Law Society (Original Respondents and Cross-appellants)v.Sephton & Co (a firm) (Original Appellants and Cross-respondents) and another and others (Original Appellants and Cross-respondents)

A cause of action in negligence for economic loss accrues only when the claimant sustains actual, relevant and measurable damage. A possibility of having to pay money in the future is not itself damage. A purely contingent liability becomes damage when the contingency occurs.

There may nevertheless be immediate damage where the same events diminish the value of an existing asset or leave a party to a bilateral transaction with rights worth less, or liabilities greater, than proper performance would have produced. Where a statutory compensation fund has a discretionary grant-making function, exposure to possible claims does not cause damage. Damage arises when a claim is received and the administrator becomes bound to exercise its discretion in accordance with public law.

A solicitor misappropriated client money over several years. Negligent accountants’ reports caused the Law Society to refrain from investigating and intervening in his practice. After the fraud was discovered, former clients claimed upon the statutory Compensation Fund and the Fund paid more than £1.24 million.

The Society issued its negligence claim against the accountants on 16 May 2002. The High Court, [2004] EWHC 544 (Ch), held that the cause of action had accrued more than six years earlier and rejected an estoppel argument. By a majority, the Court of Appeal, [2004] EWCA Civ 1627; [2005] QB 1013, reversed the limitation ruling but agreed on estoppel.

The accountants appealed and the Society cross-appealed. The central issue was whether mere exposure to possible Compensation Fund claims constituted damage, or whether damage arose only when a claim upon the Fund was received or met.

1. Disposition. The House unanimously dismissed the accountants’ appeal. Lord Hoffmann delivered the leading speech. Lord Scott of Foscote and Lord Rodger of Earlsferry expressly agreed with the reasoning given by Lord Hoffmann, Lord Walker of Gestingthorpe and Lord Mance. The declaration made below was replaced with a declaration that the Society had not suffered damage, and its negligence cause of action had not accrued, more than six years before proceedings were issued. No order was made on the Society’s cross-appeal concerning estoppel.

2. Accrual through damage. Per Lord Hoffmann, damage is an essential element of negligence. A purely contingent liability is not damage merely because payment is probable or an accountant would make provision for it. A possibility of having to pay money becomes actionable damage only when the contingency occurs. This conclusion applied the analysis in Wardley Australia Ltd v State of Western Australia (1992) 175 CLR 514.

3. Immediate loss distinguished. Per Lord Hoffmann, Lord Walker and Lord Mance, a contingency may accompany distinct present damage. A transaction may immediately diminish a specific asset, as where a mortgage reduces the value of an equity of redemption. A bilateral transaction may also leave the claimant with a less valuable package of rights or greater liabilities than proper performance would have produced. Forster v Outred & Co [1982] 1 WLR 86 and Nykredit Mortgage Bank plc v Edward Erdman Group Ltd (No 2) [1997] 1 WLR 1627 were explained on that basis. Those authorities did not establish that a purely personal and contingent obligation, standing alone, was damage.

4. The Compensation Fund. Per Lord Mance, whose conclusion Lord Scott expressly adopted, the misappropriations merely exposed the Fund to possible claims. The Society’s legal position remained unchanged until a former client submitted a claim. Receipt of the claim triggered its duty to exercise the discretion conferred by section 36 of the Solicitors Act 1974 rationally and consistently with the Fund’s purposes. The cause of action therefore accrued upon receipt of the first claim. It was not further postponed until the Society resolved to make, or actually made, a payment.

5. Earlier regulatory-risk authority. Lord Hoffmann considered Gordon v J B Wheatley & Co [2000] Lloyd's Rep PN 605 wrongly decided insofar as regulatory exposure was treated as a present contingent liability. Lord Walker and Lord Mance likewise regarded that reasoning as unsustainable. A collateral risk that a regulator or court might intervene did not itself alter the claimant’s legal position or fetter particular assets.

6. Limitation consequences. The knowledge-based period under section 14A of the Limitation Act 1980 addressed cases where damage had occurred without the claimant knowing the relevant facts. It did not convert an unfulfilled contingency into present damage. The first Compensation Fund claim was received within six years before issue, so the negligence claim was not time-barred.

1. House of Lords: In Law Society v Sephton & Co [2006] UKHL 22, the House unanimously dismissed the accountants’ appeal. It substituted a narrower declaration that the Society had not suffered damage, and its cause of action had not accrued, more than six years before issue. It made no order on the Society’s estoppel cross-appeal.

2. Court of Appeal: By a majority, Carnwath and Maurice Kay LJJ, Neuberger LJ dissenting, allowed the Society’s appeal on accrual and held that the negligence claim was not time-barred. The court unanimously upheld the rejection of estoppel: [2004] EWCA Civ 1627; [2005] QB 1013.

3. High Court, Chancery Division: Mr Michael Briggs QC, sitting as an additional judge, held that the cause of action had accrued before 16 May 1996 and that the accountants were not estopped from relying on limitation: [2004] EWHC 544 (Ch).