A majority of the Court of Appeal has held that damages payable to a lender by a firm of accountants should not be reduced to reflect a repayment by the borrower as the repayment did not arise in the ordinary course of business: Swynson Limited v Lowick Rose LLP [2015] EWCA Civ 629.

The majority agreed with the decision at first instance that the repayment was collateral to the loss caused by the accountants’ breach of duty and it did not extinguish the loss suffered by the lender in respect of certain loans extended to the borrower, despite the fact that the loans had been repaid by the borrower.

The repayment was made as part of a restructuring of the debt, largely for tax purposes, and was funded by the lender’s indirect owner, who had acquired an interest in the borrower. The court held that because the repayment did not arise in the ordinary course of business, it fell into a category of avoided loss, such as benevolent payments or insurance payments, which should not be brought into account when assessing damages. Had the lender’s indirect owner supplied the funds directly to the borrower, it would be clear that such payment was collateral; the majority said to hold that a different result should occur merely because the payment was made through the borrower would be a triumph of form over substance. However, in a strong dissenting judgment, Lord Justice Davis refused to ignore the corporate structures involved. In his view, the form of the transaction was the substance.

The decision highlights the need for caution in taking steps which might reduce a claimant’s loss (whether such steps are taken in mitigation or not) and gives rise to an interesting debate as to the extent to which the court should be prepared to “disregard technicalities” in order to achieve a “just” result. Tamsin Baird and Adam Vallance, a senior associate and trainee in our dispute resolution team, consider the decision further below.

Background

The claimant lent money to a borrower (“EMSL”) in reliance on a due diligence report prepared by the defendant firm of accountants.

The claimant’s owner, Mr Hunt, later became the majority owner of EMSL. This meant that the debt between the claimant and EMSL became a debt between two connected entities, resulting in unfavourable tax treatment for the claimant. Because of this, and to avoid the claimant having an impaired debt on its books, Mr Hunt arranged for EMSL to repay the loans in part (the “Partial Refinance”), using monies lent to EMSL by Mr Hunt. Neither the remainder of the loans, nor the loan provided by Mr Hunt to fund the Partial Refinance, were repaid.

The claimant brought proceedings against the defendant seeking damages for the full amount of the loans. The defendant admitted negligence but argued that the claimant’s damages must be reduced by the extent to which the loans had been repaid in the Partial Refinance.

At first instance, the judge (Mrs Justice Rose) awarded damages for the full amount of the loans (subject to a contractual cap on liability) on the basis that the repayment effected by the Partial Refinance was collateral to the loss caused by the defendant’s breach of duty. The defendant appealed. (Note: Mr Hunt was also a claimant in the action, but the judge found that the defendant did not owe a duty of care to Mr Hunt. This finding was not appealed.)

Decision

The Court of Appeal (with a lead judgment delivered by Lord Justice Longmore) upheld the first instance decision.  Longmore LJ recognised that there are cases where a claimant’s loss is partly or wholly avoided either as a result of taking reasonable steps to mitigate its loss, or despite taking no steps in mitigation.  He held that the principles governing the question as to whether that avoided loss should be brought into account in assessing damages are similar in each case.  That is, transactions giving rise to avoided loss by virtue of circumstances which are collateral to the breach of contract should not be taken into account, for example insurance payments and benevolent payments; but transactions giving rise to avoided loss which arise out of the consequences of the breach and in the ordinary course of business are to be taken into account.

Longmore LJ held that whilst the Partial Refinance may have arisen because of the defendant’s breach of duty, it did not arise in the ordinary course of business. In this respect, he agreed with the finding of Rose J that in light of EMSL’s poor record in repaying sums due under the loans, there was no prospect of selling the debt to a third party. The transaction was peculiar to the claimant in that Mr Hunt would not have funded the Partial Refinance for any other company. If Mr Hunt had given the funds to the claimant, this would have amounted to an act of benevolence and one could not possibly suggest that any such payment should inure to the benefit of the defendant rather than the claimant. To hold that a different result should occur merely because the payment was made “through EMSL” would be a triumph of form over substance.

Longmore LJ dismissed the defendant’s submission that to look behind the source of the funds would be to pierce the corporate veil. Instead, Longmore LJ, relying on the decision of Lord Reid in Parry v Cleaver [1970] AC 1, held that it was “merely to disregard technicalities”.

Lord Justice Sales agreed with the reasons given by Longmore LJ and added that the principles governing whether avoided loss should be taken into account in assessing damages are intended to reflect the “practical reality and basic justice” as between the parties involved.  Sales LJ held that the court is required to focus on the “substance of the matter, as against the technical form” which had been adopted by a third party choosing how to benefit the person who has suffered the loss.  As a result, Sales LJ found that it would be contrary to the “ordinary man’s sense of justice, and therefore contrary to public policy” that the funding provided by Mr Hunt to EMSL should be taken into account in reducing the amount of the damages.  Whilst Sales LJ acknowledged that Mr Hunt was not acting benevolently, he considered that the case was analogous to cases of benevolent payments.

Lord Justice Davis delivered a dissenting judgment in which he argued that the form of the transactions could not be ignored.  As he put it, “the form here is the substance”.  In his view, it was not legitimate to say that the form of the transactions was a “mere technicality” and the corporate structures involved could not simply be ignored.  EMSL had discharged its obligations to the extent of the Partial Refinance and the defendant should not be liable to that extent.

Comment

The decision highlights the importance of considering the consequences of steps taken by a claimant or third party which may have the effect of reducing the claimant’s loss (while of course bearing in mind that a claimant’s damages may equally be reduced where it fails to take appropriate steps to mitigate its loss).

In this case, it is clear that the majority was keen to achieve a “just” result by seeking to find a means by which Mr Hunt would be compensated for his loss, in circumstances where, given the finding at first instance that he was owed no duty of care, Mr Hunt would otherwise have been left with no remedy. The majority appeared to sympathise with Mr Hunt who, as Sales LJ put it, had been put in an “invidious position” by the defendant’s negligence. As a result, the majority was prepared to overlook what it described as “mere technicalities” to ensure that the defendant should not benefit from the funding provided by Mr Hunt.

It could be argued (as Davis LJ indicated) that the decision goes beyond merely disregarding technicalities and that, in equating Mr Hunt’s and the claimant’s loss, the majority wrongly lifted the corporate veil.  Further, it is interesting to consider whether the majority would have reached the same conclusion had Mr Hunt been in a less sympathetic position.

It remains to be seen whether the defendant will seek permission to appeal to the Supreme Court. In the meantime, parties should proceed with caution when taking steps which might reduce their loss in order to avoid any unintended consequences and to preserve any possible claims against third parties.