United States: Sixth Circuit Court of Appeals Interprets the Duties Imposed on Banks That Market Derivative Products and Rejects a Duty of Appropriateness

On May 17, 2006, the United States Court of Appeals for the Sixth Circuit issued its Opinion in Power & Tel. Supply Co. v. SunTrust Banks, Inc., 2006 U.S. App. LEXIS 12087, 2006 FED App. 166P (6th Cir. Tenn. 2006) addressing the duties owed by banks to their customers in derivative transactions. The Sixth Circuit affirmed the District Court’s summary judgment order dismissing all claims against SunTrust Bank in a case arising from two interest rate swap agreements entered into with its customer, Power & Telephone Supply Company, Inc. The District Court also granted summary judgment in favor of the Bank on its counterclaim, ruling that Power & Telephone Supply Company must indemnify the Bank for all attorneys’ fees and costs incurred in defending the action.

The Opinion is of interest to marketers of derivative products because the Sixth Circuit determined that there is no legal authority to support a claim that a seller of derivatives owes a duty of "appropriateness" to the end user. Plaintiff argued this duty is derived from OCC Banking Circular 277, which provides guidance to national banks regarding the internal controls necessary to monitor credit risks associated with derivative products. The Sixth Circuit held "this appropriateness assessment is not for the protection of customers but is rather to ensure that banks are conducting this business in a safe and sound manner."

Power and Telephone entered into interest rate swap agreements in 1999 and 2000 with SunTrust, fixing a portion of its variable rate indebtedness. The swaps were favorable to Power and Telephone until interest rates experienced a dramatic drop between 2000 and 2002. Power and Telephone’s borrowing needs also decreased, and the company unwound the swaps in 2003.

Power and Telephone then filed a complaint against SunTrust, seeking over $6 million in damages, asserting claims based on the theories of breach of fiduciary duty, breach of contract, agency, misrepresentation, negligence, violations of the Tennessee Consumer Protection Act, common law suitability, and tying under the Bank Company Holding Act. The District Court first granted a motion to dismiss certain claims, then granted SunTrust’s motion for summary judgment on the claims for breach of fiduciary duty, agency, and negligence, and granted summary judgment in favor of SunTrust on its indemnification counterclaim. The Sixth Circuit affirmed the District Court’s judgment in all respects, including the award of over $800,000 to SunTrust for its counterclaim for indemnification.

S. Lawrence Polk, a Partner in the Atlanta office of Sutherland Asbill & Brennan LLP who represented SunTrust, noted that there are no previous reported appellate decisions interpreting whether a duty of "appropriateness" applies for the protection of derivatives end users, similar to the duty applicable to certain purchasers of securities. The decision by the Sixth Circuit provides guidance with respect to the obligations imposed on marketers of derivative products, according to Mr. Polk. In addition to Mr. Polk, SunTrust was represented by Sutherland Associates Elena Parent and Bryan Ward.

Click here to view a copy of the Sixth Circuit Opinion.

If you are interested in more information about these developments, please contact one of the following attorneys in Sutherland’s broker-dealer litigation group:
Thomas A. Farnen, Judith A. O’Brien, S. Lawrence Polk, Avital Stadler and Terry R. Weiss.

© 2006 Sutherland Asbill & Brennan LLP. All Rights Reserved. This article is for informational purposes and is not intended to constitute legal advice.