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You Swynson, You Lose Some

Robert Blackett
The Arbiter

Summer 2017

Lowick Rose LLP (in liquidation) v Swynson Limited and Another [2017] UKSC is a decision of the Supreme Court which was handed down on 11 April 2017.

It is the latest in a line of so called ‘transferred loss’ cases - where the courts have grappled with the question of when a claimant in an action for breach of contract can recover damages for a loss which has been suffered not by them but by a non-party.

The Supreme Court’s predecessor, the House of Lords, last considered such a case some 17 years ago. That was, of course, Alfred McAlpine Construction Limited v Panatown Limited (2000] UKHL, 43 which features a majority decision, a majority subtly divided in its reasoning, and judgments running to 74 pages. It is (or was), therefore, a case much beloved of academics and the setters of exam papers.

In the Lowick Rose case Lords Sumption and Mance dealt with a transferred loss problem rather more succinctly.

The Albazero

The general rule is that a claimant can only recover loss which he has himself suffered. An exception was recognised in cases concerning the carriage of goods by sea. A shipowner contracts with a shipper to carry goods from one place to another. The shipper sells the goods while they are in transit, whereupon risk and ownership passes to someone else, who may sell them on again to someone else, and so on. The goods are damaged or lost. Whomever owns the goods at that time has no contract with the shipowner. This shipper has a contract with the shipowner but has suffered no loss, because he no longer owns the goods, and they are no longer at his risk. In such a case, the shipper can sue the shipowner to recover for the loss which has been suffered by the third party consignee, and will be accountable to the consignee for the damages recovered. In Albacruz (Cargo Owners) v Albazero (Owners) [1977] AC 774, 847 Lord Diplock described the exception in these terms:

in a commercial contract concerning goods where it is in the contemplation of the parties that the proprietary interests in the goods may be transferred from one owner to another after the contract has been entered into and before the breach which causes loss or damage to the goods, an original party to the contract, if such be the intention of them both, is to be treated in law as having entered into the contract for the benefit of all persons who have or may acquire an interest in the goods before they are lost or damaged, and is entitled to recover by way of damages for breach of contract the actual loss sustained by those for whose benefit the contract is entered into.

St. Martins

Linden Gardens Trust v Lenesta Sludge Disposals Limited and others and St. Martins Property Corporation Limited and others v Sir Robert McAlpine & Sons Limited [1994] 1 AC 85 comprises conjoined appeals, only the second of which is of interest.

St. Martins Property Corporation Limited (the “Corporation”) was a wholly owned subsidiary of St. Martin’s Holdings Limited which was itself wholly owned by the state of Kuwait. Corporation agreed to develop a site owned by a local authority. The local authority contracted to grant Corporation a 150 year lease of the site once the development was completed. Corporation retained Sir Robert McAlpine & Sons Limited (“McAlpine”) to carry out the works. The contract contained a prohibition against assignment.

Before the works were completed “a scheme was implemented for tax reasons” whereby Corporation assigned its rights under the agreement with the local authority, and purported also to assign its rights under the contract with McAlpine, to another wholly owned subsidiary of St. Martins Holdings called St. Martin’s Property Investments Limited (“Investments”).

Practical completion of the works took place in 1980. In 1981 part of the development was found to be defective. Remedial works were carried out at Investments’ cost. Corporation and Investments brought a claim against McAlpine for the cost of the remedial works.

Investments had no rights as against McAlpine, because the assignment to Investments was ineffective, it being prohibited by the building contract. As for Corporation, it had suffered no loss since it had no interest in the affected property, having transferred its interest to Investments before the defective work was ever done.

Their Lordships held that Corporation could, nonetheless, recover substantial damages by analogy with The Albazero. The following is from the judgment of Lord Browne-Wilkinson, with whom all the other judges agreed:

The contract was for a large development of property which, to the knowledge of both Corporation and McAlpine, was going to be occupied, and possibly purchased, by third parties and not by Corporation itself. Therefore it could be foreseen that damage caused by a breach would cause loss to a later owner and not merely to the original contracting party, Corporation. As in contracts for the carriage of goods by land, there would be no automatic vesting in the occupier or owners of the property for the time being who sustained the loss of any right of suit against McAlpine. On the contrary, McAlpine had specifically contracted that the rights of action under the building contract could not without McAlpine’s consent be transferred to third parties who became owners or occupiers and might suffer loss. In such a case, it seems to me proper, as in the case of the carriage of goods by land, to treat the parties as having entered into the contract on the footing that Corporation would be entitled to enforce contractual rights for the benefit of those who suffered from defective performance but who, under the terms of the contract, could not acquire any right to hold McAlpine liable for breach. It is truly a case in which the rule provides ‘a remedy where no other would be available to a person sustaining loss which under a rational legal system ought to be compensated by the person who has caused it.’

Lord Griffiths, however, suggested that the same result could also be justified on what has become known as the “broader ground.” This was that the developer had himself suffered the loss because he had his own interest in being able to give the third party the benefit that the third party was intended to have. He could recover the cost of rectifying the defects because it represented what the developer would have to spend to give the third party that benefit, even though he had no legal liability to spend it. On the broader ground, the principle would not be confined to cases where the loss related to transferred property.

Darlington v Wiltshier

In Darlington Borough Council v Wiltshier Northern Ltd. [1994] EWCA Civ 6 a local authority had entered into an agreement with a finance company under which the finance company was to have a building constructed on a site owned by the local authority. Pursuant to the agreement the finance company engaged a contractor to construct the building. The contractor was aware that, although its contract to build the building was with the finance company, the building was actually being constructed for the local authority. The building was defective. The finance company assigned to the local authority all rights and causes of action which the finance company had against the contractor. The Court of Appeal found that the local authority was able, as assignee, to recover substantial damages from the contractor under the Albazero principle, notwithstanding that the property had not been “transferred from one owner to another after the contract has been entered into and before the breach which causes loss or damage.

The Harmon case

Harmon CFEM Facades (UK) Ltd v The Corporate Officer of the House of Commons [1999] EWHC Technology 199 is a first instance decision which provides a useful illustration of a common transferred loss-type problem. The case concerns the construction of Portcullis House, a government office building which, at the time was one of the most expensive buildings ever to be built in London. The new building was to have a bombproof façade, (according to the judgment) meant that it would be “the most expensive fenestration system ever built.” A picture of portcullis house, showing its distinctive windows, is below:

The corporate officer of the House of Common (“H of C”) awarded the fenestration contract for Portcullis House to a company called Seele Alvis Fenestration Ltd. A company called Harmon CFEM Facades (UK) Ltd. (“Harmon”) had tendered for the same contract and complained that H of C was not entitled to award the contract to Seele Alvis, but should instead have awarded the contract to Harmon, under the law relating to public procurement contracts.

Harmon succeeded in this argument, and so the question arose as to what damages Harmon should be awarded. If Harmon had been awarded the contract, it would have subcontracted much of the work to other companies within the same company group. Much of the profit from the contract would have been earned by those other group companies, not by Harmon. It is not really clear from the judgment, but such arrangements often reflect some kind of transfer pricing - where profits are pushed into those group companies in which the profits will attract the least tax liability.

Could Harmon claim for a loss of profit which had been suffered not by Harmon but by its associate companies? HHJ Lloyd referred to St. Martins and Darlington v Wiltshier and held that Harmon could recover for this “intra group margin.” Despite it being only a first instance decision, the case is a useful one, and is frequently cited in arbitrations as an authority in support of claims to recover such intra group profits.

The Panatown case

Unex Corporation Limited (“Unex”) owned three subsidiaries: Unex Investment Properties Limited (“UIPL”), Unex Construction Limited (“UCL”) and Panatown Limited (“Panatown”). In 1985 UIPL acquired a site in Cambridge with a view to building a new office building and car park.

Historically, the UK had applied a zero rate of VAT to the construction of such buildings. In 1988, however, the European Court of Justice held this was in breach of the UK’s obligations with respect to the harmonisation of such taxes (Commission of the EC v UK Case 416/85 [1988] ECR 3127). As a result the UK enacted legislation which meant that, from 1 April 1989, the zero rating was only to apply to the construction of dwellings. The effect would be to increase very considerably the cost of contracts for other construction work which were entered into after that date.

UIPL was not going to be able to appoint a contractor before the 1 April 1989 deadline. HMRC agreed, however, that any payment which Unex made to a company outside the Unex VAT Group in connection with the construction project before the 1 April 1989 deadline would be zero rated.

Panatown was outside the Unex VAT group. So Unex borrowed £7.5 million from Barclays Bank, with the stated purpose of the loan being to assist with prepayment of a building contract, and paid the money over to Panatown before the 1 April 1989 deadline. At the time the relevant VAT rate was 17.5%, so this move presumably will have allowed Unex to avoid £1,312,500 of VAT.

Dealings within the Unex Group were rather informal, and so it was far from clear quite what obligations Panatown had undertaken in return for the receipt of this money. It would later be determined that Panatown’s obligation was only to procure construction of the development - i.e. an obligation just sufficient to pass the threshold required to secure the VAT saving (that the payment be for the purpose of the construction project). Panatown did not owe the other Unex group companies any detailed obligations, though, as to (say) the form which the development was to take or the time for completion.

In November 1989 Panatown retained Alfred McAlpine Construction Limited (“McAlpine”) to build the offices, for a contract price of just under £10.5 million with a Completion Date of 24 July 1991.

At the same time, McAlpine executed a “duty of care deed” (“DCD”) in favour of UIPL, which was to own the building. The DCD was a short document, in which McAlpine warranted that it had and would continue to exercise reasonable skill and care, and acknowledged that it owed UIPL a duty of care. The DCD was thus markedly different from the building contract, which imposed much stricter and more detailed obligations on McAlpine.

The construction work overran. Over a year after the contractual completion date had passed, on 4 September 1992, Panatown purported to terminate the construction contract and took possession of the site. Panatown claimed that such work as McAlpine had done were so defective that they largely needed to be demolished and rebuilt. The cost of repair was initially estimated at £7 million. But, by the time that the case reached the House of Lords, Panatown was estimating the total cost of rebuilding plus losses due to the consequential delay at £40 million. Below is a picture of (we believe) the office building which was eventually constructed on the site:

On 8 July 1992 Panatown began an arbitration claim. McAlpine argued that Panatown’s claims were doomed to fail because Panatown had suffered no loss. Panatown did not own the property which was said to be defective, and McAlpine’s breaches had not placed Panatown in breach of any obligations it owed the other Unex group companies.

The question of whether Panatown’s claims failed because Panatown was not the owner of the property was heard as a preliminary issue. The arbitrator determined that issue in Panatown’s favour. The arbitration agreement allowed appeals on the merits, though, and so in 2000, eight years after the arbitration began, the case worked its way through the appellate courts and eventually came before the House of Lords, where their Lordships found in favour of McAlpine by a majority.

The Albazero exception was based upon an assumed intention that the contracting party was to be treated in law as having contracted for the benefit of the third party. In Panatown, no such intention could be inferred because in their contractual scheme the parties had instead provided for the third party (UIPL) to have rights directly against McAlpine under the duty of care deed. Lord Griffiths’ ‘broader ground’ did not apply for the same reason. Panatown could not be said to have suffered anything more than nominal damages.

There was majority support (Lords Goff, Millett and Browne-Wilkinson) for the view that Lord Griffiths’ wider principle is correct.

Note, incidentally, the following passage from the judgment of Lord Clyde (in the majority) which seems to support the use of the transferred loss exceptions in cases like Harmon:

The problem which has arisen in the present case is one which is most likely to arise in the context of … the commercial affairs of a group of companies. How the members of such a group choose to arrange their own affairs among themselves should not be a matter of necessary concern to a third party who has undertaken to one of their number to perform services in which they all have some interest. It should not be a ground of escaping liability that the party who instructed the work should not be the one who sustained the loss or all of the loss which in whole or part has fallen on another member or members of the group. But the resolution of the problem in any particular case has to be reached in light of its own circumstances. In the present case the decision that Panatown should be the employer under the building contract although another company in the group owned the land was made in order to minimise charges of VAT. No doubt thought was given as to the mechanics to be adopted for the building project in order to achieve the course most advantageous to the group. Where for its own purposes a group of companies decides which of its members is to be the contracting party in a project which is of concern and interest to the whole group I should be reluctant to refuse an entitlement to sue on the contract on the ground simply that the member who entered the contract was not the party who suffered the loss on a breach of the contract. But whether such an entitlement is to be admitted must depend upon the arrangements which the group and its members have decided to make both among themselves and with the other party to the contract. In the present case there was a plain and deliberate course adopted whereby the company with the potential risk of loss was given a distinct entitlement directly to sue the contractor and the professional advisers. In the light of such a clear and deliberate course I do not consider that an exception can be admitted to the general rule that substantial damages can only be claimed by a party who has suffered substantial loss.

A post-mortem of Panatown

A post mortem of the Panatown case written 14 years ago (McKendrick The Common Law At Work: The Saga of Alfred McAlpine Construction Limited v Panatown Ltd Oxford University Commonwealth Law Journal Winter 2003 145) concluded:

What conclusions can we draw from this survey of some of the issues raised by the litigation between Panatown and McAlpine? The first is that it is much simpler, if not so intellectually stimulating, to pay your taxes as and when they fall due.

Mirant

Mirant Asia Pacific Construction (Hong Kong) Limited v Ove Arup and Partners International Limited [2007] EWHC 918 (TCC) concerned a complex set of contracts for the engineering and construction of a coal fired power station in the Philippines. During construction certain foundations failed and remedial works had to be carried out. The engineers who had designed the foundations were the subject of a claim. The court held that Arup had breached a duty owed to a party called CEPAS which had employed Arup, but owed no duty to CEPAS’s sister company SCC. The question then arose as to whether CEPAS could recover in respect of losses which had been suffered by SCC. Applying Lord Griffiths’ “wider principle” the court held (paragraph 628):

CEPAS may in principle recover damages in respect of losses caused to SCC as a consequence of the breach of contract by Arup because it did not receive from the defendants the performance of the bargain which it contracted for, namely that Arup failed to provide adequate designs for use by SCC on site and failed to verify the design assumptions.

The case is an example of Lord Griffiths’ wider principle being applied, in a case where the third party’s loss was not said to have resulted from a transfer of property.

Saga Cruises

In Saga Cruises BDF Limited and Others v Fincantieri SpA [2016] EWHC 1875 (Comm) shipowners contracted with a yard for repair and refurbishment of a cruise ship called the “Saga Sapphire”.

The owners chartered the ship to a related company called Acromas. The ship’s first voyage post-refurbishment had to be abandoned because of a defect in the ship’s engines, which it was alleged would have been detected and remedied if the work had been done to the required contractual standard.

The resulting loss was suffered not by the owners but by Acromas. Could the owners recover for Acromas’s loss?

In the event the court held that, even if the work had been done to the required standard, the relevant defect would not have been detected and so the claim failed. The judgment does, however, contain an obiter passage about the transferred loss issue (paragraphs 221 to 222, 225 and 226).

Chitty (paragraph 18-058) concludes that the effect of Darlington is to extend Linden Gardens so that at least in the context of defective performance of building contracts a transfer of the property affected by the breach to the third party is no longer required.

Acromas say that Darlington is analogous to the present case and rely on the evidence of Mr Rizzo that the Yard was aware that the purpose of the Works was for the Vessel to be used in Saga’ cruise business – in essence, by Acromas.

“… given the essential nature of this contract – construction/engineering - the use of the Albazero exception as extended into Darlington does not seem impermissible. Further the factual set up of this contract, as confirmed by the evidence of Mr Rizzo, is that the whole purpose of the Works was to equip the Vessel for cruise operations and the Yard would expect any losses suffered by the Owners to be felt by the Owners’ cruise operating arm, not the Owners themselves. This brings the scenario to a very close parallel with the Darlington case.

… it seems that with Acromas being the contemplated operator of the Vessel, the Contract was indeed essentially for Acromas’ benefit.

Therefore were the point to arise, I would find for the Owners.

Lowick Rose

In Lowick Rose a transferred loss problem again arose (at least in part) as a result of an attempt by a businessman called Michael Hunt to reduce the tax liabilities of a company which he owned.

Lord Sumption gave the first judgment in Lowick Rose. He began:

The distinct legal personality of companies has been a fundamental feature of English commercial law for a century and a half, but that has never stopped businessmen from treating their companies as indistinguishable from themselves. Mr Michael Hunt is not the first businessman to make that mistake, and doubtless he will not be the last.

We know from the outset, then, that this is not going to end happily for Mr Hunt.

Management buyout

The case concerns a management buyout of a US company called Medical Industries America Inc. trading as “Evo,” a manufacturer of aspirators, inhalers and similar medical equipment.

Evo’s management team wanted to buy out Evo’s owners but needed funding. They approached a wealthy investor called Michael Hunt. He decided that he wanted to finance the transaction through his wholly owned company “Swynson.”

The transaction worked as follows:

  • An English company was created called Evo Medical Solutions Limited (“EMSL”). EMSL’s shares were owned 71.4% by Evo’s management, 25% by Mr Hunt and 3.6% by an associate of Mr Hunt who joined its board.
  • Swynson borrowed £15 million from Credit Suisse, guaranteed by Mr Hunt and secured on his assets.
  • Swynson loaned £15 million (the “2006 Loan”) to EMSL. This loan carried interest at 6% above base rate payable monthly and was repayable on 31 October 2007. EMSL was also required to pay a £750,000 “arrangement fee.” Swynson took charges over EMSL’s assets and personal guarantees from the management team.
  • EMSL acquired the entire share capital of Evo.

Before entering this transaction Swynson and EMSL jointly instructed a firm of accountants called Hurst, Morrison & Thompson (“HMT”) to carry out due diligence on Evo. HMT’s engagement letter limited its liability to £15 million. HMT subsequently changed its name to “Lowick Rose,” but it is always referred to as HMT in the judgments. HMT’s report was negligent in that it failed to draw attention to some problems with Evo’s finances. If HMT had carried out their task properly the transaction would not have gone ahead.

2007 Loan

In 2007 Evo began to suffer cash-flow problems and EMSL began to default on its interest payments due to Swynson on the 2006 loan.

On 13 August 2007 Mr Hunt caused Swynson to lend EMSL a further £1.75 million (the “2008 Loan”). Interest was set at 5.5% above base rate with a facility fee of £2,400 per month. The 2007 Loan was to be repaid, like the 2006 Loan, on 31 October 2007.

2008 Loan

EMSL failed to repay the 2006 and 2007 Loans on 31 October 2007 when they fell due. Interest and arrangement fees continued to accrue. Evo continued to make a loss.

On 4 June 2008 Mr Hunt caused Swynson to make a further loan of £3 million to EMSL (the “2008 Loan”). Interest was LIBOR +1.5% with an exit fee of 2% per annum from drawdown to repayment. The date for repayment was 31 May 2010. At the same time Mr Hunt’s interest in EMSL was increased from 25% to 85%.

Refinancing

Mr Hunt now owned Swynson and had a majority interest in EMSL. This created a problem, because it made Swynson and EMSL connected companies. This meant Swynson would have to pay tax as if it were receiving interest payments due from EMSL even though EMSL continued to default on these payments.

On 31 December 2008 Mr Hunt personally loaned £18.663 million to EMSL The loan was interest free, although there was a provision for default interest. It was a term of the loan agreement that EMSL would use this money to pay Swynson, paying off the 2006 and 2007 Loans in full but leaving the 2008 Loan of £3 million outstanding.

Evo’s business did not recover. Swynson and Mr Hunt brought a claim against HMT for damages of £16.157 million, being the principal amount of all the loans (£19.75 million) less £265,798 which had been recovered under the management’s personal guarantees and £1.355 million which had been recovered from cash and assets in the hands of Evo.

Trial

At trial HMT conceded that it had owed a duty of care to Swynson. HMT also conceded that its advice had been in breach of contract and negligent. The court found that only the 2006 loan had been made on the strength of HMT’s advice, but that losses arising from the 2007 and 2008 loans were in principle recoverable as the cost of reasonable steps taken in mitigation, subject to an overall cap of £15m agreed in the letter of engagement.

HMT denied, however, that it owed any duty of care to Mr Hunt. The court agreed.

HMT argued that Swynson had suffered no loss by reason of having made the 2006 and 2007 Loans, and could recover nothing in respect of those loans, because EMSL had repaid those in full.

In response, Swynson and Mr Hunt raised three arguments:

  • the December 2008 refinancing was res inter alios acta and did not affect the amount of Swynson’s recoverable loss;
  • Swynson was entitled to recover on the principle of transferred loss;
  • HMT having been unjustly enriched by Mr Hunt’s provision of funds to EMSL to repay Swynson, Mr Hunt was subrogated to Swynson’s claims against them.

At first instance, the judge accepted the first of these arguments. She held that the repayment was not something Swynson had done in the ordinary course of its business in order to mitigate the consequences of HMT’s negligence, applying Viscount Haldane’s test of mitigation from British Westinghouse Electric & Manufacturing Co Ltd v Underground Electric Railways Co of London Ltd [1912] AC 673 at 689.

Swynson was therefore awarded damages of £15 million.

Court of Appeal

The Court of Appeal held by a majority that the judge had been right and the refinancing was res inter alios acta. They dismissed the appeal on that basis.

Supreme Court

Their Lordships allowed the appeal. They held that the refinancing was not res inter alios acta, that Swynson was not entitled to recover under the principle of transferred loss and that HMT had not been unjustly enriched.

Lord Neuberger described the principle of transferred loss in these terms:

The principle of transferred loss arises where there is a contract between A and B relating to A’s property which is subsequently acquired by C, and the principle enables A to recover damages for B’s breach of contract which injures the property, even though the loss flowing from that injury is suffered by C and not by A. Self-evidently, it is an anomalous principle bearing in mind the well-established conventional rules relating to recovery of damages for breach of contract, namely that, subject to the terms of the contract, scope of duty, foreseeability and mitigation, A can only recover damages in respect of loss which A suffers as a result of B’s breach of contract. For that reason, the principle should only apply in defined and limited circumstances.

Lord Neuberger explained the narrower form of the principle as applying when:

(a) at the time of making the contract with A, B would reasonably have anticipated that A would transfer the property to a person such as C and that that person would suffer loss if B breached the contract, so that the contract can be seen as having been entered into by B partly for C’s benefit, and (b) there is nothing in the contract or the surrounding circumstances which negatives the conclusion that the principle should apply.”

Note that Lord Neuberger considers the narrower form is predicated upon an anticipated transfer of ownership - something which was not present in any of Darlington (where the finance company recovered for defective work to a property which was owned by the local authority throughout), Harmon (which does not concern defective property at all), Panatown (where, but for the DCD, it seems Panatown would probably have recovered for defective work to a property which was owned by UIPL throughout), Mirant (where the power station ever changed hands) and Saga (where the ship never changed hands).

With respect to the broader principle Lord Neuberger said:

… it is fair to say that the Panatown decision leaves a number of points open in this difficult area. One of those points is the correctness of another version of the principle, which was first articulated by Lord Griffiths in Lenesta Sludge, namely that B could be liable if A retains an interest in B performing his obligations, even though A has transferred away the property. However, it is unnecessary to address that point in this case, because it plainly could not apply in this appeal: following repayment of the original loan, Swynson cannot sensibly claim to have retained an interest in the performance of HMT’s duties.

Lord Sumption said of the broader principle:

Like others before me, I consider that there is much to be said for the broader principle. But it is not necessary to decide the point on this appeal because it is plain that the principle cannot apply in either form to the present facts …

Lord Mance showed less enthusiasm for the broader principle, saying:

Potential difficulties about the theory of performance interest are that it cannot prima facie embrace consequential losses suffered by the company actually (as opposed to contractually) interested in the quality of the property or services and that it is not clear whether or on what basis the company contractually entitled may be liable to account to the company actually interested …

Lord Sumption stressed the qualification to the principle of transferred loss which is to be derived from Panatown:

It is, however, important to remember that the principle of transferred loss, whether in its broader or narrower form, is an exception to a fundamental principle of the law of obligations and not an alternative to that principle. All of the modern case law on the subject emphasises that it is driven by legal necessity. It is therefore an essential feature of the principle that the recognition of a right in the contracting party to recover the third party’s loss should be necessary to give effect to the object of the transaction and to avoid a “legal black hole”, in which in the anticipated course of events the only party entitled to recover would be different from the only party which could be treated as suffering loss. … it is not available if the third party has a direct right of action for the same loss, on whatever basis.

All their Lordships agreed that neither the narrower nor the broader principle allowed Swynson to recover for Mr Hunt’s loss.

Per Lord Mance:

Neither the narrow or the broad version of the transferred loss principle is in my view of assistance to Swynson. As to the narrow principle, it is clear that Swynson did not contract with HMT on behalf of or for the benefit of Mr Hunt. As to the broad principle, even if accepted, I do not see how it can apply in circumstances where Swynson itself suffered loss through being induced to support the management buyout by lending to EMSL, but the loan was ultimately repaid by EMSL. This is not a case where Swynson had any performance interest other than being indemnified in respect of the loss which it incurred in lending moneys to support the management buyout. That performance interest has been satisfied. The fact that it was satisfied by Mr Hunt making moneys available to EMSL to repay Swynson does not bear on or expand Swynson’s performance interest.

Per Lord Sumption:

… the relevant duty was owed to Swynson but the loss has in the event been suffered by Mr Hunt. Since Mr Hunt did not suffer his loss in his capacity as the owner of property, only the broader principle of transferred loss could be relevant to his case. … it is plain that the principle cannot apply in either form to the present facts. The reason is that it was no part of the object of the engagement of HMT or indeed of any other aspect of the 2006 transaction to benefit Mr Hunt. That is the main reason why no duty of care was owed to him. … Mr Hunt’s loss arises out of the refinancing of December 2008, which had nothing to do with HMT and did not arise out of their breach of duty.

Per Lord Neuberger:

… following repayment of the original loan, Swynson cannot sensibly claim to have retained an interest in the performance of HMT’s duties.

I consider that the transferred loss argument on this appeal suffers from two defects. First, this cannot be said to be a case of injury to an asset or property which came into the hands of Mr Hunt, because the loss suffered by Mr Hunt is not the same as the loss which would have been suffered by Swynson if the new loan had not led to the original loan being redeemed. The losses may be very similar in nature (non-repayment of a loan made to EMSL), in cause (EMSL’s financial problems), and in quantum (as the new loan was very similar in amount to the original loan and identical to the extent that it was used to pay off the original loan). However, Mr Hunt has suffered loss in relation to the new loan whereas Swynson would have suffered a loss in relation to the original loan.

Secondly, the principle cannot apply because, at the time HMT were advising Swynson, it was not reasonably foreseeable that Swynson would have the original loan repaid through the medium of a fresh loan made to EMSL by a third party. Of course, as with most financing arrangements, it was reasonably foreseeable that some sort of subsequent re-financing of EMSL might happen one day, but that is not enough in order for the principle to apply. If it is to apply, Swynson would have to go further and demonstrate that it was anticipated that some such refinancing would occur, so that a person such as Mr Hunt, the new lender, can fairly be said to have been an intended beneficiary of Swynson’s contractual rights against HMT. That seems to me to be an untenable proposition in this case.

Conclusions

From Lowick Rose it can be seen that the “narrow ground” undoubtedly exists but may be confined to cases where there is a pre-contract anticipation of transfer of ownership. Whether the “broad ground” exists remains something of a mystery, but Lord Sumption at least seems to think it has merit.

When drafting contracts and structuring deals we must always ask: “if the other side does not perform, who suffers?” If the answer is that it will be someone other than the contracting party then there are (at least) three possibilities:

  • Expressly provide in the contract that it is entered for the benefit of the third party, and that the third party will be entitled to enforce it against the contractor under the Contracts (Rights of Third Parties) Act 1999. I have yet to see any contract where this has been done. Every contract seems to exclude the C(RTP)A 1999.
  • Have the contractor provide a collateral warranty to the third party, warranting that the contract has been performed. If the identity of the third party is not yet known, include in the contract a power to require that the contractor provide such a warranty. Ensure the warranty is back-to-back with the contract (i.e. is in the same terms, rather than imposing a weaker obligation like the DCD in Panatown).
  • Make clear to the other party (e.g. in the recitals to the contract) that the property which the contract concerns is anticipated to be transferred to someone such as the third party, so as to bring the case within the narrow version of the transferred loss principle.
  • Expressly provide in the contract that the contracting party will be entitled to recover the relevant losses on behalf of the third party.

It is worth bearing in mind that these no-loss problems tend to arise when deals are structured with an eye to minimising tax liabilities, so that the anticipated profit from a transaction will be enjoyed by someone other than the contracting party. Company A contracts to supply Company B with (say) a piece of mining machinery. Unbeknownst to Company A, Company B has structured its affairs such that it will inevitably make almost no profit from the sale of the minerals extracted by the machine. Rather, it has contracted to sell them for very little profit to a related company in a low tax jurisdiction and it is that company which stands to enjoy any profit. This all seems like a good idea at the time, but when the machine doesn’t work, Company B may have a hard time proving and recovering its loss.

Lowick Rose illustrates a further issue to be alert to when restructuring obligations. Namely that, if the original structure / transaction was entered into in reliance on negligent professional advice one should try to ensure that the resulting loss is retained by the party which has a contractual nexus with the professional, and not transferred into some third party.

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