Landmark ruling - Supreme Court clarifies the test for determining the scope of duty
20 July 2021
Determining the scope of the duty of care in professional negligence cases has long been a challenge as practitioners struggled to apply the principles established by the House of Lords in South Australia Asset Management Corpn v York Montague Ltd (SAAMCO).
Many will therefore welcome the recent clarification provided by the Supreme Court in Manchester Building Society (MBS) v Grant Thornton UK LLP and Khan v Meadows. A majority approved a test comprising six questions formulated by Lord Hodge and Lord Sales (who gave the lead judgment).
Background
A fundamental principle of the law of negligence is that a claimant can only recover losses which fall within the scope of the duty of care owed by the defendant. In cases where a professional adviser has provided negligent advice, their liability is limited only to losses from which it should have protected the claimant. Not all losses that follow their negligence are recoverable. This is often referred to as "the scope of duty principle".
Since 1996, the leading case in this area has been SAAMCO. That case involved claims brought by lenders who had suffered losses as a result of valuers' negligent valuations. In determining the extent of the duty owed by the valuers, the House of Lords distinguished between a duty to provide information to enable someone to take a commercial decision (an "information" case) and a duty to advise someone as to the course of action to take (an "advice" case). In an "information" case, the defendant would only be liable for losses sustained as a result of the information being incorrect. In an advice case, liability extends to all foreseeable loss arising as a result of that course of action being taken.
The SAAMCO case also gave rise to the so-called "SAAMCO cap" on liability. This provided that in an information case, a claimant cannot recover losses which would have been sustained in any event, i.e. had the information been correct.
The Supreme Court's judgments largely consign SAAMCO to history. They set a new benchmark, and test for parties to consider and apply. In this note we focus on the MBS case given its greater relevance to our commercial clients.
Facts
MBS is a mutual building society which had employed the Defendant (GT) to audit its accounts between 1997 and 2012. From 2004 to 2010, MBS issued lifetime mortgages at fixed rates funded by loans borrowed at variable interest rates. To hedge against the risk of these variable rates, MBS entered into interest rate swaps. Before entering into these swaps, MBS was advised by GT that it could use "hedge accounting" in preparing its accounts.
MBS relied on this advice. Without hedge accounting, there was a danger that volatility of financial performance could cause it to have insufficient regulatory capital and it would be forced to close out its swaps before the lifetime mortgages matured.
In 2013, GT informed MBS that it was not, after all, permitted to apply hedge accounting in preparing its audited accounts. Consequently, MBS had to terminate all of its interest rate swaps early. MBS did so at a cost of £32,682,610, comprising the then (negative) mark to market value of the swaps, plus early termination transaction costs of £285,460.
The High Court and Court of Appeal dismiss the claim applying SAAMCO
At first instance and in the Court of Appeal MBS' claim was dismissed.
The Court of Appeal considered that MBS' claim was an "information" case. It would only be an "advice" case if GT had been responsible for guiding the whole decision-making process associated with its interest rate swap strategy, and considered all relevant and not only specific matters. This did not apply as GT had only provided one piece of information on accounting practice. MBS' decision to enter the swaps was also based on other commercial factors independent of GT's advice. As an "information" case, GT was only liable for the foreseeable consequences of the incorrect "information"/"advice" it had provided.
As such, MBS was then required to prove the counter-factual: namely that the loss would not have occurred if the incorrect information GT provided had in fact been correct. If that had been the case would MBS have avoided the loss? MBS was unable to show this was the case.
The Supreme Court's approach to scope of duty
The majority judgment of Lord Hodge and Lord Sales, with whom Lord Reed, Lady Black and Lord Kitchin agreed, is discussed below. Lord Leggatt adopted a different approach, focussing on causation rather than the scope of the relevant duty of care, but reached a similar conclusion as to the outcome, as did Lord Burrows.
The six stage test
The Court considered it helpful to look at the questions that arise when a claimant seeks damages from a defendant in the tort of negligence. Namely:
- Is the harm (loss, injury and damage) which is the subject matter of the claim actionable in negligence? (the actionability question).
- 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).
- Did the defendant breach his or her duty by his or her act or omission? (the breach question).
- Is the loss for which the claimant seeks damages the consequence of the defendant's act or omission? (the factual causation question).
- 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).
- 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 (including novus actus interveniens) 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 legal responsibility question).
Question 2 was key to the MBS case.
The scope of the duty of care in professional advice cases
The fact that the defendant owes the claimant a duty to take reasonable care in carrying out its activities does not mean that the duty extends to every kind of harm which might be suffered by the claimant as a result of the breach of that duty. In Caparo Industries plc v Dickman it was recognised that although the auditor of a company's accounts owes a duty of care to shareholders in the company for some purposes, breach of that duty does not mean that a shareholder can claim damages for loss flowing from its reliance on the audited accounts to make investment decisions.1
It is for the claimant to show that they have suffered loss falling within the scope of a duty of care owed to them by the defendant. That is the essence of the claimant's cause of action in tort.
In some cases, a claim may be answered at question 2 of the test without the need to address the questions of breach and factual causation. However, in cases such as SAAMCO, where the scope of duty is relevant to the extent of loss of a particular kind, it is generally more appropriate to first ascertain the extent of loss on a "but for" basis, and then focus on the extent to which the losses fall within the scope of duty. But it is simply a practical approach to working out the implications of the scope of duty concept.
The Supreme Court confirmed that 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 reason why the advice is being given.
Therefore, in the case of negligent advice given by a professional adviser, one looks to see what risk the duty was supposed to guard against and then looks to see whether the loss suffered represented the manifestation of that risk.
"Advice" and "information" distinction laid to rest
The distinction drawn by Lord Hoffmann in SAAMCO between "advice" cases and "information" cases was too rigid and, as such, liable to mislead. At one extreme were pure "advice" cases, in which the adviser has assumed responsibility for every aspect of a transaction. At another extreme were cases where the professional adviser contributes only a small part of the material on which the client relies in deciding how to act. Instead of trying to "shoehorn" a particular case into one or other category, the focus should be on identifying the purpose to be served by the duty of care assumed by the defendant.
The SAAMCO counterfactual analysis relegated to cross-checking tool
The Supreme Court also disagreed with the Court of Appeal's application of the SAAMCO counterfactual test in dismissing the claim. It was observed that linking its use to "information" cases in the "advice" and "information" framework was "unhelpful". By contrast, examination of the purpose of the duty provides an appropriate basis for identifying, out of what may be a wide range of factors which contribute to the claimant's loss, the factors for which the defendant is responsible.
It was observed that the counterfactual test had been allowed to assume too great a significance. The Supreme Court sought to redress the balance: "Analysis using the counterfactual "tool" as deployed in SAAMCO was designed to assist with looking at the scope of duty question from a causation-based perspective. Therefore, once it is accepted that the scope of duty inquiry turns on identifying the purpose of the duty, it can readily be seen that a SAAMCO-type counterfactual analysis is just a cross-check, rather than the foundation of the relevant analysis." (para 27).
The Supreme Court also recognised that the counterfactual may not always be appropriate: "There is no need to apply a counterfactual test to arrive at the correct conclusion and it has the potential to confuse rather than assist the correct analysis."
Applied to the facts of this case
In this case, the purpose of GT's advice was clear. GT was engaged to advise MBS whether MBS could use "hedge accounting" to pursue a specific commercial strategy within the constraints of the applicable regulatory environment. GT advised, incorrectly and negligently, that MBS could do so. When the mistake emerged, the losses which MBS incurred from closing out the swaps represented the realisation of the exact risk that MBS had sought to protect against in obtaining GT's advice. The counterfactual scenario that MBS would have suffered a loss even if hedge accounting could have been used was therefore not relevant to the scope of its duty of care in these circumstances. That said, MBS's poor commercial decisions in mismatching mortgages and swaps was relevant but only as to the secondary question of contributory negligence, as to which the Supreme Court upheld Teare J's funding of a 50 per cent reduction.
Comment
The Supreme Court's judgments are to be welcomed. They have provided much needed clarity and a new analytical tool for practitioners assessing the viability of professional negligence claims.
The courts' focus will now be on the purpose of the allegedly negligent advice. A claimant must only prove that the loss it has suffered represents the realisation of the risk it sought to protect against in obtaining the advice. As ever, it remains to be seen how easily the courts find the purpose test to apply in practice.
Professional advisers across all sectors should take note. This judgment could open the door to new professional negligence claims where a claimant may previously have struggled to construct a "SAAMCO counterfactual" showing that the correct information/advice would have resulted in no loss. Going forward, professional advisers will need to pay close attention to the terms of their engagement and ensure these explicitly set out the purpose of their advice so their liability is clearly delineated.
Authors: Ed Davies, James Levy and David Capps
- p 627 per Lord Bridge of Harwich; pp 651-653 per Lord Oliver of Aylmerton; pp 660-662 per Lord Jauncey of Tullichettle).
Cases referred to:
Manchester Building Society (Appellant) v Grant Thornton UK LLP (Respondent) [2021] UKSC 20
South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191
