Divided by a common language

Nowadays, any UK law firm active in financial transactions will have its complement of US lawyers, and vice versa. The rationale is that English and New York law ­ the two most prevalent governing laws in international financing transactions ­ are virtually fungible these days. What determines the governing law of a transaction will be the preference of the parties involved, the lender or underwriters’ country of origin or location, or the whereabouts of the borrower’s assets.

However, a line of cases involving attempts by US Names (investors in the Lloyd’s of London insurance market) to avoid their liabilities has demonstrated that the two legal systems are not identical. The cases are relevant to the capital markets in general because they concern the ability of non-US issuers of securities to circumvent the application of US securities laws by choosing a governing law other than that of New York. The cases came to the fore over the last three years when Lloyd’s was putting in place its reconstruction and renewal plan (completed in September this year). During the booming 1980s, Lloyd’s had attracted an influx of new Names at a time which, in retrospect, was inauspicious: US courts were making awards against US companies for long-tail liability ­ pollution and asbestosis cases going back decades.

These companies claimed on their Lloyd’s policies, which responded. In 1985 Lloyd’s changed its policy wording to prevent such open-ended liability from arising again. But the damage, as far as the past was concerned, was done. Losses escalated, not helped by a coincidence of catastrophes ­ hurricanes and oil-rig losses. The US is Lloyd’s largest overseas market: over half of its business is written in dollars and it maintains a trust fund in the US, under the auspices of the New York Insurance Department, to meet the claims of US policyholders.

As losses mounted, US Names felt duped. In the 1990s, various of them brought actions in the US courts, alleging a smorgasbord of civil offences on the part of Lloyd’s, ranging from fraud and misrepresentation to breaches of US securities laws. Their argument was that membership of Lloyd’s, like the holding of a share in a company, was a security and that Lloyd’s had been in breach of federal and state “blue skies” laws by not distributing a prospectus and complying with obligations to register and so on. If the Names were right, they would not have to meet their liabilities and Lloyd’s would be unable to pursue them. However, they lost in a string of cases because their agreement with Lloyd’s specified that any disputes would be settled according to English law in English courts. The US courts took notice of this and refused to entertain the Names’ claims, saying that English law provided its own remedies to which the US Names should resort.

However, in this respect the two jurisdictions are not identical. The US has some of the toughest securities laws in the world, in order to prevent retail investors from being preyed upon. These include Rico, the Racketeer Influenced and Corrupt Organizations Act, originally implemented to trap mobsters crossing state lines, but with a wider ambit. These laws would not be enforced by an English court, which would apply domestic UK law such as the Misrepresentation Act 1967 (originally enacted to protect credit consumers) and common law fraud and mistake. These remedies are more even-handed than their US counterparts since they are not securities-specific and the UK, with its self-regulatory regime, does not have a history of securities regulation comparable to that which spawned such US federal agencies as the Securities and Exchange Commission.

What particularly perplexed some lawyers was the fact that the US laws invoked by the Names contain anti-waiver provisions: they expressly say that you cannot get around them by specifying that they do not apply ­ because the legislature felt they provided protections not available elsewhere. But that was precisely the effect of the provisions in the Lloyd’s agreements. Most people’s understanding of securities regulation is this: what matters is where I distribute securities, not the governing law which I say applies. If I distribute securities on the streets of Manhattan without complying with SEC requirements, I am potentially in trouble. If I sell securities to Eskimoes, the SEC will not be concerned even if I specify New York law as governing the transaction, unless there is some other nexus with the US ­ for instance a US issuer or underwriter ­ which provides the SEC with a reason for asserting its jurisdiction.

What also upset observers was that the courts’ decision not to entertain the cases was based on their view that the jurisdiction specified (in these cases the UK) provided adequate alternative remedies ­ a subjective assessment which does not confer the certainty that law is intended to provide. However, these cases, Roby and Bonny, are not necessarily the last word. In Leslie (another Lloyd’s case, decided last year) the judge ruled that while English courts were as good as their Texan cousins, it would be against public policy to deprive the plaintiffs of their rights under local Texan law.

What are the implications for bankers? The first is that these insurance-related cases can cross over into the capital markets. In pt Adimitra Rayapratama v Bankers Trust (also decided last year), Bankers Trust was sued over the sale of a swap sold under the terms of the Isda master agreement, which specifies English law as governing and the UK courts as having jurisdiction. The case was thrown out for that reason.

The second implication is that it pays to be advised on both English and New York law in international financial transactions, which is why in the last few months there has been an increase in moves by partners between US and UK law firms. For example, US firm Shearman & Sterling has recently lost one of its top securities partners, Tom Joyce, to UK law firm Freshfields but has recruited four partners ­ all English lawyers specializing in project finance ­ from fellow US firm Milbank Tweed Hadley & McCloy. “It’s a common fallacy that a prospectus is written under a governing law. It isn’t. A prospectus isn’t written under any law,” explains Stephen Edlmann, head of capital markets at Linklaters & Paines, which has just hired Stephen Land, formerly a tax partner with US firm Howard Darby & Levin, bringing the UK firm’s complement of US lawyers to 17. “It’s the liabilities which arise out of distributing a prospectus which can be triggered by the laws of the jurisdiction in which it is distributed.”

With acknowledgment to Lee Buchheit of Cleary Gottlieb Steen & Hamilton for us materials