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stephanie_woods_phBackground

On 20 December 2010 the FSA commenced proceedings against (1) Sinaloa Gold plc, (2) a person or persons trading as PH Capital Invest, and (3) a Mr Glen Lawrence Hoover (together “the defendants”) on the basis that:

(i)  Sinaloa was promoting the sale of shares (an authorised activity) without authorisation or an approved prospectus;

(ii) PH Capital and Mr Hoover were knowingly engaged in the activity; and

(iii) PH Capital was an unauthorised person carrying on regulated activities in breach of the Financial Services and Markets Act 2000 (“FSMA”).

Before issuing proceedings, the FSA made a without notice application for a freezing injunction against Sinoloa and PH Capital under the FSMA, s 380(3).

Schedule B of the injunction stated that the FSA “did not offer any cross-undertakings in damages” but that the FSA would “pay the reasonable costs of anyone other than the Respondents which have been incurred as a result of this order including the costs of finding out whether that person holds any of the Respondent’s assets” (the “Third Party Costs Wording“) and “if the court later finds that this order has caused such person loss, and decides that such person should be compensated for that loss, the Applicant will comply with any order the court may make” (the “Third Party Losses Wording“).

The FSA subsequently applied to have the Third Party Losses Wording removed on the basis that it is a public authority and therefore does not need to indemnify third parties for any losses suffered as a result of complying with the injunction.  Barclays Bank plc, with whom Sinoloa had 6 bank accounts (and to which Mr Hoover was the sole signatory) intervened to oppose the application: it wanted to be able to recover any losses it may suffer as a result of complying with the order.

At first instance, the application to have the Third Party Losses Wording removed was refused. This decision was overturned in the Court of Appeal which preserved the Third Party Costs Wording (which the FSA did not dispute) but eliminated the Third Party Losses Wording. Barclays appealed this decision to the Supreme Court.

The Issues

The issues for consideration before the Supreme Court were:

(i) whether the position of the FSA in exercising its public law function and duty can be equated with that of an injunction granted for private purposes;

(ii) whether and how far the position regarding the giving of cross undertakings differs according to whether it is to protect a defendant or a third party; and

(iii) whether there is any coherent distinction between a cross undertaking in respect of third party losses and third party costs.

The considerations of the UKSC

As regards point (i), the Court stated that the starting point under English public law is that there is no general duty to indemnify those affected by an action undertaken with legislative authority. In general, a public authority, seeking to enforce the law and fulfil its public duty using only the resources which have been allocated for its function cannot be expected to back its actions with public funds: if a public authority was required to provide a cross undertaking, there is a risk that it may be deterred from (or burdened in) pursuing claims in the public interest due to the risk to public funds.

Conversely, private claimants, in order to obtain an injunction, will ordinarily be expected to give a cross undertaking in damages to both defendants and third parties in case they are ultimately awarded an unjustified injunction to the detriment of another’s interests.

The Court commented that in the current proceedings, the FSA, a legislative authority  which was acting in fulfilment of its public duty under FSMA to protect both the interests of consumers and the UK financial system, was taking positive action to shut down what it alleged to be unlawful action. The FSA was also acting in accordance with the power granted by the FSMA, s 380(3) to seek injunctive relief.  It held that in these circumstances, the FSA, unlike private claimants, should not be required to provide a cross undertaking as it was acting in accordance with its public duty and third parties could not complain about losses deriving from an unlawful scheme being closed down.

With regard to point (ii) (that is, the position on giving cross undertakings), the Court held that this should not differ depending on whether such undertaking is intended to benefit the defendant or third parties; both circumstances relate to loss caused by the injunction. It commented that whilst an undertaking to a third party is to protect an “innocent” party that is not implicated in the wrong doing from incurring any loss, an undertaking to the defendant is to protect them from loss incurred due to an inappropriately granted injunction.

It concluded that there is no general rule that the FSA should be required to provide a cross undertaking in respect of loss suffered by the defendants or third parties. Instead, whether an undertaking is required will depend on the circumstances of the case.

In relation to point (iii) above (whether there is a distinction between a cross undertaking in respect of third party losses and a cross undertaking in relation to third party costs), it was held that a pragmatic difference could be drawn.  Whilst public authorities should be able to enforce the law without risk of cross claims or the exposure of their resources to claims for third party loss, this rational would not apply to third party costs incurred in enforcing the injunction.

The UKSC’s decision

In the light of the above, the Court unanimously dismissed the appeal by Barclays.

The Court also noted that under Part IV of FSMA the FSA has the power, without an application to the court, to freeze the assets of an authorised person. The exercise of such power could equally cause losses to innocent third parties, yet no basis exists upon which any third party could claim to be indemnified in respect of such loss. Moreover, para 19 of Sch 1 to the FSMA explicitly excludes the FSA from any risk of liability. In the circumstances, it would be unjust for the FSA to be required to provide such an undertaking when applying for an injunction but not when exercising its statutory powers.

Practical Implications

This case provides comfort to public authorities that, when exercising their legislative powers, the general position is that they are not required to give a cross undertaking in respect of third party losses. Although not applicable in the current case, this general position may be varied by the court in light of the factual circumstances. Whilst public authorities can draw comfort from this case, the case has a negative impact on the level of protection available for banks in receipt of an injunction on behalf of the FSA.

The case also cements the difference between the undertaking required from private claimants and from public authorities when applying for an injunction, and the judgment provides a useful summary of the relevant case law in this area.