The Court of Appeal has held that, where an auditor negligently failed to detect management’s dishonest concealment of the claimant’s insolvency, it was liable for the losses suffered by the claimant in continuing to conduct its loss-making business: Assetco Plc v Grant Thornton UK LLP  EWCA Civ 1151.
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 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.
The judgment is of particular interest for the Court of Appeal’s discussion of the so-called SAAMCO principle, which was established in South Australia Asset Management Corpn v York Montague Ltd  AC 191 (SAAMCO) and expanded upon in Hughes-Holland v BPE Solicitors  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. This means that the claimant must establish that its loss would not have been suffered if the information had in fact been correct.
In the present case, the Court of Appeal confirmed that the SAAMCO principle applies to general audit cases, even though the purpose of an audit is not to enable a decision to be taken in respect of a particular transaction. However, the decision emphasises 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 judge to determine whether the losses it claimed would have been suffered if the information in the audit reports had been correct, and the 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 and be ready to persuade the court, if necessary, why it should not be applied.
The SAAMCO principle is due to be considered by the Supreme Court in an appeal against the decision in Manchester Building Society v Grant Thornton UK LLP  EWCA Civ 40 (considered here), 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.
The present decision is also of interest for the Court of Appeal’s discussion of the correct approach to assessing damages in “loss of a chance” cases, where the claimant’s loss depends on the hypothetical acts of third parties. The decision illustrates in particular that, in some cases, it may be appropriate to treat the lost chance as a certainty.
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 AsetCo’s contributory fault). The defendant appealed on a number of grounds including the following:
- 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.
- 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.
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.”