Court of Appeal dismisses law firm professional negligence case: Afan Valley Limited (in Administration) and others v Lupton Fawcett LLP

The claimants were special purpose vehicle companies ("SPVs") set up as part of the MBi Group and/or the Northern Powerhouse Development Group ("NPD"), which were founded by Gavin Woodhouse in 2012 and 2016 respectively.  Between 2014 and 2019, these groups promoted investment schemes involving the sale of individual units within hotels and care homes to retail investors. Under this model, new SPVs were incorporated to receive the funding for, and to operate, each relevant scheme. Investors were promised very high returns and the right to sell the investment back to the SPV. Ultimately, the schemes all failed, and in 2019 the SPVs entered administration, and subsequently liquidation, with a net deficiency to investors and other creditors of more than £68 million. 

Between 2014 and 2018, LF had been instructed on a continuing basis by the MBi Group and latterly the NPD Group to provide advice on whether the investment schemes amounted to CIS for the purposes of the Financial Services and Markets Act 2000 ("FSMA"). Under Section 19 FSMA, carrying out a CIS is a "regulated activity" which can only be lawfully promoted and operated by businesses that have been authorised by the FCA for this purpose.³  Section 26 FSMA states that any agreement made by a business carrying on a regulated activity in breach of this requirement is unenforceable against the other party, who is entitled to repayment of any money or other property transferred by it under the agreement.⁴  As none of the companies in the MBi Group or the NPD Group were FCA-authorised (including the claimant SPVs), it was therefore vital to both groups that the schemes fell outside the definition of a CIS – had they been caught by the FSMA regime then section 26 FSMA would 'bite', such that each SPV would become liable to return all the money received from investors and pay compensation to investors for loss suffered.   

The claimants issued the claim against LF in April 2022. Their central contention was that all the schemes were CIS, such that each scheme contravened FSMA with the effect that the claimant SPVs were obligated to reimburse the investors in full. The claimants alleged that LF had negligently, and in breach of an express retainer, failed to advise the claimants that the schemes were CIS or that there was a real risk of the same. The claimants contended that had they been properly advised as to the CIS status of the schemes, the SPVs would not have promoted the schemes. The SPVs would not, by extension, have accepted receipt of the investment monies or incurred a corresponding liability under section 26 FSMA to return them. 

In response, LF brought an application for reverse summary judgment and/or strike out of the claim. This was on the grounds that the claimants had not sustained any loss as a result of the allegedly negligent advice by LF on CIS and FSMA issues. If each SPV had incurred a repayment obligation on receipt of the investment monies, then each SPV had also obtained an asset of equal value to the liability it had incurred (namely the monies themselves!). Receiving the investment monies was therefore a "balance sheet neutral" transaction that had not caused the claimants any damage – the money they owed to the investors was equal to and offset by the money they had received. The real cause of the claimants' losses was the expenditure of this money in fraudulent ponzi schemes. In circumstances in which the firm was instructed to advise on whether the schemes were FSMA-compliant – this duty did not extend to advising on how the investment should be used or to "underwriting the success of the business proposition as a whole".⁵  Accordingly, these losses fell outside the firm's duty of care.

The High Court accepted the "no loss" arguments made by LF in finding that the claim should be struck out and/or dismissed on summary judgment, applying the Supreme Court's decision in Stanford International Bank Ltd (in liquidation) v HSBC.  On this basis, the High Court held that the receipt of the money had in fact had "zero effect: penny in, penny out" and that the allegedly negligent advice gave, at the most, "the opportunity for that loss to occur."

In May 2024, the claimants applied for permission to appeal the decision of the High Court. The claimants said that the judge was wrong to find that the claimants had not sustained any loss from issues that fell within the scope of LF's duty of care. 

In his judgment, Dingemans J found that the claim had a sufficiently arguable prospect of success to warrant a merits consideration by the Court of Appeal on the following grounds⁶: 

1. Whether the commission payments made to sales agents in respect of investments in the schemes meant that the transactions between the SPVs and the investors were not "balance sheet neutral" within the meaning of Stanford International ("Ground 1").
2. Whether any such loss was within the scope of LF's duty of care because it was part of the schemes on which they were advising ("Ground 2"). 
3. Whether the potential liability to pay compensation to investors under section 26 FSMA, on top of repayment of the monies received, is a loss which can be reclaimed from LF which defies a neutral balance sheet analysis ("Ground 3").

Dismissing the Appeal, Lord Justice Nugee applied the test articulated by the Supreme Court in Manchester Building Society v Grant Thornton [2021] UKSC 20, to each Ground of Appeal in turn. Manchester builds on the principle established in South Australia Asset Management Corporation v York Montague Ltd [1997] AC 191, that a defendant found to be in breach of a duty of care is not liable for all the losses which the claimant has suffered as a result of acting on their advice, but only those within the scope of their duty. 

Ground 1 sought to challenge the High Court's conclusion that the transactions were "balance sheet neutral" such that the case was distinguishable from Stanford International and Saddington. For every £100,000 invested into the schemes, 12.5 per cent was immediately transferred to the sales agent as a commission payment – the SPV received the investment monies net of this sum and of other professional expenses (for example, solicitors' fees). The claimants argued that such payments ensured this was not a "penny in penny-out" scenario. The funds had not simply been used to discharge pre-existing liabilities, as had been the case in Stanford.  Accordingly, the claimants contended that the commission payments and professional fees should be recoverable from LF as consequential losses resulting from the decision to accept the investor money. 

However, Nugee LJ found that the duty of care which LF undertook was limited to the question it was asked to advise on, that is, whether the schemes were CISs (but not the wider commercial implications of pursuing them). Accordingly, he held that the losses flowing from the commission payments, and legal and professional fees, were not within the scope of LF's duties, as they were not consequences of advice about the CIS status of the schemes.

Similarly, in respect of the Claimants' argument under Ground 2 that the claimants had suffered loss because the schemes were intended to be profitable in the medium to long term, the Court of Appeal found that as well as being "flatly inconsistent" with the Claimants' Ponzi case, this Ground sought to lay at LF's door all the consequences of the ways the schemes were operated, which was not something for which LF had responsibility. Nugee LJ emphasised that these losses had nothing to do with whether the schemes were CISs or not, and were not within the risks of harm which LF's duty of care was intended to guard against. 

In contrast to Grounds 1 and 2, the Court of Appeal found that Ground 3, regarding the compensation payable under section 26(2)(b) FSMA, did in principle fall within the scope of LF's duty of care. However, Nugee LJ held that this argument had not been pleaded by the Claimants, and confirmed in any event that he did not consider that there would have been any merit in this point had it been fully pleaded. This was on the basis that in the counterfactual scenario, investors would have claims in contract or in the tort of deceit against the SPVs that would be at least as valuable as the s.26 FSMA compensation, and "it is only if their s.26 claims were greater than the tortious and contractual claims that they have anyway that Lupton Fawcett's (assumed) negligence in failing to advise that the Schemes were CISs would make any difference to the Claimants." Accordingly, the exposure to claims under section 26(2)(b) FSMA did not create any additional liability on the part of the SPVs.

The Court of Appeal decision provides a helpful illustration of the application of the scope of duty test, as clarified by the Supreme Court in Manchester. The judgment also underscores that in professional negligence claims, a claimant must establish a real, actionable loss that is not "balance sheet neutral". Crucially, the proximate cause of that loss must fall within the scope of the professional advisor's duty of care. Claimants must therefore carefully consider the cause of their loss, and whether that loss has arisen from risks the professional advisor was engaged to guard against, in order to plead their case effectively; only losses falling squarely within the advisor's scope of duty will be recoverable.