Supreme Court of United Kingdom: The 7-Judges Bench comprising of Lord Reed, President Lord Hodge, Dy. President, Lady Black. Lord Kitchin, Lord Sales, Lord Leggatt, Lord Burrows, JJ., addressed the issue concerned with the application of the concept of scope of duty in the tort of negligence for professional advice given by expert accountants.
The similar issues were placed before the Bench in Khan v Meadows [2021] UKSC 21 with regard to professional advice given by a medical expert. The Bench addressed the issue in detail by analysing landmark cases of South Australia Asset Management Corpn. v York Montague Ltd. (SAAMCO), [1996] 3 WLR 87 and Hughes-Holland v BPE Solicitors, [2017] 2 WLR 1029.
Facts of the Case
The claimant- Manchester Building Society (MBS) was a small mutual building society. From 1997 until 2012, the society’s accounts were audited by the defendant, Grant Thornton, a large firm of accountants. The said firm allegedly advised the society, incorrectly and negligently, that the society’s accounts could be prepared using a method known as “hedge accounting” and that the accounts prepared using that method gave a true and fair view of the society’s financial position. In reliance on that advice, the society carried on a strategy of entering into long-term interest rate swap contracts as a hedge against the cost of borrowing money to fund mortgage lending. The misstated accounts served to hide volatility in the society’s capital position and became a severe mismatch between the negative value of the swaps and the value of the mortgage loans which the swaps were supposed to hedge. When after seven years the accountants realised their error, the society had to restate its accounts to show substantially reduced net assets and insufficient regulatory capital. To extricate itself from this predicament, the society closed out the swaps at a cost of over £32m.
The issue in appeal was whether the society can recover this cost as damages from the accountants (reduced by 50% for the society’s contributory negligence)?
Trial Court’s findings
The Trial Judge awarded damages to the society of only £316,845-the main item of damages being the transaction costs payable to terminate the swaps early; as the judge found that Grant Thornton’s negligent advice was an effective cause in law of that loss and that the loss was a reasonably foreseeable consequence of Grant Thornton’s negligence and therefore not too remote to be recoverable. However, it was held by the Trial Court that the society could not recover damages for this loss from Grant Thornton (apart from the transaction costs paid to terminate the swaps early) because, in the opinion of the Court, the losses flowed from market forces for which Grant Thornton did not assume responsibility, that the case did not fall within the principle as laid down in SAAMCO, and that the society had itself been negligent which contributed to its loss.
Judgment of the Court of Appeal
The Court of Appeal dwelled on the distinction between “advice” and “information” as explained by this court in Hughes Holland, and applying that distinction, the Court concluded that, that was an “information” case, such that Grant Thornton was legally responsible only for the foreseeable financial consequences of its information/advice being wrong. To show that the society suffered a loss by terminating the swaps, it would have to prove that it would have been better off if it had continued to hold the swaps, which the society was unable to establish. Hence, the Appellate Court dismissed the society’s appeal.
Analysis and Observations by the Court
The auditor’s duty of care
“Like other professional advisers, an accountancy firm acting as an auditor owes a duty, as an implied term of the contract by which the firm is retained and also in tort, to carry out the service which it has agreed to supply with reasonable care and skill.”
However, the auditor’s duty of care is limited to protecting the audited entity and its members against the risk that its audited accounts are inaccurate It is no part of the auditor’s duty to advise the audited entity what business decisions it should make nor to identify what considerations apart from the accuracy of its audited accounts are relevant for the entity to take into account in making such decisions. Those are exclusively matters for the entity’s directors and members (or possibly other advisers) to assess.
Scope of Grant Thornton’s duty
In accordance with the normal role of an auditor, Grant Thornton owed a duty to advise the society with reasonable care and skill whether its accounts had been properly prepared and gave a true and fair view of the society’s financial position. That included a duty to advise the society whether the lifetime mortgages and interest rate swaps entered into by the society were correctly accounted for in a manner which complied with applicable accounting rules and standards which governed hedge accounting. The Bench was of the view that Grant Thornton did not advise the society whether it should enter into lifetime mortgages or interest rate swaps or about which particular mortgages or swaps to enter into. In particular, Grant Thornton gave no advice about the desirability of entering into swaps with 50-year terms. Neither was it asked to advise the society about the commercial wisdom of its intended hedging strategy nor about whether it would be sensible or desirable to enter into interest rate swaps (and, if so, in what amounts and of what duration).
Impact of Contributory Negligence by the Society
- As found by the Trial Judge that the society had itself been negligent in two respects which contributed to its loss; i.e. entering into 50-years waps and fault of its Finance Director in devising the society’s approach to hedge accounting and considering that hedge accounting was available when it was not. The society’s own negligence which contributed to this state of affairs was properly reflected in the reduction of 50%, however, rejecting the findings of the Court of Appeal that the loss sustained by the society as a result of entering into long term interest rate swaps in reliance on Grant Thornton’s negligent advice was not within the scope of Grant Thornton’s duty, the Bench held that it was a loss from which Grant Thornton owed a duty of care to protect the society. Hence, after giving credit for the value of the mortgages and the 50% reduction for its contributory negligence, the society was entitled to recover damages, in addition to the amount awarded by the judge, of some £13.4m (50% of £26.7m).
Application of SAAMCO-style counterfactual analysis
The SAAMCO case proposed a form of counterfactual analysis 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. This procedure generates a limit to the damages recoverable which had been called the SAAMCO “cap”.
The Bench opined that though the counterfactual test maybe regarded as a useful cross-check in most cases, but that it should not be regarded as replacing the decision that needs to be made as to the scope of the duty of care. Analysis using the counterfactual “tool” as deployed in SAAMCO was designed to assist with looking at the scope of duty question from a causation-based perspective. Therefore, once it is accepted that the scope of duty inquiry turns on identifying the purpose of the duty, it can readily be seen that a SAAMCO-type counterfactual analysis is just a cross-check, rather than the foundation of the relevant analysis.
Where the Appellate Court’s Analysis went wrong?
The society sought to argue that its basic loss was within the scope of Grant Thornton’s duty on the ground that this loss resulted from having to break the swaps before term and that the risk of that happening was a risk which Grant Thornton owed a duty of care to protect the society against. The Courts below erred which reaching to the conclusion that the society did not suffer loss from having to break the swaps before term and the said loss was caused by entering into swaps with 50-year terms and retaining them for several years (as a result of a combination of its own imprudence and Grant Thornton’s negligent advice). The Bench opined that the evidence did not show that the loss suffered would have been avoided or reduced if the society had not needed to break the swaps.
To the contrary, the evidence indicated that the society’s loss would have been even greater if the swaps had not been broken. Therefore, the judge was bound to conclude that the society’s decision to enter into swaps with terms far longer than the likely duration of the mortgages, combined with the way that interest rates turned out, were the only effective causes of its loss. Hence,
“An equally effective cause was Grant Thornton’s negligent professional advice, maintained over a period of some seven years, that it was permissible to use hedge accounting and prepare accounts which showed the swaps to be a highly effective hedge for the lifetime mortgages, thereby hiding the mismatch between the values of the swaps and mortgages and the society’s inadequate regulatory capital.”
Conclusion
In the backdrop of above, the appeal was allowed and it was held that Grant Thornton was liable to pay the overall net loss of (approximately) £26.7m to the said society, subject to a 50% reduction for contributory negligence.[Manchester Building Society v. Grant Thornton UK LLP, (2021) 3 WLR 81, decided on 18-06-2021]
Kamini Sharma, Editorial Assistant has reported this brief.