Since the start of the global financial crisis in 2008, rating agencies have attracted substantial attention and been at the forefront of a public debate. Indeed, many people believe these agencies wield disproportionate influence. Can a credit rating agency be sued in Belgium? From a legal standpoint, there would appear to be no impediment to taking legal action against one but, in reality, we are still a long way off from holding rating agencies accountable for their actions.
Introduction
For many years, credit rating agencies remained in the shadows, rarely making their presence felt outside the financial markets. Behind the scenes, however, these agencies have always played an important role. Indeed, their ratings determine whether institutional investors can buy certain bonds and can trigger early repayment clauses in loan agreements. The recent financial crisis has brought credit rating agencies into the spotlight and changed the way the world views them. Rating agencies now stand accused of not having predicted the subprime crisis and its spread to other markets and, more recently, of causing devaluation.
Statutory framework
Until 2009, the activity and status of credit rating agencies were not regulated in Europe. However, faced with criticism of its handling of the financial and economic crisis, the European Commission decided to act and to replace the former soft law structure with a more rigorous legislative framework.
To this end, Regulation (EC) No 1060/2009 on credit rating agencies was adopted on 16 December 2009 and amended in May 2011. The main purpose of the regulation is to organise the registration of credit rating agencies in Europe, although it also contains rules on the methodology of rating agencies, their independence and conflicts of interest, the disclosure and presentation of ratings, etc. These rules are set to be amended this year, as the Commission presented in November 2011 a proposal for a regulation to amend and strengthen the 2009 version. The most important proposed changes as regards the contractual and extra-contractual liability of credit rating agencies are highlighted below.
Contractual liability
There is no specific legislation in Belgium governing contracts between issuers and credit rating agencies. Therefore, the general rules of contract law will apply in full. For the time being, however, there is a major obstacle to holding credit rating agencies liable for breach of contract: every contract concluded between an issuer and a credit rating agency includes an exclusion of liability in favour of the agency, except in cases of gross negligence or wilful misconduct. Indeed, to the best of our knowledge, a credit rating agency has never been held contractually liable in either the United States or Europe.
Proposed changes: Once the new regulation enters into force, it will no longer be possible for credit rating agencies to exclude or limit their liability by contract. Any clause excluding or limiting the credit rating agency's civil liability will be considered null and void. In theory at least, this will improve the chances of holding credit rating agencies contractually liable. In practice, however, given that exchanges between the issuer and the rating agency are organised as from issuance of the note and that the issuer could be required to produce confidential documents in order to prove breach of contract by the agency, there are still some insurmountable obstacles.
Extra-contractual liability
Disappointed investors could seek to hold credit rating agencies liable in tort (extra-contractual liability). In practice, however, this is difficult to do. At present, no specific rules exist. Therefore, as is the case with contractual liability, the general rules of liability in tort will apply in full, requiring proof of (i) a wrongful act, (ii) damage or harm, and (iii) a causal link between the two.
(i) Wrongful act
Under Belgian law, a wrongful (or tortious) act can consist of either (i) a violation of a specific statutory provision or (ii) failure to act as a reasonably prudent person would have under the circumstances. While this definition may appear straightforward, certain questions arise when it is applied to credit rating agencies:
•For breach of which statutory provisions can rating agencies be held liable in tort?
At present, with the exception of certain provisions of Regulation (EC) No 1060/2009, there are no rules governing the issuance of credit ratings. Therefore, it is quite difficult in practice to make a case for liability in tort.
Proposed changes: The EU, in particular the European Securities and Markets Authority (ESMA), has laid down rules to be followed when issuing credit ratings. In the future, credit rating agencies will have to comply with detailed rules on the content and format of their ratings. However, it is unlikely that these new rules will be used as the basis for tort claims. Indeed, an inaccurate rating most often results from a lacuna or fault during the rating process, not from issuance of the rating.
•How should the reasonably prudent person standard be interpreted when it comes to credit rating agencies?
A number of criteria, relating to the methodology and independence of rating agencies, the avoidance of conflicts of interest, the disclosure and presentation of ratings, etc., can be used to define this standard. However, the underlying question remains how to prove that a rating agency did not act as a reasonably prudent person. Rating agencies are expected to use methodologies that are rigorous, systematic, continuous and subject to validation based on relevant past experience. Nonetheless, a rating agency could use another model, one that is not best suited to rate the debt in question. The methodologies used and the manner in which they are applied must be disclosed. In practice, however, the concrete application of these methodologies, the functioning of the computer program used, and the adjustments suggested by analysts are virtually impossible to know. If a tort is committed in the course of determining a rating, it will be almost impossible to prove, except in the case of gross negligence or wilful misconduct. The European Commission has concluded as much and confirmed in the preamble to its last proposal that the EU's aim is not to allow rating agencies to be sued for every wrongful act but rather to ensure that they can be held liable if they violate intentionally or with gross negligence any obligations imposed on them by Regulation (EC) No 1060/2009 and their acts impact the markets.
Proposed changes: The Commission proposes reversing the burden of proof insofar as wrongdoing or negligence by a rating agency is concerned. Therefore, once the proposed regulation enters into force, investors need only establish facts from which it can be inferred that a credit rating agency has acted wrongfully. It will then be up to the credit rating agency to prove that it did not commit the violation or that, if it did so, the violation had no impact on the issued credit rating.
(ii) Damage
Under Belgian law, in order to hold a party liable in tort, the damage must be certain and have been foreseeable at the time of the violation. Both criteria are problematic as far as credit rating agencies are concerned; however, the main difficulty will be proving damage that is certain, especially on the fast-moving financial markets. Indeed, this task will prove virtually impossible.
(iii) Causal link
Once a tortious act and damage have been proven, it is necessary to demonstrate a causal link between them. In this regard, a distinction should be made between two types of investors:
- Institutional investors: some institutional investors, particularly under US law, are obliged to purchase only investment-grade securities or even AAA bonds. If the rating is inaccurate, it will be easier to prove a causal link since the investors had to purchase a certain type of bond;
- Other investors: other than the highly hypothetical case in which the rating is the only information available on the market, it will be extremely difficult to establish a link between the mistake made in the rating and the damage suffered, as it is neither realistic nor reasonable for an investor to rely solely on the rating.
Conclusion
On paper, it would appear possible to hold credit rating agencies liable, at least when they disregard sound principles. In practice, however, there are many obstacles to doing so, as detailed above. However, there's no need to be overly pessimistic about the situation. Knowing they are now being strictly watched by the EU authorities and the Member States, it is hoped that credit rating agencies will strive to improve the quality of their work.
