Negligent Advise: What about Market Loss?

We work with the best barristers in the Law Library, and occasionally they share their knowledge with us by way of academic publication, herewith a recent article by Jack Tchrakian BL on Market Loss.

Negligent Advise: What about Market Loss?

One question which has come before the Courts since the crash of the Irish property market has been that of what precisely a successful plaintiff can claim when he has established liability for negligent advice? This might seem like a simple question in theory but it can get extremely complicated in practice. What happens when you’ve entered into a transaction which you wouldn’t have entered into without the negligent advice being given and you have suffered losses which you would have suffered even if the advice had been correct?

It’s what they call trite law that the remoteness test for damages in a tort case is reasonable foreseeability, as set out in Overseas Tankship (UK) Ltd v Morts Dock and Engineering Co Ltd (the Wagon Mound (No. 1) [1961] A.C. 388 and that the relevant test in contract is the very similar reasonable contemplation test derived from Hadley v. Baxendale (1854) 9 Exch 341. In most cases, the test is fairly straightforward. However, when a loss is amplified by market events, clarity flies out the window.

Consider the following:

• An investor buys a building in 2006 for €2 million. Unbeknownst to him, the solicitor didn’t check the planning designation properly and the building was zoned residential instead of commercial. The true value of the building thus falls to €1.5 million.

• Had the investor discovered this defect the day after the transaction, his loss would have been roughly €500,000. However, he didn’t discover the defect until he was forced to sell in 2011, by which stage the building had lost half of its value.

• The investor is forced to sell the property for circa €750,000, crystallising a loss of €1.25 million.

• So for how much is the solicitor on the hook? €500,000 or €1.25 million?

In this case, neither Wagon Mound nor Hadley is terribly helpful, because both sides have good arguments. On the one hand, the investor will argue that the price of property goes up and down and that even if the precise quantum of the loss is not foreseeable, the fact of the loss is. In a principle somewhat analogous to the Eggshell Skull principle, the investor will insist that the solicitor must take the asset market as he finds it.

By contrast, the solicitor will argue that he bears no responsibility for the loss of value of the property. Yes, the investor would not have entered into the transaction without the mistake having been made but even if the advice he’s given had been correct, the losses attributable to the collapse in the property market would have happened anyway.

In England in the early 1990s, a property bust led to precisely this scenario being debated before the Court of Appeal in Banque Bruxelles Lambert SA v Eagle Star Insurance Co. Ltd and South Australia Asset Management Corp v York Montague Ltd (generally known as the “SAAMCo” cases) [1995] Q.B. 375. Sir Thomas Bingham MR came down on the side of our hypothetical investor. Property values, he said, were known not to be static and if a negligent adviser (in this case, a surveyor) gave negligent advice into a soft property market, that was his problem, not the client’s.

However, this wasn’t the last word on the matter. SAAMCo came before Lord Hoffman on appeal ([1997] 1 A.C. 191) and he took a different view. In his speech, he asked the court to imagine a mountain climber with a leg problem, whose doctor incorrectly advises him that his leg is sufficiently strong to allow him to undertake an expedition. Having been so advised, the climber then suffers an injury which had nothing to do with the leg. The doctor, said Lord Hoffman, could not be liable because even if his advice had been correct, the injury would have been suffered anyway. Hence, in our hypothetical example, the solicitor wins.

The same question came before Mr. Justice Clarke in Ireland in the marathon solicitors’ negligence case of ACC v. Johnston [2010] IEHC 236. In that case, a bank had lent money on foot of negligent advice and was not secured against the land that was to be purchased with the loan. The solicitor sought to argue that if the negligence had not happened, the loan would probably have defaulted and the value of the collateral would have been massively impaired. The bank sought to argue for the original SAAMCo decision of the Master of the Rolls, namely that the solicitor was on the hook for the whole loss.

Mr. Justice Clarke came down on Lord Hoffman’s side, quoting his “mountaineer” hypothesis favourably. However, he added a nuance. He preferred to state that it was probable that the bank would otherwise have lent the money to another borrower and that the loan would probably have gone into default just as this one had. He went on to say that there was nothing terribly unusual about the transaction in question and that constructing an alternative “surrogate” transaction based upon a hypothetical “fixed” version of the loan the bank actually made would lead to the banking making a smaller loss than it actually did make, but still a loss nonetheless.

As such, he held, the solicitor could only be held liable for the loss that would have occurred anyway if the transaction hadn’t been defective. So, does this put the issue to bed entirely? I think not. Mr. Justice Clarke qualified his statement by saying that if there was something unusual about the transaction, then the surrogate approach might not work. Ultimately, he said, it comes down to what the negligent adviser can foreseeably contemplate.

So, in a 360 degree journey, we seem to be back to where we started. Market loss is not foreseeable… except when it is. Ultimately, going back to our property investor, I submit that the real questions are as follows:

1. If he hadn’t bought the building, what would he have done? Would he have done nothing at all or would he have invested in another similar deal?

2. Whatever the answer to question 1 is, would the solicitor have realistically been able to foresee this alternative use?

So ultimately, the negligent adviser may well be held liable for the full loss – if he knew or believed that the investor would have entered into a completely different transaction with much lower risk, such as just putting his money on deposit. However, we need the right case to establish the answer to that.