Immobilised securities: who is entitled to sue and which law is applicable?

Executive summary

The decision provides authority that the appropriate law for determining disputes relating to immobilised securities is the law of the contract.

The decision upholds the “no look through” principle that only the holder of the notes enjoys enforceable rights against the issuer (subject to any contractual exceptions). Since that is a fundamental concept to the workings of the settlement systems in interests in immobilised securities, this decision represents a common-sense approach that will provide comfort to issuers. It provides certainty within the market for immobilised securities and therefore provides welcome clarity within this area of debt capital markets.

Background

The appellant, Secure Capital SA (Secure Capital), held an interest in notes issued by the respondent, Credit Suisse AG (Credit Suisse). The notes were linked to life insurance policies with payment on the notes contingent upon mortality rates amongst a set of "reference lives" to which the relevant life insurance policies related.

The notes were issued in bearer form and were permanently held by Bank of New York Mellon (the Custodian or the Bearer). Interests in the note were traded through Clearstream, an electronic trading system for interests in securities, through a descending succession of interests. The Custodian held the notes for Clearstream. Clearstream maintained accounts for members, such as banks, who held and dealt in interests in the securities as Account Holders. Account Holders could trade interests between each other, hold interests for themselves as principal or hold interests to the order of Account Owners, ie their customers. In this case, RBS was the Account Holder for Secure Capital, the Account Owner.


The contractual documentation governing the notes was governed by English law. Secure Capital contended that the note documentation contained a term which was misleading and which rendered the notes effectively worthless. Secure Capital argued that Credit Suisse as Issuer knew or ought to have known that the term had that effect but failed to disclose it.

Secure Capital was seeking to make a direct claim for breach of contract against Credit Suisse as issuer of the notes, rather than against RBS, its Account Holder. Since Clearstream operates under Luxembourg law, Secure Capital submitted that it was entitled to exercise the right of the Bearer to bring an action for breach of a term of the notes, based on Article 8 of Luxembourg law dated August 2001, even though it was not the Bearer. Article 8(1) of the Luxembourg 2001 law states that:

“the investor may exercise or arrange to exercise corporate rights attached to the securities and the rights attaching to the holding of the securities linked to the possession of the securities by producing a certificate drawn up by the relevant account holder attesting to the number of securities registered in its custody account”.

In the first instance decision, Hamblen J grant summary judgement. He held that Luxembourg law was irrelevant and only English law, as the governing law of the contract, applied to the enforcement of contractual rights. Under English law the Issuer’s obligations were only owed to the bearer. There was no contractual relationship between Secure Capital and Credit Suisse. Hamblen J rejected Secure Capital’s arguments that it was entitled to be treated as the bearer on a sui generis basis (as opposed to a contractual or possessory basis). Secure Capital’s claim therefore failed.

In the appeal, David Richards LJ identified three key issues: (1) whether Secure Capital was entitled to rely on provisions of Luxembourg law to establish its right to sue; (2) whether Secure Capital as a non-bearer could claim damages for breach of contract; and (3) whether Secure Capital was entitled to be treated as an additional holder so as to be able to sue on the notes for its own loss.

Decision

Richards LJ, with whom Lord Justices Beatson and Irwin agreed, dismissed the appeal. He held that the proper law of the contract governing the notes is English law as it was an express term of the contract that the notes would be governed by English law. The identification of parties who are entitled to sue under the contract was, therefore, a matter of English law.

Richards LJ held that the only party with a right to sue Credit Suisse is the Custodian, as holder of the notes, unless the contractual exception applied. Applied to this case, this could only occur if there is default in the payment of principal on the notes (in which event Account Holders may acquire directly enforceable rights against Credit Suisse), and that was not the case here.

On the issue that will be of greatest interest to issuers, Richards LJ also reinforced the “no look through” principle. He emphasised the general position for immobilised securities whose interests are traded through settlement systems is that each party only has rights against their own counterparty. That includes a situation in which one party seeks to establish a breach of contract.

Commentary

The decision provides authority on the appropriate law for determining disputes relating to immobilised securities. Ultimately, Richards LJ did not see any merit in Secure Capital’s argument that a new, exceptional and different characterisation was needed for immobilised securities based on the law of the settlement system. Rather, Richards LJ reasoned that it would “produce an incoherent, if not chaotic, result” (para 58).

The decision of both courts upholds the “no look through” principle that only the holder of the notes enjoys enforceable rights against the issuer (subject to any contractual exceptions). As a fundamental concept to the workings of the settlement systems in interests in immobilised securities, this decision represents a common-sense approach that will provide comfort to issuers. It provides certainty within the market for immobilised securities and therefore provides welcome clarity within this area of debt capital markets.