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England and Wales High Court (Commercial Court) Decisions
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Cite as:  EWHC 676 (Comm)
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BUSINESS AND PROPERTY COURTS
OF ENGLAND AND WALES
COMMERCIAL COURT (QBD)
Fetter Lane, London, EC4A 1NL
B e f o r e :
| OVERSEA-CHINESE BANKING CORPORATION LIMITED
|- and –
|ING BANK N.V
Mr D Allison QC & Mr R Perkins (instructed by Clifford Chance LLP) for the Defendant
Hearing dates: 15, 16, 17, 21, 22 and 24 January 2019
Crown Copyright ©
Mrs Justice Moulder
Issues for the court
i) whether the claim is unsustainable in law; in particular whether the measure of damages sought to be recovered can be recovered as a matter of law;
ii) If (i) does not provide a complete answer to the claim, and on the assumption that the 2008 Accounts were not properly drawn up such that the defendant was in breach of the Agreement, did that breach cause the claimant to suffer loss and damage? In particular if the claimant had been fully informed or aware of the alleged liabilities to LBF, would the Agreement have contained a specific warranty and/or indemnity in the claimant's favour in respect of the liability to LBF?
iii) Was there a breach of the warranty in Paragraph 3.1 of Schedule 7 of the Agreement that the 2008 Accounts were properly drawn up so as to give a true and fair view of the state of affairs and results of IAPBL?
i) For the claimant, the court heard evidence from Mr Soon Tit Koon, who was Head of Group Investments at OCBC at the time that the Agreement was negotiated and signed. Mr Soon gave two witness statements dated 19 March 2018 and 26 April 2018. He was cross-examined on these witness statements.
ii) For the defendant, the court heard evidence from Mr Diederik Sillevis Smitt, who was at the relevant time an in-house lawyer within ING's Corporate Mergers & Acquisitions team. Mr Smitt gave a witness statement dated 19 March 2018 and was cross-examined on this statement.
i) For the claimant, from Mr Andrew Kasapis, a Director in the Global Disputes & Investigations practice of Duff & Phelps Limited. Mr Kasapis served an expert report dated 1 June 2018 and a reply expert report dated 27 September 2018.
ii) For the defendant, from Dr Robert Selvaggio, a professional economist and the current Head of Analytics at Rutter Associates LLC (a financial risk management advisory firm). Dr Selvaggio served an expert report dated 27 July 2018.
iii) Mr Kasapis and Dr Selvaggio also produced a joint memorandum dated 7 November 2018.
i) For the claimant, from Mr Timothy Reid, the Director in charge of the Singapore office of Ferrier Hodgson Pte Ltd (a firm specialising in restructuring, corporate recovery, forensic accounting and litigation). Mr Reid served an expert report dated 1 June 2018, a reply expert report dated 28 September 2018 (and amended on 18 January 2019), an addendum dated 22 November 2018 and a supplemental expert report dated 14 December 2018.
ii) For the defendant, from Mr Kon Yin Tong, the Managing Partner of Foo Kon Tan LLP (a Singaporean audit and accounting practice). Mr Kon served an expert report dated 27 July 2018 and two supplemental reports dated 16 November 2018 and 27 December 2018.
iii) Mr Reid and Mr Kon produced a joint memorandum dated 2 November 2018.
i) For the claimant, from Professor Olivier Hari, a Professor of Law at the University of Neuchâtel, where he is chair holder for corporate and business law. Professor Hari served an expert report dated 1 June 2018 and a reply expert report dated 28 September 2018.
ii) For the defendant, from Mr Thomas Rohde, a Partner and the Head of Restructuring and Insolvency at Bär & Karrer AG. Mr Rohde served an expert report dated 27 July 2018.
iii) Professor Hari and Mr Rohde produced a joint memorandum dated 2 November 2018.
I Whether the claim is unsustainable in law; in particular whether the measure of damages sought to be recovered can be recovered as a matter of law
"But for the defendant's breach of the Agreement, the true accounting position as between IAPBL and LBF would have been disclosed with the result that:
(2) the claimant would have been informed or aware of substantial liabilities to LBF… and the Agreement would have contained a specific warranty and/or indemnity in the claimant's favour in respect of the true liability to LBF.
27 By reason of the foregoing matters the claimant has suffered loss and damage as follows:
(1) not less than US$14,500,000 namely the amount paid by [IAPBL] to LBF…
(2) Alternatively damages to be assessed."
i) that the 2008 Accounts were not properly drawn up in accordance with the provisions of the Singapore Companies Act and Singapore Financial Reporting Standards so as to give a true and fair view of the state of affairs of IAPBL as at 31 December 2008;
ii) that there were errors in the 2008 Accounts which were sufficiently material so as to mean that the 2008 Accounts did not give a true and fair view of the state of affairs of IAPBL as at 31 December 2008;
iii) that these errors arose out of the determination of Loss under the ISDA Agreement, the Collateral Set-Off and the Triangular Set-off.
"Although the Sale of Goods Act 1979 does not apply to contracts for the sale of shares, the principles relating to damages in sale of goods have been applied, as far as the subject-matter permits, to such contracts…"
Chitty at 26-189:
"In an action for a seller's failure to transfer shares, the buyer may recover the market price of the shares on the day fixed for completion, less the contract price, since the principles of law governing damages in the sale of goods are applied by analogy.
(1) Where there is a breach of warranty by the seller, or where the buyer elects (or is compelled) to treat any breach of a condition on the part of the seller as a breach of warranty, the buyer is not by reason only of such breach of warranty entitled to reject the goods; but he may—
(a) set up against the seller the breach of warranty in diminution or extinction of the price, or
(b) maintain an action against the seller for damages for the breach of warranty.
(2) The measure of damages for breach of warranty is the estimated loss directly and naturally resulting, in the ordinary course of events, from the breach of warranty.
(3) In the case of breach of warranty of quality such loss is prima facie the difference between the value of the goods at the time of delivery to the buyer and the value they would have had if they had fulfilled the warranty." [emphasis added]
"[44-413] Section 53(3) lays down only a "prima facie" rule, from which the court may depart in appropriate circumstances. For instance, the time when the actual value of the goods in their defective state is assessed may be postponed until the defect is discovered. Similarly, when the seller knows that the buyer intends to resell the goods to a sub-buyer at another place, and that the goods will not be examined until they reach the sub-buyer (e.g. because they are packaged), the date at which the latter examines the goods may be the date at which the market price should be taken to assess the buyer's damages for the defective condition of the goods. Again, a warranty as to quality may relate to the future (e.g. that seed will produce a certain crop) so that there can be no question of the buyer's opportunity to resell the defective goods until the defect becomes apparent at a later date. The market value test should not be applied until the future event is known. In Bence Graphics International Ltd v Fasson UK Ltd the Court of Appeal held that s.53(3) provided only a "prima facie" rule, which should not be applied if it would give the buyer "more than his true loss". Section 53(2) should be the "starting point"." [emphasis added]
"This difference over construction has an important effect on the way in which damages are calculated. In the case of a warranty as to the quality of the goods, the purchaser is prima facie entitled to the difference between what the goods as warranted would have been worth and what they were actually worth. If the vendor had warranted that the earnings in the last two months would be $2,223,000, there would have been an analogy with a warranty of quality and the damages would prima facie have been the difference between what the shares would have been worth if the earnings had been in accordance with the warranty and what they were actually worth. The Court of Appeal was saying that although the vendor had not warranted that the earnings would be $2,223,000, it had effectively warranted that the company could be valued on the assumption that they would be in the region of $2,223,000. As the region would be a range above and below the figure of $2,223,000, the reasonable buyer would value such a company, as the actual purchaser had done, on the assumption that the earnings would be the mean figure of $2,223,000. Accordingly, the measure of damages was the difference between the company valued on that basis and the actual value of the company, calculated by applying the same multiple to the actual earnings after tax." [emphasis added]
Counsel for OCBC emphasised the use of the words "prima facie" in the above passage.
"As is illustrated by s.53(3) the usual measure of damages for breach of the seller's contractual undertaking as to the quality or condition of the goods is the difference between: (a) the value of the goods if they had complied with the undertaking, measured at the time and place of delivery; and (b) the actual value of the goods, in their actual condition, at the same time and place. This is the "prima facie" measure of damages, which will be superseded where the buyer claims loss of profits or other consequential losses. Where there is a market price for goods of the contractual description and quality, this will fix their "value"; in the absence of an available market, any relevant evidence should be admitted, e.g. the price at which a sub-buyer had agreed to buy the goods from the buyer before the defect was discovered may be some evidence of their value, as may the price at which an offer for the goods was made by a third person. The value of the defective goods actually delivered by the seller may be fixed by any relevant evidence, e.g. the price at which the buyer has been able to resell the goods to a sub-buyer who has knowledge of their defective condition. The courts may follow the commercial practice of fixing a "price allowance" for damaged goods. [emphasis added]
"23. Before delving into the details of the way in which the damages claim was put I think that it is necessary to set out a few principles. The claim was put both as a claim for breach of warranty (i.e. a claim in contract) and also as a claim for misrepresentation (i.e. a claim in tort). The measure of damages differs according to which cause of action is in play. In the case of a claim that there has been a breach of warranty about the quality of an asset that is sold, the measure of damages is the difference between the true value of the asset and its value with the quality as warranted. But in the case of a claim in tort, the measure of damages is the different between the true value of the asset and the price paid.
28. In principle, therefore, Mr Karim is entitled to be put into the position in which he would have been if the business had had the turnover and profit warranted." [emphasis added]
"the measure of loss for breach of warranty in a share sale agreement is the difference between the value of the shares as warranted and the true value of the shares: see Lion Nathan Ltd v C-C Bottlers Ltd  1 WLR 1438…" 
"…The prima facie rule, from which departure must be justified, is that damages are to be assessed at the date of breach and that only events which have occurred at that date can be taken into account." 
"As to the principles to be applied, it is common ground that:
(1) The measure of loss for breach of warranty in a share sale agreement is the difference between the value of the shares as warranted and the true value of the shares, or as put shortly, "warranty true" vs. "warranty false", assessed as at the date of the share sale agreement since that is the date when the breach of warranty occurs.
(2) This involves a valuation, and as with any valuation the process involves establishing (as the defendants' expert put it), "The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in arm's length transaction, after proper marketing where the parties had each acted knowledgeably, prudently, and without compulsion".
(3) However, there is no one methodology to be applied in a valuation (Sycamore Bidco Ltd v Breslin [2012) EWHC 3443 (Ch) at , Mann J).
(4) As with any valuation it is necessary, as both experts agreed, to appraise the number in question in the light of the circumstances. As THG's expert aptly put it, " ... you always have to stand back and say, does the answer give you a sensible result and not get too worked up in the model itself'." [emphasis added]
[29-008]: "Where the shares are in some way not up to the promised standard this is in the nature of a breach of warranty of quality and the normal measure is of value as warranted less value in fact. This is confirmed and applied in all of three cases in the circumstances of which it was held that events subsequent to the breach were not to be taken into account. These are Ageas (UK) Ltd v Kwik-Fit (GB) Ltd, Hut Group Ltd v Nobahar-Cookson, and Bir Holdings Ltd v Mehta, considered in detail at para.10-121, above.
In Lion Nathan v CC Bottlers, the whole of the share capital in a soft drinks company was sold with a warranty not that the profits for a number of months would be a specified figure but that the forecast of profits for those months had been calculated with all due care. It was said by Lord Hoffmann that, had there been a warranty as to the level of profits, which he referred to as a warranty of quality, then
"the damages would prima facie have been the difference between what the shares would have been worth if the earnings had been in accordance with the warranty and what they were actually worth".
Since, however, the breach of warranty was only in relation to the forecast, the damages were held to be the difference between the price agreed on the basis of the forecast as made and the price it would have been had the forecast been properly made. Where the seller delivered partly paid instead of fully paid shares in Re Government Security Fire Insurance, Mudford's Claim, the buyer successfully claimed the amount unpaid."
"Turning to the case of compensatory damages…there is at the very start a basic, though somewhat latent, distinction between contract and tort. This distinction is in the general rule which is the starting point for resolving all problems as to measure of damages. The distinction is latent because the leading formulation of the general rule is sufficiently wide to cover contract and tort equally: this formulation is that the claimant is entitled to be put into the same position, as far as money can do it, as he would have been in had the wrong not been committed. In contract, however, the wrong consists not in the making but in the breaking of the contract and therefore the claimant is entitled to be put into the position he would have been in if the contract had never been broken or, in other words, if the contract had been performed. The claimant is entitled to recover damages for the loss of his bargain." [emphasis added]
"…The Court of Appeal was saying that although the vendor had not warranted that the earnings would be $2,223,000, it had effectively warranted that the company could be valued on the assumption that they would be in the region of $2,223,000. As the region would be a range above and below the figure of $2,223,000, the reasonable buyer would value such a company, as the actual purchaser had done, on the assumption that the earnings would be the mean figure of $2,223,000. Accordingly, the measure of damages was the difference between the company valued on that basis and the actual value of the company, calculated by applying the same multiple to the actual earnings after tax." [emphasis added]
"39. It seems to me therefore that the information that Mr Wemyss provided was no longer true as at the date of the contract, and moreover was incomplete and misleading. Mr Wemyss was, therefore, in breach of warranty."
40. The upshot is, in my judgment, that Mr Karim was entitled to damages on both the tortious measure and also the contractual measure. Which he chooses will be that which produces the better result for him. The tortious measure is the difference between (a) the price that Mr Karim paid and (b) the true value of the Business. The contractual measure is the difference between (a) the value of the Business if the warranted information had complied with the warranty: i.e. it had been true, complete and not misleading and (b) its true value. The difficulty confronting the judge was that he had no valuation evidence of either:
i) The true value of the Business at the contract date; or
ii) The value that the Business would have had if the warranted information had been true, complete and not misleading." [emphasis added]
Conclusion on the measure of damages
II On the assumption that the 2008 Accounts were not properly drawn up such that the defendant was in breach of the Agreement, did that breach cause the claimant to suffer loss and damage?
"26. But for the Defendant's breach of the Agreement, the true accounting position as between IAPBL and LBF would have been disclosed with the result that:
(2) The Claimant would have been informed or aware of substantial liabilities to LBF (which liabilities potentially were increasing at a high default interest rate), and the Agreement would have contained a specific warranty and/or indemnity in the Claimant's favour in respect of the true liability to LBF." [emphasis added]
"if OCBC had been informed by ING of the risk of LBF Claims prior to entering into the Agreement, OCBC would certainly have sought an indemnity from ING against that risk…".
" I also believe that ING would have agreed to such indemnity. During the acquisition process, the granting of indemnities for liabilities of an uncertain extent was discussed between the parties. ING disclosed the existence of litigation in respect of client A but said that it would not be providing any details regarding this litigation. Due to the uncertainty of this exposure, and in accordance with OCBC's standard practice, OCBC sought an indemnity from ING for any losses arising from any litigation or claim in respect of client A… ING agreed to grant an indemnity for any losses arising from any litigation or claim in respect of client A…
 Further.… ING also agreed to grant an indemnity for any losses arising from or in connection with two specific regulatory investigations…"
"clearly shows that OCBC was concerned about and sought and obtained indemnities in respect of potential liabilities which are far smaller than the LBF Claim. In the circumstances, if OCBC had been informed by ING of the risk of LBF Claims (whether assessed in terms of principal and interest, or principal alone) prior to entering into the Agreement, OCBC would certainly have sought an indemnity from ING against that risk."
i) PWC recorded that IAPBL had significant outstanding derivative financial instruments and stated that they noted significant differences between its independent valuation and the valuation provided. PWC recommended that OCBC should seek an indemnity against any liability in respect of exposures from incorrect valuation of outstanding financial derivative positions.
ii) PWC noted that the bank may have significant FX trading positions on FX derivatives and recommended that OCBC seek an indemnity on losses from outstanding financial derivative positions.
iii) PWC noted a significant number of derivative transactions with related companies giving rise to counterparty risk and recommended that OCBC should consider obtaining an indemnity on losses from outstanding financial derivative positions.
" … I think within the due diligence team we had expert from our own Treasury Department who traded a large amount of derivatives and who was very experienced in terms of valuing as well as position taking, so on and so forth. And I do not remember the detail but they were definitely very involved in looking at the position, derivative position, trading position, if any, taken by IAPBL. And at that time I remember having asked our Treasury members of the team as to what they thought of IAPBL's risk with regard to trading, derivative or otherwise.
I was assured that from their own checking while there might be valuation issues IAPBL as a practice did not get into open position taking. Their practices have always been matching on the back-to-back basis. And if that were to be the case, valuation is frankly -- of the derivative -- could be a moot point because one side would be offsetting the other side, even if there is a difference. That was what I took comfort from. And I do not remember the exact detail, but I was given the comfort that derivative or trading position would not be an issue.
Obviously we would love to have an indemnity from ING on everything, which in fact we have asked for many, many warranties. But in the course of the negotiation again -- I don't remember the exact detail -- the warranty clauses were negotiated and were -- finally they took the form they appear in the agreement.
Q. So you accept there is no warranty in the SPA in relation to the valuation of exposures to derivatives, is there?
A. As far as my recollection is concerned of the agreement there was no such warranty on valuation.
Q. And there is no indemnity in relation to losses arising from derivatives, is there?
A. With regard to -- no, there was no such clauses in the agreement.
Q. You didn't ask for that indemnity, then?
A. In the course of the negotiation we asked for many, many things. Then obviously there were numerous sessions of negotiation. Some were taken out, some were put in. For example, client A which was an indemnity that was started right at the beginning and it was in there, there were several others we asked for and there were two others that were incorporated --
Q. We will come to client A later, thank you. Just picking up on that, you said there were several others you asked for which were not incorporated in the agreement?
A. Several others as far as the wording of the warranties. For example the threshold was something that was heavily negotiated and took the final form as it appeared in the agreement.
Q. So you would rather have had additional warranties that were rejected by ING?
A. Yes, I believe we asked for more and not all were accepted." [emphasis added]
i) PWC noted that there could be additional potential exposure relating to outstanding litigation claims and sale of structured products. In relation to the sale of structured products, PwC estimated the exposure to be about USD16m. PwC recommended that OCBC consider a suitable indemnity for all liabilities in respect of exposures from litigation and claims on structured products and against undisclosed contingent liabilities.
ii) As of 30 June 2009, a total of US$ 622 million of loans were recorded as substandard or doubtful and a provision in the accounts of US$24 million had been made in respect of these loans. PwC recommended that OCBC should seek a warranty on the recoverability of all loans and the adequacy of the loan provision.
"Q. … you were told to seek a warranty and indemnity in relation to the structured notes with an estimated exposure of over 15 million, but you didn't seek it, did you?
A. We did not seek indemnity, or rather I would say the indemnity did not appear in the final agreement. I cannot remember if we sought the indemnity. But again, the comfort we had in terms of structured notes was that OCBC alone sold a substantial amount of structured notes and we had a good understanding and feeling of the risk involved and the damages that could arise from that.
Q. So you think you may have asked for the indemnity and not got it; you can't remember that?
A. I can't remember that.
Q. Also you were told that you should seek a warranty and indemnity in relation to non-performing loans running into the hundreds of millions; that wasn't in the SPA, was it?
A. That wasn't in the SPA, and again, lending business has always been the core business of OCBC bank and we have a fair number of credit expert assigned by the bank to look into that portfolio, and I believe we took comfort from the fact that we believed the provisions may not be absolutely so-called iron-clad, but it would be sufficient.
Q. Do you know whether that is another indemnity you asked for and didn't get, or can you not remember?
A. I remember that initially the draft, the earlier drafts that were circulated had much tighter warranty and indemnity clauses and as the document evolved unfortunately certain items were either diluted or eliminated.
Q. Because ING wouldn't give you what you wanted?
A. Well, it was both ways. Ultimately negotiation is a case of at the end -- I call it horse trading; one has to give something in order to protect clauses that were deemed to be more important to one." [emphasis added]
"That amount of 15 million was looked at and based on the input from our Treasury expert they felt comfortable with whatever liabilities or whatever valuations there were embedded in the balance sheet."
"put me back in time to the point before we signed the agreement, if we had understood the extent, the complexity, the uncertainty of all those factors, the components that made up the claim ultimately we received from Lehman Brothers, I would – it is only logical, sensible, practical for me to seek an indemnity from ING against that risk."
"... In deciding on the final bid to be submitted, the binding bid to be submitted, obviously we had presentation to the board and so on and so forth. The board focused on two things, one is the franchise value: how much is it worth? And the other big item there, which is a larger item, is the NAV. And the thinking behind was that NAV, so long as the accounts are done correctly, so long as whatever presented in the balance sheet are of that -- of those values, we ought not to lose the value even if we don't make any money. Therefore, goodwill is at risk and NAV is a sure amount that we want to be in the pocket, and therefore we would be very concerned about any amount that could hurt the NAV as on a downside protection basis.
And therefore, on that basis I was pretty hard, I would say pretty tough in terms of negotiating for all the threshold relating to the indemnity or the breach of warranties and so on and so forth, I believe I pushed as hard as I could on those amounts. So this amount of together close to 19 point whatever million was suddenly -- I would not even use the word "concern", it was kind of shocking when we received that letter from Lehman Brothers."[emphasis added]
"A. I -- well, seeking indemnities is very much -- is part of a negotiation and our -- as I was running the transaction, it is very important to me that things that I could box, box in terms of the team, the bank, and appreciate the limit of the liabilities, the losses and damages and so on, we would be a bit more prepared not to ask for too much protection, versus things that are difficult, uncertain and complex and we don't have enough experience or time to do it.
And I also fully appreciate that Pricewaterhouse, as a financial consultant is very -- and it's not the first time I'm seeing it -- in every page, whenever problems are pointed out, they would want to add something. Even if those are impossible or unreasonable to obtain, they would put that in.
For example, on NPL, it is very practical that if a buyer were to buy a bank, it is impossible to ask the selling bank to give too much warranties on the recoverability, because the seller bank would have to provide capital for that kind of assurance. And it is no wonder we do that kind of thing on this deal. They have capital to play with, and if that is the case, why should they sell the bank, yes, for example?
So it is a case of balancing the important and the less important and ultimately striking a set of indemnities that we would be able to live with, and in this particular instance, dealing with ING, I did find that for specific indemnities they are quite willing, I must say, quite willing to provide, perhaps because of their own situation." [emphasis added]
"We did not seek indemnity, or rather I would say the indemnity did not appear in the final agreement. I cannot remember if we sought the indemnity…"
A. I remember that initially the draft, the earlier drafts that were circulated had much tighter warranty and indemnity clauses and as the document evolved unfortunately certain items were either diluted or eliminated.
Q. Because ING wouldn't give you what you wanted?
A. Well, it was both ways. Ultimately negotiation is a case of at the end -- I call it horse trading; one has to give something in order to protect clauses that were deemed to be more important to one."
It would seem on the evidence that it cannot be said that this was a risk which was "boxed" and where the limit of the liabilities was appreciated.
"In the course of the negotiation we asked for many, many things. Then obviously there were numerous sessions of negotiation. Some were taken out, some were put in. For example, client A which was an indemnity that was started right at the beginning and it was in there, there were several others we asked for and there were two others that were incorporated –
"Q. So you would rather have had additional warranties that were rejected by ING?"
"A. Yes, I believe we asked for more and not all were accepted."
"We were very concerned about the balance sheet which provides us with the downside protection if business failed to perform."
"Ultimately negotiation is a case of at the end -- I call it horse trading; one has to give something in order to protect clauses that were deemed to be more important to one."
Conclusion on causation
III Was there a breach of the warranty concerning the 2008 Accounts?
"3.1 The IAPBL Accounts are properly drawn up in accordance with the provisions of the Singapore Companies Act, Cap. 50 and Singapore Financial Reporting standards so as to give a true and fair view of the state of affairs of the IAPBL as at the Last Accounting Date and of the results, changes in equity and cash flows of IAPBL for the year ended on the Last Accounting Date; and the other matters required by Section 201 of Singapore Companies Act, Cap. 50 to be dealt with in the IAPBL Accounts." [emphasis added]
i) there is no definition of "true and fair" in the contemporaneous or current versions of the Singapore Companies Act or in the Financial Reporting Standards ("FRS");
ii) accounts which are in full compliance with the relevant FRS are likely to be true and fair and that minor non-compliance does not necessarily result in accounts that are not true and fair.
"41. Errors can arise in respect of the recognition, measurement, presentation or disclosure of elements of financial statements. Financial statements do not comply with FRSs if they contain either material errors or immaterial errors made intentionally to achieve a particular presentation of an entity's financial position, financial performance or cash flows."
The original case advanced by OCBC
i) IAPBL had incorrectly calculated the Loss on early termination of the derivative transactions with LBF (the "Initial Sum") and undercalculated the amount due on termination (an alleged breach of FRS 39);
ii) The LBB Collateral had been wrongly (in that it was contrary to the provisions of the ISDA Agreement) treated as an Unpaid Amount owing to IAPBL and thus wrongly deducted from the amount due to LBF; it should have been shown as an unsecured liability owing to IAPBL but in the light of the insolvency of LBF and LBB, the accounts should have recorded a provision to take account of its impairment (an alleged breach of FRS 32 (Financial Instruments: Presentation) and 39);
iii) IAPBL had wrongly (due to the fact that at the time of the purported set-off LBF was in bankruptcy and thus contrary to English/Swiss insolvency law) set off amounts owed by LBF to ING Belgium (the "Triangular Set-Off") with the result that the amount payable on early termination was reduced to nil.
i) to reverse the Triangular Set-Off by an adjustment on the balance sheet to reflect the fact that this amount was due to LBF rather than ING Belgium;
ii) to reverse the Collateral Set-Off by an adjustment on the balance sheet to reflect the fact that the amount of collateral remained owed to IAPBL but with a provision (of 50-100%) to take account of the impairment of the LBB Collateral which would be reflected in an adjustment to the profit and loss statement and the balance sheet; and
iii) to reverse and restate the correct Initial Sum by adjustments to the balance sheet and the profit and loss statement.
The case advanced in closing by OCBC
The court's approach
"on any view there was at least a contingent liability that was not too remote and that should have been disclosed in the notes to the accounts"
He further submitted that in relation to all three areas of errors they were clearly areas of "potential liability" and "that being so", FRS 37 was engaged.
"A contingent liability is;
a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non occurrence of one or more uncertain future events not wholly within the control of the enterprise; or
b) a present obligation that arises from past events but is not recognised because:
i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
ii) the amount of the obligation cannot be measured with sufficient reliability."
"Unless the possibility of any outflow in settlement is remote, an enterprise should disclose for each class of contingent liability at the balance sheet date a brief description of the nature of the contingent liability and, where practicable:
a) an estimate of its financial effect…
b) an indication of the uncertainties relating to the amount or timing of any outflow; and
c) the possibility of any reimbursement."
i) there was a real risk that the Triangular Set-Off, upon which that supposed related company obligation was based, might be found to be invalid; and that
ii) if it were, LBF might bring a claim against IAPBL for the amounts represented by the Triangular Set-Off, with that claim carrying an extremely high interest rate.
i) the Triangular Set-Off does not fall within FRS 37 as that standard does not apply to financial instruments that fall within FRS 39;
ii) to qualify for disclosure under FRS 37 a contingent liability must meet the definition in FRS 37 and in this case the Triangular Set-Off is not a "past event" that gives rise to a contingent liability since set-offs or reclassifications do not amount to past events that give rise to contingent liabilities;
iii) the omission of a note or disclosure does not invalidate the true and fair view of a set of accounts;
iv) materiality depended on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, may be the determining factor.
"… There is nothing in your first report and nothing in your second report that suggests the triangular set-off has caused material misstatement of the accounts, is there?"
Mr Reid replied:
"there isn't no."
"… Nothing in paragraph 2 of the joint statement referred to or was intended to have an impact on my views about the breach of FRS 37, which remain as set out in my earlier reports, namely that IAPBL's failure to disclose the contingent liability arising from the triangular set-off amounted to a breach of FRS 37 and that this breach of FRS 37 is material to the truth and fairness of the IAPBL 2008 Accounts." [emphasis added]
"so if you have a claim, a potential liability which is within the definition of a contingent liability, that is as a possible outflow of funds from the company, that would be disclosed by way of a note to the accounts, as a contingent liability?"
"A. Generally, yes."
"Q. And if you have a case, as here, where there was a possible liability to LBF which included uncertain sums, that is the interest that is payable on the liability, then the uncertain sum is also something you would include in the note of contingent liabilities, isn't it?"
A. No,… I disagree.… In the current case the owings to Lehman's were set-off. It is still on the balance sheet. I cannot opine as to whether it is discharged or not but it is still on the balance sheet, but set-off against another asset.…
These items are already on the balance sheet, if there is liability to pay interest it is already on the balance sheet. If you underestimated the liability, it could be a change in estimate or it could be in error. But in effect the liability is already on the balance sheet.…
Q.… If you assume for the moment that there was a financial liability on the derivative… but there is a doubt that because of a dispute or potential dispute between LBF and IAPP about that liability, that is a circumstance in which you would have to include a note in the accounts about the contingent liability unless you thought it was so remote that it didn't qualify, isn't it?
A. No, I disagree.… The liability is already on the balance sheet. If there is any underaccrual, underestimate of the liability, then that underestimation should be rectified. If it is a material error, then the 2008 Accounts should have been restated." [emphasis added]
i) There are the following matters which adversely affect the general credibility of Mr Reid:a) There is no explanation for the change in position of Mr Reid in his third report or his failure to be clear that it was a change from his earlier reports.b) Although Mr Reid stated on his CV that he had more than 25 years' experience in the accounting profession, he stated in cross-examination that he spends close to 50% of his time taking appointments as an insolvency practitioner e.g. administrator, receiver, liquidator and the rest of the time on valuation work and as an expert witness in accounting related matters. He confirmed in cross-examination that his day-to-day practice does not involve auditing.c) Notwithstanding the fact that Mr Reid stated that he spends part of his time as an expert witness, he did not appear to understand his role as an expert witness: in his first report, Mr Reid considered various legal authorities and expressed his own view on the legality of the set-off of the LBB Collateral. In cross-examination, it appeared from his evidence that he did not understand why it was inappropriate for him to provide an opinion on legal matters, asserting that he had a very good understanding of the law of set-off as he had dealt with it professionally.d) Although Mr Reid confirmed orally that the opinions that he had expressed in this case were the opinions that he holds, nevertheless it is of concern that the Court of Appeal in Singapore in November 2018 criticised the expert evidence of Mr Reid on an issue of valuation, in particular that the court found that the chosen methodology was not an objective approach and the evidence was highly subjective having been based very heavily on the respondent's instructions. Asked about the findings of the court in cross-examination, Mr Reid agreed that the court found that his evidence fell short of the standards expected of expert evidence. There was a further decision of the courts of Singapore in 2017 where the court found that Mr Reid's expert evidence was inconsistent with the objective evidence.
ii) By contrast, Mr Kon is the Managing Partner of Foo Kon Tan LLP, a Singapore audit and accounting practice. Mr Kon is a fellow of the Institute of Singapore Chartered Accountants, the national accountancy body of Singapore and currently President of the Institute of Singapore Chartered Accountants and President of the ASEAN (Association of Southeast Asian Nations) Federation of Accountants. His experience includes (paragraph 5 of his report) the "preparation, oversight, audit and regulation of accounts drawn up in accordance with the provisions of the Singapore Companies Act and Singapore Financial Reporting Standards".
iii) Unlike the examples of a liability arising out of the wedding or a guarantee (referred to above) where the liability is not already on the balance sheet, the liability for the Triangular Set-Off is already on the balance sheet and thus these examples of an obligation arising from a past event can be distinguished from the present case and do not provide evidence to counter the evidence of Mr Kon that the Triangular Set-Off should not be categorised as a contingent liability falling within FRS 37.
Conclusion on Triangular Set-Off
Alternative case-materiality in relation to Triangular Set-Off
i) whether it was a material breach for the purposes of the warranty that the 2008 Accounts gave a true and fair view; and
ii) how the test of materiality would apply to a contingent liability.
i) the materiality level should have been set at no more than US$3.4 million being 10% of the pre-tax profit of US$34 million in the 2008 Accounts, but even if the threshold was higher at US$10.5 million (as ING contend) there was a risk that the liability would exceed that;
ii) no distinction was drawn in the evidence in relation to the materiality test depending on whether it is a contingent liability or actual liability.
"Material Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor."
"it follows that it is my view that the mere fact that an error would not necessarily affect the profit or net asset figures… does not mean it cannot be material."
"applying what I say is the correct approach to materiality, the relevant question with regard to the nondisclosure by IAPBL and the triangular set-off is whether the consequent breach of FRS 37 could have influenced the economic decision of the user of the IAPBL 2008 Accounts. My view is that it almost certainly would have done."
"Determining materiality involves the exercise of professional judgment. A percentage is often applied to a chosen benchmark as a starting point in determining materiality for the financial statements as a whole."
"Assessing whether an omission or misstatement could influence economic decisions of users, and so be material, requires consideration of the characteristics of those users. The Framework for the Preparation and Presentation of Financial Statements states in paragraph 21 that "that users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence." Therefore the assessment needs to take into account how users with such attributes could reasonably be expected to be influenced in making economic decisions." [emphasis added]
i) there is no evidence before the court as to how the note for the contingent liability should be presented and whether the contingent liability would be presented as the default interest which would accrue for one year or more than one year;
ii) whilst the evidence of Mr Reid is that the failure to note the contingent liability is material (without reference to any benchmark being required) it is unclear how materiality can be determined without any reference to a benchmark as a starting point or any other evidence as to how it would influence the decision of a user of the 2008 Accounts: such an approach was only adopted by Mr Reid in his third report and runs contrary to the approach in the auditing standards which acknowledges that a percentage is often applied to a benchmark as a starting point in determining materiality;
iii) if a benchmark is adopted, there is no evidence that profits would be an appropriate benchmark for a contingent liability;
iv) assuming that the default interest was to be as high as 18% and that a benchmark of 10% of normalised profits is an appropriate starting point, without evidence as to the way in which the liability would be noted (ie how many years of interest) it cannot be concluded that the amount of such a contingent liability is material.
"in relation to all three areas of errors we are talking about, there was a non-remote potential liability to LBF in respect of those matters… That being so, we say FRS 37 is engaged… There is a non-remote potential liability here … because you have not calculated the initial sum in a certain way…"
"the way they calculated the initial sum meant that there was said to be a lower sum due to LBF than in fact should have been the case and they therefore did not include in the accounts the correct liability… They were the ones doing the initial sum calculation, they chose to value using historic data,…and in those circumstances they ought to have put a note in to say -…that there was a potential liability…arising from the way that we have calculated our initial sum and … we have not also taken into account anything for unpaid cash flows."
Conclusion on breach of warranty
Errors in the 2008 Accounts; disclosure; limitation of liability