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IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE VICE-CHANCELLOR

1. 1. This is an appeal from a judgment of the Vice-Chancellor, Sir Richard Scott, given on 29 October 1999. The Vice-Chancellor decided a preliminary issue in favour of the Law Society in their action for damages against KPMG Peat Marwick (“KPMG”) and two partners of that firm, Stephen Ingleby Cawley and Neil Spencer Chapman. The Vice-Chancellor based his decision on his conclusion that accountants who report on the accounts of solicitors owe to the Law Society a duty of care when preparing their reports.
   2. Under the Solicitors Act 1974, the Law Society and its Council are responsible for the regulation of the solicitors’ profession. The Act requires the Law Society to maintain and administer the “Compensation Fund”. The purposes for which grants are made from the Compensation Fund include grants to relieve loss or hardship suffered in consequence of dishonesty on the part of a solicitor, in connection with that solicitor’s practice. (Section 36 of the Act)
   3. In general, section 34 of the Act requires every solicitor to deliver to the Law Society a report signed by an accountant unless the Council is satisfied that it is unnecessary for him to do so. The report has to contain the information prescribed by rules made by the Council under this section. The relevant rules were the Accountants’ Report Rules 1986. The rules also prescribe the information the report is to include, the form of the report and the qualifications to be held by a reporting accountant.
   4. In addition the accountant is required by the Rules to indicate whether he is satisfied that during the period to which the report relates, the solicitor has complied with the Rules. The Law Society contends that if a solicitor complies with the Rules it should then be impossible for him to confuse his clients’ money with his own, or inadvertently to make any improper payments, which could lead to claims being made on the Compensation Fund.
   5. If an accountant’s report reveals non-compliance with the provisions of the Rules, this provides the Law Society with an opportunity of exercising its powers to protect the public, clients of the solicitor and the Compensation Fund. The powers include a discretion to intervene in a solicitor’s practice where the Council of the Law Society has reason to suspect dishonesty on the part of the solicitor in connection with his practice. (See paragraph 1(1)(a) of Part 1 of Schedule 1 to the Act. It is relevant to note that, while it is the Council which “suspects”, Part 1 of the Schedule is headed “Circumstances in which Society may Intervene”). Intervention would prevent any further dishonesty by a solicitor.
   6. The preliminary issue arose in proceedings relating to the collapse of a firm of solicitors called Durnford Ford. KPMG were retained by Durnford Ford to prepare their annual reports. The report for the year ending 31 May 1989 was prepared by Mr Cawley and the report for the year ending 31 May 1990 was prepared by Mr Chapman. It is alleged the reports should have been qualified more strongly. They were sent by the defendants to the Law Society. The fees of KPMG were paid by Durnford Ford.
   7. On 6 May 1992, the Law Society commenced an investigation into Durnford Ford. On 31 May 1992, the firm stopped practice. It was then found that Mr Graham Durnford Ford, the senior partner, who was responsible for the firm’s probate department, together with another partner Mr Digby Bew, had defrauded a number of the firm’s clients. As a result some 300 clients of the firm made claims on the Compensation Fund and substantial payments amounting to some £8.5 million were paid out of the Fund.
   8. As trustee of the Compensation Fund, on 4 August 1995, the Law Society commenced proceedings against the defendants. The Law Society alleges that:

(i) KPMG, when preparing the accountant’s reports for the years 1989 and 1990, were negligent and acted in breach of the duty of care which they owed to the Law Society when examining the books and accounts and other records of Durnford Ford for the years 1989 and 1990; and

(ii) if KPMG had qualified the report as they should have done, the Law Society would have exercised its statutory power of intervention and thus put to an end the dishonesty of Mr Ford and Bew which would have reduced the amount which was paid out by the Compensation Fund. The Law Society calculates that about £1.7 million was misappropriated in the period between 1989 and 1990 and that about £5.7 million was misappropriated after the 1990 report. It is therefore alleged that, in total, the defendants’ negligence led to payments of about £7.4 million being made out of the Compensation Fund to defrauded clients. Similar proceedings were subsequently commenced on 29 May 1998 in respect of the 1991 report. Mr Ford and Mr Bew were prosecuted and convicted of a number of counts of theft arising out of the misappropriations.

1. 1. In their defence the defendants deny that they were negligent. They dispute that there is any causative connection between the alleged negligence and payments made out of the Compensation Fund. They also deny that they owe any duty of care to the Law Society in its capacity as trustee of the Compensation Fund. This last allegation resulted in Mr Justice Carnwath on 16 November 1998 making an order in the 1995 action that there should be trial of the preliminary issue, namely :

“Whether the Defendants or some or any of them owed to the Plaintiff the duty of care alleged at paragraph 11 of the amended Statement of Claim in the capacity in which the Plaintiff sues as stated in paragraph 4 thereof and in respect of the damages claimed therein or whether on the primary facts pleaded at paragraph 16 to 18 thereof the Defendants or some or any of them owed a duty of care to the Plaintiff in such capacity and capable of giving rise to a liability in respect of such damages.”

1. 1. The parties subsequently agreed that the determination of the preliminary issue in the 1995 action would be binding in the 1998 action as well.
   2. In his judgment, which is now reported [2000] 1 All ER p.515 the Vice-Chancellor found in favour of the Law Society and granted the Law Society a declaration that :

“The second defendant owed to the claimant in respect of the Accountant’s Report dated 24 November 1989 the duty of care alleged at paragraph 11 of the Amended Statement of Claim in the capacity which the Claimant sues as stated in paragraph 4 thereof and in respect of the damages claimed therein and the third defendant owed to the claimant in respect of the Accountant’s Report dated 29 November 1990 the duty of care alleged in paragraph 11 of the Amended Statement of Claim in the capacity which the claimant sues as stated in paragraph 4 thereof and in respect of the damages claimed therein.”

1. 1. As his judgment is reported, I will summarise the detailed and careful reasoning of the Vice-Chancellor. He applied the three criteria which must be met for there to be a duty of care identified by Lord Bridge in Caparo Plc v Dickman [1990] 2 AC 605 at p.617-619, namely :

a) reasonable foreseeability of damage;

b) a relationship of sufficient “proximity” between the party owing the duty and the party to whom it is owed; and

c) the imposition of the duty of care contended for would be just and reasonable in all the circumstances.

1. 1. The Vice-Chancellor also referred to the passage in the speech of Lord Oliver in Caparo. Based upon the decision of the House of Lords in Hedley Byrne v Heller & Partners [1964] AC 465, Lord Oliver listed the circumstances which should exist in order to establish the necessary relationship of proximity between the person claiming to be owed the duty and the adviser:

“(1) the advice is required for a purpose, whether particularly specified or generally described, which is made known, either actually or inferentially, to the adviser at the time the advice is given; (2) the adviser knows, either actually or inferentially, that his advice will be communicated to the advisee, either specifically or as a member of an ascertainable class, in order that it should be used by the advisee for that purpose; (3) it is known, either actually or inferentially, that the advice so communicated is likely to be acted upon by the advisee for that purpose without independent inquiry, and (4) it is so acted upon by the advisee to his detriment.”

1. 1. The Vice-Chancellor came to the conclusion that each of Lord Bridge’s and Lord Oliver’s requirements were fulfilled “in the present case – at least for the purposes of deciding this preliminary issue”. The Vice-Chancellor, however, recognised that “the chain of causation linking the want of due care to the claims on the Compensation Fund may have been broken”. Whether it had been broken would remain to be determined. As to the requirement that the imposition of a duty of care must be fair, just and reasonable, the Vice-Chancellor accepted that there had to be an appropriate control mechanism limiting the recoverable economic damage. On this point he referred to Lord Oliver’s statement in Caparo pointing out that :

“To apply as a test of liability only the foreseeability of possible damage without some further control would be to create a liability wholly indefinite in area, duration and amount and would open up a limitless vista of uninsurable risk for the professional man.” (p.643)

1. 1. The Vice-Chancellor identified two limiting factors, the first being that the liability will be restricted to payments to the solicitor’s clients whose money had been wrongly misappropriated from the client’s accounts. The second limiting factor was that the consequences of the negligent preparation of the report would, for the purposes of tortious recovery, be spent within a relatively short time by the receipt by the Law Society of the following year’s report. As the Vice-Chancellor explained, the “continued damage after receipt by the Law Society of the year 2 report would not be damage reasonably foreseeable as likely to be caused by negligence in the preparation of the year 1 report”.
   2. As to the defendants’ objection to there being a duty of care because of the statutory framework under which the reports are made, the Vice-Chancellor accepted that the Law Society was performing a public duty in regulating the solicitors’ profession. He also accepted that the Law Society did not owe any duty of care to the clients of solicitors as to the manner in which it carried out its regulatory functions. However, he regarded it as clear that the statutory framework incorporates private law remedies as part of its structure. In particular the client would have a private law remedy against the solicitor for recovery of the misappropriated funds and the Law Society, if it made a grant, would be subrogated to the client’s private law remedies against the solicitor. In addition the Vice-Chancellor could see “no logic in a system under which the ultimate responsibility for the loss caused by the accountant’s negligence can be brought home to the accountant where the dishonest solicitor has innocent partners but not where the dishonest solicitor has none”. (The Vice- Chancellor had in mind that the accountant would undoubtedly be liable to the innocent partners.) Finally, he considered that there was proximity between the accountant and the Law Society which did not exist between the accountant and the solicitor’s client which would explain the absence of a duty of care owed by the accountant to the solicitor’s client. The Vice-Chancellor was also totally unimpressed by arguments based on drawing a distinction between the Council and the Society. As the Vice-Chancellor said :

“Mr Pollock argued that since it is the Council that takes the decisions about intervention, the tortious duty of care contended for must, if it is owed at all, be owed to the Council. It is the Council, not the Society that relies on the report. But the Compensation Fund is held by the Society and payments from it are made by the Society, not by the Council. So the argument, if I have understood it, goes like this. The Council relies on the report but suffers no loss as a result of its reliance. The Society, which suffers the loss, does not rely on the report. It performs a comparable function to that which the board of directors of a company performs for the company. Every incorporeal entity with corporate status must have an organ or organs by which management decisions are taken. The Law Society is incorporated by a Charter. In section 87 of the 1974 Act, “the Council” is defined as “The Council of the Society elected in accordance with the provisions of the Charter and this Act”. The 1974 Act confers a number of powers on the Council. It confers them on the Council as the governing organ of the Law Society. If the right conclusion in the present case is that a duty of care is owed by reporting accountants to the Law Society, reliance on the report by the Council is, in my judgment, reliance by the Law Society. There is no valid distinction to be drawn.”

1. 1. The Vice-Chancellor also rejected the argument that, if there was a duty owed, it would be owed to the Law Society in its capacity as a regulator not in its capacity as a trustee. The Vice-Chancellor considered that as long as a duty of care is owed and the damage for which the action is brought is reasonably foreseeable, the capacity in which the action is brought is irrelevant.
   2. Before referring to the arguments advanced by Mr Gordon Pollock QC on behalf of the accountants, it is convenient to deal with the submissions of Lord Goldsmith QC on behalf of the Law Society. Lord Goldsmith submits that it is obvious in this case that the accountants owe a duty of care. In his view it is a very plain case falling within the categories of situation identified by Lord Devlin in Hedley Byrne (at p.528/529) where the situation is “equivalent to contract”. Lord Goldsmith points out that if the fee for the report had been paid by the Law Society instead of the solicitors, there would have been a contract. Lord Goldsmith submitted that the situation here is classical Hedley Byrne. He stressed the close statutory relationship between the requirement to obtain an accountant’s report for the Law Society and the Compensation Fund. Both are part of the same legislation and have the same legislative history. The intervention powers and the Compensation Fund are part of the same strategy for dealing with solicitors who are dishonest in handling clients’ monies. Both are dealt with in Part II of the 1974 Act. Those concerned with the regulation of solicitors, including interventions and the operation of the compensation fund operate from the same premises under the same Assistant Director who combines the role of Assistant Director Legal Services and Head of the Compensation Fund. This is a situation in which the existence of a duty of care has already been established. He relied on the approach of Lord Goff in Henderson v Merrett Syndicates [1995] 2 A.C. at p.181 and Buxton LJ in Andrew v Kounnis Freeman [1999] 2 BCLC at p.655 as establishing that there is no need to go through the steps laid down by Lords Bridge and Oliver in Caparo if the case falls within the principle established by Hedley Byrne.
   3. While I recognise the force of Lord Goldsmith’s submissions, I would not regard this as being a situation where it is self-evident that a duty is owed. The Law Society, whether acting directly or through the Council, has a number of distinct functions. I would accept Mr Pollock’s submissions that it is possible for a duty of care to be owed in relation to one of the functions of the Law Society and not in relation to other functions. However, I do not attach importance to the fact that the Act identifies the Council as being responsible for the regulatory role. The legislation by identifying the Council rather than the Law Society is doing no more than identifying that part of the Law Society which will in practice have the responsibility for making the decisions as to intervention. The regulatory role which the Council performs in its capacity as the governing body of the Law Society is separate but closely allied to the Law Society’s role in relation to the Compensation Fund. When a body, such as the Law Society, has distinct functions such as its role as a regulator and its role in relation to the Compensation Fund, it does not necessarily follow that because there is a duty owed in relation to one role there is also a duty owed in relation to the other. This is underlined where, as here, one function is a public law function and the other a private law function.
   4. In view of these features of the Law Society’s role, I do not regard the existence of a duty of care in this case as being self-evident in accordance with the argument of Lord Goldsmith. There is a need to become involved in the tests laid down by Caparo. The issue cannot be determined by saying Hedley Byrne obviously applies so as to create a duty of care. While there are similarities between the issues on this appeal and the decision of this court in Andrew v Kounnis Freeman [1999] 2 BCLC 641, caution must be exercised in seeking to apply a decision which in fact decided no more than that a claim should not be struck out as being determinative of a substantive issue. Here we are concerned with whether a duty of case exists not whether it arguably exists.
   5. I agree with the Vice-Chancellor that the correct approach is to examine the question of whether the accountants owe a duty of care to the Law Society in relation to its responsibilities to protect the Compensation Fund against the well-established test laid down in Caparo. However it is only to this extent that I am prepared to accept the submissions of Mr Pollock. Mr. Pollock was at pains to distinguish between the Council and the Law Society. Like the Vice-Chancellor I find his arguments based on the distinction between the Council and the Law Society as devoid of any merit. In considering whether a duty of care exists as a matter of private law, no distinction can be drawn between the Council and the Law Society. The Council is no more than the executive arm of the Law Society. The Act gives the Council the responsibility of being satisfied so the Law Society can take action. This is made quite clear by the references to both the Council and the Society in section 36. If the Council is satisfied as to the specified matters “the Society may make a grant out of the Compensation Fund”.
   6. The next plank in Mr Pollock’s argument is that there are two intervening transactions between any lack of care by the accountants in preparing their report and the loss suffered by the Compensation Fund. First there is the transaction by which the clients of the solicitor deposit money with the solicitors. Secondly, there are the claims made by the solicitor’s clients on the Compensation Fund and the Law Society’s decision as trustee to meet the claims. Mr Pollock submitted that neither of these transactions could be brought within Lord Bridge’s formulation. As the issue here is not whether any duty of care was owed by the accountants to the solicitor’s clients, but whether any duty is owed to the Law Society as trustee of the Compensation Fund, it is on the Law Society and its role in relation to the Compensation Fund which it is necessary to concentrate. Here it is to be noted that the intervention by the Law Society, which an adverse report can trigger, protects both the public and the Compensation Fund. The information available to the accountants makes it clear that the reports were required so that protective steps could be taken. It is obvious that if protective action is not taken because a report does not draw attention to non-compliance with the account rules, this could have adverse consequences on the Fund.
   7. It could well be correct, as Mr. Pollock submits, that those situations where a duty of care to protect against economic loss has been previously held to exist were all concerned with a potential commercial transaction, but no difference in principle arises because it is here regulatory action which the Law Society would have taken. The threefold approach identified by Lord Bridge can still be readily applied to the present situation and when it is applied, it can be readily seen that the requirements are fulfilled. Contrary to Mr. Pollock’s submission, no difficulty arises from the fact that, if the Law Society intervenes, it would be exercising a regulatory or public law activity whereas the duty which is owed to the Law Society is a private law duty. There is no reason why there should not be private law duty owed to the Law Society, the performance of which would assist it to perform its public duty. It can be difficult to establish that a body, which is required to perform a public duty created by statute, owes in relation to the same matter a private law duty as well. This is not what is being considered here and this does not mean that a private body performing private functions should not owe a private law duty to a public body. The important point here is that, if the duty exists, it is owed to the Law Society in its capacity as trustee of the Fund. It is in that capacity that the damages will be recovered so that they can be used to reimburse the Fund for the sums which it has had to pay out due to the negligence of the auditors.
   8. The final argument advanced by Mr. Pollock was that no useful purpose would be achieved in creating a right of action in favour of the Compensation Fund against the accountants. He submitted that as the Fund is financed by the solicitors’ profession, all that would be achieved by establishing a duty would be to transfer a clearly established liability of the solicitors’ profession to a liability of the accountants’ profession. Furthermore the existence of liability would often be difficult to establish without expensive litigation. He contended that it was the policy of Parliament in setting up the Fund that the loss should be borne by the solicitors’ profession as a whole. In his submission there is merit in the solicitors’ profession as a whole accepting responsibility for its dishonest members. Mr. Pollock added that the only effect of such claims will be, through the medium of expensive and time consuming litigation, to move losses from the solicitors’ profession to the accountants and then back to the lawyers in costs.
   9. It has to be accepted that whenever the courts establish that a duty of care arises for the first time, this could lead to litigation. However, if it is fair, just and reasonable that the accountants should be liable for the loss to the Fund then such consequences have to be accepted. It would not be right to deprive the Fund of the ability to recover the loss which has been suffered. It is surely for the Law Society in the context of any particular case to decide whether it wishes to take the risks that litigation inevitably involves. If it does so, assuming that the auditors are responsible for the loss, it is not for the auditors to complain about the expense involved. If there is a liability it is always open for the auditors to limit any liability for costs by accepting the appropriate responsibility for their lack of care. It is also open to them to make it clear that they disclaim responsibility for any lack of care in the preparation of the audit. That may, however, not be acceptable to the Law Society.
   10. In support of his argument that this is not the position, Mr Pollock referred to the position of the Solicitors’ Indemnity Fund. The accountants may well not owe a duty to the Solicitors’ Indemnity Fund. The Fund is an insurer of the solicitors and, as such, would not expect to be owed a duty by the auditors. Furthermore, the auditors’ report will not be made available to the Solicitors’ Indemnity Fund in the same way as it is made available to the Law Society. There is always going to have to be a limit placed on the extent of the duty owed by the auditors in relation to their report and there is a distinction between an insurer and the Compensation Fund, which is a fund of last resort.
   11. Mr. Pollock also relied on the inability of the auditors to rely on contributory negligence as against the Law Society whereas they would be in a position to allege contributory negligence in an action brought against them by the innocent partners. It has to be accepted that there could be situations where this is the case. However, if the Law Society itself was at fault in not taking action which could have helped to protect the Fund, the auditors would be entitled to rely on this fault in reduction of their liability.
   12. Mr Pollock submits that the control mechanisms relied upon by the Vice-Chancellor did not provide sufficient protection for his clients. He relied strongly on the decision of Millett J. in Al Saudi Banque v Clark Pixley [1990] 1 Ch 313. The deposits, which are made to a bank, are on a different scale to those made to a solicitor by his clients. The latter are unlikely to fluctuate so significantly. However, if they did so, that could provide a foundation for an argument that the scale of the loss is beyond anything the auditors could have foreseen having regard to the accounts to which the report related and on that basis the loss or the whole of the loss is not recoverable. I would not regard the decision of the Vice-Chancellor as preventing an argument on those lines being advanced.
   13. Despite Mr. Pollock’s persuasive arguments I have come to the same conclusions as the Vice-Chancellor and I would dismiss this appeal.

Lord Justice Ward :

I agree.

Lord Justice Clarke :

I also agree.