In a recent decision, the UK Supreme Court considered whether public authorities, acting in fulfillment of their statutory mandate, have to give an undertaking in damages when they seek an interlocutory injunction. The case arose in the context of a share sale scheme that the Financial Services Authority (“FSA”) alleged to be a fraud, involving the sale of shares to third party investors, without an approved prospectus, in Sinaloa Gold plc (“Sinaloa”). In December 2010, the FSA initiated proceedings against Sinaloa and two other defendants. Shortly before doing so, the FSA had obtained without notice an interlocutory injunction freezing the defendants’ assets. Sinaloa had six bank accounts at Barclays Bank plc (“Barclays”).
Pursuant to the original terms of the injunction, the FSA was required to give an undertaking with respect to any costs and losses that third parties (other than the defendants) may suffer as a result of the injunction. The FSA subsequently applied to have this undertaking varied, such that the undertaking would apply only to third party costs (not third party losses). Barclays opposed the FSA’s application. Although unsuccessful at the first instance, the FSA was successful at the Court of Appeal and at the Supreme Court. The Supreme Court held that there is no general rule requiring a public authority to give an undertaking with respect to third party losses, and no particular circumstances requiring the FSA to do so in this case.
The FSA is the regulator of financial services and markets and carries out this public function pursuant to the Financial Services and Markets Act 2000 (“FSMA”). Among other things, the FSMA provides that, upon application by the FSA, the court may make a freezing order, if satisfied that a person has contravened a relevant requirement. A “relevant requirement” includes the requirement to be either authorised or exempt before carrying on a regulated activity, such as selling shares to the public. It is also noteworthy that, with respect to authorised persons, the FSMA enables the FSA to impose a freezing order without going to court and thus without having to give an undertaking in damages. In this case, the FSA had to go to court—and the undertaking issue arose—because the defendants were unauthorised. Finally, the FSMA exempts the FSA from liability in damages for any act or omission in the discharge of its functions, unless the act or omission was in bad faith or unlawful under the human rights legislation.
The undertaking in this case was based on a standard-form undertaking that has been developed to accompany freezing orders under a UK practice direction. The language at issue is as follows:
The Applicant will pay the reasonable costs of anyone other than the Respondents which have been incurred as a result of this order including the costs of finding out whether that person holds any of the Respondent’s assets and if the court later finds that this order has caused such person loss, and decides that such person should be compensated for that loss, the Applicant will comply with any order the court may make. [emphasis added by the UK Supreme Court (para. 6)]
Although the FSA was prepared to live with the first part of this paragraph (thus preserving the undertaking with respect to third party costs), the FSA sought to delete the second, underlined part (thus removing any potential obligation with respect to third party losses). As the Court of Appeal observed in its reasons (at para. 40), the underlined part is not, strictly speaking, an undertaking to pay damages, but rather an undertaking to comply with any subsequent order that the court may make with respect to damages.
At the first instance, Judge Hodge refused to vary the undertaking as requested by the FSA. Although acknowledging that there were arguments in favour of the FSA’s position, Judge Hodge observed that third parties (such as Barclays) affected by a freezing order granted to a public authority may be entirely innocent. Judge Hodge concluded that their costs and losses should, as a general rule, be borne by the public purse:
The real issue seems to me to be whether the potential costs which may fall upon a third party of a statutory body exercising its law enforcement functions should, in the general run of cases, and admitting that there may be particular exceptions in individual cases, fall on a wholly innocent third party or whether they should fall on the public purse from which the enforcement authority receives its costs and resources. In other words, the real issue seems to me to be one of the allocation of costs and resources. (para. 65)
Judge Hodge held that the appropriate protection for a public authority such as the FSA comes at the stage when the court has to decide whether to order compensation for third party losses:
If there are special considerations as to why the cross-undertaking in damages should not be enforced, those can be urged at the time the third party seeks to enforce the undertaking; … it seems to me that the better position is to require the undertaking in the first instance, and then to consider whether there is, or is not, reason to enforce it in an appropriate case. (para. 67)
The Court of Appeal allowed the FSA’s appeal. Referring to earlier case law, the Court of Appeal first established that there is a general practice, when a public authority seeks an interlocutory injunction as part of its law enforcement functions, not to require an undertaking in damages in favour of the defendant(s) against whom the injunction is sought. Accordingly, as formulated by the Court of Appeal, the question in this case was whether the general practice should also prevail with respect to third parties.
The Court of Appeal concluded that the “logic of applying the same principle to third parties is compelling.”(para. 53) Among other things, the Court of Appeal noted that the FSA’s exemption from liability under the FSMA does not distinguish between defendants and third parties, and that it is both unavoidable and accepted that any form of law enforcement is likely to have adverse consequences for some third parties. Although the Court of Appeal acknowledged that a public authority should, as a general rule, be prepared to cover third parties’ costs in complying with a freezing order (such as the costs of identifying the particular assets affected by the order), the Court of Appeal held that a public authority should not be required to cover third parties’ losses (which may be much larger than their costs). Covering third parties’ losses would be tantamount to a “kind of blank cheque.” (para. 55)
The UK Supreme Court’s Decision
The Supreme Court indicated that the considerations in a law enforcement action commenced by a public authority differ from the considerations in an action commenced by a private party. Whereas an undertaking in damages is routinely required in private actions, the Supreme Court held that no such undertaking should be required, as a matter of course, in law enforcement actions commenced by a public authority, “without considering what is fair in the particular circumstances of the particular case.”(para. 33) The Supreme Court noted that a public authority is often acting in fulfillment of a statutory mandate and has only the resources that have been assigned to it for its functions. Like the Court of Appeal, the Supreme Court noted that these considerations “apply with particular force to any open-ended cross-undertaking in respect of third party loss”—the quantum of which could be significant—but that these considerations do not “apply in the same way to a cross-undertaking in respect of third party expense.” (para. 35; emphasis added)
Having held that no undertaking in respect of third party losses is required as a matter of course, the Supreme Court then concluded that there were no particular circumstances that would require such an undertaking in this case. Among other things, the Supreme Court observed that there is no general duty in English public law to indemnify those affected by action undertaken under legislative authority, and that the FSMA specifically exempts the FSA from liability in damages (excepting only acts or omissions that are in bad faith or in breach of the human rights legislation). In this regard, the Supreme Court stated:
… in a case of positive action taken by the FSA affecting innocent third persons, the general protective duties and objectives of FSMA could not involve under FSMA or at common law any assumption of responsibility towards or any liability for breach of a duty of care enforceable at the instance of third persons … (para. 37)
The Supreme Court also observed that (as mentioned above) the FSMA enables the FSA to freeze the assets of authorised persons without a court order and thus without giving any undertaking in damages, and that innocent third parties affected by this action would have no right to be indemnified by the FSA. By the same token, the Supreme Court held that innocent third parties affected by the FSA’s court proceeding as against unauthorised persons should likewise not generally be entitled to compensation for their losses:
There would be an apparent imbalance, if the FSA were required to accept potential liability under a cross-undertaking when it addresses the activities of unauthorised persons and has therefore to seek the court’s endorsement of its stance in order for a freezing order to issue. (para. 38)
The Supreme Court therefore dismissed the appeal and held that the underlined part of the above undertaking should be deleted as requested by the FSA, such that the FSA’s undertaking would be limited to third party costs and would not include any obligation with respect to third party losses.
Although the UK Supreme Court has not closed the door on the possibility that a public authority may be required to give an undertaking in damages when seeking an interlocutory injunction, it has clearly signalled that such an undertaking should not be required as a general rule and should only be required after considering what is fair in the circumstances of each particular case. Given that this issue has not been thoroughly addressed in the Canadian case law to date, the decision of the UK Supreme Court will likely be an important case in Canada going forward.
The Financial Services Authority v Sinaloa Gold plc,  UKSC 11
Date Decided: February 27, 2013