Manchester Building Society v Grant Thornton UK LLP [2018] EWHC 963 (Comm) – Accountants had not assumed responsibility for economic losses flowing from negligent accounting treatment - DAC Beachcroft

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Manchester Building Society v Grant Thornton UK LLP [2018] EWHC 963 (Comm) – Accountants had not assumed responsibility for economic losses flowing from negligent accounting treatment

Published 25 September 2018

MBS' claim against GT for £48.5M largely failed. Applying SAAMCo principles, GT was found not liable for the economic consequences of MBS entering into interest rate swaps, such losses falling outside the scope of GT's duty.

Brief Facts

MBS sold mortgages on terms that the loan and interest would not be repayable until the borrower entered a care home or died. MBS hedged its interest rate risk (the risk that its cost of funding these mortgages would exceed the fixed interest rate received from borrowers), by acquiring interest rate swaps.

GT advised on the accounting treatment of the swaps. In April 2006, GT advised that hedge accounting would be a suitable way for MBS to limit volatility under Regulations requiring MBS to include information on this on its balance sheet in order to indicate volatility. GT also audited MBS' accounts for 2006 – 2011.

In 2008, interest rates crashed causing MBS significant losses as a result of the swaps. MBS closed the swaps at a loss of £48.5M, and sought that loss from GT, alleging both negligent advice to use hedge accounting, and the failure to pick up the inappropriate use of hedge accounting on subsequent audits.

Judgment

Negligence was admitted but GT successfully defended the claim on scope of duty grounds.

In relation to causative loss, the Judge concluded that:

  1. Factual Causation: GT's negligence had caused MBS to suffer losses when breaking the swaps in 2013 using the "but for" test: but for the negligence, MBS would have broken any long term swaps entered into by April 2006, and not entered into further swaps.

  2. Legal Causation: The Judge recognised that the accounting treatment of swaps is different from the economic consequences of entering into swaps. However, the Judge found that the accounting treatment did have an effect upon determining the extent to which the volatility affected the reported profits, and regulatory capital requirements. Accordingly, legal causation was established: GT's actions were an effective cause of the losses (and did not simply provide the opportunity for the losses to arise).

  3. Scope of Duty: However, notwithstanding factual and legal causation being established, the Judge found that the losses were not recoverable because they fell outside the scope of GT's duty.

The volatility of the balance sheet was a foreseeable consequence of the swaps. However, the fact that the losses were foreseeable was not sufficient to show that GT assumed responsibility for the losses. The loss suffered by MBS was not something for which GT had assumed responsibility, or the thing that GT advised MBS they would not be exposed to. The loss flowed from economic forces for which GT did not assume responsibility and so were irrecoverable. At paragraph 179 of the judgment the Judge stated:

"… it seems to me a striking conclusion to reach that an accountant who advises a client as to the manner in which its business activities may be treated in its accounts has assumed responsibility for the financial consequences of those business activities. I do not consider that the objective bystander, or indeed the parties themselves, viewing the matter in 2006 would have concluded that the Defendant had assumed responsibility for the Claimant "being out of the money" on the swaps in the event of a sustained fall in interest rates…the loss flowed from the market forces for which the Defendant did not assume responsibility."

Accordingly, GT was not liable for the cost of breaking the swaps. 

Contributory Negligence / Companies Act Relief

MBS proved recoverable losses of £420,460 (penalties on breaking the swaps, and some costs arising from GT breaches). However, those losses were reduced by 25% for contributory negligence. The Judge considered MBS' conduct in buying 50 year swaps when they greatly exceeded the likely duration of the lifetime mortgages, and failing to consider its own Hedge Accounting Policy (which did not reflect its intention to substitute mortgages for the purpose of the interest rate swaps). A 25% deduction was appropriate taking into account the relative parties' blameworthiness and causative potency.

As an alternative to a contributory negligence deduction, GT argued that its liability as auditor should be reduced, on the basis that it had acted honestly and reasonably (relying on s.727 of the Companies Act 1985 / s.1157 of Companies Act 2006). The Judge agreed that GT had acted honestly and in good faith, but decided that GT was not entitled to relief on the facts, taking into account all the circumstances.

Comment

GT was found liable for only a fraction of the losses claimed. Although the decision was highly fact dependent, as all decisions based upon scope of duty will be, the continued willingness of the Courts to consider scope of duty issues, and to limit the damages for which professionals may be found liable, is good news for professionals generally.

Authors

Naomi Park

Naomi Park

Leeds

+44 (0)113 251 4793

Amy Beaumont

Amy Beaumont

Leeds

+44 (0) 113 251 4767

Suzanne Wharton

Suzanne Wharton

Leeds

+44 (0)113 251 4775

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