What losses is a professional adviser liable to the client for if it gives negligent advice? The Supreme Court had to consider it for the third time in Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20.
If a professional adviser gives negligent advice on which a client relies, the adviser is only liable for those losses which fall within the scope of its duty of care, not for all the losses incurred by the action taken by the client relying on the advice. The idea is that the adviser should only be liable for the consequences of its advice being wrong, not to underwrite the whole venture. So the court will first identify the ‘basic’ loss suffered by the client, by asking ‘but for’ the adviser’s negligence, would the client have suffered the loss? The court then has to decide to what extent does any of that loss fall within the scope of the adviser’s duty of care – and how to do this is the difficult part.
A previous House of Lords authority, Banque Bruxelles Lambert SA v Eagle Star Insurance Co Ltd; South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191 (“SAAMCO”), had said there was a distinction between ‘information’ and ‘advice’ cases:
- An advice case is where the adviser has assumed responsibility for every aspect of a transaction in prospect for its client, and in these circumstances the adviser should be responsible for all the foreseeable losses the client suffers by entering into the transaction
- An information case is where the purpose of the advice is limited and the scope of the duty that the adviser has assumed is limited to that purpose. To identify the loss which fell within the adviser’s scope of duty, the court should apply a counterfactual test which involves asking would the same loss have been suffered had the advice given been correct? The adviser is only liable for that loss which would not have occurred had the advice it had given been correct (this became known as the “SAAMCO cap”)
Only a few years ago the Supreme Court in BPE Solicitors v Hughes-Holland [2017] UKSC 21 confirmed the information/advice approach. In this case, solicitors had negligently failed to correct their client’s assumption that his loan would be used for development of a tower rather than paying off a charge. The ‘basic loss’ was the whole of the loan because the client would not have made the loan if he knew the facts. However the development was always going to be unviable so the client would have lost the loan money even if it had been used for development. This was an information case – it was the client’s decision that making the loan was a good investment. Therefore none of the loss fell within the scope of the solicitors’ duty of care.
Difficulties still arose in applying this approach in practice however, as can be seen in the most recent case before the Supreme Court, Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20., where auditors gave the negligent advice.
The Society had begun to offer lifetime mortgages funded by borrowing at variable rates of interest, and hedged against the risk that the variable cost of borrowing would exceed the interest received on the mortgages by entering into interest rate swap contracts. From 2005 however the Society was obliged to prepare its accounts using International Financial Reporting Standards (IFRS) which meant the swaps had to be accounted for on the balance sheet at their fair value, which would vary depending on the current market rate, whereas the mortgage loans would appear at book cost. This would mean the Society’s accounts would look very volatile. This was an issue for the Society, because the higher the volatility the accounts showed, the higher the amount of regulatory capital it was required to keep by its regulators, the then Financial Services Authority. It would have meant that the Society could not have afforded to continue its lifetime mortgages and swaps business.
Under IFRS rules hedge accounting can be used to offset such volatility in the accounts, if certain conditions are met. The hedge must be expected to be “highly effective” so that the changes in fair value or cash flow of the hedged item and the hedging derivative offset each other. If the Society could use hedge accounting, the amount of regulatory capital would be kept low enough so that it could continue to afford to continue its lifetime mortgages and swaps business. Grant Thornton advised that the Society could use hedge accounting for the lifetime mortgages and buy swaps, but this was in fact not correct. The Society relied on this advice and continued to offer lifetime mortgages and bought new swaps until, in 2013, it discovered that the hedge accounting advice was wrong. Corrections to its accounts meant that the Society had insufficient regulatory capital. It had to stop its lifetime mortgages and swaps business. It also had to sell its swaps early, and because of the financial crisis of 2008 which had caused a sustained fall in interest rates, this meant it lost approximately £32m. It sought to recover these losses from Grant Thornton.
The first instance judge said that ‘standing back and viewing the matter in the round’, Grant Thornton had not assumed responsibility for the losses. The Society appealed and the Court of Appeal held that this was the wrong approach, it was an information case, and so Grant Thornton was responsible only for the foreseeable consequences of the accounting advice being wrong. Applying the counterfactual test to see whether the same loss would have been suffered if the advice given had been correct, it said the Society would then not have sold the swaps early but would have held them to term, and the evidence showed that it was likely that the Society would have actually been worse off had it done so. Therefore Grant Thornton was not liable for the Society’s loss.
The Supreme Court held that both these approaches were wrong. It also held that the information and advice labels were unhelpful and should no longer be used. It also agreed that Grant Thornton was liable in damages to the Society (for the loss suffered on selling the swaps, although credit should be given for profit made on the lifetime mortgages, and also the Society was contributorily negligent and so the damages should be reduced by 50%). The judges were however split on what the correct approach should be to determine the extent of the adviser’s losses.
The majority came up with a new 6 step test for professional negligence to help explain how the court should identify the extent of the liability of a negligent professional adviser:
- 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 an intervening act which breaks the chain of causation from the negligence) in relation to it or because the claimant has mitigated its loss or has failed to avoid loss which it could reasonably have been expected to avoid? (the legal responsibility question)
Questions 2 and 5 focused on determining the extent of the liability of a professional adviser:
- Question 2 – 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) - the scope of 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. Here, the reason why the advice was sought was that hedge accounting allowed the Society to assess that, in terms of the constraints imposed on it by the regulatory capital requirements, it had the capacity to proceed with the lifetime mortgages and swap business. The purpose of the advice therefore was to deal with the issue of hedge accounting in the context of its implications for the Society’s regulatory capital
- Question 5 - 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) – having regard to the above purpose, Grant Thornton in effect told the Society that hedge accounting could enable it to have a sufficiently low regulatory capital requirement to allow it to carry on the lifetime mortgages and swap business, when in reality it did not. It was the fact that it did not have a sufficient regulatory capital which required it to end its lifetime mortgages and swaps business and sell out the swaps. Therefore there was a sufficient nexus between the loss and the scope of Grant Thornton’s duty of care
The majority said that the counterfactual test was a useful cross-checking tool, but one that was subordinate to this analysis. In this case, the counterfactual test had been applied wrongly by the Court of Appeal, because if it had been correct that there was an effective hedging relationship between the swaps and the mortgages, then there would have been a close match between changes in the fair value of the hedged item (the lifetime mortgages) attributable to the hedged risk and changes in the fair value of the hedging instrument (the swaps), so that there would have been no loss when the swaps were closed. The majority said that the fact that a distinguished constitution of the Court of Appeal fell into error showed that the better approach was to focus more directly on the purpose for which the defendant gave the advice in question.
In considering its judgment the Supreme Court also considered the same issue in the context of advice given by a medical expert, Khan v Meadows [2021] UKSC 21, where it applied the same approach.
It is worth noting that Lord Leggatt, dissenting, felt that the court should focus instead on the causal relationship between what made the information or advice wrong and the loss suffered. He said the court should analyse whether the loss for which damages are claimed is attributable to a matter which the defendant misrepresented or failed to report, and here it was – Grant Thornton made the negligent specific misrepresentation that there was an effective hedging relationship between the swaps and the mortgages, and it was that specific misrepresentation in the context of the advice on hedge accounting that meant that the lifetime mortgages and swaps business model was continued despite the Society having insufficient regulatory capital. Grant Thornton knew that the purpose of that representation was to provide a true picture of the Society’s financial position on which the Society would rely in pursuing its business model and therefore the loss was within the scope of Grant Thornton’s duty of care.
Lord Leggatt said that it should not be assumed that it is necessary or helpful to apply a counterfactual test in every case, but it is likely to be most useful to quantify the loss that was due to a risk that the adviser owed a duty of care to protect the client from, or to show that in fact the subject matter of the negligent advice was causally irrelevant to the loss the client suffered.
Hopefully this judgment will have brought clarity to this vexed issue of how to determine the extent of a professional adviser’s liability, but the proof will be in how this new approach is applied by the courts in future cases.
Laura Beagrie