The recently decided TCC case of The Governors and Company of the Bank of Ireland v Watts Group Plc serves as a warning to property lenders. The appointment of a project monitor to assist a lender with the assessment of the technical aspects of a project does not relieve the lender of its duties to lend within its own guidelines.
The relevant events which were the subject of litigation took place in 2007 and early 2008 and thereby provide some insight to the quality of lending decisions made in the heady days of pre-crash property finance in the UK.
The case concerned the Bank’s loan of £1.4m against a speculative residential development to be constructed in Clifford Street in the heart of York. The borrower was an SPV which was half-owned by Derwent Vale Developments and half-owned by the Modus Group. The Modus Group was one of the Bank’s “key Manchester relationships” where the Bank’s existing exposure prior to making the loan in question was around £20m.
The Bank appointed Watts in January 2008 to act on the Bank’s behalf in (1) checking costings for the development to be supplied by the borrower; (2) approving requests for drawings under the loan facility; and (3) preparing an Initial Appraisal Report (”IAR“).
Watts duly produced an initial draft of the IAR with a final draft issued in April 2008. Generally speaking, the IAR supported the borrower’s estimate of construction costs for the project. Much turned on the content of the IAR and its level of influence on the Bank’s lending decision.
The first drawdown of the loan was in April 2008 with subsequent drawdowns against the value of completed work, as reported on by Watts. Modus went into administration in May 2009 and the Bank appointed receivers to the borrower in October 2009.
The Bank’s Case
The Bank alleged that Watts’ IAR was negligently prepared. If the IAR had been properly prepared, the Bank would not have permitted the drawdown of the loan by the borrower and so would not have suffered any loss.
Much of the evidence before the Court as to Watts’ performance of their role was provided by experts who provided detailed consideration of the scope and content of the IAR. The expert evidence relied upon by the Bank was the subject of significant and detailed judicial criticism. In contrast, the expert evidence relied upon by Watts was generally accepted as being reasonable and submitted in compliance with the duties of Watts’ expert to the Court.
HHJ Coulson concluded on the evidence presented that the Bank’s expert was not an independent or reliable witness. Indeed, the Bank’s expert had attempted to mislead the court, was unreasonably intransigent in his refusal to make any concessions whatsoever and had provided criticisms of Watts which were so unpersuasive that the Bank declined to plead them as allegations of negligence.
In the Court’s view, the Bank’s expert appeared to be unaware of the duties of an independent expert to the Court which were set out in the well-known judgement in The Ikarian Reefer.²
The SAAMCO Cap
In relation to the scope of damages which should properly be recoverable if Watts had been negligent, HHJ Coulson also provided some helpful analysis regarding alternative arguments presented by the parties’ Counsel on the correct application of the so-called “SAAMCO cap” to the facts of the case.
In South Australia Asset Management Corporation v York Montague Limited,³ (as recently commented on by Lord Sumption of the Supreme Court in BPE Solicitors v Hughes-Holland) the House of Lords considered the recoverability of damages where (1) but for the negligence of a professional advisor a client would not have embarked on some course of action; and (2) part or all of the loss which the client suffered by doing so arose from risks which were no part of the advisor’s duty to protect the client against.
In SAAMCO, Lord Hoffman distinguished between the provision of “advice” where an adviser has a duty to protect his client against the full range of risks associated with a transaction, and the provision of “information” where an adviser contributes a limited part of the information which the client will rely on in deciding whether to enter into a prospective transaction, but the overall assessment of the commercial merits of the transaction is exclusively a matter for the client. In relation to the “advice” category, a client in principle would be able to recover all loss flowing from a transaction which the advisor should have protected his client against. On the other hand, negligent “information” provided by an advisor gives rise to liability only for the financial consequences of being wrong and not for the financial consequences of the client entering into the transaction, so far as these are greater.
In HHJ Coulson’s view, the instant case was plainly in the “information” category and only the information provided by Watts in relation to the borrower’s estimate of construction costs could have given rise to a claim,. There were a number of other matters relevant to the Bank’s lending decision which had nothing to do with Watts.
The Court’s Decision
The Court found that Watts had not been negligent in their preparation of the IAR and drew attention to the modest nature of Watts’ fee of £1,500 which the Court regarded as “good evidence of the limited nature of the service which Watts were expected to provide“. Rather, the Bank’s pleaded loss was caused by the Bank’s deficient consideration of the loan application leading to an unsound decision to lend.
HHJ Coulson set out some key factors in the Bank’s decision to lend which should have set alarm bells ringing in the Bank’s credit department:
- Modus had no experience in speculative residential developments and little experience of working in partnership with another company;
- The proposed loan failed to comply with three out of four of the bank’s own guidelines in relation to: loan-to-valuation ratio; loan-to-cost ratio and loan-to-cost site value versus development costs;
- A projected profit margin for the project of 10% was very tight;
- A capital guarantee of £200k from one of the borrower’s parent companies (another Modus entity) was incorrectly used to ameliorate the adverse loan-to valuation ratio. A capital guarantee can provide a lender with additional comfort if something goes wrong but is irrelevant to the value of a project. Also, the covenant of the guarantor was not properly considered.
- Contrary to its own policy, the Bank ignored its existing exposure of £20m to the Modus Group which was clearly linked to the additional loan in question.
- The bank did not incorporate certain conditions precedent included in its credit paper into the facility letter sent to the borrower and wrongly confirmed that other conditions precedent had been satisfied.
In HHJ Coulson’s estimation, the Bank was willing to override its own conditions to avoid upsetting Modus. The “die was cast” by the time Watts were instructed by the Bank.
This case serves as an important and continuing reminder of the potential consequences of lenders ignoring their own internal guidelines in approving a loan for “relationship” reasons. Another significant aspect of the case concerns expert evidence, where the danger of relying on evidence which is neither independent nor reliable was made plain.