The magnitude of investor losses means that mis-selling claims are on the rise. Macfarlanes' Barry Donnelly looks at the issues that determine whether such actions are likely to succeed in light of recent cases

Investors who lose money through declining asset values often seek to recover some of their losses from the banks or other financial institutions that have sold them the loss-making investments – but it can take a long time for these cases to reach court.

Judgment was handed down in JP Morgan Chase Bank v Springwell Navigation, the leading case in this area, in May 2008, some 10 years after the events which led to the dispute – the announcement by the Russian Government, in August 1998, of a devaluation in the rouble and a restructuring of sovereign debt.

Given the extent of investor losses in recent times, it is likely that this will be a fertile area of litigation for some time to come. Claims by investors are likely to be made on the basis that the defendant bank owed the investor a duty to provide advice as to the suitability of investments and, usually, that the bank made actionable misrepresentations that induced the investor to enter into loss-making transactions.

Recent cases

In Springwell, Justice Gloster rejected the claimant's claims for compensation for losses arising out of investments made through the defendant bank. The Court of Appeal began hearing the claimant's appeal on 14 June 2010 – at the time of writing, the decision has not been handed down.

Earlier this year, in Titan Steel Wheels v Royal Bank of Scotland, the claimant suffered losses after investing in complex investments and alleged that the bank owed a duty to advise it as to the risks in making the investments.

More recently, in Raiffeisen Zentralbank Osterreich v Royal Bank of Scotland, the claimant bank alleged that it was led by the defendant bank's misrepresentations to participate in lending to Enron. As in Springwell, the investors' claims in Titan Steel Wheels and Raiffeisen were dismissed.

Duty to provide investment advice?

Investors may argue (as in Springwell and Titan Steel Wheels) that the defendant bank owes them a general duty to provide advice about the suitability of investments. The defendant bank, on the other hand, may argue that

its employees act only as salespeople and not in an advisory capacity, and that a duty of care should not be imposed where both parties are pursuing their own financial interests in commercial transactions.

This issue will turn both on the contractual documentation and the nature of the relationship between the parties. The court will consider the extent to which the investor has relied on advice given by the defendant bank and whether it is reasonable for him to do so.

This is heavily dependent on the facts of each case and the court will conduct a detailed investigation into what was said by the parties both before and during the relationship. For example, the Springwell trial lasted six months and involved lengthy cross-examination of the key witnesses and detailed consideration of hundreds of taped telephone conversations.

An important consideration will be the levels of knowledge and expertise possessed by the investor. In Springwell, Titan Steel Wheels and Raiffeisen, the claimants were sophisticated investors and, in each case, the judge cited this as an important reason for dismissing the claim. The court will also be reluctant to find that representatives of a defendant bank are acting as advisers unless the claimant has paid for this service or there is a written advisory agreement.

Misrepresentation

Even where an investor cannot show that the defendant bank owes it a general duty to provide investment advice, he may be able to show that specific statements made by the bank's employees amounted to misrepresentations which led him to enter into loss-making transactions.

In Raiffeisen, Justice Christopher Clarke analysed the principles that apply to misrepresentation claims in some detail. He stated that the investor has to establish that statements of fact were made upon which the investor was entitled to rely. This question is to be judged objectively and depends on what a reasonable person would have understood or, in the case of implied representations, inferred from the words used and the context in which they were used.

As with claims for breach of a general duty to provide investment advice, the identity of the claimant will be important. It will be more difficult for a sophisticated investor to bring a successful claim because the court is less likely to find that it was reasonable for the investor to rely on the defendant's statements, rather than his own judgement.

Expressions of opinion, as long as they are genuinely held, will not usually give rise to an actionable misrepresentation. An exception to this general principle may exist if the court finds that there should be implied into an expression of opinion a representation that the maker of the statement had reasonable grounds for his opinion. The extent to which the court should be willing to imply such a representation is one of the issues before the Court of Appeal in Springwell.

Contractual arrangements

An important, and often decisive, consideration will be found in the contractual arrangements between the parties. The documentation will often include a statement to the effect that the bank is not providing financial advice and the customer is relying on his or her own judgement and advice in entering into particular transactions. Clauses of this nature, known as non-reliance clauses, are intended to prevent a duty of care from arising and to preclude a customer from bringing a misrepresentation claim.

However, there is some doubt about the effect of non-reliance clauses where they do not accurately reflect the actual relationship between the parties to a contract. What happens, for example, when an investor has relied on advice provided by a bank and the bank is aware of this? Will the bank still be able to rely on the non-reliance clause?

There are two apparently conflicting Court of Appeal decisions on the point. The traditional view, as espoused in Lowe v Lombank, is that a party to a contract (eg a bank) can only rely on representations made by the other party (eg an investor) as to past fact if it can show that:

- the investor intended the bank to act on its statements of non-reliance and
- the bank believed those statements to be true and did, in fact, rely upon them.

This analysis severely restricts the application of non-reliance clauses where they do not reflect the true facts and the real relationship between the parties. However, in Peekay Intermark v Australia and New Zealand Banking Group, the Court of Appeal stated: "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."

If Peekay is correct, an investor is bound by its representations as to non-reliance, etc, irrespective of the real relationship between the parties.

Notwithstanding the fact that the comments made in Peekay were obiter, the judges in Springwell, Titan Steel Wheels and Raiffeisen all preferred them. The rationale behind the Peekay approach is that commercial parties should be able to contract on whatever basis they wish, free from concern that the courts will interfere with their contractual arrangements and the inevitable uncertainty that would ensue. Until the point is decided by a higher court, this issue will remain uncertain. Hopefully the Court of Appeal will provide the necessary clarification when it hands down its decision in Springwell.

Conclusion
In his opening submissions before the Court of Appeal on behalf of Springwell, leading counsel made the point that the trial before Justice Gloster had taken place before the financial crisis, a time when nobody understood the risks posed by complex financial instruments of the type purchased by Springwell, both to individual investors and the world economy in general.

The principles outlined in this article are, in general terms, helpful to financial institutions that are resisting claims by disappointed investors. In particular, if the courts continue to prefer the Peekay approach to contractual documentation, this is likely to make it difficult for investors to bring successful claims. However, the cases also show that it is necessary to carry out a detailed factual investigation into the history of the parties' relationship. Different facts may well produce different results.

Barry Donnelly is head of Macfarlanes' banking and finance litigation group.