Manchester Building Society v Grant Thornton UK LLP

JurisdictionEngland & Wales
JudgeMr. Justice Teare
Judgment Date02 May 2018
Neutral Citation[2018] EWHC 963 (Comm)
CourtQueen's Bench Division (Commercial Court)
Docket NumberCase No: CL-2016-000318
Date02 May 2018
Manchester Building Society
Grant Thornton UK LLP

[2018] EWHC 963 (Comm)


Mr. Justice Teare

Case No: CL-2016-000318




Royal Courts of Justice

Rolls Building, 7 Rolls Buildings

Fetter Lane, London EC4A 1NL

Rebecca Sabben-Clare QC and Harry Wright (instructed by Squire Patton Boggs (UK) LLP) for the Claimant

Simon Salzedo QC, Adam RushworthandSophie Shaw (instructed by Taylor Wessing LLP) for the Defendant

Hearing dates: 22–25, 29–31 January, 1,5–8,12,19–22 February 2018

Judgment Approved

Mr. Justice Teare

This is a claim for damages by a building society caused by the admitted negligence of its accountant. The assessment of recoverable financial loss can be complex and uncertain of outcome. In the present case the recoverable loss may be £48.5m, as submitted on behalf of the Claimant, or nil, as submitted on behalf of the Defendant, or somewhere in between. One essential enquiry is whether the loss claimed is the kind of loss in respect of which the Defendant owed a duty of care. But with regard to that enquiry the leading textbook on damages states that “hard and distinct rules ……cannot be laid down. Each particular case must be taken as it comes”; see McGregor on Damages 19 th ed. para 8–132.


It may assist if I give the following guide to this judgment, by paragraph numbers:

The Claimant and its business

The Claimant and its business


The Accounting Framework


The claim


The oral evidence


The 2005 accounts and the approval of the Hedge Accounting policy


The initial swaps


Growth of the UK Lifetime Mortgage Business


The audit for the year ended 2006


Further swaps in relation to the UK Lifetime Mortgage Business


Swaps in relation to the Spanish Lifetime Mortgage Business


The audits


The views of the regulator


The Claimant's sale of lifetime mortgages


The provision of collateral


The FSA's letter dated 16 January 2013


The discovery of the error and the events thereafter


The individual heads of loss


(i) The cost of breaking the swaps


“Cause in fact”


“Cause in law”


“Scope of duty”




Conclusion as to costs of breaking the swaps


Transaction or penalty costs


(ii) Loss of the gain that would have been earned if the swaps in existence in April 2006 had been closed out in 2006


(iii) Loss of profits from the £21m UK lifetime mortgage book if held after December 2013 rather than sold


(iv) The costs of hedging the £21m UK book


(v) Restructuring and advisory costs


(vi) PwC hedge accounting fees


(vii) The set up and perational costs of the Spanish book


(viii) Credit for the benefit of holding the additional UK book


(ix) Credit for the Spanish book


Contributory negligence




Statutory relief



The Claimant is the Manchester Building Society, a small mutual building society established in 1922. It has one branch with approximately 16,900 savers and 3,600 borrowers. Prior to April 2013 it was regulated by the Financial Services Authority (the FSA). Now it is regulated by the Prudential Regulation Authority (the PRA) and the Financial Conduct Authority (the FCA). Its main activity is the provision of a range of mortgage products. Typically they were fixed term, fixed interest mortgages but between 2004 and 2009 the Claimant acquired and issued lifetime mortgages which were designed to release the equity in a house to its owner on terms that the loan and interest were not repayable until the owner either entered a care home or died. These lifetime mortgages were issued to UK owners (“UK lifetime mortgages”) and also to owners of homes in Spain (“Spanish lifetime mortgages”). The Claimant entered the market of lifetime mortgages because it was less crowded and because it believed that it could get a better return on its investment.


The Claimant needed to “hedge” its interest rate risk (the risk that the variable rate of interest which it paid to acquire funds would exceed the fixed rate which it received from borrowers) and it did so by, inter alia, purchasing interest rate swaps.


Between 2002 and 2005 the Claimant had entered into six UK fixed rate swaps for periods of 3–25 years. In January and September 2006 it entered into two further interest rate swaps for periods of 1 and 3 years. The notional value of such swaps was £37.5m. These swaps hedged the fixed rate, fixed term business.


Between December 2004 and December 2005 the Claimant acquired two tranches of UK lifetime mortgages with a value of £21m. Four further tranches of such mortgages were acquired between April 2006 and October 2008 bringing the total value of UK lifetime mortgages to £68m.


The distinctive feature of lifetime mortgages is that no sum is due from the borrower until the borrower dies, moves out of the property or chooses to redeem the mortgage. Until that point, interest is compounded. The mortgages were therefore of an uncertain duration and there was no return (“zero coupon”) until that future date.


Lifetime mortgages also included a “no negative equity guarantee” such that the final payment would not exceed the value of the property upon which the mortgage was secured. Lifetime mortgages were marketed to those above the age of fifty.


Between February 2006 and February 2012 the Claimant entered into 14 interest rate swaps to hedge its UK lifetime mortgage book. They had a notional value of £74.2m. Most had a period of 50 years. Although no new UK lifetime mortgages were issued or acquired after October 2008 the later swaps were purchased because the interest which accrued on the mortgages caused the size of the mortgages to “grow”.


During 2008 the Claimant began to offer Spanish lifetime mortgages. They were structured in the same way as the UK lifetime mortgages. Between July 2008 and January 2011 the Claimant entered into 14 interest rate swaps to hedge the Spanish book of lifetime mortgages. They had a total value of €57m.

The Accounting Framework


Before 2005 the UK Generally Accepted Accounting Principles (“UK GAAP”) did not require swaps to be included on the Claimant's balance sheet. Thus the swaps which it had entered into between 2002 and 2004 to hedge its fixed rate fixed term mortgage portfolio were not included on its balance sheet.


As the Claimant had issued listed instruments – namely Permanent Interest Bearing Shares (“PIBS”) – it was required to prepare its accounts in accordance with the International Financial Reporting Standards (“IFRS”) for the 2005 financial year onwards.


One significant change of this transition from UK GAAP to IFRS was that under IFRS the Claimant was required to bring derivatives such as interest rate swaps onto its balance sheet. Derivatives were to be valued at fair value. Thus any change in the fair value of the swaps, consequent upon changes in present and estimated future interest rates, fell to be recorded in the Claimant's profit and loss account. However, the mortgages which were hedged by those swaps were to be shown at amortised cost. Thus changes in the fair value of the mortgages (as a result of changes in present and estimated future interest rates) would not be reflected on the profit and loss accounts. The consequence of this accounting mismatch, absent any mitigating measures, would be that the Claimant's profits, and hence its capital, as recorded on the balance sheet would be “volatile”. This could, in turn, have a detrimental impact upon the Claimant's regulatory capital position – greater volatility could necessitate an increased amount of regulatory capital.


IFRS, however, provided a potential solution to the problem of increased volatility. Entities with derivatives could choose to adopt “hedge accounting”. Hedge accounting allows the volatility introduced by bringing the fair value of interest rate swaps onto the balance sheet to be offset by allowing an adjustment to be made to the value of the hedged asset, the mortgage, as shown on the balance sheet.


Hedge accounting is complex. There are very strict requirements to be fulfilled before an entity can take advantage of it. The asset being hedged and the derivative in question have to be formally designated. Various documentary requirements have to be fulfilled prior to the application of hedge accounting. It can only be applied if the hedge is expected to be “highly effective” – that is, the hedge is expected to be between 80% and 125% effective in offsetting changes in fair value attributable to the assets throughout the term of the hedging derivative. Moreover, the hedge must be determined to have actually been effective in practice.


From 2006 the Claimant used hedge accounting to enable a hedging adjustment to be made to the value of its mortgages on the balance sheet so as to eliminate or reduce the volatility risk. In 2008 the world's financial system suffered a crisis which led to a sustained fall in interest rates and, in consequence, a change in the fair value of the Claimant's interest rate swaps. Instead of being an asset they became a liability. That change was offset on the Claimant's balance sheet, though not necessarily completely, by the hedge adjustment permitted by hedge accounting to the value of the mortgages as shown on the Claimant's balance sheet.


In 2013 the Claimant learnt that it could not properly use hedge accounting. The effect of drawing up its accounts in 2013 without the use of hedge accounting was dramatic.



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