The High Court has ruled in favour of a spread betting firm that exercised its sole discretion in closing out a client's trading position during a period of significant market volatility.
Contractual discretion – how to be Braganza-compliant: CMC Spreadbet v Robert Tchenguiz
The Braganza duty is an implied contractual term, the existence of which was established by the Supreme Court in 2015. It requires a party to exercise contractual discretion honestly and in good faith as well as in a manner that is reasonable and not irrational, arbitrary or capricious.
The decision in CMC Spreadbet Plc v Robert Tchenguiz considers whether the Claimant (CMC) was in breach of its Braganza duty when it exercised its "sole discretion" under a contract to close out the Defendant's (Mr Tchenguiz) trading position during a period of market volatility in March 2020 triggered by the Covid-19 pandemic. Mr Tchenguiz also took issue with the way in which CMC effected the close out - he argued that if close out had taken place more slowly over a number of days, the value of his position might have improved thereby reducing his losses.
Whilst decisions considering the Braganza duty are inevitably fact specific, this judgment is nevertheless a useful illustration of the extent to which the courts will scrutinise the available evidence when determining whether a party is in breach of their duty. The judge noted that when assessing whether or not an exercise of discretion is rational, the weight to be attached to factors which have been taken into account in exercising that discretion is generally a matter of judgment for the party with the discretion.
The judgment carefully considers the factors that led to CMC exercising its sole discretion, as well as the various steps taken by CMC during the close-out process. In doing so, it provides broad indicia that parties might refer to in order to demonstrate that any exercise of discretion is Braganza-compliant in periods of significant market volatility or uncertainty (when such discretion is most likely to attract challenge).
The judgment can be read in full here.
Mr Tchenguiz had built up positions with a number of spread betting firms totalling the equivalent of 81 million shares in transport company FirstGroup. These bets proved to be loss making when FirstGroup's share price suffered a significant drop in value in March 2020 at the beginning of the Covid-19 pandemic. Accordingly, after Mr Tchenguiz failed to meet various requests to fund the deficit in his account, CMC closed out Mr Tchenguiz's account and sought to recover its losses of £1.31m from him either as a debt or as a sum due under contract.
Mr Tchenguiz contended that CMC failed him in two fundamental ways.
First, CMC failed to comply with the FCA's Conduct of Business Sourcebook Rules (COBS) when it categorised Mr Tchenguiz as an elective professional client (EPC) (rather than a retail client) by failing to give Mr Tchenguiz a clear written warning of the protections and investor compensation rights he would lose as a result of the EPC classification. These lost protections included negative balance protection (NBP). As a result of his classification as an EPC, Mr Tchenguiz was exposed to losses in excess of his initial investment. Mr Tchenguiz argued that had CMC complied with the relevant rules in COBS, the £1.31m debt would not have arisen because he would have been prevented from incurring losses beyond his original investment (via NBP).
Secondly, CMC either i) breached its duty under COBS to act honestly, fairly and professionally in accordance with the best interests of its client; or ii) acted in a Braganza irrational manner when exercising its "sole discretion" under its Terms of Business in manually closing out Mr Tchenguiz's account. Mr Tchenguiz sought to contrast CMC's approach to the close out of his account with that of two other spread betting firms which he submitted had approached close out in a way that was more favourable to him. He argued that he was entitled to claim damages under the Financial Services and Markets Act, the remedy being an equitable set-off which extinguished CMC's £1.31m claim.
Did CMC comply with COBS?
In cross-examination, Mr Tchenguiz was frank that his classification as an EPC was of significantly less concern to him than the close out of his account. In particular, it was clear that: i) before opening the account with CMC, Mr Tchenguiz was well aware and understood the effect of being classified as a professional client; ii) he was already classified as such with three other spread betting companies; and iii) in opening the account with CMC, he wished to take advantage of the benefits of being a professional client (i.e. leverage).
Accordingly, whilst the judge considered in detail whether the required warnings were given to Mr Tchenguiz prior to activating his account, those factual questions were viewed in the context of Mr Tchenguiz' "dismissive" attitude to the warnings that had been given by CMC. The judge was satisfied that CMC complied with its obligations under COBS to give clear written warnings concerning the loss of NBP, both in general terms, from an objective point of view, and also having specific regard to the circumstances, knowledge and experience of Mr Tchenguiz.
Regarding CMC's alleged breach of the rule in COBS to act honestly, fairly and professionally in accordance with the best interests of its client, the judge also found in favour of CMC. Two particularly persuasive evidential factors were Mr Tchenguiz's considerable experience as an investor and the fact that other spread betting firms had also closed out positions in FirstGroup that Mr Tchenguiz held with them. Ultimately, the judge considered that CMC had sought to protect both Mr Tchenguiz and itself, but in any event was not bound, where a contract had been breached, to ignore its own interests under the contract.
Did CMC act appropriately when closing out positions?
That CMC was under a duty to exercise its sole discretion in a manner compliant with Braganza was not in dispute.
The following facts were relevant to the judge's consideration of CMC's Braganza obligations:
- there was significant and unusual stock market volatility as a result of the increasing impact of the Covid 19 pandemic;
- notwithstanding CMC's entitlement to close out Mr Tchenguiz's account manually if the funds available did not sufficiently cover the exposure on the positions he had taken, CMC gave Mr Tchenguiz numerous opportunities either to fund his account or suggest credible proposals to avoid the need for close out;
- the solutions suggested by Mr Tchenguiz to make good the deficit in his trading account were unusual and impractical in the circumstances and were rejected as unsuitable because they did not involve the provision of cash required to fund the deficit; and
- CMC was aware of Mr Tchenguiz's large exposure to FirstGroup, but did not know who else was closing out his positions in FirstGroup at that time (information which was only revealed during the disclosure process after proceedings were commenced). In any event: i) execution of the orders to close out Mr Tchenguiz's account were undertaken using a Barclays market algorithm which closed out the trades over the course of a single day in three tranches to minimise the impact on the FirstGroup share price; and ii) CMC achieved a better price than two other spread betting firms who were also closing out Mr Tchenguiz's other positions in FirstGroup during the same period.
Was CMC Braganza-compliant?
The judge held that CMC had not breached its Braganza duty because:
- CMC had allowed Mr Tchenguiz a short period of time, at his request, to try to find a funding solution;
- although CMC was aware of the volatility in the market and of the volume of sales that were taking place on the day it closed out Mr Tchenguiz's position, it was entitled i) not to speculate as to what was happening with other spread betting firms; ii) not to delay further a close out decision given the lack of realistic proposals by Mr Tchenguiz to resolve his outstanding balances; and iii) not to delay further in the hope that the market might improve;
- whether CMC had acted rationally had to be considered in the context of Mr Tchenguiz's contractual duties - he was contractually obliged to clear any negative balance promptly as well as to keep his account above the relevant close out level and those contractual provisions contemplated the consequences of a volatile market; and
- the only funding solutions offered by Mr Tchenguiz were well outside the contractual funding obligations Mr Tchenguiz owed and it was far from clear how they would operate, still less how they would enable Mr Tchenguiz to adequately meet his funding obligations (for example, although CMC required cash to meet its margin call, Mr Tchenguiz instead sought to provide security via the trustees of his family trust, including by way of "an asset that possibly could be made available", which was "a long leasehold of a property in Cardiff let for 54 years to Whitbread").
In addition, the judge rejected as contrary to the fundamentals of a spread betting contract the suggestion that CMC ought to have conducted an exercise in seeking to estimate the value of FirstGroup apart from its share price and to assess the likelihood of a recovery in share price.
Finally, in response to allegations that CMC acted irrationally compared to the decisions taken by another spread betting firm (RJO) which closed out Mr Tchenguiz's position over a period of 20 days, the judge noted that CMC provided sufficient evidence of rationality in its approach to the close out, including i) the rejection of Mr Tchenguiz's offers of security and the reasons for closing out his positions, as well as ii) the approach to execution and the utilisation of the industry standard algorithm supplied by Barclays. In contrast, whilst Mr Tchenguiz sought to evidence the basis of RJO's decision, the evidence adduced did not sufficiently illustrate RJO's decision making and therefore prevented the judge to make a sensible comparison between the exercises of discretion.
Challenges surrounding Braganza duties are inevitably fact specific. That said, this decision reinforces the scrutiny the court will apply to the evidence when it comes to determine whether a party has breached its Braganza duty. The judgement also provides some useful touch points for parties who are considering exercising a contractual discretion:
1. parties should pay attention to the contractual context surrounding the discretion: that the relevant clauses were premised on the volatility which gave rise to the exercise of discretion in this case was helpful to CMC;
2. where practical, parties should communicate issues to their counterparties and attempt to reach a consensual resolution before exercising a unilateral discretion; and
3. if a party does exercise a contractual discretion, it should take care to document in detail the basis for doing so as well as the basis for the manner in which that discretion is exercised, adopting standard market practice where possible.
Where else might contractual discretion and the Braganza duty arise?
Contracts in which one party has the power to exercise a discretion are widespread and common examples include:
- requirements for consent - for instance where a contract cannot be assigned by Party A without the consent of Party B, or an asset subject to a loan agreement cannot be disposed of without the lender's consent;
- pricing or valuation provisions where one party has a discretion as to the amount – for instance a right to claim up to X% of the purchase price or to determine the price payable for an asset; and
- varying performance – for instance provisions permitting a supplier to provide lower levels of performance in certain circumstances and allowing the supplier to determine what that level of performance should be.
For further information, please contact
- +44 20 7295 3076
- Email Me
- Senior Associate
- +44 20 7295 3066
- Email Me
- Knowledge Counsel
- +44 20 7295 3471
- Email Me
- Knowledge Counsel
- +44 20 7295 3863
- Email Me