Professional negligence – Liability – Auditor – Respondent auditor negligently advising appellant about applicability of hedge accounting to reduce effect of volatile mark-to-market value of interest rate swaps – Whether court wrongly concluding respondent not liable for losses incurred when swap agreements closed out at loss on negligent advice coming to light – Court of Appeal dismissing appeal – Appellant appealing – Appeal allowed
The appellant was a mutual building society. The respondent was a firm of accountants which audited the appellant’s accounts. Between 2004 and 2009, the appellant issued a number of fixed interest lifetime mortgages designed to release the equity in a house to its owner on terms that the loan and interest were not repayable until the owner either entered a care home or died. Until that time, which was necessarily uncertain, interest compounded.
The appellant hedged its interest rate risk by purchasing interest rate swaps. The respondent negligently advised the appellant that it could apply hedge accounting to reduce the effect in its accounts of the volatility of the mark to market (MTM) value of swaps. In reliance on that advice, the appellant entered into fixed rate mortgages hedged against long-term swaps under which it paid a fixed rate and received a variable rate. As a result of the financial crisis and fall in interest rates, the MTM value of the swaps became negative. The respondent’s error came to light and the appellant was advised that it could no longer apply hedge accounting. Therefore, in 2013 it closed out the swaps and had to pay the MTM losses on the swaps and transaction fees for breaking the swaps early.
An issue arose whether the appellant could recover in damages the cost of closing out the swaps from the respondent. The High Court and the Court of Appeal held that it could not: [2018] EWHC 963 (Comm); [2019] EWCA Civ 40; [2019] PLSCS 21. The appellant appealed.
Held: The appeal was allowed unanimously.
(1) (Lords Hodge, Sales, Reed, Kitchin and Lady Black) It was helpful to analyse the scope of a defendant’s duty of care in the context of professional advice given by accountants, as laid down in South Australia Asset Management Corp v York Montague Ltd [1996] 2 EGLR 93 (SAAMCO), within a general conceptual framework in the law of the tort of negligence. The scope of that duty of care was governed by the purpose of the duty, judged on an objective basis by reference to the purpose for which the advice was being given. The distinction between “advice” and “information” cases drawn in SAAMCO was not to be treated as a rigid straitjacket. Counterfactual analysis should be regarded only as a tool to cross-check the result given pursuant to analysis of the purpose of the duty but one which was subordinate to that analysis and should not supplant or subsume it: Hughes-Holland v BPE Solicitors [2017] UKSC 21; [2017] EGLR 23 followed.
(2) The correct approach when a claimant sought damages from a defendant in negligence, was to ask: (i) whether the harm (loss, injury and damage) which was the subject matter of the claim was actionable in negligence; (ii) what were the risks of harm to the claimant against which the law imposed on the defendant a duty to take care; (iii) whether the defendant breached their duty by their act or omission; (iv) whether the loss for which the claimant sought damages was the consequence of the defendant’s act or omission; (v) whether there was a sufficient nexus between a particular element of the harm for which the claimant sought damages and the subject matter of the defendant’s duty of care; and (vi) whether a particular element of the harm for which the claimant sought damages was irrecoverable because it was too remote, or because there was a different effective cause in relation to it or because the claimant had mitigated their loss or failed to avoid loss which they could reasonably have been expected to avoid.
The application of that analysis gave the value of the claimant’s claim for damages in accordance with the principle that the law in awarding damages sought, so far as money could, to place the claimant in the position they would have been in absent the defendant’s negligence. For the purposes of accurate analysis, rather than starting with the distinction between “advice” and “information” cases and trying to shoe-horn a particular case into one or other of those categories, the focus should be on identifying the purpose to be served by the duty of care assumed by the defendant.
(3) The purpose of the respondent’s advice was clear. The appellant looked to the respondent for technical accounting advice whether it could use hedge accounting to implement its proposed business model within the constraints arising by virtue of the regulatory environment, and the respondent negligently advised that it could. It had the effect that the appellant 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 was exposed to the regulatory capital demands which the use of hedge accounting was supposed to avoid. That was a risk which the respondent’s advice was supposed to allow the appellant to assess, and which their negligence caused the appellant to fail to understand.
It was not in dispute that the loss in issue formed part of the appellant’s basic loss flowing from the respondent’s negligent advice. Examination of the purpose for which that advice was given showed that the loss fell within the scope of the duty of care. Having regard to that purpose, the respondent in effect informed the appellant 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.
(4) The judge was entitled to make the assessment that the appellant’s damages should be reduced by 50% on the basis of its contributory negligence. The contribution by the appellant to its own loss arose from the mismatching of mortgages and swaps in what was an overly ambitious application of the business model by the appellant’s management.
(5) Lords Burrows and Leggatt gave concurring judgments setting out different opinions on the proper approach to the scope of duty principle and its proper location in the tort of negligence.
Rebecca Sabben-Clare QC, Benjamin Parker and Harry Wright (instructed by Squire Patton Boggs (UK) LLP, of Manchester) appeared for the appellant; Simon Salzedo QC, Adam Rushworth and Sophie Shaw (instructed by Taylor Wessing LLP) appeared for the respondent.
Eileen O’Grady, barrister
Click here to read a transcript of Manchester Building Society v Grant Thornton UK LLP
