Supreme Court clarifies proper approach to SAAMCO and to determining scope of duty of care owed by professional advisers

In what is now the leading authority on the application of the decision in South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191 (SAAMCO), the Supreme Court has allowed an appeal by a mutual building society in the context of its claim for damages for economic loss against an auditor for (admitted) negligent advice regarding the accounting treatment of interest rate swaps: Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20. In doing so, the Supreme Court found unanimously that the mutual building society had suffered loss which fell within the scope of the duty of care assumed by the auditor, but that its damages should be reduced by 50% on the basis of its contributory negligence.

The appeal was heard by an expanded constitution of the Supreme Court, in order to provide general guidance regarding the proper approach to determining the scope of duty and the extent of liability of professional advisers in the tort of negligence, including the proper application of the SAAMCO principle. As such, the outcome and reasoning of this decision will be significant for financial institutions faced with claims for economic loss due to alleged negligent advice.

The majority (Lords Hodge, Sales, Reed and Kitchin, and Lady Black) held that the scope of the duty of care assumed by a professional adviser is governed by the purpose of the duty, judged on an objective basis by reference to the purpose for which the advice is being given. In practice, this means that, when looking at the case of negligent advice given by a professional adviser, one looks to see what risk the duty was supposed to guard against and then looks to see whether the loss suffered represented the fruition of that risk. In the view of the majority, this was the point of the mountaineer’s knee example given by Lord Hoffman in SAAMCO.

The majority said the descriptions of “information” case and “advice” case should be dispensed with as terms of art in this area. Cases should not be shoe-horned into one or other of these categories, but rather the focus should be on identifying the purpose to be served by the duty of care assumed by the defendant. In consequence, using a counterfactual test (whereby one asks whether, if the advice or information given by the defendant had in fact been true, the action taken by the claimant would still have resulted in the same loss) should be regarded only as a tool to cross-check the result in most cases, and should not be regarded as replacing the decision which needs to be made as to the scope of duty of care. The majority rejected Lord Leggatt’s emphasis on causation and the counterfactual test, and Lord Burrows’s focus on public policy. However, there was unanimous agreement as to the outcome of the appeal.

In the present case, the majority found that the purpose of the advice given by the auditor was clear: to provide technical accounting advice as to whether the mutual building society could use hedge accounting in order to implement its proposed business model within the constraints of the regulatory environment. As a result of the auditor’s negligent advice, the building society adopted the business model, entered into further swap transactions and was exposed to the risk of loss from having to break the swaps, when it was realised that hedge accounting could not in fact be used and the building society was exposed to regulatory capital requirements which the use of hedge accounting was supposed to avoid. That was a risk which the auditor’s advice was supposed to allow the building society to assess, and which its negligence caused the building society to fail to understand. Accordingly, the losses suffered by the building society when breaking the swaps were within the scope of the duty owed by the auditor.

By focusing on the purpose to be served by the duty of care, the decision may mitigate some of the difficulties which have arisen in practice in categorising “advice” and “information” cases and in applying the correct counterfactual test on the facts of a given case. In future cases, the court is likely to place greater emphasis on understanding the purpose and commercial rationale for which a party has sought advice and identifying the potential risks from which the party was relying on an adviser to protect it. This may lead to an increased evidential burden on the parties, potentially increasing the time and costs of disclosure and witness evidence, where engagements are not documented properly and fully. Accordingly, the decision highlights the importance for financial institutions to ensure, at the outset of a transaction, that there is clear agreement as to how their advice and work will be used by clients, and the impact it could have if it transpires that their advice or work is flawed in some respect.

The decision is considered in more detail below.

Background

The case involved a claim brought by Manchester Building Society (MBS) against its auditor, Grant Thornton (GT), arising out of negligent advice given by GT regarding the accounting treatment of interest rate swaps relating to its lifetime mortgage portfolio.

GT had negligently advised MBS in 2006 that it would be able to make use of an accounting treatment known as “hedge accounting” which would allow it to reduce the volatility of the mark-to-market value of the swaps on MBS’s balance sheet. In reliance on that advice, MBS acquired and issued lifetime mortgages and entered into swap transactions in order to hedge its interest rate risk.

In 2013, MBS discovered that GT’s advice had been incorrect and it could not in fact make use of hedge accounting. This meant that MBS’s balance sheet was exposed to volatility as a result of changes in the value of the swaps and, in particular, to the full losses suffered on the swaps following the fall in interest rates in the aftermath of the 2008 financial crisis. Once MBS’s accounts were corrected, it no longer held sufficient regulatory capital and was required to close out the swaps. In doing so, MBS incurred a mark-to-market loss of £32.7m.

High Court decision

The High Court’s reasoning is considered in our previous blog post: High Court applies SAAMCO principle to find no assumption of responsibility for losses flowing from market forces.

The High Court concluded that MBS had established causation both in fact and in law in respect of the break costs i.e. (a) but for the negligent advice, MBS would not have bought the swaps; and (b) if GT’s advice had been correct, it would not have needed to break the swaps in 2013. However, GT escaped liability because the High Court found it had not assumed responsibility for MBS being “out of the money” on the swaps. Rather, the mark-to-market losses suffered by MBS for terminating the swaps flowed from market forces. The High Court held that only the sum of circa £300,000 was recoverable (reflecting the transaction costs of breaking the swaps and certain other costs).

MBS appealed the High Court’s decision.

Court of Appeal decision

The Court of Appeal’s reasoning is examined in our previous blog post: Court of Appeal decision in Manchester Building Society v Grant Thornton: clarification of “advice” vs “information” distinction when applying the SAAMCO principle.

The Court of Appeal upheld the decision of the High Court, but did so on different grounds. The Court of Appeal said that the High Court had erred in approaching the issue of liability by asking in general terms whether the auditor had assumed a responsibility for the mark-to-market losses. It said that the correct approach to be taken in cases involving the application of the SAAMCO principle was to consider at the outset whether it is an “advice” or an “information” case, and that in determining which category a case falls within, what matters is the “purpose and effect” of the advice given.

In applying that distinction, the Court of Appeal found that the present case was an “information” case, and so the auditor was responsible only for the foreseeable consequences of the accounting advice being wrong. This required MBS to prove the counterfactual, that the same loss would not have been suffered if the advice had been correct, i.e. if MBS had not exercised the break clause early and continued to hold the swaps. Here, MBS was unable to prove its loss on the counterfactual as the discovery of the negligent advice merely crystallised mark-to-market losses on swaps which would have been suffered anyway if the swaps had been held to term.

MBS appealed the Court of Appeal’s decision.

Supreme Court decision

The Supreme Court allowed unanimously the appeal, finding that MBS had suffered a loss which fell within the scope of the duty of care assumed by GT, but that damages should be reduced by 50% on the basis of its contributory negligence.

The reasons given for reaching this conclusion differed between the majority (Lord Hodge and Lord Sales, with whom Lord Reed, Lady Black and Lord Kitchin agreed) and the minority judgments of Lord Burrows and Lord Leggatt. The reasoning and key distinctions are discussed further below.

The scope of duty question: how it fits within the tort of negligence

As a preliminary consideration, the majority put the “scope of duty” principle in context within the tort of negligence, setting out a series of questions which will need to be considered in each case.

  • Is the harm (loss, injury and damage) which is the subject matter of the claim actionable in negligence? (the actionability question)
  • What are the risks of harm to the claimant against which the law imposes on the defendant a duty to take care? (the scope of duty question)
  • Did the defendant breach his or her duty by his or her act or omission? (the breach question)
  • Is the loss for which the claimant seeks damages the consequence of the defendant’s act or omission? (the factual causation question)
  • Is there a sufficient nexus between a particular element of the harm for which the claimant seeks damages and the subject matter of the defendant’s duty of care as analysed at stage 2 above? (the duty nexus question)
  • Is a particular element of the harm for which the claimant seeks damages irrecoverable because it is too remote, or because there is a different effective cause (including novus actus interveniens) in relation to it or because the claimant has mitigated his or her loss or has failed to avoid loss which he or she could reasonably have been expected to avoid? (the legal responsibility question)

The central question in the appeal was stage (2), which addresses the discussion in SAAMCO regarding the scope of a defendant’s duty. The majority noted that, depending on the case, this question may be considered either at stage (2) or stage (5). In some cases, the scope of duty question will be relevant to the extent of the losses claimed, and whether they fall within the scope of the duty assumed by the defendant, e.g. in SAAMCO and Hughes-Holland. In such cases, it may be appropriate to identify losses on a simple “but for” basis first and then ask the duty nexus question at stage (5), as a practical approach to working out the implications of the scope of duty concept, which arises (in principle) earlier in the analysis at stage (2).

Lord Burrows departed from the majority view on where the scope of duty question sits within the tort of negligence. He did not consider it necessary or helpful to depart from a more conventional approach to the tort of negligence which begins with the duty of care, treats the SAAMCO principle as being concerned with whether factually caused loss is within the scope of the duty of care, and avoids the novel terminology of the “duty nexus”.

The scope of the duty of care in professional advice cases

The majority underlined that the scope of the duty of care assumed by a professional adviser is governed by the purpose of the duty, judged on an objective basis by reference to the purpose for which the advice is being given.

This was confirmed as the proper approach in SAAMCO itself and in the other leading authorities, including Caparo Industries plc v Dickman [1990] 2 AC 605, Aneco Reinsurance Underwriting Ltd (in liquidation) v Johnson & Higgins Ltd [2001] UKHL 51 and Hughes-Holland v BPE Solicitors [2017] UKSC 21).

In the view of the majority, when looking at the case of negligent advice given by a professional adviser, one looks to see what risk the duty was supposed to guard against and then looks to see whether the loss suffered represented the fruition of that risk. The majority said that this was the point of the mountaineer’s knee example given by Lord Hoffman in SAAMCO, where a doctor is consulted by a mountaineer concerned about his knee, and who negligently pronounces the knee fit. The mountaineer goes on an expedition and suffers an injury which is a foreseeable consequence of mountaineering but has nothing to do with his knee. Lord Hoffman said that the doctor will not be liable, even if the mountaineer would not have gone on the expedition if he had been told the truth, because the injury would have occurred even if the pronouncement as to the state of the knee had been correct. Rather than highlighting the distinction between a duty to provide “information” and a duty to “advise” (which distinction should be avoided following the decision in the present case, as discussed in the following section), the majority suggested that this example supports the purposive approach to determining the scope of the duty of care.

Lord Burrows agreed that the scope of duty principle focuses on the purpose of the advice or information provided by the defendant, but added that this is underpinned by the policy of achieving a fair and reasonable allocation of the risk of the loss that has occurred. The majority did not agree that the analysis should involve reference back to policy.

By contrast, Lord Leggatt held that the scope of duty principle was based upon causation and suggested that the correct approach was to assess whether the loss claimed was caused by the particular matters which made the defendant’s advice incorrect, and not by other matters unrelated to the subject matter of the defendant’s negligence. However, in the view of the majority, the principle can more readily be understood without placing emphasis on causation, which distracts attention from the primary task of identifying the scope of the defendant’s duty.

Distinction between “advice” cases and “information” cases

Lord Leggatt proposed to dispense with the descriptions “information” and “advice” as terms of art in this area.

This was welcomed by the majority, who said the distinction drawn by Lord Hoffmann in SAAMCO had not proved to be satisfactory, agreeing with Lord Sumption in Hughes-Holland that the distinction was too rigid and liable to mislead. They endorsed Lord Sumption’s view that the whole varied range of cases constitutes a spectrum, with pure “advice” cases at one end of the spectrum (where the adviser assumes responsibility for every aspect of a transaction for their client) and, at the other extreme, cases where the professional adviser contributes only a small part of the material on which the client relies in deciding how to act. They also agreed with Lord Sumption’s observation that both “advice” and “information” cases involve the giving of advice.

In the view of the majority, rather than starting with the distinction between “advice” and “information” cases and trying to shoe-horn a particular case into one or other of these categories, the focus should be on identifying the purpose to be served by the duty of care assumed by the defendant. In this context, they emphasised the importance of linking the focus of the analysis of the scope of duty question and the duty nexus question back to the purpose of the duty of care assumed in the case in hand.

Application of SAAMCO-style counterfactual analysis

The majority referred to the use of the counterfactual analysis set out by Lord Hoffman in SAAMCO. This was proposed as a way to assist in identifying the extent of the loss suffered by the claimant which falls within the scope of the defendant’s duty, by asking in an “information” case whether the claimant’s actions would have resulted in the same loss if the advice given by the defendant had been correct, i.e. if the facts or position had in fact been as represented by the defendant. This procedure generates a limit to the damages recoverable which has been called the SAAMCO “cap”.

However, the majority agreed with Lord Burrows that the counterfactual test should be regarded only as a tool to cross-check the result in most cases, and should not be regarded as replacing the decision which needs to be made as to the scope of duty of care. Lord Burrows described this as a policy decision, whereas the majority thought that it reflected more fundamental issues of principle.

In the view of the majority, linking the use of the counterfactual analysis to “information” cases in the “advice” and “information” framework is unhelpful, because of the problems associated with that framework. There was also a danger of manipulation, in argument, of the parameters of the counterfactual world; one therefore had to take care not to allow the counterfactual analysis to drive the outcome in a case. For example, in this case, Lord Burrows expressly noted, the first instance judge and Court of Appeal had not applied the “most helpful counterfactual test”. To continue the use of the counterfactual analysis would create a risk of litigation by way of contest between elaborately constructed worlds advanced by each side, which would become increasingly untethered from reality the further one moved from the relatively simple valuer case addressed in SAAMCO.

By contrast, examination of the purpose of the duty provides an appropriate and refined basis for identifying, out of what may be a wide range of factors which contribute to the claimant’s loss, the factors for which the defendant is responsible.

The scope of the duty of care in the present case

The majority held that MBS had suffered a loss which fell within the scope of the duty of care assumed by GT, having regard to the purpose for which it gave its advice about the use of hedge accounting.

The majority commented that the purpose of the advice given by GT was clear: to advise MBS whether it could employ hedge accounting in order to reduce the volatility on its balance sheet and keep its regulatory capital at a level it could afford in relation to swaps to be held to term on the basis that they were to be matched against mortgages. As a result of GT’s negligent advice, MBS adopted the business model, entered into further swap transactions and was exposed to the risk of loss from having to break the swaps, when it was realised that hedge accounting could not in fact be used and MBS was exposed to regulatory capital requirements which the use of hedge accounting was supposed to avoid. That was a risk which GT’s advice was supposed to allow MBS to assess, and which its negligence caused MBS to fail to understand.

The majority said that for the purposes of analysing whether the losses suffered by MBS fell within the scope of the duty of care assumed by GT, it was important to have regard to the commercial reason (as appreciated by GT) why advice was being sought about whether there was an “effective hedging relationship” between the swaps and mortgages being entered into and why this was fundamental to MBS’s decision to engage in the business of matching swaps and mortgages. That reason was the impact of hedge accounting on MBS’s regulatory capital position. Use of hedge accounting allowed MBS to make the assessment that, in terms of the constraints imposed on it by the regulatory capital requirements to which it was subject, it had the capacity to proceed with that business whereas otherwise it did not. Having regard to this purpose, GT in effect informed MBS in 2006 that hedge accounting could enable it to have sufficient capital resources to carry on the business of matching swaps and mortgages, when in reality it did not.

Reduction for contributory negligence

However, the Supreme Court held, unanimously, that MBS’s damages should be reduced by 50% on the basis of its contributory negligence.

In the Supreme Court’s view, MBS’s contribution to its own loss arose from the mismatching of the mortgages and swaps in what was an overly ambitious application of the business model by MBS’s management. The Supreme Court considered that the trial judge was entitled to make the assessment that MBS’s damages should be reduced by 50% on the basis of its contributory negligence.

Accordingly, the Supreme Court allowed MBS’s appeal. The overall net loss of (approximately) £26.7m was held to be recoverable, subject to a 50% reduction for contributory negligence by MBS.

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Impact of latest “SAAMCO” decision on financial services litigation

The Court of Appeal has recently had the opportunity to consider, once again, the so-called “SAAMCO” principle in AssetCo plc v Grant Thornton UK LLP [2020] EWCA Civ 1151. While many reported decisions considering the SAAMCO principle arise in the audit and accountancy sector (including the present case), it is often a key and difficult issue in claims against financial institutions.

The SAAMCO principle was established in South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191 and expanded upon in Hughes-Holland v BPE Solicitors [2017] UKSC 21. Essentially, this says that where a professional is responsible only for providing information on which a decision will be taken, rather than advising on the merits of a transaction overall, the professional will be responsible only for the consequences of the information being wrong – not all the financial consequences of the transaction (even if such losses were reasonably foreseeable). This means that the claimant must establish that its loss would not have been suffered if the information had in fact been correct. In practice, “information” cases generally reduce the level of damages recoverable by claimants, because they will not be able to recover losses arising from market fluctuations (if those losses would have been suffered even if the information had been correct).

AssetCo considers the situation of a negligent auditor that failed to apply a sufficient degree of “professional scepticism” to its work and thereby did not detect management’s dishonest concealment of the claimant’s insolvency. In summary, the Court of Appeal found that the negligent auditor was liable for the losses suffered by the claimant in continuing to conduct its loss-making business. While the decision recognises that a negligent auditor will not be liable for losses suffered simply because a business continues to trade, in the circumstances of this case the claimant’s business was ostensibly sustainable only on the basis of management’s dishonest representations to the auditors in the course of the audits. By negligently issuing unqualified audit reports, the business appeared to be sustainable when in truth it was insolvent, and this deprived the claimant’s shareholders or non-executive directors of the opportunity to call the senior management to account. The Court of Appeal found that the claimant’s losses from continuing that business fell within the scope of the defendant’s duty: the negligence was not merely the occasion for the losses but was a substantial cause of them.

Interestingly, AssetCo suggests that the SAAMCO principle may not need to be addressed in all cases, and in any event is not to be applied mechanistically. It is merely a tool the court may employ for determining which losses fall within the scope of the defendant’s duty, and it may be subject to exceptions. As a result, it was not fatal to the claimant’s case that it had not asked the High Court to determine whether the losses it claimed would have been suffered if the information in the audit reports had been correct, and the first instance judge had not done so. However, in cases where the provision of negligent advice or information is alleged, it would be prudent for the parties to consider the application of the SAAMCO principle.

In the context of claims against financial institutions, the type of loss recoverable by a customer from a bank for the alleged mis-selling of a financial product will depend upon whether the bank simply provided information or advice. The SAAMCO information/advice distinction is therefore often a key issue in dispute between the parties in such claims, particularly where the product has performed poorly in the context of a wider economic downturn. The SAAMCO principle is also a battleground in securities litigation and may have a significant impact on the extent to which falls in share price may be claimed by shareholders following alleged breaches of disclosure duties by an issuer.  For example, in The Lloyds/HBOS Litigation (see our blog post), one of the claims was that shareholders suffered loss following their approval of the acquisition of HBOS as a result of the failure to disclose HBOS’s receipt of emergency liquidity assistance from the Bank of England. Lloyds argued that this aspect of the claim was an “information” case and the alleged losses were caused by the impact of the economy on HBOS’s loan books, rather than as a result of HBOS’s liquidity issues, so would have been suffered even if the disclosures made had been correct. In obiter comments, the court in Lloyds/HBOS rejected this analysis on the basis that no bright-line distinction between “information” and “advice” cases could be drawn in the context of disclosures being made by the directors in that case. However, it is important to note that the Lloyds/HBOS claim involved both a disclosure defect claim and a claim that the recommendation to shareholders was negligent. It may be that this point receives more favourable treatment in the context of a case solely concerning disclosure defects.

Application of the SAAMCO principle remains a complex area of the law and one that is constantly being refined and can be difficult to apply to the facts of a particular case. It is due to be considered by the Supreme Court in an appeal against the decision in Manchester Building Society v Grant Thornton UK LLP [2019] EWCA Civ 40 (see our blog post), in which the Court of Appeal applied the principle to conclude that an auditor was not liable for losses suffered following negligent advice regarding the accounting treatment of interest rate swaps. That decision was also considered by the Court of Appeal in the present case.

Background

The claimant company (AssetCo) was the holding company of a group carrying on businesses related to fire and rescue services. The defendant accountancy firm audited AssetCo’s accounts for the years ending 31 March 2009 and 2010. The accounts presented a picture of a profitable group whereas, in reality, the group was insolvent and the picture presented by the accounts was entirely false. The truth was discovered in 2011, at which point new management was appointed and a scheme of arrangement was concluded with AssetCo’s creditors, thereby allowing the company to avoid insolvent liquidation.

AssetCo brought a claim for the losses it had suffered, principally comprising sums paid to AssetCo’s loss-making subsidiaries. Its case was that, as a result of the defendant’s negligence, it lost the chance to put in place a scheme and restructuring in 2009, in which case these losses would have been avoided.

The defendant admitted negligence, in particular in failing to detect management’s dishonest representations in the course of the audits, but denied causation and loss. It was common ground between the parties that, at the time the audits were carried out, AssetCo’s business was ostensibly sustainable only on the basis of management’s dishonest representations to the auditors. It was also common ground that, if the defendant had not been negligent, it would have been apparent that AssetCo was insolvent by May/June 2009, and that without a scheme of arrangement and restructuring the company would have gone into insolvent liquidation.

The defendant, however, said that AssetCo’s losses arose principally from the continuation of its loss-making business, and these losses fell outside the scope of the defendant’s duty of care. Further, it denied that AssetCo lost a real and substantial opportunity to put in place a scheme and restructuring in 2009 so as to avoid insolvent liquidation.

The High Court largely rejected the defendant’s arguments on causation and loss. It awarded AssetCo damages of just over £22.36 million (£29.8 million reduced by 25% to reflect AssetCo’s contributory fault). The defendant appealed on a number of grounds including the following:

  1. It challenged the judge’s conclusion that the losses claimed fell within the scope of the defendant’s duty of care and that its admitted breaches of duty were the legal or effective cause of the losses.
  2. It argued that the judge was wrong in his approach to assessing the claimant’s claim for a lost chance to put in place the scheme and restructuring, wrongly failing to discount the damages to take account of a chance that these would not have taken place.

The defendant also challenged the judge’s conclusion that certain benefits obtained by AssetCo did not need to be taken into account as a deduction from the damages. That aspect is not considered further in this post.

Decision

The Court of Appeal largely dismissed the appeal. Lord Justice David Richards gave the lead judgment, with which Lord Justice Phillips and Sir Stephen Richards agreed.

Scope of duty and legal causation

The defendant complained, in summary, that the judge had wrongly treated discrete breaches of duty (which the defendant admitted) in failing to identify particular instances of dishonesty as a breach of a supposed duty to identify that AssetCo was being run in a fundamentally dishonest manner. This led the judge to find, in error, the necessary causal connection between the breaches and the losses. Further, the defendant contended, the judge had failed properly to consider whether the losses claimed fell within the scope of the defendant’s duty.

The judge had found that AssetCo could not recover losses that were suffered simply because AssetCo carried on trading, but it could recover losses suffered as a result of “continuing to trade in a particular fashion in reliance on the audit” (the judge’s emphasis). He found that, by admittedly failing to detect management’s deceit, the defendant was responsible for all losses incurred by AssetCo in continuing to conduct its business in a fundamentally dishonest manner.

The Court of Appeal accepted the defendant’s criticism that, in fact, it was not common ground between the parties that AssetCo’s business was conducted in a fundamentally dishonest manner, though it was common ground that the management team’s conduct was fundamentally dishonest in particular respects (making dishonest statements to the defendant during the audit process and dishonestly “overfunding” assets). However, that was not the only basis on which the judge found the defendant liable for the losses in question. The common ground included that, when the audits were carried out, AssetCo’s business was ostensibly sustainable only on the basis of management’s dishonest representations. The defendant’s negligence in failing to detect the dishonesty had made it appear that the business was sustainable when in truth it was insolvent. The question was whether, in those circumstances, the losses from continuing that business fell within the scope of the defendant’s duty.

The court referred to previous authority on the general principles applicable to scope of duty and legal causation, in particular the decision in SAAMCO, as considered in Hughes-Holland v BPE  and Manchester Building Society v Grant Thornton (referred to above). As these decisions establish, a claimant to a professional negligence claim must establish that its loss fell within the scope of the duty owed by the defendant. In this regard the courts will distinguish between two sorts of case:

  • “advice” cases, in which the defendant advised on the merits of the transaction overall and so has a duty to protect the claimant against the full range of risks associated with entering into the transaction; and
  • “information” cases, in which the defendant supplied only part of the material on which the claimant decided whether to enter into the transaction, and so is liable only for the financial consequences of the information being wrong (and not the entire financial consequences of the claimant entering into the transaction, if greater). In an information case, importantly, the defendant is not liable for the consequences which would have occurred even if the information that was provided had in fact been correct.

In the present case, the defendant submitted that the SAAMCO principle applies to audit claims and that such claims are “information” cases, and therefore AssetCo had to establish that the losses it claimed would not have been suffered if the information in the audit reports had been correct. As AssetCo had not asked the judge to determine this question, and he had not done so, AssetCo had failed to establish a necessary element of its claim.

The Court of Appeal said this submission misstated the purpose of the SAAMCO principle. As Lord Sumption said in Hughes-Holland, the SAAMCO principle is simply a tool for determining the losses which fall within the scope of the defendant’s duty. There may be cases in which a claimant cannot succeed without specifically alleging and proving this point, but in many other cases the answer is established by the evidence as a whole without any need for it to be separately addressed in the course of the evidence. In any event, the fact that the judge was not invited by either party to address the SAAMCO principle did not inhibit the Court of Appeal from doing so.

The Court of Appeal also rejected AssetCo’s submission that the SAAMCO principle did not apply in the context of an audit report, as opposed to a situation where information is provided to enable the recipient to decide whether to enter into a particular transaction or pursue a particular course of action. The court agreed that an audit report has a different purpose, namely to enable the company to hold the management to account and ensure that errors are corrected. But this did not mean the SAAMCO principle should not, in most circumstances, be applied in the audit context, in order to “distinguish the negligent audit that is merely the occasion for the loss from the negligent audit that gives rise to a liability to make good the loss”.

There may be exceptions to the application of the SAAMCO principle (most obviously in respect of dividends that could not lawfully have been paid if the accounts had been competently audited – it is well established that these fall within an auditor’s liability even though they would have been paid if the information in the audit report had been correct). However, the court said, the principle is capable of being effectively applied to most types of loss that may be claimed in respect of a negligent audit. David Richards LJ commented, in relation to the SAAMCO principle:

“It is not a rigid rule of law but … ‘simply a tool’ for determining the loss flowing from the negligently wrong information as opposed to the loss flowing from entering into the transaction at all. If, in a particular class of case it is incapable of achieving that determination, it is not a tool which the court will use.”

Applying the SAAMCO principle to the present case, AssetCo submitted that, if the accounts and audit report had been true, and the group’s business was profitable, there was no reason why it should become loss-making in the following two years. The losses would not have been suffered in those circumstances, and therefore they fell within the scope of the duty. The defendant submitted, to the contrary, that there was no reason to suppose that the losses would not have been incurred in the following two years (through payments to AssetCo’s loss-making subsidiaries). There was no finding that the support provided to those subsidiaries was anything to do with AssetCo’s management’s dishonesty in the preparation of the accounts. In this way, the defendant argued that there was no sufficient connection between the admitted breaches of duty and the losses.

The Court of Appeal concluded, in favour of AssetCo, that the defendant’s failure to detect the dishonest concealment of the group’s substantial losses/insolvency deprived AssetCo of the opportunity to call the senior management to account and to ensure that errors in management were corrected. That was a principal purpose of an audit and, as Lord Hoffmann made clear in SAAMCO, the scope of an auditor’s duty is determined by reference to the purposes of the statutory requirement for an audit. Accordingly, liability for the losses suffered was liability for the consequences of the information being inaccurate. The negligence was not merely the occasion for the losses which AssetCo continued to incur but was a substantial cause of those losses.

This was subject to an exception, in respect of one transaction which had involved AssetCo’s CEO misappropriating £1.5 million of company funds for his own personal benefit. There was no negligence on the part of the defendant in respect of transactions of this type in its conduct of the audit, and so there was no effective causal link between the transaction and the defendant’s negligence.

Loss of a chance

Having reviewed the authorities, the judge had held that, where the loss claimed depends on the hypothetical actions of a third party, the claimant must prove on the balance of probabilities what it would have done but need only show that there was a real or substantial chance of any necessary action by the third party. The court will then evaluate the lost chance as part of the assessment of damages.

Applying this approach, the judge concluded that AssetCo would have successfully completed a scheme of arrangement and restructuring in 2009. AssetCo had established that it would have taken all the steps necessary to achieve this and that the chances of third parties doing what was necessary for this purpose were in each case either 100% or so high that they fell to be treated as 100%. Accordingly, he did not discount the amount awarded as damages to take account of any chance that the scheme and restructuring would not have been put in place.

The defendant challenged this conclusion, both as to the judge’s assessment of the specific prospects on a number of relevant contingencies and in treating each contingency as a certainty. On the defendant’s case, for any independent contingency where the judge did not hold the chance to be 100%, he should have multiplied the probabilities to calculate the overall chance. On a number of the contingencies in this case, the judge found that the chances were in excess of 90% but declined to state a precise percentage. The defendant argued that the judge must be taken to have assessed those contingencies at 90% and then, wrongly, applied a rule that these chances were to be rounded up and treated as 100% chances.

The Court of Appeal rejected the defendant’s submissions. First, it found that there was no basis for interfering with the judge’s assessment of the prospects of particular contingencies having occurred, bearing in mind the advantages enjoyed by the trial judge over the appellate court, in particular by having been immersed in the case over an extended period and received detailed written and oral submissions from the parties. And second, it rejected the defendant’s premise that there were any contingencies where the judge assessed the prospects at less than 100%. Having reached an assessment of greater than 90%, the judge was entitled to treat the relevant contingency as being, within the confines of judicial decision making, a certainty. As David Richards LJ put it:

“In my judgment, the proper analysis of the judge’s reasoning is that he was satisfied that the chances of each contingency were so high that they fell to be regarded as certainties, not because of a principle or presumption that 90% equalled 100% but because a distinction between certain and almost certain was in this case meaningless. It was a conclusion that was open to the judge, both as a matter of principle and on the authorities.”

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Court of Appeal decision in Manchester Building Society v Grant Thornton: clarification of “advice” vs “information” distinction when applying the SAAMCO principle

The Court of Appeal has dismissed the claimant’s appeal in Manchester Building Society v Grant Thornton UK LLP [2019] EWCA Civ 40, an important decision on the application of the decision in South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191 (SAAMCO) to cases involving an adviser’s negligence. The decision will be of interest to financial institutions and professional advisers generally, including auditors (the subject of the instant decision).

As explained in our banking litigation e-bulletin on the first instance decision, the case concerned an auditor’s liability for (admitted) negligent advice regarding the accounting treatment of interest rate swaps. When the auditor’s error came to light, the client had to break the swaps early, incurring mark-to-market break costs of £32.7m. The Court of Appeal upheld the decision of the High Court, but did so on different grounds.

The judgment provides a number of helpful points of clarification on the approach to be taken in such cases involving the application of the SAAMCO principle as expanded upon in Hughes-Holland v BPE Solicitors [2017] UKSC 21:

  1. In particular, the Court of Appeal clarified that the correct approach in such cases is to consider at the outset whether it is an “advice” or an “information” case. The court emphasised that although there may be a descriptive inadequacy to these labels (so that a dispute involving negligent advice can still fall within the “information” case category), this should not undermine the fact that there is a clear and important distinction between the two categories of case.
  2. In determining whether a case falls within the “information” or “advice” category, what matters is the “purpose and effect” of the advice given. If that advice does not involve responsibility for “guiding the whole decision making process” or where the adviser’s duty does not extend to “consider all relevant matters and not only specific matters” – the case should fall within the “information” case category.
  3. For “information” cases, the adviser will be responsible only for the foreseeable consequences of the advice being wrong. This will require the claimant (who has the burden of proof) to prove the counter-factual, namely that loss would not have been suffered if the advice had been correct. Applying the relevant counter-factual scenario so as to determine which, if any, losses are recoverable will remain a complex exercise in many cases.

In the instant case, the Court of Appeal held that the High Court had erred in approaching the issue of liability by asking in general terms whether the auditor had assumed a responsibility for the mark-to-market losses and found that the present case was an “information” case, and so the auditor was responsible only for the foreseeable consequences of the accounting advice being wrong. This required the claimant to prove the counter-factual, that the same loss would not have been suffered if the advice had been correct, i.e. if the claimant had not exercised the break clause early and continued to hold the swaps. Here, the client was unable to prove its loss on the counter-factual as the discovery of the negligent advice merely crystallised mark-to-market losses on swaps which would have been suffered anyway if the swaps had been held to term.

The fact that the Court of Appeal came to its conclusion by virtue of a completely different analysis highlights that this remains a difficult area of the law, particularly in its application to the facts. Professional advisers can seek to avoid the uncertainty, and the time and cost associated with complex disputes, by ensuring that the scope of their role is clear from the terms of their retainer and, where appropriate, by excluding liability for particular categories of loss.

Background

The background to the dispute is set out in detail in our e-bulletin on the High Court decision. Broadly, however, the case involved a claim brought by Manchester Building Society (“MBS“) against its auditor, Grant Thornton (“GT“), arising out of negligent advice given by GT regarding the accounting treatment of interest rate swaps relating to its lifetime mortgage portfolio.

GT had negligently advised MBS in 2006 that it would be able to make use of an accounting treatment known as “hedge accounting” which would allow it to reduce the volatility of the mark-to-market value of the swaps on MBS’s balance sheet. In reliance on that advice, MBS acquired and issued lifetime mortgages and entered into swap transactions in order to hedge its interest rate risk.

In 2013, MBS discovered that GT’s advice had been incorrect and it could not in fact make use of hedge accounting. This meant that MBS’s balance sheet was exposed to volatility as a result of changes in the value of the swaps and, in particular, to the full losses suffered on the swaps following the fall in interest rates in the aftermath of the 2008 financial crisis. Once MBS’s accounts were corrected, it no longer held sufficient regulatory capital and was required to close out the swaps. In doing so, MBS incurred a mark-to-market loss of £32.7m.

High Court decision

At first instance, the High Court concluded that MBS had established causation both in fact and in law in respect of the break costs i.e. (a) but for the negligent advice, MBS would not have bought the swaps; and (b) if GT’s advice had been correct, it would not have needed to break the swaps in 2013. However, GT escaped liability because the High Court found it had not assumed responsibility for MBS being “out of the money” on the swaps. Rather, the mark-to-market losses suffered by MBS for terminating the swaps flowed from market forces. The court held that only the sum of circa £300,000 was recoverable (reflecting the transaction costs of breaking the swaps and certain other costs).

MBS appealed the High Court’s decision.

Grounds of appeal

The principal grounds of MBS’s appeal considered by the Court of Appeal were as follows:

  1. The judge erred in law in approaching the issue of liability on the basis of assumption of responsibility rather than by following the approach set out in SAAMCO and Hughes-Holland of considering whether this was an “advice” or “information” case.
  2. The correct analysis was that GT provided advice to MBS about whether it could apply hedge accounting and this was an “advice” case.
  3. Even if this was an “information” case, the judge’s decision was wrong because it failed to hold GT liable for the reasonably foreseeable consequences of the information being wrong (which should include the mark-to-market losses on the swaps).

Court of Appeal decision

The appeal was dismissed. The Court of Appeal’s conclusions for each of the principal grounds of appeal are set out further below.

1. Assumption of responsibility or “advice” vs “information” – which approach is correct?

Having considered the authorities discussing the SAAMCO principle (and in particular the clarification provided by Lord Sumption in Hughes-Holland), the Court of Appeal concluded that the High Court had been wrong to analyse the question of whether GT was liable for the mark-to-market losses by asking in general terms whether GT had assumed a responsibility for mark-to-market losses on the swaps. The right approach was to consider whether the case was an “advice” case or an “information” case.

The High Court did not take this approach, largely because of Lord Sumption’s reference to the descriptive inadequacy of the labels in Hughes-Holland. However, the Court of Appeal commented that the descriptive inadequacy of the labels used did not undermine the fact that there was a clear and important distinction between the two categories of case.

In summary, the Court of Appeal said that a case will be an “advice” case if it is left to the adviser to consider what matters should be taken into account in deciding whether to proceed with a particular transaction, i.e. the adviser is “responsible for guiding the whole decision making process” and “his duty is to consider all relevant matters and not only specific matters“. In such cases, the adviser will be liable for all the foreseeable losses flowing from entering into the transaction.

It continued that, if a case is not an “advice” case, it will by definition be an “information” case. In “information” cases, the adviser will not have assumed responsibility for the client’s decision as to whether to proceed with the transaction (the decision itself remains the responsibility of the client). In “information” cases, the adviser will only be responsible for the foreseeable financial consequences of the advice being wrong. Those consequences can be identified by considering what losses would have been suffered if the advice had been correct. Put differently, the adviser can only be liable for losses which would not have been suffered if its advice had been correct.

2. Was this an advice case?

The Court of Appeal concluded, uncontroversially we think, that this was not an “advice” case. In particular:

  • While it was true that GT provided accounting advice, GT was not involved in MBS’s decision to enter into the swaps. That remained a matter for MBS to decide, taking into account all relevant considerations (not only the information or advice from GT).
  • What mattered was not whether advice was given, but the purpose and effect of the advice given.
  • In the Court of Appeal’s view, GT’s accounting advice manifestly did not involve responsibility for “guiding the whole decision making process” and it was plain that “GT’s responsibility was limited to the giving of accounting advice, and never came close to extending to responsibility for the entire lifetime mortgage/swaps business“.
  • The Court of Appeal distinguished Main v Giambrone [2018] PNLR 17 (in which the adviser was found to have assumed the role of “guiding the whole decision making process“) from the instant case, in which GT played no such role.

It followed that the analysis applicable to “information” cases needed to be applied.

3. If this was an “information” case, was GT liable for the mark-to-market losses?

On the basis that this was an “information” case and applying the SAAMCO principle, the Court of Appeal concluded that GT was responsible only for the foreseeable consequences of the information being wrong.

MBS contended that this meant it was entitled to recover losses which would not have been incurred if GT’s information in relation to hedge accounting had been correct. It referred to the High Court’s findings in this hypothetical scenario, that MBS would not have “broken the swaps in 2013 and so would not at that time have incurred the loss which in fact it did”, in which case MBS’s case would be made out.

However, in the Court of Appeal’s judgment, it was a “striking feature” of the case that MBS’s claim for damages consisted of the “fair value” of the swaps, and receiving fair value does not ordinarily give rise to any loss. Indeed, if the swaps had been “in the money” when GT’s error had been discovered, MBS would still have needed to close them out to remove the resulting accounting volatility and, in those circumstances, they would have sustained no financial loss.

The Court of Appeal therefore proceeded to determine what the proper counter-factual should be. In this context, it held:

  • MBS had to do more than establish the fact of the mark-to-market losses in order to prove that it would not have suffered those losses if GT’s advice had been correct.
  • The Court of Appeal emphasised that the mark-to-market losses reflected market forces. It noted this was supported by the High Court’s reasoning (paragraph 179). In particular: “the fact that the swaps were heavily ‘out of the money’ at the beginning of June 2013 was the result of market forces. The closing out of the swaps at fair value on 6 and 7 June 2013 crystallised the loss resulting from the swaps being ‘out of the money’, but it did not create that loss“.
  • The counter-factual that MBS had to prove was that loss would not have been suffered had it continued to hold the swaps. The Court of Appeal noted that this was an aspect of proof of loss.
  • MBS failed to prove its loss in this counter-factual scenario.

The Court of Appeal commented that the position might have been different if MBS could show that, had it had not been forced to close out the swaps in 2013, it would have closed them out a later and more advantageous time. That was not, however, MBS’s case.

The Court of Appeal therefore concluded that MBS had not proved that the mark-to-market losses would not have been incurred had GT’s advice been correct. Accordingly, although the High Court’s approach was not correct in law, it reached the correct overall decision and therefore the appeal was dismissed.

Simon Clarke
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High Court applies SAAMCO principle to find no assumption of responsibility for losses flowing from market forces

The decision of the High Court in Manchester Building Society v Grant Thornton UK LLP [2018] EWHC 963 (Comm) is a useful illustration of how the scope of an adviser’s duty under the SAAMCO principle can operate to limit liability. In summary, the court held that an auditor’s negligent advice in relation to the accounting treatment of interest rate swaps caused a building society to incur break costs of some £32.7m, but nevertheless found that such losses were irrecoverable, being outside the scope of the auditor’s duty.

The outcome of the case was driven by the court’s view that it would be a “striking conclusion” for an accountant who advised a client as to how certain transactions could be treated in its accounts to have assumed responsibility for the financial consequences of those transactions. As a statement of principle, that may appear self-evident. However, what makes the decision both interesting and difficult is the fact that the client in question entered into/continued the swaps only because it was led to believe that the swaps would result in an accounting treatment which removed volatility from its balance sheet with resulting advantages for the assessment of its regulatory capital requirements.

Ultimately, the court considered that the auditor had not assumed responsibility for its client being “out of the money” on the swaps, because break costs suffered by the building society for terminating the swaps flowed from market forces (for which the auditor did not assume responsibility).

However, this was a finely balanced decision, and the uncertainty in this area of law highlights the importance of clearly defining the scope of an adviser’s duty when agreeing engagement terms. While one cannot cater for every contingency, it is often possible to exclude liability for certain consequences of a breach. This can considerably reduce the scope for litigation, as relying upon the SAAMCO principle to limit liability should be a solution of last resort.

This case is an important application of the SAAMCO principle derived from the decision of Lord Hoffmann in South Australia Asset Management Corpn v York Montague Ltd. [1997] AC 191 and expanded upon more recently by Lord Sumption in Hughes-Holland v BPE Solicitors [2017] 2 WLR 1029.

Background

Between 2004 and 2009, the claimant, Manchester Building Society (the “Society“) acquired and issued lifetime mortgages. Interest accrued on the lifetime mortgages at a fixed rate and therefore the Society needed to “hedge” its interest rate risk. The Society did so by, among other things, entering into interest rate swaps.

From 2005, the Society began to prepare its accounts in accordance with International Financial Reporting Standards (“IFRS“). This change meant that the interest rate swaps now needed to be shown on the Society’s balance sheet. The swaps were to be recorded at a “fair value“, meaning that any changes in the fair value of the swaps (due to changes in present and estimated future interest rates) would have to be reflected in the Society’s profit and loss account.

Importantly, however, the mortgages which were being hedged by the swaps were still shown in the Society’s accounts at amortised cost rather than at fair value. This created an accounting mismatch because fluctuations in interest rates would be reflected in the Society’s profit and loss account for the swaps but not for the mortgages. This mismatch would result in the Society’s profits (and hence its capital) becoming volatile which, in turn, could have a detrimental impact on the Society’s regulatory capital requirements.

As a solution to this problem, IFRS permits entities with derivatives to adopt an accounting policy known as “hedge accounting” provided certain criteria are satisfied. Broadly, hedge accounting would allow an adjustment to the value of the hedged asset (the mortgage) on the Society’s balance sheet. This means that the volatility caused by changes in the fair value of the swaps could be mitigated by an opposite adjustment to the value of the mortgages.

Hedge accounting is complex and its requirements are strict. In the present case, the defendant accountants, Grant Thornton UK LLP (“GT“), incorrectly advised the Society in 2006 that it could make use of hedge accounting for its lifetime mortgage portfolio. This persisted until 2013 when the Society learnt that it could not use hedge accounting. During this period, there had been a sustained decrease in interest rates following the 2008 financial crisis which meant that the swaps held by the Society were a liability rather than an asset.

When reported without hedge accounting, the Society’s financial position was significantly worse than had previously been stated in its audited accounts. The inability to apply hedge accounting also meant that the Society’s balance sheet was now fully exposed to the risk of volatility due to changes in interest rates.

As a result, the Society was forced to close out the swaps, incurring break costs of some £32.7m. The Society subsequently brought a claim against GT to recover the break costs, and various other losses, totalling £48.5m.

Decision

GT’s negligence was admitted from the outset and therefore the key question for the court was whether the financial losses claimed by the Society (most significantly, the £32.7m break costs) were recoverable. The court ultimately concluded that the break costs were not recoverable (though it did make an award of damages of £315,345 in respect of certain other heads of losses claimed by the Society).

In reaching this conclusion, the court considered four questions: (a) but for the negligence, would the loss have been incurred; (b) was the negligence an effective cause of the loss; (c) was the loss within the scope of GT’s duty of care; and (d) was the loss too remote? This e-bulletin considers the questions of factual/legal causation and scope of duty in further detail below.

Causation as a matter of fact/law

The court accepted that GT’s negligence caused the Society to incur the break costs both as a matter of fact and as a matter of law. The court found that the Society would not have taken out any more long term swaps (and would have closed any existing swaps) “but for” GT’s negligent advice that the Society would be able to apply hedge accounting (cause in fact). Similarly, the court found that GT’s negligence was an “effective cause” of the Society’s losses (cause in law). In reaching this latter conclusion, the court explained how the use of hedge accounting was intended to mitigate the effects of volatility in the fair value of the swaps. Once the Society appreciated that hedge accounting was not applicable, its balance sheet was exposed to the full and unrestrained effects of the volatility of the fair value of the swaps. It was that volatility which forced the Society to close out the swaps in 2013 and thereby incur a substantial loss. The accounting treatment therefore had “real consequences” for the Society.

Scope of duty

Nevertheless, the court found that the break costs incurred did not fall within the scope of GT’s duty to the Society and were therefore irrecoverable. The court reached this conclusion by applying the SAAMCO principle, explaining that the question for the court was whether GT had assumed responsibility for losses of the type which were sustained in 2013 when, following the realisation that hedge accounting was not available, the interest rate swaps were closed out (and the break costs incurred by the Society). The court commented that there were no hard and fast rules to be applied in this context and recognised that cogent arguments could be put forward on both sides in the present case. Ultimately, the court found that GT had not assumed responsibility to the Society in respect of the break costs. A number of factors appear to have influenced its conclusion:

  1. The court noted that hedge accounting was concerned with the manner in which swaps and mortgages were presented in the Society’s accounts, rather than protecting the Society from losses which would flow from its purchase of interest rate swaps in circumstances where there had been a sustained fall in interest rates.
  2. Although hedge accounting had the effect of protecting the Society’s published profit and capital from changes in the fair value of the swaps, such changes were nevertheless real and exposed the Society to the risk of considerable loss regardless of whether hedge accounting applied.
  3. The risk of loss came about by reason of the risk that interest rates might fall (as in fact they did after the 2008 financial crisis).
  4. The court considered that, had the parties been asked in 2006 whether GT (by advising that hedge accounting could be used) was assuming responsibility for the risk of loss to the Society in the event that there was a sustained fall in interest rates, it was unlikely that they would have responded that GT was doing so.
  5. The fact that the advice was critical or that the losses were foreseeable was not sufficient to show that GT assumed responsibility for such losses.

When reaching its final conclusion, the court said that it was necessary to stand back and view matters in the round. Having done so, it considered that it would be a striking conclusion for an accountant who advises a client as to the manner in which its business activities may be treated in its accounts to have assumed responsibility for the financial consequences of those business activities. The court did not consider that the objective bystander, or indeed the parties themselves, viewing the matter in 2006 would have concluded that GT had assumed responsibility for the Society being “out of the money” on the swaps in the event of a sustained fall in interest rates. The court noted that the very same loss would have occurred if the swap counterparties had exercised their rights to terminate the swaps (as the regulator feared might well happen). This pointed to the fact that the Society’s loss arose from market forces for which GT did not assume responsibility.

However, this was a finely balanced decision and there were two particular points in favour of the Society’s case which were emphasised by the court (although ultimately rejected):

Firstly, in determining the matters for which GT assumed responsibility, the court said that it was required to consider whether the loss flowed from the “particular feature” of the defendant’s conduct which made it wrongful (per Hughes-Holland at paragraph 38). A helpful indication of how a first instance judge should go about answering that question was to be found in Main v Giambrone & Ors [2015] EWHC 1946 (QB). Applying this guidance, the court said that there was a cogent argument in support of the Society’s case. In summary, the break costs, which reflected the fair value of the swaps, were not only the reasonably foreseeable consequence of GT’s negligence but also flowed from the “particular feature” of GT’s conduct which made its advice wrongful. The court said therefore it could be concluded that the losses were the type of loss in respect of which GT had assumed responsibility.

Secondly, the court commented that although the defendant in a classic information case owes no duty of care to the claimant in respect of his entering the transaction (per Hughes-Holland at paragraph 35), GT owed a duty of care in respect of one prospective consequence of the Society entering into the transaction, namely, the volatility risk to which the Society’s balance sheet was vulnerable from changes in the fair value of interest swaps. Thus, if the information or advice had been correct, there would have been no need to break the swaps and the break costs would not have been incurred.

As explained above, while the court saw merit in the Society’s arguments above, it ultimately found for GT on the basis that it did not assume responsibility for the break costs. The court also dismissed most of the other claims for loss and held that only the sum of circa £300,000 was recoverable (reflecting the transaction costs of breaking the swaps and certain other costs).

Comment

This was plainly a difficult case given that the proper availability (or otherwise) of hedge accounting was a question on which GT was specifically asked to advise. Further, the Society’s loss flowed directly from the “particular feature” of GT’s advice which was wrong (mirroring the language used by Lord Sumption in Hughes-Holland). The decision illustrates the difficulty which both parties and the courts face when seeking to apply the SAAMCO principle to a particular set of facts. The judge in the instant case candidly acknowledged that his own mind had wavered during the course of considering whether GT had assumed responsibility for the type of loss incurred. Nevertheless, the court was ultimately unpersuaded that there had been an assumption of responsibility because, in truth, the Society’s losses were the result of market forces for which GT had not assumed responsibility.

Simon Clarke
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Edward Astle v CBRE: Application of the SAAMCO principle to negligent valuations in information memoranda

The recent case of Edward Astle & Ors v CBRE Ltd (and related actions) [2015] EWHC 3189 (Ch) considers South Australia Asset Management Corp v York Montague Ltd [1997] A.C. 191 (“SAAMCo“) in a novel context. The Defendants allegedly included a negligent property valuation in an information memorandum, promoting an investment in a property-owning trust structure. They applied for summary judgment on the basis that the losses suffered by the investor Claimants fell outside of the Defendants’ scope of duty, as they were caused by factors other than the overvaluation (such as the collapse in commercial property values following the financial crisis).

The Court dismissed the Defendants’ application:

  • The Court reiterated that the principle in SAAMCo will apply in straightforward cases involving negligent valuations to limit the scope of the duty owed by a valuer who is a (mere) information provider to cover only those losses attributable to the overvaluation and not the whole of the investor’s losses from entering into the investment.
  • In applying this principle to the case of a negligent valuation contained in an information memorandum, the Court held it is arguable that the scope of an investment promoter’s duty is qualitatively different from the scope of a traditional valuer’s duty and this wider duty may include statutory duties under FSMA, COB and COBS.
  • The Court held that it is at least arguable that the calculation of loss should be carried out at the date of the valuation, or possibly at the time the valuation is relied on when entering into the relevant transaction. However, the Court did not finally determine this point, given that the case raises the SAAMCo principle in a novel context and the exercise is likely to be fact sensitive.

The Claimants therefore had a real prospect of establishing that the loss they suffered was attributable, at least in part, to the alleged inadequacies in the information memorandum. The decision is considered in further detail below.

Factual Background

The Claimants were investors in a Jersey-based trust (the “Trust“), which had interests in: (a) the freehold or long leaseholds of five sites, which were intended to become regional fire and emergency rescue centres as part of a Government fire control centre project; and (b) the freehold of a property in Cirencester, which was to be developed into an office building to be leased (together, the “Properties“). In March 2006, Bank of Scotland (the “Bank“) advanced a 5-year secured term loan in excess of £100 million to finance the acquisition and development of (a) and a 5-year term loan in excess of £14 million in respect of (b). In addition to these facilities, fixed interest rate swaps were put in place and the Bank advanced working capital facilities, together with bridging facilities and a mezzanine facility, which were intended to be repaid upon the receipt of monies through the issue of units and loan notes by the Trust. CBRE Limited (“CBRE“) was engaged by the Bank to provide expert valuations of the Properties for loan security purposes.

On 3 October 2006, the units and loan notes were issued in accordance with the provisions of an Information Memorandum (the “IM“) prepared by Evans Randall Investment Management Limited (“ERIML“). CBRE’s valuation was summarised in the IM. As part of the terms of the IM, the investors were prohibited from demanding repayment of sums due and owing under the loan notes until all amounts outstanding under the facilities with the Bank and various agreements between the Trust and ERIML were repaid in full. The total amount raised from investors was £33,775,000, and of this £26,775,000 was invested by the Claimants.

Subsequently, the Government project was abandoned so the intended use for the fire and emergency rescue centres was not fulfilled, coupled with a collapse in commercial property values following the financial crisis. The term loans could not be refinanced when they fell due for repayment in July 2011, which led to an event of default and receivers were appointed over the Properties in February 2012. Accordingly, the Claimants lost the full amount of their investment.

The Claimants commenced proceedings against ERIML and CBRE alleging that the IM accorded values to the Properties which were materially overstated and contained a series of factual errors relating to the Properties. The Claimants contend that these misstatements not only go to the value of the Properties, but the viability of the investment generally.

The Defendants applied for summary judgment on the basis that losses were incurred as a result of the cancellation of the intended use for the sites and the general collapse in commercial property values, which are matters which fall outside the scope of any duty owed to the Claimants, in accordance with the principle in SAAMCo.

Decision

The Court dismissed the application for summary judgment.

Application of SAAMCo

The Court summarised the SAAMCo principle as follows:

“…a claimant seeking damage for breach of a duty of care must “prove both that he has suffered loss and that the loss fell within the scope of the duty” (per Lord Hoffmann in SAAMCo at p.218B/C). Where the relevant duty is simply a duty to inform and not a duty to advise on whether a transaction ought to be entered into, an application of the “but for” test of causation will not of itself entitle the claimant to recover. He must prove that the loss is a consequence of the information being wrong.”

The Court considered how SAAMCo has been applied in subsequent cases, stating that whether or not the principle will apply (and if so, how it is to be applied) will turn on the precise scope of the duty of care to which the negligent defendant is subject. The Court was not referred to any case in which the SAAMCo principle had been applied to similar facts/alleged duties to the instant case.

In applying the SAAMCo principle to the present case, the Court said it was required to carry out a two-stage process:

a) Stage one required the Court to ascertain the basic loss. It was accepted by ERIML and CBRE that, for the purpose of the summary judgment applications, it would be assumed that the Claimants had established not just the duties and their breach, but also that the Claimants would not have invested in the Trust if the breaches had not been committed. Accordingly, the basic loss was the loss sustained by the Claimants by reason of the fact that they made an investment which is now worthless, which they would not have made but for the negligent valuation. As such, the Claimants suffered ‘basic loss’ amounting to the total value of their investment.

b) Stage two required the Court to assess the maximum amount of loss capable of falling within the duty of care owed by the Defendants, which it does by identifying the consequences attributable to the wrongful act.

Scope of duty

In considering the second stage of the test outlined above, it was assumed that both ERIML and CBRE were subject to duties to take reasonable care in their provision of information.

However, there was a “sharp divergence of view” between the Claimants and ERIML as to whether ERIML’s duty went further. The Claimants argued that ERIML could not compare its role in the promotion of the Trust to the role of a valuer. The policy considerations for protecting the valuers of mortgage security against adverse movements in the markets should not apply to a promoter in the position of ERIML.

The Court found that there was “much force” in ERIML’s case on this issue: that the pleaded duty was to ensure that the facts stated in the IM were true and accurate, which did not extend to giving advice. However, the Court was not persuaded that the Claimants had no real prospect of establishing that there were relevant differences between the scope of a duty owed by a valuer to a mortgage lender and the scope of such duty as ERIML owed to the Claimants. In particular, the Court found that it was arguable that:

  • The range of information contained in the IM which was said to be wrong was wider than the information contained in a valuation and was included for a wider purpose, namely making an investment decision.
  • Where valuation information is provided to an investor for the purposes of making a decision on whether or not to invest, the scope of the promoter’s duty is qualitatively different from the scope of the valuer’s duty where the valuation evidence is provided to a lender for security purposes.
  • As to the scope of that duty, an investment promoter knows that the person receiving the information will be using it to make an investment decision, in relation to which there are statutory duties under FSMA, COB and COBS.

The Court did not elaborate on the precise scope of the extended duties to which ERIML was arguably subject, because of its finding on the application of the SAAMCo principle to the more limited duty owed by CBRE (and ERIML) to take reasonable care in the provision of information (see below).

Breach

Notwithstanding its conclusions in relation to the additional duties arguably owed by ERIML, the Court considered the applications on the basis of the more limited duty to take reasonable care in the provision of information (owed by CBRE in any event).

Even on the assumption that the SAAMCo principle applies so as to require the Court to identify the direct consequences of the valuation being inaccurate, the Court held that the Claimants had a real prospect of establishing that the loss they suffered on their investment was at least partly attributable to the alleged inadequacies in the IM.

Loss

The Court first considered the case of the negligent valuer who owes a duty to a mortgage lender, where the loss on application of the SAAMCo principle will usually be limited to the difference between the valuation and the true value.

In the Court’s view, it was at least arguable that this comparison exercise should be carried out at the date of the valuation, or possibly at the time the valuation was relied on when entering into the relevant transaction. This was possibly more appropriate where the valuation was produced for a purpose that relates to the viability of a wider transaction, even absent the giving of advice. On this basis, the Claimants would be entitled to claim the quantum of the overvaluation on day one, which was approximately £26 million. In accordance with the two-stage test, the qualification established by SAAMCo under the second limb is to impose a limit to the basic amount of damages a party would otherwise be entitled. The Claimants would therefore be entitled to the full amount of their lost investment, because this figure is not greater than the overvaluation.

That said, the Court commented that ERIML and CBRE had a perfectly good case for contending that the use of the above formula did not work very well to identify the loss properly attributable to the inaccuracy of the information in the present case. As at the date of valuation, the Claimants could not make a direct link between the extent of the overvaluation and the extent to which they would be prejudiced by making an investment against assets worth less than they thought, because their interests were subordinated in that respect to the rights of the Bank and other unsecured creditors. If the valuations had been accurate, the Bank would have been better off, but the Claimants would have been in exactly the same position. The formula suggested by ERIML and CBRE would require the Court to examine the extent to which the Claimants would still have suffered the loss they claim, even if the valuation had been correct (which on the Defendants’ case, would produce no loss at all).

However, the Court did not finally determine what approach should be adopted in this case. The application raised the SAAMCo principle in a novel context and the exercise was likely to be fact sensitive. The specific approach to be taken to calculate the Claimants’ losses should be determined at trial and accordingly the Defendants’ summary judgment application was refused.

Comment

This judgment relates to an application for summary judgment and so its conclusions are simply arguable and not finally determinative. However, the decision offers guidance as to how SAAMCo will be interpreted outside of the typical valuer cases, specifically in the context of a negligent valuation contained in an information memorandum promoting an investment in an asset-holding issuer.

Importantly, it appears to widen the scope of the duties arguably owed by an investment promoter who has provided information to an investor for the purpose of making an investment decision. It will be for the trial judge to decide whether this is the correct approach, and more generally to decide upon whether it is appropriate to extend the scope of the SAAMCo principle to cases of this kind.

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Melissa Federico
Melissa Federico
Associate
+44 20 7466 2561
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948