The Court of Appeal has found that Grant Thornton (GT) was not liable for commercial losses incurred by the Manchester Building Society (MBS) as a result of entering into interest rate swap agreements.
Background
MBS lent money to borrowers at a fixed rate and acquired funds at a variable rate. To hedge against this interest rate risk, MBS purchased interest rate swap agreements. Valuing swap agreements can produce volatility. Hedge accounting, if permitted, is designed to reduce this exposure to volatility by making adjustments to the value of the hedged item. In 2006, GT negligently advised MBS that it could apply hedge accounting rules under International Accounting Standard 39.
As a result of GT’s advice from 2006 to 2011, the swap agreements were brought onto MBS’s balance sheet and valued at fair value. The fair value or “mark-to-market” of a swap agreement is the market’s assessment of the current discounted value of all future payments due under the agreement.
In 2013 GT advised MBS that hedge accounting may not be applicable. The consequent changes to MBS’s accounting meant that it did not have sufficient regulatory capital. MBS broke the swap agreements at their fair value of £32.7 million, incurring £285,460 of transaction costs.
The decision
Rejecting MBS’s claim for damages for the fair value of the swap agreements, the Court of Appeal found in Manchester Building Society v Grant Thornton LLP [2019] EWCA Civ 40 that MBS’s losses flowed from market forces, not GT’s negligence. MBS was unable to prove the counter-factual scenario that it would not have suffered these losses if it had continued to hold the swap agreements. GT was only responsible for the foreseeable financial consequences of the incorrect advice it gave MBS in respect of the applicability of hedge accounting rules. GT had not advised on the commercial decision to purchase the swap agreements and was therefore not responsible for the financial consequences flowing from that decision. Breaking the swap agreements did not create MBS’s losses, but merely crystallised them.
On this basis, GT was only liable for the transaction costs incurred when MBS decided to break the swap agreements after discovering that hedge accounting was not appropriate.
Comment
In reaching its decision, the Court of Appeal confirmed the distinction between “information cases” in which a professional provides information on a specific aspect of a transaction and “advice cases” in which the professional advises on whether or not the transaction should be entered into at all. This distinction was established in the line of cases beginning with South Australia Asset Management Corporation v. York Montague Ltd [1997] AC 191, but had been queried by Teare J at first instance as well as in some other recent cases. Potential claimants seeking damages for professional negligence should appreciate the distinction between losses flowing from professional advice they have received and those flowing from commercial decisions on which the professional did not advise.
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