Manchester Building Society v Grant Thornton UK LLP

The claimant, a small building society, sued its auditors for negligent advice and negligent audits concerning the society's hedge accounting policy under IAS 39, and for approving accounts that relied upon hedge accounting when it could not properly be applied. The court found that the defendant had negligently approved the Claimant's Hedge Accounting Policy in April 2006 (and thereafter during the audits to 2011), and that the defendant knew (by 11 April 2006) that the society intended to hedge lifetime mortgages with long-term swaps.

On legal causation and scope the judge applied the SAAMCO/Hughes-Holland framework: although the defendant's negligence was an effective (contributory) cause of some losses, most of the major losses (in particular the very large mark-to-market costs of breaking long-term swaps in 2013) were not losses of the type for which the defendant had assumed responsibility and so were not recoverable. The court allowed a modest award for transaction/penalty costs and certain remedial and advisory fees, but rejected claims for the full value of the break costs, loss of future profits from mortgage books, the costs of servicing swaps and the set-up/operational costs of the Spanish book. The defendant was not granted statutory relief under the Companies Act provisions because it had not acted reasonably in the broad sense required by the statute.

Background and parties. The Manchester Building Society (Claimant) issued lifetime mortgages and used long-term interest rate swaps to hedge interest-rate risk. Grant Thornton UK LLP (Defendant) audited the society and advised on its Hedge Accounting Policy under IAS 39 in 2006 and in subsequent audits. After the 2008 financial crisis and a later review (2013) it was discovered that hedge accounting could not properly be applied, materially worsening the society's reported capital position and leading to the closure of swaps and sale of mortgage books.

Nature of claim. The Claimant sued for damages arising from the Defendant's admitted negligent auditing and negligent advice: principally the costs of breaking long-term swaps in 2013 (claimed at ~£32.7m), lost profits and other consequential losses (total claimed about £48.5m).

Issues for decision. The court determined factual questions (notably whether the Defendant knew in April 2006 that the society intended to hedge lifetime mortgages with very long swaps), then legal issues: causation (but-for and effective cause), scope of duty (applying SAAMCO and Hughes-Holland), remoteness, quantification of recoverable heads, contributory negligence, and whether statutory relief under Companies Act provisions should reduce liability.

Findings of fact and law. On the facts the judge found, on the balance of probabilities, that Grant Thornton was aware by 11 April 2006 of the society's intention to use long-term swaps to hedge lifetime mortgages and that the Defendant had been negligent in approving the Hedge Accounting Policy and in subsequent audits. The court held that, although the Defendant's negligence was an effective cause of some losses (it materially contributed to the society being exposed to accounting volatility), the very large break costs in 2013 reflected market movements and commercial decisions for which the Defendant had not assumed responsibility; therefore those major losses were not within the scope of the Defendant's duty and were not recoverable under SAAMCO/Hughes-Holland. By contrast relatively modest transaction/termination penalties and certain advisory fees were recoverable.

Quantification and contributory negligence. The court awarded recoverable damages totalling £420,460 (transaction costs and certain advisory fees), reduced for contributory negligence by 25% (the Claimant bearing some responsibility for imprudent choices including use of 50-year swaps and defects in its own accounting processes). Judgment was for 75% of £420,460, namely £315,345 plus interest.

Statutory relief. The court refused to relieve the Defendant under the Companies Act provisions (section 727 CA 1985 / section 1157 CA 2006) because the Defendant had not acted reasonably in the wide sense required by the statute.

The claim succeeded in part. The court found that Grant Thornton negligently advised on and audited the Claimant's hedge accounting, and that the defendant's negligence was an effective cause of some losses, but the principal break costs of closing long-term swaps were not losses of the type for which the defendant had assumed responsibility under SAAMCO/Hughes-Holland and were therefore not recoverable. The court awarded damages of 75% of £420,460 (£315,345) plus interest, and refused Companies Act relief.