Breaking the Mountaineer’s Knee: Supreme Court establishes “purpose test” to assess the scope of an auditor’s duty

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Breaking the Mountaineer’s Knee: Supreme Court establishes “purpose test” to assess the scope of an auditor’s duty

Published 21 julio 2021

Introduction
A lot has already been written about the June 2021 Supreme Court judgment in the case of Manchester Building Society vs. Grant Thornton UK LLP [2021] UKSC 20. That is not surprising, as it is the first Supreme Court decision on the scope of an auditor’s duty. Notably, the ruling signifies a break from the oft questioned legal logic of Lord Hoffman in South Australia Asset Management Corporation v York Montague Ltd [1997] AC 191 (“SAAMCO”) for all professional advisor cases.  
This article seeks to tease out how the decision will play out in future audit negligence claims. For those hoping for a straightforward test to determine legal liability arising from negligent advice, look away now. As before, the tests applied to determine legal liability are intertwined. The “Mountaineer’s knee” is broken, but will undoubtedly feature again in future cases. What this Supreme Court decision has changed is the approach a court must take when determining the starting point of those tests, namely, what losses fall within the scope of a professional’s duty.
The Facts
The case concerned “hedge accounting” and fixed rate lifetime mortgages. The auditors advised that the building society could manage the volatility on its balance sheet and keep its regulatory capital at a level it could afford by entering into swaps “matched” against the mortgages. That advice, and the audits which were signed in the years that followed that advice, were held to be negligent and exposed the building society to the risk of loss from having to break the swaps, when it was realised that hedge accounting could not in fact be used to manage the regulatory capital demands.
At first instance
At first instance, Teare J - whilst finding that the losses MBS sustained when closing the swaps were the reasonably foreseeably consequence of the negligence - held that the auditors had not “assumed responsibility” for those losses at the time of giving negligent advice. The extent of those losses was a result of market forces (namely a sustained fall in interest rates) and not something for which the auditors should be held responsible. Further, Teare J applied a 25% reduction because of MBS’ contributory negligence.
MBS appealed Teare J’s ruling on several grounds: notably that the Judge had made an error in law by not relying on the “advice / information” distinction set out in SAAMCO and, later, BPE Solicitors vs. Hughes-Holland [2017] UKSC 21. In reliance on these authorities, MBS argued that this was an “advice” case and that GT should have been held responsible for all reasonably foreseeable consequences of its advice being wrong, whether or not an “assumption of responsibility” could be established.
The Court of Appeal
While the Court of Appeal accepted that Teare J may have erred in law (in particular by not addressing SAAMCO with sufficient scrutiny), it found that his overall conclusion was the right one. As such, the appeal was dismissed. The Court of Appeal found that this was an “information case” as envisaged by Lord Hoffman in SAAMCO, and that the losses sustained in closing out the swaps fell outside the scope of the auditors’ duty.
The Judgment
The Supreme Court unanimously allowed MBS’ appeal (albeit with a 5:2 split on the basis for doing so) and held that the losses incurred by MBS in closing out the swaps fell within the scope of the auditors’ duty.
The Supreme Court held that the “advice / information” divide espoused in SAAMCO had “not proved to be satisfactory.” The court held that the distinction applied by Lord Hoffman in SAAMCO was “too rigid” and “liable to mislead”, and often leads to “shoe-horningparticular cases into one of those two broad categories (“information” vs “advice” cases) where often, professional advice displays elements of both.
It also dismissed the usefulness of a rigid application of counterfactual analyses used when applying SAAMCO in determining scope of duty. 
The majority set out a 6-point scheme for assessing which losses lie within the scope of a professional’s duty:
  • 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).
In the current case, the auditor provided advice on the accounting treatment of the lifetime mortgages and use of swaps to manage balance sheet volatility. Applying steps 1-6 above, the Court concluded that when the auditor’s advice, that the volatility could be managed through the use of swaps, was found to be wrong, MBS’ losses flowing from having to close out the swaps were a foreseeable consequence of that advice being wrong.
The Supreme Court found for MBS, but applied in the auditors favour a full 50% reduction for MBS’ contributory negligence.
Commentary
The decision separates determining the scope of an auditors’ duty from the question of what losses were caused by a breach of that duty. Before one addresses question of causation, one first has to answer the question, what is the “purpose” for which professional advice is sought. To quote the test given in the majorities’ judgment: “…one looks to see what risk the duty was supposed to guard against and then looks to see whether the loss suffered represented the fruition of that risk. This is the
point of the mountaineer’s knee example given by Lord Hoffman in SAAMCO..”. 
The SAAMCO principle and its analysis, based on distinguishing between information and advice cases, is relegated to a useful sense check when determining the scope of duty. 
The courts have described an auditor’s duty in the following terms (quoting from Lord Leggatt explaining what the House of Lords said in Caparo): “the purpose of a statutory audit is to provide the company and its shareholders with accurate information about the company’s finances on which to base management and governance decisions. It is not a purpose of the audit to provide information on which potential investors may rely in deciding whether to buy shares in the company. It made no difference in this regard whether the potential investor was an existing shareholder.”
That means that unless the auditor extends that duty by assuming responsibility for matters beyond his strict statutory duty, the losses must broadly arise from management decisions which would have been different had the audit not been negligent, and the losses would have been avoided in consequence. For audit cases, it must be remembered that the auditor’s liability for MBS’s losses for closing out the swaps arose not from its statutory duties, but an extended duty arising from advice the auditor gave on the accounting treatment based on the use of swaps. The statutory duty of an auditor, is “… limited to protecting the audited entity and its members against the risk that its audited accounts are inaccurate (together with the risk of certain types of wrongdoing…) It is no part of the auditor’s duty to advise the audited entity what business decisions it should make…”
And, if the auditor does extend its statutory duty by assuming responsibility for additional areas of advice, one looks at the purpose of the advice, namely, “one looks to see what risk the [assumed] duty was supposed to guard against and then looks to see whether the loss suffered represented the fruition of that risk.”
The “purpose” test set out by the Supreme Court may prove a more straightforward test to apply when determining the scope of duty of a professional adviser for its client’s losses, but SAAMCO remains relevant. When determining the scope of duty the courts will continue to use the test in SAAMCO as a sense check.  

Authors

Jamie Tomlinson

Jamie Tomlinson

London - Walbrook

+44(0)20 7894 6014

Richard Highley

Richard Highley

London - Walbrook

+44 (0)20 7894 6470

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