By Jonathan Greenacre and Andrew O’Connor
SYDNEY – On 5 November 2012, the Federal Court handed down its judgment in the case of Bathurst Regional Council v Local Government Financial Services Pty Ltd. The legal action related to leveraged debt obligations issued by ABN Amro that were given a credit rating of AAA by Standard and Poor’s (S&P). The highly complex financial instruments, known as constant proportion debt obligations (CPDOs), were sold to 13 local councils in NSW by Local Government Financial Services (LGFS). The CPDOs were purchased by the councils between November 2006 and June 2007. At the onset of the GFC in mid-2007, the CPDOs fell to less than 10% of their purchase value. As noted elsewhere on this portal, the court determined that S&P, ABN Amro and the LGFS separately engaged in misleading and deceptive conduct and that each respondent had breached its duty of care owed to the councils.
On 1 March 2013, Jagot J of the Federal Court handed down the judgment on damages, interest and costs in relation the case.
The councils were held to be entitled to damages equal to the difference between the principal amount paid for the CPDOs and the amount received when the councils cashed-out their investment. ABN Amro, S&P and the LGFS were held proportionally liable for the loss incurred by the councils and were ordered to pay an equal share of approximately $16 million in damages, excluding interest charges.
The councils were also awarded pre-judgment interest on the damages payable. Interest was awarded from the date that the instruments were cashed-out rather than the date of the initial investment. Jagot J held that this calculation was the most appropriate means of compensating the council for their loss as they were only without their money from the cash-out date onwards. This method of calculation is significant as it means the councils did not receive compensation for the foregone return from date of the original investment.
The councils also sought an order for indemnity costs arising from a letter of offer made in December 2011. This claim was dismissed on a number of grounds, including that the letter did not contain an offer that was capable of acceptance without complex negotiation between all parties and that a response was required within one day. Although indemnity costs were not awarded, S&P, ABN Amro and the LGFS were ordered to pay the council’s ordinary costs of the proceedings.
Pending a possible appeal, Jagot J’s judgment on damages closes a highly significant case. For the first time, a credit rating agency has been held liable for an inaccurate rating given to a financial product. The decision of the Federal Court poses a considerable operating risk for rating agencies, which have previously been able to avoid accountability by relying on the use of disclaimers.
However, it is important to recognise that in determining that S&P breached its duty of care, the court focused on the agency’s unreasonable, inaccurate and unjustifiable process for assessing the credit rating of the relevant financial product. The verdict did not hinge on the simple reality that the credit rating proved to be incorrect. ABN Amro’s liability also stemmed from their interference in the rating process rather than the actual risk profile of the instrument.