Loreley Financing (Jersey) No 30 Ltd v Credit Suisse Securities (Europe) Ltd

Hearing dates: 20,24,26,27 April 2023, 2,3,4,5,9,11,15,16,17,18,22,23,24,25 May 2023, 12,13,14,15 June 2023

APPROVED JUDGMENT

I direct that no official shorthand note shall be taken of this Judgment and that copies of this version as handed down may be treated as authentic.

This judgment was handed down remotely by the judge and circulated to the parties' representatives by email and release to The National Archives. The date and time for hand-down is deemed to be Friday 3 November 2023 at 10:00am

INTRODUCTION

In late 2007, as clouds gathered in the sub-prime mortgage market, the Claimant (“L30”) paid US$100m to the Defendants (“CS”) for certain Notes (“the Notes”), rated AAA, which formed the basis of what is known as a synthetic CDO transaction. Such transactions are complicated – indeed some of the banking witnesses in this case struggled to explain the concepts themselves.

But the bottom line is this: the financial crisis hit, L30 lost its money in 2010 and seeks to claim that money back. It says that this was more than a bad deal. It says that in selling the transaction CS made representations about the business packaged within the CDO transaction, that the representations were false, made either negligently or deliberately, and that L30 would not have done this deal if the representations had not been made.

L30 has likened the transaction to a Russian doll; that analogy is apt; and it in part explains the complexity of the issues which have been raised and hence fall to be decided. The Notes were not self standing; they were linked via a credit default swap (“CDS”) to the credit of a reference portfolio which comprised 100 residential mortgage-backed securities (“RMBS”). Each RMBS itself packaged a number of underlying individual mortgage transactions, in that it comprised rights to cash-flows arising from pools of underlying mortgage loans. Of those 100 RMBS, 7 RMBS were ones which had been packaged, securitised or underwritten by CS (or its affiliates) (the “CS RMBS 1”).

The bare essence of the claim is that:

i) In relation to the CDO transaction CS represented that it was unaware of any conduct on its part which tainted the credit quality of the Notes or the CS RMBS or which otherwise undermined the reliance which could be placed by an investor in L30's position on the credit ratings ascribed both to the Notes and the CS RMBS;

ii) However CS knew that the credit risk which L30 believed it was buying was not the credit risk it was actually buying; in that it knew that the CS RMBS embedded within the CDO transaction were either affected by or were exposed to a material risk of being affected by certain misconduct in the selling of the RMBS between 2005 and 2007. This is referred to as “the RMBS Misconduct”;

iii) Those allegations of misconduct are complicated – they comprised about 70 pages of pleading and (in schedule form) 5 pages of the List of Issues. At the centre of them however were allegations that CS had represented to the CS RMBS investors certain things about the rigorousness of its

compliance and due diligence processes and (in particular) that decisions as to loans were not “farmed out”. It is said that these representations were, to the knowledge of CS and numerous people involved in the RMBS process, untrue.

The misrepresentation case therefore encapsulates a myriad of issues, some factual, some legal: was there any RMBS Misconduct in relation to the CS RMBS? Are there representations in relation to the CDO transaction – and if so what? With what intent and what knowledge were they made? Did they induce L30 to buy the Notes? This latter question includes legal issues as to the right test for what L30 needs to have known or understood or been aware of in relation to such representations.

There are also issues as to limitation. This claim was commenced in late 2018. No legally aware reader will have missed the elephant in the room: on the face of it, all of these claims are long since time barred. There are therefore questions as to whether L30 lacked, as it says it did, the requisite knowledge or information to start the limitation clock running.

Finally there are issues on negligence, as a backup if the fraud case does not work, but the other features of misrepresentation are present; and a rarity – an unlawful means conspiracy case which is a genuine alternative to the primary case.

These issues are dealt with in greater detail below, under the following headings:

i) Factual Background

ii) The Trial

iii) Limitation

iv) Were the CDO Representations made?

v) Were the CDO Representations relied on?

vi) Falsity: RMBS Misconduct (Summary)

vii) Knowledge of Falsity

viii) Other Issues

a) Negligence

b) Unlawful Means Conspiracy and Irish Law

ix) Conclusion

x) Appendices:

a) Appendix 1: RMBS Misconduct (detailed findings)

b) Appendix 2A: CDO Representations (pleaded)

c) Appendix 2B: CDO Representations (revised for trial)

d) Appendix 3: RMBS Misconduct allegations

FACTUAL BACKGROUND

Agreed Background to the types of securities involved in the Transaction

As already stated, the Notes were a CDO, with the underlying reference assets being a portfolio of RMBS. The exposure to that portfolio of RMBS was synthetic, created through use of a CDS.

This overview, taken largely from a helpful document agreed by the parties, summarises the general features and characteristics including in respect of the specifics relevant to the Notes themselves, of:

i) RMBS;

ii) Collateralised debt obligations (“CDOs”); and

iii) CDS and their use in a synthetic CDO structure.

RMBS

An RMBS is a type of asset-backed security in which, as the name indicates, the securitized assets are residential mortgage loans. As with any asset-backed security, an RMBS is a structured financial instrument.

A single RMBS may be backed by thousands of individual mortgage loans. These loans are originated by companies offering mortgage finance to residential property owners. The originator may be connected with the sponsor entity, or may instead be a third party company which sells on loans it has originated to be securitised by a different financial institution.

The process of securitising an RMBS starts with the pooling of residential mortgages by a “sponsor” entity, which has originated or otherwise acquired those assets in order to pool them. This pooling of assets usually takes place in an entity related to the sponsor known as the depositor. The depositor then typically conveys the pool of loans to a special purpose securitisation trust, which then issues securities that are backed (or collateralised) by the assets and sells them into the market. The RMBS securities entitle investors to a periodic payment of interest, which flows primarily from the monthly revenue generated by the underlying mortgages, and a return of principal upon maturation of the securities.

RMBS securities are split into tranches to be sold to investors with different purchasing requirements. As such, RMBS generally consist of multiple tranches, which are typically differentiated by their risk profiles, and thus credit rating. No particular underlying mortgage is assigned to a particular tranche of the RMBS; rather, the mortgages as a pool collectively back all of the tranches in a particular RMBS. In general, lower risk / higher credit-rated tranches (referred to as “senior” tranches) have lower yields than higher risk / lower credit-rated tranches (“mezzanine” and “junior” tranches). Cash flows in an RMBS are structured such that the senior tranches receive the first “cut” of principal / interest payments when those are made, before mezzanine and junior tranches; and generally any losses of principal or shortfalls of interest from the portfolio of loans as a whole are similarly borne starting from the most junior tranches and moving upwards to the senior tranches.

Purchasers of RMBS receive interest and principal amounts repaid by the original mortgage borrowers of the individual loans that were pooled into the RMBS, but are also exposed to the risk of those borrowers failing to keep up repayments or defaulting. As such, where a sufficient number of those underlying borrowers fail to make repayments, or (for example) default on their loans, this may ultimately lead to the RMBS suffering a loss. Such losses are felt first by the higher risk / lower credit-rated tranches (i.e. the junior tranches), are often referred to as “writedowns”.

CDOs

A CDO is a financial instrument that is similar to an RMBS insofar as it pools a number of underlying assets (in this case debt instruments) into an investment vehicle that then issues new bonds or notes to investors. Like RMBS, the securities issued by the CDO are typically divided into tranches with varying interest rates and credit parameters. The assets held by a CDO can be any type of debt obligation, including, but not limited to, corporate debt, RMBS or even tranches of other CDOs.

As described in the context of RMBS above, tranches of a CDO will be categorised by risk profile. A CDO is generally divided into multiple tranches, with senior...