Why professional indemnity insurers should closely examine losses in professional negligence claims

The Supreme Court yesterday handed down judgment in Lowick Rose LLP (formerly known as Hurst Morrison Thomson LLP) (in liquidation) v Swynson Ltd and another [2017] UKSC 32, unanimously allowing the appeal of Lowick Rose (formerly known as HMT). RPC acted for the successful appellant and its insurers.

It is a salutary tale for businesses whose actions may have very serious unintended consequences; and a reminder to professional indemnity insurers always to be alive to the need for a close examination of what loss has actually been suffered.

This claim started out as an ordinary professional negligence claim against an accountancy firm, considering the familiar issues of breach and causation. Both were conceded at trial, leaving the live issue one of loss.

It was never envisaged that this claim would be assessed over 4 years, by 3 Lords Justices in the Court of Appeal and 5 Supreme Court Judges – with the key issue considered by both Courts being the proper application of the long established and complex legal doctrine of res inter alios acta (translated as "a matter between others is not our business").

Despite the uncontroversial origins of this claim, the decision is of critical significance to professionals (and their insurers) and businesses alike. It provides much needed clarity on the limits that the Courts are prepared to countenance when considering the extent to which the corporate veil can be pierced when considering damages, even if the consequence is something many would find "unfair".

Background Facts

Swynson and its owner, Mr Hunt, brought a claim against HMT in relation to loans made in reliance on a negligent due diligence report prepared by HMT in 2006.

Swynson made a £15m loan to a UK company, Evo Medical Solutions Ltd ("EMSL"), in order to facilitate a management buy-out of a US business known as Evo Medical Solutions ("Evo") in 2006.

Shortly after the initial loan was made in July 2007, Evo faced serious financial difficulties and Swynson was forced to make two further loans to EMSL in July 2007 (£1.75m) and in June 2008 (£3m) in order to protect the original investment. At the same time, Mr Hunt acquired the majority beneficial ownership of EMSL.

In December 2008, Mr Hunt, undertook a "refinancing exercise" and provided EMSL with monies to enable EMSL to repay the 2006 and 2007 loans to Swynson. This exercise carried tax advantages for Mr Hunt, though the tax advantages accrued to Swynson and allowed Swynson to avoid having an impaired debt on its books.

Ultimately, Evo's fortunes did not turn around and it was wound up, with the 2008 loan not being repaid to Swynson or Mr Hunt. Swynson and Mr Hunt subsequently brought proceedings against HMT seeking to recover damages for losses resulting from the buyout and the making of all three loans in 2006, 2007 and 2008. The argument for HMT was that it should be only liable to Swynson for the 2008 loan to EMSL, since the 2006 and 2007 loans had been repaid, thereby reducing Swynson's loss to £3m.

Trial at First Instance

Since negligence was admitted following cross-examination of a key witness at the trial at first instance, the Judge's finding focused on loss and damage. Ultimately, the Judge (Mrs Justice Rose) held that the 2008 "partial refinance" of EMSL could be disregarded as res inter alia acta given it was collateral to the loss caused by HMT's breach of duty. Swynson was therefore entitled to recover the loss in respect of the 2006 and 2007 loans (subject to a liability cap of £15m + interest), notwithstanding the fact that it had been repaid. Such a finding was controversial since it was held that there was no duty owed to Mr Hunt.

Court of Appeal

A majority of the Court of Appeal (Longmore and Sales LJJ) agreed with the Judge at first instance and dismissed HMT's appeal. The Judges sought to put the refinance into context – considering that had Mr Hunt, in an act of benevolence, given Swynson sums directly to balance its books (as opposed to lending to EMSL via Swynson) then HMT's liability would not have been reduced. As such, the fact that the payment to Swynson was structured through EMSL was res inter alios acta and should not affect the outcome, otherwise "form would triumph over substance".

Lord Justice Davis delivered a dissenting judgment in which he argued that the "form here is the substance". EMSL had discharged its obligations to the extent of the 2008 refinance (regardless of the corporate structure behind it) which could not be ignored as a "technicality".

The Court of Appeal also considered the alternative arguments put forward by Swynson and Mr Hunt, being the doctrine of transferred loss and unjust enrichment (or equitable subrogation), but no findings were made given the success of the Respondents' argument on the ground of res inter alios acta.

Supreme Court Judgment

Yesterday's unanimous judgment resolves the position once and for all, finding that the method of structuring the 2008 refinance by Mr Hunt whereby he later attempted to associate himself with Swynson (as being one and the same or interchangeable), should be seen as a businessman's mistake. Lord Sumption provided the leading judgment (agreed with by Lords Neuberger, Clarke and Hodge) and stated that "Mr Michael Hunt is not the first businessman to make that mistake, and doubtless he will not be the last".

The Supreme Court held that the 2008 refinance made by Mr Hunt to EMSL and then by EMSL to Swynson to pay off the 2006 and 2007 loans could not possibly be regarded as collateral payments pursuant to the doctrine of res inter alios acta, since the loans were received independently to the circumstances giving rise to the loss. The 2008 refinance discharged the very liability whose existence represented Swynson's loss. Mr Hunt's loss arises out of the 2008 refinance which had nothing to do with HMT and could not be said to have arisen out of their breach of duty. Mr Hunt got exactly what he bargained for when providing the loan and the structure of that loan was "a commercial risk that he took with his eyes open".

Lord Mance's concurring judgment referred to Lord Justice Longmore's assessment in the Court of Appeal, and agreed that whilst it would represent a triumph of form over substance if HMT were to benefit from the partial refinance (i.e. by avoiding paying damages in litigation and obtaining an unintended "windfall" despite its accepted negligence) merely because the payment was made via EMSL and not to Swynson directly. However, Lord Mance saw the distinction being in the nature of the payment – Mr Hunt's loan to EMSL was intended to and did lead to actual repayment of the first two loans which Swynson had made to EMSL.

Lord Neuberger helpfully concluded the judgments and clarified the Lord Justices general, unanimous consensus (despite nuances between Lords Sumption's and Mance's findings) to avoid the risk of "ingenious lawyers" identifying possible differences between concurring judgments.

The Supreme Court also considered the alternative grounds put forward by Swynson of transferred loss and unjust enrichment (equitable subrogation) and rejected them both. Transferred loss was accepted as providing a limited exception to the general rule that a claimant can recover only loss which he has suffered – a narrow and specific doctrine which could not apply to these facts. As for equitable subrogation, it was held that HMT was not unjustly enriched by Mr Hunt's 2008 refinance, meaning Mr Hunt could not be subrogated in equity to Swynson's claim against HMT since Mr Hunt got precisely what he bargained for when making the 2008 refinance, and so it did not fall into the "unjust" category.

Commentary

The Supreme Court's finding provides much needed clarification on situations where a Court will permit the corporate veil be pierced and when it will not. It is of significance to professional advisers (their insurers) and businesses alike, who undertake numerous corporate restructures for a variety of reasons during the ordinary course of business life - whilst at the time not necessarily appreciating their future consequences.

It is unlikely that the 2008 refinance affected by Mr Hunt was intended to reduce HMT's liability for its negligent advice. That was neither here nor there.

This cases serves as a useful reminder that businesses and their advisers need to consider carefully the consequences of any restructuring or refinancing. While there may be good reasons for such a transaction (in this case, a tax advantage and the removal of a debt from a company's balance sheet), it may have wider consequences. That careful analysis of the pros and cons becomes particularly acute once a legal claim is known, as it was here. Alternatives open to Mr Hunt that might have preserved the claim against HMT included giving or loaning the money directly to Swynson, or paying for an assignment of Swynson's claim against HMT – but those options might not have had the benefits Mr Hunt wanted to achieve.

However, had the previous decisions been upheld, with the Courts continuing to equate Mr Hunt's loss as indistinguishable from Swynson's then the finding would have represented the corporate veil being pierced beyond recognition by law – with damages being recovered by a party to whom no duty was owed. The leading judgment delivered by Lord Sumption critically held that:

"The distinct legal personality of companies has been a fundamental feature of English commercial law for a century and a half, but that has never stopped businessmen from treating their companies as indistinguishable from themselves. Mr Michael Hunt is not the first businessman to make that mistake, and doubtless he will not be the last."