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When reasonable skill and care is not enough

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A design and construction contract will usually oblige the contractor to design and build in accordance with the specification and perform that work to an agreed standard.  These obligations may be limited by a provision which imposes a duty on the contractor to perform its obligations with “reasonable skill and care”.  However, as the recent Scottish law case of SSE Generation Ltd v Hochtief Solutions AG and Another[i]illustrates, there are costly consequences for contractors,and potentially their insurers, of agreeing to meet such obligations, without ensuring that the limitations on their performance, including the duties imposed, extend to all relevant obligations.

The Facts 

SSE Generation Ltd (“SSE”) contracted Hochtief Solutions AG (“Hochtief”) to design and construct a new hydro-electric scheme in Scotland.

The Works Information, which formed part of the contract, provided that the civil works were to have a design life of 75 years.

Within six month of takeover of the works by SSE, a tunnel, that formed part of the civil works, collapsed.

Under the contract, Hochtief was liable for loss or damage occurring within two years of takeover provided that it was caused by a defect which existed at takeover.

A defect was defined in the contract as “(1) a part of the works which is not in accordance with the Works Information or (2) a part of the works designed by the Contractor which is not in accordance with … the Contractor’s design which has been accepted by the Project Manager.

Hochtief claimed that their liability for defects was limited because they were under a duty to only use “reasonable care and skill” in complying with the design.  As a result, they refused to carry out the rectification work without payment, and SSE instructed a third party, Royal BAM group, to construct a bypass tunnel.

SSE commenced proceedings to recover the costs of the remedial project, some £130 million (more than the original cost of the project), from Hochtief.

Scottish Outer House, Court of Session Opinion

Fiona Cain

Fiona Cain

The first instance judgment[ii]found that Hochtief had acted with reasonable skill and care in complying with the design, which in the Court’s view “placed an important brake on liability” such that Hochtief was found to have not guaranteed the works but instead to have accepted the lower obligation of reasonable skill and care. It also found that the tunnel collapse was not caused by a defect that existed at takeover but that Hochtief was in breach for failing to carry out the rectification works.  SSE was awarded £1 million to reflect the period when the hydro-electric scheme was out of operation.

The judgment, together with an earlier decision[iii] regarding the effect of a joint insurance policy, was appealed.

Scottish Inner House, Court of Session Opinion 

The majority judgments on appeal considered that as the collapse had occurred after takeover the risk would lie with SSE, unless it was due to “a defect which existed at takeover”.  The Court found that there was a defect under both limbs of the defect clause because: (1) the tunnel had not met the design life of 75 years; and (2) the design had provided that any erodible rock had to be shot creted and this had not happened.  As there was no evidence of an intervening event that would have caused or contributed to the collapse, the Court concluded that the defect must have existed at takeover.

It also considered that while Hochtief was under a duty to use reasonable skill and care to ensure that it complied with the Works Information, this did not absolve Hochtief of liability because the tunnel had collapsed as a result of the implementation of the design and not due to its design and the duty did not apply to the implementation of the design.  Hochtief was therefore liable for the cost of the rectification works.

Design Life 

In considering the design life, the Court acknowledged that there is no universally recognised definition of design life so instead looked at the recent decision of the Supreme Court in MT Højgaard A/S v E.On Climate and Renewables UK Robin Rigg East Ltd & Others[iv]  In that case the contract required, by reference to an industry standard, a design life of 20 years without replacement for the foundations of offshore wind turbines.  The Supreme Court found that the design life requirement did not amount to guarantee that the foundations would last 20 years without replacement but that they had been designed to last for 20 years without replacement.  In line with that decision, the Scottish Court considered that the assessment of whether the component had the requisite design life and offered reliable service fell to be assessed on the defects date (or at the end of the warranty period), and not before, and it was for the employer to show that this had not been achieved.  The assessment could include showing that the component would require major refurbishment or significant capital expenditure during its design life, which formed part of the definition of reliable service.  In both Hojgaard and SSE a detailed assessment was not required because the components had failed within the defects period and therefore it was abundantly clear that they did not have the requisite design life.

Insurance

The Court also looked at whether the existence of a joint names construction all risks insurance policy would prevent a claim against the contractor. The Court considered the decision in Gard Marine and Energy Ltd v China National Chartering Company Ltd[v]that a requirement for joint insurance can give rise to an implied term that the parties are not permitted to make claims against each other.  In this instance, however, the Court found that such a clause should not be implied because there was already an express indemnity clause in the contract dealing with liability between the parties.  In any event, the Court considered that the implied term would not prevent SSE from succeeding in its claims because the insurance did not cover breach of contract by Hochtief in failing to carry out their specific obligations under the contract.

Comment

As a Scottish law judgment, this judgment will not bind cases before the English courts but would be considered persuasive.  However, the Scottish Court has now granted permission for an appeal to the Supreme Court, although the precise issue(s) to be considered and when the hearing will take place are not yet known.

In both the Hochtief and Hojgaard judgments, the contractors had failed to meet the design life requirements set out in the contracts and as a result were found liable for substantial damages, which may have been picked up by their insurers.  In order to understand the potential risks for contractors and their insurers, a detailed review of the whole contract, including the specification and technical requirements,should be undertaken prior to commencement of the works in order to identify the obligations of both parties and determine, where there are competing requirements, the higher standard that they should satisfy and the extent of any limitation clause.  This should also be conducted against the insurance coverage that will be put in place.

As to the design life warranties, contractors and their insurers are no doubt relieved that they are not on the hook during the entire design life for components which fail, but should be aware that if the employer can demonstrate during the defects period that the component is likely to fail during the design life, this will be sufficient to show that the design life has not been met under the terms of the contract.  The precise terms of the contract may reduce the comfort that contractors can otherwise obtain from agreeing to perform the works with reasonable skill and care.

Fiona Cain

Counsel

Haynes and Boone CDG, LLP

[i][2018] CSIH 26

[ii][2016] CSOH 177

[iii][2015] CSOH 92

[iv][2017] UKSC 59

[v][2017] UKSC 35

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Taking control of compliance: how FS institutions can keep up with the ever-changing regulatory landscape

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Taking control of compliance: how FS institutions can keep up with the ever-changing regulatory landscape 1

By Charles Southwood, Regional VP – Northern Europe and MEA at Denodo

The wide-spread digital transformation that has swept the financial services (FS) sector in recent years has brought with it a world of possibilities. As traditional financial institutions compete with a fresh wave of challenger banks and fintech startups, innovation is increasing at an unprecedented pace.

Emerging technologies – alongside the ever-evolving concept of online banking – have provided a platform in which the majority of customer interactions now take place in a digital format. The result of this is a never-ending stream of data and digital information. If used correctly, this data can help drive customer experience initiatives and shape wider business strategies, giving organisations a competitive edge.

However, before FS organisations can utilise data-driven insights, they need to ensure that they can adequately protect and secure that data, whilst also complying with mandatory regulatory requirements and governance laws.

The regulation minefield

Regulatory compliance in the FS sector is a complex field to navigate. Whether its potential financial fraud or money laundering, risk comes in many different forms. Due to their very nature – and the type of data that they hold – FS businesses are usually placed under the heaviest of scrutiny when it comes to achieving compliance and data governance, arguably held to a higher standard than those operating in any other industry.

In fact, research undertaken last month discovered that the General Data Protection Regulation (GDPR) has had a greater impact on FS organisations than any other sector. Every respondent working in finance reported that the changes made to their organisation’s cyber security strategies in the last three years were, at least to some extent, as a result of the regulation.

To make matters even more confusing, the goalpost for 100% compliance is continually moving. In fact, between 2008 and 2016, there was a 500% increase in regulatory changes in developed markets. So even when organisations think they are on the right track, they cannot afford to become complacent. The Markets in Financial Instruments Directive (MiFID II), the requirements for central clearing and the second Payment Service Directive (PSD2), are just some examples of the regulations that have forced significant changes on the banking environment in recent years.

Keeping a handle on this legal minefield is only made more challenging by the fact that many FS organisations are juggling an unimaginable amount of data. This data is often complex and of poor quality. Structured, semi-structured and unstructured, it is stored in many different places – whether that’s in data lakes, on premise or in multi-cloud environments. FS organisations can find it extremely difficult just to find out exactly what information they are storing, let alone ensure that they are meeting the many requirements laid out by industry regulations.

A secret weapon

Modern technologies, such as data virtualisation, can help FS organisations to get a handle on their data – regardless of where it is stored or what format it is in. Through a single logical view of all data across an organisation, it boosts visibility and real-time availability of data. This means that governance, security and compliance can be centralised, vastly improving control and removing the need for repeatedly moving and copying the data around the enterprise. This can have an immediate impact in terms of enabling FS organisations to avoid data proliferation and ‘shadow’ IT.

In addition to this, when a new regulation is put in place, data virtualisation provides a way to easily find and access that data, so FS organisations can respond – without having to worry about alternative versions of that data – and ensures that they remain compliant from the offset. This level of control can be reflected even down to the finest details. For example, it is possible to set up access to governance rules through which operators can easily select who has access to what information across the organisation. They can alter settings for sharing, removing silos, masking and filtering through defined, role-based data access. In terms of governance, this feature is essential, ensuring that only those who have the correct permissions to access sensitive information are able to do so.

Compliance is a requirement that will be there forever. In fact, its role is only likely to increase as law catches up with technological advancement and the regulatory landscape continues to change. For FS organisations, failure to meet the latest legal requirements could be devastating. The monetary fines – although substantial – come second to the potential reputation damage associated with non-compliance. It could be the difference between an organisation surviving and failing in today’s climate.

No one knows what is around the corner. Whilst some companies may think they are ahead of the compliance game today, that could all change with the introduction of a new regulation tomorrow. The best way to ensure future compliance is to get a handle on your data. By providing total visibility, data virtualisation is helping organisations to gain back control and win the war for compliance.

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TCI: A time of critical importance

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TCI: A time of critical importance 2

By Fabrice Desnos, head of Northern Europe Region, Euler Hermes, the world’s leading trade credit insurer, outlines the importance of less publicised measures for the journey ahead.

After months of lockdown, Europe is shifting towards rebuilding economies and resuming trade. Amongst the multibillion-euro stimulus packages provided by governments to businesses to help them resume their engines of growth, the cooperation between the state and private sector trade credit insurance underwriters has perhaps missed the headlines. However, this cooperation will be vital when navigating the uncertain road ahead.

Covid-19 has created a global economic crisis of unprecedented scale and speed. Consequently, we’re experiencing unprecedented levels of support from national governments. Far-reaching fiscal intervention, job retention and business interruption loan schemes are providing a lifeline for businesses that have suffered reductions in turnovers to support national lockdowns.

However, it’s becoming clear the worst is still to come. The unintended consequence of government support measures is delaying the inevitable fallout in trade and commerce. Euler Hermes is already seeing increase in claims for late payments and expects this trend to accelerate as government support measures are progressively removed.

The Covid-19 crisis will have long lasting and sometimes irreversible effects on a number of sectors. It has accelerated transformations that were already underway and had radically changed the landscape for a number of businesses. This means we are seeing a growing number of “zombie” companies, currently under life support, but whose business models are no longer adapted for the post-crisis world. All factors which add up to what is best described as a corporate insolvency “time bomb”.

The effects of the crisis are already visible. In the second quarter of 2020, 147 large companies (those with a turnover above €50 million) failed; up from 77 in the first quarter, and compared to 163 for the whole of the first half of 2019. Retail, services, energy and automotive were the most impacted sectors this year, with the hotspots in retail and services in Western Europe and North America, energy in North America, and automotive in Western Europe

We expect this trend to accelerate and predict a +35% rise in corporate insolvencies globally by the end of 2021. European economies will be among the hardest hit. For example, Spain (+41%) and Italy (+27%) will see the most significant increases – alongside the UK (+43%), which will also feel the impact of Brexit – compared to France (+25%) or Germany (+12%).

Companies are restarting trade, often providing open credit to their clients. However, there can be no credit if there is no confidence. It is increasingly difficult for companies to identify which of their clients will emerge from the crisis from those that won’t, and whether or when they will be paid. In the immediate post-lockdown period, without visibility and confidence, the risk was that inter-company credit could evaporate, placing an additional liquidity strain on the companies that depend on it. This, in turn, would significantly put at risk the speed and extent of the economic recovery.

In recent months, Euler Hermes has co-operated with government agencies, trade associations and private sector trade credit insurance underwriters to create state support for intercompany trade, notably in France, Germany, Belgium, Denmark, the Netherlands and the UK. All with the same goal: to allow companies to trade with each other in confidence.

By providing additional reinsurance capacity to the trade credit insurers, governments help them continue to provide cover to their clients at pre-crisis levels.

The beneficiaries are the thousands of businesses – clients of credit insurers and their buyers – that depend upon intercompany trade as a source of financing. Over 70% of Euler Hermes policyholders are SMEs, which are the lifeblood of our economies and major providers of jobs. These agreements are not without costs or constraints for the insurers, but the industry has chosen to place the interests of its clients and of the economy ahead of other considerations, mindful of the important role credit insurance and inter-company trade will play in the recovery.

Taking the UK as an example, trade credit insurers provide cover for more than £171billion of intercompany transactions, covering 13,000 suppliers and 650,000 buyers. The government has put in place a temporary scheme of £10billion to enable trade credit insurers, including Euler Hermes, to continue supporting businesses at risk due to the impact of coronavirus. This landmark agreement represents an important alliance between the public and private sectors to support trade and prevent the domino effect that payment defaults can create within critical supply chains.

But, as with all of the other government support measures, these schemes will not exist in the long term. It is already time for credit insurers and their clients to plan ahead, and prepare for a new normal in which the level and cost of credit risk will be heightened and where identifying the right counterparts, diversifying and insuring credit risk will be of paramount importance for businesses.

Trade credit insurance plays an understated role in the economy but is critical to its health. In normal circumstances, it tends to go unnoticed because it is doing its job. Government support schemes helped maintain confidence between companies and their customers in the immediate aftermath of the crisis.

However, as government support measures are progressively removed, this crisis will have a lasting impact. Accelerating transformations, leading to an increasing number of company restructurings and, in all likelihood, increasing the level of credit risk. To succeed in the post-crisis environment, bbusinesses have to move fast from resilience to adaptation. They have to adopt bold measures to protect their businesses against future crises (or another wave of this pandemic), minimize risk, and drive future growth. By maintaining trust to trade, with or without government support, credit insurance will have an increasing role to play in this.

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What Does the FinCEN File Leak Tell Us?

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What Does the FinCEN File Leak Tell Us? 3

By Ted Sausen, Subject Matter Expert, NICE Actimize

On September 20, 2020, just four days after the Financial Crimes Enforcement Network (FinCEN) issued a much-anticipated Advance Notice of Proposed Rulemaking, the financial industry was shaken and their stock prices saw significant declines when the markets opened on Monday. So what caused this? Buzzfeed News in cooperation with the International Consortium of Investigative Journalists (ICIJ) released what is now being tagged the FinCEN files. These files and summarized reports describe over 200,000 transactions with a total over $2 trillion USD that has been reported to FinCEN as being suspicious in nature from the time periods 1999 to 2017. Buzzfeed obtained over 2,100 Suspicious Activity Reports (SARs) and over 2,600 confidential documents financial institutions had filed with FinCEN over that span of time.

Similar such leaks have occurred previously, such as the Panama Papers in 2016 where over 11 million documents containing personal financial information on over 200,000 entities that belonged to a Panamanian law firm. This was followed up a year and a half later by the Paradise Papers in 2017. This leak contained even more documents and contained the names of more than 120,000 persons and entities. There are three factors that make the FinCEN Files leak significantly different than those mentioned. First, they are highly confidential documents leaked from a government agency. Secondly, they weren’t leaked from a single source. The leaked documents came from nearly 90 financial institutions facilitating financial transactions in more than 150 countries. Lastly, some high-profile names were released in this leak; however, the focus of this leak centered more around the transactions themselves and the financial institutions involved, not necessarily the names of individuals involved.

FinCEN Files and the Impact

What does this mean for the financial institutions? As mentioned above, many experienced a negative impact to their stocks. The next biggest impact is their reputation. Leaders of the highlighted institutions do not enjoy having potential shortcomings in their operations be exposed, nor do customers of those institutions appreciate seeing the institution managing their funds being published adversely in the media.

Where did the financial institutions go wrong? Based on the information, it is actually hard to say where they went wrong, or even ‘if’ they went wrong. Financial institutions are obligated to monitor transactional activity, both inbound and outbound, for suspicious or unusual behavior, especially those that could appear to be illicit activities related to money laundering. If such behavior is identified, the financial institution is required to complete a Suspicious Activity Report, or a SAR, and file it with FinCEN. The SAR contains all relevant information such as the parties involved, transaction(s), account(s), and details describing why the activity is deemed to be suspicious. In some cases, financial institutions will file a SAR if there is no direct suspicion; however, there also was not a logical explanation found either.

So what deems certain activities to be suspicious and how do financial institutions detect them? Most financial institutions have sophisticated solutions in place that monitor transactions over a period of time, and determine typical behavioral patterns for that client, and that client compared to their peers. If any activity falls disproportionately beyond those norms, the financial institution is notified, and an investigation is conducted. Because of the nature of this detection, incorporating multiple transactions, and comparing it to historical “norms”, it is very difficult to stop a transaction related to money laundering real-time. It is not uncommon for a transaction or series of transactions to occur and later be identified as suspicious, and a SAR is filed after the transaction has been completed.

FinCEN Files: Who’s at Fault?

Going back to my original question, was there any wrong doing? In this case, they were doing exactly what they were required to do. When suspicion was identified, SARs were filed. There are two things that are important to note. Suspicion does not equate to guilt, and individual financial institutions have a very limited view as to the overall flow of funds. They have visibility of where funds are coming from, or where they are going to; however, they don’t have an overall picture of the original source, or the final destination. The area where financial institutions may have fault is if multiple suspicions or probable guilt is found, but they fail to take appropriate action. According to Buzzfeed News, instances of transactions to or from sanctioned parties occurred, and known suspicious activity was allowed to continue after it was discovered.

Moving Forward

How do we do better? First and foremost, FinCEN needs to identify the source of the leak and fix it immediately. This is very sensitive data. Even within a financial institution, this information is only exposed to individuals with a high-level clearance on a need-to-know basis. This leak may result in relationship strains with some of the banks’ customers. Some people already have a fear of being watched or tracked, and releasing publicly that all these reports are being filed from financial institutions to the federal government won’t make that any better – especially if their financial institution was highlighted as one of those filing the most reports. Next, there has been more discussion around real-time AML. Many experts are still working on defining what that truly means, especially when some activities deal with multiple transactions over a period of time; however, there is definitely a place for certain money laundering transactions to be held in real time.

Lastly, the ability to share information between financial institutions more easily will go a long way in fighting financial crime overall. For those of you who are AML professionals, you may be thinking we already have such a mechanism in place with 314b. However, the feedback I have received is that it does not do an adequate job. It’s voluntary and getting responses to requests can be a challenge. Financial institutions need a consortium to effectively communicate with each other, while being able to exchange critical data needed for financial institutions to see the complete picture of financial transactions and all associated activities. That, combined with some type of feedback loop from law enforcement indicating which SARs are “useful” versus which are either “inadequate” or “unnecessary” will allow institutions to focus on those where criminal activity is really occurring.

We will continue to post updates as we learn more.

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