Professionals obviously owe a duty of care to the clients they advise, but the scope of that duty has long been a subject of legal debate. In upholding a building society's professional negligence claim against an accountancy firm, however, the Supreme Court has clarified the position.

The society received incorrect and negligent advice from the firm that its accounts could be prepared using a method known as hedge accounting and that accounts thus prepared would give a true and fair view of its financial position. In reliance on that advice, the society entered into long-term interest rate swaps as a hedge against the cost of borrowing money to fund its lifetime mortgages business.

The misstated accounts served to hide volatility in the society's capital position and what became a severe mismatch between the negative value of the swaps and the value of the mortgages that the swaps were supposed to hedge. After the firm realised its error, the society had to restate its accounts, showing substantially reduced assets and insufficient regulatory capital.

In order to remedy that situation, the society closed out the swap contracts early at a cost of over £32 million. The society launched professional negligence proceedings but its claim to recover that sum by way of damages against the firm was rejected by the High Court and the Court of Appeal.

In unanimously upholding the society's appeal against that outcome, the Supreme Court found that the society's loss fell within the scope of the duty of care assumed by the firm. The latter was liable for the loss, subject to a reduction of 50 per cent to reflect the society's own negligence in mismatching mortgages and swaps in an overly ambitious application of the business model.

Giving guidance for the future, the Court found that the scope of the duty of care assumed by a professional adviser should be judged on an objective basis by reference to the reason why the advice was given. After considering what risk the duty was supposed to guard against, judges should go on to discern whether the loss suffered represented the fruition of that risk.

The purpose of the firm's advice was to establish whether the society could use hedge accounting within the constraints of the regulatory regime to implement its proposed lifetime mortgages business model. As a result of the firm's negligent advice that it could, the society entered into the swap transactions without a full understanding of the risks involved.

For expert legal advice on any matters relating to professional negligence, contact Sundeep Bilkhu s.bilkhu@sydneymitchell.co.uk 08081668827.

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