The credit crunch revisited: developments in the international courts

22 June 2015

In the aftermath of the credit crunch, many commentators speculated as to whether any banks or credit agencies could be held responsible for the nosedive in the economy.  Some sought to argue that traders who sold mortgaged-backed securities, a type of collateralised debt obligation, to investors could be held liable in civil law through the tort of deceit or fraudulent misrepresentation, and, in turn, the banks could be held vicariously liable.  

The tort of deceit arises from a false statement of fact made by one person, knowingly or recklessly, with the intent that it shall be acted on by another, and that other does act upon it thereby suffering loss as a result.

Some predicted that the mens rea element of the tort would not be made out, namely that the trader knew the representation was false, had no honest belief in its truth, or was reckless as to whether or not it was true.  The traders might be adamant that they relied on the rating agency’s classification of the security – for example a hard-hitting AAA rating - and made a representation on that basis. 

If so, then it seems that the blame shifts from the trader and the banks, to the rating agencies.  However, the rating agencies wipe their hands of responsibility by stressing that issuers of the securities provide information to them and they carry out no due diligence themselves in respect of that information. According to the ratings agencies, the ratings are not supposed to be relied on.    With all the protaganists shifting the blame elsewhere it was difficult to see where responsibility would lie.


Despite much commentary, little has happened in the courts of England and Wales. This is not the case internationally. 

On 11 May 2015, in the case of Federal Housing Finance Agency v Nomura Holding America Inc, U.S. District Judge Denise Cote in Manhattan found against Nomura Holdings Inc. and Royal Bank of Scotland Group Plc.  She ruled that in the lead up to the financial crisis, Nomura Holdings Inc made false statements in the offering documents of seven private label mortgage-backed securities, four of which were underwritten by RBS, to government-owned mortgage companies, Fannie Mae and Freddie Mac.

Fannie Mae is the Federal National Mortgage Association, a government-sponsored company publically traded since 1968, and Freddie Mac is the Federal Home Loan Mortgage Corporation. Nomura Holdings Inc. sold Fannie Mae and Freddie Mac $2 billion of bonds, backed by defective mortgages.

She ruled in favour of the Federal Housing Finance Agency, who brought the case as protector of Fannie Mae and Freddie Mac.  The Federal Housing Finance Agency could recover around $450 million in losses as a result.  Judge Cote wrote “[t]he origination and securitization of these defective loans not only contributed to the collapse of the housing market, the very macroeconomic factor that defendants say caused the losses, but once that collapse started, improperly underwritten loans were hit hardest and drove the collapse even further.”

In the case of ABN AMRO Bank NV v Bathurst Regional Council [2014], the Federal Court of Australia upheld the first instance finding, where the judge found a credit agency, Standard and Poor’s, to be liable to a group of local councils as a result of money they lost on a rated financial product, Constant Proportion Debt Obligation (‘CPDO’).  One criticism made by Justice Jagot was that, in rating the CPDO, Standard and Poor’s relied on the limited information provided to it from the issuer, ABN AMRO Bank NV.  It failed to conduct reasonable due diligence by, for example, requesting further documentation and material from ABN AMRO Bank NV in order to make its assessment, despite knowing that the ratings were highly material to investors and their opinion would be relied on.  Justice Jaggot also disregarded the disclaimer made by Standard and Poor’s, which qualified the rating as opinion only, principally on the grounds that it was never disclosed to the investors.  

The judgment provides that a rating agency owes a duty of care to investors to exercise reasonable care in formulating a rating and ensuring that there is a reasonable basis for issuing.  If a rating agency breaches the duty and the investor suffers a loss as a result, the rating agency may be liable for the total investment loss.

Too little too late?

In the UK, legal action must be commenced within the relevant period otherwise it is deemed time-barred.  In a claim of this nature, an investor would usually have six years from the date the damage is suffered to commence proceedings.  If the investor suffered loss in 2008, the relevant 6 year period would have elapsed.  Is it therefore too late for any proceedings to be successfully brought in the UK?  Naturally, each case will depend on the precise factual findings. Nevertheless, despite the lapse of time, some options may be open to an investor.

If an investor were to bring a claim in negligence, he or she could argue that the special time limit for negligence applies.  It is relevant where the basic facts of the cause of action are not known at the date of accrual.  In that case, the time limit is three years from the date when the investor first had both the knowledge required for bringing an action for damages in respect of the relevant damage and a right to bring such an action. 

Section 32 of the Limitation Act 1980 also provides an exception to the time limitation in instances of fraud. The limitation period does not begin to run until the claimant has discovered the fraud, concealment or mistake, or could with reasonable diligence have discovered it.  The term "fraud" is defined narrowly, including only causes of action where fraud is an essential element of the claim, G L Baker Ltd v Medway Building and Supplies Ltd [1958].  The tort of deceit falls into the definition of fraud.

The ABN AMRO Bank NV and Nomura Holdings America Inc cases represent welcome victories for the investors, given the role that rating agencies and banks played in relation to numerous defective financial products.  Even though the hurdle of limitation might be overcome, it remains yet to be seen whether the reasoning in these judgments would be followed by the courts in England and Wales and of course each case will turn on its facts.  It could however be time for investors who lost heavily to have another look at their options.

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