High Court finds arranging bank has duty of care to investors
The High Court has held that BNP Paribas (the Bank) owed a duty, which it had breached, to investors to take reasonable care to ensure that a promissory note provided by the borrower as part of a transaction was properly executed. The Bank had acted as the arranger, sole book runner and lead manager of the financing transaction, and its role was clear from the offering circular. This transaction was intended to raise $650 million for Saad Trading, Contracting and Financial Services Company, a Saudi Arabian limited partnership (Saad) and was backed by a promissory note. The Bank had assumed responsibility, as arranger of the finance, to ensure the proper execution of the promissory note (in this case a handwritten signature that was appropriately witnessed was required). It subsequently transpired that the promissory note had been "signed" with a laser-printed signature, with the effect that the note was unenforceable in Saudi Arabia.
The Court held that the bank was negligent in not having taken reasonable care in ensuring that the promissory note was properly executed. It was held to be liable to investors who had purchased the debt instruments in the secondary market, because the offering circular was made available to them, and they would understand from it that the Bank had arranged the execution of the promissory note. Although the usual disclaimers appeared in the circular, these did not negate the Bank's responsibility for ensuring that an important document for investors' protection was properly executed.
The ground breaking decision, handed down on 1 February, is the first judgment supporting such a duty and will come as a surprise to many capital markets participants.
Significance of the decision
This decision is likely to surprise many who operate in the capital markets arena. Banks arranging capital markets deals have long been aware of the theoretical risk that they could be held to owe duties in tort to investors in transactions, and this is why appropriate disclaimer wording is included in relevant documents. However, until now there has not been a judgment supporting such a duty.
The court did, however, identify a number of relevant factors which were specific to this particular case which may limit the imposition of a wider duty of care. It should also be noted that the High Court has granted permission for the bank to appeal.
BNP Paribas (the Bank) acted as the arranger, sole bookrunner and lead manager of an Islamic financing transaction known as a Sukuk (equivalent in economic effect to a Eurobond issue but structured so as to conform to Sharia law principles). The Sukuk was intended to raise $650 million for Saad Trading, Contracting and Financial Services Company, a Saudi Arabian limited partnership (Saad).
The promissory note for that sum was issued by Saad and governed by Saudi Arabian law. Its purpose was to provide certificate holders with a direct and relatively easily enforceable claim against Saad in the event of a default by Saad. The promissory note was executed with what appeared to be a signature of a Mr Al-Sanea on behalf of Saad in the presence of two witnesses. However, unbeknown to the other parties or advisers at the time, his signature was not "wet ink" but was laser-printed. This meant that the promissory note was unenforceable under Saudi law. It was common ground between the parties that the absence of a handwritten signature would not have been apparent on inspection of the original promissory note without the use of powerful magnification.
The claimants were the issuer (a special purpose vehicle called Golden Belt 1 Sukuk Company BSC(c)) and certain holders of Sukuk certificates who had purchased them in the secondary market. They brought proceedings following allegations of fraud against Mr Al-Sanea and Saad's failure to pay sums due under the transaction. The claimants alleged that the Bank owed them a duty to exercise reasonable care and skill to ensure that the promissory note was properly executed.
The judgment sets out three tests in the analysis of whether a duty of care was owed to investors. On the first test, assumption of responsibility, the judge concluded that the Bank did assume responsibility to investors to exercise reasonable care. The Bank had agreed to provide the specific service of arranging for the execution of the promissory note. That was not a particularly complicated or onerous service. The promissory note had one purpose only, which was to provide certificate holders with a relatively easily enforceable claim against Saad in the event of a default. Ensuring that the note was properly executed was a service carried out entirely for the benefit of the certificate holders. Investors in the Sukuk would rely on the Bank to ensure that the promissory note was properly executed and it was reasonable for them to do so.
The second test is a three-stage test of foreseeability, proximity and whether it would be fair, just and reasonable that the duty should be owed. With regard to this test, the court found that it was foreseeable that if reasonable care was not exercised, certificate holders would suffer loss because the package of rights which they acquired would be intrinsically flawed; the relationship between the Bank and certificate holders was sufficiently proximate; and it would be fair, just and reasonable that the Bank as the arranging bank should owe such a duty. The judge said that no good reason was suggested why, as a matter of policy, an arranging bank should not owe such a duty, and that it seemed to him that there were powerful reasons why it should. To impose such a duty would not require banks to do anything which they would not do in any event. It would not in any way undermine the contractual structure which existed and would be consistent with the transaction documents including the offering circular.
The third test is an incremental one i.e. that the law should develop novel categories of negligence incrementally and by analogy with established categories. It was suggested by the Bank that the imposition of a duty of care would be contrary to the incremental test, because no case in the English courts had held that a duty of care was owed to investors by a bank which had arranged a public listed bond issue. However, the court disagreed, because, it said: (a) there was no absolute rule of law that an arranging bank can never owe a duty to investors; (b) the duty imposed here was limited and specific; (c) the duty was imposed following the application of established principles to the specific facts of this case, referred to by the judge as "the novel facts of the Sukuk, including importantly the promissory note".
- Banks and issuers should be aware that a broad disclaimer of responsibility, for example in an offering circular, does not necessarily mean that the arranging bank is also disclaiming responsibility for the performance of its own functions. In fact, the court suggested here that the fact that it is thought necessary to disclaim responsibility for the contents of an offering circular may imply that, without such a disclaimer, there is at least a risk that such responsibility exists. The absence of a disclaimer of responsibility for performance of an arranging bank's own functions may be a factor tending to point towards rather than away from the existence of a duty of care in respect of those functions. In the light of these comments, arranging banks may wish to consider additional disclaimers in offering circulars e.g. negating responsibility to ensure that transaction documents (at least in certain jurisdictions) are properly executed.
- On the facts, the court found that the Bank had failed to meet the required standard of care with regard to the signing of the promissory note. This was the usual negligence standard, namely that of a reasonably competent banker specialising in transactions of this nature. Given the factual matrix surrounding the signing of the promissory note, commentators have indicated that this is a surprising decision. As a result, arranging banks may want to take practical steps to minimise risk around execution of transaction documents e.g. by insisting on physical document signings, or by insisting that representatives of the arranging bank or its lawyers are physically present when signing takes place. However, this may not be reasonable or indeed practicable in all circumstances.
Banks which arrange an investment and offer can owe a duty of care to primary and secondary investors to take reasonable care to ensure that underlying investment documentation is properly executed and enforceable.