FEDERAL COURT OF AUSTRALIA

Ceramic Fuel Cells Limited (In Liq) v McGraw-Hill Financial, Inc (No 3)

[2017] FCA 144

ORDERS

THE COURT ORDERS THAT:

1.    The interlocutory application filed by the respondents on 21 December 2016 to set aside the notice to produce dated 30 November 2016 is dismissed.

2.    The respondents pay the applicant’s costs of and associated with the interlocutory application.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

(Delivered ex tempore, revised from transcript)

WIGNEY J:

1    Ceramic Fuel Cells Limited is the representative applicant in representative proceedings that have been commenced against McGraw-Hill Financial, Inc and Standard & Poor’s International LLC. In simple terms, Ceramic alleges that it suffered loss and damage arising from its acquisition of financial products in reliance on credit ratings assigned to those products by Standard & Poor’s, a business operated by or associated with the respondents. The financial instruments acquired by Ceramic were mortgage-backed collateralised debt obligations. They may conveniently be referred to as Duke CDOs. Standard & Poor’s initially assigned the Duke CDOs an A rating.

2    Ceramic acquired €2,000,000 worth of Duke CDOs on 27 July 2006. It sold them in September 2009 for about $20. There is a dispute between the parties as to exactly when that sale occurred. Standard & Poor’s says it occurred on 16 September 2009 when Ceramic entered into a contract to sell them. Ceramic says it occurred on 24 September 2009 when the sale settled or was completed. That dispute is important and will need to be resolved. That is because these proceedings were commenced on 21 September 2015. If Standard & Poor’s is right about the sale date, Ceramic’s action will have been commenced outside the six year limitation period and will most likely be statute-barred. If Ceramic is right, the proceedings may not be statute-barred.

3    Standard & Poor’s contends that, irrespective of the date of Ceramic’s sale of the Duke CDOs, Ceramic suffered immeasurable loss or damage in respect of the Duke CDOs before 21 September 2009. It says that Ceramic suffered loss or damage either on the date it acquired the Duke CDOs on 27 July 2006 or, alternatively, at some stage prior to mid-2009 when the market value of the Duke CDOs decreased.

4    Standard & Poor’s has applied for the summary dismissal of the proceedings on the basis that the proceeding is statute-barred. That application is listed for hearing on 15 March 2017.

5    The present interlocutory dispute arises because Ceramic has served a notice to produce on Standard & Poor’s in respect of the summary dismissal application. The notice to produce relevantly requires Standard & Poor’s to produce documents that meet one or more of the following three descriptions:

1. A copy of all documents disclosing or recording the reasons for the downgrading by S&P of the rating of the Duke Funding XI Ltd Series 2006 Class A-3 synthetic collateralized debt obligation (Duke CDO) from A to B+ on or about 14 March 2008 (the first downgrade).

2. A copy of all documents disclosing or recording the reasons for the downgrading by S&P of the Duke CDO from B+ to CC on or about 7 August 2008 (the second downgrade).

3. A copy of all documents disclosing, recording or relating the Respondent’s analysis or assessment of the creditworthiness of the Duke CDO between 1 June 2006 and 21 September 2009.

6    Ceramic says that the documents sought by the notice to produce are likely to be relevant to the issues to be addressed at the hearing of the summary dismissal application. Standard & Poor’s, on the other hand, says that the documents sought by the notice to produce are, or are likely to be, irrelevant to its summary dismissal application and that, in any event, the notice is oppressive. It applies for the notice to produce to be set aside. It should be noted that an earlier notice to produce was also originally in issue, but the dispute concerning that notice has essentially been resolved.

7    Standard & Poor’s application to set aside the notice to produce raises two questions.

8    The first question is whether the documents sought have some apparent relevance to the proceeding. The authorities have described the requirement of apparent relevance in various different and colourful ways, often employing metaphors like whether the documents are likely to “throw light” on the issues, or whether it is “on the cards” that the documents will assist the applicant’s case. It is sufficient to say that the relevance test in this context is not a high threshold. The test is whether the documents are reasonably likely to add, in the end, in some way or other, to the relevant evidence in the case: Seven Network Ltd v News Ltd (No 11) [2006] FCA 174 at [6]; McGrath v HNSW Pty Ltd (No 2) (2015) 232 FCR 532 at [21]. It is enough if, viewed realistically, the documents sought are likely to have a bearing on an issue that is not unreal, fanciful or speculative: Lowden v Elliott Harvey Securities Ltd (No 2) [2016] FCA 740 at [14]; Wong v Sklavos [2014] FCAFC 120; (2014) 319 ALR 378 at 381-2 [12].

9    The second question is whether the notice to produce is oppressive in the sense of being unduly burdensome. Oppression may be found to exist where the categories of documents to be produced are expressed in overly broad and general terms, or because the difficulty and cost of complying with the notice is, in all the circumstances, excessive.

Are the documents apparently relevant?

10    The question whether the documents sought by the notice to produce have apparent relevance to the issues in the summary dismissal application hinges on whether they are apparently relevant to Standard & Poor’s contention that by mid-2009 the market value of the Duke CDOs had dropped to the point where Ceramic had suffered immeasurable loss or damage. In that regard, Standard & Poor’s relies significantly on documents that are said to contain valuations of the Duke CDOs. Those documents were apparently created by Oakvale Capital Limited. Oakvale was Ceramic’s financial advisor.

11    A summary of Oakvale’s valuations during 2008 and 2009 reveals that there was a steady decline in the value of Ceramic’s holding in the Duke CDOs. By 30 June 2009, Ceramic’s holding in the Duke CDOs was valued by Oakvale at about €52,000.

12    The precise basis and nature of Oakvale’s valuation of the Duke CDOs is, however, at best unclear on the evidence presently before the Court. The Duke CDOs were and are extraordinarily complex and sophisticated financial products. It is not clear whether there was any secondary market for the Duke CDOs during 2008 and 2009 or, if there was, whether there was any liquidity in that market. The documents upon which Standard & Poor’s rely simply state a valuation. There is no indication in the documents themselves, and no other evidence, concerning how Oakvale went about valuing the Duke CDOs, particularly if there was no secondary market or liquidity.

13    Standard & Poor’s also relies on valuation reports prepared by a company called Laminar Capital. Laminar was retained by Ceramic in mid-2009, apparently to advise Ceramic on a strategy to exit its investments, including its investment in the Duke CDOs. Somewhat inconsistently with the Oakvale valuation, Laminar valued Ceramic’s holding in the Duke CDOs at zero as at 30 June 2009. The basis of that valuation is also fairly unclear, but appears to be linked to Laminar’s conclusion, in a report sent to Ceramic on 14 July 2009, that “… the structure is being unwound. It will not repay principal and is unlikely to pay coupon going forward”. The source or basis of that statement is not specified, or is at least not abundantly clear.

14    Finally, Standard & Poor’s points to the fact that in September 2009, Ceramic was prepared to sell its holding of Duke CDOs for $20. It submits that such a reduction in value could not have happened overnight. Rather, it indicates that the market value had been dropping steadily throughout 2009 at the very least.

15    Ceramic’s response to Standard & Poor’s argument concerning the drop in value is that temporary fluctuations in the value of the Duke CDOs that may have occurred during 2008 and 2009 do not demonstrate a measurable loss such as to result in the accrual of its cause of action against Standard & Poor’s. In Ceramic’s submission, it suffered measurable loss and damage only when the reduction in the value of the Duke CDOs became permanent and irrecoverable. That occurred when it sold the CDOs. Ceramic submits that the Duke CDOs were not unwound or “wiped out” at any time prior to its disposal of its holding in September 2009.

16    Ceramic also contends that the valuation of complex and sophisticated financial products such as the Duke CDOs is not as simple as Standard & Poor’s suggests. In its submission, the value of the Duke CDOs depended largely on the extent of defaults in the underlying reference portfolio. It disputes the Oakvale and Laminar valuations and will submit, at the hearing of the summary dismissal application, that they cannot be relied on as an indication that the apparent reduction in value of the Duke CDOs during 2009 was permanent and irrecoverable.

17    In that context, Ceramic contends that the documents sought by the notice to produce are potentially relevant to the issues to be addressed at the hearing of the summary dismissal application in at least two ways.

18    First, Ceramic submits that the documents will bear on the valuation of the Duke CDOs during 2008 and 2009. In Ceramic’s submission, Standard & Poor’s reasons for downgrading its rating of the Duke CDOs, and its ongoing assessment and analysis of their creditworthiness, are likely to address the nature and extent of any relevant defaults in the underlying reference portfolio. The documents are also likely to contain an analysis of whether the downgrades, and any reduction in creditworthiness, merely reflected temporary fluctuations in the finance markets generally, or were permanent and irreversible. In short, Standard & Poor’s own analysis may shed light on whether any loss in value during that period was permanent and irrecoverable.

19    Second, Ceramic says that the documents are, at the very least, likely to show that the question of the value of the Duke CDOs was a very complex question. They may, in that regard, undermine the Oakvale and Laminar valuations relied on by Standard & Poor’s. Equally, they may demonstrate that the Court should not attempt to resolve the issue at the summary dismissal stage, but should wait for all the evidence on this issue to be led at the trial. That may be a basis for dismissing the summary dismissal application, at least to the extent that is based on the alleged decline in the value of the Duke CDOs during 2009.

20    There is some merit in Ceramic’s submissions concerning the potential relevance of the documents sought by the notice to produce. There is no dispute that Standard & Poor’s issued ratings downgrades for the Duke CDOs on 14 March and 7 August 2008. Indeed, Standard & Poor’s relies on those downgrades as part of its chronology of the decline in the value of the Duke CDOs during 2008. Standard & Poor’s reasons for downgrading the rating are likely to record the events and circumstances that led to the downgrade, including, for example, any relevant events of default. While the analysis and reasons for the downgrades by Standard & Poor’s do not comprise or constitute valuations as such, that does not mean that they will not be relevant. They are likely to shed some light on the value of the Duke CDOs during the relevant period, as well as indicate whether any decline in value was considered to be temporary or permanent. Much the same can be said of Standard & Poor’s internal analysis or assessment of the creditworthiness of the Duke CDOs.

21    It is at least doubtful that the question of the value of the Duke CDOs is as simple as Standard & Poor’s would have it. In any event, Standard & Poor’s evidence concerning the value of the Duke CDOs is, at least at this stage, entirely documentary. It relies heavily on the Oakvale and Laminar valuations. To an extent it also relies on its own downgrades. It is difficult to see a valid reason why Ceramic should not be permitted to test Standard & Poor’s case in that regard by requesting Standard & Poor’s to produce its own documents concerning its ratings downgrades and its own analysis of the creditworthiness of the Duke CDOs. It is at least on the cards that those documents will bear on the question of the value of the Duke CDOs during the relevant period, and more importantly, whether Ceramic did suffer measurable loss in respect of its investment in the Duke CDOs by mid-2009.

22    The Court should be wary of too readily excluding the possibility that a document or class of documents might at the end of the day be relevant to a fact in issue in the litigation: Gloucester Shire Council v Fitch Ratings, Inc [2016] FCA 587 at [23].

23    In all the circumstances, it cannot be excluded that the documents sought by the notice to produce may be relevant to Standard & Poor’s case that Ceramic suffered loss and damage before 21 September 2009. They have apparent relevance to the issues that may arise at the hearing of the summary dismissal application.

Is the notice oppressive?

24    Standard & Poor’s contention that the notice to produce is oppressive is based primarily on an estimate given by its solicitor of the cost of complying with the notice to produce. The evidence, in simplified terms, is that “preliminary inquiries” suggest that almost 30,000 documents may need to be inspected by lawyers at a cost of in excess of $150,000. The preliminary inquiries essentially comprised running a keyword search over a database. The keyword used was “Duke”. The database that was interrogated as part of the preliminary inquiries was not described or defined in any detail.

25    For its part, Ceramic relied on affidavit evidence from its solicitor to the effect that Standard & Poor’s proposed method of complying with the notice to produce was deficient, and that the cost estimate was excessive. Ways of narrowing the search parameters and inspection costs were helpfully suggested in correspondence addressed to Standard & Poor’s lawyers. Those suggestions were apparently either ignored or rejected.

26    Three matters should be noted in the context of the dispute concerning the burden and cost of compliance with the notice to produce.

27    First, Standard & Poor’s contention that the notice to produce was oppressive was raised at a very late stage. The interlocutory application to set aside the notice to produce was filed on 21 December 2016. It was supported by an affidavit sworn on the same date by Standard & Poor’s solicitor. That affidavit did not allege oppression, or refer to any fact or facts that might suggest oppression. The affidavit alleging oppression was sworn on 14 February 2017, less than a week before the hearing of the application.

28    Second, at the hearing of the application to set aside the notice to produce, the parties were encouraged to engage in discussions with a view to narrowing the search parameters or scope of the notice to produce. Discussions ensued, but apparently to no avail. It is thus necessary to resolve the oppression issue.

29    Third, neither Standard & Poor’s solicitor, nor Ceramic’s solicitor, were cross-examined in respect of their affidavit evidence. The conflict between their evidence was accordingly somewhat difficult to resolve.

30    It is, with respect to Standard & Poor’s solicitor, difficult to accept that compliance with the notice to produce would be nearly as complex, time-consuming and costly as suggested.

31    The first two paragraphs of the notice to produce require the production of documents recording the reasons for two specific rating downgrades. It is doubtful that a keyword search using the word “Duke” over some apparently large and undefined database is an appropriate way to search for documents falling within those two paragraphs. It is difficult to imagine that a large and reputable ratings agency like Standard & Poor’s would not have some sort of filing or information retrieval system which stored important documents, like documents that recorded the reasons for ratings downgrades, in such a way that they could be readily searched for and retrieved. Surely the system is such that the search would not have to range over an entire database of Standard & Poor’s documents, but could be narrowed to particular electronic folders or files. Even if that were not the case, the search parameters or keywords could surely be narrowed. A search involving a single keyword hardly seems satisfactory and would obviously produce unsatisfactory results.

32    The third paragraph of the notice to produce is a bit more problematic. Ceramic agreed to narrow the scope of the notice by deleting the words “or relating”. It also agreed to narrow the start date of the date range so that the start date would be the issue date of the Duke CDOs, being the date the rating was formally assigned. That narrowing of the terms of the third paragraph of the notice plainly should be accepted and adopted.

33    The difficulty remains, however, that the documents recording or disclosing assessments or analyses of creditworthiness extend over a lengthy period and may not be limited to documents like formal reports or memoranda. The documents might include emails. That would significantly expand the scope of the required search. It must therefore be accepted that some considerable time and expense would almost necessarily be incurred in responding to this paragraph of the notice. It remains somewhat doubtful that the cost would exceed $150,000, though it should be accepted that it could be between $60,000 and $100,000. That is broadly consistent with the estimate provided by Ceramic’s solicitor.

34    On balance, however, and notwithstanding the expense of complying with the notice, I am not persuaded that the estimated cost and expense of complying with the notice supports a finding that the notice is oppressive. This is a major piece of commercial litigation. It is a representative action involving potentially significant loss and damage suffered by potentially many investors as a result of investments in sophisticated financial products that were rated by Standard & Poor’s. In the scheme of such substantial litigation, the estimated cost of compliance is not sufficiently large as to constitute oppression.

35    The point also remains that the case Standard & Poor’s wants to advance in support of its summary dismissal application opens up to scrutiny its own documents that may bear on the issue of the value of the Duke CDOs during 2008 and 2009, and whether any loss in value was temporary or permanent and irreversible. In that respect, Standard & Poor’s has exposed itself to the burden and expense of searching for and producing those documents. It would not be fair, or in the interests of justice, for Standard & Poor’s to open up the issue concerning the apparently declining value of the Duke CDOs, but then resist the production of its own documents bearing on that issue on the basis that it would be costly and burdensome for it to search for and retrieve them. The Court should not lose sight of the fact that the public interest requires that, in the interests of a fair trial, litigation should be conducted on a footing that all relevant documentary evidence is available: Gloucester v Fitch at [23].

36    It should also be noted, in that context, that if the matter proceeds Standard & Poor’s would, in all likelihood, be required at some stage to discover the documents caught by the notice to produce. Thus, the trouble and expense involved in locating them will not be wasted. If, on the other hand, Standard & Poor’s succeeds in its application to have the proceeding summarily dismissed, it will most likely recover its costs, which will include the costs of producing the documents in answer to the notice.

37    In all the circumstances, Standard & Poor’s contention that the notice to produce is oppressive is rejected.

38    Standard & Poor’s has accordingly failed to demonstrate a proper basis to set aside the notice to produce dated 30 November 2016. Standard & Poor’s interlocutory application dated 21 December 2016 is dismissed with costs.

Associate:

Dated:    9 March 2017