Investor recovers potential loss of profits

08/06/2009

The decision in Parabola Investments v. Browallia CAL received quite a deal of media attention when it was delivered last month. Part of the attention related to its factual content, but part related to the decision of the judge in awarding damages for loss of profits to a previously successful investor who made large losses on investments based on fraudulent misrepresentations.

Background

The Claimants were special purpose vehicles set up by the investor (Gill) for the purposes of trading. Although most of the losses were incurred by the second defendant, the losses referred to here as the Claimants' losses.

G had a very successful history in investing in "market makers", essentially physical stocks and derivatives. Indeed within the industry Gill was known as "the 7 to 7 man" because he had turned a starting fund of £7,000 into £7 million within 2 years.

The first two Defendants were stockbroking institutions. The third Defendant (B) was a senior futures broker initially employed by the first Defendant, and then from June 2001 by the second Defendant.

In early 2000, Gill changed the bulk of his trading from his existing broker to the first Defendant. The majority of trades that the first Defendant dealt with on behalf of Gill were "contract for differences", being an agreement to exchange the difference in value of a particular share between the time at which a contract is opened and the time at which it is closed, and is generally conducted on a leveraged basis, albeit with much greater margins available. In particular B encouraged Gill to trade in a species of CFD called "SETS".

The account was carried out for Gill by B. Unfortunately, B was found by the Court as being, "a persistent and inveterate liar". At the commencement of the relationship Gill stated that he would require real time up to date information on the profitability of the trading. B agreed to provide Gill each day with details of his profit and loss of the previous day's trading, and that it was unnecessary for Gill to keep his own records. It was found that B knew Gill was relying on B for this information.

Trading in SETS did not go well for B and Gill, and by March 2001 Gill's account was making losses; by June 2001 the Court found it was declining sharply. Despite this, Gill remained unaware of the true position of his account, and embarked on further SETS trades based on B's advice that Gill's trades were profitable. Specifically, in October 2001 Gill asked B how much was in his account. B informed him that the account balance stood at £9.27million. The account balance, as B well knew, only stood at £2.81 million. The deceit was only discovered in February 2002 when the second Defendant made a margin call on Gill's account. B was away from the office that day, and Gill spoke with another person at the second Defendant, who informed Gill that the balance of his account was £817,000.

The Claims

The Claimants sought damages for deceit against all the Defendants, although it was plain that B had kept the details of his deceit from his employers. The usual measure of damages in such a case would have been the capital loss suffered by the Claimants, in this case being the amount the trading fund was depleted as a result of the fraudulent misrepresentations. In addition to the capital loss, however the Claimants also sought damages for the loss of profit the Claimants would have made on the investment fund had they not been defrauded, on the basis that they would have made profits if they had invested elsewhere.

During the trial, after what the Court described as a "disastrous three days in the witness box" for B, the second defendant and B admitted the allegations of fraud made against B.

Following this admission, and leaving aside the issue of quantum, the Court needed to deal with two major issues, namely (1) were the Claimants induced by the representations; and (ii) what identifiable heads of loss had they suffered as a result of the fraud.

1. Inducement

The Defendants argued that Gill was a compulsive trader, who had not been induced into the trades by the representations - Gill had continued to trade in SETS even though B had warned Gill from December 2001 to February 2002 about trading in SETS in the difficult market conditions.

However, the Court found that the context of such warnings was the continuing deceit, namely that Gill was still making profits from those trades. The Court found that Gill was not a compulsive trader who would have continued to trade if he had known the true position. The Court held that where the evidence showed that if a claimant would have acted differently had it known the true position, this indicated that the fraudulent misrepresentation was sufficiently in the mind of the victim of the fraud to constitute inducement. In this case it was decided that the Claimants had been induced to enter the transactions as a result of B's representations about the profitability of the account.

2. Heads of Loss

The main issue was whether the claimants could claim for loss of the profit they would have made in other investments had it not been for the fraud, in addition to the capital loss it suffered. In short the answer was "yes it could".

The Defendants argued that the claim for loss of profits was "speculative" and that any recovery should be limited to the amount of capital loss. Before analysing the various alternative scenarios/investments put forward by the Claimants as to their loss of profits, the Court looked at whether such a claim was recoverable in principle. After reviewing the case law the Court held that where, on the balance of probabilities, the Court concluded that some profits would have been made from an alternative transaction(s) which the Claimant would have entered but for the fraud, the Court can and should award damages for such loss of profits. It could discount the amount recovered to reflect the element of risk in the transaction. The court then went further, and held, referring to the judgment of Lord Denning MR in [i]Esso Petroleum Limited v. Marsden, that it was not necessary for the Claimant to have identified any specific alternative transaction into which he would have entered into but for the fraud. On these facts the Court found that there was strong evidence that if it had not been for the fraudulent misrepresentations, Gill would have reduced his SETS trading, concentrating on his market maker trading for which the Claimants would have made profits.

The Claimants also sought damages for loss of profits after the frauds ceased (in February 2002). This was said to involve an element of recovery of "profits on profits". The Court found that where the adverse effect of the fraud still operated at the time of trial, there was no reason why any damage suffered as a result should not be recovered. On the present facts, the Court was satisfied that Gill would have re-invested the profits in the way it had before the fraud, which would have been profitable. Although some trades may have made losses, the overall trading was not too speculative for the loss of profits to be recoverable.

The Defendants have obtained permission to appeal.

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