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Swaps close-out costs: auditor not responsible for financial consequences of decision to enter into swaps

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06 March 2019

Incorrect advice given by an auditor as to the accounting treatment of interest-rate swaps did not make it liable for the close-out costs of those swaps which became necessary, following the application of the correct accounting treatment. The Court of Appeal restated and applied the SAAMCO1 principles for determining the limits of the foreseeable losses recoverable from a negligent professional adviser. It emphasised the distinction, originally drawn in SAAMCO, between “advice” cases, where the adviser assumes responsibility for the entirety of a decision-making process and thus for the losses that flow from the decision taken, and “information” cases, where the adviser provides discrete advice or information and only assumes responsibility for the losses flowing from that advice or information being wrong. This ruling will be of interest to auditors, particularly in relation to advice as to how clients’ business activities can be treated in their accounts, as well as to other professional advisers who provide information to clients on the basis of which they will take other business decisions: Manchester Building Society v Grant Thornton UK LLP [2019] EWCA Civ 40.

Accounting standards and interest rate swaps
Grant Thornton UK LLP (GT) audited the accounts of Manchester Building Society (MBS) from 1997-2012.  During this time MBS issued a number of fixed interest lifetime mortgages in the UK and Spain.  From 2006, MBS hedged its resulting interest rate risk by entering into certain long-dated interest rate swaps.  GT negligently advised that MBS could apply hedge accounting to these swaps under the International Financial Reporting Standards, such that MBS’s accounts did not recognise the volatility of the fair value of the swaps.  When GT informed MBS in 2013 that it could not apply hedge accounting, interest rates had fallen to historically low levels, thus recognising the fair value of the swaps in MBS’s 2011 accounts resulted in a regulatory capital deficit of GBP17.9 million. Under regulatory pressure to address that deficit, MBS closed out the swaps, incurring GBP32.7 million in close-out costs, alongside significant transaction fees.
High Court decision: Causation but no assumption of responsibility
By way of a reminder, in the High Court, GT accepted that its advice was negligent, and Teare J found that that advice was both the factual and an effective legal cause of MBS’s losses in closing out the swaps, and that those losses were the reasonably foreseeable consequences of GT’s negligence.  Following the Supreme Court’s decision in Hughes-Holland v BPE Solicitors2, Teare J then identified the key question for the court as being whether GT had assumed responsibility for the particular losses claimed by MBS, and in particular “whether the loss flowed from the particular feature of the defendant’s conduct which made it wrongful”. In doing so he rejected the distinction between “information” and “advice” cases that SAAMCO and Hughes-Holland had established. The court held that, although negligence, foreseeability and loss were all present, “in the round” the loss resulted from a business decision by MBS to enter into the swaps and from a change in the market forces, for which GT did not assume responsibility, rather than the negligent accounting advice given by GT.  MBS appealed.
Court of Appeal decision: GT’s duty limited to provision of “information”
MBS argued that Teare J had failed properly to approach the case on the basis of whether this was an “advice” or an “information” case, as required by SAAMCO and Hughes-Holland. It argued that this was an “advice” case and, as a result, GT had assumed responsibility for all foreseeable consequences of its advice, including the close-out costs of the swaps.
The Court of Appeal agreed that Teare J had erred in his approach, and confirmed that the Supreme Court in Hughes-Holland had clarified that the application of the SAAMCO principle involves considering, first, whether each case is an “information” or “advice” case, as the scope of the defendant’s duty, and thus the measure of liability, differs between the two.
“Advice” cases
In an “advice” case the adviser assumes responsibility for the decision to enter into a transaction, and is thus liable for the foreseeable financial consequences of entering into the transaction.  A particular case will be an “advice” case if it can be shown that the decision-making process had been left to the adviser, whose duty it is to consider all relevant matters to the decision and, in turn, who is “responsible for guiding the whole decision making process”.
“Information” cases
If the test for an “advice” case is not satisfied, then it is an ‘information’ case, and the adviser is not responsible for the financial consequences of the decision to enter into the transaction being taken, only for the foreseeable financial consequences of the information or advice provided being wrong. The foreseeable financial consequences are only those that would not have been suffered if the correct advice or information had been provided.
Applying this approach to the facts, the court held that this was clearly an “information” case. Whilst GT had assumed responsibility for the provision of correct accounting advice, it did not assume responsibility for the decision-making process by which MBS had entered into the swaps.  The Court of Appeal thus upheld the High Court’s decision that GT was liable for the transaction costs of MBS exiting the swaps, but not for the far greater close-out costs, notwithstanding that the High Court had erred in its approach in arriving at that decision.
The court commented, citing the judge at first instance, that it would be 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”.
This case is helpful to practitioners as a clear restatement of the principles and approach to be taken in applying the SAAMCO principles. It makes clear that the critical question is whether the scope of the particular advice provided by the defendant is sufficient to make the case an “advice” case, or is more limited such that it is an “information” case. The role of the concept of assumption of responsibility is an element of this question, and not the critical question itself.
This case also clarifies the importance in professional negligence cases of the requirement for the claimant to show, not only that the defendant’s negligence caused it loss and that that loss was foreseeable, but also that the professional adviser was sufficiently central to the decision-making process such that the case amounts to an “advice case”. If the professional adviser’s role is more limited such that the case is properly characterised as an information case, the recoverable losses are likely to be more limited. Causation, foreseeability, and the SAAMCO principles each act as (in Hamblen LJ’s words) “a legal filter used to eliminate certain losses from the scope of a wrongdoing defendant’s responsibility”. A damages claim for professional negligence must pass each filter to succeed.

1 South Australia Asset Management Corp v York Montague Ltd [1997] A.C. 91.
2 [2017] 2 WLR 1029.

Further information
This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication.  If you wish to receive this publication, please contact Amy Edwards,