High Court considers banks' duty of care

Executive summary

The court held that a bank arranging an Islamic financing transaction owed a duty of care to certificate holders to ensure the proper execution of documents under applicable law.

Whilst the duties of an arranger will vary from transaction to transaction, and from bank to bank, they will include the preparation and execution of the transaction documents. The certificate holders in the transaction relied on the correct execution of the documents and were not able to independently verify that they had been validly executed

The arranger was therefore held liable for having failed to perform that essential task within its narrow role in circumstances where it had assumed responsibility to certificate holders in respect of that task. There was no assumption of any broader duty to investors.

However, the court did not specify in what circumstances and to what extent issuers could seek to exclude liability against responsibility for proper execution of transaction documents. Whether this would be acceptable to investors also remains unclear.

Permission to appeal the decision has been granted.

Facts

Saad Trading, Contracting & Financial Services Company (Saad), a large Saudi conglomerate, sought to raise capital by means of a Sukuk, a financing transaction compliant with Sharia law that operates in a similar way to a conventional Eurobond issuance.

BNP Paribas (BNPP) acted as the arranger, sole bookrunner, and one of three lead managers of the Sukuk. BNPP also agreed to underwrite the Sukuk in part and to place certain certificates with investors.

One of the key documents in the structure was a $650m promissory note. It was governed by the laws of Saudi Arabia and was given by Saad to Golden Belt 1 Sukuk Company B.S.C. (Golden Belt). Golden Belt was a special purpose vehicle, incorporated in Bahrain, which issued certificates to the holders of up to the same value as the promissory note. The SPV was ultimately owned by Mr Maan Al-Sanea, chairman of the Saad group.

As it transpired, the promissory note was not executed or witnessed in accordance with the requirements of Saudi law:

(A) First, the document had to be executed in wet ink but instead it was “signed” with a laser printed signature (a reminder that not all jurisdictions look favourably on electronic signatures), and

(B) Second, the “signature” was not independently witnessed.

None of the legal opinions provided by the law firms acting on the transaction opined on whether the promissory note had been duly executed.

Saad defaulted in the performance of its obligations under the Sukuk and the claimants, the issuer and certain certificate holders, argued that BNPP owed them a duty of care to take reasonable care to ensure that the promissory note was binding on Saad. There were also allegations of fraud made against certain individuals connected to the management of Saad. BNPP relied on a number of arguments against the assertion, including the exculpatory language of the offering circular.

Decision

Existence of a duty of care

Mr Justice Males applied the established legal test for whether a tortious duty of care was owed on the facts of this case. He held that BNPP did owe a duty of care to the certificate holders to ensure that the promissory note was properly executed. The duties of an arranger will include the preparation and execution of the transaction documents. Whilst that duty might be delegated to external lawyers, overseeing and ensuring that the documents were properly executed remains an integral part of the transaction that should be the responsibility of the arranger.

The promissory note had only one purpose within the structure: to provide certificate holders with a simple and relatively straightforward claim in the event of default by Saad. It was therefore a vital part of the structure and it was obvious both that the certificate holder would need to rely on the promissory note if default were to occur, and that proper execution of the promissory note was therefore essential.

The judge noted that although BNPP’s client was Saad, the service of ensuring proper execution of the promissory note was only carried out (in practical terms) for the benefit of the certificate holders. Prospective investors were informed by the offering circular that they would obtain the benefit of a promissory note. In that respect, there was no difference between the immediate purchasers and those who purchased subsequently in the secondary market.

Finally, there was no suggestion in the offering circular that certificate holders were expected to take the risk that the promissory note might turn out to be invalid because care had not been taken to ensure proper execution. Nor was that within the scope of any disclaimer; nor did prospective investors have any means of checking whether the promissory note had been properly executed. BNPP had therefore “assumed a responsibility” for ensuring valid execution.

Breach of the duty of care

The court held that as the promissory note was not validly executed, and the bank had failed to take necessary and practical precautions to ensure that it was validly executed, it had breached its duty of care to the certificate holders.

Comment

The case represents an application of established tort law principles, namely the “assumption of responsibility” test, leading to a narrowly framed duty. Mr Justice Males recognised that courts are (and indeed should be) slow to impose tortious duties on an arranger when carefully drafted and interlocking documentation excludes any such duty and that it should not do so “if that would contradict or unbalance the allocation of risks and responsibilities which the parties have defined” (paragraph 161 of the judgment).

In effect, the Judge found BNPP liable for having failed to perform an essential task within its role in circumstances where it had assumed responsibility to certificate holders in respect of that task. This does not mean that BNPP had assumed any broader duty to investors (under the offering circular or otherwise), and nor does the judgment imply that capital markets arrangers have such a duty generally.

If an arranger wished to protect itself to the maximum extent, it could in theory seek to include a disclaimer against responsibility for proper execution of transaction documents. The effectiveness of such a disclaimer would depend on the facts of a particular case, and no general guidance is provided by Mr Justice Males’ decision on such an approach. Whether this would be acceptable to investors also remains unclear.

The arranger might consider having any legal opinion extend to the question of valid document execution under applicable laws. However, based on this decision, even if responsibility is delegated to external lawyers, overseeing and ensuring that the documents were properly executed remains an integral part of the arranging bank’s role in the transaction.

Permission to appeal the decision has been granted. Pending that appeal there is likely to be a degree of uncertainty amongst practitioners regarding the impact of this decision on similar transactions. It may be misinterpreted by some as implying that the arranging bank owed a broader duty than the Judge in fact held to be the case. Others may try to use the judgment as a pretext for demanding broader exclusion clauses in respect of their duties and liabilities. Ultimately, however, the first instance decision in Golden Belt gave rise to a narrow duty on the arranging bank which does not - of itself - represent a significant shift in the allocation of responsibility between parties.