Tax Advisers' Negligence

Tax Advisers' Negligence — I

The tricky subject of negligent tax advice is considered by KEITH GORDON MA, ACA, CTA, barrister in this first of a series of articles on the subject.

FEW READERS OF this magazine could honestly say that they have never made a mistake in their professional lives. But not every mistake gives rise to a claim against the perpetrator. This series of articles sets out some of the issues that need to be considered when a claim is made against a tax adviser for negligent advice.

In many cases, a claim in respect of negligent tax advice can be made under the law of contract. Furthermore, with the extension of contractual rights to third parties (under the Contracts (Rights of Third Parties) Act 1999), it will now be easier for some taxpayers to commence a contractual claim than was previously the case. However, as the House of Lords confirmed in Henderson v Merrett Syndicates Limited [1995] AC 691, there is, under common law, a concurrent right to claim in tort as well as in contract. Where a contractual claim is time-barred under the Limitations Act 1980, the ability to make a later claim in tort can therefore be a valuable right.

In order to establish a successful negligence claim in tort, it is necessary for a claimant to satisfy a number of tests. These are that:

• the alleged tortfeasor (the person who has allegedly been negligent) must owe the potential claimant a duty of care;

• the alleged tortfeasor must have breached that duty;

• the potential claimant must have suffered some injury or pecuniary loss;

• the injury or loss must have been caused by the tortfeasor's breach of the duty of care;

• the loss or injury must not be too remote.

These tests, as they relate to tax advisers, are now considered in turn. This week's article considers the duty of care.

To whom is the duty owed?

The modern era of the law of negligence is generally acknowledged to have begun with the Scottish case of Donoghue v Stephenson [1932] AC 562, which was the ginger beer and decomposed snail case. That set out what has become known as the 'neighbourhood principle':

'The [biblical] rule that you are to love your neighbour becomes in law, you must not injure your neighbour … Who, then is my neighbour? The answer seems to be — persons who are so closely and directly affected by my act that I ought reasonably to have them in contemplation as being so affected when I am directing my mind to the acts or omissions which are called in question.'

This neighbourhood principle has evolved over the past 70 years as new situations have been considered by the courts with judges trying to strike the correct balance between claimants and defendants in determining whether or not a duty of care exists in a particular situation.

Negligent mis-statements

In the context of claims against tax advisers, the next milestone case is that of Hedley Byrne & Co Limited v Heller & Partners [1964] AC 465. Although the defendants in that particular case were protected by a disclaimer, the case established the principle that a person could owe a duty of care if:

• that person makes a negligent mis-statement to another person and

• the second person suffers an economic loss as a result of relying upon the statement made.

Hedley Byrne has ensured that the law of negligence covers pure financial loss as well as financial loss arising as a result of physical injury. Hedley Byrne principles were explicitly extended to the provision of services by the House of Lords in Henderson v Merrett Syndicates Limited [1995] 2 AC 145. See the Example.

Special relationship

Not every situation where there is a negligent mis-statement will give rise to a potential claim. In its attempts to curb such claims, the House of Lords in Hedley Byrne emphasised the need for a 'special relationship' between the person making the mis-statement and the person acting on it. In the words of Lord Devlin:

'the categories of special relationship … are not limited to contractual relationships or relationships of a fiduciary duty, but include also relationships which … are "equivalent to contract", that is where there is an assumption of responsibility in circumstances in which, but for the absence of consideration, there would be a contract.'

However, Lord Reid made it clear that a statement made between friends will not usually give rise to a duty of care, saying that for example:

'Quite careful people often express definite opinions on social or informal occasions even when they see that others are likely to be influenced by them; and they often do that without taking that care which they would take if asked for their opinion professionally or in a business connection.'

From this, one would assume that a tax adviser who gives informal advice at a party, would not be at risk of a negligence action if the advice turns out to be negligent. However, one should also be wary of the Court of Appeal decision in Chaudhry v Prabhakar [1989] 1 WLR 29. That case concerned advice, in respect of the purchase of a car, given to the plaintiff by a (then) close friend which turned out to be negligently given. On the basis of the facts of the case, the friend, although acting gratuitously, had assumed the role of agent which gave rise to the special relationship required under Hedley Byrne.

A tax adviser is deemed to have a special relationship not only with his clients (or equivalents), but also with others who should be within his contemplation. This is illustrated in White v Jones [1995] 2 AC 207. There, a solicitor's client had previously excluded his daughters from his will. However, he was later reconciled with them and instructed his solicitor to draft a revised will (under which the daughters would benefit). However, the client died before the solicitor got around to carrying out the instruction. The daughters sued the solicitor, who was held to have been negligent. It would follow that the negligent execution of a tax mitigation scheme (or the negligent omission to carry out a certain task) could give rise to a potential claim, even where the consequential tax loss is suffered by a person other than the client.

Employees and directors

A high proportion of readers are likely to be employees, and thus comforted by the thought that, as far as negligence claims are concerned, the buck will usually stop somewhere else. This position can, in part, be supported by the decision in Williams v Natural Life Limited [1998] 1 WLR 830. In that case, the founding director and principal shareholder of a company which ran a health food shop was sued by a franchisee of the business for the negligent provision of financial projections about the business.

Although the claim failed, this was not simply on the basis that the director was protected by the fact that the employing company was a separate legal entity. Lord Steyn made it clear that the situation would have been no different if the employer had not been a company. What was important in the particular case was whether there had been a special relationship between the plaintiff and the tortfeasor. As his Lordship said:

'It is not sufficient that there should have been a special relationship with the principal [i.e. the company]. There must have been an assumption of responsibility such as to create a special relationship with the director or employee himself.'

On the basis of the facts as found, the director was held not to have assumed any personal responsibility and, therefore, the claim was lacking the necessary special relationship.

However, it is a fact that many employed tax advisers might owe a duty of care to their employer's clients. Indeed, in order for there to be a valid claim against the employer for vicarious liability, the right to make a claim against the employee must be first established. While the existence of an insured employer will usually mean that the cost of legal action will be borne by the employer (or the employer's insurers), employees can sometimes find themselves exposed. This was the situation in Merrett v Babb [2001] 3 WLR 1. Mr Babb was an employed valuer at a firm of surveyors. Mr Babb prepared a valuation report in 1992 for a building society which was considering making a loan to the claimant and her mother secured on the property. This report was later found (and held by the county court) to have been negligently made.

Unfortunately for Mr Babb, his employer had since been declared bankrupt. Apparently contrary to the rules of the Royal Institution of Chartered Surveyors, the employer's trustee in bankruptcy cancelled the firm's professional indemnity insurance without run-off cover. Mr Babb was not insured.

Following previous authority, the Court of Appeal held that Mr Babb owed a duty of care to the purchaser. It did not matter that Mr Babb had not met the purchaser or that the purchaser was not aware of his existence (or role in the valuation process). In the words of Lord Justice May:

'Since he knew that his report would be relied on by Miss Merrett and her mother, the responsibility which he assumed included a responsibility to them … The law recognises that there is a duty of care without the need to find any direct overt dealings between the valuer and the purchaser.'

On the other hand, it is certainly arguable that Mr Babb assumed personal responsibility because he signed a valuation report in accordance with section 13, Building Societies Act 1986. That section requires, inter alia, a valuation to be 'made by a person who is competent to value, and is not disqualified under [the] section from making a report on, the land in question'. Such a heavy burden does not usually lie on tax advisers, many of whom need no professional qualifications to carry out their work.

Late in 2002, the House of Lords had the opportunity to clarify the position with respect to negligence by employees. In Standard Chartered Bank v Pakistan Shipping Corporation (Nos 2 and 4) [2003] 1 AC 959, the House of Lords held that a director was held to be liable for losses following a mis-statement. However, Lord Hoffmann, with whom the other judges agreed, emphasised that this was a case of a fraudulent mis-statement, and therefore the director had forgone any protection afforded to him. The inference that can be drawn from this judgment is that employees who make negligent mis-statements will usually be protected.

Further, as the authors of Jackson and Powell on Professional Negligence (fifth edition) suggest at paragraph 2-091:

'it could be said that a client who contracts with a firm or principal is generally to be taken to be relying on that firm or principal, rather than on its employees.'

The consequence of the courts taking this approach would be that the employee/director will not have the necessary special relationship for a claim to be made against him.

Such academic debate will, however, provide no valid defence should an employee find himself the sole defendant in a negligence case as did Mr Babb. While the current authorities suggest that Merrett v Babb was decided on its facts (in particular the qualification requirement under the Building Societies Act 1986), there is no guarantee that the boundary will not shift further.

For example, suppose an individual has been regularly providing tax advice to a client for a number of years. Suppose that the individual becomes employed by a limited company which offers taxation advice and that his client follows him. The client will be aware that the move has taken place (and that fees should now be paid to the company). However, in the mind of most clients, their accountant is the individual, not the company which happens to employ him. If things go wrong, it is likely that many clients will initially think of turning to the individual for redress. The courts may well hold that a special relationship exists in such circumstances. While this can initially be justified on the basis of the special facts of any particular case, it will only add to the current confusion.

So, what should employees do in this situation? In Merrett, Lord Justice May warns:

'Prudent professional employees will obviously want to ensure that they are covered personally by their employers' insurance and may need to take steps to obtain personal insurance if that cover does not continue after their employment ends.'

In cases where there is no special relationship, such advice is probably unnecessary. But it may be better to play it safe.

Issue: 3965 / Categories: Comment & Analysis