JJES Pty Ltd v Sayan [2014] NSWSC 541

The NSW Supreme Court recently held that a solicitor providing legal advice to a client did not have a duty to warn against business risks in circumstances where the client was shown to have commercial nous and sophistication.

This judgment provides welcome guidance to those considering the application of earlier authorities in which it was found that solicitors’ duties are not simply confined to the four walls of their retainer but that their duties could extend to advising a client of the practical implication of the client’s entry into a transaction the subject of the advice.

Earlier authorities

Back in March 2013, Jackson McDonald reported on the case ofProvident Capital Ltd v Papa [2013] NSWCA 36.

In Papa, the NSW Court of Appeal unanimously found that the solicitor did have a duty to advise its client to seek independent financial advice in the particular circumstances of the transaction, due to the knowledge held by the solicitor.

The solicitor was aware that the client was a mature lady who intended to mortgage her home (her only asset aside from a car) for a loan of $700,000, primarily to be given to her son to repay his debts and fund the son’s gymnasium business.  The solicitor was aware that the client would have no involvement in the business in the short term and that the son would be making all repayments of the loan out of the income of the gymnasium business.  The solicitor was also aware that the son had previously required an extension in order to meet rent and had defaulted on other loans he had taken out.

The court’s view was that the client was ‘facing a high risk of disaster in entering into the transaction’ and found that the solicitor’s obligation was not simply to explain the legal effect of documents but also to advise the client of the practical implication of the client’s entry into a transaction the subject of the advice.

This duty went beyond the scope of the solicitor’s usual retainer as solicitors are not ordinarily required to give advice on the‘wisdom of a transaction’.  For the solicitor, it was a case of ‘the more you know, the more you owe’.

Sayan distinguished from Papa

In Sayan, the client purchased a franchise business in two steps.  The first was to purchase the franchise business from the existing franchisee, which included a significant amount for goodwill.  The second was to enter into a lease agreement with the franchisor.

When a franchise agreement ends, the business reverts to the franchisor.  Ordinarily this means that the franchisee is left with no goodwill value.  Usually a franchisee will only recover an amount for the goodwill of a business if they sell their franchise to another new franchisee before the end of the franchise period.

The lease agreement with the franchisor was only for a short term, with the existing lease providing only a guaranteed further 18 months before expiry.  The lease contained two options to renew the lease for a period of 3 years each time – but the exercise of those options was at the sole discretion of the franchisor.  The first option was exercised, but the second was not.

The client was unable to sell the franchise business prior to the ceasing of the lease and accordingly lost the opportunity to sell the franchise with a goodwill component.

The client claimed that the solicitor should have advised about the risk of this occurring and should have told the client to seek an amendment to the lease whereby the franchisor would agree to exercise the options to renew the lease.  It was argued that:

  • if such an amendment was possible, the client would have been able to sell the franchise with a goodwill component;  and
  • if no such amendment was possible because the franchisor refused, the claimant would never have entered into the agreement.

In either case, the client claimed the lost value of the goodwill which the client paid to purchase the franchise.

The trial judge considered that the law as espoused in Papa was good law but distinguished the case in Sayan based on the facts.

In Papa, the client was unsophisticated, made uncommercial decisions based on blood ties and risked homelessness via the loss of her home, her only asset.

In contrast, the client in Sayan was found to be sophisticated, researched and made self-interested business decisions.  In particular, the client had TAFE level qualifications, had previously had the running of another franchise business for two years and ran another small business for two years after that.  There was evidence that the client had, in its own application to become a franchisee, attested to its own business acumen and to having researched the business prior to making a decision to become a franchisee.

Very significant to the judge was also the fact that the client had made its own decision to purchase and was committed to it before the solicitor was retained.  Reliance was, for this reason and others, therefore an issue.

The judge commented that the standard of professional practice must accommodate a degree of flexibility according to the commercial nous and sophistication of the client.  In the particular circumstances of Sayan, the trial judge found that the solicitor did not owe a duty to advise the client about the possible amendment of the lease.

Implications of the decision to advisors

Papa was a warning to solicitors (and other professional advisors) to not assume that their duties are confined to the four walls of their retainer.  However, in isolation, Papa did not give a clear guide as to how the law might be applied to different facts.

Sayan demonstrates that extended duties will not be owed to all clients and provides some guidance as to how the law in Papashould be applied where a client is sophisticated and experienced in business.   Professional advisors should remain mindful not to equate a client’s sophistication in some matters as sophistication in all matters.  A client who is otherwise commercially successful, but has never entered into a particular type of transaction, may still be unsophisticated and inexperienced in that context.

Prudent practice for all professional advisors, where they sense a vulnerability in a client’s position that cannot be overcome by providing advice from the professional’s own field, is to consider what advice the client should seek and recommend that it be sought.