A lender’s conduct comes under the spotlight in a case that considered the concept of unreasonable reliance in respect of an excessive valuation
● A lender can claim to have “relied” upon a negligent valuation even where that reliance is unreasonable
● But unreasonable reliance will amount to contributory negligence
No sooner have we pointed out (17 May) that negligence cases between lenders and valuers have been few and far between in recent times, than — guess what — one appears. Enter Speshal Investments Ltd v Corby Kane Howard Partnership Ltd (t/a HBSV) [2003] EWHC 390 (Ch). This contains few real lessons for valuers, since the defendant had little choice but to concede that its valuations were negligent. However, the past decade has seen valuers counter-attacking when sued by lenders, and Speshal illustrates some of the ways in which a lender may neglect its own interests.
The claimant was a special purpose company. Its core business consisted of short-term bridging finance to commercial property borrowers. When asked for a loan, it operated on the basis of a set of lending criteria produced by its solicitor. The principal criterion was that the company would lend no more than 70% of the forced sale value of the property upon which the loan was to be secured. The forced sale value was to be on ERRP or “estimated restricted realisation price” terms, the relevant restriction being the assumption of a hypothetical sale completed within three months (that is, less than would normally be required for proper marketing of a property).
In June 1999, the claimant was approached by Cheyne Lodge Investment Ltd, which wished to acquire a portfolio of properties in the North West. The company needed finance for a period of three months, pending a restructuring of its long-term financial arrangements with a major bank. Cheyne believed that the properties in question represented a bargain. In the event, a loan of £1.15m, secured on three of the properties, was made in the October.
The case under discussion concerned a further advance, secured on a further four properties; this was finalised early in February 2000. These properties had been valued in November and December 1999 by the defendant, which had been instructed by the borrower on the basis that its valuations would be shown to the lender.
The second loan of £1.9m was based upon the defendant’s valuation of the properties at £2.99m, and was further secured by personal guarantees from two of the borrower’s directors. This loan was not repaid when it fell due, and the properties were repossessed and sold early in 2001 for around £875,000. The claimant then started proceedings against the defendant, which conceded that its valuations had been negligent, since the true value of the properties on the date of valuation was only £1.13m.
The defendant raised two issues in its defence. First, the claimant had not relied upon its valuations in deciding to enter into the loan transaction. Second, even if it had so relied, its reliance was so unreasonable as to amount to contributory negligence.
The issue of reliance turned on discussions between the parties concerning a caveat in each valuation report as to the limited nature of the information upon which it was based. According to the defendant (which was obliged to tone down the clauses), these discussions left the claimant in no doubt that the defendant feared that the valuations might be unreliable. But the judge held that the claimant’s concern had always been to have valuations upon which it could rely, and that it did place reliance upon them.
The really important issue, that of contributory negligence, turned on the reasonableness or otherwise of the claimant’s reliance upon the valuations. The defendant raised a number of arguments, notably that the claimant had: known of the lack of verifiable information upon which they were based; paid inadequate regard to the considerable margin by which the valuations exceeded the purchase price of the properties; had likewise disregarded the difference between the defendant’s figures and earlier valuations by another firm; had lent more than the purchase price, with the result that the borrower had no equity risk; and had taken no steps to check the financial worth of either Cheyne or of the two directors who had given personal guarantees.
Most of these arguments were rejected by Hart J. But he regarded as crucial the disparities between valuations and purchase prices and (less significantly) between the two sets of valuations. As he put it:
There were only two possible explanations for the wild disparities. On the one hand Cheyne had… a fantastic bargain on its hands… On the other hand, the possibility was that the valuers had got it wrong.
Faced with the latter possibility, a prudent lender would have made searching enquiries into the valuer’s methodology and assumptions. This might have raised doubts as to its reliability and competence. Thus:
by its failure to subject the… disparities to the critical analysis to which a prudent lender would have subjected them, the claimant deprived itself of a significant chance which it would otherwise have had of avoiding the loss.
Contributory negligence was established. The judge then considered what reduction from the claimant’s damages would constitute a “just and equitable” allocation of its share of responsibility. Having decided that it should not be a token amount, he ordered that the damages payable to the claimant should be reduced by 20%.
Although no reference was made to previous case law, this result was the same as that in Nyckeln Finance Co Ltd v Stumpbrook Continuation Ltd [1994] 33 EG 93, where, again, a lender had made an attempt, albeit ineffective, to seek confirmation of a valuation about which it had doubts.
John Murdoch, professor of law, Reading University
