In creating the web of contractual relationships when structuring a fund, commercial parties often have a fund managed or advised by a party who is in turn advised by a separate party who has no contractual relationship with the fund. This is often done to achieve tax efficiencies or when a 'white labelling' arrangement is envisaged. The recent English Court of Appeal decision of Riyad Bank & Ors v Ahli United Bank (UK) Plc passed on 13 June 2006 upheld a lower court decision that an adviser could assume legal responsibility for negligent advice which was ultimately relied on by a fund even though the fund structure was such that no contractual relationship exists between the adviser and the fund. This update takes a look at the case and considers its significance to fund structuring and drafting advisory or management agreements.
Facts of the Case
The case involves an appeal relating to whether a legal duty of care is owed by an advisor to an investment fund to exercise proper care in relation to the valuation of leases acquired by the fund. The appellant, Ahli United Bank (UK) Plc ("AUB"), was a Kuwaiti bank that had established a syariah-compliant fund whose assets were invested in operating equipment leases used by large commercial organisations in the United States. The respondent, Riyad Bank ("RB"), was interested in establishing a similar fund.
Following discussions between AUB and RB, the Fund was set up with RB appointed as the Fund's general investment adviser and AUB appointed as RB's technical adviser. The services to be rendered by AUB were defined in a technical services agreement entered between AUB and RB, while the duties of RB were set out in an investment advisory agreement entered between RB and the Fund. Upon recommendation by RB who was in turn advised by AUB, the Fund purchased leases which eventually were found to be overvalued. At the material time, the value of the Fund's assets could not be accurately ascertained which led to the intervention by the board of directors of the Fund to suspend the Fund's redemption of shares. To preserve investors' confidence, RB found it necessary to purchase all the shares in the Fund from the investors at the par value of US$100 per share. The Fund then claimed that AUB owed a duty of care to the Fund and had acted in breach of this duty by wrongfully advising RB of the value of the leases.
Findings of lower court
The English High Court held that AUB owed a duty of care to the Fund not to be negligent in giving advice on the value of the leased assets. The High Court also decided on certain issues of principle in relation to valuation of the leases so as to enable damages to be assessed for this breach of duty.
Grounds of appeal
AUB appealed to the Court of Appeal and sought to argue, among other things, that the contractual structure was inconsistent with the existence of a duty of care; and that the judge had erred in relation to valuation of the leases.
The Court of Appeal upheld the High Court's decision and dismissed the appeal. The rationale behind the decision can be summed up as follows:
Assumption of responsibility unaffected by absence of contractual relationship
There had been an assumption of responsibility by AUB to the Fund. The fact that there was no contractual relationship between AUB and the Fund did not mean that there was no intention to assume responsibility. The decision not to have a contractual relationship was made because RB thought it would be attractive to potential investors if the Fund was seen to be associated with a Saudi investment bank rather than a Kuwaiti investment bank.
Express term in contract was insufficient to disclaim liability
The express provision in the technical services agreement for the Fund's directors to be responsible for investment decisions as advised by RB did not amount to a disclaimer of liability by AUB to the Fund. The express provision neither militated against, nor gave rise to, a duty of care by AUB to the Fund. In short, the express provision was not clear enough to amount to a disclaimer of liability by AUB to the Fund. Considering the origins of, and reasons for, setting up the Fund, the involvement of AUB throughout, the expectations of the parties and the contractual structure adopted, it had been open to the High Court judge to find that AUB did owe a duty of care to the Fund in relation to the valuation of the leases.
Liability followed where contract was structured to pass advice through third party
Where there had been and had been expected to be direct dealings between an adviser (i.e. AUB in our case) and an advisee (i.e. the Fund), a contract that caused the adviser to pass his advice through a third party would not, as a matter of law, protect the adviser from liability to the advisee.
Contractual chain principle unlikely to apply in funds
Every case that finds a tortious duty of care exists often rests on the factual matrix peculiar to the case. What is striking about this case is that the facts were not uncommon at all and the fund structure adopted in this case indeed follows the 'cookie cutter' pattern that fund sponsors and managers have become so familiar with.
The lawyers for AUB had unsuccessfully argued that where the commercial parties had deliberately created a chain of contracts, no duty of care in tort should arise to fill a gap in liability between the adviser and the ultimate recipient of the advice. As one of the judges sitting in the Court of Appeal observed, AUB "was well aware that even if that advice was provided to [RB], [RB] would be likely to pass it on to the board of the Fund without qualification since it did not consider itself competent to form an independent judgment".
This means that in a 'white labelling' arrangement where for regulatory or commercial perception reasons (as in the case) the investment advisor does not contract with the fund directly but with the fund manager, the investment advisor should not assume that it will not have a direct legal liability to the fund. Especially where the experience of the investment advisor in advising on similar kinds of funds is extolled or given emphasis in the marketing document of the fund and the fund manager on the record has no such expertise, it is hard to escape the conclusion that the adviser knows that its advice will be relied on by a non-contracting party. Although as an issue it was not considered in this case, it would be significant to see if the English or Singapore courts will extend the duty of care of the adviser to a fund investor, who is a further step removed from the chain of contracts.
Robustly worded disclaimers may avail the adviser
One of the judges sitting in the Court of Appeal seemed to have left the option open for an advisor to avoid assuming a duty of care in tort with a judiciously crafted disclaimer. A provision in the technical advisory agreement which provided that the directors of the Fund were solely responsible for investment decisions of the Fund as advised by AUB was held not to be clear enough to amount to a disclaimer of liability. Had the agreement contained an express disclaimer of liability by AUB to the Fund or any party other than its contracting party, the verdict reached by the Court of Appeal might perhaps have been different. The celebrated case of Hedley Byrne & Co Ltd v Heller & Partners Ltd (1964) which first held that a duty of care can exist for economic loss caused by negligent misstatements was also one where the advisor was ultimately exonerated of liability because of a disclaimer put in place.
A note of caution should be sounded to one who attempts to rely on disclaimer provisions. The courts have traditionally taken a strict construction of exemption of liability provisions. Singapore's Unfair Contract Terms Act - which is almost identical to the equivalent English statute - also imposes a requirement of reasonableness for an exemption clause to be valid. Since it is incumbent on the party who seeks to enforce an exculpatory clause to prove it satisfies the test of reasonableness, some pre-contracting measures that can be taken include keeping careful records of correspondence where the extent of duty is discussed and proposing a different fee structure if the exemption clause is not acceptable.
The full report of the case is available from the website of the British and Irish Legal Information Institute www.bailii.org
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