Manchester Building Society (‘MBS‘) is a small mutual society whose accounts were audited by Grant Thornton (‘GT‘) between 1997 to 2012. MBS’s business model included offering fixed rate lifetime mortgages where the principal loan amount and interest was only repaid on the death of the borrower or on the borrower selling their property. These mortgages were offset against interest rate swaps to guarantee a profit when the mortgages were finally redeemed. The effect of these swaps and their mark-to-market value was to increase the volatility of MBS’s financial position. This affected their balance sheet and MBS were obliged to hold increased capital reserves.
In 2006, relying on GT’s advice that “hedge accounting” could be employed to minimize the impact of the swaps, MBS entered into further swap contracts in order to hedge its interest rate risk. The idea was that the value by which the swaps decreased was matched by the value by which the mortgages increased. Effectively they cancelled each other out and therefore constituted a single entry in the accounts. This reduced the volatile element of the swaps. This allowed MBS to pursue its chosen business model. However, in the majority of cases the swaps had a longer term than the mortgages which meant that they did not often match exactly. Despite this, the auditors signed off the accounts each year using the hedge accounting method, and MBS continued to enter new swap contracts.
In 2013, GT realised that the advice they had been giving MBS regarding hedge accounting was wrong. They advised MBS that they would have to restate their accounts. MBS would need to account for the fair value of the swaps from now on. This heavily impinged on their financial position as by now, with the 2008 financial crisis and falling interest rates, the swaps had lost considerable value. MBS had greatly reduced assets and insufficient regulatory capital. To deal with this MBS closed out the swaps incurring a mark-to-market loss of £32.7million. They sought to recover this sum as damages (less the value of the mortgages) from GT on the basis of professional negligence.
Life is a Shylock; always it demands the fullest usurer’s interest for each pleasure. Gifts are not freely calculated by its hands; we make returns for every borrowed treasure.”
Ella Wheeler Wilcox
The SAAMCO case
GT admitted that its advice had been negligent and that they had audited the accounts negligently but argued that they should not be held responsible for the full extent of MBS’s losses. They sought protection from the SAAMCo (a 1996 House of Lords case) principle to limit its liability to issues within the scope of its duty of care. This principle has been followed in professional negligence cases for some 15 years and examines to what extent the claimant would have suffered even if the defendant’s advice had been correct.
The principle draws distinctions between “advice” and “information” given by the professional. If an adviser provides information or a piece of advice which is only one of many factors to be taken into account by a client in making its own decision to enter a transaction, then the adviser is only liable for the financial consequences of that one piece of advice/information being incorrect. This is despite the significance of that advice/information to the client’s eventual decision. If however the professional negligently advises the client to enter a transaction they will be liable for all the consequences, financial or otherwise, of that advice being wrong.
The Judgements
At first instance MBS lost their claim, and when they appealed to the Court of Appeal their claim was again dismissed. Both courts decided that GT did not assume responsibility for the wider implications of MBS’s business model by offering advice about hedge accounting. The Court of Appeal held that this was an “information” rather than “advice” case and that the loss was outside the scope of GT’s duty of care and they could not therefore recover damages. MBS appealed to the Supreme Court.
After much consideration, the seven Judges in the Court unanimously found in favour of MBS and allowed the appeal. They felt that the previously clear and rigid division between “information” cases and “advice” cases was unhelpful and apt to mislead. It was more appropriate to see cases falling on a spectrum of information/advice. The central question should concentrate on the purpose of the duty owed by the professional. The scope of that duty is defined by an objective assessment of the purpose of the duty. A fundamental question to be asked is: what risks, judged objectively, was the professional instructed to guard against? An allowance of 50% was made for contributory negligence (MBS had been too ambitious in implementing their business model), and credit was given for nearly £6million gains made by the mortgages. This led to a final settlement of damages of £13.4 million. The decision will be of interest to financial bodies and professional advisers generally, including as in this case, auditors.
Link: Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20
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