The English High Court recently considered the scope of duty principle in Richards v Speechly Bircham LLP.1 This was the first solicitor’s negligence case to consider this principle since its reformulation by the UK Supreme Court in Manchester Building Society v Grant Thornton UK LLP.2
The scope of duty principle limits a professional’s liability to losses that are sufficiently connected with the duty breached. The principle requires the court to consider what risk the duty was supposed to guard against and whether the loss suffered represented the fruition of that risk.
In Richards v Speechly, the court held that although the defendant solicitors had acted negligently, they were liable to pay damages in respect of some but not all losses claimed by the plaintiff due to the scope of duty principle.
In Richards v Speechly, the defendant solicitors acted for the founders of a technology company in an investment deal with a private equity firm. As part of that deal, the founders obtained a stake in a newly incorporated company (“IP Solutions”) and became employees of IP Solutions. The defendant solicitors advised on that deal, which included reviewing IP Solutions’ articles of association.
The articles provided that the founders’ shares were to be valued at £1 per share if they left IP Solutions as “bad leavers” or at market value if they left as “good leavers”. Another provision provided that on a sale of a controlling interest in IP Solutions, the founders (holders of class C shares) would not receive any distribution until the value of IP Solutions’ equity is at least twice the amount invested by the holders of class A and B shares ("Provision”). The articles were silent, however, as to whether this Provision would apply to determine the market value of shares (i.e., in a “good leavers” situation).
Months after the deal concluded, IP Solutions summarily dismissed the founders, who then sued for wrongful dismissal. The Court found in the founder’s favour and held that they were good leavers within the meaning of IP Solutions’ articles (“Liability Judgment”).3
In later proceedings, in determining the value of the founders’ shareholding for exiting IP Solutions, the Court ruled that the founders were only entitled to receive a nominal sum for their shares because of the Provision. The Court held the purpose of the Provision was to protect holders of class A and B shares by subordinating the realisable value of the founders’ shares and it was therefore contrary to this purpose if it did not apply in determining the market value of the founders’ shares. Further, there was no express article disapplying the Provision to the determination of market value (“Quantum Judgment”).4
The founders then brought proceedings against the defendant solicitors. The founders alleged that the defendant solicitors were negligent in failing to advise that the Provision could apply to good leavers. The founders sought compensation for costs incurred in the Liability and Quantum Judgments.
The solicitors denied liability, contending that at the time they advised on the deal, it was highly unlikely that the Provision would be interpreted as applying to good leavers.
The Court found the solicitors were negligent, holding that they had a duty to advise on any risks that could materially affect the founders even where it was highly unlikely the risk would materialise.
The Court then considered whether the solicitors’ breach of duty caused the founders to suffer loss in the form of the costs incurred in the Liability and Quantum Judgments. In doing so, the Court identified the scope of solicitors’ duty:
- Liability Judgment. The Court held that the founders’ costs in the Liability Judgment were not recoverable as they were outside the scope of the solicitors’ duty. These costs resulted from IP Solutions dismissing the founders. The solicitors’ duty did not, however, include advising the founders on the risk of IP Solutions dismissing the founders. Rather, their duty was to advise on the financial consequences if the founders were dismissed. As such, there was an insufficient nexus between these litigation costs and the scope of the solicitors’ duty.
- Quantum Judgment. Here, the purpose of the solicitors’ duty was to advise on the articles so that the founders could take appropriate steps to protect their position. The Court held that the litigation costs incurred in the Quantum Judgment were recoverable as they were within the scope of the solicitors’ duty. The Court opined that had the solicitors advised on the application of the Provision in a good leavers situation, the founders would not have concluded their investment deal with IP Solutions and costs would have been avoided. As such, there was a direct nexus between these costs and the scope of the solicitors’ duty.