Soon

• Jurisdiction: Singapore
• Judge: Lee Seiu Kin J
• Judgment Date: 10 December 2010
• Neutral Citation: [2010] SGHC 360
• Year: 2010
• Date: 10 December 2010
• Published date: 13 January 2011
• Hearing Date: 04 February 2010
• Plaintiff Counsel: Siraj Omar and Dipti Jauhar (Premier Law LLC)
• Citation: [2010] SGHC 360
• Defendant Counsel: Davinder Singh SC and Khng Una (Drew & Napier LLC)
• Court: High Court (Singapore)
• Docket Number: Originating Summons No 774 of 2009 Summons No 4834 of 2009

Lee Seiu Kin J:Introduction

The year 2008 saw the world economy mired in what has been described as the worst financial crisis since the great depression of the 1930s and its aftershocks are still being felt today. Singaporean banks and financial institutions have been more fortunate than those in many other countries, but not all Singaporeans were untouched by the chaos that raged through the financial markets. Fears over the solvency of large and once-reputable banks, declining credit availability and damaged investor confidence caused the failure or acquisition of several major banking and finance institutions; Lehman Brothers Holdings Inc (“Lehman”) was one of these. On 15 September 2008, Lehman filed for Chapter 11 bankruptcy protection in the US. The filing marked the largest bankruptcy in US history; in Singapore, it caused many individuals who had invested in Lehman-linked structured investment instruments to lose their money.

This action concerns one such Lehman-linked instrument. It was brought by 21 plaintiffs on behalf of themselves and 194 other individuals who had invested in a series of callable basket credit-linked notes known as “DBS High Notes 5” (“the HN5”). These were issued by the defendant under a US$3,000,000,000 structured note programme. The plaintiffs in this originating summons seek a declaration that the HN5 were void at the time of their issuance, and an order that the defendant (a) repay each of the plaintiffs the principal amounts they invested in the HN5 (less any interest they received under the same), and (b) bear the cost of these proceedings. The defendant denies that the HN5 were void and apply, in summons no 4834 of 2009 (“Summons 4834”), to rectify the conditions that were attached to the HN5. The originating summons and Summons 4834 were heard together and I now give my decision in respect of both matters.

The FactsBackground

The HN5 were launched on 30 March 2007 and were intended to last a period of 5.5 years until 2012. Initially, the offering was open only to existing customers of the defendant on an “invitation only” basis. On 2 April 2007, the offering was made open to the public.

At the time of the offering, information concerning the HN5 was available from two documents. The first was the base prospectus (“Base Prospectus”) – a term I shall use collectively to refer to the original prospectus dated 22 December 2005, the supplementary base prospectus dated 5 April 2006 which amended the original prospectus and a final version registered with the Monetary Authority of Singapore (“MAS”) on 27 December 2007. This Base Prospectus applied generally to govern the entire series of DBS High Note Programmes – from series 1 to 5. The HN5 was, as its name suggests, the fifth in the series. The second document was the pricing statement dated 29 March 2007 (“Pricing Statement”), which contained the specific terms and conditions relating to the HN5. During the launch, interested individuals were furnished with copies of the Base Prospectus, Pricing Statement, and an application form (“Application Form”). The Application Form was to be signed (in two places) and returned prior to 4.30pm on 30 April 2007 – the closing date and time of the HN5 offering.

A total of 1,127 persons invested in the HN5, and these were issued to them by the defendant on 16 May 2007. Between 16 August 2007 and 18 August 2008, investors (including the plaintiffs) received five quarterly payments of accrued interest in respect of their investment in the HN5. Depending on the amount of their respective investment, each of the plaintiffs received payments that ranged between S$1,568.50 and S$25,096.00, and US$2,894.31 and US$12,404.22.¹

The structure of the HN5

A description of the HN5 was provided in the Pricing Statement issued by the defendant:

DBS High Notes 5 of the Notes are 5.5-year structured credit notes designed for investors seeking enhanced yield by providing exposure to a first-to-default basket of geographically diversified investment grade credits.² [emphasis in original]

Buyers of the HN5 were promised high returns on their investment – a quarterly interest rate of either 5.00% or 6.50% per annum, depending on whether the investor had subscribed to the Singapore Dollar (“SGD”) or United States Dollar (“USD”) Tranche – until the specified maturity date in 2012. On the maturity date, they would also receive 100% of the principal amount they had invested, unless prior to that date, either:

(a) a Credit Event occurs in relation to any one of the Reference Entities under the Reference Notes; or

(b) a Constellation Event occurs in relation to Constellation.³

In order to explain what a credit event and constellation event consisted of, it is necessary to go into the details of the structure underlying the HN5. The funds raised from the sale of the HN5 were used to purchase another set of structured notes (“Reference Notes”) issued by Constellation Investment Limited (“Constellation”). The defendant was the holder of the Reference Notes. Constellation was a special purpose trust company established by the defendant in 2003 and incorporated under the laws of the Cayman Islands. Its primary objective was the issuing of various credit-linked and other structured notes to both retail and institutional investors. The defendant had previously used Constellation as a vehicle to issue 70 different structured notes to retail investors in Hong Kong between 2003 and 2007. The HN5 was part of a similar series issued in Singapore.

Constellation used the funds it raised from the issue of the Reference Notes to invest in structured securities comprising of collateral debt obligations (“CDOs”) issued by a Cayman Islands-incorporated company, Zenesis SPC. These secured its obligations under the Reference Notes and generated monetary returns, which were used to pay the interest due to the investors in the HN5. As a result, the performance of the HN5 (ie their interest yield) was directly linked to the performance of the Reference Notes. In return, investors were exposed to the risk of Constellation’s own bankruptcy and the risk of any of the securities purchased by Constellation losing all their value. Both of these risks – were they to materialise – would amount to a Constellation Event. Such an event would trigger early redemption of the Reference Notes and this would, in turn, trigger the termination of the HN5.

In addition to the above, however, the Reference Notes were also notionally linked to the credit performance of eight reference entities. The nature of this link was a “first-to-default” basis: ie, in the event that one of these reference entities failed to honour a specific financial obligation (“Reference Obligation”) that was identified in the Reference Notes, the Reference Notes would be redeemed, unwound and terminated. The HN5 would also suffer the same fate. It is this “default” by a reference entity that constitutes a credit event referred to in [6] above and it is an event that is entirely independent of Constellation’s own creditworthiness or even the value of the securities purchased by Constellation. In effect, buyers of the HN5 were risking their money on the following eventualities: that the defendant would remain solvent; that Constellation would remain solvent; that none of the securities that Constellation had bought with their money (the CDOs) would turn out to be worthless; and that none of the eight reference entities within the “first-to-default” basket would default in the 5.5-year life of the HN5. As it turned out, Lehman was one of the eight reference entities. At the time the Pricing Statement was issued, Lehman’s issuer credit ratings by Standard & Poor’s, Moody’s and Fitch stood at the confidence-inducing and secure-sounding levels of A+, A1 and A+ respectively⁴ – ratings that, with hindsight, can only be described as astounding in the light of events that transpired.

Termination

The trouble in the global financial markets began on 3 August 2007, when, as Lehman’s own former global head of quantitative equity strategies Matthew Rothman put it, “events that models only predicted would happen once in 10,000 years happened every day for three days.”⁵ Investors suffered a crisis of confidence in financial instruments underpinned by “sub-prime” debts and mortgages; the value of these and other investment instruments crashed; and the financial markets were thrown into complete turmoil. These events are too fresh and too deeply imprinted in the memory of most people to require further adumbration. Just over a year later, on 15 September 2008, Lehman filed a petition under Chapter 11 of the US Bankruptcy Code in the US Bankruptcy Court. This constituted an act of “default” by Lehman on one of the Reference Obligations – a US$1.23b subordinated note issued by Lehman and due for redemption in 2017 (the “Lehman Note”) – under the Reference Notes. The Reference Notes were terminated by Constellation and under the HN5 structure this in turn resulted in the termination of the HN5.

On 19 September 2008, the defendant wrote to the HN5 investors enclosing the relevant notices of credit event (which were themselves dated 17 September 2008). The letters also notified investors of the consequences of Lehman’s Chapter 11 petition, namely that:The HN5 had been terminated.The defendant would, as the issuer of the HN5, be redeeming the investors’ investments in the HN5 at the credit event redemption amount (“CERA”) on the credit event redemption date.The investors would be informed of the CERA as soon as the information became available.The HN5 would have ceased to bear any interest from 16 August 2008.

On 28 October 2008, the defendant wrote again to the investors. The letters informed them that the CERA for the HN5 had been calculated at zero. Thus, no amount would be due and payable to them on the credit event...