Supreme Court rules Grant Thornton must pay £13.4m over negligent adviceby
A long-running court battle between Grant Thornton and Manchester Building Society has ended with the challenger firm liable for significant damages after senior judges clarified what counts as “negligent” advice.
The Supreme Court has backed a £32.7m damages claim against Grant Thornton over suspect advice given to a client, in a ruling which experts say may leave other auditors open to litigation.
The long-running civil case, brought by Manchester Building Society in 2013, hinged on what counted as “advice” versus simple “information”.
Grant Thornton audited the books of the mutual building society until 2012, but after advising the use of “hedge accounting” an error in the treatment of interest rate swaps meant the client had to break an agreement early, incurring costs of almost £33m.
For six years the case traversed the lower courts before the Supreme Court judgment handed down on 18 June sided with Manchester Building Society and ruled that it is entitled to claim £13.4m from Grant Thornton for negligence. The sum is less than half the total amount the society originally lost, which the court said was down to its own contributory failings in the matter.
The challenger firm said it was “disappointed” by the judgment, which overturned earlier rulings in the High Court and Court of Appeal.
“We always accepted that our audits of the Society for the 2006-2011 years fell below the high standards that we strive for and regret the errors in the Society’s financial statements that arose from hedge accounting; which our audit team identified and brought to the attention of the Society and the Prudential Regulation Authority in 2013,” a spokesman for Grant Thornton UK LLP said.
Scope of duty
Hedge accounting is used to reduce the volatility of the mark-to-market value of swaps in accounts, and from 2006, Grant Thornton advised the society that its accounts could be prepared using the method to give a true and fair view of its financial position.
This allowed the society, under tightly specified circumstances, to adjust the carrying value of the lifetime mortgages to offset any changes in the value of the swaps.
Grant Thornton advised that the combination of swaps and mortgages passed the stringent tests applicable to the use of hedge accounting, and repeated this same incorrect advice in each annual audit, the court found.
Following the global financial crisis of 2008, a fall in interest rates, meant the mark-to-market value of the swaps became negative.
The misstated accounts hid both volatility in the society’s capital position and the eventual severe mismatch between the negative value of the swaps and the value of the mortgages which the swaps were supposed to hedge.
In 2013, when Grant Thornton realised its error, the society had to restate its accounts, showing substantially reduced assets and insufficient regulatory capital. To remedy the situation, the society closed out the interest rate swap contracts early for a multi-million-pound loss, and had to source emergency funding.
Information or advice?
Such was the complexity of the case, three different courts took three very different views of both the scope of duty test that applies in cases of professional negligence, and the proper outcome.
Grant Thornton admitted negligence but defended its liability on the basis that the swap break costs did not fall within its scope of duty when it gave the advice and undertook the audits
Whilst the Commercial Court awarded damages to Manchester Building Society, both it and the Court of Appeal found in favour of Grant Thornton in relation to the swap break costs, albeit on differing grounds.
The Court of Appeal weighed if “information” or “advice” had been provided by the auditor, and consequently if it would be liable for “all the foreseeable consequences of entering into the transaction”.
Ultimately, the appeal judges felt it was an information case, to which the society appealed, and eventually the case was heard in October 2020 by a panel of the Supreme Court. The seven judges unanimously determined that the losses suffered by Manchester Building Society were within the scope of Grant Thornton’s duty.
“The very thing”
Future cases of negligent advice will concern “what risk the duty was supposed to guard against and then whether the loss suffered represented the fruition of that risk”, experts told AccountingWEB.
“If one is looking for a bite-size take away from this judgment it is that, in practical terms, the scope of duty test has become the question; ‘Is this loss the very thing that the professional advice was supposed to guard against?,” said Anthony Taylor, litigation partner at Squire Patton Boggs who represented Manchester Building Society. “The judgment has significantly reformulated the legal test for the scope of duty of care owed by professional advisers to their clients.”
The case was twinned with an unrelated claim also concerning scope of duty in a professional negligence context. In that case, a doctor negligently advised a patient that she was not at risk of passing on haemophilia to any child she might have.
“The legal test for scope of duty in professional negligence had become narrow and difficult to navigate,” said Taylor. “The over emphasis on the counterfactual test had introduced both uncertainty and undue barriers to recovery in cases involving complex facts.” He said the simplification of the test provided by the court in this judgment was “very welcome”.
Audit firms in the crosshairs
The case is likely to have ramifications for auditors who provide advice to clients who later lose money.
“Claimants who have suffered loss as a result of negligent advice are likely to turn to this judgment as providing both a more generous and more common-sense test for scope of duty,” said Taylor. “Professionals giving advice should pay heed to the ‘purpose of duty’ question and make sure that their terms of engagement are absolutely clear on the agreed purpose of the advice being sought.”
The decision will fuel further scrutiny of the audit word during a difficult time for the top firms, said Paul Brehony, partner and specialist insolvency disputes expert at Signature Litigation. “It demonstrates that where an auditor is held liable for a company's losses, significant damages can follow,” Brehony said. “Going forward, we can expect an uptick in corporate failures as pandemic support measures are eventually withdrawn. Audit firms are deep-pocketed targets and large claims for negligence and potential wrongdoing seem inevitable at this time."
Professional advisers are under growing scrutiny and should pay attention to the judgment, added Janine Alexander, financial services partner at Collyer Bristow LLP.
‘This case forms part of an intensifying focus on the duties owed by accountants, and in particular, auditors when scrutinising the finances of large enterprises - a reminder that the courts and regulators expect more from them than a box ticking approach,” Alexander said.
The Financial Reporting Council (FRC) probed the matter in 2013, and the regulator took action against Grant Thornton in 2015, fining the firm just under £1m.
While the FRC did not wish to comment on this case, the thinking inside the regulator is understood to be that the outcome won’t have particularly wide-ranging implications given the unique set of circumstances involved.