In the following guest post, Francis Kean takes a look at the November 15, 2019 U.K. High Court of Justice (Chancery Division) judgment in the long-running HBOS acquisition-related lawsuits brought by a large group of shareholders against Lloyds Banking Group and its directors. As Francis discussed below, the judgment has significant implications for these kinds of actions under U.K. law. Francis is Executive Director FINEX Willis Towers Watson. I would like to thank Francis for allowing me to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is Francis’s article.
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In a recent judgment running to nearly 1000 paragraphs, a High Court judge has denied recourse to a group of almost 300 institutions and 6000 individuals, despite ruling that four of the most senior directors of a bank were in breach of their duty of care. The claimants who were claiming some £385 million from one of the UK’s largest High Street banks following the reverse take-over in 2008 of another very large financial institution have said they are considering an appeal. A copy of the court’s November 15, 2019 judgment can be found here.
Although this is only a first instance judgment, the case is noteworthy for a number of important reasons including the following:
- It’s one of the very few judgments on the nature of the duties (if any) owed by a publicly listed company and its directors to shareholders in connection with formal circulars and announcements made under UK Stock Exchange Listing Rules created under part VI of the Financial Services and Markets Act 2000
- Although seemingly resembling a US securities class action (at least in terms of its overall aims) the case in fact highlights the dangers, differences and difficulties for claimants in bringing this type of claim in the UK.
- The judgment contains some important analysis of the English law approach to causation i.e. the principles under which (even assuming a duty of care is made out and found to have been breached) the court determines what else a plaintiff must do to establish a link with any damages allegedly suffered.
Background and nature of the claim
The facts to which the case gave rise took place in the middle of the 2008 credit crunch sparked by the collapse of Lehman Brothers. It concerned a unanimous recommendation by the board of the bank to its shareholders that they approve the acquisition of HBOS. The recommendation was accompanied by a Chairman’s letter which noted:
“Whilst HBOS has been significantly affected by recent challenging marketing conditions, including the deteriorating economic environment which has negatively impacted its funding model, the Lloyds TSB Directors believe that HBOS remains an excellent franchise with the potential to contribute substantial value to the Enlarged Group.”
The acquisition was duly approved. The claim subsequently brought by a group of shareholders alleged in essence, as the judge summarised it, that :
“(a) The Lloyds directors should not have recommended the Acquisition because it represented a dangerous and value destroying strategy which involved unacceptably risky decisions (“the recommendation case”):
(b) the Lloyds directors should have provided further information about Lloyds and about HBOS, in particular about a funding crisis faced by HBOS and the related vulnerability of HBOS’s assets (“the disclosure case”).”
The claimants alleged that the directors were negligent, had breached their fiduciary duties and had actively misled the investors although they stopped short of making allegations of bad faith. They claimed that but for such negligence and breach of duty the acquisition would not have gone ahead.
The Judge’s Findings
The defendant bank and its directors conceded that they owed the claimants a common law duty to exercise reasonable care and skill with respect to any written statements or representations contained in the Circular. The judge embarked on a full review of the nature of that duty by reference to case law. He summarised the position thus:
“…where the opinions of reasonably informed and competent directors might differ over, for example, some entrepreneurial decision, the mere fact that a director makes what proves to be clearly the wrong choice does not make him liable for the consequences. When embarking upon a transaction a director does not guarantee or warrant the success of the venture. Risk is an inherent part of any venture (whether it is called “entrepreneurial” or not). A director is called upon (in the light of the material and the time available) to assess and make a judgment upon that risk in determining the future course of the company. Where a director honestly holds the belief that a particular course is in the best interests of the company then a complainant must show that the director’s belief is one which no reasonable director in the same circumstances could have entertained.”
This reaffirmation of the English common law approach to directors’ duties will be of comfort to UK based directors. It stands in stark contrast to the approach often adopted by regulators to the same question which tends to proceed from the presumption, in the event of a major problem or corporate loss, that director default must have occurred.
Having reviewed a mountain of evidence, the judge went on to conclude that the directors had in fact breached in two respects what he termed the “sufficient information duty.” He quoted the statement in the Circular to shareholders that:
“To the best of the knowledge and belief of the [Lloyds] directors (who have taken all reasonable care to ensure that such is the case) the information contained in this document is in accordance with the facts and does not omit anything likely to affect the import of such information.”
Based on his review of the evidence, the judge concluded that the directors had not in fact taken all reasonable care to ensure that two discrete issues were adequately disclosed and dealt with in the Circular. (For balance it should be added that the claimants failed to make out a case of breach of duty in respect of a range of other allegations of negligence.)
Causation
This is where the claimants’ case fell apart. Their argument was that if the disclosures had been made, the board would have terminated the transaction, or it would otherwise have collapsed and/or the shareholders would have rejected it. After a detailed review, the judge concluded that there was simply not enough evidence on which to base such a conclusion. He pointed out for example that that there was no evidence before him as to how the major institutional shareholders would have acted differently had there been additional disclosures. The few claimants who gave evidence on this issue at trial accounted for just 0.37 % of the issued shares.
The Judge carefully examined the claimants case which hinged on the fact that one of the undisclosed matters which he had ruled should have been disclosed concerned an emergency lending facility which had been afforded to HBOS by The Bank of England. Their seemingly persuasive argument was that in every case in which such a facility had been rumoured or disclosed in the past, a run on the relevant bank had occurred. The judge rejected this inference based on (among other things) expert evidence as to the different nature of the circumstances that existed at the relevant time including the fact that liquidity issues concerning HBOS were already known to exist and that the disclosure, if made, would have been “controlled and not leaked” and “contextualised”.
He concluded:
“I am not persuaded that the two failures to provide sufficient information were in fact causative of any loss. The information ought to have been disclosed in the manner I have indicated in order to present a fair, candid and rounded view of the question before the Lloyds shareholders. But if the shareholders had been presented with that information they would not have reached a conclusion other than that which they did in fact reach. Despite the imperfections in the Circular the majority who approved the Acquisition did not do so under some misapprehension of the position. They knew the course recommended unanimously by the board. They knew the risks identified by the board. They knew that the board assessed the chance of advantage as outweighing the risk inherent in the transaction….”
Conclusion
This is not the first time a case has foundered on the rocks of the principles of causation as applied by English courts. Other systems of law tend to adopt a broader brush approach to this question. Under such an approach, if a relevant breach of duty is made out, courts will generally allow recovery of damages based on a “but for..” type approach to causation i.e. but for the defendants’ negligence the claimants would not have suffered a loss. English law requires the claimants to establish (a) a direct link between the breach and the loss and (b) that it was reasonably foreseeable at the relevant time that loss of that type would occur.
Although of cold comfort to the claimants in this case, they did at least succeed in scaling a difficult mountain in establishing that the directors of this publicly listed company were in breach of their duties owed to the shareholders as a whole in omitting relevant information from formal documents produced under The Listing Rules. It was accepted that directors must “give a fair, candid and reasonable explanation” of the purpose of any shareholders’ resolution.
Arguably though, the two biggest hurdles faced by the claimants in this case which they were never going to overcome under English law and procedure were:
- The absence of a statutory “continuous disclosure” obligation of the kind which exists in Australia. This would have created much more difficult problems for the bank and its directors at the time in terms of their statutory disclosure obligations.
- The absence of an ability to launch a class action on an opt out basis based on a “fraud on the market” theory of the kind which exists in the US. Remember that in this case although some 9000 shareholders were involved in the claim, for the resolution under which the acquisition of HBOS was approved, a total of 1.4 billion votes were cast! How were these claimants going to persuade the judge how those votes would have been cast had the information been disclosed?
Finally, a note about the infamous “Loser Pays” rule under English law. The defendants’ costs in this case have been estimated in excess of £25 million. The claimants will have taken out “After The Event Insurance” (LINK) to meet these costs and of course, the judgment is still subject to appeal but the fact that they may well need to make a substantial payment to the defendants will be concentrating their minds and those of their litigation funding backers.