This article was first published in the Butterworths Journal of International Banking and Financial Law.
Today’s banks are in receipt of the largest fines ever imposed by the Financial Conduct Authority (FCA), or its predecessor the Financial Services Authority (FSA), and although they are taking responsibility for a number of failings (eg PPI, Derivatives, LIBOR and FOREX), restrictions on recovering loss, in particular where consequential loss is concerned, have come under significant scrutiny. This article examines the measure of loss in tort and contract, and particularly explores investors’ difficulties when making claims for loss of profit caused by mis selling.
- Compensatory damages are limited as a matter of policy, as recovery of all financial loss would be far too onerous.
- As legal principles apply to claims commenced both in and outside court, expectations as to recoverable losses for mis-selling need to be reconciled with the law governing recoverability.
- Claims for loss of profit remain fact-sensitive, and commonly face significant hurdles in causation and remoteness.
- Investors often mistakenly claim virtually all financial losses as consequential loss, notwithstanding authority limiting such loss to Limb II of Hadley v Baxendale.
- Greater understanding on how to formulate claims correctly, particularly for consequential loss, is essential to ensure reasonable levels of compensation and satisfaction for claimants and defendants alike.
Mis-Sold Financial Products
Many view mis-selling as a particularly apt scenario in which a bank should pay full compensation; particularly if, absent the mis-selling in question, the investor would not have purchased a financial product at all.
However, few investors are able, or indeed entitled, to recover all their perceived losses. The first problem with the idea of being entitled to “full compensation” is that English law does not apply an indemnity principle to the assessment of damages. The second is the question of how best to apply the term “consequential losses” in the context of mis-selling, to enable investors to better understand, identify, quantify and present all their losses in practice.
This is all in stark contrast to the straightforward calculation of net payments made by the investor for a mis-sold product (the most obvious direct loss); and frequently creates a gulf between expectations and outcome in relation to recovering other losses.
To make sense of why investors are unlikely to recover full compensation and the limits on recoverability of consequential losses it is necessary to consider the available causes of action before the courts and the approach to assessment of damages in English law.
Mis-selling claims based on inappropriate advice are commonly brought in:
- tort; and/or
- contract; with claims for
- breach of statutory duty and misrepresentation also regularly made (ie breaches of the FSA’s Conduct of Business Rules or the FCA’s replacement Conduct of Business Sourcebook Rules, and statutory misrepresentation under the Misrepresentation Act 1967).
The starting point for considering compensation in tort is the intention to restore the investor to the position he would have occupied absent the tort (as per Livingstone v Rawyards Coal). In contract, it is slightly different; the intention being to place the investor in the position he would have been in if the contract had been performed (as per Robinson v Harman).
English law supplements these starting points with several exclusionary rules. The policy reasons are clear and, as far back as Victoria Laundry v Newman Industries, Asquith LJ said (of the starting point in contract):
“This purpose, if relentlessly pursued, would provide [the claimant] with a complete indemnity for all loss de facto resulting from a particular breach, however improbable, however unpredictable. This, in contract at least, is recognised as too harsh a rule. Hence, in cases of breach of contract the aggrieved party is only entitled to recover such part of the loss actually resulting as was at the time of the contract reasonably foreseeable as liable to result from the breach. What was at that time reasonably so foreseeable depends on the knowledge then possessed by the parties or, at all events, by the party who later commits the breach.”
It is axiomatic that, in tort, investors need to establish that they were owed a duty which was breached; that the breach caused the consequential loss complained of; and that the type of losses claimed are not too remote (ie each type of loss was one a reasonable person might anticipate). If the losses are not too remote, the likelihood/certainty of each loss, and its value, must still be established if the investor is to recover.
Tortious losses are not too remote if they fall within an objectively predictable range, regardless of whether they were sustained in an unforeseeable way. In contract, the test of remoteness is more restrictive, inasmuch as, where the type of loss was reasonably foreseeable by the defendant at the time of the contract, as being “not unlikely” to result from his breach, then that loss is not too remote (as per The Heron II) – unless parties in their particular sector would not reasonably be considered to have intended to assume such liability (as per The Achilleas).
The conventional approach to the question of remoteness (in contract) dates back to the judgment of Alderson B in Hadley v Baxendale, in which losses were split into two limbs:
Limb I: direct losses, where the type of loss was reasonably foreseeable as not unlikely to result from the breach concerned, in the ordinary course of things; and
Limb II: indirect loss, where the type of loss arises from the special circumstances of the case that could reasonably be supposed to have been in the parties’ contemplation when the contract was made.
The case of Victoria Laundry considers the distinction between the two limbs. The defendant was an engineering company supplying a boiler to a laundry. As the date for delivery of the boiler was exceeded by some five months, the laundry lost lucrative contracts. The court concluded the engineering company knew, or ought to have known, the nature of the laundry’s business with the effect that Limb I/direct losses could reasonably be expected over the period of the delay, including loss of profit equivalent to the value of general laundry and dyeing contracts. However, as the engineering company had not known of the laundry’s opportunity to enter into even more lucrative dyeing contracts, for the Ministry of Supply, the significant loss of profit from those potential contracts was deemed too remote.
The principles in relation to remoteness in tort are more generous; and investors may have longer to bring claims in tort than in contract (by virtue of a later date of knowledge under s 14 of the Limitation Act 1980). They may also avoid potential pitfalls presented by contractual exclusion clauses and defences such as contractual estoppel.
Fortunately for investors, contractual principles are not always strictly applied. Where interest rate hedging products were sold to un-sophisticated customers from December 2001, for example, the banks agreed (with the FCA) to review all sales and, where appropriate, to pay customers fair and reasonable redress; and to the credit of the FCA and the banks, the nuances between causes of action have largely been glossed over by the approach taken in the review (which limits the applicable legal principles to those governing claims in tort and for breach of statutory duty).
What Would Have Happened?
Where mis-selling is admitted, it has been suggested (by analogy with a case concerning negligent advice given by a firm of solicitors – Levicom International v Linklaters) that the evidential burden may in fact shift to the bank to show that the mis-selling was not the cause of the losses claimed, although that is far from a settled or accepted view. Hence, the burden of proof still rests on a claimant to prove causation, both in and out of court.
In cases of mis-selling, most investors assert that absent the breach they would not have taken a financial product at all.
Unsurprisingly, such investors often blame the banks for all perceived consequential loss, whereby their own analysis suggests:
“If the bank hadn’t sold me X financial product, I would have used the money for Y, and received a greater profit of Z.”
As for the heads of loss claimed (namely Z in the above analysis), the often contentious types of consequential loss claimed tend to be:
- loss of profit (usually advanced when a specific contract or project was lost or typical contracts or projects could not be pursued) – here, damages can usually be calculated by reference to past profits achieved on such contracts/ projects;
- loss of a chance (usually advanced where profit-making rested solely on the decision or act of a third party; however the investor lost the chance to tender or compete at all) – here, damage is assessed in percentage terms, by reference to the chances of success.
It is common for the amount said to make up the opportunity cost incurred as a result of making payments under the product (namely the alternative profitmaking opportunity lost), to be the most valuable head of consequential loss. It is also common for investors to rely upon complex hypothetical scenarios setting out what would have happened and it is well established, that hypothetical scenarios may lead to recovery of loss of profit (such as in East v Maurer).
For example, where an investor is known to the bank to purchase residential properties for rental purposes, and the investor claims money he paid under a mis-sold financial product would have instead been used to grow his profitmaking property portfolio; if the investor can identify property available to him at the relevant time, he is likely to recover any capital appreciation and the value of net rental income as loss of profit (in contract or tort). Whereas an investor who can only say he would have looked for investment properties if he had retained his money instead of purchasing the mis-sold product, has the additional causation hurdles, of showing he would indeed have sought and found and been able to purchase, such property.
In Parabola Investments v Browallia Toulson LJ stated:
“Some claims for consequential loss are capable of being established with precision (for example, expenses incurred prior to the date of trial). Other forms of consequential loss are not capable of similarly precise calculation because they involve the attempted measurement of things which would or might have happened (or might not have happened) but for the defendant’s wrongful conduct, as distinct from things which have happened. In such a situation the law does not require a claimant to perform the impossible, nor does it apply the balance of probability test to the measurement of the loss.”
This suggests that if the second investor can show (on the balance of probabilities) that he could and would have bought property, the fact that a precise purchase is not identified would not be fatal. Furthermore, the court would not apply the balance of probability test when measuring loss, as noted in Parabola.
Having said that, one might also accept that in volatile markets (capable of rapid and extreme price movements), recovery for adverse market movement is likely to be too speculative a claim; however there has been some softening of judicial opinion in that regard. Tomlinson LJ cast doubt on his previous decision in Pindell v Air Asia that losses caused by extremely volatile market conditions were, by their very nature, irrecoverable. In the case of John Grimes Partnership v Gubbins, he noted he had been incautious when previously suggesting the same, and permitted a land developer (Grimes) to recover losses incurred due to a 14% fall in the property market.
Given the importance of knowledge of special circumstances when considering whether a loss is too remote, one potential advantage an investor may have, is the level of access a bank usually has to details of the investor’s financial circumstances and plans at the time financial products are purchased. Records created during due diligence checks are likely to be retained by banks for regulatory purposes, and may well assist investors seeking to demonstrate that the bank had knowledge of the purpose for which the investor sought to enter into the financial contract, and/or had knowledge of the use to which the investor intended to put any additional funds or profit.
Interpretation of "Consequental Loss"
There remain a significant number of expressions in everyday commercial use that have no accurate corresponding legal definition; “consequential loss” being one of them.
Whilst the prevailing commercial approach largely treats consequential loss as a synonym for indirect loss; direct losses can still be extensive, and direct loss often includes loss of profit in many commercial contracts.
Needless to say, many contracting parties seek to restrict liability by way of (unfortunately) ambiguous exclusion clauses that preclude liability for “any indirect or consequential loss howsoever caused”. Such wording assumes consequential loss includes all loss of profit; and has a perceived attraction that, being non-specific, it might expand the types of loss capable of exclusion. Of course, this overlooks the fact that, as far back as Victoria Laundry, a portion of lost profit was already considered direct loss.
In Croudace Construction v Cawoods, the Court of Appeal confirmed that consequential loss should be confined to loss or damage within Limb II of Hadley v Baxendale. This resulted in a line of authorities in which a similar narrow interpretation of consequential loss has prevailed (including British Sugar v NEI Power Projects; Deepak Fertilisers v ICI; Hotel Services v Hilton; and McCain Foods v Eco-Tec). The effect has been to restrict the application of exclusion clauses that purported to speak to “consequential loss”.
Where cases involved the sale of profitgenerating assets or projects (as in Deepak Fertilisers v ICI and Hotel Services v Hilton), the courts demonstrated willingness to construe loss of profit as a direct loss within Limb I of Hadley v Baxendale. Hence, such loss would be recoverable notwithstanding an exclusion clause precluding recovery of consequential loss. As a result, where the purpose of a contract is to provide a product intended to generate profit, the court is likely to construe the lost profit the product would have made, as a direct loss.
Admittedly, contracts for financial products, such as swaps, caps and collars used by investors to limit exposure to interest rate fluctuations, may rarely provide a factual basis for construing loss of profit as a direct loss, nevertheless it is important to realise that a particular set of facts may still involve an overlap, where some losses considered indirect/consequential, are (in law) recoverable as direct losses.
Over time, the restrictive construction of “consequential loss” has been subject to increased scrutiny. The leading text, McGregor on Damages, suggests a split between normal and consequential losses; describing normal losses as the type every claimant in a like situation will suffer, and consequential losses as those born of the claimant’s particular circumstances.
However, as both types of loss are only recoverable if the loss is not too remote, it is questionable whether there is any particular bite to the distinction being made.
Notably, McGregor goes on to state that limiting consequential loss in contract to Limb II of Hadley v Baxendale is illogical, and that the line of Court of Appeal authorities in that regard, require attention from the Supreme Court. In contrast, in Caledonia North Sea v BT, Lord Hoffmann only queried whether the reasoning in cases such as Hotel Services v Hilton was correct.
The classification of loss of profit is therefore extremely fact-sensitive; and the attractive simplicity of assuming consequential loss covers all losses beyond net payments made under a missold financial product, and of treating “consequential loss” as a simple substitute for “indirect loss”, is deceptive, and its reasoning is unsound.
The problem with “consequential loss” is that investors are naturally prone to use the phrase in a commercial sense, and hence aggregate all financial losses (except net payments) as consequential loss. As discussed above, some of those losses may in fact be direct/Limb I, and hence pursuing a claim with losses wrongly classified as consequential, may inadvertently increase the evidential burden (ie the need to prove special circumstances/assumption of responsibility). While it is hoped such mistakes in terminology would not ultimately result in a less favourable outcome for an investor, it remains a very real risk.
For many investors, the questions are simple:
- Will legal liability follow for the type of loss suffered; and if it does
- which causes of action give rise to such liability (ie are those causes of action open to the investor); and
- will there be liability for all or just part of the losses actually suffered.
Thus far, claims against banks for misselling pursued through the courts, have not enjoyed much success, and often face limitation difficulties (at least in relation to claims in contract).
In Titan Steel Wheels v RBS, the words “in the course of carrying on business of any kind” in the Financial Services and Markets Act 2000 were construed by Steel J as excluding Titan Steel from the category of “private persons” within s 150 (now s 138D) of the Act, which established a cause of action for breach of the Conduct of Business SourcebookRules. As such, the case removed breach of statutory duty as a cause of action available to most claimant businesses. Notably, Flaux J followed this construction of the Act in Camerata Property v Credit Suisse.
The practical effect is that businesses unable to claim such breaches of statutory duty will in many cases (where limitation issues bar a claim in contract) be limited to a tortious cause of action and/or a claim under the Misrepresentation Act 1967.
Mr Bailey’s claim against Barclays (Bailey v Barclays) is another case highlighting many of the potential pitfalls for a business claiming mis-selling. Mr Bailey entered into a swap in
May 2007, and by March 2009 interest rates had fallen so dramatically, he described the swap contract as disastrous. Rather than pay break costs to terminate the swap early, the swap was novated to Mr Bailey’s company MTR, in April 2011.
On the bank’s application to strike out the particulars of claim and/or for summary judgment, and MTR’s cross-application to amend the particulars of claim, the judge held the company’s claims failed entirely. The facts that led HHJ Keyser QC to this conclusion were unusual. MTR had acquired the swap via a novation (later argued as an assignment or partial novation). The novation destroyed any right in equity Mr Bailey may have previously had to rescind the original contract. As Mr Bailey accepted an offer of redress within the FCA agreed review (which – according to the judge – offered him “substantially all of the relief that he sought to achieve in [the] proceedings”) his equitable claim for rescission fell away. The removal of Mr Bailey as a claimant also left MTR (as a company) unable to claim for breach of statutory duty, as a result of Titan Steel.
Customers – Naturally Always Asking For More
Claiming substantial consequential losses is far from a simple task without highly competent legal advice. Where claims are not taken through the courts, such advice is unlikely to be available to investors, and so the question remains as to how best to assist investors to understand and/ or claim losses they have suffered, especially within the regulatory sphere.
While the benefit of fact-specific advice cannot be underestimated, claims management companies who have proliferated to fill the void of representation have not necessarily assisted investors to understand, calculate and recover their losses as quickly and accurately as may have been hoped.
Thankfully, judges are alive to the competing interests and forums in misselling, and many claims (perhaps issued as a protective measure) have been stayed to enable eligible investors to first participate in the FCA-agreed review. There has also been sensible use of standstill agreements to preserve the option of litigation more efficiently.
However, banks can only sensibly respond to claims on the basis they are formulated, and should not be expected to reformulate an ambiguous claim against their own interests. Accordingly, investors seeking legal advice on claims not pursued through the courts is far from extraordinary, and in many cases perfectly sensible.
For investors struggling to align their clams with their perceived consequential losses, the process inevitably remains a difficult one. Regrettably, in the absence of proper advice, they may continue to present as the proverbial Oliver Twist, empty bowl in hand, and a slightly sour aftertaste, regardless of the compensation received.
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