The High Court rejected the Libyan Investment Authority’s (LIA) claims that Goldman Sachs had exercised undue influence to procure the LIA to enter into a series of derivatives transactions or that the trades otherwise amounted to an unconscionable bargain.
Summary
Bank counterparties face increasingly high barriers to success in claims to exit financial transactions. Contractual estoppel is often an insuperable obstacle – a pleading of fraud may circumvent contractual estoppel, but will rarely be supported by the facts.
In this case, the claimant employed a new argument, based on equitable wrongs. LIA argued that Goldman Sachs had unduly influenced it to enter into the transactions (the ‘Disputed Trades’) and that the Disputed Trades amounted to unconscionable bargains.
While largely depending on its facts, the case gives useful guidance as to how far a bank counterparty can rely on undue influence and unconscionable bargain claims to set aside their contracts.
Facts
Economic sanctions were lifted against Libya between 2003 and September 2004. The Libyan government had accrued oil revenues of many billions of dollars and following the sanctions set up the LIA as a fund to invest its assets for the benefit of the citizens of Libya.
Many investment banks pitched investment proposals to the LIA. One of these was Goldman Sachs. As a result, Goldman Sachs entered into the Disputed Trades with the LIA between September 2007 and April 2008.
The Disputed Trades were designed to give the LIA exposure to different equities (including those of Citigroup, EdF, Allianz, Banco Santander, ENI and Unicredit). Under the structure of the Disputed Trades, LIA did not invest in the shares directly. All the Disputed Trades were synthetic derivatives comprising a put option and a forward. The LIA paid a premium to Goldman Sachs in return for exposure to the equities. If the share price rose by the maturity date of the Disputed Trades, Goldman Sachs would pay the LIA the amount of the increase multiplied by the total notional number of shares. Otherwise, Goldman Sachs kept the premium and the LIA received nothing. The total premium paid by the LIA was US$1.2 billion.
The LIA argued that
- It was naïve and unsophisticated with a limited understanding of the products invested in. The LIA believed that it acquired actual shares, not merely exposure to them via synthetic derivatives. The LIA did not realise it could lose all of the premiums paid to Goldman Sachs.
- A relationship of trust and confidence had grown by the time the Disputed Trades were concluded and Goldman Sachs became the LIA’s adviser (and, it was argued, ‘virtually the LIA’s in-house bank’). As a consequence, the LIA expected that Goldman Sachs would act in the LIA’s best interests.
- That relationship was different from that between the LIA and other banks because of the provision of a Goldman Sachs employee to the LIA as a secondee, training, informal advice and extensive corporate hospitality.
- The offering of an internship within Goldman Sachs to the brother of the Deputy Chairman of the LIA was said to have improperly influenced the LIA to enter into the Disputed Trades.
- The Disputed Trades themselves were priced unfairly, led to excessive profits for Goldman Sachs and were otherwise unsuitable for the LIA.
The LIA asserted that the above factors gave rise to two causes of action
- Undue influence including (i) actual undue influence and (ii) presumed undue influence.
- The Court considered two forms of actual undue influence. First, actual undue influence where there has been an improper threat or, as the LIA argued, an improper inducement. No prior relationship is required for this type of undue influence. Second, where a ‘protected relationship’ arises which places a duty on the stronger party to behave with candour and fairness to the weaker party and that duty is breached. The LIA contested that such a ‘protected relationship’ existed with Goldman Sachs.
- Presumed undue influence may arise where trust and confidence is placed in another party and a transaction is then entered into which ‘calls for explanation’. In the absence of a satisfactory explanation, the Court will infer that the transaction was procured by undue influence.
- Unconscionable bargain. The LIA needed to establish that it was seriously disadvantaged compared to Goldman Sachs and that it was exploited by Goldman Sachs in a morally culpable way with the result that the Disputed Trades were overreaching and oppressive.
Decision
Issue 1:
Was there a ‘protected relationship’?
Rose J held that the actions of Goldman Sachs in building the relationship with LIA did not cross the line into a special or advisory relationship. Goldman Sachs did what they could to win the work and build the relationship. This did not place them into a different category from the other banks that the LIA were trading with.
Issue 2:
Did the Goldman Sachs internship amount to actual undue influence on the LIA to enter into the Disputed Trades?
Rose J held that the offer of the internship did not lead to undue influence. Goldman Sachs’s motivation in offering the internship was the chance to form a strong link with someone who might be leading the LIA London office in the future. It was also unrealistic to expect that the Deputy Chairman of the LIA would be influenced to commit the LIA investing over a billion dollars on the basis of a few months’ internship for his brother. All the internship did was to create a friendly atmosphere between Goldman Sachs and the LIA.
Issue 3:
Should there be a presumption of undue influence?
Although there was no ‘protected relationship’ necessary for a finding of presumed undue influence, in any event there was no feature of the Disputed Trades that would call out for explanation and therefore lead to a presumption of undue influence. The level of Goldman Sachs profits were commensurate with the nature of the trades and the work that had gone into winning them. Even if the Disputed Trades were unsuitable, the LIA entered into similar trades with other counterparties and it was found that the LIA had its own reasons for entering into the Disputed Trades. Accordingly, the claim for unconscionable bargain also failed.
Discussion
Although the case was not argued as a misrepresentation claim, many of the classic elements of such a claim feature in the attempt to frame the Disputed Trades as having been entered into as a result of undue influence. These include allegations that Goldman Sachs assumed an advisory relationship, that the products were not suitable, that the profits that Goldman Sachs were making were excessive and that the LIA was naïve and unsophisticated.
On the face of it, an undue influence claim appears no more fruitful a way of using these types of argument to assert that a contract should be set aside than a claim in misrepresentation. The courts will still be mindful not to let a contractual party escape a bad bargain and will be likely to consider matters from that viewpoint.
However, there were other features of the case which would not ordinarily arise in a typical misrepresentation claim. The secondment of a Goldman Sachs employee to the LIA, training, informal advice and corporate hospitality were all relied on by the LIA to assert that the relationship had become something more than one merely that between a bank and counterparty. The court rejected these arguments firmly and this will provide comfort for banks marketing to sovereign wealth funds in the emerging markets.
Finally, it is worth noting that although Goldman Sachs won the case, there are risk factors for banks to be mindful of in these situations
- Although the internship offered to the brother of the LIA Deputy Chairman or the corporate hospitality provided did not result in a ‘protected’ relationship, internal policies on internships or corporate hospitality should be adhered to and any compliance issues considered carefully.
- A Court will need some degree of persuasion to find that a bank-customer relationship has become a trusted advisor relationship. In LIA v Goldman Sachs, the court accepted that banks need to market their services and that will involve a process of relationship building. It did not give excessive weight to marketing material that used wording such as ‘unique relationship’ or ‘strategic partnership’ as the substance of the relationship was that of a typical bank customer.
- Care should be taken when engaging in general market discussions with a counterparty which include comments on the state of the market and investment potential, even though the courts will probably provide a degree of protection in these circumstances. The conversations between Goldman Sachs and LIA employees did not stretch beyond general and informal discussions about the market and so a ‘protected relationship’ did not arise. However, these types of discussion should be undertaken with caution.
- Evidence of a counterparty’s dealings with other banks can be useful. If a counterparty is dealing with other banks on similar terms on similar transactions, it is less likely that a ‘protected’ relationship will be found to have arisen between the counterparty and a particular bank.
