Manchester Building Society v Grant Thornton UK LLP
In Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20 the Supreme Court has clarified 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. Applying this principle to the facts of the case, the court reversed earlier decisions of the High Court and Court of Appeal, and held that Grant Thornton was liable to compensate Manchester Building Society for break costs it had incurred to terminate interest rate swaps that the Society would not have entered into if Grant Thornton had correctly advised it on the accounting treatment of the swaps. The case is a cautionary reminder to all professional advisers of the importance of clearly documenting and managing the agreed scope and purpose of a professional engagement.
Background
In April 2006, Grant Thornton UK LLP (“Grant Thornton”) advised Manchester Building Society (the “Society”) that it would be able to apply “hedge accounting” when preparing its accounts in accordance with the International Financial Reporting Standards.[1]
In reliance on this advice, between May 2006 and February 2012, the Society entered into 14 interest rate swap agreements that were intended to hedge its cost of borrowing in respect of its lifetime mortgage business. The Society also applied hedge accounting in its financial statements for each of the years ending 31 December 2006 to 2011. These financial statements were audited by Grant Thornton and, in each year, Grant Thornton signed an unqualified audit opinion and repeated its advice that the Society was entitled to apply hedge accounting.
In 2013, Grant Thornton informed the Society that (contrary to the advice given in 2006 and subsequently) it was not entitled to apply hedge accounting. The impact on the Society’s accounts was significant: a £6.35m profit in the 2011 accounts had to be restated as a loss of £11.44m. As a result of these corrections to its accounts, the Society did not have sufficient regulatory capital. The Society took various steps to remedy this position, including terminating the swaps which had become a substantial liability as a consequence of a fall in interest rates following the 2008 financial crisis. On terminating the swaps, the Society was required to pay a break fee to the swap counterparty, of approximately £32m. The Society brought proceedings against Grant Thornton to try and recover these costs and other associated losses.
The High Court and Court of Appeal
Grant Thornton admitted that it had been negligent in its advice to the Society and in its audit of the Society’s accounts for each of the years 2006 to 2011. However, Grant Thornton argued (inter alia) that as a matter of law the losses claimed by the Society were neither caused by its negligence nor within the scope of its duty of care.
The High Court found in favour of the Society on legal causation (i.e. that Grant Thornton’s negligence had been an effective cause of the Society’s losses), but concluded that losses in respect of the swap break costs were not within the scope of Grant Thornton’s duty of care. The Society’s recoverable losses were therefore determined to be only £420,460 (in respect of other costs it had incurred) and this amount was reduced in light of a finding of contributory negligence. The Society appealed this decision.
Whilst the Court of Appeal technically took a different approach to the High Court in assessing the scope of Grant Thornton’s duty of care, it reached the same result. The Society’s appeal was therefore dismissed. The Society then took its case to the Supreme Court.
The Supreme Court
The issue before the Supreme Court was how to determine the nature and ambit of the scope of duty principle and, in particular, how this applied to Grant Thornton’s role. To answer this question the court needed carefully to analyse and interpret the principles established in South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191 (“SAAMCO”) and developed in subsequent case law.
The majority decision of Lord Hodge and Lord Sales (with whom Lord Reed, Lady Black and Lord Kitchin agreed) clarifies 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”. The test is, therefore, to examine what risk the duty was intended to guard against and then look to whether the loss suffered by the claimant represents the realisation of that risk;
- the distinction between “advice” cases and “information” cases that was established in SAAMCO (and critical to the Court of Appeal’s analysis in this case) is too rigid and is liable to mislead. Rather than trying to “shoe-horn” a case into one of these categories and letting that classification lead the analysis, the focus should be on identifying the purpose to be served by the duty of care assumed by the defendant; and
- the counterfactual test established in SAAMCO (i.e. if the case is an “information” case, asking whether the claimant’s actions would have resulted in the same loss if the advice given by the defendant had been correct) is only a tool to cross-check the result of the analysis of the purpose of the duty. Over-reliance on the counterfactual has the potential to confuse rather than assist the correct analysis. Again, the better approach is to focus on the purpose for which the advice was given.
In this case, Lord Hodge and Lord Sales concluded that the purpose of Grant Thornton’s advice was to establish whether the Society could use hedge accounting to implement its proposed lifetime mortgages business model. Grant Thornton negligently advised that it could. As a result, the Society pursued that business model, entered into the swap transactions and exposed itself to the risk of loss from having to break the swaps (if, as transpired, it was not able to use hedge accounting and volatility of the swaps exposed it to additional regulatory capital demands). That was a risk that Grant Thornton’s advice was supposed to allow the Society to assess, and which its negligence caused the Society to fail to understand. In reaching this conclusion, the majority reasoned that for the purposes of analysing whether the Society’s losses fell within the scope of Grant Thornton’s duty of care, it was important to have regard to the commercial reason for the advice as understood by Grant Thornton, i.e. the particular impact of hedge accounting on the Society’s regulatory capital. In particular, the use of hedge accounting would allow the Society to make an assessment that it could proceed with the business of entering into swaps within its regulatory capital requirements. Consequently, the break costs incurred by the Society when it turned out it had insufficient capital resources were recoverable from Grant Thornton (but again subject to deduction for contributory negligence).
Lord Leggatt and Lord Burrows agreed that the appeal should be allowed, but differed slightly in their analysis and application of SAAMCO.
Comment and conclusions
This judgment clarifies the approach to determining the scope of a professional adviser’s duty of care: on the approach of the majority, the analysis should focus on the objective purpose for which the advice was given, and the courts should avoid an overly rigid application of the SAAMCO “advice vs information” and counterfactual tests – both of which, on the majority’s approach, have the potential to oversimplify rather than assist the analysis. Whether this, in practice, will dilute the ability of professional advisers to rely on SAAMCO in future remains to be seen. The fact that all seven justices reached the same view on the result of the case (despite taking three views on SAAMCO’s true application) might suggest that its precise theoretical basis makes little practical difference.
In the final analysis, however, much will depend upon the view judges take on the objective purpose of an adviser’s role on any given set of facts. In that regard, the case is a cautionary reminder to all professional advisers of the importance of clearly documenting and managing the agreed scope and purpose of a professional engagement. In particular, it is prudent to ensure that: (i) the scope and purpose of the engagement is clearly recorded at the point of instruction (and expressly to identify in the engagement terms (inter alia) any key assumptions, third-party responsibilities, matters that are specifically out of scope, and limitations on liability); (ii) any material extensions to the scope and/or purpose, agreed through the course of the engagement, are recorded in writing; and (iii) the documented scope and purpose of the engagement is reviewed at key milestones (particularly in long term projects) to confirm it remains accurate.
The judgment in this case was delivered alongside a judgment in another case of professional negligence (heard by the same expanded constitution of the Supreme Court), Khan v Meadows [2021] UKSC 21 (a case concerning professional negligence by a medical expert). In Khan v Meadows, the same majority adopted a consistent approach to determining the scope of the duty of care, but considered in more detail the overarching structure of the tort of negligence (and the proper place for the scope of duty analysis within that structure). The two judgments are intended to be read together and are accessible by the links below.
Manchester Building Society v Grant Thornton can be viewed here.
Khan v Meadows can be viewed here.
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[1] The IFRS required that interest rate swaps be accounted for at fair value on the balance sheet. However, where “hedge accounting” was permitted the carrying value of the Society’s lifetime mortgages could be adjusted to offset changes in the fair value of the swaps, thus reducing the potential volatility in the accounts that could be caused by changes in the fair value of the swaps.
