Are settlement negotiations with regulators covered by the without prejudice rule?

What you need to know

A recent judgment of the English High Court has held that records of settlement discussions with regulators can be withheld from disclosure in civil proceedings with third parties by analogy to the "without prejudice" rule.

While the court held that something similar to the without prejudice rule applied in the context of regulatory settlements, there are important differences with how the rule is applied in normal civil litigation.

In particular, the protection from disclosure can be waived unilaterally if, in a civil claim against a third party, the basis for the regulatory settlement is put in issue. This possibility of unilateral waiver could deter regulators from entering into settlement discussions.

Unless the judgment is overturned on appeal, it is likely to be persuasive to Hong Kong courts considering the same issue with respect to settlement discussions with the Securities and Futures Commission.

What you should do

Where litigation follows a related regulatory enforcement action, think carefully about whether to rely on the regulatory outcome in the civil proceedings. Consider what documents might need to be disclosed if the "without prejudice" protection were to be lost

This is the second in our series of three updates on recent developments in the law of privilege. Our earlier update on the Citic Pacific decision which rejected the narrow definition of "client" in assessing privilege claims can be found here. Our next article on a recent Hong Kong case on the "fraud exception" to legal professional privilege will be published shortly.

Background to the proceedings

In Property Alliance Group Limited -v- The Royal Bank of Scotland Plc ¹ the English High Court has considered whether the "without prejudice" rule applies to settlement discussions between regulators and those under investigation.

This decision arises in the context of a discovery application in civil proceedings. In those proceedings, Property Alliance Group (PAG) has alleged that the bank made misrepresentations about LIBOR inducing it to enter into GBP LIBOR-linked interest rate swaps or, alternatively, that the swaps included implied terms regarding the conduct of the bank in relation to LIBOR. Following a negotiation process with the bank, the UK's Financial Conduct Authority (FCA) issued findings in the form of a Final Notice in which it was found that the bank had manipulated Japanese Yen and Swiss Franc LIBOR. The Final Notice also indicated that other currencies were also investigated, including GBP LIBOR.

Through its discovery application PAG sought a number of classes of documents, including documents relating to the settlement negotiations between the bank and FCA. The bank asserted that it was not required to produce those documents on the basis that they were without prejudice communications between itself and the regulator. In response, PAG argued that the without prejudice rule only applied to the settlement of civil claims, not to regulatory matters. While the FCA did not intervene in the application, it supported the bank's position and made representations to the court to the effect that its ability to resolve regulatory matters through negotiation would be hindered if communications in respect of those discussions were not protected from disclosure.

Decision

The court carried out a detailed analysis of the process for the settlement of regulatory matters in the UK, noting that the regulator's guidance suggested that settlement communications would be treated as confidential. It went on to highlight the difference between without prejudice negotiations in civil cases, where no judgment or decision is issued, and negotiations with the FCA which resulted in a Final Notice being published that contains findings of fact.

The court considered that caution should be exercised in treating the Final Notice as exonerating the bank in respect of the potential manipulation of LIBOR in currencies other than the Japanese Yen or Swiss Franc. It was noted that the Final Notice was the result of a settlement process and could have been based on incomplete and/or misleading information provided to the regulator.

Critical to the court's analysis was the bank's statement of defence, which admitted manipulation of Japanese Yen and Swiss Franc LIBOR, but expressly denied manipulation of GBP LIBOR. The bank had also pleaded that "… there have been no regulatory findings of misconduct on the part of [the bank] in connection with GBP LIBOR".

The Judge considered that the bank's pleading was more than a mere mention of the regulatory outcome, and that the bank had positively put the basis on which the regulatory findings were made in issue because it had relied on what was not said in the Final Notice as supporting its denial. The court held that it would be unfair to allow the bank to rely on what was absent from the Final Notice, yet at the same time not allow the plaintiff to inspect the communications that led to the creation of the Final Notice.

The court's conclusion was therefore that:

• There is a right to withhold from inspection communications which were part of genuine settlement discussions between the firm and the regulator. That right applies as against the firm and regulator in any internal appeal mechanisms within the regulator or subsequent proceedings. The protection also applies to civil litigation with third parties.
• The fact that a regulatory finding is issued does not mean the right is lost.
• The right arises by analogy with the without prejudice rule, but it is not identical to the normal rule in civil litigation.
• The right cannot be maintained in civil proceedings if the basis on which the regulator's decision is itself in issue in the proceedings. In such a case, the content of the settlement discussions will be admissible in evidence and the regulator has no right to object.

Because the court considered that in this case the bank's pleadings had put the basis upon which the regulatory findings were made in issue, it ordered the disclosure of the documents over which without prejudice protection had been claimed.

Analysis and application to Hong Kong

The decision represents the first time that the issue of whether the without prejudice rule applies to settlement discussions for regulatory matters has been expressly considered.

As a decision of the English courts, the judgment is likely to be persuasive in Hong Kong. While the regulatory framework under UK law is significantly more prescriptive than in Hong Kong with respect to settling regulatory disputes, the Securities and Futures Commission's (SFC) "Disciplinary Proceedings at a Glance" pamphlet states that, where it enters into negotiations to resolve disciplinary proceedings, those discussions will be treated as being "without prejudice" unless agreed otherwise and will not be able to be relied on by either party either in the disciplinary proceedings themselves or subsequent court proceedings.

Those who are licensed intermediaries or corporates under investigation by the SFC should therefore take some comfort from the decision as it suggests that something akin to without prejudice protection can apply to any settlement discussions for enforcement actions. However, significant care should be taken in making any references to the regulatory outcome in pleadings or witnesses statements in the context of proceedings with third parties. The English High Court's decision suggests that the protection against disclosure can be easily lost.

There are a number of issues arising from the reasoning in the judgment which could make it susceptible to being overturned on appeal. First, it is arguable that the court has not provided a clear enough basis as to why the protection against disclosure of documents related to the settlement of regulatory matters is only analogous to the "without prejudice" rule and not identical to it. While no judgment or decision is issued in respect of civil settlement negotiations, it is still open to the parties to agree a public "line to take" or for one to issue a public apology without the protection from disclosure being lost. Some may therefore argue that the distinction the judge made between a regulatory decision being released at the end of the settlement process and settlement of civil proceedings is not persuasive.

Second, and perhaps most importantly, are the consequences of the court holding that the protection against disclosure can be unilaterally waived. This contrasts with the position for civil litigation, where the conventional view is that a waiver of without prejudice protection requires the agreement of both parties. The prospect of the other party unilaterally waiving (even through inadvertence) the protection from disclosure could act as a significant deterrent to regulators from engaging in settlement discussions. If they do so, there is a risk that the final outcome of an investigation and the regulator's process in reaching it could be publicly scrutinised. This arguably puts the balance too far in favour of third party claimants in civil proceedings. It does so at the expense of the regulator, the other party to the settlement and the general public, all of whom have an interest in the efficient and effective resolution of regulatory enforcement actions, without the unnecessary expense of those proceedings being taken through the full enforcement process.