Contractual Estoppel in Investment Banking – on which party does liability now lie?

alaskan-sunrise-in-port Following the Global Financial Crisis and Britain’s regulatory overhaul of the financial sector, there is now a strong obligation on Banks and financial institutions to act in their clients best interests. Often a fiduciary duty of care and skill

arises meaning that these institutions must act with caution when proceeding with investment advice. However, the recent innovative use of ‘contractual estoppel’ by the courts has challenged the extent to which an investor, particularly larger and more sophisticated investors, are protected against potential mis-sellings at the hands of financial institutions and advisors, with Christopher Clarke J proclaiming that the rules must accommodate ‘the car dealer as well as the bond dealer’. Being a relatively new device, the use of contractual estoppel has been seen in relatively few and relatively recent court cases. Nevertheless, its use has profound implications on both parties. Investors must be aware of its implications.

What is contractual estoppel?

The doctrine of contractual estoppel arose out of the 2006 Peekay case and can be used in certain circumstances to prevent a party from relying on certain facts of rights where a contract has withdrawn their ability to do so, ultimately upholding the sanctity of freedom of contract. This means that where there is a potential breach of duty by a financial institution to its investing customer, a breach will not be found where both parties have signed a contract that expressly states that advice has not been given. This effectively dismantles any duty towards the customer. The result is that that in cases where contractual estoppel is found and upheld, an institution cannot be found to be negligent since there was never any advice given. Contractual estoppel will usually be found where there is a ‘basic clause’ in a contract that explicitly denies that advice has been dispersed hence falling outside statutory restrictions on exempting provisions. As of the last ten years, contractual estoppel is now considered one of the most significant defence tools deployed by investment advisors and institutions. It is not limited to the financial sector but all cases to date have stemmed from here.

The landmark case of Peekay held that where an investor did not read the finalised contract before signing, he could not claim that the nature of his investment was misrepresented to him when the true nature was stated in the final contract. In the case Springwell v JP Morgan, there was $290 million loss due to investment information from the investment bank representative. The investor’s claim failed on the basis that the representative was more of a ‘salesman’ than a ‘financial investor’ so here the absence of a clear contractual declaration to advise meant that the investment representative could not be found to have breached any duty to the investor. In the Crestsign case, despite the courts criticising the investment banks’ conduct towards a small family business who wanted to invest their money, the presence of a basic clause precluded any advisory duty.

 

Implicationsjudge-gavel-1461291707fA0

Up until the case of Peekay, it was acknowledged that despite usual non-interference with a contract, there were situations where contract terms did not reflect the actual relationship between the parties, meaning that on the basis of public policy justifications, the courts could on occasion intervene to redress the situation and potentially protect the weaker party. Further, Conduct of Business Regulation stemming from EU legislation and The Misrepresentation Act 1967 generally prevents firms from contracting out of their obligations. This would seem to suggest liability lays with the investment advisor however contractual estoppel demonstrates a move away from this. The powerful doctrine now seems to be firmly entrenched in English law, having been settled at the Court of Appeal though it remains to be seen as to if courts will apply the doctrine as widely as they did in Crestsign. The investment advisor and investor relationship should be reflected upon in light of contractual estoppel where investors should proceed with caution and pay close attention to the terms of their contract.

 

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