Key takeaways

The Court of Appeal’s decision in Afan Valley v Lupton Fawcett LLP shows the difficulties of applying the scope of duty and duty nexus tests from SAAMCO and Manchester v Grant Thornton. A claim for professional negligence in the context of provision of advice will be successful where it can be shown that the losses would not have happened had the advice actually given by the defendant been correct.

Why does scope of duty matter in professional negligence cases?

Scope of duty is an important concept in negligence cases which can be the difference between being found liable for negligence and winning a case. The decision in Afan Valley v Lupton Fawcett LLP demonstrates the narrow operation of the scope and nexus of duty test and the importance of using the correct counterfactual scenarios in the context of this test.

Professional negligence facts in Afan Valley v Lupton Fawcett LLP

This appeal concerned a claim brought by a group of 43 insolvent companies against a law firm Lupton Fawcett LLP for professional negligence.

These companies were Special Purpose Vehicles (SPVs) used in investment schemes to hold property assets and sell long leasehold interests in hotel, care home, and student accommodation rooms. These investment schemes never proved to be successful, and were essentially operated as ‘Ponzi schemes’, where funds from new investors were used to pay the promised returns to the previous investors. These groups of companies eventually came to suffer from cash flow problems which eventually led to the collapse of all the companies involved in the schemes.

During the course of the investment schemes, the group of companies took advice from Lupton Fawcett on whether the schemes were collective investment schemes (CISs) under the Financial Services and Markets Act 2000 (FMSA). Lipton Fawcett advised the SPVs that they were not operating CISs.

The significance of this designation is that CISs are a regulated activity and can only be run by authorised persons. Because the SPVs were unauthorised persons, the agreements concluded between the SPVs and the investors became unenforceable as against the investors. Additionally, investors gained a right to recover any assets transferred under the agreement and compensation for any loss resulting from such transfers.

What did the claimants argue in the professional negligence claim?

The claimants’ case was that they offered the schemes in reliance on the Lupton Fawcett’s incorrect advice. Consequently, they claimed that had they known that the schemes are regulated, they would not have accepted the investments and would not have incurred significant civil liabilities under FSMA.

However, the defendant applied to strike out the claim in the court of first instance. They counterargued that the scope of their advice, for which they assumed a duty of care, was limited to the impact of the CIS status. The only consequence of this advice was that SPVs were required to return monies to the investors.

Therefore, civil liability under FMSMA was equal to the investment monies received by the companies previously. As such, no loss was generated at the point of promoting those investments. This became known as the “£ in £ out” argument. Any other losses, it was argued, fell outside of the scope of Lupton’s duty and could not be recovered from them. The court of first instance agreed with the defendant and struck out the claim.

Read our article on breach of contract claims and remedies for related analysis of causation, loss and remedies in commercial disputes.

What losses were claimed on appeal?

The claimants appealed to the Court of Appeal. Their appeal was based on the argument that their losses went beyond the restitution obligations under FSMA and included:

1. commissions to sales agents, legal and professional fees on each investment;

2. losses from the Ponzi scheme nature of the investments;

3. and compensation of losses for aggrieved investors, and the law firm’s duty extended to these extra losses.

In terms of procedural history, Court of Appeal prevented the claimants from amending their appeal because the proposed amendments did not come from fresh evidence and could have been raised before with reasonable diligence.

The Court of Appeal disagreed and dismissed the appeal.

What is the scope of duty and duty nexus test?

The main focus was on the cases of South Australia Asset Management Corporation v York Montague Limited [1997] AC 191 (SAAMCO) and Manchester Building Society (Appellant) v Grant Thornton UK LLP (Respondent) [2021] UKSC 20 (Manchester v Grant Thornton). These cases established the modern approach to determining the scope of one’s duty of care in tort.

The test asks (1) what the risks of harm against the claimant are against which the law imposes on the defendant a duty to take care; and (2) whether there is a sufficient nexus between a particular element of the harm for which the claimant seeks damages and the subject matter of the defendant’s duty of care. In the context of provision of advice, the question is essentially what part of the client’s loss has been caused by the advisor’s breach of their duty.

In deciding what constitutes sufficient nexus, the courts may use the ‘counterfactual test’. This is a theoretical exercise where the court asks the question what would have happened had the advice given been correct. If the loss in question would have still occurred, then it does not have sufficient nexus to the defendant’s duty of care and cannot be recovered.

How did the Court of Appeal apply the counterfactual test?

Lord Justice Nugee delivered the judgment. He dismissed the first two grounds of the appeal which claimed losses for commissions, fees paid under the investment agreements and losses from the Ponzi scheme. They had no sufficient nexus to the scope of Lupton Fawcett’s duty because they related to the general risks of running the investment schemes, not direct consequences of the incorrect advice.

The court held that the correct counterfactual test was whether the claimant would have suffered the alleged losses if the advice had been correct and the schemes were not CISs. This is in contrast to the question of whether the losses would have been incurred had the defendant correctly advised that the schemes were CIS.

The test confirmed that the companies would have incurred the Ponzi scheme and the associated commissions and fees even if the advice was correct.

For another recent example of professional and contractual liability turning on the careful application of legal tests, read our article on when warranties may also amount to representations.

Why did the FSMA compensation argument fail?

He also ruled that there was sufficient nexus between the obligation to compensate losses flowing from investments under FSMA and Lupton Fawcett’s duty of care. The risk of exposure to civil liability under FSMA was the one that the law firm was supposed to prevent by giving correct advice.

However, the court held that these losses were not mentioned in the pleadings which only referenced the restitution for the initial investment. Even if it was adequately pleaded, this loss would have occurred even if the advice was correct under the counterfactual test. That is because investors would have still sued the companies for breach of contract and the tort of deceit.

What are the consequences for litigants in professional negligence claims?

This case is a demonstration of the way tests for the scope of duty and duty nexus are applied in professional negligence cases. It emphasises the challenges of correct identification of the sufficient nexus between losses and duty of care. It further demonstrates the difficulties associated with formulating a correct counterfactual test, as not every loss which has a causal connection to the incorrectly given advice will necessarily be within the scope of the defendant’s duty. Therefore, professional negligence cases where a determination as to the scope of the duty is needed will continue attracting uncertainty.

Additionally, this decision highlights the importance of properly pleading one’s case before trial. The right to amend on appeal is limited strictly to circumstances where newly discovered facts make it impossible for a party to have pleaded the proposed argument before the decision being appealed was handed down.

How should professional advisors assess their duties

Professional advisors must consider what risks their clients can expect to guard against when receiving advice. They should determine the scope of their advice in writing and make sure that it adequately guards their clients against those risks.

Parties to professional negligence claims must be especially careful when phrasing the counterfactual tests. An incorrectly pleaded case will result in a loss and cannot be amended later on appeal.

Barnes Law’s Commercial Litigation and Dispute Resolution team advises clients on professional negligence claims, scope of duty issues, recoverable loss, causation, pleadings and commercial litigation strategy. For more information, please contact our Commercial Litigation and Dispute Resolution team to discuss how we can support you.

Written by Barnes Law Managing Partner Yulia Barnes.