Legal Updates

Corporate update: Supreme Court clarifies law on collateral payments

Written by Henry Evans
12/05/2017

Legal and Commercial Background

A recent Supreme Court case, Lowick Rose v Swynson, has provided a useful reminder on the subject of collateral payments. The case highlights the problems that may result from structuring one’s affairs without proper care: a company lost the ability to recover millions of pounds from a negligent firm of accountants because of an avoidable misstep that the Court was not prepared to fix.

Where person A causes person B to suffer a loss, person B may be able to sue person A for damages. One cannot recover damages where a loss has been avoided (i.e. where there once was a loss but is no longer), so if person A caused person B a loss but person B managed to take steps to avoid suffering the loss, person B will not be able to recover the amount of the loss from person A (although they would be able to recover monies spent on mitigating the loss).

If, however, a loss is avoided as a result of a payment arising independently of the breach, the party that suffered the loss will not be prevented from recovering the loss as damages. For example, if a party which suffered the loss wins the lottery, this will not affect that party’s right to recover against the party which had caused them a loss, as the lottery payment arose independently of the breach.

Facts of the case

Swynson Limited (Swynson), a company owned by a wealthy individual, Michael Hunt, lent £15 million in 2006 to Evo Medical Solutions Ltd (Evo). Swynson instructed Lowick Rose, a firm of accountants, to conduct due diligence on Evo. Lowick Rose failed to draw Swynson’s attention to major issues with Evo’s finances. Evo failed to make repayments. In 2007 Swynson made further loans amounting to £4.75 million to Evo in a doomed effort to restore Evo to financial health.

On 31 December 2008, Mr Hunt arranged to lend £18.663 million from himself to Evo, on the condition that the money lent be used to repay the loan from Swynson to Evo (Hunt Refinancing), as Mr Hunt wanted Swynson’s balance sheet to look healthier and to reduce its liability to tax. Evo used these funds to repay its debt to Swynson.

In 2012 Swynson brought a claim against Lowick Rose for the whole amount loaned from Swynson to Evo on the basis of Lowick Rose’s negligent due diligence on Evo. Lowick Rose argued that, since Evo had repaid the original loan to Swynson, Swynson’s loss had been avoided and so no damages could be recovered. Swynson argued that the Hunt Refinancing and the repayment of Swynson’s loan had been collateral payments and therefore that the rule on avoided loss was irrelevant, so damages should still be recoverable.

Supreme Court decision

The first instance court and the Court of Appeal both found for Swynson, on the basis that, had the funds provided to Evo in the Hunt Refinancing been paid directly from Mr Hunt to Swynson, there would be no doubt that it would have been a collateral payment; the Courts held that to treat the situation as it happened as having been different would have been to favour form over substance. The Courts were thus prepared to lift the corporate veil, and treat Mr Hunt as being the same as his Swynson, his company, arguing that to do otherwise would be unjust. The Supreme Court, by contrast, found for Lowick Rose.

The Court found that the refinancing and repayment could not have been collateral payments on three grounds:

1. the repayment by Evo discharged the liability that represented Swynson’s loss.

2. the Hunt Refinancing could not be treated as an indirect payment to Swynson, even though it was made on the basis that the funds should be used to repay Swynson and even though that is how the funds were used; the two payments were made in respect of distinct transactions.

3. The Hunt Refinancing could not be treated as being recoverable as the costs of mitigation because the payment was made by Mr Hunt, not by Swynson.
The Court agreed with the lower courts that, had Mr Hunt paid the money directly to Swynson, this would have been a collateral payment and would not have extinguished Evo’s debt.

Consequences

While the facts of this case are unusual, this case is a reminder that parties should always consider the consequences of their actions when structuring their affairs. If they get this wrong, the judgment in this case shows that the courts may not step in to assist where things have been structured foolishly, even where it might appear equitable for them to do so, and that, sometimes, the form transactions take can be more important than the substance.

As Lord Sumption put it in the judgment on this case, “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”.

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Henry Evans

I trained at Gordon Dadds and qualified into the corporate department in 2016. I advise clients on a variety of corporate and commercial matters, primarily corporate and real estate finance and M&A. I read history at Corpus Christi College, Oxford. Outside work I am a keen runner and also enjoy reading, politics and travelling.

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