The Supreme Court have handed down a significant judgment in the case of Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20 which is now the leading authority in decisions relating to damages resulting from negligent professional advice.
The decision significantly alters the legal terrain in such cases. All firms who give or receive professional advice should take careful note of the statement of legal principles set out in this judgment.
Alex Sharples, Senior Associate in our Commercial Litigation Practice and Cecilia Busby, Trainee Solicitor in our Commercial Litigation Practice, consider the judgment and its implications in detail below.
Background
GT advised MBS in 2006 with respect to the accounting treatment of interest rate swaps entered into by MBS to hedge its lifetime mortgages. The volatility in MBS's finances caused by the use of swaps was understood and accepted by MBS's management and accounts department, and they did not require advice on the commercial decision as to whether to use swaps to match their mortgages. However, the volatility in their finances caused by the use of swaps, had they been reported in the accounts at 'fair value' and unrelated to the mortgages against which hedging was sought, would have required MBS to carry greater amounts of capital under the FSA's (now PRA) regulatory regime than they had, and thus limited their ability to use this commercial model.
MBS sought advice from GT on whether they could use a system of accounting known as 'hedge accounting', which matched the swaps with the mortgages they were designed to hedge, greatly reducing the need for regulatory capital. GT advised MBS, in full knowledge of the reasons for which they required this advice, that they could indeed use hedge accounting and thus reduce their need for regulatory capital, allowing MBS to further develop the business model of matching swaps and lifetime mortgages, which they then did.
The advice was repeated yearly at MBS's annual audit, when GT certified that the accounts, drawn up using the hedge accounting model, gave a true and fair view of its financial position.
In 2013, MBS discovered that GT's advice had in fact been incorrect. MBS could not make use of hedge accounting, and the increased volatility revealed in their accounts as a result, together with the fall in value of the swaps as a result of the 2008 crash, meant that they no longer held sufficient regulatory capital. The swaps had to be closed out, at a loss of £32.7 million.
The High Court Decision
The High Court found that GT had given negligent advice, which had caused MBS to enter the swaps. Thus GT had taken responsibility for foreseeable losses that flowed from that advice. However, the court held that GT had not assumed responsibility for the market value reduction in the value of the swaps due to the financial crash and hence did not owe damages for the majority of the loss: damages were limited to around £300,000 of administrative fees.
The Court of Appeal Decision
The Court of Appeal (CA) came to a similar conclusion but on different grounds, applying a distinction developed in the previous leading case of South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191 (SAAMCO) between the provision of 'advice' and the provision of 'information'. Where the professional advice given is by way of 'information', a 'counterfactual' analysis – what would the loss have been had the information been correct? – may be applied to ascertain damages. In applying the counterfactual of whether the loss would have been suffered anyway if GT's advice had been correct, the CA found that the loss on the value of the swaps was due to the 2008 financial crash, and would have crystallised at term anyway, even had MBS not had to close out the swaps in 2013.
The Supreme Court Decision
The Supreme Court (SC) judgment can be considered a deliberate and careful attempt to set out the definitive principles to be followed in cases of economic loss flowing from negligent professional advice. The constitution of the court was the same as that in a recent medical negligence case, Khan v Meadows [2021] UKSC 21, and the judgment made clear at the outset that this was done in order to provide, in parallel with the Khan case, an overarching set of principles for determining the scope of duty of care in professional advice cases. There was a clear intent to replace some of what the court considered unhelpful principles in the previous leading case of SAAMCO, and to some extent to consider and integrate the various judgments that had preceded and followed it, significantly returning to the principles for determining pure economic loss outlined in Caparo Industries plc v Dickman [1990] 2 AC 605 (Caparo).
The SC held that GT were liable for the losses suffered by MBS, as these losses were within the scope of GT's duty of care. MBS's management were however also negligent in developing an overly ambitious scheme. Contributory negligence was assessed at 50% and GT were found liable for damages of half of the net loss, i.e., approximately £13 million.
The actual financial result, however, will be of less interest to the majority than the reasoning behind it laid out by the SC.
In assessing how to evaluate responsibility for the economic losses flowing from negligent advice the court to some extent returned to the first principles of tort law. It is of course necessary to assessing damages for negligent advice that there is causation between the advice and the loss suffered: i.e., that the court can establish that 'but for' the negligent advice, the transaction at issue would not have been entered into, and the losses would not have been sustained.
However, a negligent advisor may not be liable for all the losses flowing from that transaction. There is always a second stage of assessing the actual damages for which the advisor is responsible.
As a result of the analysis put forward in SAAMCO, courts have tended to broadly follow a scheme to determine the actual damages which was outlined in that judgment. This scheme distinguished between 'advice' and 'information', as set out below.
Advice cases: Where the advice given by the negligent advisor can be said to fall into the category of 'advice' - that is, the client is wholly reliant on it for making a particular decision or entering into a particular transaction – then the advisor is responsible for all of the losses which flow from the transaction, and the client can seek damages that would put it back in the position it would be had the transaction not been entered into.
Information cases: Where the advice is in the category of 'information' however, the situation is different. While the information may be important, even crucial, to the decision of the client to go ahead, damages can only flow from losses related to that specific information, not the whole transaction. If the loss was caused by other factors, even though the client would not have sustained them 'but for' the negligent advice, they cannot be considered the liability of the advisor. In seeking to ascertain the extent of the losses related to the 'incorrect' information, Lord Hoffman suggested the use of the counterfactual scenario in which the advice was in fact, correct. The difference between the actual loss sustained and the loss had the advice been true was the most that the advisor could be held responsible for: this in effect 'capped' the liability and has become known as the 'SAAMCO cap'.
To illustrate this point, Lord Hoffman cited the case of a mountaineer who seeks medical advice after a knee injury. Negligent advice that the knee is sound leads the mountaineer to carry on with an expedition in which he suffers loss, but not as a result of the knee injury. Had the advice been correct, i.e., the knee had indeed been sound, the loss would still have been suffered in exactly the same way, and hence the medical practitioner cannot be held liable, even though the climber would not have embarked on the expedition had he known that his knee was not sound.
In effect, it was this sort of reasoning that was applied in the CA decision in this case: GT's advice was treated as in the category of 'information' and, applying the counterfactual, the loss to MBS sustained by being forced to close out the swaps in 2013 was not greater than the loss that would have been sustained had GT's negligent advice been correct and they had held the swaps to term.
The SC decision has in effect swept away much of the architecture of this scheme and returned to basic first principles of tort law.
Instead of categorising advice in terms of 'information' or 'advice', the SC emphasised that the second stage of narrowing the liability from the whole of the loss to the loss actually caused by the negligent advice must involve determining the scope of the advice given: what were the specific risks to guard against which the advice was sought?
Only losses reasonably considered to come within the scope of that advice could be considered to losses for which the advisor was responsible and from which he had a duty of care to protect the client.
This scope is to be ascertained, following Caparo, by examining the purpose for which the advice was sought, judged objectively. As the SC stated:
'in our view, 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 reason why the advice is being given'
Hence, the court should first look to see what risk the advice was supposed to guard against and then look to see 'whether the loss suffered represented the fruition of that risk'.
Seeking to make a distinction between 'advice' and 'information' thus becomes an unnecessary distraction from the basic principle of examining the purpose of the advice. Most professional advice sits in a continuum between pure 'information' – allowing the client to make the decision on a number of grounds, of which the information provided is only one – and pure 'advice', where the advisor essentially makes the decision for the client. Liability flowing from the former would obviously be less than that flowing from the latter, but this is not because one is in a category called 'information' and the other in a category called 'advice' but rather because the purpose of the advice in the first case is relatively circumscribed (guarding against the risk represented by that one element of the decision), while in the second case it encompasses guarding against the whole risk of the decision.
Similarly, the use of counterfactual scenarios was held to be unhelpful, not least because it was possible to construct elaborate alternative counterfactuals and in complex cases the case could easily descend into competing arguments about the parameters of the counterfactual world.
Applying these 'first principles' of the scope of duty of care, it was held that the purpose of GT's advice to MBS was to assure them that they could legally use hedge accounting to reduce the volatility of their balance sheet and (per Lord Leggatt) that that there was indeed an effective hedging relationship between the swaps and the mortgages. When both of these assurances proved to be incorrect, MBS was forced to close out the swaps at a considerable loss.
The purpose of GT's advice was clearly to mitigate the risk of entering into this business model. MBS's losses thus fell within the scope of GT's duty of care. That MBS's management were also negligent resulted in the reduction of the primary liability by 50%.
Conclusion
This case is a definitive statement of the law on economic loss arising from negligent advice. It will reduce some of the artificiality of the distinctions between 'advice' and 'information', forcing the court to focus more squarely on the purpose for which advice is sought.
Going forward, both clients and the professional firms they instruct would be well advised to make it clear from the outset what the purpose of any advice is and how it is intended to be used by the client; and particularly the specific risks which the client wishes to guard against by seeking professional advice, as well, perhaps, as any risks the advisor specifically does not consider that their advice mitigates against.
To return to Lord Hoffman's mountaineer's knee example, professional services firms might well wish to make it clear that while they consider the knee to be stable enough for an expedition, they cannot speak to the possibility of avalanches.
