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City Litigation

Directors' and financial advisers' liability

The High Court recently held in Possfund Custodian Trustee v Diamond that it is arguable that those responsible for the issue of a company's prospectus owe a duty of care not only to initial subscribers but also to subsequent purchasers of thatcompany's shares in the market. Shares in Diamond Group Holdings (Diamond) were placed on the Unlisted Securities Market in April 1989. Most of the plaintiffs were subscribers but some had also made subsequent purchases of Diamond's shares on the USM. These later purchases took place in the 'after market', the period (in this case two-and-a-half months) after the placing during which the most recent published financial information on Diamond remained that found in the prospectus.

Diamond's shares turned out to be worthless. The plaintiffs sued the company's directors, financial advisers and reporting accountants involved in the placing. It was agreed that a duty of care was owed by each of them to the initial subscribers. The issue was whether a duty was also owed to subsequent purchasers in the after market.

The plaintiffs produced expert evidence to the effect that by 1989 the established purpose of a prospectus was not simply to induce investors to subscribe, but also to induce the public to make after market purchases. A significant factor in this respect was the Stock Exchange requirement for the prospectus to be printed on Extel cards so that it could be made available to potential investors.

On the basis of this evidence, the judge held that it was at least arguable that a duty of care was owed to the purchasers in the after market.

This case was not a full hearing of the issue of whether the directors, financial advisers and reporting accountants were liable to the plaintiffs for the misleading information in the prospectus. The judge's decision was given in a preliminary hearing in which the defendants were trying to strike out the claim against them on the basis that no duty of care was owed in respect of the after market purchases.

The matter will still need to be considered at trial, when the plaintiffs' expert evidence will no doubt be tested. The plaintiffs will also have to distinguish the case from the principles in Caparo where filed audited accounts were held not to expose auditors to claims from subsequent investors. In Caparo, the House of Lords took note of the clearly defined role of auditors in assisting existing shareholders in their corporate management responsibility. The thrust of the plaintiffs' arguments in Possfund is that there is no reason why a financial adviser issuing a prospectus should have its responsibilities so limited.

Syndicated loans: default interest

In Lordsvale Finance v Bank of Zambia, the High Court has considered whether a provision in a syndicated loan agreement for a prospective increase in the rate of default interest was a penalty or not.

D defaulted when loan advances had fallen due for repayment. P claimed default interest under the loan agreement. D argued that part of the method of calculation (which provided for an uplift in the rate of 1%) was unenforceable because it was a penalty (that is, its function was to deter a party from breaching the agreement) rather than a genuine pre-estimate of loss. The judge noted that such provisions for enhanced rates of default interest were prevalent and would be enforced in New York (the other major centre of syndicated lending). He concluded that, if the increased rate of interest applied only from the date of default, a term providing for a modest increase in the rate should not be struck down as a penalty. Otherwise, disparity could emerge between practice in London and New York which would be bad for international banking.

Syndicated lenders will need to check the default interest rate provisions in their loan agreements, particularly if such provisions operate retrospectively or if any interest rate uplift is exceptionally large. In both situations, there must be a risk that the provision will be held to be a penalty and thus unenforceable.

BCCI: suing the Bank of England

One of the issues arising out of the collapse of BCCI has been the extent to which the Bank of England (the Bank) could be held responsible for the losses suffered by depositors with English branches of BCCI. This has led to BCCI's Liquidators bringing claims, as assignee of the claims of certain of the depositors, against the Bank. The claims have been brought for the tort of misfeasance in public office, because the Bank is immune from ordinary negligence claims under the Banking Act 1987.

In determining a preliminary issue, the Commercial Court has held that the tort of misfeasance in public office is concerned with a deliberate and dishonest wrongful abuse of the powers given to a public officer, in this case the Bank. If the plaintiff depositors establish, firstly, that the Bank intended to injure them or persons such as them; or, secondly, that the Bank knew that it had no power to do what it did and that the plaintiffs (or persons such as them) would probably suffer loss or damage, and the plaintiffs suffered loss as a result, they would probably have a sufficient right to maintain the action for misfeasance against the Bank. Having established these principles, the plaintiffs must provide evidence of the Bank's failings in the next stage of the proceedings. However, the argument over these principles may continue in the Court of Appeal.

Lending to local authorities

In 1991, the House of Lords held that interest rate swap transactions entered into by local authorities were ultra vires and thus void: Hazell v Hammersmith & Fulham LondonBorough Council. The principles set out in this case have recently been upheld in Credit Suisse v Waltham Forest London Borough Council and Credit Suisse v Allerdale Borough Council. In both these cases, the Court of Appeal held that local authority schemes which in effect circumvented central government controls on borrowing fell outside the powers of the local authority. Thus, the bank lender could not enforce as against the local authority a guarantee given by the local authority in return for which the bank had lent money under the scheme.

In another blow to bank lenders, the House of Lords, by a three to two majority, has decided in Westdeutsche Landesbank Girozentrale v Islington London Borough Council that where a swap agreement between a council and a bank is declared to be ultra vires, although the bank can recover the balance of sums due as money had and received, it is not entitled to recover compound interest on such sums but only simple interest.

On a more optimistic note, in Kleinwort Benson v Birmingham City Council, the Court of Appeal rejected the council's argument that the bank, which had entered into a swap contract with it, should have hedged the contract so as to avoid suffering any loss.

Neil Mirchandani,City Litigation Group,Lovell White Durrant, London

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