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Haugesund Kommune v Depfa ACS Bank, Wikborg Rein: The consequences of solicitors' negligence

24/05/2011

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In Haugesund Kommune v Depfa ACS Bank, Wikborg Rein[1] the Court of Appeal considered the extent of solicitors' liability for negligent advice on the capacity of a lender's counterparty in circumstances where the lender would not have entered the transaction but for the negligent advice.

This issue arose in the context of swaps transactions entered by Norwegian local authorities. Following the downturn in the market in 2008, the local authorities argued that the transactions were invalid as they lacked capacity to enter the transactions under Norwegian law. Such arguments have been common since the financial crisis, with German and Italian public bodies also seeking to avoid their contractual obligations by arguing before the English courts that derivatives transactions were invalid.

Although in the first instance such disputes arise between the lender and its counterparty, it is likely that lenders may turn to their advisors to make up any shortfall in the amounts recovered. Many professionals (and their insurers) will therefore have been following this case closely in order to understand the potential scope of their liabilities.

The background

In 2004 and 2005 the claimants (referred to as "the Kommunes"), both Norwegian municipalities, entered swap transactions with Depfa ACS Bank ("Depfa"), the effect of which was to achieve a form of borrowing in a total amount of approximately £40 million. The Kommunes used the proceeds of the transactions to finance further investments, as proposed by a firm of financial advisors.

Depfa was advised in relation to the swap transactions by a firm of Norwegian lawyers, Wikborg Rein. In addition to other advice, Wikborg Rein advised in unqualified terms that under Norwegian law the swap transactions were not loans and the Kommunes had full legal capacity to enter into them.

In 2008 the Kommunes ceased to perform their obligations under the swaps on the basis that the transactions were in fact invalid for lack of capacity. By that time, the investments made by the Kommunes had fallen in value substantially, so the Kommunes could not repay in full the monies received from Depfa under the swap transactions from the proceeds of those investments.

The Kommunes then commenced proceedings before the Commercial Court (in accordance with the English law and jurisdiction clauses in the swap transaction documents) claiming a declaration that the transactions were invalid. Depfa counterclaimed for restitution of the monies paid to the Kommunes should those monies turn out to have been paid pursuant to an invalid agreement. Depfa also brought a claim against Wikborg Rein as Part 20 Defendants, seeking damages for the incorrect advice given by Wikborg Rein that the Kommunes had capacity to enter the swap transactions.

At an expedited hearing, it was held that the transactions were invalid, but that Depfa's counterclaim for restitution succeeded such that the Kommunes had to repay to Depfa the monies paid under the swap transactions. That decision was subsequently upheld on appeal. The court at first instance also determined that Wikborg Rein's advice as to the capacity of the Kommunes to enter the swap transactions was negligent.  However, the quantification of Depfa's damages following from the negligent advice was held over for a subsequent hearing.

The issue

The quantification issue was heard in July 2010.  By that time, the Kommunes had liquidated the investments made with the money from the swap transactions, and had paid that money to Depfa (leaving a significant shortfall against the monies paid by Depfa under the swap transactions). The Kommunes' position was that they were not able to pay any further monies to Depfa pursuant to the Court's order.

It was accepted at first instance that, had Wikborg Rein advised Depfa correctly that the Kommunes lacked capacity to enter the swap transactions, Depfa would not have done so. Depfa therefore argued that Wikborg Rein should be liable for all the consequences of it having entered the swaps, which consisted of the shortfall in the amounts repaid by the Kommunes pursuant to the Court's order for restitution.

At first instance, Tomlinson J held that Depfa could recover all foreseeable loss flowing from Depfa's decision to enter the swap transactions, which included the whole of the shortfall in repayment by the Kommunes. Wikborg Rein appealed the decision.

The Court of Appeal's decision

Wikborg Rein's argument relied on the House of Lords decision of South Australia Asset Management v York Montague[2] ("Saamco"). That case concerned negligent advice given by property valuers to lenders. As in the present case, it was accepted that the valuers' clients would not have entered the relevant transactions had they known the true value of the property taken as security.

In Saamco Lord Hoffman distinguished two categories of case: where an advisor provides information on the basis of which his client will decide upon a course of action (referred to as "category 1" cases), and where an advisor has a duty to advise his client as to the course of action to be taken ( referred to as "category 2" cases). Only in the latter case would the advisor be liable for all the foreseeable consequences of having taken the course of action; in the former case, the advisor would only be liable for the foreseeable consequences of the information being wrong. It has subsequently been clarified that this question depends on the scope of the advisor's duty, rather than issues of causation or foreseeability.[3]

Saamco itself was held to fall within category 1; the valuers were therefore only liable for the shortfall in security held by the lenders where the borrowers could not repay the loans, rather than the additional fall in the property market which had occurred since the transactions. Wikborg Rein argued that this was also a category 1 case,  in which case the effect of the invalidity was simply to replace the intended contractual debt owed by the Kommunes to Depfa with an immediate right to restitution of the monies (and a higher interest obligation, should they not make the repayment). Depfa had therefore suffered no loss, as each of those obligations was equally enforceable against the Kommunes (Wikborg Rein having advised Depfa before the swap transactions that a claim against a Norwegian municipality to enforce the terms of the transactions would not be successful in any event).

In deciding this question, Rix LJ (who gave the leading judgment) undertook a factual analysis to determine the scope of Wikborg Rein's duties. Wikborg Rein had been engaged by Depfa to advise on three specific points: whether the swap transactions were loans for the purposes of Norwegian law, whether the Kommunes had legal capacity to enter the swap transactions and whether the transactions could be enforced against the Kommunes should the agreed terms be breached. In those circumstances, Wikborg Rein had not taken on a general retainer to advise Depfa on the swaps transactions. The case was therefore a category 1 case.

It followed that Depfa would only be able to recover loss that fell within the scope of Wikborg Rein's (limited) duty to advise. Rix LJ held that the loss was caused by the impecuniosity of the Kommunes, rather than the invalidity of the transactions. Depfa had assumed the risk of impecuniosity, as it had been advised that it would not be able to take proceedings against the Kommunes in the event of default.  Depfa had therefore suffered no loss which was attributable to Wikborg Rein's negligent advice.

It is worth noting that at first instance Tomlinson J had concluded that this was a category 2 case, and that the restitutionary right obtained when the monies were paid by Depfa pursuant to the swap transactions (which was based on the unjust enrichment of the Kommunes) was not a right to recovery of the monies, being an uncertain equitable remedy. At first instance Wikborg Rein had therefore been ordered to pay approximately £28 million in damages to Depfa.

Comment

The decision in this case can be viewed as merely the application of the Saamco principles to complex factual circumstances. The complexity of those circumstances is demonstrated by the fact that Tomlinson J and Rix LJ (with whom Gross LJ implicitly sided) disagreed as to whether Wikborg Rein had taken on specific or general duties in relation to the transactions (and therefore whether the case was of category 1 or category 2 under the Saamco principle).
Applications of the Saamco principle will always be heavily fact sensitive, and it is for that reason that solicitors should consider carefully (and seek to strictly define, if possible) the nature of their duties to their client when providing advice on complex transactions. Although it will not be determinative, the wording of engagement letters will be highly relevant to any subsequent consideration of the duties assumed by the solicitor.

From a policy perspective, this decision is also not straightforward. Whilst Rix LJ expressed that "it is difficult to understand why that loss [caused by the impecuniosity of the Kommunes]...should be visited on Wikborg Rein",  it is also difficult to see why the loss should settle on Depfa, who only suffered this (foreseeable) loss because of the negligent advice from Wikborg Rein. Although it can be said that Depfa assumed the risk of the Kommunes impecuniosity, it can equally be argued that they only accepted that risk in specified circumstances, i.e. where the Kommunes were, for all other purposes, bound by the swap transactions.

In any event, it is clear from the decision that the rule in Saamco will operate to benefit solicitors as well as valuers facing negligence claims in a falling market.

 
[1] [2011] EWCA Civ 33
                                                                                                                           
[2] [1996] UKHL 10
 
[3] Nykredit Mortgage Bank plc v Edward Erdman Group Limited (No 2) [1997] 1 WLR 162 (HL)

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