Swynson Ltd v Lowick Rose LLP (In Liquidation)
Court of Appeal (Civil Division)
25 June 2015
[2015] EWCA Civ 629
Subject: Accountants—due diligence report—duty of care—negligence—liability—funds advanced through corporate investment vehicle—mitigation of loss—res inter alios acta—quantum
Summary:
Where a negligent accountant caused a company to advance sums to a borrower which did not prosper, but the borrower then repaid a large part of its debt to the lender by using funds provided personally by the owner of the lender, those repayments were found on the facts to be res inter alios acta, and the lender could recover in full for the advances made in consequence of the accountant’s negligent advice.
Abstract:
In paragraph 1 of his leading judgment, Longmore LJ framed the central issue:
“This appeal concerns the amount of damages recoverable by a lender from a negligent firm of accountants who failed to do a proper exercise of due diligence on the borrower to whom the money was lent. The majority of the loan was repaid by utilising money lent to the borrower by the owner of the lending company. Rose J has held that that repayment was a collateral matter which did not go to reduce the damages recoverable from the negligent accountants. The question is whether she was right.”
Mr Hunt indirectly owed a company called Swynson. On 31 October 2006 Swynson lent £15m to a company called Evo Medical Solutions Limited (“EMSL”) to enable it to facilitate a management buyout of Evo, an American company specialising in the distribution of medical devices in the USA (“the 2006 Loan”).
The 2006 Loan was made by Swynson in reliance upon a due diligence report (“the Report”) prepared by the firm now known as Lowick Rose LLP (“Lowick”). At trial it was admitted that the Report had been prepared negligently, in that it had failed to identify a $3–$4m adverse difference between Evo’s actual and forecast working capital. It was also conceded at trial that there was a causal link between the Report and the making of the 2006 loan.
Evo performed poorly. In 2007, Mr Hunt caused Swynson to grant a further facility of £1.75m to EMSL (“the 2007 Loan”). Evo, however, continued to struggle and in 2008 Mr Hunt decided to provide a further £3m, again by means of a loan from Swynson (“the 2008 Loan”). As part of the 2008 Loan agreement, a shareholding in EMSL that was held on trust for Mr Hunt was increased from 25 % to 85% preferred ordinary shares, giving Mr Hunt control of EMSL.
At the end of 2008 there was what the judge described as a “refinancing of the 2006 and 2007 Loans”. On 31 December 2008, EMSL and Mr Hunt entered into a loan agreement whereby Mr Hunt made funds available to EMSL in the sum of £18,663,306.59 (“the 2008 Partial Refinance”). EMSL then paid Swynson £17,015,000 which was the totality of the sums due under the 2006 and 2007 Loans, leaving only the 2008 Loan outstanding. The 2008 Partial Refinance was made partly because, now that Mr Hunt had become the majority owner of EMSL, Swynson and EMSL had become connected entities, exposing Swynson to tax a liability on the interest due from EMSL even that interest was not paid.
Evo never prospered, and despite attempts to realise assets in 2011, the decision was taken to wind Evo down. Neither Mr Hunt nor Swynson received any monies from the realisation. In 2013, Mr Hunt and Swynson both sued Lowick, seeking to recover the amounts of the 2006, 2007 and 2008 Loans as losses resulting from its breach of duty. As to damages, Lowick’s defence was that it could only be liable for the 2008 Loan, because EMSL had, using the funds made available by Mr Hunt in the 2008 Partial Refinance, repaid the 2006 and 2007 Loans in full.
The judge held that Mr Hunt had no claim against Lowick because no duty had been owed to him in respect of the relevant advice. There was no appeal against that finding. As to Swynson’s claim for damages, the judge gave judgment in respect of the totality of the 2006, 2007 and 2008 Loans, holding that the repayments by EMSL were collateral to the loss caused by Lowick’s breach of duty (res inter alios acta). Lowick appealed, and Swynson cross appealed.
By a majority, the Court of Appeal upheld the judge’s decision. Longmore LJ reviewed the authorities, including British Westinghouse Co Ltd v Underground Electric Railways Co Ltd [1912] A.C. 673, and stated the established dichotomy as follows:
“It is usually said that, if the transaction giving rise to the avoided loss arises by virtue of circumstances which are collateral to the breach of contract, the avoided loss need not be brought into account; but if the transaction giving rise to the avoided loss arises out of the consequences of the breach and in the ordinary course of business it is to be taken into account.”
He agreed with the judge’s view that the 2008 Partial Refinance was not a transaction which came about in the ordinary course of Swynson’s business. That transaction was (citing the judge with approval) “not a transaction that Swynson could have brought about by itself….”, and was “peculiar to Swynson in that Mr Hunt would not have funded the repayment of the loan on those terms for any other company….” His Lordship’s view was that, if Mr Hunt had simply gifted the amount of the 2008 Partial Refinance to Swynson to help it balance its books, such an act of benevolence could not be suggested to enure to the benefit of Lowick as the negligent adviser. It should, therefore, be no different “merely because the payment is made through EMSL.” He did not regard this as piercing the corporate veil, but rather, considered that the contrary outcome (Lowick benefiting from the repayment by EMSL) would be “a triumph of form over substance”.
Sales LJ agreed. His Lordship’s judgment was focussed upon the “practical reality and basic justice” of whether EMSL’s repayment should be brought into account:
“I consider, on the authority of Parry v Cleaver [1970] A.C. 1, that the principles governing whether some matter which reduces loss is to be regarded as collateral (or, in old legal language, res inter alios acta), and hence to be left out of account when deciding whether damages are payable in respect of that loss, are intended to reflect practical reality and basic justice as between the three persons involved: the person who has suffered the loss, the person who is in law responsible for causing the loss and the third party who has made a payment which reduces that loss….To my mind, this approach requires a court to focus on the substance of the matter, as against the technical form which may have been adopted by the third party in choosing how to benefit the person who has suffered the loss.”
Like Longmore LJ, he was persuaded by counterfactual argument that if the funds had been advanced directly to Swynson by Mr Hunt, this would have been a collateral matter; and that being so, he was not prepared to allow the form of the subsequent transaction to diminish the damages payable. He also went on to hold, in agreement with Longmore LJ, that the 2008 Partial Refinance by Mr Hunt was on uncommercial terms and in a manner which could not be regarded as remotely in the ordinary course of business so far as Swynson was concerned.
Davis LJ dissented. In his view, the matter was simple: Swynson was repaid by the borrower to whom it had advanced the 2006/2007 Loans, pursuant to the covenants to repay that were contained in the loan agreements procured by the negligence of Lowick:
“The causal connection was “therefore plain: and the avoidance of loss to Swynson has been achieved by the very party who was otherwise in breach of the contract. This therefore cannot be regarded as a collateral matter.”
For Davis LJ, it was impermissible to look beyond the actual form which the transactions took. It would be wrong to “ignore the corporate structures involved” and the repayments to Swynson “were not to be regarded as made by Mr Hunt or by some third party. They were made, and were to be regarded as made, by the borrower itself: that is, EMSL.”
Swynson’s cross appeal sought to argue that, if EMSL’s repayments were in fact to be taken into account, then Lowick had been unjustly enriched by the diminishment in the value of Swynson’s claims against it, and either Mr Hunt or Swynson should be entitled to a remedy against Lowick by way of subrogation. This point did not arise for decision in view of the dismissal of Lowick’s appeal, but obiter, their Lordships all expressed a view.
The Court was again divided, albeit in different camps. Longmore and Davis LLJ agreed that the argument was flawed. If, due to the repayments funded by Mr Hunt, Swynson had lost the right to claim the amount of the 2006 and 2007 Loans, then there were no rights in Swynson to which Mr Hunt could be subrogated. In contrast, if Lowick was to be regarded as having been enriched at Swynson’s expense, subrogation was not needed. In addition, both of their Lordships did not consider that Mr Hunt or Swynson would establish the element of mistake necessary to make out the unjustness of the enrichment. The mistake suggested was that Mr Hunt had paid the 2008 Partial Refinance monies, and Swynson had accepted the consequent repayment from EMSL, in the mistaken belief that Lowick’s liability would be unaffected. However, Longmore LJ thought that “the probability is that no consideration was given to the matter at all… the evidence of the mistake, which is necessary if [Lowick’s] enrichment is to be considered unjust, is missing.”
Dissenting, Sales LJ would have decided this point in favour of Mr Hunt. In his view, although on this alternative hypothesis Mr Hunt’s money would actually have served to eliminate Lowick’s liability to Swynson in respect of the 2006 and 2007 Loans, nonetheless “the law would regard that liability as extant for the purposes of allowing Mr Hunt to be subrogated to Swynson’s rights against [Lowick] in order to provide an appropriate remedy to reverse the unjust enrichment which would have occurred.” Sales LJ consciously expressed his views, as a minority member on an obiter issue, in a very brief form.
Comment
The ratio of the decision is the relatively compact finding by the majority that the repayment by EMSL was not a matter arising in the ordinary course of Swynson’s business, and that therefore, the facts did not satisfy the British Westinghouse criteria for that repayment to be brought into account as avoided loss.
In reaching that conclusion, the majority of the Court was prepared to look beyond the formal structural arrangements of the loans between Swynson and EMSL. Davis LJ, in the minority, was not. The more expansive approach espoused by Sales LJ is, however, based on the highest authority. When citing the decision in Parry v Cleaver, Sales LJ relied on Lord Reid’s proposition that:
“… the distinction between receipts which must be brought into account and those which must not must depend not on their source but on their intrinsic nature.”
This suggests that substance is indeed intended to triumph over form, and not vice versa. This was ostensibly the issue that divided the Court, but it is submitted that the majority got it right.
Simon Hale 4 New Square