Entering into an agreement without specifying its governing law is rarely a good idea. In Molton Street Capital LLP v Shooters Hill Capital Partners LLP & Odeon Capital Group LLC [2015] EWHC 3419 (Comm), 26 November 2014, this case confirms that, where no governing law clause is included, escaping the default governing law provisions of the Rome I Regulation will be harder than under the old Rome Convention and contains useful analysis on how to apply the new test. It also highlights the continuing uncertainty surrounding the doctrine of ex turpi causa under English law.
The claimant, Molton Street Capital LLP (Molton), was a London-based broker-dealer specialising in structured credit products. The second defendant, Odeon Capital LLC (Odeon), was a New York-based broker-dealer. Molton sued Odeon and Shooters Hill Capital Partners LLP[1] (Shooters Hill) in England for the wrongful cancellation of a contract for sale of junk bonds. Molton claimed the cancellation had affected a chain of transactions and had caused it to fail on a trade to Morgan Stanley. Molton sought damages for loss of profit and an indemnity for any liability owed to Morgan Stanley.
A contract – with no governing law clause
Although Shooters Hill had negotiated the trade, for regulatory capital reasons, it could not conclude the trade and so Odeon had acted as principal. The court examined the relevant correspondence and concluded that a contract had been formed when Molton confirmed the essentials of the trade to Odeon via Bloomberg message. This, combined with the late substitution of Odeon and the absence of an overarching agreement between the parties, meant no choice of governing law had been expressed.
Article 4(1)(a) of the Rome I Regulation (EC No 593/2008) (the Rome Regulation) states that, in the absence of the parties expressing a choice, "a contract for the sale of goods shall be governed by the law of the country where the seller has his habitual residence". On this basis, the governing law of the trade would be New York law (which Odeon argued was the case).
Molton sought to rely on Article 4(3) of the Rome Regulation. This so-called 'escape clause' provides that "[w]here it is clear from all the circumstances of the case that the contract is manifestly more closely connected with a country other than that indicated in [Articles 4(1) or (2)], the law of that other country shall apply."
Clear and decisive connection required to displace default rule
Popplewell J stated that the revised wording of the escape clause under the Rome Regulation had created a more stringent threshold to be satisfied than under the Rome Convention.
The insertion of the word "manifestly" (which did not appear in the Rome Convention) indicated a stricter test. Popplewell J emphasised that, in deciding whether this test was met, the combined weight of the factors connecting a contract to another country "must clearly and decisively outweigh" the desirable certainty of the default provisions under Article 4(1).
England not a manifestly more connected country
Popplewell J rejected a number of Molton's arguments in favour of English law, namely:
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Odeon had played a relatively insignificant role (only stepping in at the last minute because Shooters Hill could not act as principal
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the upstream and downstream contracts in the chain of transactions were governed by English law (although Odeon was not aware of this);
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the place of delivery was London; and
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Molton was based in London and regulated by the FCA.
Popplewell J stated that by acting as principal, Odeon had assumed counterparty risk and became subject to regulatory capital requirements – this was not an insignificant role. The proper law of the contracts above and below the disputed contract would not normally be a strong connecting factor (though he noted the case may be different where other contracts in the chain contained express choice of law provisions of which the parties were aware). Finally, that Molton was subject to UK criminal and regulatory regimes did not prevent it also being subject to New York civil law obligations.
Place of delivery of junk bonds
Popplewell J noted that, the question of the place of delivery of the junk bonds was more complex as no paper or electronic certificates changed hands between the parties. Rights in the junk bonds would be transferred by means of the creation and deletion of book entries which reflected beneficial interests in the instruments. These beneficial interests could be held through the Depositary Trust Company (DTC) in New York and/or Euroclear in Belgium. The disputed transaction involved the transfer of a beneficial interest from Odeon's DTC participant to Molton's Euroclear participant. 'Delivery' was therefore effected by deleting the book entry of Odeon's DTC participant and creating a new entry with Molton's Euroclear participant. Molton argued that because its Euroclear participant was London-based, the final stage of delivery took place in England.
Popplewell J found that it was necessary to examine the substantive rights attaching to the junk bonds, not simply local arrangements. There were considerable factors which indicated New York to be more closely connected. First, the junk bonds were complex residential sub-prime mortgage backed securities which granted rights exercisable against special purpose vehicles incorporated in New York. Contractual performance was to take place in New York (through monthly coupon payments made by DTC on behalf of the issuer). Finally, the purchase price was in USD and was to be paid through New York-based settlement agents.
Taking these factors together, Popplewell J concluded that the applicable law was New York law under Article 4(1) (place of seller's habitual residence). Molton had failed to satisfy the escape clause in Article 4(3).
Claimant's wrongful act prevents recovery?
On a separate note, Odeon raised the defence of ex turpi causa. Molton's broker had knowingly given inaccurate information as to the value of the junk bonds. Accordingly, Odeon argued, the doctrine of ex turpi causa applied to prevent Molton claiming relief as a result of its wrongful act.
As highlighted in Jetivia SA v Bilta (UK) Ltd [2015] 2 WLR 1168, the law relating to the doctrine is in a state of uncertainty. One line of case law suggests that the doctrine may only be raised as a defence where a claimant's pleading relies on facts which disclose the wrongful conduct in question (see Tinsley v Milligan [1994] 1 AC 340). A second line of case law suggests that an 'inextricable link' between the wrongful conduct and the claim is sufficient (see Hounga v Allen [2014] 4 All ER 595).
In this case, Molton's claim relied simply on pleading the existence (and subsequent breach) of a contract. Molton's claim did not depend on facts arising from its wrongful conduct and therefore would not be precluded by the doctrine of ex turpi causa as interpreted under Tinsley v Milligan. Contrastingly, were the Hounga v Allen line of case law to be applied, the court stated it would have held that the necessary inextricable link existed so as to preclude Molton's claim.
Ultimately, a disclaimer included on Odeon's communications to the effect that only principals of Odeon could bind the firm meant that Odeon was able to cancel the purported junk bond sale and provided it with a full defence to Molton's claim (applying New York law). As a result, the court did not have to determine which test applied. Nonetheless, the case provides yet another example of the impact the current uncertainty surrounding the doctrine may have on contractual disputes (and highlights the importance of precisely drafting pleadings where wrongful conduct may be at issue).
Comment: The judgment offers a useful indication of factors a court will take into account in assessing whether a contract is manifestly more closely connected to a particular country when determining the proper law of that contract. In particular, Popplewell J's detailed analysis of place of delivery provides a helpful focus on how classic choice of law concepts will apply in complex financial markets.
In an earlier case[2], Males J (also sitting in the Commercial Court) had very briefly considered issues relating to applicable law, noting that Article 4(3) created a "high hurdle" for parties to overcome. Molton Street confirms this. The ECJ had previously stated that the old Rome Convention's escape clause was intended to provide a certain degree of flexibility in deciding the proper law of a contract.[3] This flexibility has been reduced by the Rome Regulation. However, many parties may view the increased certainty provided by the curtailed escape clause as desirable.
The court, applying New York law, was clear in this case that parties should be bound "from the moment unequivocal acceptance of a firm bid or offer is made". The completion of a trade ticket – while an important step in evidencing and processing a trade – should not be mistaken for the point of agreement where the essential terms have already been concluded. A disclaimer on a trade ticket alone may therefore come too late where traders can (in theory) have formed the basis of a contract by Bloomberg message, email, phone or "any other oral or written form".
Parties concerned by the choice of law that the default rules under Article 4(1) would otherwise impose would do well to expressly document their preferred choice of law. The facts of the case serve as a caution to parties that, in the absence of agreed terms of business or framework agreements, the fundamentals of a contract for sale can be agreed without expressing which law is to govern. If this occurs, escaping from the application of the Rome Regulation's default rules will be no easy matter.
[1] Shooters Hill played no part in the litigation and the claim in relation to them was compromised.
[2] BNP Paribas SA v Anchorage Capital Europe LLP & ors [2013] EWHC 3073 (Comm) (11 October 2013).
[3] Intercontainer Interfrigo v Balkeende [2009] C-133/08.
