UK: Carefully Drafted Retainer Prevents Liability To Third Party

Last Updated: 24 August 2012
Article by Simon Konsta

KPMG has recently been successful in striking out a claim in the High Court when an investor in a failed company tried to recoup substantial losses from the firm after the company collapsed (Arrowhead Capital Finance Ltd v KPMG LLP). This matter serves as a reminder of the benefits of appropriately drafted terms of engagement and the law on tortious duties of care.

Facts

KPMG's client was Dragon Futures Limited ("Dragon"). In 2003, Dragon decided to trade in the "grey market" in mobile telephones, a grey market being a trade in branded goods outside of the normal distribution channels authorised by the brand's owners. A typical transaction would involve Dragon buying a consignment of mobile telephones from one party and then selling them on to another party for a profit. This would require Dragon to pay VAT on the purchase price, which it subsequently reclaimed from HM Customs and Excise (HMCE) (as it then was). It was critical to Dragon's business plan therefore that it would be able to recover VAT. Dragon engaged the services of KPMG to advise on the recovery of VAT. KPMG's engagement letter dated 17 September 2003 provided as follows:

"We will deliver services to you in connection with the implementation of a due diligence strategy to address the threat posed by HMCE and its approach to companies dealing in the mobile telephone industry.

Scope of services

KPMG will provide the following services:

  • Review the existing business records to identify areas for attention
  • Analyse the current measures Dragon Futures takes to protect itself from fraudulent traders
  • Update the existing procedures to take into account the recent Budget measures
  • Provide a regular review of systems and documentation, dates to be agreed with yourself
  • We will agree with you, in advance, the scope of any further work that you require us to do over and above that detail"

In addition, the engagement letter referred to the associated Terms of Business which contained various provisions limiting KPMG's liability. Although not specifically referred to in the engagement letter itself, the Terms of Business provided that the contract between Dragon and KMPG would not create or give rise to any third party rights, and excluded the application of any legislation conferring any contractual or other rights on third parties.

In January 2004, the Claimant, Arrowhead, loaned money to Dragon through an intermediary. As part of the loan negotiations, Arrowhead was shown documents referring to the due diligence exercise undertaken by KPMG for Dragon. HMCE began investigating Dragon's transactions. In March 2004, Dragon arranged a conference call with Arrowhead, which was attended by an individual from KPMG, to discuss the investigations. By November 2004, HMCE had rejected all of Dragon's claims for input tax on the basis of missing trader fraud. Dragon appealed HMCE's decision, but the appeal was dismissed by consent because Dragon had to accept that it should have known that the transactions were connected to fraud and would have known if it had made sufficient enquiries. Dragon was subsequently ordered to be wound up and was dissolved with no distribution to creditors. Dragon had made some repayments to the intermediary through which Arrowhead had made the loans, but US$52 million remained outstanding. Arrowhead claimed against KPMG.

The claim

Arrowhead's claim against KPMG was in tort, as there was no contractual relationship between the parties. It was Arrowhead's case that KPMG owed a duty of care not only to Dragon as its client but also to Arrowhead as an indirect investor in Dragon. It was said that KPMG should have understood the relationship between Dragon and its investors, and that the business success of Dragon and its ability to repay its loans was wholly dependant on the success of its VAT repayment claims.

It was Arrowhead's case that KPMG performed its services negligently by failing to uncover fraud within Dragon's supply chains or to provide Dragon (and in turn Arrowhead as an investor in Dragon) with warnings as to the former hallmarks of fraudulent trading and that it failed to carry out sufficiently stringent checks on Dragon's proposed counterparties so as to meet HMCE's requirements for a VAT refund. The allegations of negligence were denied by KPMG.

KPMG applied to have Arrowhead's claim struck out on the basis that it owed no duty to Arrowhead as it was not the client and that the claim was out of time.

Judgment

In this decision, Stephen Males QC (sitting as a deputy High Court Judge) accepted, at least for the purposes of the application, that KPMG would have fully understood the critical nature of the success of Dragon's VAT repayment claims to its success, and that it would have been readily apparent to KPMG that the recoverability of VAT would be of great importance to any investor providing finance to Dragon as Dragon was unlikely to be able to offer any security other than its VAT repayment claims. In addition, KPMG was aware that Dragon was seeking to raise finance in order to expand its business and that loan finance was one of the options being considered.

The Court considered both the well known "assumption of responsibility" test and the "threefold" test (foreseeability, proximity, and whether it is fair, just and reasonable to impose a duty) set out in Customs & Excise Commissioners v Barclays (2006) in order to determine whether a duty of care could be established by Arrowhead.

Assumption of responsibility

It was held that it was "inconceivable" that any reasonable businessman would have considered that KPMG was voluntarily assuming an unlimited responsibility towards potential investors in Dragon, even more so towards a sophisticated investor such as Arrowhead, who was investing in Dragon at several removes. Whilst Arrowhead had probably not known of the express exclusion in KPMG's terms of business of liability to third parties, this was not an unusual term and a reasonable businessman would expect to find it there.

Three-fold test

Applying the threefold test, the court was prepared to assume for the purposes of the application that Arrowhead would be able to satisfy the requirements for foreseeability and, with some hesitation, proximity. However, it was the Court's view that it would not be fair, just, and reasonable to impose a duty of care on KPMG resulting in unlimited liability (for essentially the same reasons that there was no assumption of responsibility) as several factors had been obvious to all concerned: KPMG's relationship with its client, Dragon, was governed by an engagement letter which was likely to contain limitations on the extent of KPMG's liability and very possibly an exclusion of liability to third parties; that the business in which Dragon proposed to engage was a high risk business; and that KPMG would not have been prepared to accept such a responsibility to Arrowhead had it been asked to do so.

Arrowhead therefore failed to establish that it was owed a duty of care by KPMG. The court also found that the claim had been made out of time and it was struck out.

Conclusion

Whilst this case represents an application of established legal principles, it does serve as a reminder of the protection that appropriately drafted terms of engagement can provide.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.