Supreme Court overturns ruling on assessment of damages in accountants' negligence case

The Supreme Court has ruled that, where loans made to a company on the basis of a firm of accountants’ negligent due diligence report had been repaid by the company using money borrowed from the lender’s owner, neither the lender nor its owner could claim against the accountant for loss of the loan funds. The lender had suffered no loss (as it had been repaid); and the accountant owed no duty to the lender’s owner. The case is a salient lesson to those involved in restructuring lending where they want to preserve rights of recourse against third parties; and an important defence to be alive to when faced with such a claim.

In 2006, Swynson Ltd lent money to Evo Ltd. Swynson was indirectly owned by Mr Hunt. When Evo failed to repay the loans, Mr Hunt (for tax reasons) made funds available to Evo to allow it to repay part of the loans to Swynson. The accountants admitted that their due diligence report was negligent but argued that, as the loans had been repaid, Swynson had suffered no loss that could be recovered by way of damages.

Swynson and Mr Hunt submitted that they should be able to recover damages from the accountants because (1) the repayment of the loans was a collateral payment, (2) the principle of transferred loss applied and (3) the accountants would otherwise be unjustly enriched.

The Supreme Court found in favour of the accountants, overturning the Court of Appeal’s decision that where a debt incurred as a result of negligent advice is repaid, that repayment should only be taken into account when assessing damages if the repayment was made in the ordinary course of business but not where, as in this case, the repayment arose through circumstances which were collateral to the breach of contract.

Collateral payments

The general rule is that loss which has been avoided is not recoverable as damages (although expense reasonably incurred in avoiding it may be recoverable). The Supreme Court confirmed that the law treats collateral payments as an exception to this general rule and that they do not make good the claimant’s loss. Collateral payments are broadly defined as those whose receipt arose independently of the circumstances giving rise to the loss. Common examples are gifts or payments under liability insurance policies. Here, the fact that the money used for the repayment was borrowed from Mr Hunt was held to be irrelevant. The repayment transaction discharged Evo Ltd’s liability which represented the lender’s potential loss resulting from the accountants’ negligence.

Ironically, if Mr Hunt had provided a loan to strengthen Swynson generally, rather than for repayment of the money lent on the basis of the negligent report, that loan would not have discharged the debt and loss of the loan could have formed part of damages to be paid by the accountants. Lord Sumption commented that the distinct legal personality of companies has been a fundamental feature of English commercial law for a century and a half, but that has never stopped businessmen from treating their companies as indistinguishable from themselves. Mr Hunt had made that mistake.

Transferred loss

The Supreme Court also considered whether the owner could benefit from the principle of ‘transferred loss’, which provides a limited exception to the rule that a claimant can only recover loss which he has himself suffered. This, however, only applies where the known object of a transaction is to benefit a third party, in which case the contracting party may be able to recover on behalf of the third party. The court ruled that this could not apply here. The accountants had owed no duty to Mr Hunt and the loan transactions had not been intended to benefit him in any way.

Unjust enrichment

The claimant lender argued that allowing the accountants to escape penalty whilst its owner suffered a £15 million loss would constitute unjust enrichment for the accountants. The Supreme Court found that even if the accountants were, in effect, being enriched at Mr Hunt’s expense, he could not rely on the doctrine of equitable subrogation to recover his loss, as equitable subrogation can only be invoked where a person discharges a debt on the basis of some agreement or expectation of benefit which fails. When discharging the debt, Mr Hunt was not bargaining on a right to recover damages from the accountants – his participation in the repayment transaction was not a question of consent to the defendant’s enrichment that was ‘impaired, qualified or absent’. Mr Hunt’s loss resulted from a commercial transaction bearing commercial risk. As he had not been defeated in a legitimate expectation of reimbursement, Mr Hunt had not suffered an injustice recognised by the law.

Comment

Those defending professional negligence claims should bear in mind that where loss has been averted through the intervention of a party to whom no duty was owed by the negligent professional, the rule that collateral payments do not make good the claimant’s loss may not apply. Those advising on steps taken to mitigate loss must also ensure that mitigation in the form of repayment of sums due does not have the effect of extinguishing possible rights of recovery from a negligent third party.

Further reading:

Lowick Rose LLP (in Liquidation) v Swynson Ltd & Anor
Accountants’ PI: assessment of damages