Secure Capital SA v Credit Suisse AG

The Defendant (“Credit Suisse”) applies for summary judgment and/or to strike out the claim made by the Claimant (“Secure Capital”). The claim relates to 8 longevity contingent notes, 4 coupon and 4 zero coupon, issued by Credit Suisse in 2008 (“the Coupon Notes” and “the Zero Notes”, together “the Notes”). The Notes are governed by English law and are in bearer form.

The Notes were linked to life insurance policies which meant that the prospect of the holder of the notes receiving any redemption payment for the Notes depended on mortality rates among a set of “reference lives” to which the relevant life insurance policies related.

The issuance documentation incorporated into the Notes included a term that Credit Suisse had taken all reasonable care to ensure that the information provided in the pricing supplement taken together with the other issue documentation was accurate and that there were no material facts the omission of which would make any statements contained in the relevant documents misleading (“the misleading statements term”). Secure Capital contends that the information provided in the issuance documents was misleading because a material fact was omitted, namely that the mortality tables used to generate the estimated life expectancies were shortly to be updated in a way that would significantly increase life expectancies rendering the Notes effectively worthless. It is alleged that Credit Suisse knew or ought to have known this but failed to disclose it and was therefore in breach of the misleading statements term and that Secure Capital can bring a claim for damages for breach of that term of the Notes.

Secure Capital’s claim is based on Article 8 of Luxembourg law dated August 2001 on the circulation of securities (the “2001 Law”). Secure Capital’s position is that it is entitled to exercise the rights linked to the possession of the Notes, including, so it contends, the right of the bearer to bring an action for a breach of a term of the Notes, pursuant to Article 8 of the 2001 Law.

Credit Suisse contends that Secure Capital’s claim is misconceived. Secure Capital is not the bearer of the Notes, and accordingly is not in a contractual relationship with Credit Suisse. The claim it seeks to bring is a contractual claim and is governed by English law being the contractually chosen applicable law. Luxembourg law in general and the 2001 Law in particular are irrelevant to any such claim. As a matter of English law there is no basis on which Secure Capital is entitled to claim under contracts to which it is not a party. The claim should accordingly be dismissed or struck out.

Credit Suisse’s Nassau branch issued the Coupon Notes on 21 July 2008 and the Zero Notes on 25 August 2008. Both parties approached the application on the basis that, in so far as relevant to the issues in dispute, all of the Notes were in materially the same terms.

The Notes are supported by an Agency Agreement between Credit Suisse and JPMorgan entities dated 2 August 2006, and a Deed of Covenant by Credit Suisse also dated 2 August 2006. The Deed of Covenant provides a direct right against Credit Suisse in limited circumstances (not present in this case) to a ‘Relevant Account Holder’ (clause 2): essentially an entity holding a securities account with Euroclear/Clearstream in which there is an entry relating to the security (in this case RBS Global Banking (Luxembourg) SA (“RBSL”)).

The amounts payable by Credit Suisse under the Notes on final redemption are determined by the mortality of the ‘Reference Individuals’. If mortality is above the ‘Mortality Attachment Point’, the size of the return is relative to the number of mortalities up to the ‘Maximum Mortality Payment’. Information regarding the ‘Reference Individuals’ is attached to the Pricing Supplement. This includes a life expectancy quote from 21st Services (as ‘Life Expectancy Provider’), with the date of the relevant quote. Secure Capital alleges that when Credit Suisse issued the Notes in July and August 2008 it failed to disclose that 21st Services intended to revise its tables, as it did in September 2008. Secure Capital says this breached the “misleading statements term” in the Pricing Supplement.

The Notes were deposited with a common depository (Bank of New York Mellon (“BNYM”)), which (as is common ground) is and remains the bearer of the Notes, and therefore the only contractual counterparty of Credit Suisse under the Notes.

The common depository holds the securities on behalf of the clearing system (in this case Clearstream). Any subsequent dealing takes place by way of book entries between accounts. An account holder of the clearing system may sell an entry in its security account to another account holder, the effect of which is simply to debit the seller’s security account and credit the buyer’s security account. The buyer’s right is against the clearing system, which in turn has a right against the common depository. Payments made under the underlying securities are made to the bearer/common depository, and then passed onto the clearing system for the credit of the account holder.

On 7 July 2008 and 8 August 2008 respectively (pre-issue), Prometeo Investment Services SA (“Prometeo”) agreed to acquire (through the clearing system) the Coupon Notes and the Zero Notes from Credit Suisse Securities (Europe) Ltd (“CSSEL”). It is Secure Capital’s case that RBSL acquired Prometeo’s interest on 21 July 2008 (the Coupon Notes) and 25 August 2008 (the Zero Notes), and that RBSL holds its interest in its Clearstream account as custodian for Secure Capital.

Each Note is represented by a Permanent Global Security document (“PGS”). The PGS states that it is “a bearer document and negotiable accordingly”. It states that it is freely transferable by delivery “and such transfer shall operate to confer upon the transferee all rights and benefits appertaining hereto...”. The PGS states that “This Permanent Global Security shall be governed by and construed in accordance with English law”.

The PGS was subject to the Conditions which were defined to comprise the Programme Memorandum, the Product Supplement and the Pricing Supplement.

The Programme Memorandum is dated some 2 years before the Notes, and is a set of standard terms on which Credit Suisse would issue notes of different descriptions. The Programme Memorandum referred to the possibility of there being different tranches of note which together would form a series although in this case each Note was in one tranche equal to the total amount of the Note.

The main features of the Programme Memorandum are:

The PGS would be deposited with a common depository for Clearstream, Euroclear or another agreed clearing system. In this case Clearstream was the relevant clearing and settlement system for the Notes. Clearstream would credit each purchaser of the Notes with a nominal amount of the Notes.

The securities were fungible.

Title would pass by delivery to the bearer of a bearer security, and the holder would “be deemed to be and may be treated as its absolute owner for all purposes”.

It was provided that “the Securities are governed by, and shall be construed in accordance with, English law”, and the English court had jurisdiction.

Each person shown in the records of Clearstream must look solely to Clearstream “for his share of each payment made by the Bank and in relation to all other rights arising under the Global Securities, subject to and in accordance with the respective rules and procedures of ... Clearstream”. This provision is sometimes called the “no look through” provision. It was subject to the rules and procedures of Clearstream.

So long as Clearstream’s rules permitted, the notes were tradable only in amounts equal to a specified amount. If Clearstream was closed for a continuous period of 14 days, or closed down, the PGS would be exchangeable in the form which could be enforced (definitive security). The Notes contemplated that the interests in the Notes would be settled through Clearstream.

The PGS could also be exchanged for a definitive security if principal in respect of any notes was not paid when due by the holder (in this case RBSL) giving notice to the fiscal agent for such exchange.

There was a Pricing Supplement for each Note. Essentially it gave general information about the life settlements and risks which were the basis of the investment, rather than the details of the terms of the Notes which were set out in the Pricing Supplement. The Pricing Supplement contained the misleading statements term, as did the Pricing Supplement. There was also a Pricing Supplement for each Note which included general details of the intended Note.

The Agency Agreement dated 2 August 2006 was made between Credit Suisse and JP Morgan Chase Bank NA London branch as fiscal agent and JP Morgan Bank Luxembourg SA as paying agent, among others. Essentially, the agents would deal with most matters relating to the issue and administration of the Notes for Credit Suisse, deal with any payments and interest, and report to Credit Suisse.

The duties of the fiscal agent included completing the PGS and delivering it to the common depository for Clearstream “with instructions to the clearing system ... to credit the underlying Securities represented by such Global Security ... to the securities accounts at [Clearstream], on a delivery against payment basis...” (paras 3.3 and 3.4).

The fiscal agent was also to instruct Clearstream to hold the Notes to its order pending transfer to the Clearstream account, and on receiving payment for the Notes, to pay Credit Suisse (para 3.5).

The Deed of Covenant dated 2 August 2006 essentially provided that if Credit Suisse failed to pay principal when due under the Notes, and the holder of the PGS gave notice (i.e. the common depository), a security interest holder in Clearstream would acquire “all rights” which the security interest holder would have had if it had been the holder of the Notes in which it has a security interest (para 2.1). English law applied to the deed. No provision was made for the case where Credit Suisse was in breach of a term of the Notes.

Clearstream is an international central securities depository, established in Luxembourg and operated under Luxembourg law (formerly known as Cedel). Essentially, its purpose is to enable securities including bearer notes to be traded easily and quickly.

The essential features of the system for current purposes as described in the evidence of Mr Rosen, Secure Capital’s solicitor, and Blair et al, Financial Markets and Law (2^nd ed. 2012) paras 17.04-17.17. are:

Rights in relation to securities are traded electronically between members who have accounts with Clearstream, rather than the securities themselves.

Members could act for themselves. Commonly they will hold interests for their customers who may hold for themselves or for customers of theirs. So in this case RBSL was the member of Clearstream and Secure Capital was its customer.

In relation to an issue of bearer notes represented by a PGS, the issuer will deposit the PGS with the common depository for Clearstream (as provided in the Agency Agreement and the Notes themselves) in order that security interests in the note can be dealt with on the system. In normal circumstances, the physical PGS remains at all times with the common depository, that is, it is immobilised.

Payments by the issuer under such a note are made to Clearstream which pays the members, and payments by members are made to Clearstream which pays the issuer.

A purchaser of a security interest in the notes will have an account with Clearstream directly or indirectly with a member. The member’s account is governed by Clearstream’s General Terms and Conditions, and the Clearstream Handbook. Clearstream treated all securities received as fungible (article 7). A transfer of an interest in a security to and from a member would be affected by a book entry only on the account of the member (article 12). Members would not have a right to specific securities themselves, but would have a right to require Clearstream to deliver securities equivalent to the book entry (article 11). Luxembourg law applied (article 61).

The role of the common depository was essentially to receive the deposit of the PGS and hold it in safe custody for Clearstream, and to provide asset servicing through the life of the security.

The Notes in this case were classic global notes (“CGN”). It is also possible to have a new global note (“NGN”), in which case there will be an issuer-ICSD agreement between the issuer and Clearstream. The NGN structure is mandatory for issues of for issues of securities that are intended to be recognised as eligible collateral for Eurosystem monetary policy and intra-day credit operations.

The 2001 Law on the circulation of securities, applies to settlements under the Clearstream system.

Mr Thieltgen, Secure Capital’s expert on Luxembourg law, dealt generally with its effect in his report. No expert evidence was adduced by Credit Suisse, its case being that it is irrelevant.

On Secure Capital’s case the essential features of the 2001 Law are:

The purpose of the 2001 Law was that if securities were immobilised, the security interest holder should not be in a worse position because he only holds an interest in the securities rather than being the holder of the securities. The 2001 Law is part of a comprehensive scheme under Luxembourg law dealing with the rights of security interest holders, as appears from the answers to the Legal Certainty Group.

Section 3 contains a provision relating to account owners that is those with a security interest under Clearstream. The law provides for an account owner (in this case Secure Capital) to have an intangible right in rem in relation to securities of the same type held by the account holder:

That right is only exercisable against the person providing the account to the account owner (the account holder – in this case RBSL). Each account owner could exercise the same right against the person providing his account, and so on up the chain up to Clearstream. The basic principle is “no look through” to a direct claim against the issuer.

There were provisions to protect the rights of the account holder in the event of liquidation of the account owner or holder (Article 4(2)).

Section 4 deals with the integrity of the system, and provides protection against seizure of securities, and third party claims.

Section 5 deals with the obligations of the account holder. Essentially the account holder’s obligation was to ensure that it held a security interest up to at least the number of securities in which a customer account owner held a security interest.

Section 6 deals with the obligations of Clearstream, including keeping securities held by them separate, and provides protection from enforcement measures against accounts.

The provision relied upon by Secure Capital in this case is Article 8 which provides that:

In relation to Article 8(1) Secure Capital contended that:

It is important to note, as explained by Mr Thieltgen, and as appears from the Parliamentary texts he exhibits, that Article 8 is not concerned with payment by the issuer of sums due under the notes by way of principal or interest. Those rights may only be exercised by the security interest holder against the account holder not the issuer. The “no look through” principle applies to the principal claims which may be made in respect of the notes.

Article 8 is only concerned with “residual” situations in which the ultimate investor may need to exercise rights which would be available to the holder against the issuer but which apart from Article 8 would not be exercisable by the ultimate investor.

It provides for the exercise of voting rights attached to securities by the ultimate investor even though it is not the holder of the securities.

It also provides for the ultimate investor to exercise rights attaching to the holding of securities and linked to possession of them on production of a certificate by the relevant account holder. The parliamentary works exhibited by Mr Thieltgen make plain that these rights were intended to include legal proceedings which might be brought against the issuer or third parties: See, for example:

Article 8 is consistent with the objective of the law that the position of the security interest holder should not be worse than it would be if he were the holder of the securities in which he has an interest.

The purpose of the requirement in Article 8(1) that the relevant account holder certify the number of securities in which the investor had an interest was clearly to evidence to the issuer that the investor had such an interest because the issuer would otherwise not have that information.

Although Credit Suisse questioned whether Article 8 had the effect contended for by Secure Capital it put in no evidence of its own. For the purpose of this application I shall therefore assume that it has the effect contended for by Secure Capital and that it does seek to confer “rights attaching to the holding of the securities linked to the possession of the securities” which may be enforced against by the investor against the issuer.

The pleading alleges the following:

In summary, Secure Capital claims damages for breach of the misleading statements term. The basis of the damages claimed is that had Credit Suisse not been in breach of the misleading statements term Secure Capital would not have purchased the Notes and it claims the losses which it allegedly suffered as the consequence of so doing.

The fundamental issue which arises on the application is the applicable law and in particular whether Secure Capital is entitled to rely on Luxembourg law, as it seeks to do.

The relevant principles governing the identification of the applicable law are helpfully summarised by Mance LJ in Raiffeisen Zantralbank Osterreich v Five Star Trading[2001] QB 825, at 840:

In my judgment “the true issue thrown up by the claim and defence” is whether Secure Capital can claim damages against Credit Suisse for breach of the misleading statements term. That term is a contractual term. Secure Capital’s entitlement to claim damages for breach of such a term involves the assertion of contractual rights. It involves Credit Suisse owing it a duty to comply with the term. That means owing it a contractual duty.

As Credit Suisse submitted, the existence of contractual duties and the right of a party to sue upon a contract are themselves contractual questions. As Bowen LJ said in Picker v The London and County Banking Co (1887) XVIII QBD 515, at 519:

In my judgment the issue in this case is clearly to be characterised as contractual.

Secure Capital’s arguments to the contrary were inconsistent and to a significant extent legally incoherent.

Its first difficulty was in identifying what its claim actually is. The claim it originally advanced was put forward on the basis that it was the bearer of the Notes as set out in the Particulars of Claim in 2013 Folio 717. Secure Capital was asked to produce the Notes which it was unable to do since, as is common ground, the bearer was and is BNYM. That action was stayed whilst Secure Capital considered its position.

Nine months later Secure Capital commenced the present action putting forward its claim on the basis of the 2001 Law. That claim alleges an entitlement on the part of Secure Capital “to exercise the right of the bearer to bring an action for a breach of the term of the… Notes” (emphasis added).

Secure Capital is therefore asserting that it can exercise the rights of BNYM, the bearer of the Notes. It is alleging some species of derivative action, through which Secure Capital can pursue the claims of the bearer on its behalf. However, the claim it makes is its own independent claim; not that of BNYM. On its own case BNYM has no claim. The claim it asserts is that it (not BNYM) was misled. The damages it claims are losses it (not BNYM) is alleged to have suffered. Its claim is premised on an alleged entitlement to bring a derivative claim but it is in fact asserting a direct, independent claim on its own behalf.

Although that remains Secure Capital’s pleaded case, at the hearing of the application it asserted an entitlement “to exercise the rights of a bearer” (emphasis added).

As explained in oral argument, Secure Capital’s case is that the bearer retains its right of action under the Notes against the issuer. However, the 2001 Law creates a new, parallel but independent right of action as bearer in favour of the investor (however many there may be) against the issuer in respect of any breaches of the terms of the Notes.

Not only has Secure Capital’s case as to the nature of its claim fluctuated, so has its characterisation of the issue raised by its claim.

It was explained in correspondence that it was asserting a property right:

The impracticality of a governing law dependent on the situs of the account holder is obvious. As Credit Suisse pointed out, it is perfectly possible for the chains between intermediaries and leading to the ultimate investor to involve accounts in several different jurisdictions. On Secure Capital’s case under (1), the laws of those different jurisdictions might also have an impact on the entitlement to sue under the Notes, despite the governing law chosen in the Notes. Hence, it would be possible for the issuer to face a variety of different sorts of obligations to different parties depending on where the ultimate investor holds his account.

That assertion was not pursued in argument at the hearing. Nor was the assertion of a property right.

Secure Capital’s case as developed orally was that its entitlement to “be treated as a bearer” of the Notes was neither contractual nor proprietary but was a novel situation which did not fit existing characterisations and was sui generis. Further or alternatively it was “not merely contractual” and/or was a form of deemed possessory right.

Secure Capital submitted that its entitlement to enforce that right was to be distinguished from the content of the right and that it should be governed by the lex situs, being the law applicable to whether or not a person is entitled to be treated as a holder of a bearer note. In this connection it relied on Alcock v Smith[1892] 1 Ch 238, Embiricos v Anglo Austrian[1905] 1 KB 677 and Dicey, Morris & Collins (15^th ed), at para 33-383:

In my judgment none of these arguments satisfactorily explain why the “true issue” is not one of contract or, if it is not, what it is and why.

Seeking to redescribe the issue in non contractual terms does not alter the true nature of the issue. In the Raiffeisen case, for example, the claimant bank sought declarations of validity in respect of an assignment to it of a marine insurance policy, both governed by English law, following a French attachment order in favour of creditors of the assignor. The claimant said that the question in issue was whether the policy had been validly assigned, this being a contractual issue. The creditors said that the issue raised was a proprietary one, effectively as to who was entitled to the benefit of the policy.

Mance LJ characterised the issue as a contractual one:

It is artificial to seek to treat the issue as being who is entitled to be the holder of the Notes. This is not a case where there is a dispute between two parties as to who is entitled to be the holder. It is accepted that BNYM is the holder. The argument is that Secure Capital is entitled to be treated as an additional holder. It is also artificial to seek to divorce that question from the rights which Secure Capital is seeking to enforce which are clearly (and admittedly) contractual rights. As stated in Dicey Morris & Collins at [33-388, 389]:

For all these reasons I have no doubt that the correct characterisation of the “true issue” is that it is contractual. Further, however one characterises the issue, given that it involves the enforcement of rights against Credit Suisse under Notes governed by English law it is difficult to see how the appropriate law can be other than English law.

Once the issue has been characterised as contractual, there is an academic question, which does not need to be decided, as to whether the appropriate conflict of laws rule derives from the Rome Convention or the common law. The question, briefly, is whether the “one-sided” nature of the instrument means that it falls outside the Rome Convention. As to this, the view of Dicey & Morris & Collins at 32-043 is that:

That question does not need to be determined because under both the Rome Convention (Article 3) and English common law principles the contractual issues would be determined by the governing law chosen by the parties, namely English Law.

Under English law, the obligations of the issuer were owed to and only to the bearer (here BNYM).

I agree with Credit Suisse that there is no scope in this contractual analysis for the introduction of foreign law. The fact that a foreign law might or might not purport to grant to a third party a right to sue on an English law contract is irrelevant. A foreign law cannot (even if it purported to do so) create new contractual obligations in an English law contract.

It follows that the 2001 Law is irrelevant and cannot found Secure Capital’s claim. The sole basis of its claim accordingly falls away.

Credit Suisse further submitted that any other conclusion would fly in the face of market practice and the unanimous views of the commentators relating to intermediated securities, which, for good reason, is to the effect that all rights to sue the issuer under a bearer note are held and exercisable only by the bearer, not an intermediary and certainly not the ultimate investor. For example:

Goode,The Nature and Transfer of Rights in Dematerialised and Immobilised Securities, (1996) JIBL 167, 168 says that the immobilisation of tangible securities by depositing them with custodians is a widely used measure which operates to “prevent a direct link between issuer and investor…so that the custodian is substituted for the investor as the holder of record and the investor’s entitlement is thereafter against the custodian, not the issuer” (at p168), “the effect of immobilising a security is, in the case of a permanent global note, to shut out any direct link between issuer and investor” (at p172); “As under an ordinary trust, the account holders do not have direct rights against issuers of investments held by the custodian; their entitlements subsist purely against the custodian itself.”

Benjamin, Determining the situs of interests in immobilised securities, (1998) ICLQ 923, 929, fn 22 says that: “Participants do not have direct rights of action against the issuer…The issuer agrees to pay principal and interest to the bearer of the Global…the participant has no direct recourse against the issuer or the Common Depositary…On issuer default the only direct rights against the issuer are held by the trustee or by the participant. However, these last rights do not arise under the immobilised securities but, rather, under the deed poll as a separate though ancillary document”.

Elias, Legal aspects of swaps and collateral [2001] JIFM 232. 242 says that: “in the context of indirect holding systems, commingling fungible property terminates the direct property rights of owners of the individual co-mingled items, with the following legal and practical consequences… Each participant does not have a direct right of action against the issuer of the securities, his right being “indirect”, except when such direct right is given by way of a deed poll or a trust deed”;

Ooi, Shares and Other Securities in the Conflict of Laws (2003), at [6.28] states (using the example of shares held indirectly through a clearing system): “The only entity legally entitled as against the issuers is the operator with whom all these shares have been deposited. In other words, as regards the issuers, the operator is the only shareholder”;

Fuller, the Law & Practice of International Capital Markets (3rd edition, 2012) says that the account holder cannot enforce any of the issuer’s obligations “as it has no privity of contract with the issuer (its rights being merely against the clearing system)” (at 1.129), with mechanisms such as deed polls being crafted to confer certain rights against issuers on third parties. Moreover, “invariably…the common depository…is the only person entitled to receive payment from the issuer” (at 1.132);

Fuller (at 1.153)also notes that the standard approach in the market is (as happened in this case) to contract out of the Contracts (Rights of Third Parties) Act 1999, which was recommended by the International Capital Market Association “on the basis that the legal structure of the rights arising from the transaction documentation…is effective, certain and generally accepted in the market”.

Credit Suisse also emphasised the importance of separating the interests of the underlying investor from the position of the issuer to the proper functioning of the system. As is explained in Goode, Legal Problems of Credit and Security at 6-07:

Secure Capital did not dispute these general statements but emphasised that they relate to the payment of sums due under the notes rather than “residual” situations such as claims for breach of the terms of notes. However, a failure to make payment is itself a breach. Further, the general desirability and importance of separating interests would equally apply to direct claims for breach, a right which potentially arises in respect of all notes.

As Credit Suisse pointed out, the impracticality of Secure Capital’s case can be illustrated by considering ramifications on an obligation arising out of a “misleading statements” term. Secure Capital’s case is that whoever ends up as the ultimate investor can (at least if it has a relevant interest in a Luxembourg account) make a claim for breach of contract against the issuer if it was unaware of any relevant matter. The issuer can therefore owe a contractual obligation of disclosure to a second stage investor with which it has had no direct dealings (indeed, it may well not even be aware of the existence of the investor). On this argument, it will owe a similar obligation to a third stage investor, or a fourth stage investor, or a 50^th stage investor. Does each investor have its own cause of action? And what if the first 49 investors are well aware of the facts in question but the 50^th is not? Does a new cause of action for non-disclosure self-generate years later on the purchase by the 50^th stage investor?

In so far as one is to have regard to the practical consequences of applying a particular law in determining what law is appropriate these considerations are strong pointers against Luxembourg law, if it has the effect which Secure Capital contends for. Moreover, if it does, none of the commentators appear to have picked up on it, despite its obvious significance to the operation of Clearstream.

For the reasons outlined above I conclude that Secure Capital’s claim has no real prospect of succeeding and that Credit Suisse’s application should be granted. I shall hear the parties further as to the precise form of the order.