A Look Forward To UK Banking Litigation In The 2020s

By Christa Band and Jane Larner
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Law360 (May 19, 2020, 3:27 PM EDT) --
Christa Band
Christa Band
Jane Larner
Jane Larner
The start of a new decade is an opportunity to consider some of the key themes underlying litigation risk for financial institutions. Despite different legal systems under which financial institutions operate around the world, these themes show a remarkable degree of consistency. In this article, we focus on the challenges presented by the COVID-19 pandemic and the ongoing threat of financial crime.

Novel Coronavirus

The pandemic is first and foremost a human and social crisis. However, the measures which have been introduced to limit its impact on nations' health have had a profound impact on business. The sudden, unplanned and enforced cessation of normal trade for businesses which were otherwise sound has put unique pressures on commercial relationships.

Any changed trading conditions put contracts under stress. They can reveal flaws in agreed contractual terms; the risk allocation no longer suits one party, and gaps can be revealed for which the contract does not provide an answer. Parties are considering ways to renegotiate their obligations and buy themselves time or seek grounds on which to extricate themselves altogether.

Experience shows that market dislocation always leads to claims and, in that regard, the COVID-19 pandemic is a clear cause of dislocation. What we are seeing here, though, are some novel issues or principles of law which are covered in the text books but rarely litigated in practice.

There are two contractual techniques being much discussed at present: force majeure and "material adverse change," or MAC, clauses, and frustration.

Force majeure and MAC clauses both depend on the parties having provided for the unexpected in their contractual terms and there will be questions of interpretation and effect. MACs are particularly relevant to financial institutions.

The object of a MAC is to protect the counterparty, e.g. the lender, in case of an unforeseen event which has a significant negative impact on the borrower's business and/or its ability to repay a loan. MAC clauses can stipulate for an objective test — an event or circumstance which has a material adverse effect. Other clauses are negotiated to give scope for the lender to have an opinion as to the changed conditions.

MACs will also generally apply to the validity, legality and enforceability of any security given. However, the enforceability of each MAC or force majeure clause will turn on the contractual wording in the context of the overall bargain. Even when reported court decisions start to come through, whether COVID-19 falls within one party's force majeure or MAC clause won't necessarily answer the question for other contracts.

Frustration is about the allocation of risks in the case of unforeseen events. As a principle of English law, it is notoriously difficult to apply and rarely relied on on its own. Where facts permit — and often they don't — frustration allows parties to terminate a contract on the basis that performance has become impossible or radically different from what was envisaged. Note that the fact that performance has become more difficult or more expensive does not generally mean that it is impossible.

A practical challenge facing contractual counterparties is whether, when and on what basis to exercise discretion given by a contract or, more seriously, to terminate it. With a real focus on renegotiation, parties are taking steps to avoid a "use it or lose it" argument in relation to their contractual rights.

Calling a default based on a MAC or arguing a contract is frustrated is a big call and there are potentially significant legal and reputational consequences for getting it wrong. But lenders are having to reassess the risks of the facilities they have provided and difficult decisions may have to be made.

Every country has its own legislative response to COVID-19, leading to some interesting questions as to the impact on English-law-governed contracts of, for example, foreign moratorium laws. Finally there is the regulatory, political and reputational dimension. There is a clear focus on ensuring that there is support for the real economy and that parties are acting responsibly in relation to forbearance and the enforcement of loans.

Financial Crime

There has been a concentrated focus on financial crime by enforcement bodies for some years with tackling money laundering being top of many agendas.

It is hard to criticize this as an objective given the ever-new ways in which the threats of financial crime affect individuals, businesses and states. However, measures taken by banks to mitigate the danger of being used to launder criminal property risk exposing them to claims from customers that their banking relationships have been unfairly terminated due to money laundering or sanctions concerns.

Although courts in many jurisdictions are ultimately upholding banks' rights to terminate customer relationships where they suspect criminality, banks can expect to face similar claims in the coming years. Moreover, creative claimants backed increasingly by third-party litigation finance are finding new and imaginative grounds for their claims, such as breaches of data protection laws, defamation and other less obvious grounds.

It has already been reported that instances of "push payment" fraud, finance-related phishing scams and other cybercrime activity have increased considerably since the COVID-19 outbreak began. Europol has highlighted how these are being used by criminal organizations to exploit anxiety and fears raised by the COVID-19 pandemic. Given the current climate, the failure of banks to deliver sufficient operational resilience to protect their customers could provide more fertile ground for group litigation from affected individuals.

The increase in the number of sanctioned parties, combined with diverging policy objectives for the U.S. and the European Union has led to significant litigation risks for banks and other financial institutions.

In particular, the application of the so-called "EU blocking regulation" may prohibit EU persons from complying with U.S. sanctions on Iran, putting banks and financial institutions with operations in both the territories in a tricky position.

As well as criminal and regulatory enforcement risks on both sides of the Atlantic, a company caught in the middle faces the risk of private litigation in the EU. Under the blocking regulation, if a person or entity based in the EU suffers loss because of a firm's compliance with the U.S. sanctions on Iran (or any other U.S. sanctions listed in the blocking regulation), then that person can claim damages.

For example, a bank based in the EU that withdraws banking facilities from a sanctioned Iranian entity could face a claim if that entity suffers loss as a result. There have been a handful of claims and interim applications already heard in various jurisdictions across the EU, including Italy and Germany, which have led to a range of different decisions on the application of the blocking regulation in practice.

Whether or not the EU and U.S. sanctions regimes become more aligned, banks will continue to face shifting risks from the use of sanctions, in terms of both regulatory enforcement and private litigation.

Christa Band is a partner and Jane Larner is counsel professional support lawyer at Linklaters LLP.

The opinions expressed herein are those of the author and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

For a reprint of this article, please contact reprints@law360.com.

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