The State of the Law After Procter & Gamble v. Bankers Trust

Denis Forster, a New York sole practitioner who advised Procter & Gamble in its suit against Bankers Trust, analyzes this case and its probable impact.

On May 8, 1996, Judge John Feikens issued an order stripping from Procter & Gamble several legal grounds for recovery in its case against Bankers Trust Co. and BT Securities in federal court in Cincinnati, Ohio. It is critical to note, however, that these counts were peripheral. Judge Feikens left intact the core of P&G's case-its common law fraud count. In fact, in this ruling Judge Feikens enhanced considerably the strength of P&G's case by finding that a legal requirement exists that the dealer disclose material information even if there is no fiduciary duty. In short, the center of P&G's legal position held, Bankers Trust settled on terms extraordinarily favorable to P&G, and (to the extent that there was any doubt) P&G's position in challenging the transactions was vindicated.

It is human nature to view the outcome of an event in the manner most favorable to one's own interests. Reaction to the results of Procter & Gamble v. Bankers Trust-particularly the order and opinion delivered by Judge Feikens on May 8, 1996 (hereafter, the "Opinion")-is a prime example of this phenomenon. This article is, perhaps, no exception.

Procter & Gamble had alleged numerous separate bases for relief against Bankers Trust. The Opinion rejected 12 of these counts. This ruling was met with euphoria by some observers. For instance, in its May 17 editorial column under a piece entitled "Swaps Defended," The Wall Street Journal wrote: "The Feikens decision's main charm is the clarity it brings to the legal status of swaps." For the numerous reasons indicated below, the Opinion did not clarify in any definitive manner the legal status of swaps. Indeed, the Opinion raises new (and for the dealer community, potentially troubling) issues as to the legal obligation of the dealer to disclose material information "both before the parties enter into the swap transactions and in their performance, and also a duty to deal fairly and in good faith during the performance of the swap transactions."

The Opinion is helpful in that it is the first written holding by a judge in the United States to address the broad range of legal issues challenging the enforceability of swap and swap-related transactions. However, as a guidepost to the future, the Opinion has several significant limitations.

Placing the opinion in perspective

The Opinion is not binding in any other case.

The Opinion was not an action with far-reaching authority and effect, such as a decision by the U.S. Supreme Court or legislation enacted by Congress. In fact, this Opinion by a single U.S. district judge is legally binding in one and only one case-and that case has now been settled. In the future other courts, even those in the Southern District of Ohio where the Opinion was rendered, will be free to accept or reject Judge Feikens's reasoning.

The decision was not legally tested.

Another court, in deciding whether or not to adopt Judge Feikens's analysis, will undoubtedly note that these legal conclusions were not tested on appeal. Such a court may also note that in the one instance in this case where a decision by Judge Feikens was appealed (prior restraint of publication by Business Week of sealed documents), the federal Sixth Circuit Court of Appeals not only reversed but sharply criticized Judge Feikens's legal findings.

Judge Feikens rejected the analysis of an expert regulator.

Another court might view the Securities and Exchange Commission (SEC) as better positioned to determine whether a particular structure is an option on a security or group or index of securities and thus a "security." And that court might then defer to (rather than, as here, disagree with) the SEC's conclusions in that regard.

The decision has limited scope even in relation to swaps.

Judge Feikens himself stressed that his decision, particularly with respect to the federal securities counts, was limited to the facts of this case and that some swaps "because of their structure, may be securities."

P&G is unique.

The findings regarding fiduciary duty, commodity trading advisor and others were made against P&G. But P&G is one of America's corporate giants. Few end-users have annual revenue in excess of $30 billion or the accompanying level of sophistication. Another court with another end-user counterparty might reach other conclusions on these issues.

The choice of substantive law is questionable.

Judge Feikens's rejection of the claims based on breach of fiduciary duty, negligent misrepresentation, professional negligence, violation of Ohio securities laws and the Ohio Deceptive Trade Practices Act rests on a vulnerable premise. Early in his analysis Judge Feikens reached a fork in the road-what substantive law to apply to determine the validity of these claims? A logical candidate for these tort and other claims would be Ohio law. To determine the applicable substantive law, it is generally held that a federal court in a diversity action is bound by the choice of law rules in the forum. But Judge Feikens looked to the contractual choice of New York law in the International Swaps and Derivatives Association (ISDA) agreement and, over P&G's objection, then applied New York substantive law to decide the validity of these non-contractual claims.

Another court (in Ohio, Illinois or elsewhere), applying its own state's conflict principles, could well limit the ISDA contractual choice of law to contractual claims (resolving any doubts in this respect against the dealer as "the drafter") and conclude that its own substantive law is to be applied to determine the fiduciary duty and other claims-resulting in findings entirely different from those of Judge Feikens based on New York law.

Other state security laws might apply in other cases.

Judge Feikens examined Ohio law to determine whether either or both of the two disputed swaps was a "security" as defined therein. After extensive discussion, the court concluded that the swaps were not a security. The three state security law counts were dismissed on the basis of that interpretation, and on the additional ground that the ISDA choice of New York law precluded recovery under the security laws of another state. As suggested above, another court could well disregard the notion that this ISDA clause displaces the protection of its own state securities laws and then proceed to interpret its statute to determine whether the subject trade is a "security." There was no suggestion or finding that federal law in some manner preempted state law. Even if the Opinion were correct as to Ohio law as applied to these two swaps, the law of the 49 other states could be applicable and, if applied, could reach a different result.

Summary of the opinion

In the Opinion Judge Feikens dismissed, on various bases, several counts asserted by P&G-claims based on the federal securities laws, Ohio state securities laws, federal commodity laws, the Ohio Deceptive Trade Practices Act, breach of fiduciary duty, negligence and negligent misrepresentation. But he left in place the core common law fraud count, and strengthened it considerably by finding that under New York state law Bankers Trust had a duty to disclose material facts-even if there were no fiduciary duty.

Bankers Trust owed no fiduciary duty to P&G

Judge Feikens stated that "New York case law is clear" on this issue. He did not state why he was applying New York (rather than Ohio) substantive law to decide this point. Presumably (but not necessarily correctly) he was again relying on the ISDA Master Agreement choice-of-law clause. After quoting case authority to the effect that in New York no fiduciary relationship can exist where the two parties were acting and contracting at arm's length or between parties to a business relationship, the court noted that "P&G and BT were in a business relationship"-and therefore no fiduciary duty was owed by BT to P&G. However, the court then made an important finding rendering the fiduciary duty issue largely irrelevant here and significantly facilitating the case for P&G had the litigation not been settled.

But Bankers Trust owed a duty to disclose material information to P&G.

Judge Feikens found that under New York law the agreement between the parties contained an implied covenant of good faith and fair dealing which, in turn, imposed a duty on Bankers Trust to disclose material information. Here-unlike with many of the other dismissed claims-the application of New York law appears entirely appropriate. That is because the court was construing an ISDA agreement which provided that it was to be "construed and enforced" under New York law. In his Opinion, Judge Feikens states, "I conclude that defendants had a duty to disclose material information to plaintiff both before the parties entered into the swap transactions and in their performance, and also a duty to deal fairly and in good faith during the performance of the swap transactions." What triggers this duty is not entirely clear. Judge Feikens started the discussion of this issue by citing the Second Circuit decision in Banque Arabe et Internationale D'Investissement v. Maryland National Bank, 57 F.3d 146 (2d Cir. 1995) and stating that an implied contractual duty to disclose in business negotiations "may arise where 1) a party has superior knowledge of certain information; 2) that information is not readily available to the other party; and 3) the first party knows that the second party is acting on the basis of mistaken knowledge." However, the need for the third element-or even the second-is unclear based upon his further comments on the issue and the cases then cited.

The upshot of all this was that, if the case had gone forward, P&G would have been allowed to establish a common law fraud case based on the breach of a duty to it to disclose material information. Here, because of the posture of this case, the breach of this duty was available only as part of the fraud claim. Judge Feikens stressed that in order to prevail, P&G would need to prove its fraud case with "clear and convincing" evidence. In another case such a breach of duty to disclose might also be asserted as a claim for breach of contract requiring proof only by a mere preponderance of the evidence.

Again, this is a decision by a single U.S. district judge where the issues immediately became moot and were not appealed. But the application of New York law certainly seems correct and for many Judge Feikens's reasoning and analysis on this issue may seem persuasive. If mere "superior knowledge" not readily available to the other party does create a duty on the part of the dealer to disclose to the end-user "material information," then numerous issues arise. What does "readily available" mean? Does availability from third parties suffice? How can the duty be satisfied? What is "material information"? Can the duty be contractually negated? What is the effect of the current ISDA-sponsored non-reliance representations? Will end-users expressly agree that a dealer with superior knowledge need not disclose material information to the end-user?

This opinion can be seen as a vindication of P&G.

P&G had the determination and the resources to pursue its convictions to the end. And it appeared clear from Judge Feikens's prior comments that, while he might clear away the underbrush and simplify the case for the jury, he was going to allow the case to go forward on the fundamental fraud count. While the content of the Opinion was not known until after a settlement had been reached, its substance should not have been a surprise in view of a number of comments by Judge Feikens in open court in the weeks leading up to the Opinion.

Judge Feikens noted in his Opinion that "BT claims that P&G owes it over $200 million." With a trial date fast approaching, Bankers Trust agreed to settle this claim by receiving the sum of $35 million. In addition, the parties agreed to the cancellation of a third "plain vanilla" swap under the master agreement which when earlier "terminated" by BT had a close-out value to P&G of approximately $14 million but had, as of April 1996, declined to about $4.8 million. Also, it was agreed that P&G would retain the approximately $4.1 million it had received under the two disputed swaps. These terms, overwhelmingly favorable to P&G, presumably reflect the well-advised parties' views as to the relative merits of the case. As such, the settlement can be viewed as a recognition of the correctness and propriety from the outset of Procter & Gamble's challenge of these trades.