Trouble in Paradise. Accountants found liable, DBAs and £5.1m costs

Published 10 febrero 2017

(1) Harlequin Property (SVG) Limited (2) Harlequin Hotels and Resorts Limited v Wilkins Kennedy (a Firm)

Wilkins Kennedy ("WK") provided financial and business advice to the First Claimant ("Harlequin") in connection with properties to be built at Buccament Bay (a luxury Caribbean resort) and sold to investors. Despite the large scale project, WK advised Harlequin not to enter into a contract with its building contractor (ICE) and instead to proceed with informal arrangements where ICE was paid weekly lump sums (initially $125,000 per week, ultimately $600,000 per week) to complete phase 1 of the project by July 2010.

A multitude of problems arose. ICE (for whom WK also acted) slowed down progress to extract maximum funds from Harlequin, yet spent the money on luxury items (e.g. yachts) and not construction! Relations broke down and the agreement with ICE terminated.

None of the parties involved avoided criticism from HHJ Coulson in the High Court. He commented that Harlequin's business model "might be said to bear the hallmarks of a serious and significant scam". Investors paid a deposit to Harlequin to purchase a property at a resort, but the deposit was not ring fenced for use only in building the property for which it was taken. Around 1,900 deposits were taken for Buccament Bay, but the site could not accommodate so many properties; in fact only 199 have been built. Deposits were treated as Harlequin's own money and used for various purposes. The Serious Fraud Office investigation into the scheme continues.

Notwithstanding this background, in this claim Harlequin sought c. $60,000,000 from WK being alleged losses arising from the arrangements with ICE. Twenty alleged breaches of duty were grouped into three main heads of claim: that WK should have (1) advised Harlequin to enter into a contract with ICE, (2) advised Harlequin that ICE were never going to complete the works by July 2010, and (3) never have accepted instructions to also act for ICE given the clear conflict and that WK knew that ICE was misappropriating funds (and should have told Harlequin about that).

Breach of Duty

The partner at WK was found to have acted far beyond the role of Harlequin's accountant. He was involved in all aspects of Harlequin's business model, visited the site on around 45 occasions and played a crucial and detailed role in the development project. He was found to be the de facto CFO or FD of Harlequin.

WK was found in breach under the first head: for failing to advise Harlequin to have a contract with ICE. Harlequin had no security and was paying ICE huge weekly instalments, which had no link to the work done. WK should also have advised Harlequin to have a contractually binding valuation mechanism to ensure ICE was only paid for the value of the work actually carried out.

On the second head, WK was not in breach of duty for failing to advise that works would not be complete by July 2010 as this fell outside its remit and expertise. In fact, the delays were primarily ICE's responsibility.

On head three, the ICAEW Code of Ethics appears to allow a firm to act for two clients where there is a conflict of interest, but that was not appropriate here. In any event, proper information barriers were not in place, nor was informed consent obtained. WK was in breach of contract in also acting for ICE and breached confidentiality by passing information to ICE. However, no loss was claimed as a result of those breaches, and the judge found that WK had no obligation to pass on to Harlequin confidential information that it had obtained from ICE.

Causation and Loss

HHJ Coulson found that Harlequin would not have entered into a formal contract with ICE, even if advised to do so. However, the scope of the works would have been recorded, and a process to only pay for works actually carried out would have been in place but for WK's breach.

After consideration of the expert valuation evidence, Harlequin was found to have overpaid ICE by $23,261,941: the difference between the payments to ICE and the value of the work done, less an allowance for the cost of the valuation process (had it been in place). However, that loss was reduced by 50% to account for Harlequin's contributory negligence, reducing damages to $11,630,970.50.

Costs / Damages Based Agreement ("DBA")

The Claimant's total costs of bringing the claim were £5.1m, and it was awarded 60% of its costs (to reflect that it lost on a number of issues). Significantly, Harlequin's lawyers acted under a Damages Based Agreement. A DBA operates to share the risk of litigation between the lawyer and client. Had Harlequin lost, its lawyers would not have been paid.

Following Harlequin's (partial) success, Harlequin's costs will, absent agreement with WK, be assessed by the Court in the usual way, with WK liable to pay 60% (subject to the caveat that WK will not have to pay more than Harlequin is liable to pay its lawyers under the DBA). There is also a separate agreement between Harlequin and its lawyers (the DBA) which defines success and provides – in the event of success - for the lawyers to be paid a percentage of the damages recovered. If the costs recovered from WK do not cover Harlequin's liability to its lawyers under the DBA, Harlequin will be required to pay the shortfall out of its damages. Whilst Harlequin could end up having to pay a significant share of the damages to its lawyers, without the DBA, Harlequin may not have been able to bring the claim at all (for lack of funds).

Implications

This case arises from unusual circumstances and was decided on the facts. However, accountants and their insurers should take heed of the risk management issues arising. For example, firms should always ensure that appropriate retainers letters are in place with clients (WK had no written retainer with Harlequin), that all staff are aware of the need to preserve client confidentiality, and that procedures are in place to identify and appropriately manage any conflicts of interest, both when a new file is opened and as a matter progresses.

The case is also significant because the claim was funded by a DBA and, in practice, very few solicitors have been willing to accept DBA funding arrangements because the current DBA Regulations 2013 leave claimant solicitors unable to recover their fees if the claim fails. The successful use of a DBA in Harlequin, however, may be the start of a sea change where we see increasingly more litigation funded by DBAs with claimant lawyers sharing the risk, but also the spoils of litigation.