As we approach the end of the decade, we take a look at two important contrasting cases in the collective action sphere to have recently been under the Court's microscope.
First, we consider Tesco plc's failed strike-out application in relation to the claim it faces under s90A Financial Services and Markets Act 2000 ("FSMA") before moving on to Lloyds Banking Group plc's recent defeat of the common law claims pursued by shareholders arising out of its 2008 acquisition of HBOS.
Tesco fails to strike-out after the High Court rules on the application of s.90A FSMA
This claim arises as a result of two institutional shareholder claimant groups bringing proceedings against Tesco under section 90A FSMA, alleging they suffered losses as a result of false and misleading statements made by Tesco when reporting its commercial income and trading profits in 2014.
In September, Mr Justice Hildyard heard argument on Tesco's application for strike-out and handed down his decision in late October1.
As is now commonplace, the shares in Tesco were held in dematerialised form (on a computer-based form as opposed to paper certificates) through the Certificateless Registry for Electronic Share Transfer ("CREST") using custodians (which in turn used sub-custodians) to acquire, hold or dispose of those shares (as the case may be). None of the Claimants held shares in Tesco as a registered member of CREST. In the case of every Claimant in these two sets of proceedings, the shares held through CREST were registered in the name of a bank or financial institution providing custodian services. None of the Claimants, therefore, ever directly acquired, held or disposed of a legal interest in any of the shares. Further, most of the shares in Tesco held by custodians were held by them, not for a Claimant, but for another intermediary in what is commonly referred to as a 'custody chain'.The key feature of intermediated securities held in a custody chain is that the ultimate investor (the person for whose account the securities are ultimately held) is given the benefit of a right without holding the right itself, known as a "right to a right". .
Tesco therefore argued the action should fail as the Claimants lacked standing to bring a claim under section 90A and Schedule 10A for two reasons:
- the Claimants' interest was not an "interest in securities" within the meaning of Schedule 10A; and
- none of the Claimants could be said to have "acquired, continued to hold or disposed of" any interest in securities, as required by the statute.
Consequently, Tesco considered it was not liable for any untrue or misleading statement in its published information to any Claimants who held shares in a custody chain with more than one intermediary.
Mr Justice Hildyard was not persuaded and found neither of Tesco's arguments sustainable.
In considering the first question of whether the Claimants had an "interest in securities", the Court came to the view that while an investor at the end of a chain of intermediaries does not have any direct proprietary interest in the underlying security, the concept must denote something more than simply having a contractual or economic interest.
Given the limited case law relating to the relevant sections of FSMA, the court considered cases, such as In the matter of Lehman Brothers International (Europe) [2012] EWHC 2997 (Ch), to analyse what would constitute "any interest in securities". The court concluded that the investors' "right to the right" could be equated to an equitable property right in respect of the securities, and this was sufficient to satisfy the meaning of Schedule 10A.
Importantly, the court stated that in drafting this legislative scheme, the legislature "did not intend to strip away the rights of investors who chose that mode of holding their investment, and must have been persuaded that the words they used were appropriate to preserve and enhance those rights."
With regard to the second limb, Tesco's position was that the Claimants could not be said to have "acquired" or "disposed" of their interest in the shares as any transfer or dealing on their part was not in that particular interest, and that the ultimate investors had at the very most, a beneficial interest. The court considered this a narrow interpretation of "acquired" and "disposed" and held that any process whereby the ultimate beneficial ownership of securities that are, with the consent of the issuer, admitted to trading on a securities market, comes to be vested in or ceases to be vested in a person constitutes the acquisition or disposal of any interest in securities and would fall within the remit of Schedule 10A.
The court therefore held that neither one of the two limbs of Tesco's argument was sustainable and dismissed the strike-out application. These civil proceedings are now due to go to trial in June 2020 and it will be interesting to see how the issues of reliance and the appropriate measure of loss are decided.
Lloyds and its directors succeed in defeating the first shareholder action to have reached judgment in the Courts of England and Wales
The Lloyds Shareholder Action arose out of Lloyds' 2008 all-share acquisition of HBOS, with more than 5,000 shareholders coming together under a Group Litigation Order to pursue (with the help of a litigation funder) the bank and five of its former directors, seeking damages in the region of £385 million. In contrast to the Tesco claim which is on a statutory footing, the claim against Lloyds and its directors was based in common law.
In a nutshell, the Claimants' case was as follows:
- The proposed acquisition was a 'Class 1' transaction (under the Listing Rules) and therefore required shareholder approval at an Extraordinary General Meeting ("EGM");
- The directors should not have recommended the acquistion because it represented a dangerous and value-destroying startegy which involoved unacceptably risky decisions (the recommendation case);
- The directors should have provided further information in the circular about Lloyd's and about HBOS, in particular about a funding crisis faced by HBOS and the related vulnerability of HBOS's assets (the disclosure case); and
- If the directors had either not recommended the acquisition or had made further disclosures about Lloyd's and about HBOS, it was said that the shareholders of Lloyds, and the market in general, would not have been misled as to the true financial circumstances of HBOS or as to the merits of the acquisition, and the Claimants would have avoided the recapitalisation of the merged entity and the consequential loss in value by dilution of their shareholding.
Mr Justice Norris' long-awaited judgment2 was handed down on 15 November 2019. At 280 pages, it represents an incredibly detailed account of the evidence heard during the five month trial, which began in late 2017, but a number of interesting broader points also arise.
The recommendation case was dealt with fairly swiftly, with Mr Justice Norris holding that a reasonably competent director of a large bank could reasonably have reached the view, at the end of October 2008, that the acquisition was beneficial to the shareholders and made the recommendation accordingly at the EGM. The Court found that, when considering whether to make a recommendation to shareholders, a director needs to take a fair and balanced view on what he or she thinks are the realities, based on probabilities.
One further point to note in relation to the recommendation case was a suggestion by the Claimants that the directors were wrong to rely on the views of the investment banker advising on the transaction as "investment bankers are only paid (and are handsomely paid) if transactions proceed". Mr Justice Norris was not persuaded, finding "it is altogether too cynical to regard investment bankers as being so devoid of integrity as to warrant a discounting of their views. Investment bankers also have personal and corporate reputations to protect. Indeed a board that did not seriously consider the advice of an investment banker on a significant takeover (given that it would be required under the Listing Rules to appoint a sponsor in relation to the ensuing circular) would almost certainly be negligent."
The disclosure case was not so straightforward. While the majority of alleged non-disclosures were dismissed, the Court did decide that HBOS's use of emergency liquidity assistance ("ELA") and the £10bn loan facility, provided by Lloyds to HBOS, ought to have been disclosed in order to discharge the duty to provide sufficient information, namely to provide, when viewed objectively, a fair, candid and reasonable account of the circumstances which will enable an informed decision to be made.
However, it did not then follow that, in failing to discharge that duty, the directors were necessarily guilty of a negligent misstatement by omission. How to assess the materiality of ELA was a judgement call but the Court was confined by the evidence or rather lack thereof: there was no evidence of a process through which that judgement call was made. The Court therefore determined that there was a misstatement about the care exercised in relation to how the Circular dealt with ELA. In relation to the loan facility, the Court again held that there was a misstatement in the Circular as they did not consider that the facility needed to be disclosed but assumed (without testing or enquiry) that their legal advisers had considered the question when drafting the Circular.
The Court noted that the normal consequences of the sufficient information duty is that the Court will enquire there any reasonable ground for supposing that such imperfections as may be found in the Circular have had the result that the majority who have approved the transaction have done so under some misapprehension of the position with a view to setting aside the result of the meeting and giving directions for the convening of a fresh meeting. However, this was not the relief sought by the Claimants. Instead, they sought damages or equitable compensation.
Consequently, in order to recover, the Claimants would have to have shown that (i) the failure to discharge the sufficient information duty; and (ii) the misstatement about the degree of care exercised in preparing the Circular in relation to matters known about but omitted, were causative of loss. The Claimants' case therefore proceeded on the basis that, if the Lloyds board had recognised that they were bound to make disclosure of the existence of ELA or of the Lloyds facility then the acquisition would not have completed because: (i) the Board would have declined to proceed; (ii) the transaction would have collapsed; or (iii) the majority of shareholders would have voted against the transaction.
The Court found that the Claimants' case on causation fell someway short. The Claimants could not demonstrate on the evidence that the outcome of the shareholder vote at the EGM would have been different. The Claimants also could not establish their other two cases on causation as it seemed more likely than not that the UK Government would have permitted a controlled disclosure of the ELA in the Circular rather than risk being left with large stakes in two relatively weak competing clearing banks. In addition, the Claimants had failed to establish that, had the ELA and facility been disclosed, the HBOS share price would have collapsed.
Accordingly, both the recommendation case and the disclosure case were dismissed.
For that reason, the Court did not need to go into the nuts and bolts of how one would ever go about quantifying losses in a case such as this. Mr Justice Norris did, however, comment that, if the directors had caused an overpayment for HBOS, this would be a matter for the company to pursue and, in principle, any shareholder seeking to recover such a loss as a result of the acquisition and recapitalisation would be met by an argument grounded in the principle of reflective loss. Otherwise, the Court rejected all three bases upon which the Claimants' expert had calculated loss on the basis of the value of Lloyds' shares.
Commentary
When one considers that, for Tesco's application to have succeeded, the Court would have had to have found a gaping hole in FSMA, the decision is perhaps not that surprising.
CREST has been around since 1996 and a decade later saw the introduction of section 90A and Schedule 10 FSMA to regulate the liability of issuers of UK securities for false financial reporting. However, as the Tesco judgment notes, before CREST most transfers of interests were effected by transfers of paper certificates, whereas now the use of CREST is prevalent, with CREST being the only central securities depositary approved in the UK by HM Treasury. Mr. Justice Hildyard therefore considered the question as to the nature of interests held in a dematerialised market as a "systemic one of considerable importance". This was particularly so when paper shares are due to be entirely phased out by 2025. The Tesco decision, therefore, helps to define the scope of the legal rules governing the market practice of intermediation.
However, this judgment also highlighted concerns, including those raised by the Financial Markets Law Committee and the Law Commission, as far back as 2004, recommending legislative intervention on the basis that the law had not kept up with the speed of recent market changes. In August 2019, the Law Commission issued a call for evidence in respect of intermediated securities, which included a section concerning investors' ability to sue the company or a higher intermediary, given the "no look through principle" which prevents investors from suing anyone in the intermediated securities chain beyond their immediate intermediary. The Law Commission will publish its findings in autumn 2020.
It seems the Tesco strike-out judgment has provided some certainty regarding the question of standing for the purposes of section 90A, but it remains to be seen whether the Government will seek to address this perceived issue, or whether this judgment will suffice for investors to rely on when bringing future actions. Many will await with interest the more substantive trial of the issues next year and it remains to be seen whether Tesco will yet defeat these claims.
It also remains to be seen whether the shareholders will appeal the decision in Lloyds but it is worth remembering that the claims were brought in common law and against the backdrop of an economic situation the likes of which may never be seen again. That said, the judgment gives rise to an interesting question as to whether there could ever be a circumstance in which shareholders would be able to surmount the issue of reflective loss when seeking to pursue an overpayment or diminution in value claim.
As we move into the next decade it seems apparent that attempts to bring collective actions in the UK are going to continue, fuelled as they are by the presence of litigation funders. Funders were involved in both of these cases and whilst the result in the Tesco case must have buoyed the industry, the defeat in the long-running, and no doubt costly, Lloyds shareholder action, the first to reach judgment, may have dampened appetite somewhat. Further, it remains to be seen whether we will see the first s90A claim actually make it all the way to trial. Close attention should also be paid to claims working their way through the collective action regime introduced by the Consumer Rights Act, such as MasterCard.
Footnote
1 SL Claimants v Tesco Plc [2019] EWHC 2858 (Ch)
2 Sharp & Other Claimants Listed in the GLO Register v Blank & Ors [2019] EWHC 3096 (Ch)<</small>
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