Marketing derivatives - seller beware

Tuesday 6 December 2016

Author: David Craig

​On 28 November 2016, the High Court handed down a decision in a case centered on the marketing of interest rate swaps to farmers. The decision offered a mixed bag for the parties. The plaintiff’s win, while awarding it the moral high ground, was a hollow one financially. And the defendant’s loss, while leaving it financially unscathed, still leaves plenty for it to ponder.

Some history

In the mid-1990s, the global spotlight in the derivatives industry was focused on one player in particular, Bankers Trust (BT), but for all the wrong reasons. From multi-national conglomerates (Proctor & Gamble), to Indonesian financial institutions (Dharmala), to Cincinnati-based greeting card companies (Gibson Greetings), counterparties were lining up to take a crack at BT.

While the particular facts of each case were, of course, different, they tended to be variations on a common theme that went something like this:

  • bank markets derivatives to counterparty, allegedly making representations about the suitability and effect of the products,
  • partly in reliance on those representations, counterparty enters into derivatives with bank,
  • market moves against counterparty, which becomes significantly out-of-the-money, and
  • counterparty looks to exit the derivatives without paying any break costs, making claims such as misrepresentation, breach of duty of care, breach of regulatory standards, or fraud.

Some claims were settled. Others went before the courts. Some cases required the plaintiff company to achieve the seemingly impossible task of alleging to the bank that they didn’t know what they were signing up for while simultaneously assuring angry shareholders that they did.

In one of the most significant cases for us in New Zealand – Dharmala – the English Commercial Court held that, among other things, BT did not owe a broad duty to its counterparty to explain the terms of their transaction. BT merely assumed a more limited duty to fully, accurately and properly state whatever representations it decided to make.

That decision was of great comfort to market participants in common law jurisdictions – who had assumed (but without much direct judicial support) that was the case all along.

Commerce Commission investigates interest rate swaps with farmers

Until four years ago, interest in this line of cases in New Zealand was largely academic only. Then, in August 2012, the Commerce Commission launched an inquiry into the marketing of interest rate swaps to the rural customers of our major banks. That inquiry led to three banks settling with both the Commission and the Financial Markets Authority between December 2014 and February 2015. Part of the settlement included a compensation offer to affected farmers. Some farmers accepted. Some didn’t.

Cygnet Farms v ANZ 

One of those that didn’t accept was Cygnet Farms Limited (Cygnet), a company set up by a Taranaki couple to buy a dairy farm. Cygnet had entered into interest rate swaps with ANZ in early 2008. Like many other farmers, Cygnet was caught up when, post-GFC, interest rates plummeted and left it paying substantially more on servicing its debt than would have been the case without the swaps. So Cygnet sued ANZ for misrepresentation. 

Cygnet used several different areas of law to try to impose liability for misrepresentation on ANZ: the law of tort, the law of contract, and statutory law (the Fair Trading Act 1986). In relation to those areas of law, the court found as follows:

  • ANZ owed two duties of care in tort, founded on “its initiation of active promotion of swaps, its trusted adviser status with Cygnet and the vulnerability of Cygnet”. ANZ breached the first duty (to take reasonable care to ensure proffered explanations were accurate and replies to inquiries were correct). However, ANZ was saved from breaching the second duty (to take reasonable care in giving investment advice) by standard ‘non-reliance’ and ‘assumption of risks’ wording that was prominently highlighted in the swap confirmations.
  • Cygnet’s contractual claim was defeated by a standard exclusion clause (which, incidentally, did not also have the effect of excluding liability in tort).
  • Cygnet’s Fair Trading Act claim was time-barred, as the application was made more than three years after Cygnet’s discovery of loss.

However, despite finding ANZ had breached a tortious duty of care owed to Cygnet, and was liable as a result, Cygnet walked away with a mere declaration that the breach had occurred. It was not awarded damages. In an outcome the court described as “unfortunate”, Cygnet was held to have fallen between a statutorily-created crack. Specifically, the Contractual Remedies Act 1979 provides that only contractual, not tortious, damages can be awarded when a party is induced to enter into a contract by a misrepresentation. Consequently, even though there may be liability in tort (as there was here), the fact that there is no concurrent liability in contract (e.g., due to the exclusion clause in this case) means there can be no damages in tort.

Our thoughts

Cases such as Cygnet are invariably highly fact-dependant. However, there are some general observations we can make:

  • New Zealand law continues to reflect the position in Dharmala (i.e. there is generally no positive duty on a bank to provide advice to its customer).
  • A court is unlikely to have a problem imposing a duty of care in circumstances where a bank actively promotes products to unsophisticated parties. However, the interrelation of that tortious duty with duties imposed, or liabilities excluded, by contract is unclear and not always rational.
  • Standard provisions intended to exclude liability, or confirm non-reliance and assumption of risks, can be very useful. In order to maximise the effect of these provisions, they should be specifically and prominently drawn to the attention of the counterparty, not buried in the darkest reaches of the contract.
  • Treading the fine line between, on the one hand, merely explaining the terms of a product and, on the other hand, proclaiming its benefits and suitability is something best left to product specialists rather than relationship managers.
  • Notes of meetings and conversations are invaluable.


This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

For more information
  • David Craig

    Partner Wellington
Related areas of expertise
  • Derivatives