From credibility to suitability

Do two recent cases signal the end for contractual estoppel in Hong Kong? 

What you need to know

• In the latest Hong Kong judgment on mis-selling investment products, the Court of First Instance has held that a bank breached its advisory duty to customers, notwithstanding contractual documentation containing clear non-reliance clauses: Chang Pui Yin and ors - v - Bank of Singapore Limited.
• The Court found that the particular facts of the case indicated that the bank had, in fact, contracted to provide an advisory service to the customers. The Court further held that the bank breached that duty by failing to ascertain the customers' investment objectives and their risk appetite, by offering products which were not suitable and failing to warn them about the risks of the products offered.
• The decision in Chang Pui Yin comes shortly after a decision of the Hong Kong Court of Appeal in June 2016, which also suggests a trend against defences of contractual estoppel: DBS Bank (Hong Kong) Limited - v - Sit Pan Jit.
• While in Sit Pan Jit, the Court of Appeal dismissed the customer's claim on the basis that it would only disturb a finding of fact by a trial judge where it has been demonstrated the finding was "plainly wrong", it nonetheless questioned the availability of contractual estoppel as a defence to claims under section 108 of the Securities and Futures Ordinance (SFO).

What you should do

• If you have not already done so, take steps to ensure compliance by 9 June 2017 of all existing and new client agreements with the requirements under the professional investor regime, including incorporation of the new mandatory clause that products are suitable for the customer.
• Financial institutions should implement policies to assess the suitability of financial products for particular investors, as well as adequate systems and controls to monitor compliance by sales staff with those policies. Records of the reasons behind suitability assessments are likely to be critical in future mis-selling claims.
• The ability to successfully defend a financial services mis-selling claim often depends on whether a comprehensive documentary record of the client's interactions with the bank can be retrieved and effectively presented to the court. Ensure that your systems enable the efficient storage and retrieval of this information.

The Chang Pui Yin case

The plaintiffs were an elderly couple, Mr and Mrs Chang (who were 90 and 80 years old, respectively, at the time of trial), and a company, Nextday International Limited (Nextday), which was owned by Mrs Chang. The Changs lived a modest lifestyle, with Mr Chang working as a factory manager and sandwich maker and Mrs Chang as a primary school teacher and cashier. They had minimal investment experience and knowledge. However, in 1997 they received a windfall of almost HK$120m through a family connection.

Mr and Mrs Chang opened a private banking account with the bank around 2004, having followed Mrs Chang's relationship manager, Mrs Li, from another bank. Nextday also opened an account in 2006. Despite being initially classified as medium risk investors by the bank, between 2004 and 2008 Mr and Mrs Chang were sold large numbers of high risk investments including equity linked notes (ELNs), foreign currency options and accumulative forwards, knock-out daily accumulators, foreign currency loans, high yield bonds and equity options. The Court accepted expert evidence that the plaintiffs' porfolios were "extremely risky" and that, during the two years and nine months since Mrs Chang's portfolio had been opened, it had lost over US$2m.

When their son became aware of the Changs' losses in 2008, he complained to the bank. That complaint was rejected and in 2011 the Changs commenced proceedings against the bank. In its defence, the bank sought to rely on non-reliance clauses in the contractual documentation and the doctrine of contractual estoppel.

In a detailed judgment spanning over 125 pages, the Court of First Instance found that the Changs were not experienced or knowledgeable investors and that they had always had a medium investment risk profile. In entering into the high risk products, the Changs had trusted and relied entirely on Mrs Li, who failed to properly explain the risks and disadvantages of the investments to them (and in some cases gave inaccurate information about the investments). The Court noted that the bank's client suitability forms had been completed by Mrs Li without sending them to the Changs for verification and that they contained patent inaccuracies, inserted in order to permit the purchase of high risk products by the Changs. In establishing these findings, the Court stated that, in contrast to the Changs, Mrs Li was an unreliable witness who sought on occasion to make up her evidence on the spot during cross examination.

The Court found that, despite the non-reliance clauses in the contractual documentation, in reality, Mrs Li gave investment advice to the Changs and Nextday and effectively managed their investment portfolios for them. Statements in the bank's marketing brochure which referred to provision of "investment advice" and "quality advice" also indicated that it was providing an advisory service to the Changs. Accordingly, the Court held that the only proper construction of the documentation was that the bank had contracted to provide an advisory service. The Court considered that, on the ordinary meaning of the words used, provisions of the client agreements containing disclaimers of liability for advice given could only apply to "pure" custody accounts, not those where the bank had in fact agreed to provide advice.

This contractual duty of care was held to have comprised at least three elements:

(a) a duty to exercise reasonable care and skill to ascertain and have regard to the investor's investment objectives and risk appetite;

(b) a duty to exercise reasonable care and skill to only offer products which were suitable to the investment objectives and risk appetite of the investor; and

(c) a duty to exercise reasonable care and skill to warn clients of the risks inherent in the investments that were being offered.

The Court held that, based on its findings of fact, the bank breached each of these duties and entered judgment in favour of each of the plaintiffs, with damages to be assessed at a later date.

The Court added that, if it had found that the banking relationship was non-advisory, the bank would have otherwise succeeded in defending the claim. The Court stated that the bank would have succeeded in its defence of contractual estoppel and that no claim of waiver could have succeeded. The Court outlined the comments by the Court of Appeal in Sit Pan Jit regarding contractual estoppel (described in detail below), however it noted that the doctrine of contractual estoppel could only be overturned by a higher court in Hong Kong. The Court also stated that, if it had found that the relationship was non-advisory, the plaintiffs' claims under the Unconscionable Contracts Ordinance and Control of Exemption Clauses Ordinance would also have failed.

The Court concluded that the facts of the case were quite unique as the Changs were "wholly different from the vast majority of plaintiffs" in mis-selling cases as they were clearly elderly, unsophisticated clients who did not make informed choices, did not understand the products or risks involved and entrusted their money to the bank's relationship manager.

The Sit Pan Jit case

The background to the Court of Appeal case, decided in June, was that the plaintiff, Sit, purchased ELNs using funds borrowed from the bank. When Sit failed to meet a margin call by the bank on the ELNs, proceedings were commenced for repayment of the remaining outstanding amounts due from him. In his defence and counterclaim, Sit alleged, among other things, that the bank made various misrepresentations regarding the ELNs and breached section 108 of the Securities and Futures Ordinance (SFO).

The Court of First Instance held in favour of DBS and dismissed all of Sit's counterclaims. It found that Sit was a sophisticated businessman who understood ELNs and the risks involved in investing in them. After establishing that Sit was an unimpressive and unreliable witness, the Court held that, aside from a statement that the ELNs were specifically "structured" for Sit, none of the representations alleged had been made. For the one representation he had been able to establish, the Court of First Instance held that Sit had not been induced to act on it. The Court of First Instance also found that a non-reliance clause in the bank's contractual documentation would, in any event, have precluded Sit's claims under common law and statute, although this finding was obiter dicta and therefore not binding.

Sit launched a wide-ranging appeal against the first instance judgment, relying on no less than 20 separate grounds of appeal. In particular, Sit argued that the trial judge erred in:

(a) finding that the representations were not made and that Sit was not induced to buy the ELNs by the one statement that was made; and

(b) holding that contractual estoppel was part of Hong Kong law and that DBS was entitled to advance contractual estoppel as a defence to a statutory claim under section 108 of the SFO.

The Court of Appeal upheld the decision of the Court of First Instance, citing the well-established principle that an appellate court will only disturb a finding of fact where an appellant can demonstrate that it is plainly wrong. The Court of Appeal concluded that the trial judge's findings were backed by clear evidence and supported both the findings in the court below and its reasoning.

Because Sit's appeal failed on factual grounds, it was not necessary for the Court of Appeal to consider many of the legal arguments that were advanced in support of his appeal. While the Court of Appeal stated that it could see the "force" in the submissions made by Sit's counsel regarding contractual estoppel, it refrained from expressing a view on these matters, which it described as "interesting legal issues".

Analysis

A large number of mis-selling claims were commenced in Hong Kong following the 2008 financial crisis. Where those claims have gone to trial, the majority of the judgments have applied English precedents on contractual estoppel and non-reliance clauses in favour of banks. However, it is also clear that a large number of mis-selling claims flowing from the financial crisis were settled. This is no doubt because, as any litigation lawyer will advise, there is always a risk that a judge who is sufficiently sympathetic towards an investor may seek to find a way through the contractual documentation and legal precedent to find in their favour. There is therefore always an incentive for banks to settle claims with "bad" facts.

While the facts and outcomes of both of the cases discussed above clearly differed, the judgments suggest a potential shift towards a more critical approach to non-reliance or exclusion clauses in financial mis-selling claims. It can be argued that Chang Pui Yin is an example of a court looking to the factual relationship between the parties to interpret the agreements between them and focusing on the suitability of the products sold to unsophisticated investors. Sit Pan Jit, on the other hand, is an example of an appellate court casting doubt on the applicability of contractual estoppel arguments under Hong Kong law, and, in particular, their relevance to defending claims advanced under section 108 of the SFO, which creates a statutory cause of action for fraudulent, reckless or negligent misrepresentations that induce others to deal in securities. It is significant that, while it refrained from expressing a view, the Court of Appeal in Sit Pan Jit outlined the submissions by Sit's counsel on these points as having "force". This is similar to the approach taken by the Court of First Instance in the Li Kwok Heem case in January 2016, where it was held that the specific wording of a non-reliance clause did not preclude the plaintiff's claims of mis-representation, breach of duty and breach of section 108.

It is therefore critical to put forward a compelling narrative of the facts of the case before the court. Whether a witness will be found to be credible at trial often turns on the availability of contemporaneous evidence that supports the material in their witness statement. It is therefore critical for banks and other financial institutions to ensure that they maintain detailed records of sales activities and interactions with customers that can be readily retrieved when mis-selling allegations are made. This will enable an early assessment of likely areas of risk and the strength of contemporaneous evidence upon which the bank will be able to rely if the matter goes to trial.

The future of mis-selling claims in Hong Kong

The SFC would no doubt welcome a more critical view of non-reliance and exclusion clauses by the Courts, as suggested in Chang Pui Yin and Sit Pan Jit. Such clauses are often seen by regulators as unduly stacking the odds against members of the investing public when seeking redress, concerns which were no doubt behind the SFC's introduction of the new mandatory clause for client agreements in paragraph 6.2 of its Code of Conduct.

This new clause, which will be required for all client agreements from 9 June 2017 onwards, provides that where the sale of any financial product is solicited or recommended to a client, it must be "reasonably suitable" for them having regard to their financial situation, investment experience and investment objectives. The SFC has declined to define the standard of "suitability", which will depend on future judicial interpretation. The clause also expressly provides that it cannot be derogated from, meaning that financial institutions cannot contract out of the duty.

The new clause is likely to shift the focus in future mis-selling claims towards an assessment of the suitability of products for the individual investor, rather than focusing on non-reliance or exclusion clauses. It is therefore increasingly important for financial institutions to implement policies to assess the suitability of financial products for individual investors, as well as adequate systems and controls to monitor compliance by sales staff with those policies. Ensure that accurate records of suitability assessments are maintained and that these clearly detail the information provided by clients regarding their financial situations, investment objectives and the reasons why the product is suitable for the clients.