Unsurprisingly, negligence claims by financial institutions against valuers arising from secured lending transactions tend to follow recessions. Property values slumped in 2008 following the onset of the global financial crisis and this has led to more cases reaching the courts recently. However, in the light of low interest rates and the longer term view adopted by lending institutions, we have not seen quite the number of such cases that we did following the collapse of the property market in the early 1990s and it may well be that there are a large number of such potential claims which have not yet been recognised.
This article looks at some recent decisions in this field and at some litigation currently in progress, including claims by special purpose vehicles involved in structured finance transactions. Since there is a real risk that further crisisrelated claims will become time barred unless they are pursued promptly, thereby closing off this potential route for recovery of losses, we also consider limitation issues.
The basic principles
In order to bring a successful claim against a valuer for overvaluing property securing a loan it is necessary to establish negligence, causation and loss. Fundamentally, this means establishing each of the following:
- that the valuer owed the claimant a duty of care (which may be more complicated in respect of structured investment arrangements such as commercial mortgage backed security transactions, where the issuer may not have a direct contractual relationship with the valuer)
- that in preparing the valuation the valuer fell below the standards to be expected of a reasonably competent valuer and that his valuation fell outside an acceptable ‘margin for error’
- that the lender (or issuer) relied on the valuation and would have acted differently if the valuation had been accurate
- that as a consequence the lender has suffered a loss which falls within the scope of the valuer’s duty of care (in the sense established by SAAMCO v York Montague Ltd  AC 191 (SAAMCO).
There is then scope for the quantum of the claim to be reduced if the lender was itself negligent in its lending practices (contributory negligence).
Correct claimant, duty of care, reliance and loss
In a straightforward property loan it will be the lender who will bring the claim against the valuer for negligent overvaluation of the security, having suffered loss following the borrower’s default and the realisation of the security for less than the outstanding loan. It is far more complicated to identify the correct claimant in respect of structured investment arrangements such as commercial mortgage backed security transactions – ‘CMBS’, where the party who ultimately suffers the loss may not have a direct contractual relationship with the valuer. In addition, these cases raise interesting questions about the interaction between limited recourse and nonpetition clauses and the recoverability of loss: in particular, whether the fact that any reduction in cashflows payable to the special purpose vehicle (SPV) arising from an undervaluation leads to a matching reduction in amounts payable by the SPV to bondholders prevents the SPV from suffering any loss due to an undervaluation.
These issues have arisen in two recent cases where the claimant was the special purpose vehicle (SPV) itself, rather than the ultimate lenders: the syndicate of financial institutions or the bondholders. A further two cases are currently being litigated: Gemini (Eclipse 2006-3) v CBRE & Warwick Street and Windermere X CMBS v Warwick Street.
The case of Capita Alternative Funds Services (Guernsey) Limited and Matrix Securities Limited v Drivers Jonas  EWCA Civ 1417 provides a fairly recent and stark example of a negligent valuation resulting in a £12 million judgment for the purchasers of a factory outlet centre in an Enterprise Zone, arising from the valuer’s lack of expertise in valuing such a specialist asset and the associated tax implications.
Capita was the trustee of a trust set up as an investment vehicle for multiple individual investors and Matrix sponsored the creation of the trust and was responsible for establishing and promoting the investment. However Matrix suffered no loss itself. Accordingly Drivers Jonas sought to argue that, in the absence of an engagement letter recording the scope of its duties, it was only retained by Matrix and owed no duty to advise Capita or the investors. The judge at first instance was not attracted by this technical argument and had no difficulty in finding, in the light of the contents of Drivers Jonas’ own report, that it was retained by Capita to provide valuation and investment advice in relation to the leasehold purchase. This aspect of the decision was not challenged on appeal.
Similar issues as to the identity of the correct claimant arose in the very recent Commercial Court case of Titan Europe 2006-3 plc v Colliers International UK plc (in liquidation)  EWHC 3106 (Comm). Titan was an SPV formed by the lender, Credit Suisse, to act as the issuer of securities in a complex CMBS transaction. Credit Suisse lent approximately €1billion in respect of eighteen separate loans secured on commercial property and that portfolio of loans was subsequently purchased by Titan using subscriptions from the investors who purchased the securities in the debt (the ‘Noteholders’). One of the loans was secured on a large commercial building in Nuremberg in Germany, which had been valued by Colliers. When the tenant of that building became insolvent the borrower was unable to service the loan and the security was sold for very considerably less than the outstanding loan. Titan sued Colliers for the loss it claimed arose from Colliers’ negligent overvaluation of the property.
However Colliers sought to argue that Titan was not the correct party to bring the claim because it had suffered no loss. It had purchased the loan with funds raised by the issue of the securities to the Noteholders on a non-recourse basis. Accordingly Titan essentially acted as an economically neutral conduit between the Noteholders and the debt in which they were investing and it was the Noteholders, not Titan, who would ultimately suffer any loss.
The judge held that, whilst the loss might ultimately rest with the Noteholders, for various technical legal reasons they were not likely to be in a position to bring a claim themselves. Titan could be treated as suffering a loss immediately on purchase of the loan for more than its true value and the fact that it had subsequently securitised that debt on a non-recourse basis was irrelevant as a matter of law as being an arrangement with third parties which should not benefit the valuer (the principle of res inter alios acta). Critically, he further held that Titan was contractually required to apply any damages awarded according to the structure to which the Noteholders subscribed when they made their investments.
Colliers also suggested that, although Credit Suisse may have relied on its valuation when making the loan, Titan had not done so. However the judge concluded that even if Titan had not actually seen the valuation before it purchased the loan it could still be said to have relied upon it if it was aware of its existence and contents.
Negligence and the ‘margin for error’
In both of the cases referred to above the claimant was able to establish by expert evidence that, in preparing the valuation, the valuer had fallen below the standards to be expected of a reasonably competent valuer. For instance, in Titan, the judge concluded that the valuer had failed to give sufficient consideration to the possibility that the tenant of the property might not renew its lease and that the property might be difficult to relet or sell because it had been purpose built for the needs of the current tenant and it was very large and ageing.
However, it is not sufficient simply to be able to demonstrate that a valuer has gone wrong in respect of some (or even all) of its inputs. It is still necessary to show that the valuation figure derived fell outside the reasonable range of values that a competent valuer could have reached, known as the ‘margin for error’. As highlighted by Coulson J in cases such as K/S Lincoln v CBRE Hotels  EWHC 1156 (TCC) and the two related cases he decided subsequently, Blemain Finance Ltd v E.Surv Ltd  EWHC 3654 (TCC) andWebb Solutions Ltd v E. Surv Ltd  EWHC 3653 (TCC), the acceptable margin for error can vary depending on the state of the market and the type of property. For instance, if the market is particularly volatile, or very flat, so that there are not many comparables, the margin will be wider and, whilst standard residential properties should be fairly straight forward to value, commercial
development projects are likely to be more challenging. Generally, the margin for error for residential property valuations is +/-5 per cent, whilst for commercial properties it is likely to be between +/-10-15 per cent. Indeed in the Titan case the valuer argued that the margin should be 20 per cent or more given the unique aspects of the property in question, although the judge decided that the acceptable margin should be 15 per cent.
SAAMCO, Causation and the scope of the duty of care
As is well known, in the SAAMCO case, the House of Lords (as it then was) effectively held that losses arising out of the subsequent fall in the property market fell outside the scope of duty of care owed by a valuer to a lender. Accordingly a lender’s loss is capped at the amount of the overvaluation (i.e. the difference between the negligent valuation and the true value of the property as at the date of valuation). Subsequently this analysis of what losses fall within the scope of a professional’s duty of care has been applied in a number of fields.
A recent example is Rubenstein v HSBC Bank plc  EWCA Civ 1184, a successful claim brought by a retail client against a financial adviser in respect of investment advice. Mr Rubenstein wanted an investment that carried no risk of loss to his capital, as in due course he wanted to use the capital to fund the purchase of a new house. HSBC recommended that he invest in the AIG Premier Access Bond (which included the Enhanced Variable Rate Fund). Ultimately, following the unforeseeable collapse of Lehman Brothers and the subsequent run on AIG in September 2008, Mr Rubenstein did suffer the loss of some of his capital and he pursued a claim against HSBC. Although at first instance the judge held that HSBC had advised negligently, he then decided, applying the SAAMCO principles, that Mr Rubenstein’s loss had been unforeseeable and too remote, and had not been caused by HSBC’s negligent recommendation but by the ‘extraordinary and unprecedented financial turmoil which surrounded the collapse of Lehman Brothers’ and that therefore the loss fell outside the scope of HSBC’s duty of care.
However, on appeal, the Court of Appeal rejected this approach. In his leading judgment, Rix LJ held that the loss was not caused by the run on the AIG fund but by the impact of adverse market forces on the underlying assets of the fund, which was foreseeable. Indeed it was precisely this ‘market’ risk (as opposed to the risk of ‘issuer default’) against which the bank was supposed to protect Mr Rubenstein and therefore the loss did not fall outside the scope of the bank’s duty of care.
Accordingly, whilst the SAAMCO cap remains likely to be applicable to the majority of claims against valuers, where the loss flows from a cause from which the lender has expressly sought protection (for instance in the unusual event that the lender has asked the valuer to advise about likely future movements in the property market), then it might be possible to seek to recover losses flowing from a fall in the market.
It is common for valuers to seek to reduce the quantum of claims against them by raising allegations of contributory negligence on the lender’s behalf in approving the loan. The court is likely to reduce any damages awarded by an appropriate percentage if it is satisfied that the lender’s approach fell below that of a reasonably competent lender (such as applying an excessive LTV) and that such negligence contributed to the loss. However in a number of recent cases, such as the cases determined by Coulson J in 2012 referred to above, the courts have emphasised that allegations of contributory negligence must be judged in the light of the facts and against the background of the lending market at that particular time, such as during the over-heated market in 2007 when lending policies were less stringent. This led the judge to find in those cases that, for instance,a relatively high LTV of 85 per cent, errors on the borrower’s application form and self-certification of income did not amount to contributory negligence.
As explained at the start of this article, claims against valuers often arise in the wake of recessions. This is partly because valuers are perhaps more prone to overvalue property in an overheated market or fail to appreciate the impact of a deteriorating economy on property prices and partly because of the increased likelihood of borrower default in difficult financial times. However, as it can take some time for lenders to enforce their security and realise any losses, claims may arise years after the date of the relevant valuation. Accordingly it is necessary to consider at an early stage whether any such claims may be time barred.
Claims against valuers are normally brought in both contract and tort and these causes of action have different limitation periods, which can be crucial. Whilst a claim in contract becomes statute barred within six years from the date of breach (which will normally be the date of the valuation), the claim in tort does not become statute barred until at least six years after the lender has first suffered a loss. In the context of valuers’ negligence claims this has been held to occur when the value of the property, together with the value of the borrower’s covenant, first falls below the amount of the loan (see Nykredit v Edward Erdman Group  UKH 53). Accordingly, whilst on the face of it a claim arising from a valuation carried out in 2007 might appear to be potentially time barred, it is quite possible that, on analysis of when the loss occurred, a claim may still be available.
Indeed, a lender may have an even longer period in which to bring a claim. As discussed in our article on Mis-Selling elsewhere in this edition of Banking and finance disputes review, s14A of the Limitation Act 1980 sets out an extended limitation period of 3 years after that date on which the claimant discovered (or ought reasonably to have become aware) that the property had been over-valued (subject to a fifteen year long stop date). Indeed it was on this basis that the claim against Drivers Jonas referred to above succeeded in respect of a valuation given in 2001.
Banks and financial institutions may well have potential claims against valuers arising out of losses sustained during the global financial crisis. Many of these claims are in danger of becoming time barred. Others raise challenging questions of causation and the scope of the duty of care. Nonetheless, if lenders are sitting on losses arising from secured lending transactions entered into during or shortly before the global financial crisis of 2008/9 it is critical that these are reviewed now to ensure such claims are not lost.