Financial Services & Markets Dispute Resolution Quarterly Update: July 2018 Edition

Welcome to our quarterly update, in which we look at some of the recent highlights and developments in financial services and markets disputes, investigations and financial crime.

In this edition, we consider two important Supreme Court decisions relating to contractual disputes: the first judgment of its kind relating to a claim brought by private persons under s.138D FSMA; and a decision relating to privilege in the context of internal interview notes.

We also report on: a recent FCA financial penalty for inadequate anti-money laundering systems and controls; co-operation between the FCA and the Insolvency Service; the passing into law of the new Sanctions and Anti-Money Laundering Act 2018; and changes to guidance on breaches of financial sanctions.

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No Oral Modification clauses are effective

In Rock Advertising Limited v MWB Business Exchange Centres Limited [2018] UKSC 24, the Supreme Court considered whether a contractual term prescribing that an agreement may not be amended, except in writing and signed on behalf of the parties (commonly called a “No Oral Modification” or “NOM” clause), is legally effective.

The Court found that NOM clauses are effective. A NOM clause prevents any variation to a contract that is not made in writing, including any attempt to disapply the NOM clause itself.

The Claimant, MWB Business Exchange Centres Limited (MWB), operates serviced offices in central London. The Defendant (the Appellant in the Supreme Court), Rock Advertising Limited (RA) entered into a contractual licence with MWB to occupy office space for a fixed term of 12 months commencing on 1 November 2011.

The licence contained the following NOM clause:

"All variations to this Licence must be agreed, set out in writing and signed on behalf of both parties before they take effect".

By February 2012, the Defendant had accumulated arrears of licence fees amounting to more than £12,000. A call took place between the sole director of RA and MWB’s credit controller during which RA contended that the credit controller orally agreed to a revised payment schedule. MWB denied this agreement.

MWB subsequently refused the payment schedule, locked RA out of the premises for failure to pay rent arrears and terminated the licence with effect from 4 May 2012. MWB sued for licence fee arrears, and RA counterclaimed damages for wrongful exclusion from the premises.

The Supreme Court was asked to consider the legal effect of the NOM clause, in relation to which the lower courts had disagreed.

In the leading judgment, Lord Sumption noted that NOM clauses are common in business contracts and are recognised as effective in other legal systems around the world. The Court recognised three legitimate commercial reasons for this: (i) they prevent attempts to undermine written agreements by informal means; (ii) they avoid disputes as to whether a variation was intended and, if so, its precise terms; and (iii) they allow corporations to police internal rules restricting the authority to agree to variations.

The Court held that the NOM clause was effective, noting there was "no mischief in No Oral Modification clauses, nor do they frustrate or contravene any policy of the law".

On a practical level, there was no variation to the payment schedule and therefore MWB could recover licence fee arrears from RA.

This decision is likely to be welcomed by businesses as it provides greater certainty for contracting parties to monitor and control their contractual relationships with third parties. It also upholds the autonomy of parties to stipulate their own contractual arrangements.

Businesses must, however, be alive to the very real risk that they may now unwittingly rely, to their detriment, on a purported oral variation, only to be held subsequently to the terms of the original bargain. Financial institutions should carefully consider the advantages and disadvantages of including NOM clauses when drafting contracts and agreeing to any variations.

Supreme Court restricts the availability for negotiating damages

On 18 April 2018, the Supreme Court overturned the Court of Appeal’s earlier judgment in Morris-Garner and another v One Step (Support) Ltd [2018] UKSC 20. The normal position in a breach of contract claim is that the Court will award compensatory damages, i.e. it will put the Claimant in the position it would have been in if the Defendant had not breached the contract. Prior to the Supreme Court’s decision, the lower courts had been increasingly willing to award "negotiating damages" (also referred to as "Wrotham Park" damages). An award of negotiating damages is based upon the price that the parties would have agreed if the Defendant had sought to negotiate a release from the provisions of the contract which it had breached. Negotiating damages have proven particularly useful in circumstances where the Claimant may not have suffered any specific loss which can be linked to the Defendant’s breach – for example, through the use of the Claimant’s intellectual property in a market that it did not operate in. It is now clear that the courts have much less discretion to award negotiating damages than previously thought.

In One Step, the Defendant (the Appellant in the Supreme Court) and Mr and Mrs Costelloes (C) had been shareholders in the Claimant’s care business. There had been a breakdown of relations between the shareholders, and C served a deadlock notice pursuant to which the Defendant sold its remaining shares in the Claimant to C. As part of that transaction, the Defendant agreed to a number of restrictive covenants, including a covenant not to compete with the Claimant for three years. Inevitably, the Defendant wasted little time before starting a rival business and the Claimant’s performance suffered as a result. The trial judge found that the Defendant had acted in breach of the restrictive covenants and awarded negotiating damages to the Claimant. In 2016, the Court of Appeal upheld the High Court’s decision, and considered that the Court had substantial discretion to award negotiating damages where it was just to do so (even if compensatory damages were available and there were no exceptional circumstances).

The Supreme Court unanimously held that the Court of Appeal had been mistaken in its approach. Negotiating damages were not a matter of wide discretion for the Court, and could not be awarded simply because the Court considered it just to do so.

The Supreme Court traced the origin of negotiating damages back through three strands of the law on damages. It concluded that negotiating damages could only be awarded where "the contractual right is of such a kind that its breach can result in an identifiable loss equivalent to the economic value of the right, considered as an asset". In other words, the alleged breach must, in substance, be an infringement of property (or at least something very similar to property): a right to land, real property, intellectual property or confidential information. A contractual agreement not to compete was not sufficiently analogous to property and no negotiating damages were available.

The Supreme Court’s judgment leaves open the question as to what economic rights can be considered as an asset, and there will no doubt be a further line of cases seeking to clarify this position. This judgment can be considered part of a general trend in the senior Courts to hold commercial parties to the bargain they have struck: if the parties intend there to be onerous consequences for a breach of contract that does not cause loss to the wronged party, they should make it an express term of their agreement. This case also reasserts the principle that if a claimant has suffered no loss, then it should not generally be entitled to more than nominal damages and that a defendant should not be deprived of profit earned from a breach.

The Supreme Court did however note that where a party brings an injunction for breach of contract, damages awarded in lieu of an injunction could take on the character of negotiating damages, even where no property has been infringed. This emphasises the importance of a party acting quickly where it considers that a contract has been breached, as delay could not only result in the loss of the right to bring an injunction, but also reduce the measure of damages available to it.

Private individuals lose first full trial of an IRHP claim for bank’s breach of statutory duty

In Parmar and Another v Barclays Bank Plc [2018] EWHC 1027 (Ch), the High Court dismissed claims for alleged breaches of statutory duty relating to two interest rate swaps entered into by the Claimants in April 2009 (the Swaps).

This is the first time an English Court has ruled on an Interest Rate Hedging Product (IRHP) claim by private persons asserting a breach of statutory duty under s.138D Financial Services and Markets Act 2000 (FSMA). This provision provides a right of action for private persons who suffer loss as a result of a breach of the rules made by the FCA under FSMA.

The Claimants brought a claim for damages for alleged breaches of the applicable Conduct of Business Sourcebook rules (COBS) contained in the FCA Handbook. The Claimants argued that, but for the alleged breaches, they would never have entered into the Swaps and would instead have entered into interest rate caps. The alleged breaches included that: (i) the Defendant bank had advised them to enter into the Swaps; (ii) the Swaps were unsuitable; (iii) the Bank had failed to conduct an adequate fact-finding exercise; and (iv) the Bank should have disclosed its internal calculation of the maximum credit risk it faced in the event of the Claimants’ default (referred to as "credit equivalent exposure" or "CEE").

The judge rejected the Claimants’ claims and found that, although there had been breaches of certain of the COBS rules, the Claimants had suffered no loss as a result of these breaches. The judge held that it was not an advised sale and, even if it were, the Swaps were suitable for the Claimants and the Bank had conducted an adequate fact-finding exercise to determine the appropriateness of the Swaps for them. In line with recent case law, the judge also dismissed the Claimants’ allegations that the Bank was required to disclose its CEE to the Claimants before they entered into the Swaps.

While the decision in this case is fact specific, it is a further example of the English Court finding in a bank’s favour in relation to IRHP mis-selling claims. This may deter other individuals from bringing similar claims under s.138D FSMA, although it is clear that the success of such cases will depend upon the circumstances of the case and the particular facts in question.

Interview notes from a company’s investigation into its duty to self-report suspected wrongdoing are not considered privileged

As readers might remember, in 2016, the SFO entered into its second Deferred Prosecution Agreement (DPA) with XYZ Ltd (XYZ - the company has not been named as the individuals implicated by the company’s decision to self-report have been indicted and a trial is fixed for 2019).

When deciding whether to self-report, XYZ had instructed external lawyers to carry out an internal investigation, which included (amongst other matters) interviews of four senior executives suspected of wrongdoing. Detailed notes of those interviews were taken by the instructed solicitors and the outcome of the internal investigation led to the company’s decision to self-report under the Bribery Act 2010.

XYZ asserted privilege over the interview notes and refused to disclose them to the SFO. However, XYZ did agree to an "oral proffer", which involved an external lawyer reading out (but not providing a copy of) a short statement which purported to summarise the interviews with the four employees. The SFO recorded these oral summaries and then transcribed them.

After concluding the DPA, the SFO prosecuted a number of individuals. In R (AL) v Serious Fraud Office [2018] EWHC 856 (Admin), one of the individual defendants sought judicial review of the SFO’s decision not to force XYZ to disclose the full interview notes from its internal investigation (so that they could then be disclosed in the criminal proceedings), despite the terms of the co-operation clause in the DPA.

In the event, the judicial review application before the Divisional Court failed because it was decided that the Crown Court rather than the High Court was the appropriate forum for resolving this disclosure dispute, but in his judgment, Green J made a number of obiter observations in relation to privilege. In general, the Court was very critical of the SFO’s failure to force XYZ to disclose the full interview notes:

  1. The Court disagreed with the SFO’s view that XYZ’s assertion of privilege was "not obviously invalid".  Green J said that "[t]he law as it stands today is settled. Privilege does not apply to first interview notes". Any argument that the law is uncertain pending further clarification in the appellate Courts was "untenable". The interviews were conducted when XYZ was making a decision whether to self-report. Material obtained for the purposes of deciding whether there has been a breach of the law is not privileged.
  2. The suggestion that the interview notes contained lawyers’ "musings" was insufficient to cloak the notes in privilege. Any genuinely privileged entries in the notes could be redacted.
  3. XYZ also argued that the interviews were conducted in contemplation of civil litigation. This did not justify extending privilege to unrelated parts of the interview concerning the criminal claims.
  4. The provision of the "oral proffers" by XYZ’s lawyers amounted to a waiver of privilege (despite the fact that the lawyer, who had read out the summaries, had expressly said this was not to be taken as a waiver of privilege). The test for waiver is objective and a (subjective) assertion that privilege is not being waived is not determinative. Although privilege can be waived for a limited purpose, the purpose of the waiver in this case extended to providing the interview notes to the defendants in the criminal proceedings.

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FCA imposes sanctions against UK branch of Indian bank in relation to AML systems and controls failings

The FCA has published a Final Notice in respect of Canara Bank (Canara) which it fined £896,100 (after early settlement discount of 30 per cent) and prohibited from accepting deposits from new customers for 147 days for breaches of Principle 3 (which requires firms to take reasonable steps to organize their affairs responsibly and effectively, with adequate risk management systems). This notice demonstrates the FCA’s continued focus on financial crime and its willingness to impose wider sanctions than simply financial penalties.

In November 2012 and March 2013, Canara was visited by the FCA as part of its "Trade Finance Thematic Project" (the 2012 / 2013 visits). The FCA notified Canara of a number of serious weaknesses in its Anti-Money Laundering (AML) systems and controls. Canara subsequently confirmed to the FCA that it had taken steps to remedy the weaknesses identified. The FCA visited Canara again in April 2015 as part of its "pro-active" AML programme (the 2015 visit). The FCA found, following its 2015 visit, that the remedial action taken by Canara after the 2012 / 2013 visits was insufficient, and that Canara had failed to test the implementation and effectiveness of the steps taken after the 2012 / 2013 visits.

As a result of the continuing perceived deficiencies in Canara’s AML systems and controls, the FCA appointed a Skilled Person pursuant to s.166 FSMA) in September 2015. The Skilled Person’s final report, produced in January 2016, highlighted a number of significant deficiencies in relation to both Canara’s AML systems and controls and its corporate governance structure. In particular, the FCA determined that Canara: (i) had entirely failed to implement adequate AML systems and controls; and (ii) had subsequently failed to rectify identified weaknesses in those systems and controls. The FCA found that the AML deficiencies were endemic throughout Canara’s UK operations and covered almost all levels of its business and governance structure. The FCA did however acknowledge that since the date of the Skilled Person’s report, Canara had invested significant resource in improving and upgrading its AML systems and controls.

FCA and Insolvency Service strengthen relationship with memorandum of understanding

The FCA and the Insolvency Service (IS) have agreed a Memorandum of Understanding (MoU). It follows a call by the Government for better coordination between the FCA and IS, such that both agencies can fulfil their respective duties and obligations to the best of their abilities.

The IS is responsible for investigating the affairs of insolvent companies and bankrupt individuals. It has the powers to seek the disqualification of individuals as directors and to petition for the winding up of companies in the public interest. There are potential common interests with the objectives of the FCA as the financial conduct regulator. Those individuals or companies that find themselves within the remit of both regulators may now find it more likely that they will be subject to two sets of sanctions following an investigation.

The MoU encourages collaboration and the pro-active sharing of information between the two organisations. However, the MoU is not legally binding and only sets out the high level framework for cooperation. The gateways under which the regulators may disclose information to other parties will continue to be s.449 Companies Act 1985 (and schedules 15C and 15D to that Act) for the IS, and The FSMA 2000 (Disclosure of Confidential Information) Regulations 2001 for the FCA. Both the IS and the FCA will also have to respect the restrictions on sharing information that may be imposed by the General Data Protection Regulations, the Human Rights Act 1998 and legal professional privilege.

FCA new address

A reminder to update details for the FCA as it has now moved to new offices in Stratford.

The new address is: 12 Endeavour Square, London, E20 1JN

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The Sanctions and Anti-Money Laundering Act 2018

The Sanctions and Anti-Money Laundering Act 2018 (the Act) received Royal Assent on 23 May 2018.

Prior to the Act, the UK was heavily reliant on the European Communities Act 1972 (ECA) to implement sanctions. The Act therefore aims to provide the UK with a domestic sanctions framework post-Brexit, required to fulfill its international obligations to implement sanctions, anti-money laundering and counter-terrorist financing measures.

However, the operative provisions of the Act are not yet in force as they require implementation via secondary legislation. It is currently anticipated that its terms will be implemented in line with the Brexit timetable. Until that date, the UK will be able to rely on ECA legislation in these areas.

The Act is in largely the same form as the Bill which was considered in our April Quarterly Bulletin. It confers very broad powers on the UK Government to introduce sanctions that are considered "appropriate" for the purposes of international obligations and in pursuit of various other aims, such as international security.

The extent to which the UK’s approach to sanctions will diverge from the EU and its international partners remains to be seen, and will largely be a matter of political policy.

OFSI publishes updated guidance on monetary penalties for breaches of financial sanctions

In May 2018, the Office of Financial Sanctions Implementation (OFSI) updated its guidance on "Monetary Penalties for Breaches of Financial Sanctions" (the Guidance).

The Guidance, first issued in April 2017, clarifies the circumstances in which OFSI may consider it appropriate to impose monetary penalties on individuals or organisations, and how it will determine the amount.

The recent updates relate to:

  • Voluntary disclosure: While the previous version of the Guidance confirmed that voluntary disclosure of a breach of financial sanctions will be a mitigating factor when OFSI assesses the case, under the updated Guidance it may be a mitigating factor. OFSI has therefore subtly broadened its discretion. Nonetheless, the updated Guidance confirms that OFSI values voluntary disclosure and that voluntary disclosure may have a real effect on any subsequent decision to apply a penalty. The updated Guidance also provides additional detail on the process which OFSI expects parties to follow when voluntarily disclosing breaches.
  • Right of appeal: The final section of the Guidance on individuals’ rights of appeal to the Upper Tribunal has been updated in order to refer to the Upper Tribunal’s newly introduced procedure for appealing financial sanctions monetary penalties. Further details on the new procedure are set out in The Tribunal Procedure (Amendment) Rules 2017.
  • It will be important for practitioners to ensure that they refer to the updated Guidance, although it is worth noting that OFSI is yet to issue a monetary penalty for a sanctions breach.

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