Court of Appeal Holds Standard Non-Reliance Clause an ‘Unconscionable Term’, Bank Liable for Investment Losses

In Chang Pui Yin & Ors v Bank of Singapore Ltd (CACV 194/2016), the Court of Appeal has upheld a Court of First Instance ruling that a bank be held liable for losses suffered by investors in a mis-selling claim.  Industry standard clauses in the bank’s terms which might otherwise have enabled the bank to sidestep liability were found to fall foul of the Unconscionable Contracts Ordinance and Control of Exemption Clauses Ordinance.

Five Things you Should Know

  1. This is the first time the Hong Kong Court of Appeal ("CA") has found in favour of investors in a financial mis-selling dispute.
  2. The CA found that the bank’s standard non-reliance clauses and risk disclosure statement were unconscionable clauses under the Unconscionable Clauses Ordinance (Cap. 458), which it held applies to private banking services.
  3. The clauses also did not meet the reasonableness requirement under the Control of Exemption Clauses Ordinance (Cap. 71).
  4. In reaching these findings, the CA had regard to the bank’s failure to comply with the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission.  Failure by banks to meet regulatory standards may therefore increase the risk of civil liability towards customers.
  5. Although the rationale behind this judgment is fact-specific, the case may provide encouragement to plaintiffs who are contemplating bringing mis-selling claims linked to counter-performing investments.

Background

Mr. and Mrs. Chang, and Mrs. Chang’s investment vehicle Nextday International Limited, commenced a claim for damages against the bank for breach of contract, negligent advice, misrepresentation and/or undue influence in relation to their investments made through the bank.

Between 2004 to 2008, the bank had sold the Changs a range of investment products (including accumulators and equity linked notes).  These investments suffered significant losses as a result of the 2008 financial crisis.

The Court of First Instance found the Changs to be medium-risk investors with moderate investment objectives. They possessed limited investment knowledge and lacked experience in high-risk, complicated investments.

The Decision of the Court of First Instance

At trial, the Court of First Instance ("CFI") found that the bank owed the Changs an advisory duty in relation to their non-discretionary accounts, notwithstanding the presence of industry standard disclaimers and non-reliance clauses in the bank’s terms which were arguably inconsistent with an advisory relationship.  This duty was breached as the bank, acting through its relationship manager in charge of the Changs’ account, recommended products that exceeded their risk appetite and failed to explain the risks of such products to them.

For further information, please read the full CFI judgment here.

The Decision of the Court of Appeal

Applicability of Non-Reliance Clause

The CFI had originally decided that the non-reliance clause and risk disclosure statement did not find application in relation to the Changs’ non-discretionary accounts.  The CA disagreed, and held that the clauses were capable of applying to these accounts, notwithstanding that advice may have been rendered by the bank in relation to them.

The CA then proceeded to consider whether the bank’s terms of business – specifically, the non-reliance clauses and risk disclosure statement – were in breach of the Unconscionable Contracts Ordinance (Cap. 458) (“UCO”) and/or the Control of Exemption Clauses Ordinance (Cap. 71) (“CECO”).

Bank’s Terms of Business ‘Unconscionable’ and Prohibited

In a landmark decision, the CA (Lam VP, Cheung JA and Kwan JA) held that the UCO applies to private banking services.  Notwithstanding the class of consumers to whom these services were offered, the CA held that these services were provided for private use, consumption or benefit, which brought them within the scope of the UCO.  It was therefore necessary to consider whether the terms were unconscionable under the UCO.

In assessing whether the terms were unconscionable, the CA paid particular attention to the following factors:

  • The relationship manager was aware of the trust the Changs placed in her owing to their previous history;
  • The Changs had very limited understanding and experience in investments and financial products;
  • The bank knew that the Changs’ investment objectives and risk appetite was moderate;
  • The bank’s marketing materials stated that it provided solutions to suit the personal situation of its customers and its customers’ risk profiles; and
  • The relationship manager not only gave the Changs investment advice, she managed their investment portfolios without alerting them to the risks inherent to the products.

The CA also considered the SFC Code of Conduct, which it regarded as setting out the benchmark standards in the financial services industry and the “embodiment of the business conscience”, to which a court was entitled to make reference in assessing unconscionability under the UCO. 

Under the Code, the bank was required to take into account customers’ investment objectives and their risk appetite in recommending products.  The bank, the CA held, had failed to comply with its regulatory duties pursuant to the Code, which were designed to protect investors such as the Changs.  In doing so, the bank had effectively deprived the Changs of the opportunity to make informed decisions about the level of risk of investment products they were purchasing, but at the same time sought to place the entire risk arising out of such decisions on them.  To give full effect to the terms, the CA held, would be unconscionable.

While the CA acknowledged that not every breach of the Code would give rise to unconscionability under the UCO, and that each case would be evaluated by reference to its specific facts and circumstances, in this case, the bank’s conduct had been “so aberrant from the commercial norms that the reliance of the clauses in question to avoid liabilities on the part of the Bank can properly be characterized as unconscionable”.

Non-reliance Clause and Risk Statement Failing ‘Fair and Reasonable’ Requirement under Control of Exemption Clauses Ordinance

In deciding whether the CECO applied to the bank’s terms, the CA considered that the bank had let the Changs believe that it would select products according to their investment objectives and risk appetite, and the relationship manager was aware that the Changs would rely on her advice.  These factors, the CA held, were relevant to the analysis: the bank’s terms were effectively operating to “rewrite history” by excluding or restricting the bank’s duties to the Changs.  As such, the terms operated as exclusion clauses, and therefore could only be effective if they satisfied the requirement of reasonableness set out in section 3 of the CECO.  As the terms were unconscionable, the bank had failed to satisfy the CA that these clauses were fair and reasonable, and could therefore not rely on them.

Commentary

This is the first time a financial mis-selling claim has reached the Court of Appeal in Hong Kong and resulted in a decision in favor of investors. The CA judgment indicates an unexpected shift in approach by the courts in considering the non-reliance clauses and disclaimers which are routinely relied upon by financial institutions in mis-selling litigation, and signaling that such clauses and risk statements will be subjected to scrutiny pursuant to the UCO and the CECO requirements. 

This judgment represents a significant departure from the approach taken by the CFI in DBS Bank (Hong Kong) Ltd v San-Hot HK Industrial Co Ltd & Anor [2013] 4 HKC. In that case, the judge considered that similar non-reliance clauses and risk disclosure statements were designed to define the nature and scope of services which the bank contracted to provide to its customers, as opposed to exclusion clauses.  

The factual circumstances which gave rise to this decision are unusual, and the judgment may be distinguishable from future claims on their facts.  However, financial institutions should expect plaintiffs and their lawyers to tailor their mis-selling allegations to closely match the approach taken by the CA.  This in turn will place a greater emphasis on the manner in which financial institutions have complied with their regulatory duties pursuant to the Code, both in form and in substance.

In the long term, the impact of this decision may be limited: since June 2017, the Code obliges financial institutions to include a suitability clause into client agreements.  The mandatory suitability clause limits the ability of financial institutions to rely upon non-reliance clauses and risk disclosure statements of the kind that were central to this dispute.  However, in the short to medium term, and certainly until the limitation period on pre-June 2017 investment sales expires, we expect the CA’s judgment to become central to the outcome of mis-selling disputes between financial institutions and their customers.

While the judgment is not likely to be welcomed by financial institutions, the CA did provide guidance as to the steps that could have been taken by the bank to avoid non-reliance clauses and risk disclosure statements being found unconscionable.  In particular, the CA noted that it would not have been unconscionable for the bank to stipulate that the Changs should bear the consequences of their investment decisions, if it had:

  • allowed the Changs to make informed decisions and had not conducted itself in a manner which misled them;
  • specifically alerted the Changs that the RM was only acting as a salesperson in making recommendations on investment products and that she might suggest products which were unsuitable or not consistent with their investment objectives; and
  • made sure that the Changs understood the risk level of the products it recommended.

Lawyers representing financial institutions will no doubt want to help them benchmark their conduct, and their response to mis-selling claims, on this guidance.

It is not yet known whether this judgment will be appealed.

Read the full judgment here.

Jurisdictions: 

Head of Financial Services Disputes and Investigations, Asia, Eversheds