In this update Caroline Carmichael and Jonathan Porteous consider the recent case of Bank of Ireland & Anor v Watts Group Plc, in which the High Court rejected the bank’s claim that a monitoring surveyor was negligent when reporting on a residential development transaction which subsequently failed.
This is an interesting case since it provides a salutary reminder to banks of the risks associated with overlooking lending criteria and committing to transactions when all the available evidence would suggest doing the contrary.
1. Case facts
The case concerned a £1.4m loan made by the claimant bank (the “Bank”) to a special purchase vehicle named Derwent Vale York Limited (the “Borrower”) to fund the construction of a residential development in York. The Borrower was partly owned by the Modus group of companies (“Modus”), a Manchester-based property development group that was a long-established client of the Bank.
The Bank instructed Watts as independent quantity surveyor in January 2008 to check the borrower’s costings and approve requests for drawings under the loan facility. Watts produced an Independent Appraisal Report (the “IAR”) in which they agreed that the stated construction cost was a realistic estimate for a project of the type and nature in question.
First drawdown took place later in April 2008. In May 2009 Watts advised that, although practical completion would be delayed until August 2009, there was at that stage no anticipated shortfall in the construction costs. However later that month, Modus Ventures Limited entered administration and the Borrower was placed into creditors’ voluntary liquidation. The Bank demanded repayment from the Borrower but no such repayment was made and receivers were subsequently appointed to sell the property with the Bank suffering a loss of approximately £750,000.
2. Relevant issues
The Bank claimed that Watts had been negligent in preparing the IAR and that, but for this report, the Bank would have declined to have lent funds to the Borrower. Watts denied negligence and raised further issues as to reliance, causation and loss.
The High Court rejected the Bank’s claim. According to Mr Justice Coulson, on the balance of probabilities, the Bank would not have lent the funds at all but for its pre-existing relationship with Modus. The Court did not consider Watts to have acted negligently, but even assuming that were the case, the Court was unable to conclude that the Bank had relied upon the IAR produced by Watts. In particular, there was an absence of any evidence from the Bank demonstrating that anyone at the Bank had actually read or relied upon the final IAR.
In addition, much of the evidence presented on behalf of the Bank was the subject of judicial criticism, with the Bank’s expert witness found to be unreliable and not independent and the relationship manager who was responsible for the loan at the Bank not being called to give evidence.
Mr Justice Coulson determined that the true cause of the Bank’s loss was its “botched consideration of the loan application and the fundamentally flawed decision to lend to the Borrower”. To illustrate this point he listed several examples of how the Bank had erred in electing to lend to the Borrower. Among these examples were the following factors:
- Modus’ previous success was based upon large pre-let developments, most of which were commercial. They had no experience of speculative residential development.
- The proposed loan failed to comply with three out of four of the lending guidelines set by the Bank (including its loan to cost and loan to value ratios).
- The profit margins were extremely tight, leaving insufficient ‘fat’ in the project.
- The Bank was found to have ignored its existing exposure of £20m to the Modus group of companies.
- The Bank overlooked advice in a separate report prepared by Savills that before any drawdown occurred, the build costs should be verified by an independent quantity surveyor. This recommendation was not followed and a separate land loan was advanced for the acquisition of the site without any such independent verification of the construction costs.
- Savills had also recommended that a condition precedent be included in the loan to the effect that confirmation should be sought that the absence of any available on-site car parking would not affect marketability. The bank failed to include any such conditionality in the Borrower’s facility letter.
Whist this case does not depart from any existing law, it is a very useful reminder of the risks associated with relying too heavily upon a monitoring surveyor and ignoring internal lending guidelines for the sake of preserving relationships.
Jonathan Porteous, Head of Banking & Finance, commented as follows: "This is likely one of many examples of how lending decisions were made in the heady days of the property finance world that preceded the financial crash. In our experience since then banks have across the board become much more rigorous when evaluating prospective transactions and these days we would not expect such a transaction to get over the starting line without undergoing a thorough approval process first."
To read this case in full, please click the following link: http://www.bailii.org/ew/cases/EWHC/TCC/2017/1667.html