Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20

A building society sued its auditors for negligently advising that hedge accounting could be used for interest rate swaps. When the error was discovered, the society had to close out swaps at significant cost. The Supreme Court held the loss fell within the scope of the auditor's duty of care, clarifying the SAAMCO principle on professional advisers' liability.

Facts

Manchester Building Society entered into long-term interest rate swap contracts to hedge against interest rate changes affecting its mortgage lending business. From 2006, Grant Thornton UK LLP, the society’s auditors, negligently advised that the society could apply hedge accounting to its accounts. This advice was wrong because there was no effective hedging relationship between the swaps and the mortgages. When Grant Thornton discovered its error in 2013, the society had to restate its accounts showing substantially reduced net assets and insufficient regulatory capital. To extricate itself, the society closed out the swaps at a cost of over £32 million.

The Society’s Business Model

The society purchased and issued lifetime mortgages funded by borrowing at variable interest rates. To protect against the risk that borrowing costs would exceed the fixed rate receivable on mortgages, it entered into interest rate swaps. The intention was to guarantee profit when mortgages were redeemed by matching variable rates payable by swap counterparties with the society’s borrowing costs.

Issues

The central issue was whether the costs incurred in closing out the swaps fell within the scope of Grant Thornton’s duty of care. This required the court to consider:

• The proper application of the SAAMCO principle regarding scope of duty
• Whether this was an ‘advice’ or ‘information’ case
• The role of counterfactual analysis in determining recoverable loss

Judgment

The SAAMCO Principle

The Supreme Court unanimously allowed the appeal. Lord Hodge and Lord Sales (with whom Lord Reed, Lady Black and Lord Kitchin agreed) emphasised that the scope of a professional adviser’s duty is governed by the purpose of the duty, judged objectively by reference to why the advice is being given.

“[T]he 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.”

The court rejected rigid application of the advice/information distinction, noting Lord Sumption’s observation in Hughes-Holland that cases constitute a spectrum.

Application to the Facts

Grant Thornton advised the society that it could employ hedge accounting to reduce volatility on its balance sheet and maintain regulatory capital at an affordable level. The purpose of this advice was clear: to enable the society to determine whether it had capacity to proceed with its business model within regulatory constraints.

“The society entered into the swap transactions in and after 2006 and did not close the prior swap transactions in 2006 because they were advised that hedge accounting could be deployed to counter the volatility risk and its consequences for the societys regulatory capital.”

Lord Leggatt explained that the critical matter making Grant Thornton’s advice wrong was that there was no effective hedging relationship between the swaps and mortgages. Had there been such a relationship as Grant Thornton advised, the loss would not have occurred because the fair value of the swaps would have been offset by a corresponding difference in the fair value of the mortgages.

The Counterfactual Test

The court clarified that counterfactual analysis should be regarded as a cross-check rather than the foundation of the relevant analysis. Lord Burrows stated:

“[T]he decision as to whether loss falls within the scope of the professionals duty of care is a question of law, with a particular emphasis on the purpose of the advice or information, that is underpinned by the policy of achieving a fair and reasonable allocation of the risk of the loss that has occurred as between the parties.”

Implications

This case significantly clarifies the application of the SAAMCO principle to professional negligence claims, particularly against auditors. Key implications include:

• Courts should focus primarily on the purpose of the duty when determining scope of liability
• The advice/information distinction should not be applied rigidly as a straitjacket
• Counterfactual analysis is merely a cross-check, not determinative
• Auditors may be liable for losses caused by matters they negligently failed to detect or report where those matters fall within the purpose of their duty

The decision demonstrates that where an auditor’s negligence conceals a mismatch between financial instruments that the client relies upon in making business decisions, the resulting losses may fall within the scope of the auditor’s duty of care.

Verdict: Appeal allowed. The society was entitled to recover damages of approximately £13.4 million (being 50% of £26.7 million after reduction for contributory negligence) in addition to the amount awarded by the trial judge. The loss fell within the scope of Grant Thornton’s duty of care as it resulted from matters which Grant Thornton negligently misstated, namely the absence of an effective hedging relationship between the swaps and mortgages.

Source: Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20