Lenders contemplating claims against negligent professionals should think carefully about the impact the refinancing of loans might have on potential recoveries. This recent Supreme Court decision, which prevented both a lender and its ultimate owner from recovering over £15 million in damages from an accountancy firm which had admitted liability in negligence, serves as a cautionary tale.
In October 2006, Swynson lent £15 million to Evo Medical Solutions Limited (EMSL) to facilitate a management buyout of a US company trading under the name "Evo" (2006 Loan). Mr Hunt was the beneficial owner of Swynson. Following the buyout, Mr Hunt took a 25% shareholding in EMSL of which Evo was a wholly owned subsidiary.
Prior to the transaction, an accountancy firm, Hurst Morrison Thomson (HMT) (now known as Lowick Rose LLP), prepared a due diligence report relied on by Swynson and EMSL. HMT accepted that the report was prepared negligently and that the transaction would not have proceeded but for that negligence.
By July 2007, Evo was in serious financial difficulties and Swynson (at Mr Hunt’s direction) consequently lent a further £1.75 million to EMSL (2007 Loan). Swynson lent a further £3 million in July 2008 (2008 Loan). By then, Mr Hunt held 85% of the equity in EMSL.
By December 2008, none of the loans had been repaid. Mr Hunt and EMSL then entered into an arrangement which saw Mr Hunt (in his personal capacity) advance £18.663 million to EMSL to allow the 2006 and 2007 Loans to be repaid. The loan was structured in this way (rather than being made by Swynson) for tax reasons and to avoid Swynson having a large non-performing loan on its books.
Neither the 2008 Loan nor Mr Hunt's refinance loan were ever repaid. Swynson and Mr Hunt issued proceedings against HMT.
At first instance, Rose J found that only the 2006 Loan had been made in reliance on HMT's negligent report, but concluded that losses arising from the 2007 and 2008 Loans were in principle recoverable as reasonable costs of mitigation.
HMT argued that any losses associated with the 2006 and 2007 Loans were irrecoverable as Swynson's losses had been extinguished following the 2008 refinancing funded by Mr Hunt. Swynson and Mr Hunt advanced counter arguments: (1) that the repayment was collateral to the loss caused by HMT's breach (res inter alios acta); (2) that Swynson was entitled to recover on the principle of transferred loss; and/or (3) that HMT had been unjustly enriched.
Rose J accepted the first argument (and therefore did not consider the second and third arguments) and awarded damages of £15 million. A majority in the Court of Appeal held that Rose J had been right in relation to res inter alios acta and the appeal was dismissed. HMT appealed to the Supreme Court.
Collateral benefits - Res inter alios acta
As a general rule, a party cannot recover damages in respect of a loss which it has avoided, but collateral payments which arise independently of the circumstances giving rise to the loss e.g. payments made as a gift or under an insurance policy, may be considered as an exception. Lord Sumption noted "the critical factor is not the source of the benefit in a third party but its character".
Overruling the Court of Appeal, the Supreme Court unanimously decided that Mr Hunt’s payments could not be regarded as collateral. His loan discharged the very liability that represented Swynson's losses and could not be considered an indirect payment to Swynson - it was a distinct transaction between Mr Hunt and EMSL.
The fact that the loan was made by Mr Hunt was irrelevant. Had the loan been provided by an unconnected third party, the repayment of the original loan would not have been viewed as a collateral benefit. The source of the payment did not alter its nature.
Had Mr Hunt simply gifted Swynson a sum equivalent to the outstanding 2006 and 2007 Loans, this would not have discharged the loans or the liability of HMT. However, as Lord Neuberger noted, "the fact that a transaction could have been differently arranged does not mean that it must have the same consequences as if it had been differently arranged".
A party can only recover loss which he himself has suffered. The principle of transferred loss provides a "limited exception" to this general rule. However, the court held that the principle would not apply to the present case because: (1) Mr Hunt did not suffer his loss in his capacity as the owner of property transferred from Swynson; and (2) it was no part of the object of the engagement of HMT to benefit Mr Hunt.
Unjust enrichment and equitable subrogation
The court rejected the argument that HMT had been unjustly enriched at Mr Hunt's expense and that equitable subrogation should be invoked to reverse that enrichment. The relevant authorities cited were all cases which involved a "defective" transaction and this feature was "fundamental to the principle on which they were decided". The 2008 refinancing was not a defective transaction. Mr Hunt got what he had bargained for namely a covenant to repay, security and the removal of the debt from Swynson's books. Whilst accepting that Mr Hunt had mistakenly understood that the repayment of the 2006 and 2007 Loans would not affect any claim against HMT, the court held that the unjust enrichment/subrogation arguments must fail.
Although the Supreme Court was not unsympathetic to Mr Hunt's position, in the interests of providing certainty there was an emphasis on the need for judges to base their decisions on established principles which have been derived from considerations of justice, reasonableness and public policy. Hard cases should not make bad law.
The impact of the decision was significant as it reduced HMT's liability from £18.5 million (including interest) to about £3.5 million. It is therefore important that lenders, even in circumstances where liability is not in issue, undertake a proper analysis of their recoverable losses particularly in circumstances where loans have been redeemed. The law will not always provide an escape route even if the outcome may be perceived as unjust.