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5 Client Agreements and Compensatory Damages

From: The Law of Financial Advice, Investment Management, and Trading

Lodewijk van Setten

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: null; date: 06 June 2023

Banker-customer contract — Remedies for lenders’ breaches — Regulation of banks — Capital markets — Investment business

(p. 191) Client Agreements and Compensatory Damages

A.  Client Agreements and the Applicable Standard of Skill and Care

1.  Construction of client agreements

5.01  An investment firm must not offer the investment service unless it has made a ‘written basic agreement with the client, setting out the essential rights and obligations of the firm and the client’.1 The terms of the client agreement, therefore, are the primary source for the investment firm’s private law duties to the investor. To arrive at a set of contractual duties, the client agreement needs to be construed. ‘Construction’, as a concept, may be divided into the process of interpretation (p. 192) of the express terms, that is, to ascertain the meaning that the express terms of a contract would convey to a reasonable businessperson, and the process of implication of terms into an agreement by law, by fact, or based on custom and usage, that is, supplying what is not expressed by the parties.2 In practice, as a technique, interpretation may not always be distinguishable from implication, because both implication—‘supplying what is not expressed’3—and interpretation—‘ascertainment of the meaning which the document would convey to a reasonable person’4—amount to ‘gap filling’.5 Accordingly, implication and interpretation operate under the same principles. Gerard McMeel summarizes it thus:6

First, like interpretation, the exercise in implication is an objective one. It asks what the reasonable person (who looks poised to oust the officious bystander) would regard as necessary to make the contract work, in addition to the express language of the contract. Secondly, in carrying out both exercises the judge must have regard to the contract as a whole. Thirdly, the admissible materials for ascertaining the context or background are the same for both exercises. Fourthly, the court will consider the commercial purpose of the overall contract or a particular part or provision of the contract.

(p. 193) 5.02  The principles that govern interpretation are the same at law and in equity,7 and for simple contracts and for specialties.8 Conceptually, the object of interpretation of the express terms of a contract is to discover the common intention of the parties. However, the common intention is to be assessed objectively.9 That means that the task is to ascertain, not the subjective understanding of one or more parties to the contract, but, in the words of Lord Hoffman, ‘the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract’. With the exception of ‘the previous negotiations of the parties and their declarations of subjective intent’, the background includes anything that ‘should have been reasonably available to the parties’ which ‘would have affected the way in which the language of the documents would have been understood by a reasonable man’.10

5.03  When construing a commercial document in the ordinary way, Lord Bingham said, ‘a business sense will be given to business documents’, which is the meaning that ‘businessmen, in the course of their ordinary dealings, would give the document’, while the court ‘must of course construe the whole instrument before it in its factual context, and cannot ignore the terms of the contract’, but the court must do so with the object ‘to give effect to the contract as intended, so as not to frustrate the reasonable expectations of the businessmen. If an obviously inappropriate form is used, its language must be adapted to apply to the particular case.’11 Accordingly, the objective intentions must be ascertained from the expressed intentions of the parties (including insofar as these may reasonably be inferred from their conduct) in the context of the entire agreement (ie words and provisions should not be analysed in isolation), having regard to the business purpose of the transactions and the reasonable expectations of the parties, which must be understood within the legal, regulatory, and factual context in which the agreement was drafted or declarations were made. Unreasonable results should be avoided, if necessary, by adapting the meaning of certain language.12

(p. 194) 5.04  Thus, although formation of a contract may be largely within the realm of the subjective discretion of the parties, once a contract has been created, any dispute about its effect is beyond the individual parties. The rules of interpretation instil impartiality and predictability by removing post-formation proof of intent from the subjective realm and, instead, give meaning by reference to the business purpose of the transaction, as it is to be understood within the legal, regulatory, and factual framework in which the agreement came about.

5.05  Implication is the process of ‘supplying what is not expressed’.13 Terms may be implied into an agreement by law, by fact, or based on custom and usage, even though the parties did not express the terms themselves.14 In Liverpool City Council v Irwin, Lord Wilberforce specified three varieties of permitted implication techniques.15 The first two permit the addition of terms even though on the face of it there might be an ‘apparently complete bargain’ between the parties. Thus, terms may be added in mercantile contracts, ‘where there is an established usage’, or in general if, on its facts, without such terms ‘the contract will not work’. The third technique concerns contracts that, on the face of it, do not fully state the terms, so that ‘the court is searching for what must be implied’.16 Lord Steyn in Equitable Life Assurance Society v Hyman17 discerns between terms implied in law as ‘general default rules’ and terms implied in fact as ‘ad hoc gap fillers’ that operate within the framework of the contract, ‘read in its particular commercial setting’.18 Arguably, once the law implies duties as a matter of ‘general default rules’, the better position perhaps is to accept that the additional terms are to be regarded as being imposed, rather than implied,19 albeit subject to the parties’ ability to modify the terms.

(p. 195) 5.06  Where statute or judicial precedent has established a rule that operates as a matter of general application in relation to classes of contractual relationship, it is said that these rules become terms implied into contracts of that particular class, by operation of law.20 Implication in law, therefore, is external to the contract.

5.07  Traditionally, implication of terms has relied in practice on a standard of strict necessity, employing a ‘business efficacy’21 and an ‘officious bystander’22 test. Lord Hughes in the decision of the Privy Council in Nazir Ali v Petroleum Company of Trinidad and Tobago,23 summarized the current position as follows:24

It is not necessary here to rehearse the extensive learning on when the court may properly imply a term into a contract, for it has only recently authoritatively been re-stated by the Supreme Court in Marks and Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] UKSC 72; [2016] AC 742. It is enough to reiterate that the process of implying a term into the contract must not become the re-writing of the contract in a way which the court believes to be reasonable, or which the court prefers to the agreement which the parties have negotiated. A term is to be implied only if it is necessary to make the contract work, and this it may be if (i) it is so obvious that it goes without saying (and the parties, although they did not, ex hypothesi, apply their minds to the point, would have rounded on the notional officious bystander to say, and with one voice, ‘Oh, of course’) and/or (ii) it is necessary to give the contract business efficacy. Usually the outcome of either approach will be the same. The concept of necessity must not be watered down. Necessity is not established by showing that the contract would be improved by the addition. The fairness or equity of a suggested implied term is an essential but not a sufficient pre-condition for inclusion. And if there is an express term in the contract which is inconsistent with the proposed implied term, the latter cannot, by definition, meet these tests, since the parties have demonstrated that it is not their agreement.

In practice, whether a term is found to apply as a matter of interpretation, ad hoc gap filling, or, as a matter of general default rule, will not always be without controversy. All are ‘shades on a continuous spectrum’.25

(p. 196) 2.  Pre-contractual dealings

5.08  As part of the dealings between the investor and the investment firm prior to conclusion of the written terms, the investment firm will provide the investor with information about its capabilities in writing or in the form of presentations. To constitute evidence of an intention by the investment firm or both parties that there should be contractual liability in respect of a promise made, or the accuracy of the facts presented, in the pre-contractual information, each such statement (as opposed to a mere representation26) is potentially capable of being treated as a term of the contract,27 or as having created a separate, ‘collateral’, contract.28

5.09  Whether a statement must be treated as a primary or a collateral term will depend predominantly on the prevailing circumstances at the time. Therefore, general observations should be made with caution. It is suggested that, in normal circumstances, the parties to an investment services agreement ought to assume that the written instrument constitutes proof of all the express terms of the agreement, and that written or verbal preliminary statements or assurances should be treated (if not as expressions of subjective intent, discussed in para 5.12) as representations rather than as a term of the contract or as a collateral term. This is because documentation or presentations prepared by the investment firm for the investor as a prospective client are typically intended as general informational communications and, accordingly, are usually discursive. Normally communications of this nature are not intended to be binding and ought not to be held up as such.

5.10  Judicial authority is clear in its direction that, in interpreting commercial contracts, ‘the restriction on the use of background has been quietly dropped’,29 and that the background ‘includes absolutely anything which would have affected the way in which the language of the document would have been understood by the reasonable man’.30 Nevertheless, on balance, it appears that the primacy of the written document, that is, subordination or even exclusion of extrinsic material for purposes of proof of express terms, is a central principle of English contract law which applies to the construction of commercial contracts. Consequently, there is a relatively high barrier to introducing extrinsic evidence of the existence of additional express terms into the context of a written and (p. 197) specific agreement, which purports to be complete and is the product of substantial negotiations between commercial parties.31

5.11  This does not mean that a preliminary statement could not be proved to be a term of the contract, whether primary or collateral. Where a preliminary statement amounts to a specific assurance about a verifiable and reasonably certain fact or fact pattern,32 and it is, or ought to be, clear to the investment firm that the investor is relying on that assurance to enter into the investment agreement, and that reliance is reasonable, statements that are made as part of general informational communication could be classified as a primary or collateral term.33

5.12  A distinction needs to be drawn between communications that are statements made to induce the investor as prospective client to enter into the contract, and communications that ought to be cast as part of the negotiations proper between the parties. In particular, statements that do not concern the investment firm’s general business processes, or past facts or events, but are subjective intentions relating to the investment service and specific aspects of the operating process as this may apply to the investor as prospective client, should be distinguished. If a statement ought to be treated as a subjective intention expressed during negotiations, that statement should be regarded as irrelevant and inadmissible as extrinsic evidence to establish a term not set out in the written investment management agreement, although that does not exclude the use of such evidence for other purposes.34

(p. 198) 5.13  The practical importance of treating a pre-contractual statement as giving rise to a contractual term rather than to a representation appears limited as both claims permit an action for compensatory damages for a false statement. Further, a fact that circumscribes the practical importance of the classification is that most client agreements customarily provide that the written document containing the terms of the client agreement represents the ‘entire agreement’ of the parties. Generally, such a clause will be interpreted as precluding an argument that there are collateral terms to be found in oral negotiations or other preliminary documents, but will not be construed as restricting the liability of either of the parties for misrepresentations made during the negotiations.35

3.  Standard of care, agency, and other duties implied by law

5.14  Investment services as contractual services supplied by way of a business are in scope of the Supply of Goods and Services Act 1982. Unless excluded by s 16, therefore, the Act implies several terms. The investment firm will have to carry out the service with reasonable care and skill, and within a reasonable time, in consideration of which the investor will have to pay a reasonable charge.36 The implied standard at law, according to Lord Goff’s speech in Henderson v Merrett Syndicates Ltd,37 concurs:

It is however my understanding that by the law in this country contracts for services do contain an implied promise to exercise reasonable care (and skill) in the performance of the relevant services; indeed, as Mr. Tony Weir has pointed out (XI Int. Encycl. Comp. L, ch. 12, para. 67), in the 19th century the field of concurrent liabilities was expanded ‘since it was impossible for the judges to deny that contracts contained an implied promise to take reasonable care, at the least, not to injure the other party.

5.15  Sections 2(2) and 3 of the Unfair Contracts Terms Act 1977 (UCTA) apply to implied terms and accordingly, contractual exclusions or limitations must pass the UCTA test.38

5.16  The standard of care informs the way the investment firm is expected to perform the investment service, that is, the standard of professional judgement, knowledge, and skill required of the investment firm. It must be set by reference to the state of things at the time of the relevant conduct. Particularly in matters of investment, it is tempting to question the selection of investments with the benefit of hindsight. In Duchess of Argyll v Beuselinck Megarry J exposed undeniably the fallacy of that approach when he said:39

(p. 199)

In this world, there are few things that could not have been done better with hindsight. The advantages of hindsight include the benefit of having sufficient indication of which of the many factors present are important and which are unimportant. But hindsight is no touchstone of negligence. The standard of care to be expected of a professional man must be based on events as they occur, in prospect, and not in retrospect.

5.17  In the case of investment services, a further common source of implied duties of the investment firm, in the meaning of ‘general default rules’, is the law of agency. Not surprisingly, given the purpose of agency, the general principles centre on the scope and use by the agent of the agency authority.40 Accordingly, an agent must not exceed the scope of its authority, must use reasonable care and skill in exercising this authority, and must comply with instructions relating to the exercise of the agency powers. In addition, the exercise of discretion by the agent will usually be subject to fiduciary duties.41 The operation of agency law does not change the application of the normal principles of contract law. A contractual agent must perform his duties in accordance with the terms of the contract; agency does not subvert contract.42

5.18  It is a fundamental rule of contractual agency that the agent is in breach of the contract if the agent exceeds the agency authority, or fails to use it.43 Unless the client agreement provides otherwise, it is therefore beyond doubt that an investment firm is in breach of the client agreement if s/he acquires or otherwise deals in a financial asset for the client, or fails to dispose of an asset held for the client, when such dealings or holdings are outside the scope of the actual agency authority. In both cases, upon discovery of the breach, the investment firm will be under a duty to remedy the situation by placing, or entering into, corrective trades.

5.19  Every professional agent acting for reward is under a duty to exercise such skill, care, and diligence as is usual or necessary in, or for the ordinary or proper conduct of, the profession.44 If the agent is holding out as possessing a special skill that exceeds those basic skills, the duty may be to exercise that higher degree of skill.45 In the context of the supply of investment services, therefore, the benchmark is the skill, care, and diligence that may be expected of a hypothetical investment firm that possesses an ordinary level of professional competence, taking into account the special skill that the investment firm professes to possess, and that is acting in like circumstances.

5.20  Agency law, in the absence of contractual modification, imposes a general standard of care on the investment firm that is for all practical intents and purposes identical (p. 200) to the standard of care implied by section 13 of the Supply of Goods and Services Act 1982. It is also identical to the standard of care in tort. Based on the decisions in Hedley Byrne & Co Ltd v Heller & Partners Ltd46 and Henderson v Merritt Syndicates Ltd47 it appears beyond doubt that an investment firm assumes a duty of care to exercise such skill, care, and diligence as is usual or necessary in or for the ordinary or proper conduct of the profession.48

5.21  Subject to circumstances indicating otherwise, a contractual agent is under a general duty to accept and implement all lawful and reasonable instructions of its principal in relation to the way the agent carries out its duties. In determining what is reasonable, regard must be had to all relevant circumstances, including the nature of the agency and the customs, practices, and ethics of the business undertaken by the agent.49 Bowstead & Reynolds on Agency, noting that there is very little judicial authority to support this proposition, suggests ‘it is almost self-evident’.50 Although it is without question that a principal may always withdraw or modify authority and therefore, notwithstanding anything to the contrary in the contract, may instruct the agent not to perform a certain agency transaction, it is not so obvious, in the absence of an express contractual right to do so, whether the principal should be able to prescribe how a professional agent should perform its duty. In the case of investment services, terms implied by the law of agency are embedded in a commercial contract for the supply of services. The principal employs the professional agent with a view to its special skill. It is not conceivably in the interest of either principal or professional agent that the principal interferes with the application of that special skill, potentially at substantial cost and risk to the investment firm. Therefore, although the investor may withdraw the investment firm’s authority to transact for it at any time, there appears to be no basis to imply a right for the investor to prescribe to the investment firm how to carry the investment service out. Where the investor requires such a right, it should be stipulated as an express term.

4.  Implied duties of the client

5.22  Implication of terms in connection with general duties of the investor is less straightforward. The Supply of Goods and Services Act 1982 will imply a term (p. 201) that a reasonable fee must be paid to the supplier of services by way of business. Bowstead & Reynolds on Agency notes that, although there is a tendency in judicial authority to find certain elemental duties for a principal to an agency relation, the authorities are not always easy to reconcile.51 The duties are typically implied in fact, rather than in law, and strictly based on necessity, so that ‘there is nothing in the law sufficiently specific to make the formulation of a general [principle] on the principal’s inherent duties towards the agent appropriate’.52 Nevertheless, it is possible to describe the agent’s basic rights in connection with remuneration, reimbursement, and indemnification. Apart from claims in restitution, an agent will not be entitled to remuneration unless this is expressed or implied in the contract. Terms providing for remuneration will only be implied where circumstances are such that it is clear that parties intended that there should be remuneration.53 Where the contract contains express terms providing for remuneration, the agent cannot normally claim remuneration other than in accordance with those terms.54 If the agent has accepted additional instructions outside the duties that are expressly stipulated in the contract, exceptionally, a term may be implied that a reasonable sum shall be payable by the principal.55

5.23  The client agreement will usually be very specific about the fees due from the investor. The contract will typically be less clear about reasons for suspension or abatement of fees. If a client agreement is terminated in accordance with its terms, the investment firm will not be entitled to any further fees. Also, as a matter of general principle, an agent will not be entitled to remuneration in respect of any unauthorized transaction that is not ratified by the principal, or in respect of transactions in relation to which it is in breach of its fundamental duties as an agent.56

5.24  An agent has a right against its principal to be reimbursed for all expenses and to be indemnified against all losses and liabilities incurred by it in the execution of its authority,57 although the right to reimbursement of expenses will not apply if the expense in question should be covered by the remuneration.58

(p. 202) 5.  The regulatory standards of care and construction of the client agreement

5.25  Firms that are in the business of providing an investment service specified in Appendix A59 to MiFID II60 must be authorized and regulated in accordance with the supervisory framework set out in MiFID II and MiFIR61 and their subsidiary legislation.62 The laws and regulations so made will usually be classified as ‘public law’ in the national legal systems of the Member States of the European Economic Area (EEA).63 Therefore, the starting point for national courts deciding cases concerning private law actions is that they are, in principle, not bound by the content of any particular regulatory rule.

5.26  Nevertheless, the conduct of business rules contained in MiFID II and others contain ever more articulate standards of care and effort that are expected of investment firms and that profoundly influence their behaviour towards their clients. Common practice, that is the skill, care, and diligence as is usual or necessary in, or for the ordinary or proper conduct of, the profession, usually plays a significant part in the construction of contractual terms. Also, client agreements between investment firms and professional investors typically include a general undertaking of the investment firm ‘to comply with all material rules and regulations’ that apply to the investment firm in the carrying out of the relevant investment service. Consequently, in most jurisdictions there is a consensus that regulatory rules, particularly conduct of business rules, inform the scope of the duty of care of investment firms.64

5.27  Under English law, it appears to be reasonably well established that professional codes of conduct in general, and the FCA rules in particular, provide prima facie (p. 203) evidence of the standard of care expected by the industry.65 In general, the courts will look to the relevant rulebooks to glean an expression of the principles by which the supply of service by an authorized and regulated firm ought to be judged.66 Caution should be taken not to import wholesale those rules in every detail into the relation between the supplier of professional services and the recipient, even when the mandate expressly refers to those rules.67 The scope and purpose of such rules are peculiar to the situation for which they were created, and the rules are subject to exclusions, exemptions, waivers, and regulatory interpretation. They cannot be interpreted independently, without taking their purpose and context into account.

6.  The (remarkable) provision of Article 69(2) of MiFID II

5.28  Notwithstanding the fact that the public law duties may provide compelling evidence for a standard of care in private law, the private law duty of care is—at least conceptually—separate and independent from the public law regulatory duties. A court could, depending on the circumstances of a specific case, very well believe that the scope of that private law duty of care ought to be different from the standard set out in the regulatory regime.68 At least, that is the conceptual principle, which must be confronted with the provision of Article 69(2) of MiFID II, final para:

Member States shall ensure that mechanisms are in place to ensure that compensation may be paid or other remedial action be taken in accordance with national law for any financial loss or damage suffered as a result of an infringement of [MiFID II] or of [MiFIR].

(p. 204) 5.29  This is a remarkably stark provision in a curious—in fact, unintelligible69— location in MiFID II. Depending on what is meant by a ‘mechanism’ in the context of national laws, it could mean that this provision overrides not just the national public law order, but also its private law order. MiFID II and MiFIR are silent on the scope of this provision, however. There is no guidance in the recitals, and Article 69 provides no clues.

5.30  Busch has pointed out, based on decisions of the Court of Justice of the European Union (CJEU), in Littlewoods Retail v HMRC70 and Genil v Bankinter,71 that this provision may be construed as an expression of the principle of effet utile, that is, the principle of equivalence and effectiveness.72 The CJEU has described the operation of effet utile in Littlewoods, a decision concerning the calculation of interest on tax due, as follows:73

In the absence of EU legislation, it is for the internal legal order of each Member State to lay down the conditions in which such interest must be paid … Those conditions must comply with the principles of equivalence and effectiveness; that is to say, they must not be less favourable than those concerning similar claims based on provisions of national law or arranged in such a way as to make the exercise of rights conferred by the EU legal order practically impossible.

5.31  In Genil, the CJEU deployed the principle of effet utile set out in Littlewoods in the context of a breach of know-your-customer rules. The CJEU held that it was the internal legal order of each Member State that determines ‘the contractual consequences in the event that an investment services provider failed to comply with the MiFID’s requirements’, but always within the confines of the principle of effet utile.74 The final paragraph of Article 69(2) of MiFID II, therefore, at least as far as the reference to national law mechanics is concerned, appears to codify effet utile, provided that it means that if the national law does not provide for compensation mechanisms, that absence is not an infraction based on the effet utile.

5.32  Nonetheless, the potential operational reach of Article 69(2) may very well be construed differently. According to the CJEU’s words in Littlewoods, the (p. 205) operative purpose of effet utile is to protect ‘the exercise of rights conferred by the EU legal order’, that is, it remains to be determined what rights certain EU legislation confers. Article 69(2), however, on its face appears to stipulate that national systems must provide a path to compensation in respect of ‘any financial loss or damage suffered as a result of an infringement of [MiFID II] or [MiFIR]’. In other words, the compensation provision may be conferring—independently, without further reference to any other provision of MiFID II—rights to compensation for losses that are causally linked to a breach of MiFID II or MiFIR. Seen in that light, it concerns a substantive provision, that is, not a reference to the principle of effet utile. In Genil, the CJEU did not take a view on whether MiFID I75 conferred private law duties of care or compensatory rights or remedies. It merely confirmed that the role of effet utile is to protect certain rights conferred by MiFID I without defining what these rights are. The decision in Genil could be said to be entirely consistent with the purpose of EU legislation and, therefore, to be unremarkable.76 The compensation provision of Article 69(2) of MiFID II, on the other hand, seems to be anything but unremarkable. On a plain reading it is difficult to avoid a conclusion that the provision seeks to afford private rights of action to investors in relation to a breach of regulatory obligations under MiFID II.77

5.33  The—possibly intentional—legislative blurring of the lines between public law conduct of business rules, that is, regulatory obligations of an authorized firm, and private law obligations of that same firm is a clear legislative trend. Similar blurring can be found in the relatively recent Alternative Investment Fund Manager Directive (AIFMD).78 The second paragraph of Article 19(10) AIFMD reads ‘notwithstanding the first subparagraph and irrespective of any contractual arrangements providing otherwise, the external valuer shall be liable to the AIFM for any losses suffered by the AIFM as a result of the external valuer’s negligence or intentional failure to perform its tasks’. Article 21(12) provides in the first paragraph that the ‘depositary shall be liable to the AIF or to the investors of the AIF, for the loss … of financial instruments held in custody’ and in the third paragraph that the ‘depositary shall also be liable to the [Alternative Investment Fund], or to the investors of the [Alternative Investment Fund], for all other losses suffered (p. 206) by them as a result of the depositary’s negligent or intentional failure to properly fulfil its obligations pursuant to this Directive’.79

5.34  In conclusion, the liability language in Article 69(2) of MiFID II, as is true for the above provisions of the AIFMD, appears to create or preserve, as the case may be, private rights of action against the firms authorized under MiFID II for breach of MiFID II or MiFIR. If pursued in the national courts, effet utile may operate to the effect that courts will afford remedial relief. It is not clear, however, what the nature of these private rights of action would be under any national law. Is it a statutory right of action? Is it to be implied in the contractual relationship, if any, between the injured parties and the authorized firm? Or does it set a negligence standard that gives separate actions in tort to the injured parties? Also, as there is no reference to clients, it is not clear whether or not professional clients and eligible counterparties are in scope. Finally, and critically, it is not at all clear what the scope of the responsibility of the investment firm under Article 69(2) of MiFID II is supposed to be. The European Commission observed in relation to this matter in the context of its 2010 consultation on MiFID I that,80

the Commission services regularly receive complaints, especially from retail investors, claiming that firms have violated conduct of business obligations. Introducing a principle of civil liability of investment services providers would be essential for ensuring an equal level of investor protection in the EU. Such a principle, could be included in the framework directive and would enable clients to claim damages against investment firms infringing MiFID rules, particularly in areas concerning the relationship between firms and clients and where specific obligations towards the client are foreseen. The following areas could be covered: information requirements, suitability and appropriateness test, reporting requirements, best execution and client order handling.

It suggests that the original intention—at least as far as the Commission was concerned—was to limit the scope of express MiFID II-based compensation rights to retail clients and breaches of the rules set out in Articles 24–28 of MiFID II and its subsidiary legislation.

5.35  Broad-brush liability for any breach of any rule or provision of MiFID II or MiFIR is unworkable. On that basis, Article 69(2) of MiFID II might fail the legal certainty test as used by the CJEU in Nationale Nederlanden v Van Leeuwen, which insists that the legal basis for a remedy must be such that the scope of the responsibility is reasonably foreseeable.81

(p. 207) 7.  Exclusion of liability

5.36  In practice, investors and investment firms will regulate the investment firm’s responsibilities and liability via a client agreement, which may seek to exclude, mitigate or alter any liability of the investment firm under Article 69(2) of MiFID II, or indeed, as envisaged by Articles 19(10), 20(3), or 21(12) and (13) AIFMD. In this context, the Financial Conduct Authority’s (FCA) Handbook of Rules and Guidance contains an interesting rule in 2.1.2R of the Conduct of Business Sourcebook (COBS).82 The rule provides that an FCA-authorized firm must not in any communication relating to its regulated business seek to exclude or restrict, or rely on any exclusion or restriction, of any duty or liability it may have to a client under the regulatory system.

5.37  In a 2006 consultation paper, the Financial Services Authority (FSA) proposed to remove the provision from COBS arguing that the rule ‘overlaps significantly’ with other parts of the FSA’s Handbook of Rules and Guidanceh as well as with general law and, therefore, that it can be removed without impact on the scope of the regulated firm’s duties and responsibilities.83 In particular, the FSA referred to Principle 6 of the Principles for Businesses,84 the Unfair Terms in Consumer Contracts Regulations 1999 (UTCCR), and UCTA. After the consultation, however, the FSA decided to retain the limited rule of COBS 2.1.2R. Although the FSA remained of the opinion that the general regulatory duty to act in the client’s best interest85 combined with the general legal principles of UTCCR and UCTA prevent a regulated firm from contractually restricting or excluding duties or liabilities it has to its clients under the regulatory framework, the FSA also observed that ‘having a specific rule on the exclusion of liability might, however, serve as a further deterrent’.86

(p. 208) 5.38  Accordingly, the rule in COBS 2.1.2R is not intended to restrict the freedom of an FCA-authorized firm to limit its liability beyond the restrictions imposed by general principles of contract law. Rather, it is intended as a clarification, to put beyond doubt that in the opinion of the FCA, this type of exclusion clause ought to be caught by the provisions of the UTCCR or UCTA. It is well established that contractual clauses that negate liability or responsibilities for representations or extra-contractual duties that may arise as a matter of professional assumption of responsibility are effective.87 Whether a breach of the rule would be interpreted by a court to constitute a failure to meet the ‘reasonableness’ test within the meaning of UCTA will depend on the circumstances, although a breach ought to be capable of constituting evidence for such a conclusion.

5.39  Subject to the point made on the lack of certainty of scope, it could be argued that Article 69(2) of MiFID II needs to be interpreted more strictly than COBS 2.1.2R, or, in other words, more strictly than UCTA and UTCCR. Alternatively, it could be argued that the national law mechanism referred to Article 69(2) of MiFID II, assuming its scope is limited to retail clients, does already exist—up to a point88—in the United Kingdom’s national legal order, because a breach of the FCA’s organizational or conduct of business rules is actionable at the suit of a ‘private person’, subject to the defences and other incidents applying to actions for breach of statutory duty,89 and save for rules that have been carved out specifically.90 A private person is a person who, at the time of the loss, is neither an individual who is carrying on a regulated activity, nor a legal person that is carrying on a business.91 Professional investors will not normally be able to base a claim on breach of a statutory duty of care, that is, of the FCA rules, with a few exceptions.92 The exceptions concern the rule in 2.1.2R COBS discussed in the preceding paragraphs, the market abuse rules, or circumstances in which a fiduciary or representative brings the suit on behalf of a private person exclusively for the benefit of that private person, and that suit could not be brought by the private person directly.93

(p. 209) 5.40  Not all clauses that have the effect of an exclusion clause are capable of being caught by UCTA. Note the observations made by Paul Marshall94 in respect of the decision in Crestsign v NatWest and RBS:95

Thus, despite it being found by the judge to be negligent, the bank was not liable for breach, either in contract or negligence, because of the agreed basis of the relationship, under bank standard-form documents. Although at the conclusion of his judgment the judge says that the bank had ‘successfully excluded’ liability, this was, in the judge’s judgment, not in law an exclusion clause, which would have been subject to statutory control under the Unfair Contract Terms Act 1977, but a ‘basis’ clause, which is quite different. A basis clause may have similar effects to an exclusion clause but is significantly more effective because in theory it precludes the antecedent relevant duties from arising in the first place, and therefore, it is said, falls out[side] statutory control and protection.

5.41  A basis clause—commonplace in insurance contracts96—seeks to establish ‘the basis’ for the engagement. It is essentially a statement of the scope of the undertaking and of factual matrix, and conversely a denial of any out-of-scope duties or of potentially contrary facts. The bank’s standard terms included a clause that proclaimed that the bank will not act and has not acted as an adviser and that no reliance may be or has been placed on advice or recommendations. It is a curious drafting technique that ought to be treated with caution, in particular in view of the regulatory obligation to act fairly and in the client’s best interest.97

B.  Subcontractors (Outsourcing)

1.  Governance and control of outsourcing risks

5.42  Investment firms rely materially on services supplied by third parties to support their operating models. In regulatory terms, when an operating function of the investment firm is performed by a third party, the arrangement is referred to as ‘outsourcing’. If an investment firm outsources an operating function or task, supervisory concerns arise about the loss of control by the outsourcing investment firm and the extent to which loss of substantive know-how and ability to perform the task itself presents a risk to the investment firm or might even undermine the (p. 210) conditions upon which the firm had originally been authorized. Separately, outsourcing invokes supervisory concerns about the way the acts or omissions of the service provider might impact the outsourcing investment firm and its clients, and how these risks are identified, measured, and mitigated in relation to responsibility, liability, and risk management. The European Banking Authority (EBA) observes:98

Outsourcing arrangements, in particular when the service provider is located outside the EU, create specific risks both for institutions and payment institutions and their competent authorities and must be subject to appropriate oversight. Any outsourcing that would result in the delegation by the management of its responsibility, altering the relationship and obligations of the institution and the payment institution towards their clients, undermining the conditions of their authorisation or removing or modifying any of the conditions subject to which the institution’s and payment institution’s authorisation was granted is not allowed. Outsourcing arrangements should not create undue operational risks or impair the quality and independence of institutions and payment institutions internal controls or the ability of those and the competent authorities to supervise compliance with regulatory requirements.

5.43  The regulatory framework that applies to outsourcing is risk-management focused and sets expectations around governance and controls. Recital (36) of MiFID II’s Delegated Regulation (EU) 2017/565 surmises:

For the purposes of requiring an investment firm to establish, implement and maintain an adequate risk management policy, the risks relating to the firm’s activities, processes and systems should include the risks associated with the outsourcing of critical or important functions. Those risks should include those associated with the firm’s relationship with the service provider, and the potential risks posed where the outsourced functions of multiple investment firms or other regulated entities are concentrated within a limited number of service providers.

5.44  Operating functions are functions that are distinctive and continuous components of the investment firm’s business process, that is, functions that are particular to its regulated investment services or investment activities. In the (p. 211) words of the EBA, it concerns ‘a function that is undertaken by the firm itself’.99 Logically, notwithstanding that the interruption of supply may critically impair the investment firm’s ability to continue its investment business,100 purchased goods or utilities are not functions an investment firm undertakes itself. The supply of goods and utilities, therefore, is not in scope of the outsourcing regime.101 Equally, ‘purchased services’ such as professional services or market information services and the provision of price feeds that may be essential ‘fuel’ for the successful execution of the investment business of a firm, are not part of that investment business.102

5.45  MiFID II casts its outsourcing net less widely than the EBA. Under MiFID II, only outsourcing that concerns ‘operational functions which are critical for the provision of continuous and satisfactory service to clients and the performance of investment activities on a continuous and satisfactory basis’ are in scope and therefore subject to its conditions for outsourcing.103 An ‘operational function’ is ‘critical or important’ if ‘a defect or failure in its performance would materially impair’: (1) the ability of an investment firm to comply with its regulatory obligations, including the conditions for its authorization, under MiFID II; (2) its financial performance; or (3) the ‘soundness or the continuity of its investment services and activities’.104 EBA, on the other hand, seeks to distinguish between outsourcing generally, and outsourcing that is critical or important within the meaning of MiFID II.105 In that model, all outsourcing is subject to governance and risk management requirements, but outsourcing that is critical or important within the meaning of MiFID II is subject to additional requirements.106 Consequently, investment firms must consider carefully which arrangements are to be considered as outsourcing arrangements and identify which outsourcing arrangements are to be considered as critical or important.

5.46  Member States must not frustrate an investment firm’s ability to outsource provided the arrangement complies with the relevant conditions under MiFID II:107

(p. 212)

Competent authorities should not make the authorisation to provide investment services or activities subject to a general prohibition on the outsourcing of one or more critical or important functions. Investment firms should be allowed to outsource such functions if the outsourcing arrangements established by the firm comply with certain conditions.

5.47  If the outsourcing concerns the handling of client assets or funds, further rules apply. Article 3 of MiFID II Delegated Directive 2017/593 (Depositing client financial instruments) provides that investment firms must be ‘allowed to deposit financial instruments held by them on behalf of their clients into an account or accounts opened with a third party provided that the firms exercise all due skill, care and diligence in the selection, appointment and periodic review of the third party and of the arrangements for the holding and safekeeping of those financial instruments’. In addition, the outsourcing firm must consider the ‘expertise and market reputation of the third party as well as any legal requirements related to the holding of those financial instruments that could adversely affect clients’ rights’. Subparagraph 2 prescribes that the sub-custodian must be in a jurisdiction that regulates and supervises the custody business of that sub-custodian. Certain exceptions apply according to subparagraph 3 if that is not the case.

5.48  Similarly, if the outsourcing concerns the placement of client money, Article 4 of MiFID II Delegated Directive 2017/593 (Depositing client funds) requires that investment firms that are not authorized as a bank must promptly on receipt place client funds into one or more accounts held at a bank, including a central bank or a non-EEA bank, or a qualifying money market fund. Except if the account is held at a central bank, the investment firm must ‘exercise all due skill, care and diligence in the selection, appointment and periodic review of the credit institution, bank or money market fund where the funds are placed and the arrangements for the holding of those funds and they consider the need for diversification of these funds as part of their due diligence’. The investment firm must consider ‘the expertise and market reputation of such institutions or money market funds with a view to ensuring the protection of clients’ rights, as well as any legal or regulatory requirements or market practices related to the holding of client funds that could adversely affect clients’ rights’. Clients must give express consent for the placement of their funds in a qualifying money market fund.

2.  Authority to delegate and liability for outsourcing

5.49  If an investment firm contracts with a third-party service provider to supply a service to the investment firm in relation to an operational function of the investment firm, in the absence of exemption or exclusion clauses in the client agreement between the investor and the investment firm, that investment firm is liable to the investor for any acts or omissions of subcontractor that result in a breach (p. 213) of the client agreement.108 The outsourcing investment firm is under an explicit regulatory obligation to retain full responsibility for the performance of the outsourced function, and any outsourcing is subject to the condition, inter alia, that the investment firm may not ‘alter’ its ‘relationships and obligations … towards its client’.109 In that light, it is unlikely that an attempt by an investment firm to exclude liability for acts or omissions of the subcontractor would survive the test of Article 69(2) of MiFID II or COBS 2.2.1R.110

5.50  Conversely, under the common law doctrine of privity of contract, the general rule is that contracts cannot be enforced either by or against third parties,111 and the investor would therefore not, in principle, be able to enforce the client agreement against the subcontractor. This principle will hold true if the outsourcing concerns an operational function that is a component part of the business processes of the investment firm that, together with the functions and tasks performed by the investment firm itself, mixes into the supply of the investment service by the investment firm to an investor pursuant to the client agreement. For instance, the service provider could provide and maintain a critical or important system for the investment firm such as a trading or a recordkeeping system, or the service provider could contribute a critical or important component task, such as a settlement service. Although the performance of these functions or tasks affects the individual clients of the investment firm, as component parts of the investment firm’s business processes they are functions and tasks that ought not be treated as distinct and separate from the investment service itself and, therefore, should not be treated as a task of function that the investment firm has subcontracted to the service provider with the intention to confer a benefit on the investor. The investment firm remains the party that performs the investment service that the investor contracted for under the client agreement and the subcontractor often acts as agent of the investment firm, for example where the subcontractor provides client reports and other information to the investor.

5.51  Outsourcing could, however, extend beyond a distinct operational function or task and concern integral delegation of part or whole of the investment service, for example when a broker delegates the execution of a trade to a correspondent (p. 214) broker in a different market because the primary broker does not have access to the relevant trading venue. Equally, an investment manager may delegate the management of certain assets to another, specialist, investment manager. In such circumstances, the investment service that the investor contracted for is, wholly or partially, vicariously performed by the subcontractor. Given that the investor will receive the benefit of the performance, the subcontract may be expected to be in scope of the Contracts (Rights of Third Parties) Act 1999 as a contract made for the benefit of the investor within the meaning of that Act. Under section 1(1)(b) of the 1999 Act, the investor may enforce a term of the contract if ‘the term purports to confer a benefit on’ the investor. The question whether the investment firm and its subcontractor had any such intention, or the opposite, is one of construction.112 Presumably, the delegation by way of subcontracting of the investment service—which was originally contracted for by the investor—confers the benefit of the service by the subcontractor on the investor. It is then necessary to construe the subcontract to determine the nature and extent of any rights the investor may have to enforce a term.113 Notwithstanding, under MiFID II and COBS, the subcontracting firm may treat the outsourcing investment firm as its client for purposes of the appropriateness and suitability tests, subject to some exceptions.114

5.52  Section 1(2) of the 1999 Act negates the third-party beneficiary’s right ‘if on a proper construction of the contract it appears that [the investment firm and the subcontracting investment firm] did not intend the [terms of the subcontract] to be enforceable by’ the investor. That amounts to a rebuttable presumption that a term is intended by the contracting parties to be enforceable by the third-party beneficiary. To rebut the presumption, according to s 1(2), the promisor must show that the contracting parties did not intend the term to be enforceable by the third-party beneficiary. It is not enough for the promisor to show that he did not so intend; he must show that neither he nor the other party had this intention.115 Typically, commercial contracts provide express terms that no rights or benefits are conferred on any third party, which would satisfy the test of section 1(2) of the 1999 Act. That means that in practice, an investor who would want to seek directly enforceable rights against a delegated investment firm will at least have to require that the primary investment firm does not agree to a term that excludes the investor’s rights under the subcontract.

5.53  There is a risk, under English law, that if the investor is not somehow entitled to enforce rights arising under the subcontract, loss suffered by the investor because (p. 215) of the acts or omissions of the subcontractor might end up in ‘remedial no man’s land’ if it is not also a loss of the intermediating investment firm. The general rule in an action for damages is that the claimant cannot recover more than the amount required to compensate him for his loss, so that the promisee cannot, in general, recover damages for breach of a contract made for the benefit of a third party in respect of loss suffered not by the promisee himself, but by that third party.116 This general rule was set aside in Jackson v Horizon Holidays Ltd,117 but the assumption that a claimant can only recover own loss was reinforced in Woodar Investment Development Ltd v Wimpey Construction UK Ltd.118 Therefore, although the subcontract is binding between the outsourcing investment firm (as promisee) and the subcontracting investment firm (as promisor), the fact that the contract was made for the benefit of the third-party investor might mean that a loss that is incurred by the investor might give rise to recovery problems if the outsourcing investment firm is not liable for the loss to the investor under the client agreement or otherwise. An important reason for the investment firm not to seek to exclude liability for subcontractors,119 which attempt could—as it leads to a risk of non-recoverable loss exposure for the investor—also be argued to be capable of being set aside because it is in violation of the investment firm’s MiFID II obligation to act fairly and in the best interest of the investor.120 There are exceptions to the rule, for example damages for breach of contract can be recovered by a trustee even though the loss is suffered by his cestui que trust, or by an agent even though the loss is suffered by his undisclosed principal.121

5.54  Unless the client agreement contains express permission, an investment firm will not necessarily be free to enlist the assistance of a third party to perform vicariously, in whole or in part, the investment service that the investor contracted for under the client agreement. If a person has been selected with reference to individual skill, competence, or other personal qualification, that person is not entitled to subcontract the performance of the contract to another.122 Given the professional nature of investment services,123 therefore, permission in the client agreement will be a condition for the investment firm to be authorized to select another investment firm to perform the investment service vicariously.

(p. 216) 5.55  Separately, an agent may not delegate agency authority in whole or in part except with the express or implied authority of the principal.124 Consequently, if the investment service includes agency powers that need to be delegated to the subcontractor to enable the subcontractor to perform the client agreement vicariously, such as in the case of outsourcing of brokerage or portfolio management service, the client agreement must permit that delegation. Delegation authority is implied if the agency authority conferred is of such a nature as to necessitate its execution wholly or in part by means of a sub-agent or where the employment of a sub-agent is justified by the usage of the trade or business in which the agent is employed, provided that such usage is not unreasonable, and not inconsistent with the express terms of the agent’s authority.125 Accordingly, the use of a correspondent broker in another jurisdiction might be construed as an authority that is implied by reason of usage of the trade.

5.56  In the event of sub-agency, the investor and the sub-agent will not be in privity of contract. The subcontractor is only in privity with the appointing investment firm and owes common law duties only to the investment firm, and not the investor. It cannot be denied, however, that the sub-agent has been given delegated agency powers to bind the investor as principal when acting in connection with the investor’s affairs. Bowstead & Reynolds on Agency argue that this shows that the sub-agent is ‘at least in some respects to be regarded as an agent of the principal’, and therefore, ‘that there will be circumstances when he should be also directly liable to the principal’, adding that ‘[i]n a sense, this is a contract for the benefit of a third party’.126 Indeed, an agency relationship ought to be a persuasive circumstance to afford direct remedies to the investor against the subcontracting investment firm as sub-agent under the 1999 Act.

5.57  Somewhat surprisingly, the position in English law of the sub-agent in respect of the various forms of equitable duties is not clear. ‘The legal position where the sub-agent makes profits which could not have been made but for the agent’s position as such, or where the sub-agent engages in a transaction where he can be said to have interests conflicting with those of the principal, is unsettled.’127 It has been held that a sub-agent may owe fiduciary duties to the principal, and can therefore be directly liable for diverting business opportunities to a competitor of the principal.128 But the mere existence of a conflict of interest or simple profiting from position, where there is no suggestion that the principal was harmed by the sub-agent’s actions, may be capable of being excused by the agent, properly (p. 217) informed of the circumstances.129 This may be contrasted with the rule in Article 26 of MiFID II, which requires compliance with conduct of business rules, including, importantly, conflict rules (emphasis added):

The investment firm which receives client instructions or orders through the medium of another investment firm shall remain responsible for concluding the service or transaction, based on any such information or recommendations, in accordance with the relevant provisions of this Title.

5.58  That ought to be the position in equity as well. A sub-agent that acts using discretionary agency powers ought to be subject to fiduciary duties, as appropriate in the circumstances, including the level of information that the subcontractor has about the purpose and situation of the investor. But it is not clear whether that is the position and, accordingly, an outsourcing investment firm should be careful to ensure that the subcontract is clear on the scope and content of the duties the subcontracting investment firm has to the investor.

5.59  The case of outsourcing that includes sub-agency, where the outsourcing investment firm is substituted as agent by the subcontracted investment firm as sub-agent, should be distinguished from circumstances where the investment firm appoints a co-agent to perform different functions for the investor from those performed by the appointing investment firm as agent under the original client agreement. For instance, an investment manager will have authority to appoint a broker to execute transactions for the investor. This will create a new and additional agency relationship and privity of contract between the investor and the broker by way of a new client agreement for investment services that is independent and separate from the original client agreement between the investor and the investment manager. The investment manager as the appointing agent and the broker as the additional agent are not in a sub-agency relationship. The broker is not a ‘sub-agent’, but a ‘co-agent’. Unfortunately, usage of these terms in the cases appears to be indiscriminate.130

C.  Compensatory Damages for Conduct Breaches

1.  Losses from acts or omissions of an investment firm

5.60  Given the subject matter of investment services—financial assets—the type of loss that an investor will incur is typically of a monetary nature. Therefore, although it is expected that an investor will be prompted to seek compensation (p. 218) from an investment firm if the investor suffers a loss in connection with the investment service or product, it is unlikely that an investor will have cause to seek compensation for injury to persons, property, or reputation, except, maybe, in special circumstances where the investment firm failed to keep certain matters confidential. That, however, ought to be true only in special circumstances. Normally, even in the event of breach of a duty of confidentiality, an investor will seek compensation for monetary losses in the form of an award for compensatory damages.131

5.61  The investment firm is liable to the investor to compensate for the loss if a breach of duty can be established. In general, the investor will be entitled to compensation for monetary losses that would not have been suffered but for the breach of duty, regardless whether arising in contract, negligence, or statute,132 unless that loss is too ‘remote’. The decision in Rubenstein v HSBC Bank plc,133 a case concerning negligent advice, confirmed the framework for analysis: (1) what was the scope of the duty undertaken, (2) was the loss in fact caused by the breach of that duty (causation), and (3) was the loss suffered of a type that was foreseeably likely to arise from a breach of that duty (remoteness).134

5.62  Investor claims for compensation for monetary losses incurred in connection with an investment service or product, as opposed to restitutionary or disgorgement claims, can be divided, broadly, into two categories. First, complaints may be based on competence failures of the investment firm. This category of complaint, in general terms, will seek to base a claim on an allegation that a specific investment or investment service falls short of the undertaking of the investment firm as construed under the terms of the client agreement. Second, (p. 219) complaints may be based on mis-selling, that is, the investor will allege that the investment service or investment product, as agreed, is not appropriate for the investor, that is, is unsuitable, or is otherwise not what the investor might reasonably have expected it would be. This category of complaint seeks to base a claim on misrepresentation, breach of warranty, or breach of a duty of care to advise the investor that the investment service or product is inappropriate or unsuitable.

5.63  A loss may manifest itself directly by way of a market loss, that is, a reduction in the market value of a financial asset incurred because of the alleged breach by the investment firm, or indirectly by way of an opportunity cost, that is, the cost of not having been able, because of the alleged breach by the investment firm, to have the benefit of an alternative investment, potentially more beneficial or less disadvantageous.

5.64  If liability for breach of duty can be established,135 the question is whether the loss is recoverable. A claim for damages might be circumscribed because the loss is too remote due to lack of causation or foreseeability, or because of the investor’s contributory negligence or failure to take reasonable steps to reduce the original loss or to avert further loss, that is, mitigate the loss.136 In the case of a breach by an investment firm, the difficulties will usually concern remoteness rather than contributory negligence or failure to mitigate losses. Matters pertaining to the investment service are normally within the control of the investment firm. It may be that business operations are interrupted by an external calamity, but beyond that, it is less likely that intervening events, or an act or omission of the investor, contribute to the investment firm’s breach. Equally, it is difficult to imagine circumstances that would constitute a failure of the investor to mitigate damages, although a debate might arise between the investment firm and the investor if the investor claims compensation for a loss in relation to a breach sometime after the investor became, or ought to have become, aware of that breach, and the investment firm failed to spot or recognize that breach before that time. In such a case, the investment firm might contend that the investor should have complained earlier, enabling the investment firm to rectify the situation in more advantageous market circumstances. The onus of proof is on the investment firm, which must show that the investor, as a reasonable claimant, ought to have taken steps earlier to mitigate the loss.137

(p. 220) 2.  The loss must have been caused by the breach

5.65  The act or omission must be the condicio sine qua non for the loss.138 If it can be established that the investment firm failed to perform the investment service in accordance with its duties under the client agreement and that failure constitutes a breach, it should not usually be problematic to establish that the breach is causally linked to the loss. Difficult questions of causation may arise, however, if the investor seeks to base a claim for damages on the proposition that the investment service or product, as agreed, was and is not appropriate or suitable for the investor or is otherwise not what the investor might reasonably have expected it would be, and that the investment firm is responsible for that fact. Such a claim may be based on breach of warranty, misrepresentation, or an assumption of responsibility within the meaning of Hedley Byrne.139

5.66  In the case of breach of a warranty, the causation requirement is satisfied if the plaintiff can prove that the statement was false. In the case of a misrepresentation, causation requires proof that the statement was prepared negligently, that the plaintiff relied on it, that is, that s/he would have acted differently had s/he not been given incorrect advice.140 If the claim is based on mis-selling, for example that the investment service or product was unsuitable, causation requires proof, on the balance of probabilities, of what the investor’s course of action would have been had the investor been informed that the investment service or product was unsuitable, that is, how the investor would have acted had the right information been given.141

5.67  Next, it needs to be determined to what extent subsequent development is or is not a legal consequence, that is, a consequence for which the defendant is liable, of the fact that the warranty, representation, or advice was negligent, or that the investment firm negligently failed to inform the investor. The difficulty is that in (p. 221) these cases the causative link between the wrongful act and the loss is indirect: the loss is not strictly caused by the wrongful act. The causal link is inverted: had the wrongful act not happened, the loss could have been avoided. In SAAMCO v York Montague,142 Lord Hoffman said on the matter, distinguishing between a duty of care to provide information and a warranty:143

In the case of breach of a duty of care, the measure of damages is the loss attributable to the inaccuracy of the information that the plaintiff has suffered by reason of having entered into the transaction on the assumption that the information was correct. One therefore compares the loss he has actually suffered with what his position would have been if he had not entered into the transaction and asks what element of this loss is attributable to the inaccuracy of the information. In the case of a warranty, one compares the plaintiff’s position as a result of entering into the transaction with what it would have been if the information had been accurate. Both measures are concerned with the consequences of the inaccuracy of the information, but the tort measure is the extent to which the plaintiff is worse off because the information was wrong whereas the warranty measure is the extent to which he would have been better off if the information had been right.

5.68  In matters where the purpose of the defendant’s duty is the giving of information, whether fact or professional opinion, and the plaintiff acted upon that information, or acted based on a lack of information where this should have been provided, causation is not strictly a matter of identifying the condicio sine qua non but becomes hypothetical. If the defendant negligently failed to provide information or misrepresented certain matters, the hypothetical question of causation is: in a parallel universe, what would have been the consequence if the information had prevented the plaintiff from a certain course of action? However, if the defendant had warranted that the information was correct, the hypothetical question of causation is: what would have happened had the circumstances actually been as represented? The outcome, in both cases, is still subject to the applicable tests of remoteness of damages.

5.69  Conclusions may be drawn in relation to claims based on mis-selling. If the investor can establish that the investment firm misrepresented the investment strategy as suitable, or failed to inform the investor that the investment strategy was unsuitable, the loss that the investor suffered as a result of the breach of the warranty will be deemed to be the difference between the actual value of the portfolio and the value of the portfolio the investor would have had, had it been aware that the investment strategy was unsuitable. If the investor can establish that the investment firm warranted that the investment strategy was suitable, the loss that the investor suffered as a result of the breach of the warranty will be deemed to be the difference between the actual value of the financial asset and the value it would (p. 222) have had, if the investment strategy had been suitable as represented. The method used in case of a tort could very well produce the same result as the method used in case of breach of warranty. However, in the case of a claim in tort, the investment firm could possibly prove that the investor suffered no loss because it would have chosen to invest in a financial asset that would have delivered a similar investment return.144

3.  Remoteness of damages (scope) in contract, tort, and equity

5.70  Not every loss that is causally linked to a breach of duty, whether arising in contract, tort, or equity, is eligible for compensation. The law seeks to provide compensatory rights only in relation to a loss that can be said to be within the realm of the injuring party’s legal responsibility. To that end, judicial authority has developed various tests.145

a)  Contract

5.71  In a breach of contract, where causation has been established, the principles by which to determine, in the absence of express exclusion terms, whether a particular type of loss is too remote to be eligible for compensation146 are set out in Hadley v Baxendale,147 Victoria Laundry (Windsor) Ltd v Newman Industries Ltd,148 and Koufos v C Czarnikov Ltd (‘The Heron’ II).149 Hadley v Baxendale established that the damages to which the non-defaulting party is entitled should be:

such as may fairly and reasonably be considered either as arising naturally, ie according to the usual course of things, from such breach of the contract itself, or such as may reasonably be supposed to have been in the contemplation of parties, at the time they made the contract, as the probable result of the breach of it.150

5.72  In Victoria Laundry, the plaintiffs sued for loss of profits in respect of laundry business that could not be performed because of the defendant’s failure to deliver (p. 223) a large boiler in a timely manner. The court held that what ‘was at the time reasonably so foreseeable depends on the knowledge then possessed by the parties, or at all events, by the party who later commits the breach’.151 It further held that the reasonable man could have foreseen that the delay in delivery of the boiler would cause some loss of profits, but that this did not include loss of profits relating to special circumstances that were not, or ought not to be, known to the defendant. The launderers had a material contract with a government body and the plaintiff could not recover all of the actual loss of profit relating to loss of business that corresponded to that special contract. In ‘The Heron’ II, the House of Lords discussed in extenso the concept of the scope of the matters that ought to be in the contemplation of reasonable men and concluded, on the balance of the speeches, that it is not sufficient that the loss was ‘reasonably foreseeable’ per se, but that it must be foreseeable in the sense that it must ‘not be unlikely’ to occur.152 It is clear from Hadley v Baxendale, Victoria Laundry, and ‘The Heron’ II that the defendant’s ‘knowledge’ may include knowledge of special circumstances, but that this must be actual knowledge. ‘Knowledge’ also includes ‘imputed knowledge’, being that which a reasonable person ought to understand or know to be ‘the usual course of things’.

5.73  Thus, the traditional account of the test for remoteness of damages in contract has been that the plaintiff may recover for losses which are of a type that arises ‘in the usual course of things’, and were ‘not unlikely’, unless the loss was of a type that should have been avoided by taking reasonable steps. Note that a loss may be too remote on account of its quality, not simply because the extent of the loss in quantitative terms could not reasonably have been foreseen.153 Special losses, losses arising from special circumstances beyond the reasonable prevision of parties,154 may be recoverable if the defendant can be said to have had sufficiently detailed knowledge of the special circumstances, and that there was a reasonable probability that the special kind of loss would occur in the event of a breach.

(p. 224) 5.74  The decision of the House of Lords in Transfield Shipping Inc v Mercator Shipping Inc (‘The Achilleas’), however, appears to have introduced a new facet to the remoteness test.155 In this case, the plaintiff shipowner claimed damages from the defendant charterer for failure to redeliver the chartered ship within the contractual redelivery period. With less than a fortnight of the original charter to run, the charterer hired the vessel under a sub charter. If this voyage could not reasonably have been expected to allow timely redelivery, the shipowner could probably have refused, but it made no objection. The vessel was then delayed and not redelivered to the owner until a few days after the expiry of the redelivery period. Because of the late redelivery, the owner had to renegotiate a charter rate previously agreed with a new charterer. Because, by that time, market rates had fallen, in return for an extension of the cancellation date, the shipowner agreed to reduce the rate of hire for the new fixture. The owner claimed damages for the loss of the difference between the original rate and the reduced rate over the period of that new fixture. In the first instance the case was submitted to arbitration. The arbitrators said that the loss on the new fixture fell within the rules in Hadley v Baxendale and ‘The Heron’ II as arising ‘naturally, ie according to the usual course of things, from such breach of contract itself’ because it was damage of a kind which the charterer, when making the contract, ought to have realized was ‘not unlikely to result’ from that breach. The dissenting arbitrator did not deny that a charterer would have known that the owners would very likely enter into a following fixture during the course of the charter and that late delivery might cause them to lose it, but he was of the view that a reasonable man in the position of the charterers would not have understood that he was assuming liability for the risk of the type of loss in question. The general understanding in the shipping market was that liability was restricted to the difference between the market rate and the charter rate for the overrun period and ‘any departure from this rule [is] likely to give rise to a real risk of serious commercial uncertainty which the industry as a whole would regard as undesirable’.156 Lord Hoffman notes in reply to that proposition:157

[T]here is a good deal of support in the authorities and academic writings for the proposition that the extent of a party’s liability for damages is founded upon the interpretation of the particular contract; not upon the interpretation of any particular language in the contract, but (as in the case of an implied term) upon the interpretation of the contract as a whole, construed in its commercial setting. … I agree that cases of departure from the ordinary foreseeability rule based on individual circumstances will be unusual, but limitations on the extent of liability in particular types of contract arising out of general expectations in certain markets, such as banking and shipping, are likely to be more common. There is, I think, an analogy with the distinction which Lord Cross of Chelsea drew in Liverpool City Council v Irwin [1977] AC 239, 257–258 between terms implied into all contracts (p. 225) of a certain type and the implication of a term into a particular contract. It seems to me logical to found liability for damages upon the intention of the parties (objectively ascertained) because all contractual liability is voluntarily undertaken. It must be in principle wrong to hold someone liable for risks for which the people entering into such a contract in their particular market, would not reasonably be considered to have undertaken. The view which the parties take of the responsibilities and risks they are undertaking will determine the other terms of the contract and in particular the price paid. Anyone asked to assume a large and unpredictable risk will require some premium in exchange. A rule of law which imposes liability upon a party for a risk which he reasonably thought was excluded gives the other party something for nothing.

5.75  It would appear that, in Lord Hoffman’s mind, the test is first whether the losses are reasonably foreseeable as not unlikely to arise from a particular breach, and second whether the loss in question falls within the scope of the contract, which is a question of construction, in particular, for mercantile contracts, against the commercial expectations that are common in the relevant market:158 ‘But the question of whether a given type of loss is one for which a party assumed contractual responsibility involves the interpretation of the contract as a whole against its commercial background, and this, like all questions of interpretation, is a question of law.’ The reasoning of the Court of Appeal in Rubenstein, discussed in para 5.61, confirms that a court will consider whether the breach of contract and the loss are disconnected both by an unforeseeable event as well as by the fact that the event is beyond the scope of the defendant’s duty, although in the circumstances of Rubenstein, they were not.

b)  Tort

5.76  The formula in the test for remoteness of damages in tort is similar to that in contract: ‘the essential factor in determining liability is whether the damage is of such a kind as the reasonable man should have foreseen’.159 However, Lord Reid observed in ‘The Heron’ II that the contractual test for remoteness requires a higher degree of probability than the test for remoteness in tort:160

The modern rule in tort is quite different and it imposes a much wider liability. The defendant will be liable for any type of damage which is reasonably foreseeable as liable to happen even in the most unusual case, unless the risk is so small that a reasonable man would in the whole circumstances feel justified in neglecting it; and there is good reason for the difference. In contract, if one party wishes to protect himself against a risk which to the other party would appear unusual, he can direct the other party’s attention to it before the contract is made, and I need not stop to consider in what circumstances the other party will then be held to have accepted responsibility in that event. In tort, however, there is no opportunity for the injured (p. 226) party to protect himself in that way, and the tortfeasor cannot reasonably complain if he has to pay for some very unusual but nevertheless foreseeable damage which results from his wrongdoing.

5.77  Although the tests for remoteness of damages in tort and contract both employ the concept of foreseeability, there is a difference in the manner in which the concepts operate, at least to the extent that it concerns claims for damages in tort relating to personal injuries or property rights. The gap appears to have been closed, however, in relation to claims for damages in tort relating to economic interests, that is, monetary losses, particularly if, in the circumstances, the plaintiff and the defendant are also in a contractual relationship.

5.78  In Hedley Byrne161 the House of Lords held that an action for negligence could lie in a situation where the loss is purely monetary, but the decision made it clear that in such a case foreseeability was not, of itself, enough to create the relationship of proximity that gave rise to the duty of care.162 In Caparo Industries plc v Dickman, Lord Bridge observed:163

What emerges is that, in addition to the foreseeability of damage, necessary ingredients in any situation giving rise to a duty of care are that there should exist between the party owing the duty and the party to whom it is owed a relationship characterised by the law as one of ‘proximity’ or ‘neighbourhood’ and that the situation should be one in which the court considers it fair, just and reasonable that the law should impose a duty of a given scope upon the one party for the benefit of the other.

5.79  The defendant auditors were found not to be liable for their failure to use reasonable care in auditing a company’s accounts to a plaintiff shareholder who relied on the accounts in order to make a takeover bid for the company, because they were not liable for losses, which the plaintiff suffered in a capacity as buyer, that is, a capacity other than shareholder.164 Lord Bridge’s speech in Caparo has since been generally accepted as representing the proper approach to the identification of a duty of care in the law of negligence.165

(p. 227) 5.80  In Aneco Reinsurance Underwriting Ltd (in Liquidation) v Johnson & Higgins Ltd,166 the plaintiffs wrote insurance contracts in reliance on the advice of the defendants, their brokers, that reinsurance was available on appropriate terms, but it was not. Since the plaintiffs would not have entered into the insurance contracts but for the negligent advice, had the test for remoteness of damages in tort, as quoted by Lord Reid in ‘The Heron’ II, still applied without limitation, the brokers should have been liable for the full amount of the loss on the insurance contracts even though their advice was referable exclusively to the reinsurance. Lord Millett noted that167

the law has never imposed liability for all the consequences of a defendant’s negligence. It has formulated general rules to restrict the scope of liability within acceptable limits by reference to concepts such as foreseeability and remoteness of damage. In traditional cases of negligent conduct which causes physical injury, it has seldom been found necessary to place limits on the scope of the duty of care or the extent of the defendant’s liability for the foreseeable consequences of his acts. Claims for damages for economic loss which is the result of negligent statements or advice, however, are very different. There is a potential for foreseeable but indeterminate and possibly ruinous loss by a large and indeterminate class of plaintiffs. Foreseeability of reliance alone is not a sufficient limiting factor. One response has been to limit the scope of the duty of care by reference to a test of ‘proximity’. Another has been to decline to admit new categories of liability unless it is ‘fair, just and reasonable’ to do so.

5.81  Lord Millett, citing in particular the decision in Caparo and illustrating the Caparo principle through SAAMCO v York Montague,168 and Nykredit Mortgage Bank plc v Edward Erdman Group Ltd (No 2),169 addresses the question of remoteness of (p. 228) loss through the scope of the duty of care. In respect of Aneco, he concludes that the defendant brokers assumed a duty to protect the plaintiff insurer from loss on the transaction, but only to the extent that the insurer wished to reinsure it and relied on the broker to do so, not for the full loss.170

5.82  In Customs v Barclays171 the House of Lords had to decide whether a bank served with an order freezing a customer’s account owed a duty to the claimant to take reasonable care to ensure that no payments were made out of the account. Lord Hoffman asked:172

How does one determine whether a duty of care is owed? In cases of pure economic loss such as this, it is not sufficient that the bank ought reasonably to have foreseen that unless they had proper systems in place and their employees took reasonable care to give effect to any freezing orders which came along, the beneficiaries of those orders might suffer loss. In the case of personal or physical injury, reasonable foreseeability of harm is usually enough, in accordance with the principle in Donoghue v Stevenson [1932] AC 562, to generate a duty of care. In the case of economic loss, something more is needed.

5.83  The additional factor, in the mind of Lord Hoffman, is the requirement of ‘proximity’:173

In these cases in which the loss has been caused by the claimant’s reliance on information provided by the defendant, it is critical to decide whether the defendant (rather than someone else) assumed responsibility for the accuracy of the information to the claimant (rather than to someone else) or for its use by the claimant for one purpose (rather than another). The answer does not depend upon what the defendant intended but, as in the case of contractual liability, upon what would reasonably be inferred from his conduct against the background of all the circumstances of the case. The purpose of the inquiry is to establish whether there was, in relation to the loss in question, the necessary relationship (or ‘proximity’) between the parties and, as Lord Goff of Chieveley pointed out in Henderson v Merrett Syndicates Ltd [1995] 2 AC 145, 181, the existence of that relationship and the foreseeability of economic loss will make it unnecessary to undertake any further inquiry into whether it would be fair, just and reasonable to impose liability.

5.84  What emerges from these decisions is, in the case of an economic loss resulting from a negligent statement or negligent advice, that the courts apply a test of remoteness that equates to a process of elimination based on the purpose and situation of the plaintiff and the defendant in the circumstances, after the outer boundary has been determined by reference to what the ‘reasonable person’ should have foreseen. The conceptual approach to that process of elimination, on the face of it, varies from case to case. Lord Bridge in Caparo refers to ‘proximity’ and ‘fairness’. Lord Millett in Aneco sidesteps these concepts and seeks to limit (p. 229) the type and kind of loss that may be recovered through the scope of the duty that was breached.174 Lord Hoffman contends in Customs v Barclays that ‘fairness’ follows from ‘proximity’ and defines ‘proximity’ as a function of the existing relationship between plaintiff and defendant. The defendant is liable, ‘as in the case of contractual liability’, if based ‘upon what would reasonably be inferred from his conduct against the background of all the circumstances of the case’ he can be said to have assumed responsibility for that loss. It would appear, nevertheless, that on all applications of the test in tort, ultimately, the same underlying premise operates. The loss, if foreseeable by the reasonable person, must also fit the purpose of the relationship somehow, it must correspond meaningfully to the defendant’s action or inaction in the context of the relationship with the plaintiff. So, if for example information is false or misleading, but the plaintiff used it for a purpose other than provided for, according to Caparo, or seeks to rely on it for a purpose that is outside the scope of what the defendant reasonably ought to have been understood to have assumed responsibility for, according to Aneco, the defendant will not be liable for those losses. Accordingly, although a loss might have been foreseeable and a reasonable defendant might be found to have realized that this was not unlikely to result from the breach of its duty of care, ultimately liability in tort for that loss will ‘not depend upon what the defendant intended but, as in the case of contractual liability, upon what would reasonably be inferred from his conduct against the background of all the circumstances of the case’,175 and contractual liability will depend on ‘whether a given type of loss is one for which a party assumed contractual responsibility involves the interpretation of the contract as a whole against its commercial background, and this, like all questions of interpretation, is a question of law’.176

5.85  On that basis, the conclusion must be that in a case of concurrent claims in contract and tort for damages relating to monetary losses that result from professional services that have been provided in breach of a duty of care, the tests of remoteness of damages are similar. They entail a process of elimination based on the purpose and situation of the plaintiff and the defendant in the circumstances, which are applied after the outer boundary has first been determined by reference to what the ‘reasonable person’ should have foreseen, albeit in contract ‘foreseeability’ is linked to ‘probability’. It is not obvious, considering the process of elimination, how the element of probability should lead to a different result.177

(p. 230) c)  Equity

5.86  The rules for compensation in a breach of an equitable duty of care are less obvious, but it appears that in a breach of a duty of care and skill by a professional, contractual agent, the test for remoteness of damages is not, or ought not to be, any different from the tests for remoteness applied in tort or contract. Lord Browne-Wilkinson observed in Target Holdings Ltd Respondent v Redferns (a Firm) that in a case of equitable compensation ‘the common law rules of remoteness of damage and causation do not apply’,178 that ‘foreseeability’ as such has no place in assessing a plaintiff’s monetary loss for breach of trust, and that the actual loss should be considered ‘using the full benefit of hindsight’.179 However, that matter concerned compensation for breach of trust. In Henderson Lord Browne-Wilkinson had equally put it beyond doubt that equity does not impose on a fiduciary a general duty of skill and care that is separate or different in scope from the duty that is to be found at common law.180 The equitable duty that was the subject matter of the decision in Target Holdings, that is, breach of trust, is a (p. 231) different type of equitable duty to the duty that was the subject matter of the decision in Henderson, that is, breach of a duty to apply skill and care. The conceptual approach to monetary compensation for breach of trust, that is, unauthorized dealings with the trust property by the trustee, is restitutionary in nature, and naturally requires a test that is different from the test that applies in the case of breach of duty to use skill and care, which is not special to equity.

5.87  If, according to Lord Browne-Wilkinson in Henderson, equity does not impose on a fiduciary a general duty of skill and care that is separate or different in scope from the duty that is to be found at common law, it ought to follow that neither are the rules of remoteness and causation of damages for breach of that type of equitable duty separate or different from the tests in tort or contract. Thus, Millett LJ concludes in Bristol and West, a decision of the Court of Appeal:181

Although the remedy which equity makes available for breach of the equitable duty of skill and care is equitable compensation rather than damages, this is merely the product of history and in this context is in my opinion a distinction without a difference. Equitable compensation for breach of the duty of skill and care resembles common law damages in that it is awarded by way of compensation to the plaintiff for his loss. There is no reason in principle why the common law rules of causation, remoteness of damage and measure of damages should not be applied by analogy in such a case. It should not be confused with equitable compensation for breach of fiduciary duty, which may be awarded in lieu of rescission or specific restitution.

d)  Synthesis

5.88  Based on the analyses in subsections C(3)(a) to (c), in the context of investment services, that is, a contractual service supplied by way of business by a professional, sometimes agent, it may be concluded that the test for remoteness of damages is singular and not separate or different depending on whether the duty that has been breached is sourced in contract, tort, or equity. Thus, a loss must have been a foreseeable and not unlikely result from the breach. In addition, according to ‘The Achilleas’, the loss must be one for which the investment firm assumed responsibility, which is to be construed against the commercial background and common purpose of investment management relationships.

5.89  The most foreseeable and likely loss that will occur in the event of a breach is a loss to the financial asset that is the subject matter of the client agreement.182 That loss may be absolute and manifest itself by way of a reduction in the value of the asset, and/or relative and manifest itself as an opportunity cost, that is, the cost of not having been able to make an alternative, potentially more beneficial (p. 232) or less disadvantageous, investment. The very purpose of the investment service is to acquire, sell, or manage financial assets, or advise on the same, with a view to ensuring, subject to the terms of the client agreement, that the investor is exposed to the chosen asset in accordance with the agreed objectives. Therefore, losses to the financial asset, including opportunity costs, ought to be well within the scope of the parties’ presumed contemplations.

5.90  The same cannot necessarily be said for losses that result as a consequence of the loss to the financial asset, rather than from the breach itself, unless, according to ‘The Achilleas’, the investment firm somehow assumed responsibility for that type of loss. For example, an institutional investor may incur a loss as a consequence of the fact that the loss affects the performance of duties owed by that investor to third parties in connection with the investment portfolio. An insurance company may have liabilities under a unit-linked insurance policy to its insured and may have appointed an investment manager to manage the unit-linked portfolio. Fluctuations in the value of that portfolio will affect the notional value of the corresponding insurance policies. Similarly, the investor may be a pension scheme and losses to the value of the portfolio caused by a financial advisor, broker, or investment manager might affect the manner in which the scheme is able to provide retirement benefits.

5.91  It is suggested that, although it may be common ground that a pension fund or insurance company has legal relations with clients or other third parties, and that these relations might be affected by a fluctuation in the value of the portfolio of investments, the manner in which these relations are likely to be affected is not necessarily foreseeable without an investigation by the investment firm. Therefore, as is the case in determining whether the investment firm made a misrepresentation or assumed a duty of care to ensure that a particular investment strategy is suitable, it could be unreasonable for an institutional, presumed sophisticated, investor acting in the course of its business to insist that, in appointing the investment firm, reliance was placed on an implied assumption of responsibility by the investment firm for losses other than a direct loss to the portfolio of investments.183 If such other, special, losses form an economic interest that the institutional investor wishes to be protected, that investor should make the intention explicit at the time the client agreement is concluded.

(p. 233) 4.  Quantum of damages

5.92  If it has been established that a plaintiff is entitled to compensation for a certain type of loss, damages must be assessed. Subject to certain limitations,184 the investor and the investment firm may specify in the client agreement the remedy available to the investor in the event of breach of a duty of care by the investment firm. It is not practically feasible, and therefore not common, to stipulate special or liquidated damages in relation to investment services. The reason is that the quantum of the loss will depend entirely on the circumstances of the breach, in particular, the market conditions prevailing at and after the time of the breach. The parties to an agreement for investment services will normally rely, therefore, on the general principles of the law of damages to determine the quantum. In contract, the general rule is that the plaintiff must be put in a position it would most likely have been in had the contract been performed. This implies a ‘net loss’ approach in which gains made from the breach of the duty of care are to be set off against the losses incurred.185 Similarly, in tort, the plaintiff must be put in a position it would most likely have been in had the tort not been committed. In the event of concurrence of liability for breach of a duty of skill and care in contract, tort, or indeed equity, there should be no difference in the assessment of damages.186

5.93  The most common losses that an investor will incur as a result of an investment firm’s breach of the client agreement divide into absolute losses in the form of a fall in the value of a financial asset, and relative or contingent losses in the form of opportunity costs.187 In case of an absolute loss, quantification of damages will be relatively straightforward as long as the offensive transaction, or offensive failure to conclude a transaction, can be identified. That should not present any difficulty if the investment firm made a mistake in the execution of a transaction, or if, under the terms of the client agreement, the investment firm did not have permission to effect the offensive transaction because it fell outside the scope of its agency authority. The investment firm might also fail to act in circumstances, such as where as a result of market movements the client agreement requires a portfolio manager to sell part or all of a certain holding in a portfolio and it fails to do so. In these cases, the investment firm, upon discovery of the breach, will have to remedy the situation by placing or entering corrective trades. The absolute loss can be equated to the cost of the corrective trades, that is, the difference, if negative, between the value of the offensive investment or parcel of investments (p. 234) at the date purchased, sold, or not sold, and the value of that investment or parcel at the time of the corrective trade or trades.

5.94  Quantifying the relative cost of a lost opportunity may be a much less certain affair because it will depend on certain contingencies. The investor may have a justified claim that, had the investment firm not breached the client agreement, it would have obtained a better investment return, but will face the challenge of establishing what that return would have been. In these cases, damages must be assessed as best as possible based on the available evidence.188 The question will be what the investment firm’s most likely course of action would have been, had the client agreement not been breached. The answer to that question must be decided on the ‘balance of probabilities’. Once the investor proves that, but for the breach of the client agreement, the investor, or the investment firm on behalf of the investor, would have been more likely than not to have entered into certain investment transactions, that more likely than unlikely course of action will be treated as a fact.189 This outcome is mitigated by the rule that, if the defendant had an option to perform the contract in one of several ways, damages are assessed on the basis that it would have performed in a way that would have benefited itself most, for example at the least cost to itself,190 provided that the chosen method of hypothetical performance must be reasonable in all circumstances.191 The reverse may be true as well. If it can be shown that, but for the breach, the investment firm would have delivered a worse return, the difference between the actual position of the portfolio and its hypothetical position should be set off against the loss incurred because of the offensive transaction.192


1  See Recital 90 and art 58 of Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive, [2017] OJ L87/1 (MiFID II Delegated Regulation (EU) 2017/565), but note the observation in Recital (91) of that Regulation, that the Regulation

should not require competent authorities to approve the content of the basic agreement between an investment firm and its clients. Nor should it prevent them from doing so, insofar as any such approval is based only on the firm’s compliance with its obligations under [MiFID II] to act honestly, fairly and professionally in accordance with the best interests of its clients, and to establish a record that sets out the rights and obligations of investment firms and their clients, and the other terms on which firms will provide services to their clients …

See also the rules and guidance in the Financial Conduct Authority’s (FCA) Handbook of Rules and Guidance (FCA Handbook), Conduct of Business Sourcebook (COBS), Chapter 8A.1, ‘Client agreements (MiFID, equivalent third country or optional exemption business)’.

2  Often, ‘interpretation’ and ‘construction’ are used interchangeably, but to use the term ‘construction’ as a term that refers to the process of arriving at a complete picture of the contractual duties of the parties, ie including those that are implied by law or by fact, would appear to be correct. See on the distinction between interpretation and construction, Gerard McMeel, The Construction of Contracts (OUP 2017) para 1.20 (noting that the use of the term ‘construction’ as meaning the broader process which encompasses both the interpretation of the express terms of the contract and the neighbouring technique of implication of terms, surfaced in Equitable Life Assurance Society v Hyman [2002] 1 AC 408, 458–59, see Lord Steyn). See also Hugh Beale (ed), Chitty on Contracts—General Principles (32nd edn, Sweet & Maxwell 2017) para 13-041, noting that the term ‘construction’ refers to the process by which the court determines the meaning and legal effect of a contract, which embraces oral contracts as well as those in writing, and implied terms as well as those that are expressed, but subsequently using the term in the narrower meaning of the process, observing that this process is sometimes referred to as ‘interpretation’, by which a court arrives at the meaning to be given to the express terms of the agreement.

3  Lord Wilberforce in Liverpool City Council v Irwin [1977] AC 239, 253.

4  Lord Hoffman in Investor Compensation Scheme v West Bromwich Building Society [1998] 1 WLR 896, 912.

5  Lord Hoffman, ‘The Intolerable Wrestle with Words and Meaning’ (1998) 56 South African Law Journal 656, 662. Similarly, Lord Steyn in Equitable Life (n 2) 459. See for a discussion McMeel (n 2) paras 10.05–10.09.

6  McMeel (n 2), para 10.09, citing in support Equitable Life (n 2), and Attorney-General for Belize v Belize Telecom Ltd [2009] UKPC 10, [2009] 1 WLR 1988, PC (Belize).

7  On the absence of a distinction in rules of interpretation at law or in equity, see Bank of Credit and Commerce International SA (in compulsory liquidation) v Ali [2002] 1 AC 251 (the House of Lords rejected any suggestion that there are different rules of interpretation at law and in equity). See further on this topic, McMeel (n 2) paras 1.54–1.55.

8  Total Transport Corp v Arcadia Petroleum Ltd [1998] 1 Lloyd’s Rep 351, 362. See also Chitty on Contracts (n 2) para 13-042.

9  Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749 and ICS (n 4) .

10  Lord Hoffman in ICS (n 9) 912.

11  Homburg Houtimport BV v Agrosin Private Ltd, ‘The Starsin’ [2004] 1 AC 715, 737–38 (citing, inter alia, Lord Halsbury LC in Glynn v Margetson & Co [1893] AC 351, 359).

12  See for a summary of the principles that underpin interpretation, McMeel (n 2) paras 1.190–1.199.

13  Lord Wilberforce in Liverpool City Council (n 3) 253.

14  Chitty on Contracts (n 2) para 14-001.

15  Liverpool City Council (n 3) 253–54, observing that ‘to say that the construction of a complete contract out of these elements involves a process of “implication” may be correct; it would be so if implication means supplying what is not expressed’, and identifying usage, implication in fact, and implication in law, as ‘varieties of implications which the courts think fit to make’.

16  Lord Wilberforce’s passage is discussed by McMeel (n 2) paras 9.40–9.43, identifying the first technique as custom and usage, the second as implication in fact, and the third as implication by law.

17  [2002] 1 AC 408, 459.

18  Chitty on Contracts (n 2) para 14-005, appears to avoid a distinction between implication techniques and notes that ‘in the case of terms implied in law, many such terms have become standardised for particular classes of contract, so that it is somewhat artificial to attribute them to the unexpressed intention of the parties to the particular contract in dispute. The court is, in fact, laying down a general rule of law that in all contracts of a defined type … unless the implication of such a term would be contrary to the express words of the agreement.’ Accordingly, ‘the courts do not confine themselves to a narrow test of necessity but instead can draw upon a broader range of factors, such as the reasonableness of the term, its fairness and a range of competing policy considerations.

19  See Madeleine Yates and Gerald Montagu, The Law of Global Custody (Bloomsbury 2013) para 6.16, n 3 in the context of the imposition of fiduciary duties, citing Lord Scarman in Tai Hing Cotton Mill Ltd v Liu Chong Hing Bank Ltd [1986] AC 80, 104, as saying that ‘the test of implication is necessity. … Implication is the way in which necessary incidents come to be recognised in the absence of express agreement in a contractual relationship. Imposition is apt to describe a duty arising in tort, but inept to describe the necessary incident arising from a contractual relationship’.

20  cf McMeel (n 2) paras 9.01–9.11.

21  The ‘Moorcock’ (1889) 14 PD 64, 68 implying a duty on wharfingers to provide a safe wharf for a vessel, where it was agreed that the vessel had permission to moor and discharge cargo, and noting that ‘the implication which the law draws from what must obviously have been the intention of the parties, the law draws with the object of giving efficacy to the transaction and preventing such a failure of consideration as cannot have been within the contemplation of either side’.

22  Shirlaw v Southern Foundries (1926) Ltd [1939] 2 KB 206, 227, noting that ‘prima facie that which in any contract is left to be implied and need not be expressed is something so obvious that it goes without saying; so that, if, while the parties were making their bargain, an officious bystander were to suggest some express provision for it in their agreement, they would testily suppress him with a common “Oh, of course” ’.

23  [2017] UKPC 2.

24  See for a discussion, McMeel (n 2) para 10.59.

25  Lord Wilberforce in Liverpool City Council (n 3) 254.

26  A misrepresentation renders the agreement voidable and may give rise to an action for damages, but it cannot give rise to an action for breach of contract: Jack Beatson, Anson’s Law of Contract (30th edn, OUP 2016) 141 noting that the question of whether a particular statement is a term of the contract or a representation is frequently one of considerable difficulty, and that the basis for distinction between the two has been criticized. See Chitty on Contracts (n 2) paras 7-001ff.

27  Heilbut, Symons & Co v Buckleton [1913] AC 30. See for an analysis, Chitty on Contracts (n 2) para 13-003, and Anson’s Law of Contract (n 26) 142.

28  Chitty on Contracts (n 2) paras 13-004ff.

29  Lord Hoffman in Mannai [1997] AC 749, 779.

30  Lord Hoffman in ICS (n 4) 912.

31  Heilbut, Symons (n 27) 50. Lord Steyn, ‘Interpretation: Legal Texts and their Landscape’ in Basil S Markesinis (ed), The Clifford Chance Millennium Lectures (Bloomsbury 2000) 79, 81.

32  Assurances that relate to a process that, inherently, produces unpredictable outcomes, are not to be treated as warranties: Thake v Maurice [1986] QB 644 (statement that vasectomy is irreversible not treated as a warranty).

33  See Lord Denning in J Evans & Son (Portsmouth) Ltd v Andrea Merziano Ltd [1976] 1 WLR 1078, 1081, observing that ‘when a person gives a promise or an assurance to another, intending that he should act on it by entering into a contract, and he does act on it by entering into a contract, we hold that it is binding’. See further Dick Bentley Productions Ltd v Harold Smith (Motors) Ltd [1965] 1 WLR 623 in which a statement as to the mileage of the car, which was false, was held to be a contractual term, essentially on the grounds that the dealer, who was in a position to know or find out, should have researched the matter more thoroughly before making the statement. Dick Bentley Productions was distinguished from Oscar Chess Ltd v Williams [1957] 1 WLR 370 on the ground that in Oscar Chess, the maker of the statement, a private individual selling to a professional car dealer, ‘honestly believed on reasonable grounds’ that the statement was true. See for a discussion of these two decisions Anson’s Law of Contract (n 26) 142–44.

34  See Prenn v Simmonds [1971] 1 WLR 1381, and Lord Hoffman in ICS (n 4) 913, noting that ‘the law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life’, and further in Chartbrook Ltd v Persimmon Home [2009] UKHL, holding at para 33 that it would not be consistent with English law to admit evidence of negotiation as part of the background, that may throw light on what the parties meant with language used in the contract.

35  McMeel (n 2) paras 26.14–26.41.

36  See Chitty on Contracts (n 2) para 14-045.

37  [1995] 2 AC 145, 193.

38  See McMeel (n 2) paras 9.27–9.28.

39  [1972] 2 Lloyds Rep 172, 185.

40  See Chapter 1, paras 1.44ff (on the agency powers of certain investment firms).

41  See Chapter 4, paras 4.50ff (on fiduciary duties).

42  Peter G Watts (ed), Bowstead & Reynolds on Agency (21st edn, Sweet & Maxwell 2017) paras 6-002 to 6-003.

43  Bowstead & Reynolds on Agency (n 42) paras 6-002 to 6-003.

44  Bowstead & Reynolds on Agency (n 42) paras 6-017 to 6-019.

45  Bowstead & Reynolds on Agency (n 42) para 6-022.

46  [1964] AC 465.

47  Henderson (n 37).

48  See McNair J in Bolam v Friern Hospital Management Committee [1957] 1 WLR 582, 586: a tort case, in which it was observed that in ‘a situation which involves the use of some special skill or competence, then the test as to whether there has been negligence or not is not the test of the [ordinary] man, because he has not got this special skill. The test is the standard of the ordinary skilled man exercising and professing to have that special skill’.

49  Bowstead & Reynolds on Agency (n 42) para 6-008.

50  Bowstead & Reynolds on Agency (n 42) para 6-009.

51  Bowstead & Reynolds on Agency (n 42) para 7-001.

52  Bowstead & Reynolds on Agency (n 42) para 7-001.

53  Bowstead & Reynolds on Agency (n 42) paras 7-003 to 7-004.

54  Bowstead & Reynolds on Agency (n 42) paras 7-003 to 7-004.

55  Bowstead & Reynolds on Agency (n 42) paras 7-003 to 7-004.

56  Bowstead & Reynolds on Agency (n 42) paras 7-048 to 7-050.

57  Bowstead & Reynolds on Agency (n 42) para 7-057, suggesting, at n 25, that the implication of the right to be indemnified is probably best characterized as implied based on the ‘business efficacy’ or ‘officious bystander’ tests.

58  Bowstead & Reynolds on Agency (n 42) para 7-061.

59  Appendix A specifies ‘investment services and activities’ as:

(1) Reception and transmission of orders in relation to one or more financial instruments; (2) Execution of orders on behalf of clients; (3) Dealing on own account; (4) Portfolio management; (5) Investment advice; (6) Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis; (7) Placing of financial instruments without a firm commitment basis; (8) Operation of an MTF; (9) Operation of an OTF.

60  Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (recast), [2014] OJ L173/349 (MiFID II).

61  Regulation (EU) 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) 648/2012 (MiFIR).

62  The list of MiFID II and MiFIR implementing and delegated directives, regulations, and decisions is substantial and expanding: <https://ec.europa.eu/info/business-economy-euro/banking-and-finance/financial-markets_en>,accessed 1 September 2018.>

63  See Danny Busch, ‘The Private Law Effect of MiFID I and MiFID II’, in Danny Busch and Guido Ferrarini (eds), Regulation of EU Financial Markets—MiFID II and MiFIR (OUP 2017) para 20.01.

64  Busch (n 63).

65  See Bankers Trust v Dharmala Sakti Sejahtera [1996] CLC 518. See also Gorman v British Telecommunications plc [2000] 1 WLR 2129, observing that the courts can be expected to ‘attach considerable weight’ to the content of the codes ‘drafted by those concerned with the maintenance of proper standards’, although in the circumstances, the court considered the common law duty of care to extend beyond the scope of the applicable pension regulations. See also Seymour v Caroline Ockwell & Co (a firm) [2005] EWCH 1137 (QB), commenting that ‘whilst the ambit of the duty of care owed by a financial adviser at common law is not necessarily co-extensive with duties owed by that adviser under the applicable regulatory regime, the regulations afford strong evidence as to what is expected of a competent adviser in most situations’.

66  See Alastair Hudson, The Law of Finance (Sweet & Maxwell 2013) para 25.24, suggesting that the ‘position would appear to be that the courts will consider the extent of a defendant’s common law duties by reference to the defendant’s regulatory obligations, although the defendant will not be able to limit its obligations by relying on a narrow set of obligations in the appropriate context if the common law imposes a higher requirement’.

67  See Toulson J in Brandeis Brokers Ltd v Black and Others [2001] 2 Lloyd’s Rep 359, 363 (in which the broker’s general terms of business generally referred to the rules of the then regulator of brokerage business, the SFA): ‘I accept that the parties cannot have intended to incorporate the SFA rules, holus bolus, because they contain matters which would have no bearing on the way in which Brandeis was to perform the services which it contracted to perform and could not sensibly be transposed into the contractual arrangements between the parties. But the relevant parts of the SFA rules are those which do potentially have such a bearing.’

68  See Gorman (n 65).

69  Article 69 of MiFID II concerns the supervisory powers, ie the regulator’s toolkit, such as access, audit, and information rights, as well intervention rights, sequestration and freezing rights, and removal rights. It does not address investor rights or remedies, or any other matter concerning the investor’s ability to seek compensation for loss or damage.

70  Littlewoods Retail and Others v Her Majesty’s Commissioners of Revenue and Customs (C-591/10) [2012] STC 1714; ECLI:EU:C:2012:478.

71  Genil 48, S L and Comercial Hostelera de Grandes Vinos, S L v Bankinter S A and Banco Bilbao Vizcaya Argentaria, SA (C-604/11) [2013] (CJEU); ECLI:EU:C:2013:344 para 57.

72  Busch (n 63) paras 20.03ff. Similarly, Hodge Malek and Sarah Bousfield, ‘Private Enforcement under MiFID II & MiFIR’ (2017) JBILF 485. See on the principle of effectiveness in European Union law inter alia: Takis Tridimas, The General Principles of EU Law (2nd edn, OUP 2006) 418–76; Walter van Gerven, Of Rights, Remedies and Procedures (2000) 37 CMLR 501.

73  Littlewoods (n 70).

74  See Busch (n 63) para 20.19, and Malek and Bousfield (n 72) 486.

75  Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC, [2004] OJ L145/1 (MiFID I).

76  Similarly, Malek and Bousfield (n 70) 486–87.

77  Although the provision does not specify who is entitled to compensation, the reference to loss or damage resulting from infringement would not have meaning other than in the context of the supply of an investment service to an investor.

78  Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) 1060/2009 and (EU) 1095/2010, [2011] OJ L174/1 (AIFMD).

79  Emphasis added. See Danny Busch and Lodewijk Van Setten, ‘The Alternative Investment Fund Manager Directive’ in Lodewijk Van Setten and Danny Busch (eds), Alternative Investment Funds in Europe—Law and Practice (OUP 2014) paras 1.13–1.22.

80  European Commission, Review of the Markets in Financial Instruments Directive (MiFID) (Consultation Paper, 8 December 2010) section 7.2.6.

81  Nationale-Nederlanden Levensverzekering Mij NV v Hubertus Wilhelmus Van Leeuwen (C‑51/13) [2015]; ECLI:EU:C:2015:286, discussed by Busch (n 63) para 20.16.

82  The FCA has the power, inter alia, to make rules that prescribe how an authorized person must organize and conduct their regulated business, see s 137Aff of the Financial Services and Markets Act 2000 (FSMA). Section 138G(1) FSMA requires the FCA (or Prudential Regulatory Authority, as the case may be) to make the rules by way of a written instrument, defined in s 138G(2) as a ‘rule-making instrument’, which see s 138G(4) is published ‘in the way appearing to the [FCA] to be best calculated to bring it to the attention of the public’. The FCA publishes the rule-making instruments, as well as other regulations such as general guidance and codes, at <http://www.fca.gov.uk>. To facilitate access, the FCA, and previously its predecessor, the FSA, consolidates the rule-making instruments in a single rulebook, the FCA Handbook of Rules and Guidance. The FCA’s Handbook is updated daily and made available at <http://www.fca.gov.uk>. In practice, the Handbook, and not the underlying rule-making instruments, is predominantly used as the source for the FCA’s rules.

83  Financial Services Authority, Reforming Conduct of Business Regulation (Consultation Paper No 06/19, 2006) paras 6.62–6.67.

84  Principle 6 required (and still requires) an authorized firm to pay due regard to the interests of its customers and treat them fairly. The Principles of Business are part of the, then FSA, now FCA Handbook. See for a discussion of the best interest rule under art 24 of MiFID II Chapter 4, paras 4.42ff.

85  As provided for at that time in art 19(1) of MiFID I and implemented through the Principles of Business and COBS.

86  Financial Services Authority, Reforming Conduct of Business Regulation (Policy Statement 07/6, 2007) para 6.7.

87  See Chapter 4, paras 4.03ff (on misrepresentation) and paras 4.11ff (on assumption of responsibility).

88  The FSMA definition of ‘private person’ must be contrasted with the MiFID II definition of ‘retail client’. As described in the Glossary Chapter 1, para 1.65, a ‘retail client’ in MiFID II terms may include bodies corporate and governmental (local) authorities, which the English courts have proved reluctant to bring into the definition of ‘private person’, see George Walker and Robert Purves (eds), Financial Services Law (4th edn, OUP 2018) para 19.52.

89  Section 138D(2) FSMA.

90  Section 138D(3) FSMA.

91  See s 138D(6) and the definition of ‘private person’ in Regulation 3 FSMA 2000 (Rights of Action) Regulations 2001, SI 2001/2256.

92  Section 138D(4) FSMA.

93  See Regulation 6(3) Financial Services and Markets Act 2000 (Rights of Action) Regulations 2001, SI 2001/2256.

94  Paul Marshall, ‘Humpty Dumpty is Broken: “Unsuitable” and “Inappropriate” Swaps Transactions’ (2014) December JIBFL 679, 680.

95  [2014] EWHC 3034 (Ch), in which the court found that the bank had assumed a responsibility, see Hedley Byrne, to advise on the suitability of the proposed swap transaction and that the advice was given negligently, but that the banks were not liable because ‘they successfully excluded any duty not to do so’.

96  See Anson’s Law of Contract (n 26) 361, observing that ‘insurance companies frequently insert a “basis of the contract” clause in the proposal form by which the proposer is made to warrant the accuracy of the information supplied by him to the insurer’.

97  See Chapter 4, paras 4.42ff (on the duty of an investment firm under art 24(1) of MiFID II to act fairly in the investor’s best interest).

98  European Banking Authority, EBA Draft Guidelines on Outsourcing arrangements (Consultation Paper No EBA/CP/2018/11, 2018) 7, section 5. The EBA’s guidelines matter to investment firms within the meaning of art 4(1)(1) of MiFID II that also are in scope of the definition of ‘institutions’ within the meaning of Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC, [2013] OJ L176/338 (Capital Requirements Directive Mk IV, CRD IV) and Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) 648/2012 (Capital Requirements Regulation, CRR) and, therefore, are subject to prudential supervision under CRD IV and CRR, see art 3(1)(3) CRD IV in conjunction with art 4(1)(2)(c) CRR, ie investment firms that are authorized to provide the ancillary service referred to in point (1) of Section B of Annex I to MiFID II (safekeeping and administration of instruments), which deal on own account, underwrite, or place instruments, or that are permitted to hold money or securities belonging to their clients.

99  EBA (n 98) 18, section 11, definition of ‘outsourcing’: ‘an arrangement of any form between an institution, a payment institution or an electronic money institution and a service provider by which that service provider performs a process, a service or an activity, or parts thereof that would otherwise be undertaken by the institution, the payment institutions or the electronic money institution itself’.

100  That matter is within the purview of business continuity requirements; see art 21(3) of Delegated Regulation (EU) 2017/565.

101  See EBA (n 98) 23, s 23, and art 30(2) of Delegated Regulation (EU) 2017/565.

102  Delegated Regulation (EU) 2017/565, art 30(2)(b).

103  Article 16(5) of MiFID II.

104  Article 30(1) of Delegated Regulation (EU) 2017/565.

105  See EBA (n 98) 17, s 5, and 22, section 22.

106  Such as the requirement: to be able to take the critical function back in-house or transfer it to another firm, EBA (n 98) 26, section 32 under (g); to have a documented exit plan, EBA (n 98) 25, section 34(e)(ii); and put substantial contractual controls in place, EBA (n 98) 37ff, sections 62ff.

107  Recital (43) of Delegated Regulation (EU) 2017/565.

108  See Anson’s Law of Contract (n 26) 712, citing Lord Greene MR in Davies v Collins [1945] 1 All ER 247, 249 who said:

In many contracts all that is stipulated for is that the work shall be done and the actual hand to do it need not be that of the contracting party himself; the other party will be bound to accept performance carried out by someone else. The contracting party, of course, is the only party who remains liable. He cannot assign his liability to the sub-contractor, but his liability in those cases is to see that the work is done, and if it is not properly done, he is liable.

109  Art 31(1)(b) of Delegated Regulation (EU) 2017/565.

110  See paras 5.36ff above.

111  Chitty on Contracts (n 2) para 18-001.

112  See McMeel (n 2) paras 16.28ff.

113  Chitty on Contracts (n 2) para 18-093.

114  Article 26 of MiFID II (Provision of services through the medium of another investment firm); COBS 2.4.3R (Agent as client).

115  See n 114.

116  Beswick v Beswick [1968] AC 58 (a majority of the House of Lords did not permit the promisee’s estate to recover damages as it had suffered no loss).

117  [1975] 1 WLR 1468 (Lord Denning upheld the award saying that the claimant promisee could recover damages in respect of the third-party beneficiaries’ loss as well as in respect of his own).

118  [1980] 1 WLR 277. See for criticism of the general rule: Chitty on Contracts (n 2) para 8-053.

119  See paras 5.36ff above (on exclusion of liability).

120  See Chapter 4, paras 4.42ff (on art. 24(1) of MIFID II and the duty of the investment firm to act fairly in the best interest of the investor).

121  Chitty on Contracts (n 2) para 18-054.

122  Anson’s Law of Contract (n 26) 472.

123  Contracts of services are normally personal to the contracting parties: Anson’s Law of Contract (n 26), citing Nokes v Doncaster Amalgamated Collieries Ltd [1940] AC 1014.

124  Bowstead & Reynolds on Agency (n 42) para 5-001.

125  Bowstead & Reynolds on Agency (n 42) para 5-001.

126  Bowstead & Reynolds on Agency (n 42) para 5-011.

127  Bowstead & Reynolds on Agency (n 42) para 5-012.

128  Bowstead & Reynolds on Agency (n 42), citing JD Wetherspoon Plc v Van De Berg & Co Ltd [2009] EWHC 639 (Ch) [77].

129  Bowstead & Reynolds on Agency (n 42) para 5-012, citing In Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134, in which the directors of the claimant company were held capable of approving a profit made by the company’s solicitor, even though they could not retain their own profits.

130  Bowstead & Reynolds on Agency (n 42) para 5-010.

131  ‘Compensatory damages’ may generally be defined as monetary compensation for a civil wrong (i.e. a tort or a breach of contract): James Edelman, Jason Varuhas, and Simon Colton, (eds), McGregor on Damages (20th edn, Sweet & Maxwell 2017) para 1-001. Three categories of claims that provide monetary awards if pursued successfully are not characterized as ‘damages’ because they are not dependent on wrongdoing: “These are actions for money payable by the terms of a contract, actions for restitution based on unjust enrichment, and actions under statutes where the right to recover is independent of any wrong”, see: ibid para 1-004. Compensatory damages must be distinguished from restitutionary and disgorgement damages based on tort, breach of contract, or equitable wrong, seeking restitution of a benefit or profit greater than the claimant’s loss, if anys: ibid para 1-009.

132  Lord Diplock in Albacruz (Cargo Owners) v Albazero (Owners), The Albazero [1977] AC 774, 841C, surmising that the ‘general rule in English law today as to the measure of damages recoverable for the invasion of a legal right, whether by breach of contract or the commission of a tort, is that damages are compensatory. Their function is to put the person whose right has been invaded in the same position as if it had been respected so far as the award of a sum of money can do so’.

133  [2012] EWCA 1184. See for a discussion of the decision of the Court of Appeal in this case that the loss caused by the market downturn of 2008 and 2009 was not too remote, Chapter 7, paras 7.84ff.

134  See Gerard McMeel and John Virgo (eds), McMeel and Virgo on Financial Advice and Financial Products (3rd edn, OUP 2014) para 18.41.

135  It being accepted that in defining a duty of care, whether in contract or in tort, it is not always easy to distinguish between matters pertaining to the scope of the duty, and matters pertaining to the scope of the damages, where formulation of the duty often seems to be a function of determining which types of loss ought to be losses from which the defendant owed a duty of care to protect the claimant. See also McGregor on Damages (n 131) para 6-002.

136  McGregor on Damages (n 131) para 6-011ff.

137  Chitty on Contracts (n 2) para 26-089.

138  McGregor on Damages (n 131) para 8-005ff.

139  See Chapter 4, paras 4.11ff (on liability for assumption of responsibility).

140  See Chapter 4, paras 4.03ff (on liability for misrepresentation).

141  See Millett LJ in the decision of the Court of Appeal in Bristol and West [1998] Ch 1, 11:

In considering the issue of causation in an action for negligence brought by a client against his solicitor it appears from Downs v Chappell that it is necessary to distinguish between two different kinds of case. Where a client sues his solicitor for having negligently failed to give him proper advice, he must show what advice should have been given and (on a balance of probabilities) that if such advice had been given he would not have entered into the relevant transaction or would not have entered into it on the terms he did. … Where, however, a client sues his solicitor for having negligently given him incorrect advice or for having negligently given him incorrect information, the position appears to be different. In such a case, it is sufficient for the plaintiff to prove that he relied on the advice or information, that is to say, that he would not have acted as he did if he had not been given such advice or information. It is not necessary for him to prove that he would not have acted as he did if he had been given the proper advice or the correct information. This was the position in Downs v Chappell [1997] 1 WLR 426.

142  [1997] AC 191.

143  SAAMCO v York Montague (n 142) 216.

144  See Lord Hoffman in SAAMCO v York Montague (n 142) 218, noting in relation to a valuer’s liability for providing a lender with a wrong valuation report,

I say this only because in practice the alternative transaction which a defendant is most likely to be able to establish is that the lender would have lent a lesser amount to the same borrower on the same security. If this was not the case, it will not ordinarily be easy for the valuer to prove what else the lender would have done with his money. But in principle there is no reason why the valuer should not be entitled to prove that the lender has suffered no loss because he would have used his money in some altogether different but equally disastrous venture. Likewise the lender is entitled to prove that, even though he would not have lent to that borrower on that security, he would have done something more advantageous than keep his money on deposit.

145  McGregor on Damages (n 131) paras 8-005ff.

146  Chitty on Contracts (n 2) para 26-119.

147  (1854) 9 Ex 341.

148  [1949] 2 KB 528 (CA).

149  [1969] 1 AC 350 (HL).

150  (1854) 9 Ex 341, 354.

151  Victoria Laundry (n 148) 539.

152  See the discussion in Chitty on Contracts (n 2) paras 26-119ff.

153  Brown v KMR Services Ltd [1995] 4 All ER 598 (the Court of Appeal rejected the argument of the defendant/insurance underwriters that the scale of the financial disaster was unforeseeable).

154  The terminological relationship between ‘special damages’ and ‘consequential losses’, remains elusive: see McGregor on Damages (n 131) para 3-008, suggesting, in the context of contracts and torts concerning property, a division between normal losses and consequential losses, the former being a loss that every claimant in a like situation will suffer, and the latter a loss that is special to the circumstances of the particular claimant. In contract, a normal loss is typically the loss that corresponds to the diminished value of the goods or services that were not provided at all, provided late, or that were defective. The distinction is not the same as that between the first and second rule of Hadley v Baxendale, as a consequential loss within this meaning may very well be a loss that fits within the first rule. However, the available judicial authorities equate consequential losses, so far, to losses within the second rule: ibid para 3-009. The matter is mostly discussed in the context of exclusion clauses. As to services, it may be asked, using this definition, whether perhaps all losses are consequential losses, thus rendering the term less useful. In the present book, the term ‘special losses’ or ‘special damages’ is used within the meaning of the second rule in Hadley v Baxendale.

155  [2008] UKHL 48, [2008] 3 WLR 345.

156  Quoted by Lord Hoffman in ‘The Achilleas’ [2008] 3 WLR 345, 348.

157  ‘The Achilleas’ (n 156).

158  ‘The Achilleas’ (n 156) 353–54.

159  Overseas Tankership (UK) ltd v Morts Dock & Engineering Co Ltd (‘The Wagon Mound’) [1961] AC 388, 426.

160  ‘The Heron’ II (n 149) 386.

161  Hedley Byrne (n 46).

162  Phillips LJ on the meaning of Hedley Byrne in Reeman and Anor v Department of Transport [1997] PNLR 618, 624.

163  [1990] 2 AC 605, 617.

164  Caparo (n 163) 627, Lord Bridge concluding on the basis that it ‘is never sufficient to ask simply whether A owes B a duty of care. It is always necessary to determine the scope of the duty by reference to the kind of damage from which A must take care to save B harmless.’

165  Phillips LJ in Reeman [1997] PNLR 618, 625. See also the speech of Lord Bingham in Customs v Barclays [2007] 1 AC 181, 189–90, noting, on the matter of the test of tortious liability in negligence for pure financial loss, that the

parties were agreed that the authorities disclose three tests which have been used in deciding whether a defendant sued as causing pure economic loss to a claimant owed him a duty of care in tort. The first is whether the defendant assumed responsibility for what he said and did vis-à-vis the claimant or is to be treated by the law as having done so. The second is commonly known as the threefold test: whether loss to the claimant was a reasonably foreseeable consequence of what the defendant did or failed to do; whether the relationship between the parties was one of sufficient proximity; and whether in all the circumstances it is fair, just and reasonable to impose a duty of care on the defendant towards the claimant (what Kirby J in Perre v Apand Pty Ltd (1999) 198 CLR 180, para 259, succinctly labelled ‘policy’). Third is the incremental test, based on the observation of Brennan J in Sutherland Shire Council v Heyman (1985) 157 CLR 424, 481, approved by Lord Bridge of Harwich in Caparo Industries plc v Dickman [1990] 2 AC 605, 618.

166  [2002] 1 Lloyd’s Rep 157.

167  Aneco Reinsurance (n 166)188.

168  SAAMCO v York Montague (n 142) in which the plaintiff lender sued a defendant valuer for providing the lender with a negligent overvaluation of the property offered as security for a loan. It was not disputed that, had it known the true value of the property, the lender would not have lent. Further, a fall in the property market after the date of the valuation greatly increased the lender’s ultimate loss. Lord Hoffman considered (211) that a ‘plaintiff who sues for breach of a duty imposed by the law (whether in contract or tort or under statute) must do more than prove that the defendant has failed to comply. He must show that the duty was owed to him and that it was a duty in respect of the kind of loss which he has suffered. Both of these requirements are illustrated by Caparo Industries plc v Dickman [1990] 2 AC 605’.

169  [1997] 1 WLR 1627 in which Lord Nicholls (1631) said that the defendant ‘is not liable for all the consequences which flow from [the plaintiff] entering into the transaction. He is not even liable for all the foreseeable consequences. He is not liable for consequences which would have arisen even if the advice had been correct. He is not liable for these because they are the consequence of the risks [the plaintiff] would have taken upon himself even if the … advice had been sound. As such they are not within the scope of the duty owed to [the plaintiff] by [the defendant].’

170  Aneco Reinsurance (n 166) 197.

171  Customs v Barclays (n 165).

172  Customs v Barclays (n 165) 198.

173  Customs v Barclays (n 165) 199.

174  A position already taken by Lord Millett in an earlier case, Bristol & West [1998] Ch 1, [12] who noted that ‘in this class of case the plaintiff must prove two things: first, that he has suffered loss; and, secondly, that the loss fell within the scope of the duty he was owed. In the present case the society must prove what (if any) loss was occasioned by the arrangements which the purchasers had made with the bank.’

175  See Lord Hoffman in Customs v Barclays (n 165).

176  See Lord Hoffman in ‘The Achilleas’ (n 156).

177  See also the argument put forward by John Cooke and David Oughton, The Common Law of Obligations (3rd edn, OUP 2000), 300, observing that as ‘the policy of common law appears to be more generous to a plaintiff suffering physical harm as opposed to one suffering financial loss, the Wagon Mound (n 159) rule might not be appropriate. The most likely rule would appear to be a version of “The Heron” II test involving the foreseeability of a loss to a substantial degree of probability’. It would appear from the decisions in Customs v Barclays and ‘The Achilleas’ that Lord Hoffman agrees, although the test is to be one of reasonable assumption of responsibility, construed against the background of the conduct of the plaintiff and the defendant, and all other relevant facts.

178  [1996] AC 421, 434.

179  Lord Browne-Wilkinson, Target Holdings (n 178) 438–39:

[citing McLachlin J in Canson Enterprises Ltd v Boughton & Co (1991) 85 DLR (4th) 126] at p. 163: ‘In summary, compensation is an equitable monetary remedy which is available when the equitable remedies of restitution and account are not appropriate. By analogy with restitution, it attempts to restore to the plaintiff what has been lost as a result of the breach, ie, the plaintiff’s loss of opportunity. The plaintiff’s actual loss as a consequence of the breach is to be assessed with the full benefit of hindsight. Foreseeability is not a concern in assessing compensation, but it is essential that the losses made good are only those which, on a common sense view of causation, were caused by the breach.’ (Emphasis added.) In my view this is good law. Equitable compensation for breach of trust is designed to achieve exactly what the word compensation suggests: to make good a loss in fact suffered by the beneficiaries and which, using hindsight and common sense, can be seen to have been caused by the breach.

180  Henderson (n 37) 205, saying that the

liability of a fiduciary for the negligent transaction of his duties is not a separate head of liability but the paradigm of the general duty to act with care imposed by law on those who take it upon themselves to act for or advise others. Although the historical development of the rules of law and equity have, in the past, caused different labels to be stuck on different manifestations of the duty, in truth the duty of care imposed on bailees, carriers, trustees, directors, agents, and others is the same duty: it arises from the circumstances in which the defendants were acting, not from their status or description. It is the fact that they have all assumed responsibility for the property or affairs of others which renders them liable for the careless performance of what they have undertaken to do, not the description of the trade or position which they hold.

Lord Browne-Wilkinson’s speech is cited in agreement by Millett LJ, in Bristol and West [1997] 2 WLR 436, [1998] Ch 1, 16.

181  [1998] Ch 1, 17.

182  See paras 5.60ff above (on manifestation of losses).

183 The Achilleas’ [2008] 3 WLR 345; see also paras 3.85ff. Support for this approach can be found in Lord Hoffman’s considerations in SAAMCO v York Montague (n 142) 211–14, observing that, although it had been established that the plaintiff lender would not have entered into the loan had the defendant valuer provided him with a correct valuation, the law does not ‘penalise wrongful conduct by shifting on to the wrongdoer the whole risk of consequences which would not have happened but for the wrongful act’.

184  For example, the law on penalties and certain statutory controls such as the Unfair Contract Terms Act 1977; see Chitty on Contracts (n 2) para 26-001.

185  See Chitty on Contracts (n 2) para 26-001, citing Robinson v Harman (1848) 1 Exch 850, 855; Livingstone v Rawyards Coal Co (1880) 5 App Cas 25, 39; and British Westinghouse Electric and Manufacturing Co Ltd v Underground Electric Railways Co of London Ltd [1912] AC 673, 688–89.

186  cf Cooke and Oughton (n 177) 326.

187  See paras 5.60ff (on manifestation of losses).

188  Tai Hing Cotton Mill Ltd v Kamsing Knitting Factory [1979] AC 91, 106. See also Chitty on Contracts (n 2) para 26-007.

189  Chitty on Contracts (n 2) para 26-042, citing Davies v Taylor [1974] AC 207, 213 (a tort case).

190  Chitty on Contracts (n 2) para 26-048.

191  Paula Lee Ltd v Robert Zehil & Co Ltd [1983] 2 All ER 390.

192  Chitty on Contracts (n 2) para 26-001, referring to the ‘net loss’ approach. See also Lord Hoffman in SAAMCO v York Montague (n 142) 218, noting on the point of the likely outcome of an alternative transaction, that ‘in principle there is no reason why the valuer should not be entitled to prove that the lender has suffered no loss because he would have used his money in some altogether different but equally disastrous venture’.