Accountants´ Professional Liability: Tackling Limitation Issues In A Transactional Setting

PEGASUS MANAGEMENT HOLDINGS AND BRADBURY –v- ERNST & YOUNG

Chancery Division, 11 November 2008

Background

In April 1997, the Second Claimant, Mr. Bradbury, who had been advised by Ernst & Young on his personal tax matters since 1980, sold an electronics manufacturing business. Ernst & Young recommended a tax saving scheme, which required heavy investment in a new Luxembourg company before 5^th April 1998. The Luxembourg company was the second Claimant, Pegasus. It was incorporated on 26^th March 1998 and shares were issued on 2^nd April 1998 in return for $40k capital.

When the Scheme did not work as anticipated, both Pegasus and Bradbury launched a claim for damages against Ernst & Young for alleged negligence over the tax advice given. They alleged that, in April 1998, Ernst & Young ought to have appreciated it was necessary to change the share purchase structure in order to achieve tax savings. In these circumstances, they went on, E & Y should have advised Mr. Bradbury to incorporate and fund subsidiaries to make purchases and to hive the business up to those subsidiaries, rather than to Pegasus.

Decision

Ernst & Young raised a limitation defence, which was dealt with as a preliminary issue. The Court ruled as follows:

1. It was clear from the facts that Ernst & Young owed no duty to Pegasus as there was no contract in existence and there had been no assumption of responsibility;
2. As the advice that Mr. Bradbury should incorporate and fund subsidiaries ought to have been given before completion of the share issue on 2^nd April 1998 (because once the share issue had taken place it was too late to retrieve the situation), then the damage for the purposes of limitation was sustained at the date of the share issue.

Comment

In reaching the above decision on limitation, Mr Justice Lewison applied Nykredit Mortgage Bank PLC v Edward Erdman Group Limited (1998) and conducted a review of a number of other relevant authorities on limitation and loss, including the recent decision of the Court of Appeal in Shore v Sedgwick Financial Services Limited (2008). He distinguished Shore as he found that Mr. Bradbury had suffered loss when the share issue took place on 2^nd April 1998 as he could not have disposed of his shares without forfeiting his tax relief -- so therefore, objectively, his shares in Pegasus were worth less to him than shares in the company (which could have preserved his entitlement to reinvestment relief.)

It is worth noting that even if proceedings had been issued in time, it would have been difficult for the Claimants to establish loss: although there was potential for a tax bill of £15 million, this was contingent on a number of conditions first being fulfilled.

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