The Commercial Court has dismissed a breach of contract claim brought by a London-based broker dealer (Molton Street Capital) against a New York-based counterparty (Odeon Capital) concerning a trade in residential mortgage-backed securities. The judgment addresses a number of important issues, including the application of the Rome I Regulation to back-to-back contracts of sale and the defence of illegality.

The claim was for damages of up to US$3 million for non-delivery of Bear Stearns bonds pursuant to a trade allegedly concluded between Molton Street (as buyer) and Odeon (as seller) in June 2014.  The terms of the trade had been negotiated by Molton Street with another broker dealer, but Odeon had stepped in at the last minute to facilitate settlement of the trade.  In the event, the bonds were not delivered to Odeon by the upstream seller and so Odeon in turn could not deliver them to Molton Street.  Molton Street claimed lost profits of US$1.1 million that it would have made on a subsequent sale of the bonds to Morgan Stanley, and an indemnity (of up to US$2 million) in respect of its own liability for breach of contract to Morgan Stanley.

Following a 6-day trial, Popplewell J concluded that, as a matter of New York law, there had never been a binding contract because of the terms of a disclaimer used by Odeon on its Bloomberg messages and trade tickets.  He also concluded that the reasonably foreseeable damages in the bond trading industry would have been limited to a 1% spread on the bonds, and that Molton Street’s claim for an indemnity would have been barred by a New York law public policy defence arising from the fact that the Molton Street trader had made a series of fraudulent misrepresentations to his counterparty at Morgan Stanley. 

These conclusions made it unnecessary for the judge to resolve the live controversy in relation to the illegality defence in English law between the approach of one constitution of the Supreme Court in Les Laboratoires Servier v Apotex [2015] AC 430 (which upheld the “reliance” test in Tinsley v Milligan [1994] 1 AC 340) and that of a differently constituted panel in Hounga v Allen [2014] 4 All ER 595 (which used an “inextricable link” test).  The Judge said that the conflict between those authorities could have been of potential significance, because the lies of the Molton Street trader would not have fulfilled the “reliance” test but would have satisfied the “inextricable link” test.

The judgment contains what is likely to prove to be an influential analysis of article 4 of the Rome I Regulation. Popplewell J observed that the “text and architecture” of the Regulation is very different from that of the Rome Convention and that there is a higher threshold for displacing the proper law designated by article 4(1) and article 4(2). The judge’s careful analysis of the place and time of transfer of securities held at the Depositary Trust Company in New York is also likely to be of interest to market participants.

Molton Street was refused permission to appeal.

Conall Patton appeared for Odeon. He was instructed by Nabarro LLP.

The full text of Popplewell J’s judgment is available here.