A summary of recent developments in accountants' liability law
Saved by the bell: High Court holds that tax advisors breached duty of care but finds that the claims were time barred
In one of the first cases to apply the long established SAAMCO principles recently clarified by the Supreme Court in the widely reported case BPE Solicitors v Hughes-Holland  UKSC 21 ("BPE"), the High Court has considered in Halsall & Ors –v- Champion Consulting Limited & Ors (Rev 1)  EWHC 1079 (QB) (1) the duty of care owed by a reasonably competent tax advisor with respect to clients entering into tax planning schemes; and (2) the accrual date for limitation purposes in professional liability disputes.
- The Claimants were four solicitors who were said to have been negligently induced into two tax avoidance schemes by the Defendant accountants.
- The first "charity shell scheme" sought to take advantage of tax relief available on donations to charities through Gift Aid. In short, the Claimants subscribed for shares in a shell company, which then acquired a target company before the shell company was listed on the stock exchange. At that point, the Claimants gifted the shares to a charity and sought tax relief on the value of the gift (effectively the list price of the shares).
- Crucially, as tax relief would be available at the investors' marginal rate of tax, in order for the tax relief to exceed the Claimants' initial subscription in the shell company, the scheme relied on the listing price of the shell company being significantly higher than the initial subscription. Accordingly, there was a question as to whether the listing price (upon which tax relief was sought) represented the true market value of the shares.
- The second scheme was supposed to deliver tax benefits through investment in film rights.
- In respect of the first scheme, the key issue was whether the Defendants had advised that there was a significant risk that the valuation of the shell company was subject to challenge by HMRC. The Claimants contended that they had not been so advised and that the Defendant had assured them that the scheme would work effectively.
- In respect of the second scheme, the Claimants alleged that the Defendants had advised that this scheme had a 75-80% chance of success and further that if it failed the maximum loss would be the cash invested.
- Both schemes apparently failed, and the Claimants brought proceedings on the basis of negligent advice and losses suffered.
Liability/Duty of care
SAAMCO/BPE – a recap
In South Australian Asset Management Corp v York Montague  AC 191 ("SAAMCO") the House of Lords distinguished between (1) providing information for the purposes of enabling someone else to decide upon a course of action (in which case the information giver is generally not responsible for all of the consequences of the course of action); and (2) a duty to advise someone as to what course of action to take (in which case the adviser must take reasonable care to consider all of the consequences of the course of action).
In BPE, Lord Sumption explained that where a case fell into the 'advice' category "it is left to the adviser to consider what matters should be taken into account in deciding whether to enter into the transaction", and accordingly the professional should consider all relevant factors. However, where a case fell into the 'information' category "a professional adviser contributes a limited part of the material on which his client will rely in deciding whether to enter into a prospective transaction, but the process of identifying the other relevant considerations and the overall assessment of the commercial merits of the transaction are exclusively matters for the client."
The consequence is that if a professional has provided advice, he or she will be liable for the consequences of that advice being wrong, whereas if the professional has provided information he or she will only be liable for the more limited consequences of the information being wrong.
Halsall: The High Court Decision
- The Court concluded that on the facts the Defendant accountants had failed to properly advise the Claimants of the risk that the valuation would be challenged and, in fact, "gave them a 100% assurance that their tax liability would be reduced as a result of this investment". In the circumstances, it considered that (having applied the Bolam test) no reasonably competent tax adviser could have acted as the Defendants did.
- The Judge stated that whilst in all cases it is the client that ultimately takes the decision; the key test (applying BPE) "is whether the adviser is responsible for 'guiding' the whole decision-making process." On the facts, she found that the Claimants were guided entirely by the Defendant accountants and had not "retained responsibility for assessing the full range of risks". Accordingly, it was a case that fell into the 'advice' category and liability was established.
- The Court made similar findings in relation to the second tax scheme, in which the Claimants entered into a sole trader business to trade film distribution rights creating losses to set against income. The Court concluded here that the advice given regarding this scheme was advice that no reasonably competent tax adviser could have given.
The Court held that the claim ultimately failed as a result of it having been brought outside the limitation period. The judgment provides a useful reminder of the issues at play when considering the accrual date for statutory limitation purposes in professional liability disputes under the Limitation Act 1980 ("the Act").
Primary limitation period
- Section 2 of the Act requires an action founded on tort to be brought within six years from the date on which the cause of action accrued.
- In this case, the relevant date was considered to be the point at which the Claimants contracted to enter into the scheme, not because loss at that point was inevitable, but because that was the point at which they were "tied into the 'commercial straitjacket'".
Additional limitation period
- Section 14A of the Act requires Claimants to bring the claim within three years of the earliest date upon which the Claimants had both the knowledge required for bringing an action for damages and the right to bring such an action.
- In determining the relevant date, the Court considered Section s14A(5) of the Act which sets out that the correct date for these purposes is "the earliest date on which the plaintiff or any person in whom the cause of action was vested before him first had both the knowledge required for bringing an action for damages in respect of the relevant damage and a right to bring such an action."
- In Haward v Fawcetts (2006) it was held that what is required is "sufficient knowledge to realise that there is real possibility of his damage having been caused by some flaw or inadequacy in his advisers' investment advice, and enough therefore to start an investigation into that possibility...".
- Considering this issue in Halsall, the Judge found that the relevant point in time for the Claimants was "not when they first knew they might have a claim for damages but when each of them first knew enough to justify setting about investigating the possibility that [the] advice was defective."
- In other words, the point at which the Claimants were aware that HMRC were investigating and challenging the scheme and accordingly the point at which the Claimants knew that success was no longer assured contrary to what the Defendant accountants had said.
Contractual limitation of liability
- Of further note is the Court's obiter consideration of a limitation of liability clause in the Defendant's terms of business that provided that a claim could only be brought against it within six years of the date of breach of duty which appeared on its face to exclude the operation of section 14A of the Act.
- Here, the Judge noted that where there is uncertainty as to the intention of an exclusion clause it should be resolved against the person relying on it, but considered that as the Claimants were litigation solicitors they would have been well aware of the issue and law regarding limitation and accordingly did not accept there was any uncertainty. Accordingly, the Judge considered that the terms of business did not permit any extension of the limitation period by reference to section 14A.
- Further, it was found that the clause met the requirement of reasonableness under section 11 of the Unfair Contract Terms Act 1977, given that, among other things, it could be inferred from the fact the Claimants were litigation solicitors that they were capable of understanding the significance of the limitation clause.
The decision is a useful reminder of the key principles applicable in professional negligence claims and provides a careful examination of (a) duty of care arguments (post BPE); and (b) limitation.
It is also a reminder, if needed, that:
- appropriate risk warnings should always be considered particularly where advice is being given;
- consideration should be given to the political/cultural shift against (aggressive) tax avoidance and reputational issues at risk for any professional. Indeed, in Halsall the expert for the Defendants opined that the charity shell scheme was tax planning of the sort that "large accounting firms would not have been willing to be involved in due to the risk to their reputation...";
- HMRC has a particular appetite for challenging tax planning schemes. Indeed, it asserts that it wins 8 out of 10 avoidance cases heard in court (although of course many cases will be settled or dropped before that stage);
- The Finance Bill, currently before Parliament, has reintroduced the provisions that were dropped before the general election, providing for penalties for enablers of defeated tax avoidance schemes. Going forward therefore, firms will need to tread even more carefully when advising in this area.
Criminal Finances Act: Failing to Prevent the Facilitation of Tax Evasion
On 30 September 2017 the Criminal Finances Act 2017 came into force and introduced the new criminal offences of failing to prevent the facilitation of tax evasion. Up until now it has been very difficult to hold a corporate body liable for tax evasion. This new Act makes companies and partnerships criminally liable if they fail to prevent the facilitation of tax evasion - both in the UK and overseas - by an associated person, even in circumstances where the corporate body was not involved in, or aware of, the criminal conduct.
The new offences are modelled on the "failure to prevent" bribery offence contained in the Bribery Act 2010. Similar to the bribery offences, they impose strict liability and therefore require no proof of involvement by the 'directing mind' of the company, thus overcoming the difficulties previously faced when bringing businesses to account for corporate offences.
A complete statutory defence is, however, available where the corporate can show that they implemented reasonable preventative procedures, or where it would have been unreasonable or unrealistic, in the circumstances, to have expected such procedures to be implemented.
Penalties for committing these offences include an unlimited financial penalty and/or ancillary orders including confiscation orders or serious crime prevention orders. Conviction for the offences may also prevent the company from being eligible to receive public contracts as well as wider reputational damage.
The Act essentially makes owners and managers responsible for preventing their staff and agents from committing tax evasion. The larger and more dynamic the business, the greater the risk that such activity might have occurred. Accountants' firms are squarely in the sights of the legislation so firms should be reviewing processes and procedures to ensure that appropriate prevention and detection measures are in place.
Financial Reporting Council (FRC): Developments in Audit and Enforcement
The FRC held its Annual Open Meeting on 21 September 2017 emphasising the importance of improving corporate governance to ensure that the reputation of UK business is maintained despite the uncertainty surrounding Brexit.
This was followed by a speech on 25 October 2017 by the FRC CEO Stephen Haddrill looking at 'Developments in Audit'. Both speeches raise interesting challenges and give an indication as to the FRC's priorities in the coming months and years.
Below is a summary of the main points from the keynote speeches to the FRC Open Meeting:
- Whilst the quality of audit has been improving, the FRC feels that there is still more to be done to meet its target of 90% of FTSE 350 firms' audits requiring only limited improvements.
- The FRC is currently exploring options for the UK's future accounting framework in light of Brexit. Recognising that the International Financial Reporting Standards (IFRS) play a vital role for comparability, nonetheless the FRC needs to "understand the UK impact and if, subject to some strict criteria, there are points that need to be adopted differently in the UK we should not be afraid of exploring those." In addition, the FRC stressed the importance of a need for answers on equivalence and the need to maintain a Third Country Auditor regime post-Brexit in order to give confidence to investors and for auditors to work across borders.
- The FRC welcomed the government's recent proposals for reform of the corporate governance framework, which included: proposals for a wider role and new powers for the FRC to act as regulator and enforcer of directors' duties; the development of a new corporate governance code for large, privately held companies with 2000 plus employees; and a new body to oversee compliance with the new code.
In his 'Developments in Audit' speech on 25 October 2017, Stephen Haddrill set out that:
- In respect of audit reporting, whilst extended audit reports are to be welcomed, audit should move away from past performance review and become more forward-looking. In particular: "It is time for law makers and standard setters, whether at international level or through bodies like the FRC at national level, and through the profession, to ask whether audit should be fitted with front-facing halogen spotlights as well as reversing lights. The FRC will lead debate with the profession, with lawmakers and international bodies, to explore and embrace that idea and to respond to that challenge."
- In respect of enforcement (and responding to recent stories in the press):
- The test of misconduct, formerly established in the previous statutory framework, is too high a bar for taking cases in relation to audit. For new cases, under the 2016 audit regulation regime the test of misconduct has been replaced and enforcement action can be taken on the basis that there has been a breach of the relevant requirements. This is a lower threshold test than proving misconduct and it is expected that "more potentially deficient audits will therefore be investigated, prosecuted and ultimately sanctioned to varying degrees."
- Recently retired Court of Appeal Judge, Sir Christopher Clarke, has been instructed to lead a panel to review the FRC sanctions regime and consider if the range of fines and sanctions available is adequate to safeguard the public interest and deter wrongdoing. The panel will report later this year.
- Cases must be brought to tribunal much faster. Recent new powers are expected to help in this regard particularly securing information from companies. At 30 lawyers, the FRC legal team is also now four times the size it was a few years ago.
Taming the Disclosure Beast: An end to Default Standard Disclosure
Plans have been announced for a two year pilot scheme on disclosure for the Business and Property Courts (the Commercial Court, TCC and Chancery Division and the Financial List as well as the Business and Property Courts in Birmingham, Manchester, Leeds, Bristol, Cardiff, Newcastle and Liverpool). It is anticipated that changes to the CPR will be sought in spring next year, if the plans go through.
The proposals are radical; aimed at ensuring that parties can no longer simply default to using standard disclosure, the changes are intended to ensure greater take-up of the "menu" of options for disclosure which was introduced in the Jackson reforms of 2013 (and which, it seems, both the parties and judges have been reluctant to adopt so far) to ensure proportionality, as well as ensuring the rules are fit for purpose in an electronic age.
The key changes are as follows:
- "Standard disclosure" (that is, documents which assist or harm the case of any of the parties to the dispute) as the default option will disappear and there will be no one "default" order.
- The proposals begin with the concept of "Basic Disclosure" of the documents on which a party intends to rely (and which are necessary to understand the case) which will be given with Statements of Case. The parties (or the court) can agree to dispense with or defer this requirement and it will not apply where complying with it would involve a party providing over 500 pages of documents. A search is not required although the parties may undertake one. Importantly, basic disclosure does not require a party to disclose documents that are adverse at the outset of a claim (i.e. with statements of case).
- If the parties wish to go beyond Basic Disclosure, they will need, at the same time, to state their intention to do so and (unless choosing Model A (see below)) to agree a draft List of Issues for Disclosure and produce a joint Disclosure Review Document ("DRD"), which will replace the Electronic Disclosure Questionnaire and must be produced after the close of Statements of Case and before the CMC. The proposals are intended to set out a framework for parties and advisers to co-operate and engage on disclosure before the first CMC in order to agree a proportionate approach to disclosure.
- The DRD will include proposals for "Extended
Disclosure" (and if so, on what Disclosure Model for which
issue). There will be five "Extended Disclosure" Models
as follows, (with Model D in general terms equivalent to the old
- Model A – No order for disclosure.
- Model B – Limited disclosure – disclosure of the key documents on which each party relies and which are necessary to understand the case to be met (in contrast to Basic Disclosure this includes disclosure of documents adverse to the disclosing party).
- Model C – Request led search disclosure – disclosure of particular documents or narrow classes of documents by reference to a request set out in the DRD or defined by the Court.
- Model D – Narrow search based disclosure, with or without narrative documents – documents likely to support or undermine the disclosing party/other party's case in relation to one or more of the Issues for Disclosure. The Court will be required to be satisfied that use of the model is reasonable, appropriate and proportionate.
- Model E – Wide search based disclosure (essentially train of enquiry disclosure) – this will only be ordered in an exceptional case.
- Bespoke models may be ordered but again this will be exceptional.
- The courts should be proactive and only accept the models proposed by the parties where persuaded it is appropriate to do so in order to resolve the Issues for Disclosure. The Court has considerable flexibility to apply different models to different parties and to different Issues.
- Form H Costs Budgets in relation to disclosure will be completed after the disclosure order is made (although costs estimates should be provided in the DRD).
The duty to disclose known documents that are adverse to the disclosing party remains a core duty, and applies even if the court makes no disclosure order.
The proposals also enable parties to seek guidance from the court at a Disclosure Guidance Hearing either before or after the CMC and set out express duties on disclosure applying to parties and their legal advisers to cooperate with each other and assist the court with disclosure, with sanctions for non-compliance.
Further details can be found here: https://www.judiciary.gov.uk/announcements/disclosure-proposed-pilot-scheme-for-the-business-and-property-courts/
Although the models themselves are not radically different from the current menu options, the rules steer parties away from the ability to adopt Standard Disclosure as the default. They also require the parties to give thorough consideration to the correct model for disclosure at an earlier stage.
Despite the fact that the proposals will involve a "wholesale cultural change", it is recognised that the 'cards on the table' disclosure regime in England & Wales can be a key selling point for parties choosing a forum for their dispute, and in the right case, full disclosure (akin to the current standard disclosure order) will still be ordered. The proposals which seek to limit and control unnecessarily expensive trawls for documents are likely to be welcomed by professional services firms, although in some specific instances, such as audit cases, it may be in the auditors' interest to push for fuller disclosure. Comments from interested parties are sought by the end of February 2018, and we will be seeking your views on the proposals as well as your experiences of the current regime.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.