The recent case involving JP Morgan shows that not even one of the largest banks in the world is immune from a simple breach of contract action.
In this case, Leonard Blavatnik, a Russian billionaire, had made an agreement with JP Morgan, allowing them to invest $1 Billion of his fortune. JP Morgan and Blavatnik, negotiating the terms of the investment, agreed that no more that 20% of the money would be invested in mortgage securities, as Blavatnik’s preference was for lower-risk investments. In early 2006, the parties formalized the agreement.
Perhaps unsurprisingly for the time, JP Morgan invested a great deal of Blavatnik’s fortune directly into subprime mortgage-based securities, and, by the time of the 2008 Financial Crisis, which collapsed the subprime securities market, over 60% of Blavatnik’s investment portfolio had been invested in that class of securities. In the ensuing turmoil, Blavatnik lost millions of dollars, and, upon learning how JP Morgan had invested his fortune, filed suit against JP Morgan, both for breach of contract as well as negligence for having so heavily invested in such high-risk securities.
In the end, a New York court ruled that JP Morgan had breached the contract by placing too large a proportion of Blavatnik’s money into high-rick subprime mortgages. The bank, in its defense, had claimed that the subprime home loans were in fact “asset-backed securities” rather than mortgages according to the prevailing standards in the banking industry, and therefore were not mortgages by the terms of the contract. The court rejected this argument, instead reasoning that because these securities were backed by home equity loans, they were effectively mortgages, and that the bank had breached the contract as a result.
The court, however, then found that the bank’s conduct, though showing an “error in judgment”, was not so severe as to violate their duty to Blavatnik and therefore was not negligent in the investment of Blavatnik’s money. It rejected the negligence charge.
There are two interesting takeaways from this case. First, it appears that, even in situations where the layperson would find the conduct of the bank to be highly negligent, such as putting the majority of an investor’s portfolio into a single type of high-risk security, a court may be reluctant to substitute its judgment for those of professional bankers.
Second, and perhaps more heartening for those who have trusted banks with their money, it appears that at least some courts are willing to push back on the notion of allowing industry standards to determine the course of litigation. JPMorgan had insisted that Subprime Mortgage-Backed securities were not mortgages, and that no bank considered them to be. Instead of accepting that explanation at face value, the court instead dug deeper, ultimately coming to the conclusion that, semantics aside, a security backed by a home equity loan is, in fact, a mortgage after all.