The High Court of England and Wales delivered last week (26 November 2015) its judgment in Molton Street Capital LLP v Shooters Hill Capital Partners LLP and Odeon Capital Group LLC ( EWHC 3419 (Comm)). The judge (Mr Justice Popplewell) applied Article 4 Rome I. He noted the difference between Rome I and the Rome Convention and subsequently refused to apply Article 4.3 (escape clause). Here is the relevant part of the judgment (we underline):
“91. It is common ground that the putative proper law of the contract is to be determined by reference to Article 4 of Regulation (EC) No 593/2008 of The European Parliament and of The Council of 17 June 2008 on the law applicable to contractual obligations (“the Rome I Regulation”)
- Odeon asserts that Article 4.1(a) applies. Molton Street takes issue with whether the Bonds are “goods” within the meaning of the subparagraph. Little time was devoted to this point, and it is not necessary to decide it, because Molton Street accepts that the characteristic performance of the contract is delivery of the Bonds by Odeon, whose habitual residence is in New York, such that New York law applies by application of Article 4.2 unless, as Molton Street contends, it is clear that the contract is manifestly more connected with England so as to come within Article 4.3, which is described in recital (20) of the Rome I Regulation as the “escape clause”.
- The text and architecture of Article 4 of the Rome I Regulation is very different from that of the Rome Convention. In particular, the test is no longer expressed as one of closest connection; the test is that contained in the rules set out in Articles 4.1 and 4.2, which are no longer expressed as presumptions or as being subject to the closest connection test; and the closest connection test has become an “escape clause” to be applied only where it is clear that the connection is manifestly closer to a country other than that dictated by the tests in Articles 4.1 and 4.2 so that they are to be disregarded. The word “clear” reflects what the ECJ had already said was the effect of Article 4.5 of the Rome Convention in the Interfrigo case, but the word “manifestly” suggests a more stringent standard than before, as does the elevation of the criteria in Articles 4.1 and 4.2 to tests from mere presumptions of closest connection. The new language and structure suggests a higher threshold, which requires that the cumulative weight of the factors connecting the contract to another country must clearly and decisively outweigh the desideratum of certainty in applying the relevant test in Article 4.1 or 4.2.
96. On the footing that the contract with Odeon was not a novation Mr Atrill submitted that the following factors brought the contract within Article 4.3:
(1) Odeon’s role was relatively insignificant, the terms having been negotiated by Shooters Hill, with Odeon’s involvement being “a matter of chance” because Shooters Hill was unable to contract as principal. All the “work” in negotiating the contract was done by Shooters Hill, which is reflected in the fact that it received 90% of the mark up and Odeon only 10%.
(2) The contracts immediately up and down the chain were governed by English law because in each case the seller (City & Continental and Molton Street respectively) was based in London.
(3) The place of delivery of the Bonds would be London rather than New York.
(4) Molton Street is based in London and regulated by the FCA. It would be odd if Mr Rohailla’s conduct in London, which is subject to English criminal law and English regulatory provisions, should simultaneously give rise to overlapping, but distinct, New York law civil and regulatory consequences.
- I am unable to accept that these factors, singly or cumulatively, make it clear that the contract is manifestly more closely connected with England than New York so as to fulfil Article 4.3.
- The starting point is that there are considerable connecting factors with New York, quite apart from that being Odeon’s place of business. The Bonds themselves are closely connected with New York, and not with England. The Bonds are choses in action comprising a complicated bundle of rights set out in the prospectus, which defines how such rights are to be exercised and transferred. An analysis of those rights points to the conclusion that the Bonds are essentially New York instruments in which the primary rights they confer are against Bear Sterns Asset Backed Securities I Trust 2007 AQ (“BS Trust”), a New York common law trust, and/or The Depository Trust Company (“DTC”), a New York chartered limited purpose trust company, acting on its behalf. BS Trust is the issuing entity, which was a special purpose vehicle set up by Bear Sterns & Co Inc, a bank headquartered in New York. The rights conferred by the Bonds, as set out in the prospectus, primarily comprise (a) beneficial ownership in the pool of sub-prime mortgage loans secured by liens on residential properties which BS Trust has purchased from the original mortgagees through a chain (it is not clear whether these confer real property rights or merely personal rights against BS Trust); and (b) the rights to monthly distributions (“coupons”) which are to be made by DTC on behalf of BS Trust.
- On analysis it is also the case that performance of the contract between Molton Street and Odeon was to take place in New York. As to payment, the price was in US$ and was to be paid by Molton Street to Odeon through their respective settlement agents in New York for clearing purposes (ICBC and Pershing respectively).
- As to delivery of the Bonds, the position is a little more complicated. The rights conferred by the Bonds are reflected in “certificates” which represent the obligations of BS Trust. There are no issued certificates in paper or electronic form which change hands. The certificates are issued to the subscribers in book entry form i.e. simply by registration, and transfers involve book entries only. At issue of the securities, subscribers may elect to hold their beneficial interests through DTC in New York, or Euroclear in Belgium (or Clearstream in Luxembourg which I can ignore for present purposes). Registrations of beneficial interests are made for those holding securities in the US by a book entry at DTC in New York. The entries are typically made by DTC in the names of participant brokerage firms, who in turn hold book entries for the beneficial owners. DTC is to record its nominee, Cede & Co as the single registered “security holder”, but DTC itself records the beneficial ownership in its own books. For subscribers to the Bonds through Euroclear there is (a) registration in Euroclear’s name at DTC as an omnibus entry for all Euroclear’s customers holding beneficial interests (in fact indirectly via JP Morgan Chase Bank NA as the DTC participant, so that the DTC book entry is in JP Morgan’s name and Euroclear has a book entry in its name at JP Morgan); and (b) registration as a book entry with Euroclear in the name of the beneficial owner (again typically in fact recorded at Euroclear in the name of a Euroclear brokerage participant which in turn records a book entry with the client’s name).
- The mechanism for payment and transfer of title where Bonds were sold by a DTC participant to a Euroclear participant was set out in the prospectus. So far as book entries were concerned it involved (1) the book entry at DTC being amended on the settlement date to delete the seller (if, as here, it was changing from a DTC participant to a Euroclear participant) and to enter JP Morgan Chase’s name under Euroclear’s omnibus arrangement; and (2) Euroclear recording the name of the buyer in its records as the new beneficial owner, typically by recording the name of the Euroclear participant which in turn recorded the name of the buyer. The prospectus recognises that this second step would or might occur the following day after settlement. Accordingly to complete a sale of the Bonds from Odeon to Molton Street, Odeon’s title, reflected in a book entry at its DTC participant, and in an entry at DTC in the name of its DTC participant, would be deleted in those books and replaced at DTC with an entry in the name of JP Morgan Chase; and there would be a series of changes in book entries at JP Morgan Chase, Euroclear and the relevant Euroclear participant used by Molton Street which would result in a book entry in Molton Street’s name with its Euroclear participant.
- Mr Atrill contended that because a Euroclear buyer acquired no direct rights against DTC or BS Trust, but only rights against its Euroclear participant, who in turn could only enforce the rights attaching to the Bonds through a chain of requests to exercise rights via Euroclear, JP Morgan Chase and DTC, title is transferred where the Euroclear buyer acquires the book entry with its Euroclear participant; and that that is therefore the place of performance of a contract for sale of the Bonds to a client of a Euroclear participant. Accordingly, he submitted, transfer of title would occur where the entry would be made in the books of Molton Street’s participant which he said was in England.
- This is not a sound contention. If transfer is looked at by reference to the rights of Odeon and Molton Street against their immediate contractual counterparties, through which instructions could be given to exercise the substantive rights conferred by the Bonds, there is no single transfer between the two: Odeon would divest itself of such rights with the amendment of the entry in the books of its US participant in DTC and the deletion of that participant’s name in the book entry at DTC; Molton Street would not acquire them until creation of the book entry at the Euroclear participant. If transfer of title is looked at in this sense, it involves a series of steps only one of which occurs in England if the Euroclear participant’s client is English. However for the purposes of seeking to identify the place of delivery in performance of the contract of sale, it is necessary to look at the substantive rights attaching to the Bonds, not the local arrangements by which the beneficial owner of the rights may give instructions for the exercise of those rights. The substantive rights attaching to the Bonds are represented by the book entry at DTC in New York. It would be when that changed, in New York, that Odeon’s interest in the substantive rights would be extinguished and there would be an effective acquisition of such rights by Molton Street, albeit that it would require JP Morgan Chase to implement their exercise through a chain of instructions via Euroclear.
- I have dealt with this question in a little detail because it arises again in the context of an issue as to the extraterritorial application of the 1934 Act. What matters for the purposes of the proper law issue is that in both a legal and commercial sense this was a contract of sale of New York securities whose performance on both sides, both payment and delivery, was to take place in New York.
- Turning to the four factors relied on by Mr Atrill as demonstrating closest connection with England:
(1) Odeon’s role was not, as he submitted, relatively insignificant and was not a matter of chance. It was always contemplated by Molton Street and Shooters Hill when the contract was being negotiated that Odeon would be Molton Street’s counterparty, and therefore it was, or at least ought to have been, contemplated that Odeon would ultimately have a discretion whether to decide to be bound, since Shooters Hill did not have authority to contract on its behalf. The role of principal contracting party is a significant one as everyone involved must have appreciated. It involves assuming counterparty risk, which is why regulatory authorities impose capital requirements, which Shooters Hill was unable to fulfil. The fact that negotiations took place between exclusively English parties carries little weight when they were conducted on the understanding that the contract would be with a US party, and against the background that it ought to have been contemplated that the US party would itself have to decide whether to give its independent assent by adopting the outcome of those negotiations.
(2) As to the upstream and downstream contracts being governed by English law, Mr Atrill referred to Haeger & Schmidt GmbH v MMA IARD  QB 319 in which the European Court of Justice said at paragraph  “significant connecting factors to be taken into account include the presence of a close connection between the contract in question with another contract or contracts which are, as the case may be, part of the same chain of contracts, and the place of delivery of the goods.” Mr Atrill also relied on cases concerned with networks of contracts involving letters of credit, insurance and reinsurance contracts and guarantees, referring compendiously to the cases identified by Blair J at paragraph  of his judgment in British Arab Commercial Bank Plc v Bank of Communication  EWHC 281 (Comm);  1 Lloyd’s Rep. 664. None of those cases involved a chain of contracts of sale, which raise different considerations. Moreover they were all cases on the Rome Convention 1980 and for the reasons I have endeavoured to explain, decisions on the Rome Convention must be used with caution in view of the difference in approach and language of the Rome 1 Regulation, as the editors of Dicey Morris & Collins observe at paragraph 32-079. It would no doubt be generally conducive to commercial coherence that in a chain of contracts for purchase and sale of goods or securities on back to back terms, the same proper law should govern each contract. That may be promoted or impeded by express or implied choice of law in individual contracts. But leaving aside considerations of choice of law, there is a conceptual difficulty of where to start if the quest is to seek to achieve a single system of law governing all contracts in the chain. Contracts in the chain may have sellers resident in a number of different jurisdictions with such contracts not having even the slightest connection with countries with which other contracts in the chain have their closest connection. It would not be conducive to the general desirability that all contracts should be governed by the same law to treat the Odeon/Molton Street contract as most closely connected with England if others in the chain had no English party or connection; nor to treat it as so because City & Continental was an English seller, when the seller to City & Continental may have been based in New York or indeed any other financial centre which trades in junk bonds; and its seller might have been based in the same jurisdiction with the result that their contract overwhelmingly had its closest connection with the place of business of both parties, as it surely would if they were both based in New York. Indeed if taken to its logical conclusion, Mr Atrill’s argument would involve all the contracts being governed by New York law, not English law, because that would be the proper law of the contract at the beginning of the chain, being a sale by Tilden Park whose business is in New York (assuming, which raises a further complication, that one were applying English conflicts rules). Accordingly the proper law of the contracts above and below the Odeon/Molton Street contract is not a strong connecting factor to the proper law of that contract, at least where the proper law of those other contracts is based on the location of the seller or closest connection of those contracts with England (different considerations might apply in the case of an express choice of law known to the parties).
(3) Contrary to Mr Atrill’s third point, I have concluded that the place of delivery of the Bonds was New York rather than London.
(4) The fact that Molton Street is based in London, regulated by the FCA and subject to English criminal law, is neutral. Odeon is based in New York and regulated by the SEC and FINRA and subject to New York criminal law. Different conflicts of law principles apply to criminal and civil obligations, and indeed to different kinds of civil obligation. The fact that conduct of one party inducing a contract may be criminal conduct under English law has no necessary bearing on the proper law of the contract.
- Accordingly the putative proper law of the contract is the law of New York”.