A loan refinancing transaction led to both the original lender and new lender being unable to recover damages against a negligent advisor who had advised on the original loan, after the borrower defaulted. In Lowick Rose LLP v Swynson Ltd & anr  UKSC 32, the Supreme Court’s ruling illustrates, even in what Lord Mance describes as a windfall for the negligent advisor, that normal rules relating to recoverability of loss will not easily be avoided. Transactions need to be structured so that loss and right of action reside in the same party.
In 2006, a company (Swynson, the Lender) owned and controlled by Mr Hunt, lent GBP 15 million to EMSL (the Borrower) to purchase a target company as a subsidiary. Pre-transaction, the Lender and the Borrower jointly instructed a firm of accountants, Hurst Morrison Thomson LLP (HMT), to carry out due diligence on the target. HMT was not engaged by, and owed no duty of care to, Mr Hunt. HMT’s report was negligent: it failed to draw attention to fundamental problems in the target’s finances. Had HMT carried out its task properly, the loan would not have gone ahead.
Post-acquisition, after the target suffered cash-flow difficulties, the Borrower defaulted on interest payments. The Lender provided further debt financing in 2007 and 2008, but the Borrower’s financial position did not improve.
In 2008, as a tax management strategy, both the 2006 and 2007 loans were refinanced. Mr Hunt (in his personal capacity) loaned GBP 18 million to the Borrower. In accordance with the terms of that loan, the Borrower used the proceeds to repay the 2006 and 2007 loans to the Lender. The Borrower subsequently became insolvent, leaving the refinanced loans owed to Mr Hunt outstanding.
In 2012, Mr Hunt and the Lender brought a claim against HMT. HMT admitted that it had been negligent but argued that it was not liable in damages to the Lender (because the Lender had not suffered any loss) or Mr Hunt (because it did not owe a duty of care to Mr Hunt).
This was a classic case where the sufferor of the loss (Mr Hunt) was not owed a direct duty by the wrongdoer (HMT). The Lender and Mr Hunt advanced a number of arguments for why either the Lender should be able to recover the loss, on Mr Hunt’s behalf, and/or Mr Hunt should recover directly. All arguments failed.
No application of res inter alios acta to refinancing
The Lender argued the refinancing was res inter alios acta and therefore did not affect the amount of its recoverable loss. This principle is an exception to the general rule that avoided loss is not recoverable. It means that “collateral benefits”, whose receipt arose independently of the circumstances giving rise to the loss, do not make good a recoverable loss. As Lord Neuberger made clear, ‘collateral’ payments to a claimant which should not be taken into account when assessing loss are normally those payments that are effectively paid out of a claimant’s own pocket (such as from insurance which the claimant has taken out) or which are the result of benevolence (eg from a government, family and friends).
The Lender argued that the refinancing was a collateral benefit such that the amounts it received from the Borrower did not make good its loss arising from HMT’s negligence.
The court ruled that the refinancing was not a collateral benefit. The Lender’s loss from the wrongdoing was made good when the loan was repaid. The fact that the money used to repay the loan was borrowed from Mr Hunt (as the beneficial owner and controller of the Lender) was irrelevant, as it would have been if borrowed by the Borrower from a bank or other third party.
No extension of the principle of transferred loss
The principle of transferred loss is a limited exception to the general rule that a claimant (such as the Lender) can only recover loss which he has himself suffered.
Its purpose is to avoid a legal black hole preventing recovery when the third party (eg Mr Hunt) who suffers the loss is not the party with a contractual relationship (eg the Lender) with the wrongdoer (eg HMT). Where the known purpose of a contract is to benefit a third party, and the anticipated effect of a breach will be to cause loss only to that third party, then the third party's loss may be recovered by the contracting party (even though the contracting party has not itself suffered any loss). The contracting party will account to the third party for damages recovered from the wrongdoer. A narrow version of this principle has been widely recognised by the courts where the third party suffers loss as the intended transferee of property. Some previous cases have extended the principle more broadly to all contracts, not just those that involve a transfer of property.
The court ruled that neither the narrow nor the broader application of the principle could help the Lender or Mr Hunt. The narrow approach did not apply because Mr Hunt did not suffer loss in his capacity as the owner of an asset or property: while he suffered loss, it arose from the refinancing, rather than the original loan and therefore was different to the Lender's original loss. The broader approach also did not assist Mr Hunt because, although he had suffered loss, the original contracts (HMT's engagement and the 2006 loan agreement) had not been entered into with the known object to benefit Mr Hunt, as a third party effecting a refinancing.
Equitable subrogation unavailable as no finding of unjust enrichment
The Lender argued that HMT had been unjustly enriched by Mr Hunt’s provision of funds to the Borrower to repay the loans, such that Mr Hunt was subrogated in equity to the Lender’s claim against HMT.
The four basic questions in a claim of unjust enrichment are:
- Was the enrichment at the expense of the claimant?
Although expressing some doubt about the position, the court was prepared to assume that HMT was enriched (as its liability for damages was reduced to nil), at Mr Hunt’s expense (tracing through the advance made by Mr Hunt to the Borrower).
The court rejected the argument that the enrichment was unjust. The court accepted that Mr Hunt was labouring under a form of mistake when he arranged the repayment of the loans: he had no intention to relieve HMT of any liability, and did not understand the significance of the repayment of the loans on such liability.
However, this was not a mistake in respect of which equity would grant relief: there was no defect (such as a defeated expectation) whatsoever in the refinancing transaction. It worked exactly as intended and provided Mr Hunt with the tax structuring benefit sought through repayment of the loans. While the indirect consequential effect of his arrangement was to extinguish the Lender’s claim against HMT in respect of the earlier loan, Mr Hunt did not seek or envisage that he might obtain any direct interest in such a claim through the refinancing (unlike in cases such as Menelaou involving defeated expectations of mortgages by way of security for funds). As there was no defeated expectation in respect of the refinancing transaction, there was no injustice recognised at law that could be corrected by the law of equitable subrogation, and Mr Hunt’s claim failed.
The negligent accountants escaped liability. As Lord Mance observed “I can understand it being said that it is an injustice….and a pure windfall for HMT”.
A clear line is being drawn around the law of unjust enrichment by the Supreme Court, with Lord Sumption keen to emphasise that the law of unjust enrichment does not “create a judicial licence to meet the perceived requirements of fairness on a case-by-case basis”. Rather, there are discrete factual situations where enrichment is treated as unjust: where some legal norm or legally recognised expectation has been disrupted, leading to a windfall benefit conferred on the recipient. In such circumstances, a unilateral mistake can be undone to restore participants to their pre-transfer position, with a defeated expectation specifically enforced. But the law of unjust enrichment will not provide a party who has made a unilateral mistake, or a party whose expectation is ‘disappointed’, with recourse against any who may have indirectly benefited from the mistake or disappointment: the claimant must show some specific defect or defeated expectation in the transaction at hand for the doctrine of unjust enrichment to attach. It is therefore necessary to ensure any contract (such as the refinancing between Mr Hunt and the Lender) reflects the parties' expected allocation of benefits or security (such as a claim against a negligent advisor, or a charge over an asset), rather than relying on a judicial protection against unfairness to remake their bargain. Mr Hunt was unable to show that there was such a defeated expectation in this case – the refinancing had been largely carried our for tax purposes, had worked entirely as intended and was thus not a defective transaction.
In some transactions, parties provide a contractual payment mechanism to ensure that any potentially 'unjust' enrichment is pre-emptively contractually addressed. An example is the inclusion of termination payments by the public authority, in PPP-type concession contracts on early termination, for default by the private sector party. It might seem odd for a defaulting party to be receiving termination payments. However, this is a way of alleviating the public authority’s potential 'unjust' enrichment on account of it getting the main project asset (eg a hospital, bridge or prison), on termination, before it is paid for. Instead of the authority being ‘enriched’, the termination payments payable to the private sector concessionaire allow, in turn, the lenders to be paid. This reduces the risk associated with litigating an unjust enrichment claim and helps make the project more bankable. By the same token, in this case, Mr Hunt could easily have anticipated the lack of an ability to claim against HMT and asked for reliance on the due diligence of HMT as a condition of the loan that was being made in his personal capacity, as regularly occurs in a commercial context.
For those with potential claims against negligent advisors, all three aspects of the judgment are important. There are clear limits imposed on the use of legal exceptions to general principles of loss: despite general considerations of fairness, the existence of the corporate veil means that the structure of the underlying transaction and correct identification of the party benefiting from the cause of action should not be discounted as technicalities. The obvious point, however, is to ensure issues of reliance are addressed before committing to transactions if at all possible.
However, the refinancing in this case was somewhat peculiar, in that it was effected by a transaction between the beneficial owner of the Lender and the Borrower, rather than as between the Lender and the Borrower. However, for those whose claims fall into this category, while the judgment does not directly overrule or conflict with last year’s Court of Appeal decision in Tiuta International Ltd v De Villiers Surveyors, which extended liability for negligent advice to the entirety of any refinanced liability, the Supreme Court has now granted leave to appeal that decision.