Raiffeisen Zentralbank Osterreich AG v The Royal Bank of Scotland Plc [2010] EWHC 1392 (Comm)

“I have no issue doing this type of deal in view of the verbal assurances we have been given consistently by senior Enron staff – most recently by Andy Fastow to ISR [Robertson], JANC [Cameron] and other leading lights. We can seriously differentiate ourselves from the crowd by looking keenly at equity risk, especially where the risk is for less than 364 days. The question for debate is quantum…”

“This is exactly aligned to the Sutton Bridge deal we did last year – as has already been referenced, the whole thing hinges on an ‘understanding’ with Enron they will buy it all back but we have no reason to believe this would not be delivered on. The only rider I would add is that we should protect ourselves (probably through the pricing) against Plan B emerging at some point in Enron's fertile mind whereby they may subsequently decide to roll Teesside into “son of margaux”

“I’d like to keep the lot, but have the ability to sell out of some of the Senior Debt as and when we need to, because: (i) It will be our first deal in London with the new RBS. (ii) As the Debt pricing is 10-(ish) basis points above standard corporate pricing, it should be easier to sell than other stuff, and essentially short term. (iii) Keep the Equity regardless as our real return is here and if we believe them on repayment for £1 m, we may as well believe them for £ 3m and reap the rewards. Risk is not that great as it should only be 364 day max. (iv) I don’t want to (sic) rest of the market to see the structure as it is not that intellectually difficult and we are getting a very nice return (thank you very much)”

“We assume that the return on the preference shares will be achieved via a semi-annual cumulative fixed coupon with any potential shortfall being picked up in the repurchasing agreement…”

“Outstanding Issues 2. Return of 3% equity. Expecting 12.5%/13,5%/15% … RBS accept this is their risk”

“The transaction is aimed at monetisation of the dividend flows from ETOL …Enron’s aim is to effect a “true sale” of its assets under …FAS 125. If Enron can effect a transfer of the economic interest of ownership of ETOL (currently 50%) via the sale of preference shares to a non-Enron entity, which will be an RBS owned Special Purpose Entity (SPE) this will allow Enron to realise the increased value in the project as a result of cost savings. … Equity element of the transaction will be dealt with by means of a side letter between RBS and [EEL] with our return on the equity averaging 13.5% via a semi annual cumulative coupon. This will be serviced by approximately 3% of the preference share dividend (the remaining 97% being swapped under the total return swap for the Debt). There will be an understanding between Enron and RBS that any coupon not being met will be made up at the end of the 3 years and that the Equity will be financed at the same time as the debt, although for FAS 125 purposes this will not be documented.”

“7.0 Risk Analysis As detailed in Appendix 4, the risk associated with Enron Corporation under the proposed structure (i.e. the Senior Debt element) is considered acceptable. On this basis, our principal risk is the residual loss of our Equity stake and non-payment of the required return on the Equity. The risks associated with this are analysed as follows. 7.1 Enron Relationship/Informal Agreement with Enron As detailed in section 1.10, our key source of comfort that the expected return on equity is achieved and that the auction process provides Enron with the opportunity to make us whole at the end of the transaction…. Given the strength of our relationship with the company, the high level assurances that have been made and the reputational risk to Enron of not honouring this arrangement, we believe that this is acceptable. 7.2 However, to the extent that we become unable to rely upon our relationship with Enron to achieve our required return and repay our Equity we take comfort from the following...”

“Dividend Income: Sourced from 3% of expected preference share dividend flow the model clearly demonstrates ETOL’s inability to service the annual 13.5 % coupon and given the accelerated payback period. We are, therefore, looking to verbal undertakings (they cannot be formally documented for accounting reasons) from Enron that they will ensure that RBS is kept whole through the exit strategy. Exit Strategy: The proposal to hold an auction to find a buyer for the preference shares or failing that exercising a Put Option back to Enron at FMV, whilst not ideal provides a mechanism to trigger the debate with Enron.” and later: “….notwithstanding ETOL equity control mechanism that will restrict Enron’s ability to sell their management (voting rights) interest in ETOL, considerable reliance will still have to be placed on Enron’s verbal undertakings to see RBS whole of the equity tranche. Previous understandings with Enron have always been delivered upon and there is no reason to believe that this particular transaction will prove to be the exception to the rule.”

“We will not leave you hanging. We will absolutely get you the 13.5 % return of principal.”

“absolutely have my commitment.”

“…Enron Corporation will not leave RBS hanging out to dry on this deal. It will ensure that your principal and 13.5% return are paid” and “that, insofar as we were prepared to take further comfort “…you have my absolute commitment (as CFO, Enron Europe) to ensure that RBS does not suffer a loss from its equity investment in the ETOL transaction”

“The structure struck the Committee as “21st Century Alchemy”.”

“(ii) Fair Market Value (FMV) Put Option In addition to the Enron “promise” to make us whole on the Equity at the end of the transaction, we also have the Fair Market Value (FMV) Put Option, which provides comfort that there is a market in which to dispose of the preference shares. This must be demonstrated as being an “arm’s length” calculation in order to achieve Enron’s accounting treatment. We believe that the option will only be exercised in the event that Enron do not bid under the auction process, or where the FMV calculation provides for the value of the shares to be sufficient to make us whole on the Equity. The calculation of the FMV is detailed below...”

“the consummate innovator because of our extraordinary people. It is our intellectual capital – not only our physical assets – that makes us Enron”

“Finally, Ben assured us that the Put Option being provided in the ETOL transaction is not only a real obligation on the part of Enron in terms of seeing us out, but also at the agreed return.”

“Enron continue to underline their recognition that the strategy being pursued can only be continued with the co-operation/understanding of its bankers and investors. As such, we can continue to recognise ‘their word is their bond’ and they would always take every step necessary to avoid lenders/investors suffering losses, notwithstanding the non-recourse of much of their overall obligations.”

“[RBS] has been mandated by [Enron] to arrange and underwrite Project Magpie, a £143.5 million financing in order to enable Enron to realise its economic interest in [ETOL] for US accounting purposes.”

“In order for Enron to achieve a sale of its economic interest in ETOL for US accounting purposes, they must be sold to an independent third party with a minimum capitalisation of 3% equity.”

“Three per cent of dividend flows is retained by the SPE as its return on equity, and our required return is 13.5%. At maturity, the SPE is guaranteed a sale of the preference shares via an auction in the first instance and failing that, a Fair Market Value (“FMV”) Put Option, which will be guaranteed by Enron Corporation.”

“(a) all written, oral or computer generated information relating to the Company or the Transaction received by you (the “Recipient”) from RBS or the Company (or any of their Affiliates or any of their respective officers, employees agents or professional advisers) in connection with the Transaction; and (b) any documents or computer generated information produced by the Recipient which contain or reflect any information specified in paragraph (a).”

“(a) keep and safeguard as private and confidential all the Confidential Information; (b) use the Confidential Information solely for the purpose of evaluating the Company with a view to participating in the Transaction; …”

“The Recipient [i.e. RZB] acknowledges and agrees that: (a) RBS and its Affiliates, officers, employees, agents, and professional advisers do not make any representation or warranty, express or implied as to, or assume any responsibility for, the accuracy, adequacy, reliability or completeness of any of the Confidential Information. (b) RBS and its Affiliates, officers, employees, agents and professional advisers shall be under no obligation to update or correct any inaccuracy in the Confidential Information or be otherwise liable in respect of the Confidential Information; and (c) The Confidential Information is not intended to provide the sole basis of any credit evaluation and should not be considered to be a recommendation that the Recipient participate in the Transaction.”

“..This Information Memorandum (the “Memorandum”) has been prepared from Information supplied by the Company [EEL being defined as the Company]. The contents of this Memorandum have not been independently verified. No representation, warranty or undertaking (express or implied) is made, and no responsibility is accepted as to the adequacy, accuracy, completeness or reasonableness of this Memorandum or any further information, notice or other document at any time supplied in connection with the Facility.” “This Memorandum is being provided for information purposes only and is not intended to provide the basis of any credit decision or other evaluation and should not be considered as a recommendation that any recipient of this Memorandum should participate in the Facility. Each potential participant should determine its interest in participating in the Facility based upon such investigations and analysis as it deems necessary for such purpose. No undertaking is given to assess or keep under review the business, financial condition, prospects, creditworthiness, status or affairs of the Company, the Borrower or any other person now or at any time during the life of the Facility or (except as specifically provided in the Facility Agreement) to provide any recipient or participant in the Facility with any information relating to the Company, the Borrower or otherwise. ... This Memorandum is being made available to potential participants on the strict understanding that it is confidential. Recipients shall not be entitled to use any of the information contained in this Memorandum other than for the purpose of deciding whether or not to participate in the Facility. Recipients are reminded that this Memorandum is subject to the confidentiality undertaking signed by them.”

“The Senior Credit Facility of £138.5 million that forms the subject of the Information Memorandum (together with an equity investment of £4.9 million) has been arranged for the monetisation of Enron Europe Ltd’s (“EEL”) economic interest in Enron Teesside Operations Ltd (“ETOL”). Since its acquisition by EEL in December 1998, the economic value of ETOL has increased due to cost savings and operating efficiencies. For the purpose of monetising this value, The Royal Bank of Scotland plc (“RBS”) was mandated by EEL to set up a special purpose entity, RBS Financial Trading Company Ltd (“RBSFT”), capitalised with approximately 3.5% equity and 96.5% debt, to buy newly issued security, the Class “B”

“That RBS’ equity in RBSFT was “at risk” (as that term is understood for the purposes of relevant US accounting requirements) in that there was no support for the returns thereon and the repayment of capital other than as identified in the transactional materials.”

“23 Q. Reading those clauses, you would have understood at the 24 time, would you not, that RBS was expressly telling you 25 that it was not making any statements on which you could 1 rely in relation to the information supplied? 2 A. Yes.”

“19 Just to round off a point, which I think I know what 20 you are going to say, can you go back to bundle A2/84. 21 If you could read paragraphs – well actually, first of 22 all, can you take the other document, the hand out 23 document Containing the representations relied on. . I think you have already said to me that the 24 only representation you now think you would have been – 25 you had heard RBS to be telling you implicitly was as to 1 the lawfulness of the transaction generally. 2 A. Yes. 3 Q. So can we take it that none of the other representations 4 suggested here are ones which you can now recall you 5 understood to be made at the time and relied upon? 6 A. Yes. 7 Q. That’s correct, and you have looked at the various – 8 the four representations? 9 A. Yes.”

“to RBS’ knowledge there was nothing improper or unlawful about the ETOL transaction...”

“The transaction had the effect actually and legally of monetising Enron’s future dividend stream from ETOL while at the same time retaining Enron’s 50% voting rights and thus the transaction satisfied the accounting principles necessary to be complied with in order to achieve its purpose lawfully.”

“EEL and certain of its subsidiaries entered into a series of transactions on 1 November, 2000 … whereby it achieved a monetisation of its future dividend stream from ETOL, while at the same time retaining its 50% voting rights.”

“...It is true that if he had not supposed he would have a charge he would not have taken the debentures; but if he also relied on the misstatement in the prospectus, his loss none the less resulted from that misstatement. It is not necessary to show that the misstatement was the sole cause of his acting as he did. If he acted on that misstatement, though he was also influenced by an erroneous supposition, the Defendants will be still liable...”

“…when you have proved the statement was false, you must further show that the plaintiff has acted upon it and has sustained damage by so doing: you must show that the statement was either the sole cause of the plaintiff’s act or materially contributed to his so acting.” and at page 483: “[Counsel] contended that the Plaintiff admits that he would not have taken the debentures unless he had thought they would give him a charge on the property, and therefore he was induced to take them by his own mistake, and the misstatement in the circular was not material. But such misstatement was material if it was actively present to his mind when he decided to advance his money. The real question is, what was the state of the Plaintiff's mind, and if his mind was disturbed by the misstatement of the Defendants, and such disturbance was in part thecause of what he did, the mere fact of his also making a mistake himself could make no difference...”

“… In real life decisions are made on the basis of a complex of assumptions of fact. Some of these may be fundamental to the validity of the decision. “But for” that assumption, the decision would not be made. Others may be important factors in reaching the decisions and collectively, but not individually, fundamental to its validity. Yet others may be subsidiary factors which support or encourage the taking of the decision. If these latter assumptions are falsified in the event, whether individually or collectively, this will be a cause for disappointment to the decision taker, but will not affect the essential validity of his decision in the sense that if the truth had been known or suspected before the decision had been taken the same decision would still have been made.”

“It seems to me that the true position is that the misrepresentation must be an effective cause of the particular insurer or reinsurer entering into the contract but need not of course be the sole cause. If the insurer would have entered into the contract on the same terms in any event, the representation or non-disclosure will not, however material, be an effective cause of the making of the contract and the insurer or reinsurer will not be entitled to avoid the contract. Thus I agree with Sir Christopher Staughton, whose judgment I have seen in draft, that, in this context at least, causation cannot exist when even the ‘but for’ test is not satisfied...”

“86 … I conclude that the representation as to the participation of Munich Re did not induce the participation of Arig on the terms which they agreed to. 187 In reaching that conclusion I have had regard to the classic speech of Lord Mustill in Panatlantic Insurance Co Ltd v Pine Top Insurance Co Ltd (1995) 1 AC 501 at p549, and I hope that I have followed it. A misrepresentation or non-disclosure which did not make any difference, in the sense that the underwriter would have agreed to the same contract on the same terms if it had never been made, cannot be an inducement. Benjamin Franklin once wrote that for want of a nail a shoe was lost; for want of a shoe the horse was lost; and for want of a horse the rider was lost (Poor Richard’s Almanac). But in my view, causation cannot in law exist when even the "but for" test is not satisfied.”

“(i) In order to be entitled to avoid a contract of insurance or reinsurance, an insurer or reinsurer must prove on the balance of probabilities that he was induced to enter into the contract by a material non-disclosure or by a material misrepresentation. (ii) There is no presumption of law that an insurer or reinsurer is induced to enter in the contract by a material non-disclosure or misrepresentation. (iii) The facts may, however, be such that it is to be inferred that the particular insurer or reinsurer was so induced even in the absence of evidence from him. (iv) In order to prove inducement the insurer or reinsurer must show that the non-disclosure or misrepresentation was an effective cause of his entering into the contract on the terms on which he did. He must therefore show at least that, but for the relevant non-disclosure or misrepresentation, he would not have entered into the contract on those terms. On the other hand, he does not have to show that it was the sole effective cause of his doing so.”

“...I agree with Ward LJ that in determining whether the insurer or reinsurer was induced to enter into the contract the court does not embark upon the exercise of finding the decisive cause or the main reason. However, I remain of the view that the non-disclosure must be an effective (or as Arnould puts it in the passage quoted in paragraph 58 above) a real and substantial cause of the decision to enter into the contract. That conclusion seems to me to be supported by the passages from the judgments in Edgington v Fitzmaurice quoted by Ward LJ ...”

“...Having reconsidered the evidence I also remain of the view that it was open to the judge to conclude that what was said (or written) about the participation of Munich Re played no part in ARIG’s decision to participate. In short, it was open to the judge to hold that ARIG had not shown that, if it had known that Munich Re was participating only in section A, it would not have entered into the contracts or would have taken some other share and I can see no basis upon which this court could properly interfere with that conclusion...” and at paragraph 153: “I would dismiss the appeal on the Munich Re point on the ground summarised in paragraph 80 above, namely that the judge was correct to hold that ARIG had not shown that, if it had known that Munich Re was participating only in section A, it would not have entered into the contracts or would have taken some other share and I can see no basis upon which this court could properly interfere with that conclusion...”

“... I take the law to be this: if it is established that the representee did not allow the representation to affect his judgment in any way then he could not make it a ground for relief. If on the other hand the representee relied on the misrepresentation, then the representor cannot defeat his claim to relief by showing that there were other more weighty causes which contributed to his decision to enter into the contract. In this field the court does not allow an examination into the relative importance of contributory causes. In other words, it is sufficient if the representation is a cause even if it is not the cause operating on the mind of the representee when he enters into the contract...” and at paragraphs 218 and 219: “218 I am happy to express my agreement with the analysis of the law conducted by Clarke LJ subject to this reservation. I am not entirely sure that it is necessary to require the misrepresentation to be an effective cause of a party’s entering into the contract on the terms on which he did. If by that qualification my Lord means no more than that it did actually play upon his mind and influence his decision then I have no argument. In other words I readily accept it must have some causative effect. I would be concerned if the insistence on an effective cause were to lead to an evaluation of the weight placed by the representee upon the various matters which in combination lead to the agreement. We must be careful not to be led back into the error that the cause has to be a decisive cause. 219 The crucial question has now become, adopting the language of Bowen L.J., a mere question of fact: was Arig’s corporate mind disturbed by the misstatement of Generali and was such disturbance in part the cause of what it did? ...”

“This raises a question of some importance. Is it sufficient for the creditor to identify the period during which he was induced by the error to refrain from making the claim, or must he go further and identify the date on which he would have made the claim but for the error? I am satisfied that he need not take this further step which involves a hypothetical inquiry which can never be answered precisely and may sometimes be incapable of being answered at all. A representee can say why he acted as he did. He can say that it was, inter alia, because of the representation. But he can only speculate on what he would have done if the representation had not been made. As a matter of English law, a representee must always be prepared to prove that the representation had an effect on his mind. But it is sufficient for him to prove that the representation wasan inducing cause which led him to act as he did; he need not prove that it was the inducing cause: Edgington v Fitzmaurice.... Whether, if a full disclosure of the truth had been made, he would or would not have acted differently is a question to which English law does not require an answer; it is sufficient that he might have done so: see Spencer Bower and Turner…. There are many authorities to this effect.”

“...But this is a most unusual case and the findings of fact made below do undoubtedly raise the question whether it was necessary for Barton in order to obtain relief to establish that he would not have executed the deed in question but for the threats…”

“...Had Armstrong made a fraudulent misrepresentation to Barton for the purpose of inducing him to execute the deed of January 17, 1967, the answer to the problem which has arisen would have been clear. If it were established that Barton did not allow the representation to affect his judgment then he could not make it a ground for relief even though the representation was designed and known by Barton to be designed to affect his judgment. If on the other hand Barton relied on the misrepresentation Armstrong could not have defeated his claim to relief by showing that there were other more weighty causes which contributed to his decision to execute the deed, for in this field the court does not allow an examination into the relative importance of contributory causes. ‘Once make out that there has been anything like deception, and no contract resting in any degree on that foundation can stand’: per Lord Cranworth LJ in Reynell v Sprye (1852) 1 De G.M. & G. 660, 708 - see also the other cases referred to in Cheshire and Fifoot's Law of Contract, 8th ed. (1972), pp250-251. Their Lordships think that the same rule should apply in cases of duress and that if Armstrong's threats were "a" reason for Barton's executing the deed he is entitled to relief even though he might well have entered into the contract if Armstrong had uttered no threats to induce him to do so...”

“...The proper inference to be drawn from the facts found is, their Lordships think, that though it may be that Barton would have executed the documents even if Armstrong had made no threats and exerted no unlawful pressure to induce him to do so the threats and unlawful pressure in fact contributed to his decision to sign the documents and to recommend their execution by Landmark and the other parties to them...”

“BEING VIEWED AS ENRON CORP RISK DUE TO THE SECURITY PROVIDED”; (b) The Synopsis included the following: “While the facility is being provided to a special purpose vehicle (RBSFT) owned by RBS, due to the Total Return Swap mechanism … entered into between RBSFT and Enron Corp, the exposure is being viewed as Enron risk”; (c) Under the heading “Business Environment” it stated that “As RBSFT is a special purpose vehicle, the following commentary is on Enron Corp”; (d) Under the heading “Financial Situation”, the financial details set out, together with the “Comment” and “Outlook”, related only to Enron Corp. The paper noted that “No past financials have been provided on ETOL Mr Stuart-Prince had asked for copies of ETOL’s accounts and had been told that he would not need to review them because of the TRS and the Put Option. He never received copies. . EEL have provided forward forecasts and these are highlighted within the Appendices. However, as this is an indirect source of servicing and repayment no comment is made here”. (e) The first bullet under “Recommendation” stated: “The transaction is well structured and all the risks are effectively guaranteed by Enron Corp.”

“The structure is not dependent upon the performance of ETOL”

“Purpose of facility is to provide additional funds for Enron Group, dressed as a purchase of preference shares to be issued by an UK subsidiary and purchased by a SPV using the requested facility. Amount of shares issued reflects discounted expected dividends of UK subsidiary of next 10 years. Most probably repayment of facility through Put Option of pledged shares against Enron Corp (USA) at 1/2004.”

“unsecured, however:” • Supported by pledge of preference shares combined with Put Option against Enron Corp (USA) at the end of tenor. • Based on Enron Corp. (USA) risk through “Total Return Swap”.”

“Inducement in fact is shown by proof that the representation was made both with the object, and with the result, of inducing the representee to alter his position. Neither element suffices without the other. To prove the representor’s intention to produce the effect comes to nothing, unless the effect itself be proved; and to establish the result is idle, unless it be shown that the representor actually, or presumptively, intended to bring it about.”

“This Memorandum is being provided for information purposes only and is not intended to provide the basis of any credit decision or other evaluation and should not be considered as a recommendation that any recipient of this Memorandum should participate in the Facility.”

“(c) the Confidential Information is not intended to provide the sole basis of any credit evaluation and should not be considered to be a recommendation that the Recipient participate in the Transaction.”

“The Recipient [i.e. RZB] acknowledges and agrees that: (a) RBS and its Affiliates, officers, employees, agents, and professional advisers do not make any representation or warranty, express or implied as to, or assume any responsibility for, the accuracy, adequacy, reliability or completeness of any of the Confidential Information. (b) RBS and its Affiliates, officers, employees, agents and professional advisers shall be under no obligation to update or correct any inaccuracy in the Confidential Information or be otherwise liable in respect of the Confidential Information; and (c) The Confidential Information is not intended to provide the sole basis of any credit evaluation and should not be considered to be a recommendation that the Recipient participate in the Transaction.” “Confidential Information” was defined by clause 1 as “all written, oral or computer generated information relating to [Enron Europe Limited] or the transaction [the SCF] received by [RZB] from RBS or [Enron Europe Limited] in connection with the Transaction.” (2) The “Important Notice” at the front of the IM, which stated (amongst other things) as follows: “[RBS] has been mandated by [EEL] (the Company) to arrange a structured senior credit facility for [RBSFT] (the Borrower). The information memorandum has been prepared from information supplied by the company and others. The contents of this Memorandum have not been independently verified. No representation, warranty or undertaking (express or implied) is made, and no responsibility is accepted as to the adequacy, accuracy, completeness or reasonableness of this Memorandum or any further information, notice or other document at any time supplied in connection with the Facility. This Memorandum is being provided for information purposes only and is not intended to provide the basis of any credit decision or other evaluation and should not be considered as a recommendation that any recipient of this Memorandum should participate in the Facility. Each potential participant should determine its interest in participating in the Facility based upon such investigations and analysis as it deems necessary for such purpose. No undertaking is given to assess or keep under review the business, financial condition, prospects, creditworthiness, status or affairs of the Company, the Borrower or any other person now or at any time during the life of the Facility or (except as specifically provided in the Facility Agreement) to provide any recipient or participant in the Facility with any information relating to the Company, the Borrower or otherwise.” (3) In a supplement to the IM on Transaction Maturity/Early Termination the footer indicated that the Important Notice in the IM applied equally to the contents of the supplement. Similarly, in a Transaction Summary the header indicated that: “the provisions of the ‘Important Notice’ in the Information Memorandum shall apply as if set out in full in this summary.” (4) The documentation executed by RZB upon acquiring its participation in the SCF contained a number of provisions re-affirming the absence of any responsibility on the part of RBS, and the fact that RBS had not made any representations to RZB in connection with the transaction. (a) By clause 5.1 of the Syndication Agreement, executed by RZB on 23 February2001, the rights and obligations of RBS as “Original Lender” under the Facility Agreement in respect of the SCF were novated to (among others) RZB. By clause 5.1.4(iii), RZB agreed that: “the Agent, the Arranger, each New Lender and the Original Lender shall acquire the same rights and assume the same obligations between themselves as they would have acquired and assumed had each New Lender been an Original Lender…” (b) By clause 22.4(a) of the Facility Agreement of 1st November 2000 (to which RZB thus became a party by novation) RZB agreed that RBS, as Existing Lender: This and the other Relevant Provisions in the Facility Agreement are in LMA standard form: see Syndicated Lending, Tony Rhodes, 5th ed., pp.388-389, 393 & 394. “…makes no representation or warranty and assumes no responsibility to [RZB] for: (i) the legality, validity, effectiveness, adequacy or enforceability of the Finance Documents or any other documents … (iv) the accuracy of any statements (whether written or oral) made in or in connection with any Finance Document or any other documents, and any representations or warranties implied by law are excluded.” (c) By clause 24.3 of the Facility Agreement, RZB agreed that: “except as specifically provided in the Finance Documents, the Arranger has no obligations of any kind to any other Party under or in connection with any Finance Document.” (d) By clause 24.8 of the Facility Agreement, RZB agreed that: “Neither the Agent nor the Arranger: (a) is responsible for the adequacy, accuracy and/or completeness of any information (whether oral or written) supplied by the Agent, the Arranger, the Borrower or any other person given in or in connection with any Finance Document or any Operative Document; or (b) is responsible for the legality, validity, effectiveness, adequacy or enforceability of any Finance Document, any Operative Document or any other agreement, arrangement or document entered into, made or executed in anticipation of or in connection with any Finance Document or any Operative Document.” (e) By clause 24.15(d) of the Facility Agreement RZB agreed: “Without affecting the responsibility of the Borrower for information supplied by it or on its behalf in connection with any Finance Document, each Lender confirms to the Agent and the Arranger that it has been and will continue to be solely responsible for making its own independent appraisal and investigation of all risks arising under or in connection with any Finance Document including but not limited to … (d) the adequacy, accuracy and/or completeness of any other information provided by the Agent, any party or by any other person under or in connection with any Finance Document or Operative Document, the Transactions contemplated by the Finance Documents or any other agreement, arrangement or document entered into, made or executed in anticipation of, under or in connection with any Finance Document or Operative Document.”

“A convention of the parties, which binds them to adhere to an assumed state of facts, may amount to an express contract, in which case each party contracts with the other to be estopped. Burroughs Adding Machine Ltd v Aspinall (1925) 41 TLR 276 C.A. is an example …. It is not proposed to discuss estoppel by contract in this chapter, which is concerned with a type of estoppel by convention in which estoppel arises not as a matter of contract, but from a convention of the parties having less than contractual force. But it has been of interest to notice, by way of introduction to the subject , that there may be an estoppel whereby parties are precluded, as a matter of contract, and not of a mere recital, from setting up a version of the facts different from that which they have agreed to assume.”

“14. Without prejudice to the duty of the vendor to disclose all latent easements and latent liabilities known to the vendor to affect the property , the property is sold subject to any rights of way and water, rights of common and other rights, easements, quasi-easements, liabilities and pubic rights affecting the same. 17. The purchaser shall be deemed to purchase with full notice of and subject to: …. (e) all easements, quasi-easements rights and privileges (whether of a public or private nature) now affecting the property but without any obligation on the part of the vendor to define the same.”

“In my judgment they are nothing of the kind. Section 3 deals with provisions which exclude or restrict a party’s liability for “any misrepresentation made by him before the contract was made”

“[Clause 9 (ii)] is expressed to be an acknowledgement, that is to say a representation by the plaintiff that she had not made known by implication that the car was required for a particular purpose, and also as an agreement that she had not made that purpose known to the defendants. Insofar as [clause 9 (ii)] was a representation it could operate only as an estoppel preventing the plaintiff from asserting the contrary, but Mr Roche expressly disclaims reliance upon it as an estoppel, no doubt for the very good reason that there was no evidence (and it is difficult to see how there could have been truthful evidence) that the defendants believed in the truth of the representation. To call it an agreement as well as an acknowledgment by the plaintiff cannot convert a statement as to past facts, known by both parties to be untrue, into a contractual obligation, which is essentially a promise by the promisor to the promisee that acts will be done in the future or that facts exist at the time of the promise or will exist in the future. To say that the hirer “agreed” that he has not done something in the past means no more than that the hirer, at the request of the owner, represents that he has not done that thing in the past. If intended by the hirer to be acted upon by the person to whom the representation is made, believed to be true by such person and acted upon by such person to his detriment, it can give rise to an estoppel; it cannot give rise to any positive contractual obligation. Although contained in the same document as the contract, it is not a contractual promise. There lies the fallacy in Mr Roche’s contention. Whether or not the plaintiff made known to the defendants by implication the particular purpose for which she required the car is a pure question of fact as to the state of knowledge of the defendants to be inferred in the light of all the circumstances, including the terms of the contract itself. On this issue the rule of construction relied on by Mr Roche that you cannot imply in a contract a promise, which is inconsistent with an express provision It is no clearer to me than it was to Gloster J in Springwell how it was said that such a provision would not have been caught by section 8 (3) of the Hire Purchase Act 1938. , is irrelevant for the inference to be drawn from the terms of the contract that the defendants knew the particular purpose for which the plaintiff required the car is not an implied promise, nor is the representation in clause 9 (ii) of the contract an express promise.”

“You should also ensure that you fully understand the nature of the transaction and contractual relationship into which you are entering” 239. and “The issuer assumes that the customer is aware of the risks and practices described herein, and that prior to each transaction the customer has determined that such transaction is suitable for him.”

“The Risk Disclosure Statement was a contractual document … ANZ accepted the investment instruction in that letter on the basis of the investor’s confirmation that it had read and understood the terms of the statement. That confirmation, as it seems to me, operated as a contractual estoppel to prevent Peekay from asserting in litigation that it had not, in fact read and understood the Risk Disclosure Statement. And if it had read and understood the Risk Disclosure statement, it must be taken to have accepted that ANZ would assume that it fully understood the nature of the transaction into which it was entering, was aware of the risks, and had determined that the transaction was suitable for its purposes. Given that, Peekay could not be heard to say that Mr Pawani had assumed that the FTCs which he had signed on its behalf did not need to be read and understood.”

“In conclusion on this topic, I see nothing inappropriate or commercially offensive about Chase being permitted to rely on the statements contained in the Relevant Provisions, even if it could be said that in some respects they did not accurately reflect every aspect of the dealing relationship. All of the relevant terms of the contractual documentation fall squarely within the Peekay analysis, as contractual representations (and in some cases, warranties) or “agreements” as to the basis upon which the business was to be conducted. Thus, for example, where the contract provided that, by placing an order, Springwell represented … that it was a sophisticated investor and that it had independently and without reliance on Chase made a decision to acquire the instrument, that was not a mere statement of historical fact, but a contractual representation forming the agreed and binding basis upon which the parties would transact every future purchase. The same analysis applies in respect of every clause in every document to which Springwell takes this objection. The fact that some statements are expressed in the language of representation or acknowledgement cannot, in my view, make any difference to the analysis that the statements give rise to a contractual estoppel.”

“agree[d] and acknowledge[d] that save as expressly stated in this Agreement and the other Transaction Documents to which [the claimant] is a party [the claimant] has not and shall not be deemed to have made any warranties or representations, express or implied, about the aircraft.”

“Whether or not the plaintiff made known to the defendants by implication the particular purpose for which she required the car is a pure question of fact as to the state of knowledge of the defendants to be inferred in the light of all the circumstances, including the terms of the contract itself. On this issue, the rule of construction relied on by Mr. Roche that you cannot imply in a contract a promise, which is inconsistent with an express promise, is irrelevant, for the inference to be drawn from the terms of the contract that the defendants knew the particular purpose for which the plaintiff required the car is not an implied promise, nor is the representation in clause 9 (ii) of the contract an express promise.”

“Avoidance of provision excluding liability for misrepresentation. If a contract contains a term which would exclude or restrict — ( a ) any liability to which a party to a contract may be subject by reason of any misrepresentation made by him before the contract was made; or ( b ) any remedy available to another party to the contract by reason of such a misrepresentation, that term shall be of no effect except in so far as it satisfies the requirement of reasonableness as stated in section 11 ( 1 ) of theUnfair Contract Terms Act 1977; and it is for those claiming that the term satisfies that requirement to show that it does.”

“(b) any intending purchaser must satisfy himself by inspection or otherwise as to the correctness of each of the statements contained in those particulars.”

“… go further and say that if the ingenuity of the draftsman could devise language which would have that effect, I am extremely doubtful whether the court would allow it to operate so as to defeat section 3. Supposing the vendor included a clause which the purchaser was required, and did, agree to in some terms as “notwithstanding any statement of fact included in these particulars the vendor shall be conclusively determined to have made no representation within the meaning of the Misrepresentation Act 1967”, I should have thought that that was only a form of words the intended and actual effect of which was to exclude or restrict liability, and I should not have thought that the courts would have been ready to allow such ingenuity in the form of language to defeat the plain purpose at which section 3 is aimed.”

“... in particular with the observations that my Lord made about the submissions put to the court by Mr Maurice …. Nevertheless, the case for the appellant does have an audacity and a simple logic which I confess I find attractive. It runs thus: a statement is not a representation unless it is also a statement that what is stated is true. If in context a statement contains no assertion express or implied that its content is accurate there is no representation. Ergo, there can be no misrepresentation; ergo, the Misrepresentation Act 1967 cannot apply to it. Humpty Dumpty would have fallen for this argument. If we were to fall for it, the Misrepresentation Act would be dashed to pieces, which not all the King’s lawyers could put together again.” and held that the notice, fairly construed was: “a warning to the would-be purchaser to check the facts; that is to say, not to rely on [the representation]. It is because the statement contains the representation that the warning is given. Since the statement was false, there was a false representation; the Act therefore applies.”

“There are, as it seems to me, at least two good reasons why the courts should give effect to an acknowledgment of non-reliance in a commercial contract between experienced parties of equal bargaining power – a fortiori, where those parties have the benefit of professional advice. First, it is reasonable to assume that the parties desire commercial certainty. They want to order their affairs on the basis that the bargain between them can be found within the document which they have signed. They want to avoid the uncertainty of litigation based on allegations as to the content of oral discussions at pre-contractual meetings. Second, it is reasonable to assume that the price to be paid reflects the commercial risk which each party – or, more usually, the purchaser – is willing to accept. The risk is determined, in part at least, by the warranties which the vendor is prepared to give. The tighter the warranties, the less the risk and (in principle, at least) the greater the price the vendor will require and which the purchaser will be prepared to pay. It is legitimate, and commercially desirable that both parties should be able to measure the risk, and agree the price, on the basis of the warranties which have been given and accepted.”

“a term [of the contract] which would exclude or restrict – (a) any liability to which a party to [the] contract may be subject by reason of any misrepresentation made by him before the contract was made” “A term which negates a reliance which in fact existed is a term which excludes a liability which the represent or would otherwise be subject to by reason of the misrepresentation. If that were wrong, it would mean that section 3 could always be defeated by including an appropriate non-reliance clause in the contract, however unreasonable that might be.”

“… there is no reason why the parties should have intended, by the words which they have used in the first sentence of the limit of liability clause “Neither the Company nor the Customer shall be liable to the other for any claims for indirect or consequential losses whether arising from negligence or otherwise.” to exclude liability for negligent pre-contract misrepresentation. Liability in damages under the Misrepresentation Act 1967 can arise only where the party who has suffered the damage has relied upon the representation. Where both parties to the contact have acknowledged in the document itself that they have not relied upon any pre-contract representation, it would be bizarre (unless compelled to do so by the words which they have used) to attribute to them an intention to exclude a liability which they must have thought could never arise. Whether the parties thought that such a liability could never arise might be said to depend on whether they were aware of the conditions laid down in Lowe v Lombank for the efficacy of an evidential estoppel. ”

“The statements in the SIM … went to the scope of the representations being made and cannot properly be characterised for the purposes of either Act as attempts to exclude liability for misrepresentation … The relevant paragraphs of the SIM are not in my view to be characterised in substance as a notice excluding or restricting a liability for negligence, but more fundamentally as going to the issue whether there was a relationship between the parties (amounting to or equivalent to that of professional adviser and advisee)...”

“The Act of 1977 [UCTA] is normally regarded as being aimed at exemption clauses in the strict sense, that is to say, clauses in a contract which aim to cut down prospective liability arising in the course of the performance of the contract in which the exemption clause is contained.”

“terms which simply define the basis upon which services will be rendered and confirm the basis upon which parties are transacting business are not subject to section 2 of UCTA. Otherwise, every contract which contains contractual terms defining the extent of each party's obligations would have to satisfy the requirement of reasonableness.”

“Having contracted to trade with Chase on those terms, it is not, in my judgment, now open to Springwell to seek to elevate those trading discussions into pre-contractual representations or statements in relation to which it is contended that Chase assumed a duty of care.”

“The Lessee [i.e. FFCL] also agrees and acknowledges that save as expressly stated in this Agreement and the other Transaction Documents to which the Lessor is a party, the Lessor has not and shall not be deemed to have made any warranties or representations, express or implied, about the aircraft, including but not limited to matters referred to above.”

“The Lessee [FFCL] gives up any rights against the Lessor [Trident] regarding any warranty or representation, except in respect of any warranty or representation expressly made in this Agreement or the other Transaction Documents to which the Lessor is a party. The Lessee cannot make any claim against the Lessor at any time after Delivery relating to the condition of the Aircraft.”

“However, the effect of a clause must always depend on its exact wording. In this case the first half of cl 19.1 undoubtedly contemplates that FFCL might assert that Trident was liable in relation to the description, merchantability, satisfactory quality or fitness for any use or purpose of the aircraft. Clause 19.2 expressly contemplates that FFCL, as lessee, would but for the clause, have rights in respect of representations. Therefore, I have concluded that both cl 19.1 and 19.2 do fall within the scope of s 3 of the 1967 Act because they both purport to exclude or restrict liability for misrepresentation.”

“the term shall have been a fair and reasonable one to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made.”

“Where experienced businessmen representing substantial companies of equal bargaining power negotiate an agreement, they may be taken to have had regard to the matters known to them. They should, in my view, be taken to be the best judge of the commercial fairness of the agreement which they have made; including the fairness of each of the terms in that agreement. They should be taken to be the best judge on the question whether the terms of the agreement are reasonable. The court should not assume that either is likely to commit his company to an agreement which he thinks is unfair, or which he thinks includes unreasonable terms. Unless satisfied that one party has, in effect, taken unfair advantage of the other – or that a term is so unreasonable that it cannot properly have been understood or considered - the court should not interfere.”

“256. As for the element of dishonesty, the leading cases are replete with statements of its vital importance and of warnings against watering down this ingredient into something akin to negligence, however gross. The standard direction is still that of Lord Herschell in Derry v Peek (1889) 14 App Cas 337 at 374: "First, in order to sustain an action in deceit, there must be proof of fraud and nothing short of that will suffice. Secondly, fraud is proved when it is shown that a false representation has been made (1) knowingly, (2) without belief in its truth, or (3) recklessly, careless whether it be true or false." 257. In effect, recklessness is a species of dishonest knowledge, for in both cases there is an absence of belief in truth. It is for that reason that there is "proof of fraud" in the cases of both knowledge and recklessness. This was stressed by Bowen LJ in Angus v. Clifford [1891] 2 Ch 449 where he said (at 471): "Not caring, in that context, did not mean not taking care, it meant indifference to the truth, the moral obliquity of which consists in a willful disregard of the importance of truth, and unless you keep it clear that that is the true meaning of the term, you are constantly in danger of confusing the evidence from which the inference of dishonesty in the mind is to be drawn – evidence which consists in a great many cases of gross want of caution – with the inference of fraud, or of dishonesty itself, which has to be drawn after you have weighed all the evidence." 258. And in Armstrong v. Strain [1951] 1 TLR 856 at 871 Devlin J, after a full citation of passages in earlier authorities which stress the need for dishonesty (also called actual fraud, mens rea, or moral delinquency), said this about the necessary knowledge: “A man may be said to know a fact when once he has been told it and pigeon-holed it somewhere in his brain where it is more or less accessible in case of need. In another sense of the word a man knows a fact only when he is fully conscious of it. For an action of deceit there must be knowledge in the narrower sense; and conscious knowledge of falsity must always amount to wickedness and dishonesty. When Judges say, therefore, that wickedness and dishonesty must be present, they are not requiring a new ingredient for the tort of deceit so much as describing the sort of knowledge which is necessary.”

“Where knowledge of a fact held by the speaker is relied on to make his statement deceitful, he must be "fully conscious" of that fact and have conscious knowledge of the falsity of his statement: Armstrong v Strain [1951] TLR 856 at p 871, per Devlin J.” "First, in order to sustain an action in deceit, there must be proof of fraud and nothing short of that will suffice. Secondly, fraud is proved when it is shown that a false representation has been made (1) knowingly, (2) without belief in its truth, or (3) recklessly, careless whether it be true or false." "Not caring, in that context, did not mean not taking care, it meant indifference to the truth, the moral obliquity of which consists in a willful disregard of the importance of truth, and unless you keep it clear that that is the true meaning of the term, you are constantly in danger of confusing the evidence from which the inference of dishonesty in the mind is to be drawn – evidence which consists in a great many cases of gross want of caution – with the inference of fraud, or of dishonesty itself, which has to be drawn after you have weighed all the evidence." “A man may be said to know a fact when once he has been told it and pigeon-holed it somewhere in his brain where it is more or less accessible in case of need. In another sense of the word a man knows a fact only when he is fully conscious of it. For an action of deceit there must be knowledge in the narrower sense; and conscious knowledge of falsity must always amount to wickedness and dishonesty. When Judges say, therefore, that wickedness and dishonesty must be present, they are not requiring a new ingredient for the tort of deceit so much as describing the sort of knowledge which is necessary.”

“Enron reviews each such development with Arthur Andersen ahead of creation to ensure that off-balance sheet status can be achieved, as well as discussing these with the external rating agencies to ensure that they fully understand the nature and scope of such engagements.”

“The only agreement between RBSFT and Enron relating to RBSFT's equity holding if the Put Option.”

“…in order to achieve the desired accounting treatment for Enron, no formal arrangement for the sale of the equity may be made. Irrespective of this, it is intended that the TRS arrangement will cover any loss on disposal/redemption of the prefshares.”

“The transaction needs to be structured as described below in order to achieve the desired US Accounting treatment and, in particular there must be no arrangements to ensure the repayment of the return on the 3% of equity that RBS will be providing via a subscription for shares in an SPE (see 8 below) . … 8. The remaining 3% of the dividends will be attributable to the equity investors in the SPE (i.e. RBS). It is not possible for the equity investors to be given a guaranteed return in respect of income or capital as this would prejudice the desired US accounting treatment.”

“The remaining 3% of the dividends will be attributable to the equity investors in the SPE (i.e. RBS). RBS does not anticipate realising a loss on its equity investment and anticipates that it would receive a return on this investment equal to 3% of the dividends received on the preference shares”

“… also have the right to require an Enron Subsidiary (guaranteed by Enron Corp.) to purchase the shares at a price which would be at least equal to the fair market value of [the] share. The meeting considered the potential profit for the Company of a sale of the shares.”

“This Statement provides accounting and reporting standards for transfer and servicing of financial assets and extinguishments of liabilities. These standards are based on consistent application of a financial components approach that focuses on control. Under that approach, after a transfer of financial assets an entity recognises the financial and servicing assets it controls and the liabilities it has incurred, derecognises financial assets when control has been surrendered, and derecognises liabilities when extinguished. This Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings.” 4 Paragraphs 9 and 30 provide: “9. A transfer of financial assets in which the transferor surrenders control over those assets is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. The transferor has surrendered control, over transferred assets if and only if all of the following conditions are met: a. The transferred assets have been isolated from the transferor – put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or receivership (paragraphs 23 and 24). b. Either (1) each transferee obtains the right – free of conditions that constrain it from taking advantage of that right(paragraph 25) – to pledge or exchange the transferred assets or (2) … c. The transferor does not maintain effective control over the transferred assets through (1) an agreement that both entitles and obligates the transferor to repurchase or redeem them before their maturity (paragraphs 27-29) or (2) an agreement that entitles the transferor to repurchase or redeem transferred assets that are not readily obtainable (paragraph 30).” “30 A call option or forward contract that entitles the transferor to repurchase, prior to maturity, transferred assets not readily obtainable elsewhere maintains the transferor’s effective control because it would constrain the transferee from exchanging those assets…”

“129 The Board observes that a special-purpose entity that has distinct standing at law may still be an affiliate of the transferor, and therefore its assets and liabilities may be required to be included with those of the transferor in consolidated financial statements. Many respondents maintained that existing principles are not clear and asked the Board to develop within this Statement additional consolidation guidance for special-purpose entitles. The Board concluded that this Statement is not intended to change existing generally accepted accounting principles for consolidation issues. However, the Board acknowledges that consolidation of special-purpose entities is an issue that merits further consideration and is committed to deliberating that issue in its current project on consolidated financial statements.” 6 That lack of clarity makes it necessary to turn to two EITF Topics, namely Topic D-14 and Topic 90-15 issued by the end of May 1990 and July 1991 respectively. These deal with the question whether an SPE (such as RBSFT) needs to be consolidated into the financial statements of the transferor (Enron). If it did, Enron would not be able to recognise its gain from the sale of ETOL. THE EITFs EITF Topic D-14 Transactions Involving Special-Purpose Entities 7 EITF Topic D-14 provides “Generally, the SEC staff believes that for nonconsolidation and sales recognition by the sponsor or transferor to be appropriate, the majority owner (or owners) of the SPE must be an independent third party who has made a substantive capital investment in the SPE, has control of the SPE, and has substantive risks and rewards of ownership of the assets of the SPE (including residuals). Conversely, the SEC staff believes that non-consolidation and sales recognition are not appropriate by the sponsor or transferor when the majority owner of the SPE makes only a nominal capital investment, the activities of the SPE are virtually all on the sponsor’s or transferor’s behalf, and the substantive risks and rewards of the assets or the debt of the SPE rest directly or indirectly on the sponsor or transferor.”

“The initial substantive residual equity investment should be comparable to that expected for a substantive business involved in similar leasing transactions with similar risks and rewards. The SEC staff understands from discussions with Working Group members that those members believe that 3 percent is the minimum acceptable investment.” 10 The guidance available as to the meaning of the phrase “at risk” amounted to the following: (1) The response to Q3 in EITF 90-15, which states: “As the consensus states, the investment should be at risk with respect to the leased asset for the entire term of the lease. The investment would not be considered to be at risk, for example, if the investor were provided a letter of credit or other form of guarantee on the initial investment or return thereon. An investor note payable issued to the SPE would not qualify as an initial substantive residual equity investment at risk.” (2) The answer to Q7 in EITF 96-21 – Implementation Issues in Accounting for Leasing Transactions Involving Special Purpose Entities “Source of Initial Minimum Equity Investment Question No.7 Would an equity investment that is financed with nonrecourse debt qualify as an initial substantive residual equity capital investment as that term is used in condition 3 of Issue 90-15? Would an equity investment that is financed with recourse debt qualify? Response If the source of the funds used to make the initial minimum equity investment is financed with nonrecourse debt that is collateralized by a pledge of the investment, the investment would not meet the at-risk requirement discussed in condition 3 of Issue 90-15. Similarly, the at-risk requirement would not be met if the owners purchased residual insurance or obtained a residual guarantee that would ensure recovery of their equity investment. If the initial minimum equity investment is financed with recourse debt from a party not related to the lessee, the owners (borrowers) must have other assets at risk to support the borrowing in order to avoid condition 3 of Issue 90-15.” 11 As at November 2000 no court or tribunal had either decided, or provided any ruling or guidance as to, the meaning of “at risk”

“49 Q - Would a transferor’s contractual right to repurchase a loan participation that is not a readily obtainable asset preclude sale accounting? A – Yes. … 50 Q – In certain industries, a typical customer’s borrowing needs often exceed its bank’s legal lending limits. In order to accommodate the customer, the bank may “participate” the loan to other banks (that is, transfer under a participation agreement a portion of the customer’s loan to one or more participating banks). In those situations, a noncontractual understanding may exist among the participants. Under that noncontractual understanding, the participating banks will return some portion of the loan at par to the lending bank if its legal lending limit increases. The noncontractual understanding is not an enforceable right, although the participating banks generally comply. These loans generally are not-readily-obtainable assets, and the participating banks are not constrained from selling their interest in the participation. Does this noncontractual understanding constitute a call on not-readily-obtainable assets? A – No. A probable behavior is not equivalent to a contractual right. Paragraph 9(2) (c) focuses on a transferor’s right (it is phrased entitles) to repurchase or redeem the transferred assets. Therefore, while in most circumstances the transferee will likely return the assets if the transferor asks for them, it is not obligated to do so. That is, the transferor has not retained control over the transferred assets if it does not have a legal right to call those assets.”

“The Board concludes that disclosure of those loss contingencies, and others that in substance have the same characteristic, shall be continued. Disclosure shall include the nature and amount of the guarantee.”

“the Commission [i.e. the SEC] is of the view that, depending upon the facts and circumstances, oral guarantees, even if legally unenforceable, may have the same financial reporting significance as written guarantees. Statement of Financial Accounting Standards No.5, paragraph 12, states that material undertakings which in substance have the characteristics of a guarantee should be disclosed in financial statements. Thus, whether oral or written, a material commitment which is in substance a guarantee should be reported. One factor, among others, in determining whether statements made by an issuer constitute an oral guarantee which should be reported is whether the financial institution relied upon the statements in making the decision to extend credit. Guarantees and guarantees-in-substance can affect the accounting treatment for transactions. … Therefore, financial institutions and other entities should report those oral arrangements which constitute guarantees-in-substance in response to an audit confirmation request….” 22 These observations by the SEC were made in response to an argument that had been addressed to the SEC in a case where a company ("the issuer”) had materially overstated its income and net assets. The issuer’s subsidiary had purported to sell a substantial amount of assets to an unrelated foreign company (“the buyer”) in order to raise cash. There was in fact no true sale and the risks of ownership never passed to the buyer because the subsidiary agreed with the buyer to repurchase an amount of assets sufficient to enable the buyer to pay its debts incurred in purchasing the assets sold. In order to obtain finance for the transaction the buyer had obtained standby letters of credit from several banks. The issuer told the banks it would issue comfort letters stating that it knew of the obligations of its subsidiary arising from the agreement with the buyer. A senior executive of the issuer told a representative of one large New York bank that the issuer viewed its comfort letter as a guarantee and would make sure that the bank was paid and did not lose money on the transaction. In response to an audit confirmation request from the issuer’s auditor asking for information regarding guarantees, liabilities or other third party obligations, the bank did not report the existence of the guarantee. 23 The argument was that “as a matter of contract law … oral guarantees were not legally binding under applicable state law and that only legally binding guarantees should be reported in response to an audit confirmation request”

“Based upon the applicable accounting literature, the Commission believes that oral statements, which are in substance guarantees, are contingent liabilities which may, under certain circumstances, require disclosure. They may also have material significance in accounting for transactions. The Commission emphasizes that the substance of oral guarantees should be considered by financial institutions and others in completing audit confirmations. Agreements which in substance constitute guarantees should be reported in response to an audit confirmation request.”

“…. most liabilities are legally enforceable. However, those features are not essential characteristics of liabilities. Their absence, by itself, is not sufficient to preclude an item’s qualifying as a liability… although most liabilities rest generally on a foundation of legal rights and duties, the existence of a legally enforceable claim is not a prerequisite for an obligation to qualify as a liability if for other reasons the entity has the duty or responsibility to pay cash, to transfer other assets, or to provide services to another entity. … 40 … although most liabilities stem from legally enforceable obligations, some liabilities rest on equitable or constructive obligations, including some that arise in exchange transactions. Liabilities stemming from equitable or constructive obligations are commonly paid in the same way as legally binding contracts, but they lack the legal sanction that characterizes most liabilities and may be binding primarily because of social or moral sanctions or custom. An equitable obligation stems from ethical or moral constraints rather than from rules of common or statute law, that is, from a duty to another entity to do that which an ordinary conscience and sense of justice would deem fair, just, and right – to do what one ought to do rather than what one is legally required to do. … A constructive obligation is created, inferred, or construed from the facts in a particular situation rather than contracted by agreement with another entity or imposed by government. For example, an entity may create a constructive obligation to employees for vacation pay or year-end bonuses by paying them every year even though it is not contractually bound to do so and has not announced a policy to do so. The line between equitable or constructive obligations and obligations that are enforceable in courts of law is not always clear, and the line between equitable or constructive obligations and no obligations may often be even more troublesome because to determine whether an entity is actually bound by an obligation to a third party in the absence of legal enforceability is often extremely difficult. Thus, the concepts of equitable and constructive obligations must be applied with great care. … 203 An entity may incur equitable or constructive obligations by actions to bind itself or by finding itself bound by circumstances rather than by making contracts or participating in exchange transactions. An entity is not obligated to sacrifice assets in the future if it can avoid the future sacrifice at its discretion without significant penalty. The example of an entity that binds itself to pay employees vacation pay or year-end bonuses by paying them every year even though it is not contractually bound to do so and has not announced a policy to do so has already been noted (paragraph 40). It could refuse to pay only by risking substantial employee-related problems.”

“Generally accepted accounting principles recognize the importance of reporting transactions and events in accordance with their substance. The auditor should consider whether the substance of transactions or events differs materially from their form.”

“Substance over form is an idea that also has its proponents, but it is not included because it would be redundant. The quality of reliability and, in particular, of representational faithfulness leaves no room for accounting representations that subordinate substance to form. Substance over form is, in any case, a rather vague idea that defies precise definition.”