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Limelight Articles

Limelight 06/14

Liability of rating agencies, financial institutions and resellers of complex financial products

Authors, Gavin Beardsell , Ronan Guyomarc'h

ABN Amro Bank NV v Bathurst Regional Council [2014] FCAFC 65


On 6 June 2014, the Full Court of the Federal Court of Australia handed down a landmark decision with potentially wide-ranging ramifications for rating agencies and insurers. In a lengthy judgment running to 474 pages, the Full Court unanimously dismissed appeals by investment bank, ABN Amro, ratings agency, Standard and Poor’s (S&P) and Local Government Financial Services Pty Ltd (LGFS), against judgments in favour of a number of municipal councils in NSW (Councils) for damages in the order of $16 million plus interest and costs.


In or about November 2006, LGFS, a subsidiary of FuturePlus Financial Services Pty Limited (FuturePlus), was introduced to a structured financial product known in Australia as the Rembrandt notes, being a Constant Proportion Debt Obligation (CPDO), issued by ABN Amro.   The notes were assigned an “AAA” rating by S&P.

LGFS had been seeking out opportunities with ABN Amro to explore investment vehicles offering higher returns than fixed interest and term deposits that LGFS had traditionally facilitated the purchase of for councils.  LGFS purchased notes to the value of $55 million for the purpose of it on-selling them to councils in NSW.  LGFS sold a substantial portion of the notes to the Councils.

From late 2007, the value of the notes fell dramatically triggering a “cash-out” event by October 2008, which returned 6.67 cents for each dollar invested.

In 2009, the Councils commenced proceedings in the Federal Court of Australia against LGFS, ABN Amro and S&P, with funding from IMF Australia.  The causes of action were as follows:

  • negligence;
  • breach of contract;
  • breach of fiduciary duty; and
  • misleading and deceptive conduct in contravention of sections 1041E and 1041H of the Corporations Act 2001 (Cth) and section 12DA of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act).

The Councils alleged that LGFS failed to advise them of the risks associated with the CPDOs and that LGFS misleadingly represented that they were suitable investments for them.  The Councils also alleged that LGFS had breached its Australian Financial Services Licence (AFSL) on the basis that its AFSL did not authorise it to deal in derivatives.

In turn LGFS issued cross-claims against ABN Amro and S&P. Subsequently, LGFS’s insurer was joined to the proceedings.

The Councils and LGFS contended that the AAA rating was crucial to their decisions to purchase the notes.

The decision at first instance

At first instance, the Councils established all of their causes of action.  Justice Jagot found that S&P, ABN Amro and LGFS were liable to the Councils and that proportionate liability applied to their claims.


Her Honour found that S&P’s assignment of a AAA rating was misleading and deceptive and involved the publication of information or statements which were false and otherwise involved negligent misrepresentations to the class of potential investors in Australia, including the Councils. The AAA rating conveyed a representation that, in S&P’s opinion, the capacity of the notes to meet all financial obligations was extremely strong and that S&P had formed this opinion based on reasonable grounds and as a result of exercising reasonable care and skill. Her Honour concluded that these representations were untrue and that S&P knew them not to be true when they were made.

ABN Amro

Her Honour found that ABN Amro had influenced S&P with the view to securing an AAA rating and that S&P adopted ABN Amro’s assertions with respect to the notes. ABN Amro was knowingly concerned in S&P’s misleading and deceptive conduct and ABN Amro also engaged in conduct that was misleading and deceptive having regard to its marketing material and the statements it made to LGFS as to the creditworthiness of the notes and their high degree of security.


LGFS’s AFSL did not permit it to deal in, or advise the Councils in respect of, derivatives. Her Honour concluded that LGFS breached its AFSL because the notes were a derivative and were not a debenture and thus not a security.  Her Honour also found that LGFS had engaged in misleading and deceptive conduct in selling the notes to the Councils, breached its duty of care and also breached its fiduciary duty to avoid a conflict of interests in its relationship with each of the Councils.

The decision of the Full Court

In a joint judgment, Jacobson, Gilmour and Gordon JJ endorsed the primary judge’s description that the notes were a “grotesquely complex” financial instrument.

One of the issues on appeal concerned the volatility parameters used by ABN Amro for its modelling and applied by S&P as a basis for assigning an AAA rating. The Full Court confirmed the primary judge’s finding that S&P had adopted unwarranted and overly favourable assumptions about critical parameters such as volatility so that S&P’s AAA rating was unjustifiable, unreasonable and unreliable and that ABN Amro knew that to be so.

Duty of care

The Full Court rejected ABN Amro’s and S&P’s submissions that they owed no duty of care to the Councils.

The Full Court said:

“…The concept of indeterminacy has no, or no separate, role in cases of negligent misstatement or advice. Those ideas are unrelated. Knowledge of the identity of the person or persons to whom a duty is owed is not necessary, or generally of significance, in determining the existence of a duty of care…”

The Full Court concluded that even if determinacy was a separate criterion for the imposition of a duty of care, it was satisfied as it was possible to identify the class of persons to whom the duty was owed as investors in the notes.

The Full Court also rejected ABN Amro’s and S&P’s submissions that vulnerability was a prerequisite for the existence of a duty of care to avoid pure economic loss and that the Councils were not vulnerable because they were capable of protecting themselves from the loss suffered.  The Full Court found that in the field of negligent misstatement, vulnerability is a consequence of, not an additional criterion of, knowledge (actual or which a reasonable person would have) of reasonable reliance by an ascertainable class of persons.  Given the high complexity of the notes, the reasonableness of the rating could not be gleaned by intuition, but required mathematical modelling.  The Councils relied on the rating and that reliance made them vulnerable.

The Full Court concluded that each of ABN Amro, S&P and LGFS owed a duty of care to the Councils.  This was not surprising insofar as ABN Amro and LGFS were concerned, being the financial product issuer and the seller of it, respectively.  S&P’s duty was to exercise reasonable care and skill in forming, and to have reasonable grounds for, the opinion expressed by the rating.

Breach of duty of care

The Full Court agreed with the primary judge that each of ABN Amro, S&P and LGFS breached the duty of care it owed to the Councils.  In particular, S&P’s breach was that it had no reasonable basis for the opinion it expressed in relation to the creditworthiness of the notes and it did not exercise reasonable care and skill in forming that opinion.

 Misleading and deceptive conduct

The Full Court also upheld the primary judge’s conclusion that each of ABN Amro, S&P and LGFS engaged in misleading and deceptive conduct in contravention of sections 1041E and 1041H of the Corporations Act and section 12DA of the ASIC Act.

The Full Court rejected S&P’s submissions that it did not contravene section 1041H as its impugned conduct occurred outside Australia and not “in this jurisdiction” and that it did not contravene section 12DA as the impugned conduct was not in relation to financial services.

The Full Court also rejected ABN Amro’s submissions that it was a mere conduit for S&P’s rating.  By permitting the publication or promotion of the AAA rating to a class of potential investors of the notes in circumstances where ABN Amro knew that the rating could not be relied on, its conduct went far beyond acting as a mere conduit.  ABM Amro was an active participant in the rating process.

Breach of fiduciary duty

The Full Court concluded that LGFS was not a mere salesman and that it acted as an investment advisor. LGFS’ relationship with the Councils was a fiduciary one and LGFS owed a fiduciary duty to avoid conflicts of interest.

The Full Court found that LGFS breach its fiduciary duty by failing to disclose to the Councils the potential risks and ramifications faced by LGFS in holding the amount of notes it held, including LGFS’ commercial imperative of addressing the impact of those notes on its balance sheet.

Reliance and causation

The Full Court rejected S&P’s and ABN Amro’s submissions that their conduct did not cause the Councils’ losses.

The Full Court said that the Councils were entitled to rely upon S&P’s and ABN Amro’s conduct in disseminating and promoting the AAA rating to LGFS as a step in the chain of causation that ultimately led to the Councils’ losses.  The Councils relied on the AAA rating and this would not have occurred if LGFS had not relied upon the representations made to it by ABN Amro.  There did not need to be a direct inducement by ABN Amro, it was sufficient that its representation was material to the Councils’ decision to invest in the notes, in the sense that “the representation was a link in the causal chain“.

Proportionate liability under Federal legislation

The Full Court upheld the primary judge’s conclusion that damages for contravention of section 1041E of the Corporations Act were not apportionable. It disagreed with the primary judge’s conclusion that the section 1041E claims arose from the same facts as the contraventions of section 1041H which were apportionable.

The Full Court said that the omission of section 1041E from the Corporations Act apportionment regime reflected a deliberate intention by the legislature which should be respected. It is only claims made for damages for loss or damage caused by conduct that was done in a contravention of section 1041H which are apportionable claims.  The Full Court found that the damages awarded for the contravention of section 1041E should not have been apportioned as between LGFS, S&P and ABN Amro, rather each of them was liable for 100% of the Councils’ losses.

The Full Court’s conclusion conflicts with the decision of the majority of the Full Court in Wealthsure Pty Ltd v Selig [2014] FCAFC 64 on 30 May 2014 in which Mansfield and Besanko JJ concluded that a proper construction of the Corporations Act proportionate liability provisions means that there is a single apportionable claim in respect of the same loss of damage even if the claim for the loss or damage is based on more than one cause of action, some of which are not themselves apportionable claims.

These conflicting decisions of intermediate appellate courts open the door for a special leave application to the High Court of Australia.

Potential underwriting ramifications: the section 21 duty of disclosure

The Full Court upheld the primary judge’s finding that LGFS’s insurer was liable to indemnify LGFS. It found that LGFS was not a party to the insurance contract, rather it was a beneficiary under the insurance contract. The insurance contract was made between the insurer and FuturePlus only.

Only FuturePlus completed a proposal form. The Full Court rejected the insurer’s submission that FuturePlus was acting as LGFS’s agent in the negotiation for, and entry into, the contract of insurance.

The Full Court concluded that no duty of disclosure under section 21 of the Insurance Contracts Act 1984 (Cth) was imposed on LGFS because it was not a party to the insurance contract.

It remains to be seen whether or not this decision will cause insurers to change their underwriting practices to ensure that the duty of disclosure also applies to all subsidiaries in a group of companies. One way might be to make it clear in the proposal form that the “insured” is acting in the negotiation as the agent for all of its subsidiaries. Another way might be to require that each of the subsidiaries completes a proposal form; however this may be impractical. Some insurers might conclude that seeking legislative change as to the scope of section 21 is warranted.

Date: 11 June 2014

This publication constitutes a summary of the information of the subject matter covered. This information is not intended to be nor should it be relied upon as legal or any other type of professional advice. For further information in relation to this subject matter please contact the author.