Funds Litigation Update

Shareholder action groups and purchasers of distressed debt at a heavy discount are using litigation to realise value.  Conventional views are being challenged and any inconsistencies in the drafting of documents or the Court's approach to contractual interpretation being exploited.  These well informed buyers often acting in conjunction with litigation funders and/or after the event insurers are a strong feature of the financial litigation landscape.  

Asset and fund managers who hold client assets are increasingly targeted as the vehicle through which lawyers can communicate to potential claimants.  Fiduciary duties and a duty of care in negligence can compel that a communication about potential litigation is passed on to shareholders.  Intermediaries would rightly be concerned about investors not opting-in and later asking why they were not informed about their options, especially if the claim goes on to be successful.

Shareholders of Tesco are pursuing a claim against it alleging that recent misleading statements and omissions made to the market impacted on profits and their investment.  Shareholders in Lloyds Banking Group are bringing claims alleging key information about HBOS was withheld in 2009 which diluted their interests after the group was recapitalised.  Shareholders in RBS have also alleged that the prospectus provided to them before the 2008 rights issue was untrue and misleading.  Intermediaries, trustees and administrators will no doubt continue to be asked to pass on details of potential claims to investors and beneficiaries.

These claims are also part of a renewed interest in fiduciary duties in the asset and investment management sector.  In addition to any written contractual obligations set out in an investment management or professional service agreement, a fiduciary's duty to act in the best interests of its client extends to four key areas:  not to place himself in a position of conflict of interests, not to profit from his position at the expense of the client (or misuse property), undivided loyalty and to preserve confidentiality of information.

Breaches can create grounds for removal, non-payment of fees, delivery up of information and damages or an account of profits.  For a hedge fund, an alleged breach may have caused redemptions or lower subscriptions leading to lower management and performance fees.  In calculating loss it is necessary to create a counterfactual scenario based on past performance, historical data or similar funds which estimates the alterations to fund flows and performance caused by the breach of duty.

The recent case of Titan Europe v Colliers International UK plc (September 2014) relating to commercial mortgage-backed securities (CMBS) has established a new recovery option for investors who lost out in property based structured investments during the recession.

In late 2005 Colliers prepared a valuation of a German commercial property which stated it was worth €135m and as a result Credit Suisse lent the owner, a Dutch company called Valbonne Real Estate BV, €110m secured against the portfolio.  Titan was a special purpose vehicle which offered loan notes to investors secured against the pool of mortgages on the properties.  Titan used the money from investors to purchase mortgages from Credit Suisse, take a fee and account to investors for any profit (or loss).

One of the tenants became insolvent and when Valbonne was unable to find a replacement it defaulted on the loan from Credit Suisse causing the value of the loan notes to fall rapidly.  Eight years later the property was sold for €22.5m and the SPV Titan brought a claim against Colliers for negligence.  The claim was defended on the grounds Titan had not suffered any loss – the ultimate investors had and they had no claim either because the valuation was not prepared for their benefit.  However, the claim was successful on the basis that Titan relied on the Colliers valuation in purchasing the mortgages from Credit Suisse and Colliers knew its report would be made available to Titan's investors.  Titan was able to recover damages of €32m, being the difference between the actual valuation of €135m and a non-negligent valuation of €102m, plus interest and legal costs.

Many investments are similarly structured using SPVs and secured loan notes and therefore, this precedent will be wider significance.  This is also the first reported case in England relating to CBMS.

Jonathan Kitchin is a member of the Commercial & Regulatory Disputes team and can be contacted on jonathan.kitchin@michelmores.com or 01392 687635.