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Jerry del Missier

Deborah Baic/The Globe and Mail

An Ontario Superior Court Judge has ruled that Britain's Barclays Bank PLC engaged in "fraudulent misrepresentation" in a tangled dispute that followed the meltdown of Canada's asset-backed commercial paper market in 2007.

In the ruling, released last week, Mr. Justice Frank Newbould also questioned the reliability of testimony from Barclays Capital's Canadian-born co-CEO, Jerry del Missier.

The decision declares that Barclays, one of the world's largest and most respected banks, "breached its good faith obligations" and sent out "misleading" statements. Barclays completely rejects the findings and is mulling an appeal.

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The judgment – in a fight over investments that Judge Newbould calls "byzantine" – provides a look inside the collapse of Canada's $30-billion asset-backed commercial paper (ABCP) market, which seized up as the first signs of the global financial crisis began to set in four years ago.

Other banks in similar positions were spared the threat of litigation because they participated in the Montreal Accord negotiations that restructured the ABCP mess. The result of this trial suggests that was a wise move.

In 2009, Barclays launched a lawsuit against Devonshire Trust, which was known as a "conduit" in the ABCP market. Devonshire's largest investor was the large public sector pension fund, the Caisse de dépôt et placement du Québec.

Devonshire, partly owned by the National Bank, had been set up in 2006 to buy income-producing assets from Barclays with money made by issuing ABCP to other investors. The assets in question were complex: two so-called "synthetic leveraged super senior credit default swap" contracts. Devonshire paid $600-million to Barclays for them.

According to the judgment, the deal took nine months to negotiate. Barclays was to pay a monthly premium to Devonshire for what was essentially "credit protection." Devonshire agreed that if losses in portfolios of debt obligations – corporate bonds and mortgage-backed securities not owned by Barclays – reached a predetermined level, it would pay a specified amount to Barclays.

If there were no defaults in those portfolios, Barclays would have to return $600-million to Devonshire in 2016. That money, and another $100-million of Devonshire cash, is now at stake in the litigation.

In a footnote, the judge compared the credit-default-swap deal to a sports bet: "The concept is not different than one boy betting against another that the Toronto Maple Leafs will not end up worse that some agreed place in the standings … in the next NHL Season."

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Barclays had also signed on to be a "liquidity provider" for Devonshire, agreeing to provide funds to repay ABCP notes issued by Devonshire in the event of a "market disruption," in exchange for premiums paid by Devonshire.

The precise definition of "market disruption" was a "hotly contested issue" in court, the judge writes. But there is no question that in August of 2007, most observers outside a courtroom would say the ABCP market was disrupted, as it froze completely while panic spread about defaults on U.S. subprime mortgages.

Devonshire sent the required market-disruption notices to Barclays, asking for emergency cash infusions. When they didn't arrive, Devonshire told Barclays it was in default.

Meanwhile, meetings between the market's big players, held in Montreal in the days after the crisis, would result in the Montreal Accord. But Barclays refused to sign on for this restructuring, and held its own talks with Devonshire investors.

By late 2008, the Caisse was the only holdout. Both sides had agreed to suspend the effects of the default notices during their negotiations.

Each day, Barclays sent an e-mail to Devonshire (which was not involved in the talks) indicating that the "standstill" agreement was still in place while negotiations with the Caisse continued. Like all the e-mails, the last one, sent Jan. 9, 2009 stated that the agreement would remain "to allow for these negotiations to continue."

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But Judge Newbould ruled that these statements were "misleading." Despite this assurance that talks were continuing, Barclays had just issued an "ultimatum" to the Caisse – an ultimatum, the judge ruled, that Barclays knew the Caisse would never accept. Judge Newbould ruled that the evidence showed Barclays had already decided to end the talks, kill its deal with Devonshire and file a lawsuit.

While senior Barclays executives, including Mr. del Missier, testified they believed the talks with Caisse would still continue, Judge Newbould said he did not buy it.

"If Mr. del Missier held the rosy view that he testified to, of which I have considerable doubt, it appears that it would have been a misinformed view," the judge writes.

Judge Newbould concludes that Barclays failed to "be honest and candid" with Devonshire.

"While it is not strictly necessary for the purposes of the misrepresentation claim to determine whether the misrepresentations amounted to a fraudulent misrepresentation, in my view they did," the judge writes.

In addition to ruling in favour of Devonshire, the judge also dismissed the methodology the bank had used to argue that it had lost $1.2-billion, pegging its losses instead at just $12,000.

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A spokeswoman for Barclays Capital in New York, Kerrie Cohen, said the bank did nothing wrong.

"We are disappointed in and disagree with the Court's decision and are carefully reviewing our options with respect to an appeal," Ms. Cohen said in an e-mail.

"We believe we acted in full accordance with our legal and commercial rights in terminating the swaps transactions, and we completely refute that we acted in bad faith or made any misrepresentations in connection with the events leading up to our termination of the swaps."

Despite the ruling, the complex dispute is not over yet. In addition to a possible appeal by Barclays, key issues in the case were actually separated into two trials, the second of which has yet to occur.

Toronto lawyer Tom Curry of Lenczner Slaght Royce Smith Griffin LLP, who acted for the trustee of Devonshire Trust, said the trial was hard-fought.

The ruling, he said, was a reminder that banks must be upfront with clients and business partners: "It's the way I think that all Canadians would think that the law works. And that's why, although it's a case surrounded by enormous complexity, at its essence it is a case about commercial behaviour."

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