Claims Against Auditors for Negligent Advice: Assessing when the SAAMCO Principle will Apply

Lucas Arnold

A professional is liable in negligence for losses suffered by their client falling within the scope of the professional’s duty. Where the professional provided negligent information or advice relating to a transaction, an issue that often arises is whether all or only some of the losses suffered by the client arising from the transaction fall within the scope of the professional’s duty.

The issue was recently considered by the Court of Appeal in Manchester Building Society v Grant Thornton LLP [2019] EWCA 40. The Court of Appeal’s judgment held that the issue turns on whether the professional gave “information” or “advice” as these terms are used in the scope of duty context, stemming from the decisions in South Australian Asset Management Corporation v York Montague Ltd [1997] AC 191 (“SAAMCO”) and Hughes-Holland v BPE Solicitors [2018] AC 599 (“Hughes-Holland”).

Facts

The Claimant, Manchester Building Society (“MBS”), was a building society. The Defendant, Grant Thornton (“GT”), was its auditor for the years 1997 to 2012.

Between 2004 and 2009 MBS issued a number of fixed interest lifetime mortgages.  MBS needed to hedge its interest rate risk and it did so by purchasing interest rate swaps. Between February 2006 and February 2012 MBS entered into a number of interest rate swaps worth tens of millions of pounds.

From 2005 onwards MBS was required by accounting standards to include in its financial statements the fair value of the swaps at mark-to-market value (“MTM”).

Hedge accounting provided a potential solution to the volatility of movements of the fair value of the swaps. In April 2006, GT incorrectly advised MBS that it could apply relevant hedge accounting rules.

In March 2013 GT informed MBS that hedge accounting may not be applicable, and this was subsequently confirmed by an independent accounting firm. Because of the volatility to which MBS’s balance sheet was exposed, the decision was taken in June 2013, with the encouragement of the relevant regulator, to close out the swaps. They were closed at their fair value on 6 and 7 June 2013 at a significant loss.

GT admitted in its defence that its advice and audits were negligent in failing to advise MBS in April 2006 and on the occasion of each audit thereafter that it could not apply hedge accounting. The issue was whether its breach of duty caused MBS loss.

First Instance Decision

At first instance, Teare J found that both factual and legal causation had been established. He accepted MBS’s factual case that but for GT’s negligence MBS would not have entered into the swaps after 11 April 2006 and would have closed out those it had entered into before then (at TJ[124]-[128]) and also that at law GT’s negligence had been an effective cause of the loss.

As recognised by the authorities including SAAMCO and Hughes-Holland, Teare J then sought to determine whether the losses fell within the scope of GT’s duty. Teare J recognised that the accounting treatment of the swaps was different from the actual economic consequences of the swaps, but found that the losses sustained by MBS when it broke the swaps were the reasonably foreseeable consequence of GT’s negligence (at TJ [167], [177]).

Teare J rejected the arguments advanced by the parties that the case should be decided on whether the advice of GT amounted to advice or information, a distinction stemming from the decisions in SAAMCO and Hughes-Holland. In rejecting this approach, His Lordship referred to a passage of Lord Sumption’s judgment in Hughes-Holland describing such a distinction as potentially confusing “because of the descriptive inadequacy of the labels” (TJ [151]).

Concluding that the losses did not fall within the scope of duty, Teare J approached the question on an assumption of responsibility basis, finding that an objective bystander, or indeed the parties themselves, would not have concluded in 2006 that GT had assumed responsibility for MBS being out of the money on the swaps in the event of a subsequent fall in the value of the swaps due to market forces (at TJ [179]).

Judgment of the Court of Appeal

The central issue on appeal was whether the trial judge erred in law in approaching the issue of liability on the basis of assumption of responsibility rather than by applying the advice/information distinction.

Following from this, a second point was whether the sales made at MTM were losses for which GT was responsible.

Giving the judgment of the Court of Appeal, Lord Justice Hamblen, with whom Lord Justice Males and Dame Elizabeth Gloster agreed, commenced by repeating the judgment of Lord Hoffmann in SAAMCO in what has come to be known as the ‘SAAMCO principle’ (at [46]):

“It is that a person under a duty to take reasonable care to provide information on which someone else will decide upon a course of action is, if negligent, not generally regarded as responsible for all the consequences of that course of action. He is responsible only for the consequences of the information being wrong. A duty of care which imposes upon the informant responsibility for losses which would have occurred even if the information which he gave had been correct is not in my view fair and reasonable as between the parties. It is therefore inappropriate either as an implied term of a contract or as a tortious duty arising from the relationship between them. The principle thus stated distinguishes between a duty to provide information for the purpose of enabling someone else to decide upon a course of action and a duty to advise someone as to what course of action he should take. If the duty is to advise whether or not a course of action should be taken, the adviser must take reasonable care to consider all the potential consequences of that course of action. If he is negligent, he will therefore be responsible for all the foreseeable loss which is a consequence of that course of action having been taken. If his duty is only to supply information, he must take reasonable care to ensure that the information is correct and, if he is negligent, will be responsible for all the foreseeable consequences of the information being wrong.”

Referring to the further analysis of the distinction between advice and information cases conducted by Lord Sumption in Hughes-Holland, Lord Justice Hamblen held that the application of the SAAMCO principle could be expressed as follows (at [54]):

(1) It is first necessary to consider whether it is an “advice” case or an “information” case. This is a necessary first step because the scope of the duty, and therefore the measure of liability, is different in the two cases.

(2) It will be an “advice” case if it can be shown that it has been “left to the adviser to consider what matters should be taken into account in deciding whether to enter into the transaction”, that “his duty is to consider all relevant matters and not only specific matters in the decision” and that he is “responsible for guiding the whole decision making process”.

(3) If it is an “advice” case, then the negligent adviser will have assumed responsibility for the decision to enter the transaction and will be responsible for all the foreseeable financial consequences of entering into the transaction.

(4) If it is not an “advice” case, then it is an “information” case and responsibility will not have been assumed for the decision to enter the transaction.

(5) If it is an “information” case, the negligent adviser/information provider will only be responsible for the foreseeable financial consequences of the advice and/or information being wrong.

(6) This involves a consideration of what losses would have been suffered if the advice and/or information had been correct. It is only losses which would not have been suffered in such circumstances that are recoverable.

Lord Justice Hamblen held that “this was clearly a case in which the SAAMCO principle applied” (at [55]) and as such the trial judge erred in focusing on assumption of responsibility. Whilst noting the caution given by Lord Sumption that the advice and information labels could give rise to confusion, it was clear from the judgment in Hughes-Holland that this was the approach to be adopted, “rather than by asking an open-ended question as to the extent of assumption of responsibility” (at [58]).

Hamblen LJ then considered into which category this case belonged. It was found that MBS’s decision to enter into the swaps was based on a number of commercial considerations, of which GT’s input was only one (at [60]). As such, this was an information case – whilst GT had given “advice”, “what matters is not whether advice is given, but the purpose and effect of the advice given” (at [64]).

The finding that this was not an advice case was important as it meant it was not within the scope of GT’s duty to assume responsibility for the losses arising from the transaction as a whole, which would be far broader and may have extended to the losses arising from closing out the swaps. Being an information case, an assessment was required to be made between what losses arose as a result of the negligent advice, and what losses would have arisen even if the advice had been correct. This required a counter-factual assessment of what would the financial position have been had the swaps been held to maturity or some other advantageous date.

However this was not how MBS chose to run its case. Instead of seeking to prove a counter-factual, MBS argued that it was sufficient to show that at the time of closing out the swaps it had done so at a loss (at [88]). The court considered that on this argument no loss was suffered at all, as MBS had received fair market value when it closed the swaps. This was not a case of forced sale for a distressed price. As Lord Justice Hamblen succinctly put it, “[r]eceiving fair value does not ordinarily give rise to any loss” (at [88]). His Lordship concluded, in dismissing the appeal (at [95]):

The fact that the swaps were heavily “out of the money” at the beginning of June 2013 was the result of market forces. The closing out of the swaps at fair value on 6 and 7 June 2013 crystallised the loss resulting from the swaps being “out of the money”, but it did not create that loss.

Analysis

One salient consideration arising out of the MBS litigation is to what type of cases will the information/advice distinction be applied in relation to claims against auditors? Whilst this will depend on a case by case basis, guidance will be drawn by analogy from the decisions in SAAMCO, Hughes-Holland and Manchester Building Society.

The information/advice test is most apt to apply where there is a negligent misstatement resulting in a transaction and the question is whether the defendant adviser is liable for all or only some of the consequences of entering into the transaction. The introductory paragraph of Lord Sumption’s judgment in Hughes-Holland summarises these types of cases as cases in which “but for the negligence of a professional adviser his client would not have embarked on some course of action”.

An example of a situation in which the information/advice test will likely not apply is where an auditor has conducted a negligent audit. In such a case, the purpose of the audit is well defined by statute and leading case law as well as the auditor’s retainer letter, generally being to provide assurance to a company (and its shareholders) that the financial statements of the company give a true and fair view of the state of its financial affairs. The enquiry and purpose will be different to the situation in Manchester Building Society where the auditor (albeit in the course of providing audit services) is advising on a particular transaction.

Every case must be carefully approached on the basis of its own facts. However in a standard audit negligence case the enquiry of what losses fall within the scope of the audit’s duty will be to assess acts and omissions of an auditor in the context of the performance of the audit as a whole. In cases where the focus is on a particular discrete transaction or investment, the SAAMCO principle is likely to apply and the information/advice distinction will assume importance. This distinction will have wide-ranging implications for the way a claim against an auditor is pleaded, and the loss likely to be recoverable.

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