Manchester Building Society v Grant Thornton UK LLP

This was an appeal by the claimant building society from a decision of the Court of Appeal ([2019] EWCA Civ 40; [2019] 1 WLR 4610) dismissing its claim against its auditor (GT) for professional negligence.

Between 2004 and 2010 the society acquired and issued lifetime mortgage loans, which were funded by borrowing at variable rates of interest. The society entered into interest rate swaps to hedge the lifetime mortgages. GT advised that it was permissible to apply ‘hedge accounting’ and the society relied on that advice in preparing its financial statements for the years 2006 to 2011 and entering into more lifetime mortgages and swaps during that period.

In March 2013, GT informed the society that it was not after all permitted to apply hedge accounting in preparing its financial statements. The society terminated all of its interest rate swap contracts early at a cost of £32,682,610, together with transaction costs of £285,460.

The society brought proceedings against GT claiming the amount paid to close out the swaps. GT admitted that it had been negligent in advising the society that it was entitled to apply hedge accounting, but argued that its negligence did not cause the losses claimed by the society and/or that those losses were not recoverable in law because they were not within the scope of the duty which GT owed to the society.

The judge held ([2018] EWHC 963 (Comm)) that the society was entitled to recover the transaction costs but not the cost of terminating the swaps. He held that GT's advice had been negligent, but that the society's loss flowed frommarket forces and not from matters for which GT had assumed responsibility. If GT had been liable to compensate the society for the costs incurred in terminating the swaps, the damages would have been reduced by 50% to reflect the society's contributory negligence.

The society's appeal to the Court of Appeal was dismissed ([2019] EWCA Civ 40; [2019] 1 WLR 4610). The judge had erred in approaching the issue of liability on the basis of assumption of responsibility and should have considered whether the case was one of giving advice or only providing information, followingSouth Australia Asset Management Corp v York Montague Ltd[1996] CLC 1179; [1997] AC 191andHughes-Holland v BPE Solicitors[2017] UKSC 21; [2018] AC 599. The Court of Appeal concluded that the case was not an ‘advice’ case where GT was liable for all the foreseeable financial consequences of the decisions to enter into the swaps; rather, it was an ‘information’ case, so that GT was legally responsible only for the foreseeable financial consequences of the information being wrong. The judge had been correct to dismiss the claim, because the society could not show that it had suffered any loss by closing out the swaps at their fair value.

Held, allowing the appeal:

1. The scope of the duty of care assumed by a professional adviser was governed by the purpose of the duty, judged on an objective basis by reference to the purpose for which the advice was being given. The distinction between ‘advice’ cases and ‘information’ cases should not be treated as a rigid straitjacket, and counterfactual analysis should be regarded only as a tool to cross-check the result given pursuant to analysis of the purpose of the duty.

2. The fact that the defendant owed the claimant a duty to take reasonable care in carrying out the defendant's activities did not mean that the duty extended to every kind of harm which might be suffered by the claimant as a result of the breach of that duty. The burden of proof lay on the claimant to show that the loss for which he claimed damages lay within the scope of the duty of care owed to him by the defendant. In the case of negligent advice given by a professional adviser it was necessary to consider what risk the duty was supposed to guard against and then whether the loss suffered represented the fruition of that risk.

3. The application of ‘hedge accounting’ reduced the level of capital which the society was required to maintain to meet regulatory requirements. GT understood the regulatory capital issue and the importance for the society of being able to use hedge accounting. The society needed that advice in order to make a commercial decision whether to enter into swaps to be matched against mortgages. GT's negligent advice that the society could use hedge accounting had the effect that the society adopted a business model, entered into further swap transactions and was exposed to the risk of loss from having to break the swaps, when it was realised that hedge accounting could not in fact be used and the society was exposed to the regulatory capital demands which the use of hedge accounting was supposed to avoid. That was a risk which GT's advice was supposed to allow the society to assess, and which its negligence caused the society to fail to understand. On the judge's findings the society had suffered a loss which fell within the scope of the duty of care assumed by GT, having regard to the purpose for which it gave advice about the use of hedge accounting.

4. The judge was entitled to find that the society's damages should be reduced by 50% on the basis of its contributory negligence.