SAAMCO extended to Accounting Claims: A Defendant's Assumption of Responsibility Remains a Key Factor in Professional Indemnity Claims
On the 2nd May 2018, Teare J handed down the decision in the case of Manchester Building Society v Grant Thornton UK LLP  EWHC 963 (Comm). The judge applied the principles established in South Australia Asset Management Corp v York Montague Ltd  AC 191 ('SAAMCO') and re-affirmed in the case of Hughes v BPE Solicitors  2 WLR 1029 ('BPE') to an accountant's negligence claim. This article discusses the implications of the application of these principles to accountants and considers the impact the Judgment may have on future professional indemnity claims, in particular the emphasis placed on the assumption of responsibility.
The Claimant, a small building society, bought a claim for damages against the Defendant accountancy firm. The claim was based on the Defendant's negligent advice in relation to the availability of hedge accounting.
In 2006, the Claimant entered into the business of offering lifetime mortgages and hedged the mortgages by entering into interest rate swaps. They sought advice from the Defendant as to whether they could use 'hedge accounting' under the International Financial Reporting Standards ('IFRS') to reduce the volatility of the claimant's balance sheets caused by the recording of the rate swaps in the profit and loss accounts. The Defendant advised that 'hedge accounting' was a method of accounting open to the building society and appropriate in the circumstances. The Claimant then entered into further interest swaps to hedge their lifetime mortgage books and implemented 'hedge accounting' to record these transactions.
The financial crisis in 2008 led to a continued fall in interest rates and this affected the fair value of the interest swaps the Claimant had entered into. The change in the value of the interest swaps was offset on the Claimant's balance sheet by using 'hedge accounting' to adjust the value of the mortgages. However, in 2013 it was discovered that 'hedge accounting' was not permitted under IFRS and consequently the Claimant's profit and losses were vulnerable to the full movement in the fair value of the interest swaps and could not be offset against the mortgages. This resulted in the Claimant's profits of £6.35m for 2011 becoming a loss of £11.4m, its net assets were reduced from £38.4m to £9.7m and the regulatory capital position was greatly reduced.
The Claimant had to close out the interest rate swaps, stop lending and sell its book of UK lifetime mortgages, which incurred losses of £48.5 million. The Claimant sought to recover these losses from the Defendant due to their allegedly negligent advice.
Almost, But Not Quite……One Key Factor Missing
It was conceded by the Defendant that the advice given in respect of the 'hedge accounting' was negligent. It was also conceded that the further auditing of the Claimant's accounts between the years 2006 and 2011 was negligent.
In addition to the Defendant's concessions, Teare J found:-
- The 'but for' causation test had been satisfied – it was more likely than not that "but for" the Defendant's negligent advice, the Claimant would not have suffered the costs of breaking the swaps in 2013. This is because the Claimant would not have entered into interest swaps after April 2006 and would have closed out those it had already entered into.
- The Defendant's negligence was an effective cause of the loss – the reason hedge accounting was utilised was to reduce the volatility of the movement in the fair value of the swaps. Once it was realised that this accounting could not be used, the Claimant's balance sheet was exposed to the full volatility of the fair swaps and it was this that led to the decision to break the swaps and incur the loss. Therefore the accounting was one of the effective causes (amongst others) of the Claimant's losses.
- The losses incurred by the Claimant were not too remote
Despite the above findings, Teare J found that the losses incurred by the Claimant in breaking the swaps were not recoverable from the Defendant. Put simply, the missing factor was an assumption of responsibility by the Defendant towards the Claimant. Teare J found that the losses fell outside the Defendant's scope of duty because they had not assumed responsibility for such losses.
The loss flowed from the market force (falling interest rates for a continued period) for which the Defendant had not assumed responsibility. The principle established in SAAMCO, that the Defendant had to assume responsibility for a particular loss to be liable, applied and was extended to the profession of accountants.
SAAMCO involved lenders who received a negligent valuation of a property, which stood as security for a loan. When the borrowers of the loan defaulted and the security was realised the property market had fallen and the value of the property had reduced significantly. However, the court found that the valuers could only be liable for the difference between the valuation and the true value of the property at the time of the valuation. The valuers could not be responsible for the further losses caused by the fall in the property market because such losses were not within the scope of the valuers' duty.
The principle in SAAMCO was confirmed and applied in the BPE case. Here a firm of solicitors negligently drew up a loan facility agreement but were not legally responsible for the client's decision to make the loan. They had only been instructed to draw up the agreement and could not be responsible for the client's commercial misjudgement in lending the money, as this was not within the scope of the solicitor's duty.
Given the decisions in both SAAMCO and BPE it is less surprising that Teare J found that the accountants were not liable for the losses suffered by Manchester Building Society in breaking the swaps and those such losses were consequently not recoverable.
This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.