The Court of Appeal has allowed an appeal by a purchaser in the context of its claim for damages for fraudulent misrepresentation against the sellers of certain business assets that it had acquired. In doing so, the Court of Appeal held that damages for fraudulent misrepresentation should, as a general rule, be assessed by ascertaining the actual value of the assets bought at the relevant date and deducting that figure from the price paid: Glossop Cartons and Print Ltd and others v Contact (Print & Packaging) Ltd and others [2021] EWCA Civ 639.

The Court of Appeal found that the High Court was incorrect to apply the “deduction method” to calculate the market value of the business assets as at the transaction date. The approach adopted by the High Court involved deducting from the purchase price the cost of every flaw or defect that the claimant had not itself factored into its calculation of the price. The Court of Appeal said that, in a normal case for fraudulent misrepresentation, this method is wrong in principle, unduly complex and inappropriately requires the court to consider what subjectively the claimant factored into its calculation of the purchase price. These matters are irrelevant to the calculation of direct loss for fraudulent misrepresentation, which merely requires the court to ascertain the actual value of the assets bought at the relevant date and to deduct that figure from the price paid (as per Smith New Court Securities Ltd v Scrimgeour Vickers (Asset Management) Ltd [1997] AC 254). In Smith New Court Securities, the House of Lords emphasised that the general rule for the measure of damages in deceit claims should not be “mechanistically applied”. However, the Court of Appeal’s decision in the present case suggests that these general principles will be the norm and that there is a threshold question as to when an alternative measure of damages may be applied.

The decision is noteworthy for financial institutions faced with claims founded in the tort of deceit, particularly in the context of mis-selling disputes and shareholder claims. In securities litigation, the judgment is relevant to claims based on alleged fraudulent misrepresentation at common law. It may also be relevant to claims brought under section 90A of the Financial Services and Markets Act 2000, although currently it remains unclear whether the appropriate measure is as for the tort of deceit or the tort of negligent misstatement (and of course there are many additional, complicating factors in measuring damages in securities litigation, not least the impact of “harmed” investors both buying and selling securities during the period in which the misrepresentation is alleged to have endured).

In the context of a shareholder claim based on a false representation, the general rule in Smith New Court Securities means that damages will be assessed on the date on which the securities were purchased (the transaction date). Accordingly, the amount will be calculated as the difference between the price paid for the shares and their actual/true value as at the transaction date. As a result of the Court of Appeal’s decision in Glossop, claimants may face additional challenges where they try to depart from the general rule, for example by seeking to recover the difference between the price paid for the shares and the amount realised on disposal of the shares, which is often one of the methods by which damages are calculated by claimants in such claims. This may be an attractive option for claimants where there has been a later fall in value of the shares due to some separate event.

The extent to which falls in the share price may be claimed by shareholders is an important battleground in securities litigation, and there is a clear (although complex) inter-relationship between the measure of damages (in cases such as Smith New Court Securities and Glossop) and the application of the principle in South Australia Asset Management Corpn v York Montague Ltd [1997] AC 191 (SAAMCO).

The SAAMCO principle confirms that a claimant can only recover loss that falls within the scope of the duty of care assumed by the defendant issuer, and was recently considered by the Supreme Court in Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20 (see our banking litigation blog post). In Manchester Building Society, the Supreme Court said that cases should not be shoe-horned into the categories of “information” cases or “advice” cases, and confirmed that the scope of the duty of care assumed by a professional adviser is governed by the purpose of the duty, judged on an objective basis by reference to the purpose for which the advice is being given. Whether or not a claimant can recover an unrelated stock price drop during the period between acquisition and disposal of the shares will usually depend upon whether the defendant’s responsibility extended to the decision to purchase the shares in the first place. This will present a further hurdle for claimants seeking to depart from the general rule as to the measure of damages in such cases.

The case is considered in more detail below.

Background

A packaging manufacturer (Glossop), entered into an asset sale agreement and lease sale agreements (together, the agreements) to buy the business assets of a print company, and the lease of a property owned by Mr Smith and a pension company. The print company was a loss-making company which was ultimately owned and controlled by Mr Smith.

Glossop subsequently issued proceedings against the print company, Mr Smith and the pension company (together, Carton), claiming that it had been induced to enter into the agreements by Mr Smith’s fraudulent misrepresentations about the property.

High Court decision

The High Court found in Glossop’s favour, but held that a claimant in a deceit claim could not recover for losses which directly flowed from the relevant transaction if those losses were the product of the claimant’s own commercial misjudgement.

In attempting to ascertain the market value of the business assets sold, the High Court applied the “deduction method”, deducting from the purchase price the cost of every flaw or defect that Glossop had not itself factored into its calculation of the price. Following this approach, the High Court found that certain crucial flaws or defects could not be deducted from the purchase price, for example where Glossop had appreciated certain risks and had factored them into the purchase price.

Glossop appealed the High Court’s decision, arguing that the deduction method was not an appropriate way to assess damages. It argued that the High Court had failed to award damages for the direct loss caused by the fraudulent misrepresentations: the difference between the actual market value of the business assets sold and the price paid. Glossop argued that the difference was £300,000, which was the sum Glossop claimed it had paid for goodwill.

Court of Appeal decision

The Court of Appeal allowed Glossop’s appeal. It held that the High Court was incorrect to apply the deduction method, and that the direct loss here was simply the difference between the price paid and the market value.

The Court of Appeal referred back to the basic rules applicable where claimants (as in this case) have been induced by fraudulent misrepresentations to buy property, as per Smith New Court Securities. In that case, where the claimant acquired shares in reliance on fraudulent misrepresentations made by the defendants, the House of Lords held that a defendant is liable for all losses directly flowing from a fraudulently induced transaction even if they were unforeseeable. The House of Lords re-stated the general rule for the assessment of damages, which is that damages for tort or breach of contract are assessed at the date of the breach. In a shareholder claim based on a false representation, the House of Lords confirmed the general rule that this would be the date on which the securities were purchased (the transaction date). The amount would be calculated as the difference between the price paid for the shares and their actual/true value as at the transaction date.

In assessing the direct loss for fraudulent misrepresentation, in the Court of Appeal’s view the deduction method is wrong in principle. It is unduly complex and inappropriately requires the court to consider what subjectively the claimant had factored into its calculation of the purchase price. These matters are irrelevant to the calculation of direct loss for fraudulent misrepresentation in a normal case, which merely requires the court to ascertain the actual value of the assets bought at the relevant date and to deduct that figure from the price paid.

The Court of Appeal emphasised that a claimant is entitled to the difference between the price paid and the market value, whatever miscalculations it may have made in entering into the transaction. Claimants may, therefore, be compensated for making (or notwithstanding that they made) a bad bargain, even if they knew or ought to have known about defects before entering into the transaction. The purchaser’s commercial judgements and misjudgements are irrelevant to the evaluation of what direct loss it suffered.

On the facts of the present case, the Court of Appeal held that an alternative “broad brush” approach was appropriate. Glossop was entitled to recover, by way of direct loss, the difference between the price it paid and the market value of the assets purchased at the relevant date. That difference was best represented by the sum of £300,000 which Glossop paid for goodwill (mostly for business contracts) that had no real value and it was hard to see how there could be any goodwill in a loss-making business.