" and "securities".

What is "commercially reasonable"?

In Barclays Bank Plc v Unicredit Bank AG & Anr [ 2014 ] EWCA Civ 302, the Court of Appeal determined to what extent Barclays had exercised its discretion reasonably in refusing to consent to early termination of guarantees which it had entered into with the Defendants.

The proceedings related to three guarantees entered into between Barclays and the Defendants between 29 September 2008 and 22 December 2008 (together the "Guarantees"). The Defendants entered into the Guarantees to improve their balance sheets as they enabled them to reduce the amount of regulatory capital they were obliged to maintain in respect of pools of underlying loans (the "Portfolios").

The material terms of the Guarantees were:

  • the Defendants would pay Barclays quarterly payments of premium and a fixed fee;
  • Barclays would make quarterly payments to the Defendants in respect of first losses suffered arising from defaults on the Portfolios;
  • the duration of the Guarantees was that of the longest loan in each of the Portfolios: 11, 19 and 19 years respectively. However, the Defendants could elect to terminate the Guarantees early on five bases (together the "ETPs"). The key basis for the purposes of this case was following a "Regulatory Change" under clause 12.1(b), which required the Defendant to gain prior consent from Barclays, "such consent to be determined by Barclays in a commercially reasonable manner"; and
  • by Clause 20.1 (the "WAC") the parties agreed: "This Guarantee…constitutes the entire agreement and understanding of the parties with respect to its subject matter and supersedes all oral communication and prior writings...".

Barclays considered that, by virtue of the nature of the ETPs, it was guaranteed to receive a minimum of five years payments of premiums and fees pursuant to the Guarantees.

Following changes in the regulatory regimes applying to the Defendants, the Defendants lost the right to obtain capital relief in respect of the Guarantees. On 14 June 2010 the Defendants therefore wrote to Barclays to request that it consent to termination of the Guarantees as a result of Regulatory Change pursuant to clause 12.1(b) (the "Early Termination").

Barclays sent letters of response to the Defendants on 23 June 2010 refusing to agree to the Early Termination stating: "[ The Defendants ] cannot reasonably expect Barclays to consent to termination so early in the term of the Agreement, in circumstances where this would deprive Barclays of a significant proportion of the overall revenue that it had bargained for...". Barclays' position was that unless the Defendants agreed to pay Barclays five years' fees (discounted to the then present value) it would not consent to the Early Termination (Barclays had already booked the discounted value of these fees as a profit).

The Defendants then wrote to Barclays stating that Barclays had unreasonably withheld consent to the Early Termination and they were treating the Guarantees as terminated. Accordingly, the Defendants ceased making payments as they fell due. Barclays therefore issued proceedings against the Defendants seeking, amongst other things, a declaration that its decision not to consent to the Early Termination was commercially reasonable.

At first instance, Mr Justice Popplewell held that Barclays’ refusal to consent to Early Termination was made in a commercially reasonable manner as:

  • although the standard of reasonableness that applied to Barclays’ exercise of discretion was an objective one, it was entitled to take into account its own commercial interests, in preference to those of the Defendants; and
  • the WAC did not restrict Barclays from relying on pre-contractual negotiations in considering whether to consent to the Early Termination.

The Defendants argued that Mr Justice Popplewell was wrong in holding that: (i) Barclays was entitled to give precedence to its own commercial interests in refusing to consent to Early Termination; (ii) Barclays was entitled to demand a sum equal to the entire discounted present value of the fees that it would have received had the Guarantees continued for five years; and (iii) no effect should be given to the WAC.

The Defendants submitted that the purpose of a provision requiring Barclays to exercise its discretion in a commercially reasonable manner was to ensure that Barclays had regard to the interests of the Defendants to achieve a mutual or mutually satisfactory outcome.

The Court of Appeal held as follows:

  1. Barclays was entitled to give precedence to its own commercial interests in exercising its discretion

    In exercising its discretion in a commercially reasonable manner, Barclays was entitled to take into account its own interests in preference to the Defendants'. If it was required to exercise its discretion in the terms the Defendants submitted, the result would be wholly impracticable.

    The clause did impose some limitation on Barclays' discretion. The Court held that on the facts the relevant test might be whether the price demanded was "way above what [ the demanding party ] can reasonably anticipate would have been a reasonable return from the contract", i.e. a test drawn from Wednesbury unreasonableness.

    The Court emphasised that it would not be feasible to formulate a general test for what is commercially reasonable, as each case would turn on its own facts.

  2. On the facts Barclays had exercised its discretion in a commercially reasonable manner

    The quantum which Barclays had sought in exchange for consenting to early termination of the Guarantees was “not out of line with the reasonable return it could have expected had the contract run its expected course".
  3. The WAC did not preclude Barclays using pre-contractual understandings to make the decision

    Whole agreement clauses were "intended to exclude any evidence or argument to the effect that the terms of the contract are to include any mutual understanding that is not recorded in the contract" and were not: "intended to exclude admissible evidence or argument about the way in which parties exercise rights[ under ]the contract." The WAC did not restrict Barclays from relying on pre-contractual understandings to justify the manner in which it had exercised its discretion.


The Court of Appeal judgment will be welcomed by many banks, given how frequently documents require them to act in a "commercially reasonable manner" (see for example the close-out wording of the 2002 ISDA Master Agreement). The decision makes it clear that a party which is contractually obliged to exercise its discretion in a commercially reasonable manner is entitled to give preference to its own commercial interests, except where the outcome would be much more beneficial to that party than it can reasonably have anticipated would have been a reasonable return from the contract. If it is intended that the interests of each party are to be considered where one party is obliged to exercise its discretion, an accurately worded mechanism to determine their relative interests should be included in the relevant contract.

The risks associated with entering into swap transactions with foreign public bodies

In HSH Nordbank AG v Intesa Sanpaolo SpA [ 2014 ] EWHC 142 (Comm), the High Court considered the validity of an interest rate swap under Italian law and the Claimant's claim that it was entitled to restitution of monies that it had paid to the Defendant as consideration for the novation of the swap.

This claim arose out of interest rate swap transactions entered into by the Defendant ("Intesa") and subsequently by the Claimant ("HSH") with an Italian local authority ("the Local Authority"). On 21 February 2005, Intesa entered into an interest rate swap transaction with the Local Authority ("the 2005 Swap") which the parties subsequently restructured in May 2006 ("the 2006 Swap"). The Local Authority then invited tenders in respect of a new swap transaction and, as part of this process, HSH put forward a tender which was successful. The result of this successful tender by HSH was that Intesa was removed and replaced by HSH by a novation of the 2006 Swap on virtually identical terms. As part of this novation, HSH paid Intesa EUR 8,972,000 ("the Novation Payment"). The novated swap was concurrently replaced by a new swap between HSH and the Local Authority ("the 2007 Swap") on the basis of the terms put forward as part of HSH's successful tender.

The ability of the Local Authority to enter into derivative contracts was governed by Law No. 448 of 28 December 2001 (referred to in the judgment as "Financial Law 2002") and Ministerial Decree 389 of 1 December 2003 (referred to in the judgment as "Decree 389"). In particular, Article 3 of Decree 389 sets out the permissible derivative transactions for a local authority. In November 2007, an Italian government body conducted a detailed examination of the legality of the three swaps and produced a report ("the Report") which was subsequently reviewed by an Italian Court of Auditors. The Court of Auditors upheld the Report and found that the 2007 Swap failed to comply with Decree 389 in certain respects but that the 2005 Swap and the 2006 Swap were valid as they were of the "plain vanilla type" that was acceptable under Decree 389.

HSH brought a claim (in separate proceedings) against the Local Authority and obtained repayment of the majority of the monies paid to the Local Authority under the 2007 Swap. The case which is the subject of this summary is HSH's claim against Intesa in respect of the 2006 Swap by which HSH sought to establish an entitlement in restitution for the return from Intesa of the Novation Payment. HSH claimed (contrary to the findings of the Report and the Court of Auditors) that the 2006 Swap (which, as noted above, Intesa had novated to HSH) was also void for non-compliance with Decree 389 on the basis that Decree 389 does not permit (a) restructuring of principal (only of interest), (b) an "increasing profile of the present values of single payment flows", or (c) a premium payable to the Local Authority.

On the premise that the 2006 Swap was void, HSH advanced a claim that (i) it had acquired the 2006 Swap and made the Novation Payment under the mistaken belief that the 2006 Swap was valid (when it was not), or alternatively (ii) there was a total failure of consideration.

In order to determine the claim, the High Court carried out a detailed review of the precise nature and terms of the 2006 Swap, a complex analysis of Italian law on the subject and an assessment as to whether the 2006 Swap was (as HSH claimed) void under Italian law. In doing so, the Court heard a considerable amount of expert evidence in relation to Italian banking and finance law.

The Court held that HSH had not shown the 2006 Swap to be void under Italian law. The burden of proof was on HSH who had failed to discharge this burden and, in particular, had not provided sufficient authority to set aside the clear conclusion of the Italian Court of Auditors that the 2006 Swap was valid. HSH's claim against Intesa therefore failed as HSH could not establish the underlying premise for its claim i.e. that the 2006 Swap was void.

The court went on to consider HSH's claim for restitution on the premise that the 2006 Swap was void (in case its conclusion on the validity of the 2006 Swap was wrong):

(i) Mistake - the Court found that HSH's case on mistaken belief failed. It held that HSH had not had the belief that the 2006 Swap was valid. Rather, HSH had either had no belief at all (and hence did not take advice on the matter) or knew that it (like all such transactions) had risks and accepted those risks (particularly given that it was to replace the 2006 Swap with the 2007 Swap).
(ii) Total failure of consideration – the Court found that there was no total failure of consideration for the novation. The 2006 Swap was, and was effectively, novated to HSH; HSH had understood and accepted the risks as to its invalidity and Intesa had not assumed any responsibility with respect to its legality, validity or enforceability. HSH had obtained what it had bargained for, namely, for Intesa to be eliminated from the picture so that HSH could put in place the 2007 Swap with the Local Authority.



There have been a lot of English court decisions recently arising out of swaps contracts with Italian local authorities. In this case, unlike many others, the claimant bank was trying to establish that the swaps were invalid in the context of a decision in Italy that they were valid. The decision suggests that, even where swaps with Italian (and other) local authorities are found to be void, the Court will not necessarily find that related transactions, such as novations or assignments of the swaps, are also void.



Edward  Davis

Edward Davis

T:  +44 20 7809 2327 M:  Email Edward | Vcard Office:  London

Sue Millar

Sue Millar

T:  + 44 20 7809 2329 M:  + 44 7825 625 898 Email Sue | Vcard Office:  London