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Nine lessons for lenders from latest commercial loan professional negligence case

Reported professional negligence cases are coming through thick and fast as claims emanating from the financial crash - which could not be settled - reach the courts. One of the most recent, Barclays Bank Plc v Christie & Co, provides a number of useful lessons for lenders in the context of claims arising from commercial lending.

The judgment is a lengthy but helpful (for lenders) illustration of how the Court will approach a number of issues that commonly arise in commercial lending professional negligence claims.

Facts surrounding the case

In 2007, Barclays loaned £1.8 million to Thurston UK Limited - £1.6 million to buy an amusement arcade in Great Yarmouth (The Flamingo) and a further £200,000 to enable alterations to  join it to two adjacent arcades (Circus Circus and the Golden Nuggett) already owned by Thurston. The business fell into financial difficulties and, following administration, the arcades were sold for £1.35 million, leaving Barclays significantly out of pocket.

Barclays sought to recover those losses against Christie & Co, a firm of valuers who provided Barclays with valuation reports for The Flamingo and Circus Circus/the Golden Nuggett. They valued them at £1.5 million and £2.7 million respectively. Barclays contended that the true value of the arcades was £1 million and £2.1 million.

The Court held that the true value of The Flamingo was £1.185 million and Circus Circus/the Golden Nuggett £2.317 million. As a result Christie & Co had been negligent and this caused the loss suffered by Barclays. The Court awarded Barclays more than £600,000 after deductions for contributory negligence.

Lessons learned from this case

Valuation method - lesson one

The Courts will place significant weight on the RICS Red Book and RICS Guidance and a valuer will need good reasons to depart from the recommended methodology.

Amusement arcades are one of the types of property (other examples include pubs, hotels and care homes) whose value is typically ascertained with reference to their trading potential. Christie & Co had valued the arcades by assessing their fair maintainable turnover and applying a multiplier to arrive at a capital value.

Taking account of the RICS Red Book and relevant Guidance notes, the Court found that the correct valuation methodology was to assess the fair maintainable net profit, on an EBITDA basis, that can be achieved by a reasonably competent and efficient operator of the business. Then an appropriate multiplier should be applied based on comparable evidence.  Although there were other bases upon which properties of this type could be valued, the Court held that there are relatively limited circumstances in which it would be appropriate to depart from the recommended method. 

In this case, there was no good reason for such a departure because:

  • sufficient evidence, in the form of historic trading accounts, was available to the valuer in 2007 to enable an EBITDA-based valuation to be performed;
  • there was sufficient market evidence to arrive at a multiplier; and
  • there was no evidence that other methodologies are or were at any material time used in the market.

The Court as valuer - lesson two

Where the valuation process involves a number of variables, such as in trading property valuations, a lender need not be successful on each and every point in order to ultimately achieve a successful outcome.

There was considerable divergence of opinion between the parties' expert valuers. Rather than choosing between the experts, the Court held that the appropriate approach was, after considering all available evidence (including that of both experts and the factual evidence), to embark on its own valuation exercise to arrive at the true market value of the arcades. This involved the Court carrying out its own EBITDA calculation.

Relevance of the purchase price - lesson three

The agreed purchase price should be treated with caution as evidence of market value, particularly where factors suggest a property has not been fully exposed to the open market.

It is often argued by valuer defendants that the agreed purchase price is the best evidence of a property's market value. In this case, the Court held that it would be unsafe to regard the sale price as cogent evidence of open market value because there was no evidence that The Flamingo had been widely marketed prior to sale. Furthermore, Thurston could be considered a ‘special purchaser’ in that it could be expected to pay more than market value to enable The Flamingo to be joined to their existing arcades.  
 
The Court also noted that there was a degree of circularity in the valuer's argument that the sale price supported the valuation, because it was likely that Christie & Co's valuation probably facilitated the sale at that price. A lower valuation could have resulted in a lower price being negotiated, or  no sale proceeding. 

Margin of error - lesson four

A margin of error of 15% can be reasonably expected in the case of unusual properties.

Unless the valuations fell outside of the appropriate margin of error, there is no cause to consider the steps taken by a valuer (even if, on the facts, the valuer had been negligent in the methodology adopted). The Court accepted the experts' consensus that a 15% margin of error was appropriate, given the nature of the properties being valued, namely that the comparable evidence was relatively limited as the arcade property market was small and that the nature of the EBITDA/multiplier meant that small changes to any variable (turnover, staff costs etc.) could result in significantly different end values.

In this regard, the case provides further support for the starting point as enunciated in cases such as K/S Lincoln v CB Richard Ellis: 5% for standard residential properties, 10% for unusual residential properties and most commercial properties and 15% for more unusual commercial properties.

The total security package - lesson five

When advancing the loan to Thurston, Barclays held security over three arcades (including The Flamingo and Circus Circus). The Court held that, when assessing whether Christie & Co's valuations fell outside the margin of error, the total value of the security package needed to be assessed. This was because it was against the total security, rather than individual property values, that the Bank assessed the risk of the loan.

When considering the total security package, Christie & Co's valuation was circa 20% more than the true value as assessed by the Court (The Flamingo being considerably more over-valued than Circus Circus).

Causation - lesson six

Consider whether there is evidence that the loan, or an alternative loan, could have proceeded had the true value been advised.
 
The Court found that Barclays would have been willing to provide a loan at a higher loan to value ratio to enable the purchase of The Flamingo to proceed.  On the evidence before it, however, the Court also found that neither Thurston nor those behind it would have been able or willing to make up the shortfall between the sum which the bank would have been willing to lend (based on a correct valuation) and the purchase price.

The need for evidence as to whether an alternative loan could have proceeded is often overlooked by defendants.

Calculating quantum - lessons seven and eight

There is no need for a lender to give credit for a borrower's 'payments' where such payments are made from overdrawn accounts that are never put back in credit after such payments.

A lender is entitled to apply the proceeds of sale to pre-existing lending under an ‘all monies’ charge rather than giving credit for the proceeds  in the claim against a valuer


Contributory Negligence - lesson nine

An otherwise competent assessment of lending risk may be tainted by adverse information, such as a borrower's dishonesty.

The Court had been set to conclude that a reasonably competent bank would have acted as Barclays did regarding its financial analysis of Thurston, particularly where Thurston and the individuals behind it were long standing customers of Barclays. The result was that the bank had lots of financial information concerning their business(es) and their ability to manage the borrowing.

The Court was critical, however, of Barclays' attitude and response to the fact that Thurston had used monies from a previous loan in 2003 for purposes other than that intended by that loan. This was not merely a case of the bank failing to carry out diligent enquiries but an example of the bank positively knowing about the dishonesty. Had this fact been properly considered and passed to the bank's credit sanctioning team, it might have led to  a greater degree of scrutiny and a refusal of such a ‘full lend’. 

To that end, the court found that the appropriate reduction was 40%. This is not as negative a precedent for lenders as it may first appear because the majority of commercial lending cases will not involve instances of a lender having actual knowledge of a borrower's dishonesty. In the judge’s words, “what would have been reasonable without knowledge of dishonesty was not reasonable with that knowledge”.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at November 2016. Specific advice should be sought for specific cases. For more information see our terms & conditions.


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