Supreme Court restates test for application of SAAMCO principle

On Friday 18 June 2021, the Supreme Court handed down judgment in  Manchester Building Society v. Grant Thorton UK LLP [2021] UKSC 20.

The decision restates the test for the application of the principle defined in the 1996 House of Lords decision in Banque Bruxelles Lambert SA v Eagle Star Insurance Co Ltd; South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191.

Before the Supreme Court’s decision, SAAMCO was understood to distinguish the damages awarded for negligent information from the damages awarded for negligent advice.

In SAAMCO, which concerned the negligent valuation of commercial property, the House of Lords concluded that the valuer was only liable in damages for the difference between the negligent valuation of the property stated and the (lower) actual value of the property at the date of valuation.  The banks in question had lost significant sums on loans advanced against the properties valued negligently.  The banks sought to recover those losses from the valuers.  The SAAMCO principle limited their damages to a much smaller amount.

In the Manchester Building Society decision, the Supreme Court has restated the test.  The Justices have restated the SAAMCO principle as merely an “analytical tool” to cross-check whether damages are assessed appropriately in the circumstances. 

The Supreme Court’s decision gives primacy to the purpose of the duty of care assumed by the professional and whether the loss claimed is with the scope of the duty of care assumed by the professional.  This is said to be done to avoid forensic points being taken in argument that the duty related to the provision of information, rather than the provision of advice.

The decision also clarifies the application of the SAAMCO principle in a more general and common commercial situation.  Some courts, including the High Court and the Court of Appeal in this case, found it difficult to apply the SAAMCO reasoning to cases outside of the sphere of valuation.  This decision should provide clarity in a broader range of commercial situations.

Key points for professionals and insurers

The Manchester Building Society decision appears to tip the balance in favour of claimants.  Provided claimants can demonstrate that the loss was foreseeable considering the scope of the duty of care assumed by the professional, it should – at least theoretically – be easier to recover damages.  All other elements of a tortious claim will also have to be satisfied to succeed.

Professional indemnity insurers are unlikely to welcome the latest decision.  The market is already “hard” and a number of indemnity insurers have already ceased providing cover to both new and existing customers. This decision may further dissuade some insurers continuing in the market, with the inevitable consequence of driving up prices.

We can also expect a round of redrafting of standard form engagement letters used by professionals to try and restrict the scope of the duty of care assumed to clients.  This in itself may spark a new wave of litigation as claimants who seek to litigate over negligent professional advice also argue over whether the contractual restrictions are fair terms to include in a standard form contract. 

Professionals may also have to consider what, if anything, their Codes of Conduct say about attempts to limit liability to clients.  The codes of conduct of many professional bodies – including solicitors, architects, accountants and others – contain restrictions on when and how liability to clients may be limited.

Potential wider applications in financial disputes

The Manchester Building Society case is an example of litigation following the global financial crisis of 2008-9.  There have already been many similar cases in the English courts involving financial institutions and disputes over complex financial products, including interest rate hedging swaps.  This has led to the recasting of many long-held principles in English law.

Some of these disputes have involved allegations that the selling bank owed a duty of care to explain the nature of the interest swap being sold.  Generally, the English courts have tended to reject the idea that a bank owes its customers a general duty of care, but it may owe a duty if there are clear words of advice or if the facts of the case require a duty to be imposed (see: for example, Property Alliance Group Ltd v Royal Bank of Scotland plc [2018] 1 W.L.R. 3529).

A bank may owe a duty of care to a customer where there is a Financial Conduct Authority or Prudential Regulation Authority rule requiring the bank to act in a particular way. In cases where the bank can be shown to have been subject to a rule with which it has not complied, the bank’s customer may have a statutory claim under section 138(D)(2) of Financial Services and Markets Act 2000 (see, for example: Abdullah v. Credit Suisse (UK) Limited and Another [2017] 2 C.L.C. 792, in which Seamus Andrew of Velitor Law acted successfully for the bank’s customer). 

Other financial disputes have involved allegations that a financial institution deliberately misrepresented the nature of a product to induce the customer to buy that product.  Again, the English courts have generally been reluctant to find in favour of customers, partly because of tightly drafted terms in bank engagement letters and warranties given by the customer at the outset of the contract. 

For example, in Springwell Navigation v. J. P. Morgan Chase Bank & Others [2010] 2 C.L.C. 705 the Court of Appeal held that a clause which fairly defined the future obligations of the parties under the contract (a so-called “basis clause”) could be relied upon (as a contractual estoppel) by a selling bank to argue that it had not assumed any duty of care to the customer and was not liable in misrepresentation for inaccurate statements of opinion expressed by its salesman.

Where terms seek to exclude liability on the basis of adjusting or negating past statements actually made by the parties, then such terms are not to be deemed the basis on which the parties have contracted and can be reviewed for reasonableness under the Misrepresentation Act 1967 and the Unfair Contract Terms Act 1977 (see, for example: First Tower Trustees Ltd and another v CDS (Superstores International) Ltd [2019] 1 W. L. R. 637).

As the law currently stands, it seems that this restatement of the SAAMCO principle will only be of assistance where the claimant can identify a duty of care owed, whether that is a statutory duty or a duty imposed at common law, that covers the loss in question when considering the purpose for which the duty was assumed.  The scope of such a duty may also depend on the terms of any contract and the course of previous dealing between the professional and the client.

Facts of the case

In the Manchester Building Society case, the building society claimed losses of c. £32 million from Grant Thornton.  Between 2006 and 2009 the Manchester Building Society (“MBS”) had expanded into offering lifetime mortgages to customers in the UK and Spain.  It appears it bought these mortgages from other lenders and operated them as a book with a view to making profit.  This was thought to provide better returns on capital than MBS’s traditional business.

Loans were secured against the borrowers’ residential properties.  The mortgages were at fixed interest rates.  The return on the mortgages was uncertain because MBS did not receive payment of principal or interest until the borrower died, sold the secured property, or exercised an option to repay the loan.  Interest on the loans rolled up until a repayment event occurred, subject to a cap that prevented the borrower from being in negative equity.

MBS would finance the mortgages by borrowing in the open market.  MBS’s own borrowings would be at variable interest rates.  MBS was in the classic position of borrowing variable but lending fixed. MBS determined that it would hedge its exposure to variable interest rates by purchasing swaps. 

Between 2002 and 2012 MBS entered into various sterling and Euro denominated interest swaps in an effort to hedge its exposure to these lifetime mortgages.  The term of these swaps was up to 50 years, which exceeded the term of the lifetime mortgage loan book.

In 2005, following the issue by MBS of listed Permanent Interest Bearing Shares (“PIBS”), MBS was required to change its accounting from UK Generally Accepted Accounting Practice (“UK GAAP”) to the International Financial Reporting Standards (“IFRS”).  A key distinction between UK GAAP and the IFRS was that UK GAAP did not require swaps to be recorded on MBS’s balance sheet, whereas IFRS did require the swaps to be recorded on MBS’s balance sheet.

Complying with the IFRS therefore involved MBS regularly “marking to market” the value of its interest swaps.  This would introduce significant volatility in MBS’s reported profits, and in turn the capital position on its balance sheet, because the swaps varied in value daily in accordance with market sentiment and interest rate changes.

Lacking internal expertise in the IFRS, MBS consulted its auditor, Grant Thornton, as to options available for reducing the reporting volatility.  MBS was concerned to avoid wide variations in profit reporting.  MBS was also concerned that it would always be able to meet its regulatory capital limits, imposed and supervised by the Financial Standards Authority at the time.

Grant Thornton told MBS it could use a complicated method of accounting known as “hedge accounting”.  This involved offsetting “mark to market” changes in the value of the swaps by making a similar, opposite adjustment to the value of the mortgages hedged by the swaps.  In this way, profit reporting volatility was greatly reduced.  MBS could also have some certainty around its regulatory capital ratios.

Under IFRS, hedge accounting could only be employed by MBS if the swaps delivered actual protection from the risk posed by borrowing in variable rates but receiving repayments at uncertain intervals on fixed rate loans.

Between 2006 and 2013 MBS duly implemented the hedge accounting treatment identified by Grant Thornton.  In turn, Grant Thornton gave a clean audit opinion on MBS’s accounts.

The global financial crisis in 2008-09 severely affected the value of MBS’s swaps and mortgage portfolio.  By 2012, MBS had to pay significant cash collateral to the swap counterparties to cover a loss of around £40 million.  The swaps ceased to provide any effective protection against MBS’s interest rate risks and became a significant liability for MBS.  Reductions in the property values of the lifetime mortgage portfolio also worsened MBS’s financial position.

By 2013, the Financial Services Authority had condemned MBS’s business model as unsustainable and very hight risk.  Grant Thornton itself advised that MBS was not entitled to use hedge accounting because the interest swaps were not delivering any effective protection for the mortgage book.  A second opinion from PwC confirmed the position. 

The effect of ceasing the hedge accounting treatment meant that by the time the swaps were terminated in 2013, MBS’s regulatory capital was £16 million (approximately 40%) below the minimum.  MBS’s profits for the year turned into a significant loss.

Accordingly, MBS had to take drastic steps to recapitalise itself by issuing new share capital, selling the UK lifetime mortgage book, ceasing new lending and closing out the interest swaps.  In June 2013, the swaps were closed at a loss of around £32 million.

MBS sought to recover its £32 million of losses from Grant Thornton.  Grant Thornton admitted that it had negligently failed to identify that hedge accounting was not in fact available to MBS, because the interest swaps did not in fact afford effective protection for the lifetime mortgage book, but disputed that it was responsible for MBS’s losses. 

Grant Thornton argued that its actions were covered by the SAAMCO principle.  Grant Thorton had advised on only one part of the information MBS took into account when making a commercial decision as to which hedging arrangements to make and which accounting treatment to adopt.  The losses MBS sustained as a result of those decisions turning out to be incorrect were not within the scope of Grant Thornton’s duty of care.  In particular, the losses would have been smaller if MBS had not bought 50 year swaps and instead bought shorter swap that more closely matched the term of the lifetime mortgage book.

The High Court and the Court of Appeal agreed, also holding that MBS was at least 50% liable for its own loss because MBS’s management had aggressively pursued an ill-conceived business model, including acquiring 50 year swaps and entering the lifetime mortgage business, when there were already warning signs about the long-term sustainability of the market.  The only damages the High Court and the Court of Appeal allowed were the fees paid to PwC for its second opinion on the applicability of the IFRS, some of PwC’s accountancy fees, some legal fees and some of the transaction fees incurred in breaking the swaps, a total of around £315,000.

As above, the Supreme Court – emphasising a previous decision in Hughes-Holland v BPE Solicitors [2018] A.C. 599– held that the starting point was not whether the case concerned advice or information, but the nature of the duty of care assumed by the professional. 

This examination involved first determining the purpose of the duty of care and then determining whether the losses in question were within the scope of the duty of care, going on to consider whether the losses had been caused by the defendant’s negligence and whether the claimant had contributed to the loss.

The Supreme Court found that Grant Thornton had assumed a duty of care to MBS to provide it with accurate information about its accounting treatment of the hedging.  Grant Thornton was aware that MBS intended to enter into hedging arrangements and to adopt hedge accounting so as to protect its regulatory capital and to reduce profit volatility.  Grant Thornton failed to take any steps to establish, as required under the IFRS, whether the swaps would actually provide effective protection for the lifetime mortgage loan book, which was a critical element necessary to apply the IFRS hedge accounting treatment. 

The Supreme Court held that the losses arising from closing out the swaps early because the hedge accounting treatment was not suitable for MBS was foreseeable and was within Grant Thornton’s duty of care.  The Supreme Court agreed that MBS was 50% liable for its own contributory negligence given the aggressive pursuit of the lifetime loans business model and its purchase of 50 year swaps.

Overall, Grant Thornton and its insurers are now looking at bill for c. £16 million in damages for MBS.

Related decision in Khan v. Meadows [2021] UKSC 21

The same panel of Justices also heard the appeal in Khan.   A separate judgment in that case was also handed down on the same day. 

Khan concerned the negligence of a doctor in failing to identify, when interpreting the results of a genetic test, that a mother carried a gene for haemophilia.  The mother had undertaken the test to determine if she was at risk of passing on the disease to any child she may have.  The doctor negligently advised that the mother did not have the gene.

The mother subsequently conceived and gave birth to a haemophilic son, who was later diagnosed with a form of autism.  The son’s haemophilia is severe and not responsive to standard treatments with blood clotting factors.  The mother sought to recover all costs of treating the child from the doctor, arguing that the autism made it more difficult and more expensive to treat her son.

The doctor admitted that he was responsible for the costs of treating the son’s haemophilia (expressed in a lump sum of around £9 million for the son’s lifetime), but disputed that he was responsible for the costs of treating the son’s autism.

The Supreme Court, upholding the decisions of the High Court and the Court of Appeal, held that the doctor was liable for the costs of care only insofar as such costs were attributable to the son’s haemophilia.  The Supreme Court considered that the son would have been born with autism in any event and that was not something the doctor could have foreseen when conducting the gene testing.  The doctor had not been asked to advise, and had not advised, on the risks of autism or whether the mother should conceive a child.  It was therefore unjust to impose the burden of the costs of treatment of the son’s autism on the doctor.

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