Who has the right to sue on a bearer global security?

Important Court of Appeal Decision 

On 6 October 2017 the UK Court of Appeal delivered a judgement in the first English case to examine the contractual rights attaching to a permanent global security in bearer form expressed to be governed by English law and held by a depositary for a clearing system (Secure Capital SA - v - Credit Suisse AG [2017] EWCA Civ 1486). The unanimous decision of the court, delivered by Lord Justice David Richards, confirmed in every material respect the conventional analysis and, in particular, rejected the assertion that the laws of the country in which the clearing system is located could supervene to create additional rights.

The facts

Briefly, the case concerned Notes, described as longevity notes, linked to life insurance policies whereby payment on the Notes was contingent on mortality rates amongst a set of "reference lives" to which the relevant life insurance policies related. Subject to this, so far as is apparent from the judgement, this case concerned an entirely conventional bearer form debt security in permanent global form issued under a programme and held by a common depositary for Euroclear and Clearstream Luxembourg.

According to the judgement, each Note was represented by a single Permanent Global Note which provided that it was "a bearer document and negotiable accordingly". The Permanent Global Note was stated to be transferable by delivery "and such transfer was stated to operate to confer upon the transferee all rights and benefits appertaining hereto...". The Permanent Global Note was expressed to be governed by English law.

The Conditions of the Notes were defined to comprise the Programme Memorandum, the Product Supplement and the Pricing Schedule. The Programme Memorandum was a set of standard terms and conditions for securities to be issued by Credit Suisse as Issuer. It stated, so far as relevant, that each security or series of securities to be issued in bearer form would be represented by a permanent global security to be held by a common depositary for Euroclear, Clearstream Luxembourg or another agreed clearing system. Title would pass by delivery of the permanent global security. The holder would "be deemed to be and may be treated as its absolute owner for all purposes". In the case of Notes held through Clearstream (for example), each person shown in the records of Clearstream must look solely to Clearstream "for his share of each payment made by the Issuer 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". The Programme Memorandum expressly provided that no person would have any right to enforce any term or condition of the securities under the Contracts (Rights of Third Parties) Act 1999 except and to the extent (if any) that the securities expressly provide otherwise. Securities were to be governed by English law and the Issuer agreed to the jurisdiction of the English courts for the exclusive benefit of the holders of securities.

There was no trustee. The Notes were supported by a Deed of Covenant made by the Issuer which provided that in the event of non-payment of principal an Account Holder at either clearing system with interests in the Notes acquires direct rights against the Issuer if it had been the bearer of the Notes, including but not limited to the right to receive all payments due on the Notes.

The claim brought by the claimant, Secure Capital, related to eight of the larger number of Notes represented by the Permanent Global Note. Secure Capital's interest in these eight Notes was held through a Royal Bank of Scotland account with Clearstream Luxembourg. Secure Capital was not the Clearstream Luxembourg Account Holder but the holder of an account with a Clearstream Luxembourg Account Holder.

The claim

The Pricing Supplement, contained a term which Secure Capital alleged was incorporated into the Conditions and which was misleading. Secure Capital asserted a right to bring the claim based on Article 8 of the Luxembourg law dated August 2001 on the circulation of securities (the "2001 Law"). Secure Capital argued that, by reason of the 2001 Law, it was entitled to exercise the right of a bearer to bring an action for a breach of a term of the Notes, although it was not the bearer.

The 2001 Law applies to settlements under the Clearstream system. The unchallenged expert evidence on Luxembourg law adduced by Secure Capital was that the purpose of the 2001 Law was to provide that, in the case of immobilised securities, the security interest holder should not be in a worse position because it holds an interest in the securities rather than holding the securities themselves.

It is important to note that this case was pleaded as a claim in damages for breach of contract. No claim was made in tort or under statute.

Initially Secure Capital asserted that it was the bearer of the Notes. This was not pursued after it was asked to produce the Notes, which it could not do as they were of course held by the common depositary.

Secure Capital then asserted the 2001 law created "a new, parallel but independent right of action as bearer in favour of the investors (however many there may be) against the Issuer in respect of any breaches of the terms of the Notes". Secure Capital pointed out that the Issuer chose to use Clearstream Luxembourg as the settlement system and Account Holders and their clients invest in the Notes through that system. They argued that while English law as the governing law of the Notes would determine the meaning and effect of the Conditions of the Notes, Luxembourg law as the law of the settlement system would determine who could sue for breach of those Conditions.

Finally Secure Capital argued that the following (italicised) provision in the Programme Memorandum had the effect of incorporating substantive rules of Luxembourg law, including Article 8(1) of the 2001 Law, into the Conditions of the Notes:

"Each of the persons shown in the records of Euroclear, Clearstream, Luxembourg, DTC or any other clearing system as the holder of a Security represented by a Global Security must look solely to Euroclear, Clearstream, Luxembourg, DTC or such clearing system (as the case may be) for his share of each payment made by the Bank, acting through the Relevant Branch, to the bearer of such Global Security or the holder of the underlying Registered Securities as the case may be, and in relation to all other rights arising under the Global Securities, subject to and in accordance with the respective rules and procedures of Euroclear, Clearstream, Luxembourg, DTC or such clearing systems (as the case may be). Such persons shall have no claim directly against the Bank or the relevant Branch in respect of payments due on the Securities for so long as the Securities are represented by such Global Security and such obligations of the Bank and the relevant Branch will be discharged by payment to the bearer of such Global security or the holder of the underlying Registered Securities, as the case may be, in respect of each amount so paid." (emphasis added)

The judgement

Under English conflicts of law principles, the identification of the parties entitled to sue on a contract is governed by the proper law of the contract. In this case, the proper law is, by the express terms governing the Notes, English law. The only party entitled to sue is the holder of the Notes represented by the Permanent Global Note, that is, the common depositary, unless one of a limited number of events specified in the Permanent Global Note has occurred in which case direct rights may arise under the Deed of Covenant for the beneficiaries of that Deed.

In the case of immobilised securities, Clearstream Luxembourg and other settlement systems exist to facilitate efficient trading in interests in securities, not in the securities themselves. The fact that security issues are organised in this way so as to facilitate such trading is nothing to the point. Participants in the market know that they are trading in interests, not in the underlying securities. They are interests in contractual arrangements constituted by the Notes and ancillary documents. The documents expressly provide for English law to be the proper law and expressly identify the parties who may either generally or in limited circumstances sue for breach of the terms of the Notes. Those provisions are as much part of the package of rights as the payment terms and any other terms of the Notes. Market participants trade in interests in that total package of rights.

As for the argument that article 8 of the 2001 Law was incorporated into the terms governing the Notes, this was rejected on a number of grounds including (1) that the "rules and procedures of...Clearstream" do not on a natural reading include Luxembourg law; and (2) that the context overwhelmingly suggests that they do not do so, particularly given all the other contrary provisions in the governing documents which emphasise that only the bearer can claim against the Issuer, subject to well-defined exceptions.