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SAAMCo, Supreme Court and Scope of Duty

  • Legal Development 29 juin 2021 29 juin 2021
  • Royaume-Uni & Europe

  • Pratiques professionnelles

The Supreme Court has upheld the claimant’s appeal in Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20 and, in doing so, has reframed the long-established, if never quite certain, ‘SAAMCo’ principle derived from South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191. It has also set out a general framework to be applied in the tort of negligence. At the same time, the Supreme Court handed down a judgment in Khan v Meadows [2021] UKSC 21, which considered scope of duty principles in a clinical negligence context (click here for more detail). The Supreme Court indicated that both judgments should be considered together.

While it remains the case that an adviser will be liable only for losses which fall within the scope of its duty of care to a claimant, key now to assessing the scope of that duty is identification of the purpose of the duty assumed by the adviser. The SAAMCo distinction between “information” and “advice” cases (which limited the professional’s liability in “information” cases to the foreseeable consequences of the information being wrong) has effectively been discarded.  In addition, the SAAMCo counterfactual (which asked in an “information” case whether the claimant’s actions would have resulted in the same loss if the information given by the defendant had been correct) while not completely redundant, is now subordinate to an analysis of the purpose of the duty; it may be a means to sense-check the outcome, but no more. Inevitably, this will invite more textured thinking around (1) client and adviser expectations at the point of, and throughout, engagement, and (2) the sensitivity of precise fact-sets in the early consideration of claims. This article considers Manchester with particular focus on its implications for accountants and auditors.

Background

Grant Thornton (“the auditor”) incorrectly and negligently advised Manchester Building Society (“MBS”) that its accounts could be prepared using a method known as “hedge accounting”, and that, prepared on that basis, the accounts gave a true and fair view of MBS’ financial position. In reliance on that advice, MBS pursued a business model of entering into long-term interest rate swap contracts as a hedge against the cost of borrowing money to fund mortgage lending. The auditor’s error was repeated in subsequent years when the auditor signed an audit opinion, stating that the society’s annual accounts, drawn up on the basis of the hedge accounting policy, gave a true and fair view of its financial position. The misstated accounts hid volatility in the society’s capital position and what 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 the accounting error was realised, MBS had to restate its accounts to show substantially reduced net assets and insufficient regulatory capital and had to close out the swaps at a cost of 32.7 million.  The question for the Court was whether MBS could recover this loss from the auditor.

High Court and Court of Appeal

In the High Court, Teare J applied the SAAMCo test to find that the auditor was not liable for MBS’s £32.7m loss resulting from having had to break the swaps. He did not find it necessary to decide whether this was an “information case” or an “advice case”. Instead, he based his reasoning on a finding that the auditor had not assumed responsibility for this type of loss, flowing as it did from market forces (a sustained fall in interest rates). All the auditor had assumed responsibility for was certain penalty costs associated with terminating the swaps, as well as a number of professional fees. The Judge’s reasoning ruled out recovery by MBS of the bulk of its loss, even though MBS had made out factual causation (as MBS would not have entered into more long-term swaps, and would have closed out its existing ones, if the auditor had not been negligent), lack of remoteness (as the type of loss claimed was in the auditor’s contemplation as not unlikely to result from its negligence) and legal causation (as there was no break in the chain of causation).

The Court of Appeal dismissed MBS’ appeal, but its reasoning diverged from that of Teare J. The Court was unanimously of the view that SAAMCo did not support a free-standing “assumption of responsibility” approach. Instead, the Court applied the “information case” vs “advice case” distinction. It held that this was an information case and MBS was unable to prove that, if the auditor’s advice had been correct, it would not have suffered the same loss. The mark-to-market losses on the swaps would have been suffered even if MBS had not broken the swaps; the discovery that the auditor’s advice was incorrect had merely crystallised those losses. The Court applied a SAAMCo counterfactual (“Would the same loss have been suffered if it had been true that it was acceptable to use hedge accounting?”) in support of its decision that the auditor could not be held liable for the swap losses.

The Supreme Court

On appeal by MBS to the Supreme Court, by judgments given on 18 June 2021 (in which not all the Justices’ underlying reasoning was fully aligned), the Supreme Court upheld MBS’s appeal (although it applied the 50% reduction for contributory negligence set out by Teare J and took account of the £5.6m profit MBS realised from the sale of its book of lifetime mortgages).

The Supreme Court set out a framework of six questions that it suggested could be helpful when considering the place of the scope of duty question in the tort of negligence. These were as follows:

  1. Is the harm (loss, injury and damage) which is the subject matter of the claim actionable in negligence? (the actionability 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).
  3. Did the defendant breach his or her duty by his or her act or omission? (the breach question).
  4. Is the loss for which the claimant seeks damages the consequence of the defendant’s act or omission? (the factual causation 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).
  6. 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 novus actus interveniens) in relation to it or because the claimant has mitigated his or her loss or has failed to avoid loss which he or she could reasonably have been expected to avoid? (the legal responsibility question).

 

In allowing the appeal, the Supreme Court re-cast the approach to be taken in assessing the extent of liability of professional advisers in the tort of negligence (which applies equally to any parallel liability in contract for failure to act with reasonable care and skill). The proper approach is as follows:
 

  1. The scope of duty question should be located within a general conceptual framework in the tort of negligence (the six questions set out above);
  2. The scope of the 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;
  3. The distinction between “advice” and “information” cases drawn in SAAMCO should not be treated as rigid strait-jacket;
  4. The counterfactual analysis should be regarded only as a tool to cross-check the result given pursuant to analysis of the purpose of the duty (see (ii) above), but one which is subordinate to that analysis and which not should supplant or subsume it.

 

Question two (“the scope of duty question”) was the central question in the appeal. The Supreme Court said that  to answer this question and identify the purpose of the duty  judged on an objective basis by reference to the purpose for which the advice is being given, “one looks to see what risk the duty was supposed to guard against and then looks to see whether the loss suffered represented the fruition of that risk”. In some cases, the Supreme Court explained, it might be possible to answer the purpose question without the need to consider questions of breach and factual causation. However, where (as here) the question of scope of duty was relevant to the extent of a single type of loss, it was more practical to look at the question of scope of duty after considering the extent of the basic loss which flowed from the defendant’s alleged negligence and consider the scope of duty and nexus questions together to determine the extent to which the basic loss fell within the scope of the duty owed by the professional.

Applying the above approach, the Supreme Court concluded that the purpose of the advice (appreciated by the auditor) was to determine whether hedge accounting could be used by MBS to implement its desired business model within the regulatory environment; hedge accounting, if applicable, enabled MBS to have sufficient capital resources to carry on its business.

The Supreme Court found that the purpose of the auditor’s advice was clear: “They advised that [MBS] could employ hedge accounting in order to reduce the volatility on its balance sheet and keep its regulatory capital at a level it could afford in relation to swaps to be held to term on the basis that they were to be matched against mortgages. In other words, [MBS] looked to [the auditor] for technical accounting advice whether it could use hedge accounting in order to implement its proposed business model within the constraints arising by virtue of the regulatory environment, and [the auditor] advised that it could. That advice was negligent. It had the effect that the society adopted the business model, entered into further swap transactions and was exposed to the risk of loss from having to break the swap, when it realised that hedge accounting could not in fact be used and [MBS] was exposed to the regulatory capital demands which the use of hedge accounting was supposed to avoid. That was a risk which [the auditor’s] advice was supposed to allow [MBS] to assess, and which their negligence caused [MBS] to fail to understand.”

They agreed that Teare J at first instance was essentially correct, when he found that, whether classified as information or advice, the auditor’s contribution was supplied with the accepted purpose of avoiding or mitigating the volatility to which the balance sheet would be exposed if hedge accounting were not deployed. However, he should, in their view, have gone on to conclude that the auditors were liable for the losses suffered by MBS in being compelled to break the swaps once the true accounting position was appreciated.

Alternative views on the place of the SAAMCo principle in the analysis of a negligence

Although all seven Supreme Court judges were unanimous in allowing MBS’ appeal, there were distinctions in the reasoning they applied. Lord Leggatt regarded the scope of duty principle as being based on causation. In his view, the question to ask was what the causal relationship was between what made the information or advice provided by the professional wrong, and the loss. The professional’s responsibility is limited to the foreseeable consequences of the matters that he or she “got wrong” (i.e. misrepresented or failed to report). Lord Burrows stressed that the scope of duty principle is underpinned by the policy of achieving a fair and reasonable allocation of the loss between the parties.

While the distinction between the focus on the purpose of the duty, the causal approach and the “fair and reasonable” enquiry may seem slight, the difference in emphasis could lead to different results. For example, on the approach of the majority, the emphasis is likely to be on the commercial setting of the professional relationship, what was communicated between the parties as to the purpose for which the professional was being hired and in what circumstances his/her advice was to be used etc. (an analysis akin to the exercise a court will carry out to decide on the true construction of a contract and any terms to be implied into it). By contrast, the approach of Lord Burrows, based as it is on policy considerations such as “fairness” and “reasonableness”, is less dependent on evidence of the parties’ actual relationship and may therefore lead to results which the parties are less able to anticipate (for example by defining the scope of their relationship as tightly as possible in the terms of engagement).

Difficulties in applying the SAAMCo counterfactual test

The Supreme Court considered carefully the use of the counterfactual test proposed in SAAMCo to assist in identifying the extent of loss suffered by a claimant which falls within the defendant’s scope of duty - namely to ask 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. If so, then a cap to the recoverable damages is generated. The Court was wary of the counterfactual test becoming a driver for the outcome of a case, when its application enables “elaborately constructed worlds advanced by each side, which would become increasingly untethered from reality the further one moves from the relatively simpler valuer case addressed in SAAMCo.” The Supreme Court indicated that the counterfactual could be used as a cross-check to the central question of the purpose of the duty in some cases; Lord Burrows (with whom the majority agreed), highlighting that the more limited the advice and information provided (and the more left for the client to decide) the more appropriate application of the counterfactual as a cross check was likely to be. The passage of the case up to the Supreme Court and the different counterfactuals posited by both parties was an illustration, the Supreme Court said, of the difficulties in applying a counterfactual analysis in an audit case where there will be a whole range of factors underlying the conclusion that the accounts gave a true and fair view of the financial position.

Contributory negligence

At first instance, Teare J decided that if he were to have awarded the full losses contended for by MBS i.e. the costs of breaking the swaps, he would have reduced them by 50% on account of MBS’ contributory negligence; specifically, he found that MBS had been negligent in failing to realise that its hedge accounting policy did not allow for substitution and did not reflect MBS’ intention to hedge using 50 year swaps which would last much longer than the initial mortgages. In the event, however, he held that the costs of breaking the swaps were not the type of losses for which the auditor assumed responsibility, and that those losses which were recoverable by MBS should only be reduced by 25% for contributory negligence. The Supreme Court has upheld his assessment of a 50% reduction for contributory negligence in relation to the full losses now found in scope of the auditor’s duty citing an “overly ambitious” application of the business model.

Conclusion

It remains to be seen whether the application of the principles elucidated by the Supreme Court will impact significantly on the extent of losses recoverable from professional advisers. Certainly, the distinct reasonings of the concurring judgments (Lord Leggatt and Lord Burrows) indicate that even after the Courts’ careful consideration of these matters, the route to scoping duty is far from straight, and parties will wish to focus on whether, on the specific facts of their cases, those distinctions can be exploited.

SAAMCo persists, but is now of more limited application; the counterfactual analysis still has its place in suitable cases, and may be a useful cross-check in “information” cases, but it is no adequate substitute for the fundamental assessment of purpose of the duty,  which is characterised as “an appropriate and refined basis for identifying, out of what may be a wide range of factors which contribute to the claimant’s loss, the factors for which the defendant is responsible.

Assessment of the purpose of the duty will lie in a careful analysis of client and adviser expectations and understanding at the point of engagement, and the extent to which those are manifest in the engagement terms agreed. Professional advisers must obtain a thorough understanding of clients’ business models and commercial goals, and assess to what extent their services will contribute to or underpin them. For those engagements which occur or develop without formal written terms, the importance of contemporaneous documents to aid later appreciation of what was understood by the parties at the time of relevant events will be even more critical. Moreover, as engagements progress, parties will need to be alive to developments which might indicate a re-purposed duty.

For audit professionals, by its current proposals for audit and corporate governance reform, the Government proposes to significantly increase the scope of financial and other corporate reporting. On the basis of the current proposals, the auditors’ assurance role in relation to non-financial reporting is unclear. In those circumstances, auditors should be quick and thorough to horizon-scan and ring-fence their possible liabilities as and when any reforms are implemented, mindful of the question which the Supreme Court has now illuminated – what is the purpose of the (assurance) duty in any given case?

Fin

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