Article

Note: NewCap Reinsurance Holdings Ltd. and its subsidiaries in Australia and Bermuda (Reinsurers) provided reinsurance for insurance companies in order to redistribute and diversify risk and reduce reserve requirements for their clients. Reinsurers "could only do business if they gave letters of credit (LOCs) to the reinsured entity, either on inception of the cover or when a claim was made." Reinsurers maintained a line of credit to secure the LC obligations with Chase Manhattan Bank (Issuer), which was collateralized with its assets. As the volume of LCs increased, more assets were subject to collateralization.

As a result of losses, Reinsurers sought to raise additional capital through an issue of AU$40,000,000 in converting notes. Although Reinsurers successfully raised the capital, it was insufficient to cover its severe losses and Reinsurers were later forced to liquidate. By the time Reinsurers sought to liquidate due to significant financial losses, the value of LCs was US$193,154,982.

The noteholders (Plaintiffs) sued fourteen businesses and individuals (Defendants) associated with creating the prospectus and raising the capital needed by Reinsurers for the entirety of their investments under Australian fair trade protections and securities statutes on the theory that various financial representations were misleading and deceptive regarding the financial health of Reinsurers. The Supreme Court of South Wales, McDougall, J., dismissed Plaintiffs' claims.

One alleged misrepresentation was the suggestion that the additional capital provided good prospects for the continuation of Reinsurers despite increasing collateralization of assets in order to provide security for issued LCs. Also, Plaintiffs argued that representations regarding the security of noteholders were false and misleading because they were unaware of the impact of the LCs on Reinsurers' assets. Defendants argued that Plaintiffs did not rely on any representations found to be misleading or deceptive, nor could Plaintiffs prove any losses. Additionally, Defendants argued that Plaintiffs were contributorily negligent and also relied on due diligence defenses available under the applicable statutes.

The court stated:

The prospectus did not represent that noteholders would have priority over creditors of [Reinsurers]. It was plain to any reader of the prospectus that the realisation of [Reinsurers'] interests in its subsidiaries could not occur (or be finalised) until all creditors of those subsidiaries had been paid out. To the extent that the process of realisation involved the runoff of the book of business, reinsureds would be paid either out of assets or, if there were no available assets, by drawing down on [LCs]. Where [LCs] were drawn down, [Issuer] would be entitled to recoup itself from its security. Where [LCs] were not drawn down, and expired, the amount held as security would be reduced accordingly. Thus, neither the existence of the [LCs] nor the requirement to give security to [Issuer] in respect of them, had any impact on the priority, or ''security'', of noteholders. Neither of those matters diminished the net assets available to noteholders in the event of runoff. To the extent that the [LCs] and claims were interrelated or overlapped, the net assets of the company available to noteholders were not affected; and to the extent that there was no overlap (because no claim was made under a policy in respect of which an [LC] had been issued) the assets would in due course be released from the collateral account.

[JEB/dep]

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