PRACTITIONER PERSPECTIVES

March 2010
Managing
litigation and dispute risk in the financial services markets

Managing litigation and dispute risk in the financial

services markets
MARIA SANDLER
Solicitor, Eversheds LLP

The financial crisis and subsequent recession have brought with them a stream of litigation ranging from
classic disputes involving straightforward payment claims (such as those arising out of default under loan
agreements and deeds of guarantee) to the more scandalous disputes arising out of the Madoff fraud and the
bankruptcy of Lehman Brothers. In times of economic downturn, it is inevitable that the number of disputes
in the financial services markets will increase. Investment companies and financial institutions as well as disgruntled investors are reviewing the ways in which they can potentially recover the losses they have recently
suffered. In managing litigation and dispute risk in the financial services markets, it is crucial that the underlying contractual documentation is tightly drafted, thus giving the contracting parties certainty and comfort
on the occurrence of a particular event, or even a breach. This article examines the types of contractual issues
that are particularly relevant where the contracting parties are financial institutions, and discusses how these
could be approached in the context of managing dispute risk.

A. What litigation is coming out of the financial

crisis?
The turbulence in the financial markets has, like never
before, seen enormous losses suffered by banks, financial
institutions, companies and ordinary investors. Predictably,
law firms have reported an increase in pre-litigation advice
and are grappling with complex contractual documentation
relating to structured products such as collateralised debt
obligations and structured investment vehicles. However, the
litigation coming out of the financial crisis essentially centres
around one premise: investors, companies and banks all want
their money back.
Indeed, credit crunch litigation has included various
types of claimants: investors who have suffered losses as a
result of advice given in relation to the purchase, investment
and sales of their securities, shareholders who have seen the
value of their investments plummet as companies and the
stock market continue to suffer losses, and borrowers
claiming against lenders that are unable to meet their obligations under credit facility agreements. Conversely, the parties
that have found themselves defending claims have included
investment banks accused of creating risky securities with
complicated structures and subsequently misselling these
products, brokers, professional advisers such as auditors and
financial advisors, and fund managers.
It is clear that in times of financial stress, litigation (especially in the financial markets) will be on the rise and some
litigation will flow naturally on the occurrence of an entirely
unpredictable event, eg the bankruptcy of Lehman Brothers
or the Madoff scandal. However, the general themes that are
coming out of the crisis remain the same: poorly negotiated

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contracts, reliance on precontractual representations, failure

to read the small print, ineffective exclusion clauses, failure
to do proper due diligence on ones counterparty, etc. As the
financial services markets develop and become more sophisticated, it remains important that parties remember the basic
legal premises underpinning their relationships which can be
invaluable in helping to guard against litigation or dispute
risk.

B. What is litigation risk?

It is difficult to define the concept of litigation risk. In fact,
there are many definitions of risk that can vary depending
on circumstance and specific application. However, what is
clear is that litigation is generally recognised as a method of
last resort in the toolbox of dispute-resolution mechanisms:
it is time consuming, expensive and it destroys business relationships. Even by reference to these three consequences, the
risk of litigation can take many guises: it can mean the risk of
getting embroiled in a dispute in the first place or, once a
dispute has arisen, the risk that the party in question may
not be able to successfully pursue or defend its claim.
Once litigation has commenced, the risks that ensue
include: the uncertainty of outcome, cost control, internal
disruption, and damage to personal relationships and reputations. Various rules also require financial institutions to make
accounting or market disclosures that can cause significant
problems which have a roll-on effect on brand reputation, eg
a fund management house being sued for breaching an
investment mandate and causing loss to a fund will inevitably lead to its clients investing their money elsewhere. In

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Managing litigation and dispute risk in the financial services markets

circumstances where litigation is taking place in another

jurisdiction, parties are faced with the more specific litigation risks of unfamiliar court systems, different laws, variable
quality of external advisers, and different attitudes to risk
and conflict.
Litigation risk can also mean the risk of being unable to
ultimately enforce an award or judgment this is closely
related to counterparty risk. This could be due to the fact
that the counterparty to a contract is domiciled in a country
which does not recognise or enforce judgments handed
down by the courts of England and Wales (eg China or
Russia). Alternatively, the inability to enforce could be the
consequence of a counterparty simply not having adequate
funds to pay the claim or the assets to enforce against.

C. Managing litigation risk grassroots

The term risk management is another ambiguous premise.
Risk, simply put, is the probability of something happening
so risk management is the process by which future issues can
be avoided or mitigated, rather than present problems that
must be immediately addressed.
In the US, litigation risk analysis is viewed as an art
mathematical formulas are used to assign quantitative probabilities that predict the likelihood that various litigation
events will occur and litigation risk analysis is performed by
using litigation budgets and forecasts. This cannot be
described as a legal approach to limiting litigation or
dispute risk, though for some trading houses or investment
banks that are accustomed to forward contracts and hedging,
this may be an attractive method of evaluating such risks.
Other, more administrative methods of managing risk
include forward planning, eg defining acceptable outcomes,
identifying best/worst-case scenarios, creating proper
budgets to measure legal spend and manage cashflow, and
deciding on the right methodology to conduct the case (litigation, arbitration, mediation). The choice of advisers can
also be important in helping to manage the litigation, advise
on strategy and establish project management disciplines.
What is clear, however, is that, ultimately, litigation risk is
idiosyncratic. The financial services sector is vast with many
types of institutions operating under different structures and
management styles. However, notwithstanding the definition
of litigation risk that is adopted by a particular player in the
financial market or indeed its approach to risk management,
it is clear that litigation risk can largely be avoided or mitigated by getting back to basics, the grassroots of any business
relationship the underlying contract.
It is a truth universally acknowledged that business is
facilitated by legal certainty. The freedom of contract principle means that parties are largely free to dictate the terms
on which they are willing to conduct business. The courts
have repeatedly relied on and enforced this principle and
will, wherever possible, give effect to the intentions of the
parties. The financial services sector, more than any other, is
dominated by relationships, be they business to business or
investor to client. It is therefore crucial, in managing litigation or dispute risk, that the terms of any contract setting
out that relationship are negotiated with full understanding

March 2010

of their repercussions and are recorded accurately to reflect

the parties intentions.

D. Types of claims
In order to analyse the litigation or dispute risk in the financial markets by reference to the underlying contractual
matrices, it is necessary first to examine the types of claims
that institutions operating in this sector may face. The most
common type of claim remains the claim for breach of
contract. The early rumblings of the credit crunch in the
UK saw banks threatening to pull out of acquisition funding
deals before completion and reneging on their commitments. Borrowing buyers then found themselves without
funding, but still facing completion deadlines, plus the threat
of proceedings from disappointed sellers.
Other contractual claims include those by investors
against fund managers for breaches of investment mandate
where the fund manager in question has ventured outside
the investment objective or failed to have regard to investment restrictions. Counterparties to structured finance
products have also claimed for breaches of conditions that
enable them to terminate the agreement and sue for
damages, and banks are pursuing guarantors, be they
corporates or private individuals, in circumstances where
counterparties are defaulting under credit facility agreements.
Many disputes in the sector are also based on the
precontractual misselling premise: for example, claims against
investment banks in relation to advice given vis--vis the
appropriateness of a structured product to a particular portfolio or disputes concerning liability for inaccuracies in
offering documents and other information on which investors based their original decisions to invest. Claims also arise
for inadequate disclosure where claimants seek to argue that
officers, directors and underwriters of financial institutions
have failed to disclose material facts such as the extent of
their mortgage-related losses, the true status of their finances
and conflict of interests. These investors can also assert
breach of fiduciary duty in the same circumstances.
What case-law has repeatedly confirmed, however, is that
contract is king and that the courts are willing to uphold the
parties agreement in circumstances where, for example,
liability is effectively excluded (see JP Morgan Chase Bank &
Ors v Springwell Navigation Corporation & Ors1). It is therefore
up to the parties, in managing litigation risk, effectively to
include or exclude terms in the negotiation of the contractual documents to mitigate such risk.

E. Managing litigation risk through contractual

certainty
1. Excluding liability non-reliance clauses
Effectively excluding liability under a contract is standard
practice for guarding against litigation risk. This can be done
in a number of ways: liability can be capped, duties of care

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Managing litigation and dispute risk in the financial services markets

can be excluded altogether or parties may seek to rely on

entire agreement clauses. Institutions operating in the financial markets will often seek to enforce non-reliance (or
entire agreement) clauses, the reasoning here being that
professionally advised and experienced parties of equal
bargaining strength desire commercial certainty and have
willingly accepted the commercial risks expressed in the
agreement.
A final written agreement often includes a non-reliance
clause which sets out an acknowledgement by, for example,
an investor that it has not relied on any representations or
warranties other than those contained in the agreement.
Critically, the courts are likely to uphold such exclusions. In
JP Morgan v Springwell, Springwell, which had a longstanding relationship with Chase, brought claims against
various members of the Chase group, arising from losses
made on investments in emerging markets instruments
which Chase had sold or issued. Gloster J found that the
contractual provisions negating a duty of care in the context
of a banks duty of care to advise was effective. This was
because the contractual documents were written contractual
agreements and had been concluded between commercial
parties of equal bargaining power. The documents were not
exceptional or unusual; they were ordinary standard form
documents of the sort which might be expected to pass
between a bank and its customer in the relevant area of
activity.
In managing litigation risk, parties should be aware of
entire agreement clauses whether they are seeking to rely on
them or otherwise; for example, parties who are having such
clauses imposed on them should ensure any statement or
representation on which they have relied and may want to
sue on is incorporated into the documents as a warranty.
The precision of the drafting will ultimately depend on
whether the clause can be enforced and is integral in
managing dispute or litigation risk.

2. Excluding liability fund managers as fiduciaries?

Fund managers are an integral part of the financial services
markets. They manage investments on behalf of all sorts of
clients: private individuals, investment companies, banks and
even other fund managers. However, the simple basis on
which they provide their services can potentially give rise to
litigation risk.
Although there are arguments for and against this
premise, fund managers (particularly those that are operating
on a discretionary as opposed to on an execution only basis),
are likely to be regarded as fiduciaries as they are essentially
agents entrusted with the power to deal with assets
belonging to their client so as to affect their clients legal and
financial position. A fiduciary has an obligation to act in the
interests and for the benefit of his beneficiaries. Therefore, in
their dealings with clients assets, the mutual expectation is
that fund managers will exercise their professional skill with
a view to furthering their clients financial interests.
There are four main duties which fiduciaries are bound
by. Fiduciaries must (i) not place themselves in a position
where their own interests conflict with those of the client
(the no-conflict rule); (ii) not make a profit out of their posi-

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tion at the expense of the client (the no-profit rule); (iii) act
in the best interests of the client (the undivided loyalty rule);
and (iv) not use confidential information for their own
benefit (the duty of confidentiality). However, there are
circumstances (eg in relation to fee structures and commissions received for fund management services) in which fund
managers will find themselves particularly vulnerable to allegations of breach of, for example, the no-profit rule. If the
fund subsequently makes a loss, fund managers may find
themselves liable to a claim for breach of fiduciary duty.
Therefore, to minimise the risk of dispute and achieve
contractual certainty, parties may consider it prudent to
exclude the full scope of the fiduciary duty under an express
term of the investment management agreement which the
general law would otherwise impose. This would have the
net effect of limiting the risk that a claim is made for breach
of fiduciary duty as the courts are likely to uphold any such
restriction.

3. Alternative dispute resolution

Dispute resolution clauses in contracts are generally widely
overlooked. However, in the management of litigation risk,
they are fundamental as they can provide a very precise
framework for the way in which the dispute is ultimately
resolved. The general trend has been to move away from
expensive, lengthy and document-heavy litigation. It has
been recognised that the role of dispute resolution is exactly
that: to resolve the dispute. A long, costly and confrontational process is unlikely to achieve this. For financial
institutions that are essentially service based and rely on the
trust and loyalty of their clientele it is vital that, as part of the
litigation risk-management process, they consider the risks
associated with brand management and preserving business
relationships. It follows that an effectively drafted disputeresolution clause can be instrumental in helping to mitigate
these risks.
While arbitration is an obvious and frequently discussed
option as an alternative means of dispute resolution, there
are also other ways in which the resolution of disputes can
be provided for in the contract, eg negotiation, mediation,
expert determination or adjudication. Each one of these
methods has its particular advantages. Where preserving the
business relationship is the priority behind an institutions
assessment of dispute risk, negotiation as a first port of call
may be the most effective way in managing that risk. Alternatively, in circumstances where a bank has rolled out a
complicated syndicated lending programme or a boutique
structured product, the advantages of having an expert with
banking or market expertise to resolve that dispute may
make expert determination a particularly appropriate
method for determining difficult issues relating to usual or
market practice.
Additionally, while the benefits of arbitration have been
widely publicised, they have also been largely ignored by
major financial institutions that have historically relied on
the courts and their standard terms of engagement which
give English courts exclusive jurisdiction. However, the flexibility, confidentiality and cost-effectiveness of arbitration as

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Managing litigation and dispute risk in the financial services markets

a dispute-resolution mechanism make it an attractive choice

for parties operating in the financial services industry
The confidentiality aspect of arbitration can be crucial in
circumstances where, for example, large investment banks are
accused of misselling or well-known fund management
houses are being sued for making unwise investments. For
example, in the notorious case of Unilever v Mercury Asset
Management,2 Merrill Lynch investment managers were
publicly criticised over their handling of approximately
1bn of money for the Unilever pension fund during a very
public court battle. Inevitably, this had grave consequences
on the fund management houses reputation. This risk could
have easily been avoided had the investment management
agreement provided for arbitration, a confidential process.
Further, prior to the financial crisis, financial firms were
frequently dealing with counterparties from the emerging
economies, such as Russia or China. In these scenarios, the
litigation risk was often one of enforcement as English court
judgments are not recognised by many of these jurisdictions.
One of the major advantages of arbitral awards is that they
can be enforced in far more countries and with far less cost
and delay than court judgments. Over 130 countries have
ratified the New York Convention, which requires their
courts to enforce foreign arbitral awards, except in very
limited circumstances. There is no scheme that is similar in
geographical scope for the enforcement of foreign
judgments.

1
2

[2008] EWHC 1186 (Comm), [2009] EWCA Civ 716

Unilever Superannuation Trustees Ltd v Mercury Asset Manage-

March 2010

E. Conclusion
As discussed above, there are many different ways in
managing dispute or litigation risk: some firms may prefer to
use a mathematical approach based on probabilities and
quantitative analysis, while others have a formal litigation
management plan. There will also always be the macro
impact of legislation, regulation, market activity, etc, in the
management of dispute risk in the financial services markets.
However, it is always useful to return to the grassroots level
and define what litigation risks actually may apply to a
particular financial institution and identify the types of
claims that it may be making or be vulnerable to. This will
necessitate an analysis of the underlying contractual documentation governing the business relationships in question.
That is not to say that there needs to be a dramatic reappraisal of the documents that have been previously used to
achieve this. For example, the terms on which syndicated
credit or bond issues have been provided will largely remain
the same as, despite the increase in litigation, the financial
crisis has not disclosed unacceptable flaws in the legal
protections contained in the documents that have been built
up over many years. The issue is simply one of awareness so
that institutions operating in the sector do not neglect the
fundamentals and use the underlying contractual documents
that govern their business relationships prudently in order to
help them guard against and manage dispute or litigation
risk.

ment (the claim was settled shortly before judgment was due,
Commercial Court).

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