SAAMCO reconsidered: the purpose of advice

In Khan v Meadows, the Supreme Court dismissed Ms Meadows’ appeal against the Court of Appeal’s finding that Dr Khan (who was asked to advise on whether Ms Meadows carried the haemophilia gene) was liable only for costs associated with Ms Meadow’s child being born with haemophilia and not the additional costs associated with his autism. Meanwhile, in Manchester Building Society (MBS) v Grant Thornton (GT), the Supreme Court allowed MBS’ appeal and held that MBS had suffered a loss within the scope of GT’s duty of care (albeit subject to a 50% reduction for contributory negligence). In both cases, which need to be read together, the majority in the Supreme Court emphasised the importance of looking at the purpose for which the professional advice was given.

In this article, we will focus on the decision in MBS v GT and the implications arising for accountants and auditors.

Background

In a nutshell, the facts of MBS v GT are as follows: the claimant, MBS, had been negligently advised by the defendant, GT, that it could apply an accounting treatment (hedge accounting) to reduce the effect in its accounts of the volatility of long term interest rate swaps. At the time of its advice, GT was aware that MBS was required to maintain a certain level of capital under the then regulatory regime. In reliance upon GT’s advice, which was repeated annually in audit opinions signed by GT, MBS entered into the swaps. When, in 2013, GT advised MBS that it could not in fact apply hedge accounting, MBS closed out the swaps and incurred “mark-to-market” losses of over £32 million. GT accepted that its advice in relation to the hedge accounting was negligent.

The High Court held that MBS could not recover damages from GT on the basis that a defendant is only responsible for losses that flow from matters for which it has assumed responsibility and, in this instance, the losses flowed from market forces for which GT did not assume responsibility. The Court of Appeal upheld the High Court’s decision but found that the judge should have considered whether GT gave “advice” or “information” to MBS, concluding that this was an “information” case such that GT was only responsible for the foreseeable financial consequences of the information being wrong (not of the decision to enter into the swaps).

The question before the Supreme Court was whether the Court of Appeal was right to hold that the costs claimed by MBS fell outside GT’s duty of care as professional accountants.

The Supreme Court’s decision

Whilst all the Supreme Court justices were in agreement regarding the outcome of the appeal, there were divergent views on the approach and three different judgments were handed down. This article considers the decision of the majority, which was given in just 39 paragraphs and which, in contrast to the lengthy decision of Lord Leggatt, moves away from framing the scope of duty principle in the language of causation and the counterfactual test.

A conceptual framework

The Khan and MBS cases were both heard by the same constitution of the Supreme Court with the aim of providing general guidance on the approach to determining the scope of duty and extent of liability of professional advisers for negligence. To that end, the Court suggested it might be helpful to locate this within a conceptual framework for the tort of negligence and posed the following six questions:

1. Is the harm (loss, injury and damage) which is the subject matter of the claim actionable in negligence?
2. What are the risks of harm to the claimant against which the law imposes on the defendant a duty to take care? (the "scope of duty question")
3. Did the defendant breach his or her duty by his or her act or omission?
4. Is the loss for which the claimant seeks damages the consequence of the defendant’s act or omission?
5. Is there a sufficient nexus between a particular element of the harm for which the claimant seeks damages and the subject matter of the defendant’s duty of care as analysed at stage 2 above? (the "duty nexus question")
6. Is a particular element of the harm for which the claimant seeks damages irrecoverable because it is too remote, or because there is a different effective cause in relation to it or because the claimant has mitigated his or her loss or has failed to avoid loss which he or she could reasonably have been expected to avoid?

The Court reiterated that this framework is not intended to be comprehensive, and that it is possible to consider matters in a different order and to address more than one question at the same time (such as the second and fifth questions).

The scope of duty question

Turning to the second question (described as the “scope of duty question”), which was central to MBS’ appeal, the Court drew three key conclusions:

• First, the Court held that 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 purpose for which the advice is being given. Having first identified what risk the duty was supposed to guard against, it is then necessary to see whether the loss suffered represents the fruition of that risk.
• Second, the Court found that the distinction drawn between “advice” and “information” cases in SAAMCO has not proved to be satisfactory; it is too rigid because there is in reality a spectrum of cases between these two extremes. Rather than trying to shoe-horn a case into either of these categories, the primary focus should be on identifying the purpose to be served by the duty of care. The Court even went so far as to suggest that the terms “information” and “advice” should be dispensed with altogether, not least because they both involve giving advice.
• Third, the Court stated that a counterfactual causation-based analysis of the nature proposed in SAAMCO, which looks at whether the claimant’s actions would have resulted in the same loss had the advice been correct, should only be used as a tool to cross-check the result pursuant to an analysis of the purpose of the duty – noting that even as a cross-check it was 'subordinate' to that analysis (and query, therefore, what role it will actually serve). In particular, the Court highlighted that one problem associated with a counterfactual analysis is the scope for arguments on both sides about how the counterfactual world should be constructed, which risks driving the outcome in the case. Indeed, here, GT had sought to argue that the counterfactual world should be constructed in a way that meant MBS would have suffered the same loss if GT’s advice had been correct.

Applying these principles to the facts, the Court found that examination of the purpose for which GT’s advice was given shows that the loss suffered by MBS fell within the scope of their duty of care. GT’s advice was sought in order that MBS could assess whether it could use hedge accounting in order to implement its proposed business model within the constraints of the regulatory environment. GT effectively advised MBS that hedge accounting could enable it to have sufficient capital resources to carry on its business (and thus also have sufficient regulatory capital), but in fact it did not.

The duty nexus question

The Court acknowledged that sometimes answering the second question also answers the fifth question (described as “the duty nexus question”). However, where the professional adviser guides the whole decision-making process, the duty nexus question becomes important in order to separate out the element of the loss attributable to the defendant’s negligence.

The mechanism by which the duty nexus question is answered in the SAAMCO valuer negligence cases is to look at the counterfactual, in order to identify the loss which falls within the scope of the defendant’s duty. In Khan, the Court clarified that the question is not whether the claimant would have behaved differently if the defendant’s advice had been correct, but whether, on the assumption that the claimant would have behaved as they did in fact behave, their actions would have resulted in the same loss if the defendant’s advice had been correct. However, the Court recognised that it may not always be appropriate to use this counterfactual test: in some cases, the scope of duty question may allocate the risk without need for the counterfactual and, in other cases, the counterfactual may contribute nothing.

Analysis and implications

What is clear from the majority decision in MBS is that there is a definitive move away from the information/advice distinction towards looking at the purpose of the advice given by the professional adviser. Whilst the intention of the majority seems to have been to simplify this complex area of law in just 39 paragraphs, it remains to be seen whether the Court’s new conceptual framework and its accompanying guidance will, in fact, achieve this objective. In particular, it is unclear whether a counterfactual analysis has any substantive role to play in analysing scope of duty and there are questions surrounding precisely how the “duty nexus question” should be answered.

As to the implications for accountants and auditors, the advice in this case dates back to 2005/2006 when auditors would more frequently provide advice or guidance on key accounting treatment issues arising from the accounts. With the increased focus on auditor independence, advice of this nature has become less prevalent, but auditors are still required to point out non-compliance with accounting standards or policies. Where a significant disagreement arises, audit clients will often need specialist independent accounting advice. In a case of this nature, the auditor then unreasonably relying on negligent advice would not relieve the audit firm of liability. However, the audit firm could achieve better protection for these types of issues through the company obtaining independent accounting advice and/or the auditor limiting the scope of any reliance on that advice (or any guidance the auditor provides itself on accounting treatment) to the accounting treatment in the accounts (i.e. seeking to disclaim responsibility for commercial/regulatory matters).