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City Litigation

Damages for fraud

The House of Lords has delivered an important decision on the measure of damages for fraudulent misrepresentation. In Smith New Court Securities v Citibank, Smith New Court (SNC) was induced by a Citibank employee's fraudulent misrepresentation to buy shares in Ferranti from Citibank. It was subsequently discovered that a separate fraud involving fictitious contracts had been perpetrated on Ferranti designed to bolster its apparent profitability. On discovery of the second fraud, Ferranti's share price crashed and SNC eventually sold the shares at a heavy loss.

The High Court held that SNC was entitled to the difference between the price paid for the shares and their 'true' value on the date of purchase, assessed by valuing the shares at what would have been their open market value had the market known of the second fraud. However, the Court of Appeal rejected this, deciding that the market value had to be taken to be the quoted value.

The House of Lords overruled the Court of Appeal and held that, as a matter of principle, SNC should be compensated for the loss flowing from the transaction, ie the difference between the price paid for the shares and the proceeds of subsequent sales. The Law Lords held that, in assessing the damages payable for fraudulent misrepresentation, the plaintiff is entitled to recover the full price paid but must give credit for any benefits received. As a general rule, the benefits received would include the market value of the property acquired as at the date of acquisition. However, this general rule was not to be inflexibly applied where to do so would prevent the plaintiff obtaining full compensation for the wrong suffered. Thus, the general rule would not normally apply where the misrepresentation continued to operate after the date of acquisition or where the plaintiff was, by reason of the fraud, locked into the property.

The Law Lords took the view that SNC was locked into the transaction by reason of the fraud perpetrated on it. As such, Citibank was liable for full damages even though it had no responsibility for the second fraud.

Auditors' duty of care

In Baring plc (in administration) v Coopers & Lybrand & Others, the Court of Appeal considered whether it was arguable that auditors of an indirect subsidiary owed a duty of care to the holding company. The case arose out of the collapse in February 1995 of the Baring group. The holding company (Baring) and an indirect subsidiary (BSL) issued proceedings against, among others, Coopers & Lybrand Singapore, who were the auditors of BFS, an indirect subsidiary of BSL. Coopers & Lybrand Singapore challenged the issue of proceedings, arguing that it could owe no duty of care to Baring or BSL, only to BFS.

The Court of Appeal rejected this. It was arguable that Coopers & Lybrand Singapore did owe a duty of care to both Baring and BSL. The significant fact was that the auditors knew that their audit and report were required so that the Baring directors could comply with their obligation to provide accounts showing a true and fair view of the group's financial affairs.

This decision was given in a preliminary hearing. We will have to wait for the full trial for final determination of the scope of the duty owed by the auditors, and the consequences of any breach of duty. In the meantime, holding companies in particular should consider whether their audit instructions make it clear that auditors of group companies are expected to report any concerns either to the lead auditor or direct to central management.

Liability of an arranging bank

The High Court in Sumitomo Bank v Banque Bruxelles Lambert considered whether BBL, as arranging bank, owed a duty of care to a syndicate of banks in discharging its obligations to the insurers of certain mortgage indemnity guarantee policies (MIGs) under the terms of those policies. BBL had taken out two MIGs in respect of syndicated loans to finance the purchase of commercial property by special purpose vehicles. Although the loans were secured, the MIGs were intended to protect the banks if the security failed to realize the amount lent.

The borrowers defaulted and the banks suffered heavy losses. The insurer contended that the MIGs were void or voidable for non-disclosure and breach of various terms of the MIGs. The syndicate banks sued BBL as arranger alleging that it was responsible for ensuring the obligations were fully carried out and had failed in this respect.

The Court found that, as the syndicate banks were not party to the MIGs, only BBL could have complied with the terms of the MIGs. BBL knew that the MIGs were important for the banks' interests and that they were depending on BBL to perform its obligations. On these grounds, the Court held that BBL owed a duty of care to the banks to discharge its obligations.

The judge also held that the usual exclusions of agent bank liability in the loan agreements could not assist BBL, because its liability had arisen in its capacity as arranger, not agent, and before signature of the loan agreement.

An arranging bank should thus proceed carefully when undertaking any duties for which it alone, and not the syndicate members, could be held responsible. Equally, a syndicate bank should consider its position if the arranger has sought to avoid responsibility for pre-contractual duties, if that syndicate bank is at risk in relation to matters over which it has no knowledge or influence.

DTI investigations

In the long-running Guinness saga, the European Court of Human Rights has decided that Ernest Saunders's right not to incriminate himself was infringed when evidence obtained from him by DTI inspectors (under legislation depriving him of the right to silence) was used at his criminal trial. Although finding in favour of Saunders, the Court refused to speculate whether the outcome of his trial would have been any different had use not been made of the statements by the prosecution. The Court also rejected Saunders's claim for several million pounds compensation.

Although this decision does not impact directly on the powers of DTI inspectors to interview witnesses as part of the investigations procedure, it will have a significant effect on the way in which fraud and insider dealing prosecutions are brought. It will no longer be sensible to bring such prosecutions on the basis of evidence obtained under compulsion because any conviction obtained in such circumstances is likely to be overturned.

Neil Mirchandani
City Litigation Group
Lovell White Durrant, London

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