Ernst and Young Strike Out Judgement

IN THE HIGH COURT OF JUSTICE Claim No. 2002 F 339
QUEEN’S BENCH DIVISION
COMMERCIAL COURT

SKELETON ARGUMENT OF
ERNST & YOUNG ON THE SOCIETY’S APPLICATION TO AMEND
4 APRIL 2003

Mark Hapgood QC, Cyril Kinsky, Brick Court Chambers, 020 7379 3550
1 April 2003.

(1) Should the Society have permission to amend the Re Amended Particulars of Claim (“RAPC”) in the form of the draft?

(2) Is the contingent liability disclosure claim to be struck out as a result of the judgment of the court dated 10 February 2003 (“the Judgment”)?

(b) The costs of and occasioned by the Society’s amendments to the Amended Particulars of Claim.

2. The bonus declaration claim set out in the proposed amendments stands no realistic prospect of success because it does not overcome E&Y’s objection that if the Society suffered a loss by paying out too much before the result of Hyman was announced, it in fact mitigated that loss by reducing payouts after the result was announced.

(1) Set out the steps that had in fact been taken by the Society after the decision in Hyman was announced in order to save money.

(2) Recorded E&Y’s submission that by taking these steps the Society had in fact achieved later what it alleges would have been done earlier had the provisions been made.

(b) The fact that different policyholders would be affected according to the timing of the bonus cuts and adjustments

(4) Rejected point (b) on the ground that it could not affect the loss to the Society itself;

(6) Came to the conclusion that for the reasons set out the bonus declaration claim was not based on reasonable grounds and had no real prospects of success,

(7) But nevertheless gave the Society an opportunity to address these issues in a proper pleading or claim.

4. The re-formulated bonus declaration claim does not seem to address the point at all. Instead, the Society seems to take the position that E&Y have misunderstood the Judgment. E&Y do not agree.

5. In paragraph 12 of its skeleton argument on the current application, the Society takes a point that is only open to it on appeal. The court has already ruled in E&Y’s favour on this point of principle.

6. In any event, the point is a bad one. The victim of the thief expected to get the convenience and comfort of the bus rides during the year. That he has lost, even if he has recouped his £500. By contrast, the Society expected to get nothing in return for its distribution of bonus. If the Society did indeed suffer a loss by paying out bonuses in 1997-2000, it recouped that loss by not giving away an equivalent amount of bonus in the first seven months of 2000.

7. The re-formulated bonus declaration claim therefore is not based on reasonable grounds, the proposed amendments should not be allowed, and the conclusion of the court in the Judgment on the bonus declaration claim should stand. It should be struck out along with the lost sale claims.

8. It is common ground that reductions of any material size in the overall growth rates announced between 1997 and 2000 would have had some adverse impact on the Society. This is because any such reductions

(1) Would have increased the number of policies where the cost of the annuity capitalised at the GAR would have exceeded the announced policy value[1] and

(2) Would have reduced the payouts made and therefore adversely affected the Society’s record in the marketplace by comparison with other life companies.

9. It must therefore follow that the Society must show that the benefits resulting from making the reductions would at least arguably have outweighed the disadvantages of doing so. The directors, it can be assumed, would not have acted irrationally.

10. The Society’s claim as explained in the evidence of Mr Thomson was that it would have been forced to abandon its commitment to mutuality and attempt a sale, or alternatively if that had proved impossible, it would have been forced to make a 19.7% cut in policy values as at 31/12/97 in order to save about £1.6bn over the period up to July 2001. According to that evidence, the Society would have been placed in that position because of the severe shortage of working capital that would have been revealed by the making of an additional GAR provision of £900m in its 1997 accounts, or alternatively £1.4bn in its 1998 accounts, or alternatively £1.1bn in its 1999 accounts.

11. The revised claim is put on the basis that the directors would have announced policy growth of only 3% for 1997 instead of 13%, thus achieving a reduction in policy values of 10% by comparison with what actually happened.[2] It is said that a reduction in announced policy values of this scale would have produced savings of £500m by July 2000 and that lesser reductions would have produced lesser savings over the same period.[3] The smallest saving that it is alleged would have been made as a result of a breach in November 1997 is £51m.

12. In answers 1.1, 1.2 and 2.2 of the further information served by the Society [4] the Society explains that the directors would have tried to make the maximum savings possible because “drastic cuts” were required. This reveals the flaw in the revised claim. The Society has not explained (and cannot explain) why the directors would have decided to make savings of between £500m and £51m. There might have been some logic in the original claim, because evidence might have been adduced to show that the directors would have set out to save £1.6bn over 3½ years, and thus “fill the hole” in the FFA by reducing payouts.

13. In the revised claim, there can be no such logic. There is no doubt that announcing just 3% growth in policy values for a year (1997) where the investment return had been 16.7%[5] would have had significant adverse repercussions for the Society. The compensating advantage? An anticipated saving of just £186m in payouts in the course of 1998 and a similar amount in the following year (when an increase to £1.4bn in the provision would have been required).[6] If, which E&Y deny, the making of an additional provision of £900m in the 1997 LTBP would have revealed a severe shortage of working capital, that shortage would not have been cured (or even significantly affected) by making the kind of reductions in policy growth now put forward. There would therefore have been no point in inflicting on the Society the damage that would undoubtedly have been caused by announcing overall policy growth for 1997 of just 3%.

14. The lack of logical connection between cause and alleged result is once again visible in the Society’s case. This is an alternative reason for coming to the conclusion that the bonus declaration claim is not based on reasonable grounds, the proposed amendments should not be allowed, and the conclusion of the court in the Judgment on the bonus declaration claim should stand. It should be struck out along with the lost sale claims.

(1) its 1998 and 1999 statutory accounts should have included a note disclosing the existence of contingent liabilities relating to the Hyman litigation (section F3);

(2) by failing to insist that such a note should be included, E&Y breached their duty to the Society (section F4);

(3) if E&Y had advised the Society that such a note was required, the Society would not have declared or awarded the bonuses which it did declare or award in 1998, 1999 and 2000 (paragraph 72).

16. The court addressed the question of contingent liability disclosure at paragraphs 33 and 34 of the Judgment. It concluded that:

(1) if the Society could not show reasonable grounds and real prospects of success on the basis of the allegations concerning technical provisions, it was fanciful to suppose that it could show such grounds or prospects on this basis and

(2) the claim based on the absence of a contingent liability note did not add anything of significance to the provisions claim such as could tip the balance of the outcome; this was because the board was well aware of the risks of losing the Hyman litigation and relied upon legal advice in assessing the likelihood of those risks materialising.

17. Despite the “and/or” in paragraph 72 of the proposed RRAPC, the former point now seems to be accepted (see letter from Herbert Smith of 12 February 2003 and paragraph 11 of the Society’s skeleton argument for CMC on 14 February 2003).

18. The proposed new paragraph 72(b) seeks to address the latter point. It explains that if there had been a contingent liability note in addition to the increased technical provision the directors would have appreciated the “reality of the Hyman risk”. That, in turn, would “also have caused” the directors to reduce bonuses.

19. The claim is therefore now put forward not as a free standing claim, but merely one that might “tip the balance of the outcome”, on the assumption that a breach in connection with the need for technical provisions is established.

20. This claim is no less fanciful than the full alternative claim for the simple reason relied upon by the court in its judgment. The directors (a) were aware of the existence of the Society’s GAR liabilities (and ex hypothesi had just agreed to include a large provision in the accounts in respect of those liabilities), (b) knew of the existence of the Hyman claim (c) had taken legal advice to equip themselves to assess the probability of a commercially adverse outcome and (d) were relying on that legal advice when doing so. There is therefore no real prospect of showing that their attitude to bonus declarations would have been changed or even affected by E&Y’s insistence on the inclusion of a note disclosing contingent liabilities relating to the Hyman litigation.

21. For those reasons permission to amend on this point should be refused and the whole of Section F should be struck out.

22. Costs of the application to strike out. E&Y were successful on the application. But for the submission of the proposed re-re-amendments, the entirety of the criticised parts of the RAPC would have been struck out. For the reasons set out in the Judgment, those parts of the RAPC that were not unconditionally struck out were held to have no reasonable grounds or real prospect of success as they stood. All that happened was that the Society was given an opportunity to have another attempt at identifying and explaining a claim that did have such grounds or prospects. This is not a case where the application was half successful, half a failure.

23. Further, as for the points raised in paragraphs 21 and 22 of the Society’s skeleton argument on the current application:

(1) It is not right to say that E&Y has failed to strike out the bonus claim. The £1.6bn claim pleaded in the RAPC has been struck out, to be replaced (perhaps) by one worth somewhere between £12m and £500m covering both reversionary and terminal bonuses. This is a different claim from (a) the one originally pleaded and (b) the one explained in the Society’s evidence. This is properly reflected in paragraph 68 of the proposed RRAPC where it is recorded that the paragraphs containing both the lost sale and the bonus declaration claims have been “struck out …or deleted in the light of” the Judgment.

(2) It is true that, at the hearing, very little time was spent debating the contents of Mr McNamara’s statement. This is because his evidence was either (a) uncontroversial or (b) disputed as a matter of fact.

(a) Uncontroversial evidence is often required from the maker of the application in order to construct the basis of fact upon which the issues can be debated; that it is uncontroversial does not make it any less necessary or useful.

(b) If, on a strike out application, evidence is disputed, the party which has served that evidence is unwise to spend much time trying to persuade the court to accept it. Time is better spent on the application examining those issues which arise on the assumption that the respondent’s evidence is accepted at trial.

(3) E&Y do not accept that its case was not “properly set out” until its skeleton argument was served:

(a) The Society wrote a letter before action to E&Y on 18 December 2001. On 14 January 2002, E&Y responded. The first point taken in that letter was that the Society’s claim on loss and causation was unclear.

(b) On 25 January 2002, the Society responded, explaining that but for E&Y’s alleged breaches of duty, the Society would not have paid out so much by way of bonuses and would not have lost the opportunity to achieve a sale of the Society.

(c) On 5 February 2002, E&Y wrote back, pointing out that it would be necessary to establish not just “but for” causation, but the chain of causation in detail and that the losses claimed fell within the scope of E&Y’s duty.

(d) On 28 June 2002, E&Y served a Defence which set out in detail its arguments on causation (including[7] the “timing point” – see below), scope of duty and loss.

(e) On 9 July 2002, E&Y wrote a letter expanding on the arguments set out in the Defence, and threatening to apply to strike out the lost sale and the bonus declaration claims.

(f) On 22 July 2002, the Society wrote promising to set out its answer on scope of duty in its Reply. The Reply was dated the same day, and set out those arguments in paragraph 15.

(g) E&Y served Mr McNamara’s evidence on 31 July 2002. In his WS, among other things, Mr McNamara explained that the decisions taken by the Society’s board in January/February could not have been taken on the basis of E&Y’s audit report for the relevant year, because that audit report was always produced in the latter half of March (this is the “timing point”).

(h) On 12 August 2002, the Society amended its Particulars of Claim to remove E&Y LLP from it, but made no further substantive amendments.

(i) On 15 November 2002 the Society put forward its proposed amendments to the Amended Particulars of Claim. The nature of the amendments suggested that the purpose of making them was an attempt to head off E&Y’s strike out attack, including the timing point. The Society’s approach here was to introduce the argument that E&Y’s duty required them to advise on the need for making the GAR provision as early as November of the previous year. E&Y do not accept this argument, but recognise that it could not be resisted at the strike out stage. It was for this reason that little or nothing was heard at the hearing on the timing point.

(4) In the light of the above, it would have been right to award E&Y their costs of the timing point in any event – as the reason why it played no part in the hearing was the Society’s late amendments. If there had been no re-amendment, the point would have been a complete and simple answer to the bonus declaration claim.

(5) In any event, the costs incurred in the preparation of Mr McNamara’s WS must have been a very small part of the overall costs.

(6) Further, the Society disputed “the issues as they appeared from Mr McNamara’s statement” and nevertheless failed to establish a real prospect of success for the claim set out in its statement of case. It is not clear why E&Y should suffer any costs consequences. There has not been a mini-trial between competing sets of evidence, but an analysis of whether or not the Society’s claim stood a real prospect of success on the basis of its own evidence.

24. The costs of and occasioned by the Society’s amendments to the Amended Particulars of Claim. These should by E&Y’s in any event.

25. The costs of the action referable to those parts of the claim that were/are struck out. To the extent that E&Y have incurred costs (otherwise than in connection with the strike out application) in investigating and responding to the lost sale claim, they should have those costs in any event. If permission to amend is refused and the bonus declaration claim is therefore also struck out, E&Y should have the costs of the action, save of the costs attributable to the Guernsey tax claim.

26. Payment on account of costs. CPR Part 44.3(8) provides the jurisdiction. Given that the only reason why a costs order cannot be satisfied immediately is the need to wait for a detailed assessment, an order for a payment on account should usually be made (Mars v Teknowledge [2000] FSR 138).

27. E&Y’s schedule of costs shows total expenditure (excluding VAT) of just over £500,000 in connection with the strike out application alone. Using 70% as a rough rule of thumb, E&Y can expect to recover £350,000 in respect of the strike out application alone, leaving aside the contractual claim for an indemnity (see below). Given the very significant costs of the action which they are also likely to recover when the detailed assessment is carried out, an appropriate payment on account would be £350,000.

28. Indemnity Costs. Article 67 of the Society’s Articles [3/34/398] provides an indemnity to E&Y against any liability incurred by the firm in defending proceedings in which judgment is given it its favour. E&Y’s right to claim under the indemnity does not accrue until it obtains an order for costs in its favour (John v Price Waterhouse [2002] 1 W.L.R. 953). E&Y wish to make clear, however, that they reserve their right to make such an application or claim in the future.

[1] The Society accepts this in paragraph 73 of the RRAPC

[2] This is the claim based on an assumed breach of duty in November 1997. The claim based on a November 1998 breach assumes an overall growth rate for 1998 of 0% (instead of 10%) and the one based on a breach in November 1999 assumes an overall growth rate for 1999 of 2% (instead of 12%).

[3] See Table 2, paragraph 83 of the RRAPC. The equivalent figures for later breaches are £31m to £299m for a breach in November 1998 (Table 7, paragraph 93 of the RRAPC) and £12m to £115m for a breach in November 1999 (Table 12, paragraph 103 of the RRAPC).

[4] See letter from Herbert Smith dated 28 March 2003.

[5] See 3/54/559-568

[6] See Table 2, paragraph 83 RRAPC

[7] In paragraph 67.1 1/6/120A