ATTACK OF THE CREDIT CRUNCH CLAIMANTS Written by Tim…

               ATTACK OF THE CREDIT CRUNCH CLAIMANTS

Written by Tim Strong and Ivan Wilkinson


As the credit crunch continues, financial institutions are likely to face increasing
litigation risks. More than 175 subprime-related law suits have already been lodged in
the US. Given that so many of the world's banks have capital markets operations in
London, what are the risks of similar claims in the UK, and what defences are
available?

So far, many of the subprime-related claims lodged in the US are class actions, often
brought by shareholders against corporations which have suffered capital market
losses and/or their directors and officers. However, the UK is less likely to see claims
of this type because its regimes for both class actions and shareholder actions are
more restrictive than in the US. The UK is also generally a less claimant-friendly
jurisdiction. Civil trials are not decided by juries, punitive damages are not available
and the losing litigant has to pay the winner's costs.

However, there is a much greater risk of UK litigation by market counterparties. To
date, most credit crunch-related disputes in the UK have resulted from banks pulling
out of acquisition funding deals before completion. Buyers have then tried to enforce
the terms of the banks' commitment letters. Banks have tended to rely on two main
lines of defence: first, that commitment letters are only `agreements to agree' and not
binding; second, that borrowers cannot anyway obtain `specific performance' of a
finance deal, but instead must find replacement finance elsewhere (and then seek
damages for any difference in cost). Although the legal merits of these arguments
can be unclear, such claims have tended to be settled by a renegotiation of the
financing terms in the banks' favour.

Mis-selling claims

The credit crunch has also started to lead to mis-selling claims by investors against
fund managers and against the arrangers or issuers of collateralised debt obligations
(CDOs) and other structured products. Even if, as is often the case, the products are
listed or the underlying structures are managed outside the UK, investor claims are
likely to be brought in the UK if the business was written by a branch here.

Fund management claims will typically relate to alleged breaches of investment
mandate or negligence in portfolio selection. Claims against arrangers and issuers
are more complex and are likely to focus on inadequate disclosure or explanation of
how the products' structure allocates risk. Claims based on positive
misrepresentations may be hard to prove if the offering documents include the usual
risk disclaimers. However, where an offering document qualifies as a `prospectus',
investors will be able to rely on omissions from the document, as well as any positive
misrepresentations.


                                                                                      1
This may well give rise to conflict between arrangers/issuers and investors about how
the offering documents should reasonably be understood. If investors are successful
on that front, they will still have to show that any loss suffered resulted from mis-
selling and not just from a fall in the market.

Banks will often perform multiple roles in such structures: for example, acting not only
as arranger or issuer but also as counterparty for associated repo agreements and
hedging transactions. Investors may claim that the bank owed duties of care to
investors in one capacity, breached by serving its own interests in another capacity.
Again defensive wording in documents is likely to assist banks. However, in extreme
situations there may be a risk, for example, that a court would find a breach of some
unwritten, overriding duty to act in good faith. Banks should be particularly aware of
the risks of taking on additional roles in a structure as other parties drop out.

Only a few disputes in this area have turned into formal claims. However, if
underlying asset values deteriorate further, it is possible that many more claims will
be brought in the UK by investors in CDOs and other structured products. This will be
particularly likely if losses are crystallised early by the activation of default triggers - a
risk which banks will have to assess carefully in considering any events of default
which they might otherwise wish to call.



Tim Strong is a partner and Ivan Wilkinson an associate director in the Financial
Services Litigation team at Barlow Lyde & Gilbert LLP.

This article was first published in The Banker (www.thebanker.com) in March 2008.




                                                                                            2