Alleged mis-selling with a trusts twist – extra risks for banks in providing “one stop shop” services for wealthy individuals?
Wealthy individuals maintain a private banking account, through which they buy high risk investment products on margin. The markets then fall. The assets held in the account fall in value. Margin calls are made by the bank. The wealthy individuals then allege that the bank should not have sold such products to them.
Such allegations of investment mis-selling on a bank’s part were common in the years after the 2008 global financial crisis. However, in the recent Hong Kong Court of Appeal (“CA”) ruling of Zhang and others v DBS and others, the wealthy individuals who incurred investment losses instituted breach of trust-related claims instead.
The background to this case involves much detail. More salient aspects include:
- For tax and various other asset protection reasons, a married couple engaged the Defendant bank (“Bank”) and various trustee and corporate services entities under it to assist in setting up a corporate and trust structure for holding the Husband’s and the Wife’s account (“Account”) with the Bank. The husband (“Husband”) was a senior banker with leading international banks, and the wife (“Wife”) held a postgraduate degree in economics.
- The Account was held in the name of a BVI company (“Company”). At relevant times, the Company was held by a trust (“Trust”). The Company’s director was the Bank’s BVI corporate services entity (“BVI Corporate Services”). However, the Wife was appointed as the Company’s “investment advisor”, and she made investment and credit utilisation decisions on the Company’s behalf in respect of the Account.
- The Trust had the Bank’s trustee services entity as its trustee (“Trustee”). The deed governing the operation of the Trust stated that, in various ways, the Trustee had no obligation to get involved in or inquire into the affairs and decisions of the Company save where the Trustee knows of dishonesty in the Company’s affairs. There were also various indemnities in favour of the Trustee and the BVI Corporate Services in respect of losses incurred by them.
- Nonetheless, the Trustee gave evidence conceding that this was “subject, however, always to the Trustee’s overarching supervision, regular monitoring and responsibility to ensure the value represented by the overall trust fund was subject to appropriate controls, reviews, investment expertise and management”.
- The Bank’s Hong Kong corporate services entity (“HK Corporate Services”) assisted the Trustee and BVI Corporate Services as the entity with which the Wife had day to day dealings on trust and Company issues.
- On the Wife’s instructions as investment advisor, the Company engaged in increasingly high risk investments through the Account during the course of 2008, as well as seeking higher margin facilities with the Bank. The 2008 global financial crisis then took place. Asset values in the Account fell, and the Bank made its margin calls. Significant losses were ultimately incurred in the Account.
- The Husband, the Wife, the Trust’s new trustees and the Company sued (i) the Trustee and BVI Corporate Services for breach of trust/fiduciary duties; and (ii) the Bank, HK Corporate Services and their various senior employees for knowingly assisting in the Trustee’s and BVI Corporate Services’ breaches. At trial, the first claim was upheld in so far as that related to the Company’s engaging in high risk investments and margin lending in 2008 was concerned, but the second claim failed. Appeals were lodged by the unsuccessful parties in each of these claims.
The CA ruling (“Ruling”)
The CA dismissed both sets of appeals. The Ruling analysed the law on the duties of trustees and directors, as well as the proper legal scope and limits of any exemptions from their liability in some detail. In very broad terms, the CA held that:
- The provisions in various agreements limiting the role and obligations of the Trustee and BVI Corporate Services were valid. Nonetheless, there still existed a residual, high level supervisory duties to exercise powers to intervene in the Company’s investment choices in circumstances where any reasonable trustee or director would have intervened. Such duties cannot be excluded (and the Trustee and BVI Corporate Services did not seek to so exclude) by agreement.
- In this case, the high risk investments and increases in margin facilities in the Account during 2008 were clearly not in the Company’s best interests. The Trustee and BVI Corporate Services in their roles therefore had duties to intervene and act as checks against Wife’s decisions as the Company’s investment advisor.
- The trial judge’s decision to award equitable compensation, essentially to restore the Account to its position had various 2008 investments and credit utilisations had not taken place, should be upheld.
- The various indemnities relied on by the Trustee and BVI Corporate Services were not applicable to the losses in question, with those provisions being interpreted narrowly.
- The Plaintiffs’ claim that the Bank, HK Corporate Services and various individual employees knowingly assisted the Trustee’s and BVI Corporate Services’ breaches fails due in large part (though not entirely) to the lack of any finding of dishonesty on the part of the Trustee and BVI Corporate Services.
When providing ancillary services to clients creates additional liability risks
Arguably, trustee and corporate services do not form the core services of a bank. However, where wealthy clients wish to hold assets in a bank account through specific trust or corporate structures for tax or other reasons, it is natural for a bank to seek to make such services available.
These services are typically charged at relatively low levels when compared with the value of high net worth clients’ underlying assets held with the bank. This reflects the reality that, on a day to day level, such services tend more often than not to be perceived by clients (though that is by no means the case as a matter of fact) to be administrative in nature.
However, the Ruling adds to risks for banks in providing such services through trustee and corporate services entities in at least two ways:
- This case involved two individual Plaintiffs whose backgrounds suggest that they were sophisticated investors, with an evolving history of demonstrating a healthy appetite for risk. Thus, if the Account was held by them as individuals, it is by no means clear that any attempt to allege mis-selling on the Bank’s part would necessarily succeed. However, where clients hold a bank account through structures similar to those found in this case (and such structures were described in the Ruling as “common”), the Ruling shows that banks’ trustee and corporate services provide an additional line of attack for disgruntled clients seeking compensation.
- Legally speaking, remedies in equity (to which claims such as breaches of trust and fiduciary duties apply) are wider in scope than remedies in common law (to which typical mis-selling claims such as negligence, breach of contract and misrepresentation apply). The latter is limited to losses which are not too “remote” from the breaches in question in a way that the former is not. While the extent to which equitable and common law remedies would in fact be materially different in cases involving investment losses is open to debate, the legal risk of payouts on equitable claims being larger than common law claims remains live.
Does the Ruling (if it is not appealed or if any further appeal is dismissed) mean that banks should cease offering ancillary trust and corporate services? In a world where clients increasingly expect “one stop shop” services, it may not always be straightforward or desirable for banks that are already providing such services to exit from these lines of ancillary business.
As noted above, where banks continue to provide such services, the Ruling appears to suggest that banks’ trustee and corporate services arms carry more liability risks than in the past. Further, even with the existence of valid contractual and trust deed provisions that limit the scope of their duties, these lines of business may now be expected, in practice, to be even more pro-active in supervising the investment decisions of nominally corporate accounts held by a trust. Subject to competitive pressures, these additional liability risks arguably provide reasonable justification for banks to re-consider the pricing for providing such ancillary services.