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Duty of care to third parties, how far does it go?

 A recent case has confirmed the boundaries of the duty ofcare owed by professionals to third parties. An investor in Dragon Futures, acompany that traded in mobile telephones, argued that accountants retained toadvise Dragon owed investors in the company a duty of care. This arose, theinvestor said, because the accountants knew that Dragon would relay advicegiven by the accountants to potential investors in the company.

On an application for summary judgment, the court found:

•It would be inconceivable that any reasonable businessmanwould consider that the accountants had voluntarily assumed an unlimitedresponsibility; and

•It would not be fair, just and reasonable to impose a dutyof care exposing the accountants to an unlimited liability.

Background

Dragon traded in branded mobiles through distributionchannels not authorised by brand owners. It was critical to its business thatit could reclaim VAT paid on purchases. However, this market was subject to acrack down on VAT fraud by HM Customs & Excise. Dragon therefore employedaccountants to implement a due diligence strategy addressing HMCE’s approach toVAT recoveries. Dragon, with the accountants’ knowledge, told investors aboutthe accountants’ involvement. In January 2004 the claimant invested in Dragonvia loans to a chain of subsidiaries. By November 2004 HMCE had rejected all ofDragon’s VAT claims and the company was eventually wound up with nodistributions to creditors.

Decision

Duty of care

In considering whether a duty of care may be owed by aprofessional person to a third party with whom he is not in a contractualrelationship, the courts have formulated a number of different principles. Thelaw in this area is still developing but, broadly, the approaches adopted bythe courts are:

1.Whether there has been an assumption of liability

2.Whether a threefold test of foreseeability, proximity and'fairness, justice and reasonableness' has been satisfied, and

3.Whether the alleged duty would be 'incremental' toprevious cases.

In the present case the investor argued that a duty of careshould be imposed on the basis of both an assumption of responsibility and thethreefold test.

In ruling that the accountants had not assumedresponsibility towards the investor, the court highlighted:

1.There was no direct contact with the accountants untilafter the investor had decided to make the loans

2.Any assumption would have involved the accountantsaccepting unlimited liability for a whole string of investors given the loanstructure

3.There was no engagement letter defining any liability, and

4.The accountants would not have accepted unlimitedliability if asked.

For similar reasons, it would not be fair just andreasonable to impose a duty of care. It would be obvious, in the court’sopinion, that the accountants’ relationship with Dragon would containlimitations, including an exclusion of liability to third parties. Therefore itcould not be fair, just and reasonable to impose unlimited liability to anindirect investor.

The court found that as no duty of care could beestablished, the claimant’s case had no reasonable prospects of success. Theaccountants were granted summary judgment, and the court was not required todecide whether the services had been performed negligently.

Limitation

The court also found that the claimant’s action was timebarred, because it failed to issue proceedings within six years of sustainingdamage. The claimant argued they did not sustain damage until 2006 when itdecided to write down the loan values. The accountants argued the damage wassustained as early as the date of the loans. The court found that whether themaking of a loan (upon which the borrower later defaults) itself constitutessustaining damage will depend on a comparison between the amount of the loanand the value of the rights the lender acquires. In this case, the rightsacquired were the subsidiary’s covenant to repay and the value of the VATclaims. The subsidiary’s ability to repay was entirely based upon the VATclaims. Viewed objectively these claims were always going to fail and were allrejected by November 2004. Therefore, if the claimant did not sustain damage atthe date of the loan (a point the court did not decide upon) then it haddefinitely done so by November 2004. Therefore the proceedings, issued on 30August 2011, were also time barred.

Comment

The law recognises that professionals, includingaccountants, may, in certain circumstances, owe a duty of care to thirdparties. In general terms, however, the English courts have adopted areasonably restrictive approach and have been reluctant to find a duty of carein circumstances where there has been no clear assumption of duty. The decisionin the present case reflects the general approach taken by the courts and willbe welcomed by professionals and their insurers.

This article first appeared in Law-Now, CMS Cameron McKenna'sfree online information service, and has been reproduced with their permission.For more information about Law-Now, click here

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