There is an amount of litigation concerning the collapse of Opes Prime Stockbroking Ltd (Opes Prime), which is mainly concerned with two questions:
- whether the contracts between the investors and Opes Prime transfer absolute ownership of the securities held by the investors to Opes Prime; and
- whether Opes Prime mislead investors into thinking that they actually retained ownership of the securities.
The Federal Court of Australia was recently asked to consider the legal nature of the securities lending contract (contract) entered into between Opes Prime and one of its clients, Beconwood Securities Pty Ltd (Beconwood). The decision only deals with the first question. In coming to its decision, the Court only looked at the bare contract and did not have regard to any representations made or other correspondence between the investors and Opes Prime, which could have a bearing on the meaning of the contract when examined in isolation.
The decision is important because the Court was asked to interpret the legal effects of a securities lending contract, which many other Opes Prime clients had entered into and which was used in the securities market generally.
Background
Beconwood owned about $7 million of shares and it entered into a securities lending contract with Opes Prime because it wanted to set up a so called 'margin lending facility' to purchase further shares. Beconwood transferred its $7 million of shares to Opes and borrowed a further $1.3 million from Opes to purchase those further shares.
A typical margin lending facility lends on shares held by investors with the investors retaining legal ownership of the shares and the lender holding an interest in the mortgage over them. The securities lending contract used by Opes Prime was not a typical margin lending facility. It was instead a share lending agreement, loosely based on an international standard document called an ISLA. The characteristics of the contract were such that:
- the investor transferred shares it held to Opes Prime;
- Opes Prime provided collateral (a loan), to the investor;
- Opes Prime promised to transfer an equivalent number of shares in the same company back to the investor once the investor repaid the loan.
Once Opes Prime received the shares from investors, it on-transferred them to third parties which had made loans to Opes to enable it to make loans to investors.
When Opes Prime collapsed, Beconwood wanted to regain possession of its shares. However, title to the shares had now passed to Opes' financiers. Beconwood, like many other investors, was told that it ranked as an unsecured creditor in the administration and should expect to receive X cents in the dollar after repayment to served creditors. Beconwood began legal proceedings to recover its shares from the financier.
Beconwood's arguments
The securities lending contract stated that "all right, title and interest" in the shares passed from Beconwood to Opes Prime. Notwithstanding this, Beconwood claimed that the contract was, in reality, a legal mortgage pursuant to which it borrowed money from Opes Prime and provided its shares as security. Under a legal mortgage, property in the shares passes to the lender, but the borrower retains an equity of redemption – which is the right to regain title to the shares upon repayment of the loan.
Beconwood argued that, even after transfer to Opes Prime and then to its financier, the shares were subject to the equity of redemption. This would mean that Beconwood would be entitled to have the shares returned to it. This argument, if successful, would have had significant implications for the securities lending industry in Australia and overseas because Opes Prime's contractual clauses were standard in the industry particularly for wholesale investors.
Decision
Justice Finkelstein rejected Beconwood's claim and held that the securities lending contract was an outright transfer of property, rather than a mortgage. Even though the term "securities lending" used in the contract is factually incorrect and suggests that the contract was a mortgage, the Court relied upon a strict reading of the contract which provided that all rights, title and interest in the shares passed absolutely to Opes Prime. Opes Prime was then free to transfer the title in the shares to its own financiers.
Furthermore, the fact that the contract only entitled Beconwood to receive the same "type" and "quantity" of shares back from Opes Prime at the end of the loan (and not the actual shares), was further reason why Beconwood did not retain the title in the shares.
The Court paid particular attention to the fact that the Opes Prime contract was largely similar to contracts used in commercial securities lending transactions around the world and the fact that industry users have always proceeded on the basis that the contract passes the title in the shares.
Beconwood also argued that the contract should be given a different effect because it was used by a retail investor. These contracts have been in place in the securities lending market for years and years but have, until relatively recently, been predominantly used by institutional investors. Beconwood tried to argue that, as a retail investor, it was less sophisticated and the contract should be given a different construction.
His Honour rejected this argument on a number of bases. First His Honour said that "Beconwood borrows for and invests in millions of dollars in share trading. It does not qualify as an unsophisticated investor". His Honour further said that Beconwood "is not a candidate for the special protection courts give to the weak and vulnerable". He did not say what this would be. In any case, Justice Finkelstein concluded as follows: "I do not accept that a share lending agreement (indeed any agreement) can have a meaning that is dependent upon (and changes with) the subjective motivations for which it is entered into".
Implications of decision
The decision highlights the need for investors to understand the legal effect of a contract. This seems quite elementary but, as we have seen with the collapse of Opes Prime (and other companies), many investors simply do not understand the product or facility in which they are investing.
While some investors might still have recourse against Opes Prime for allegedly misleading them and representing that the facility was a mortgage rather than an outright transfer of shares, these are still questions to be determined. The value of that recourse is also questionable given Opes' insolvency. The extra step of pursuing claims against Opes' financiers is even more difficult.
This finding could come home to rest with advisors, financial planners and stock brokers who recommended the Opes Prime facility to investors, many not knowing the true legal effect of the facility and certainly not that the contracts absolutely transferred the actual shares held by investors to Opes Prime.
Beconwood Securities Pty Ltd v Australia and New Zealand Banking Group Limited [2008] FCA 594.
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