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The Actuary The magazine of the Institute & Faculty of Actuaries

Equitable legal action in difficulty

Judgment announced on behalf of Mr Justice Langley on 10 February 2003 appeared highly critical of action by Equitable against its former auditors.

Background to the litigation

The House of Lords in Equitable Life Assurance Society (Equitable) v Hyman decided that Equitable did not have the right to adopt a policy of awarding a different terminal bonus to guaranteed annuity rate (GAR) policyholders depending on whether they took their benefits in GAR form or not (the ‘differential terminal bonus policy’). This decision meant that the cost to Equitable of meeting its GAR liabilities was much higher than it had previously anticipated.

In April 2002 Equitable commenced proceedings against Ernst & Young for alleged negligence. It claimed that Ernst & Young ought to have warned the directors that the provisions which Equitable included in its Companies Act accounts in respect of its GAR liabilities for the years ended 1997 to 1999 were inadequate. Equitable claimed that had Ernst & Young advised that higher provisions were required it would not have declared the bonuses which it did over the relevant period and would have put itself up for sale from 1998.

Had a sale been achieved Equitable claimed it would have received up to £2.6bn more than it was worth following the House of Lords decision in Hyman (the ‘lost sale claim’). Alternatively even if a sale was not achieved, Equitable would have reduced terminal bonuses from 1998 such that a saving of £1.6bn would have been achieved by March 2002 (the ‘bonus claim’) Ernst & Young has always maintained that Equitable’s claims were misconceived and entirely without merit. Consistent with that view, in July 2002 Ernst & Young applied to strike out both the sale claim and the bonus claim. That application was heard by Mr Justice Langley in January this year.

Overview of judgment

Mr Justice Langley struck out the lost sale claim. It failed to satisfy the legal test of causation in that, even assuming Ernst & Young had been negligent as alleged, there was an insufficient causal link between that negligence and the loss which Equitable was claiming. The bonus claim was ‘starkly exposed as seriously flawed’. The judge found it to be ‘fanciful in approach and amount’.

The judge has given Equitable the opportunity to advance any proper bonus claim which may exist on the same or a related basis provided that such claim is presented with ‘a rigour and reality’ which the judge found to be lacking in the claim presented at the hearing. If Equitable cannot meet the judge’s objections or declines to accept his invitation, the bonus claim will be struck out which will dispose of the entire claim save for a discrete and minor claim in respect of Equitable’s Guernsey operation.

Key findings: lost sale claim
Equitable’s lost sale claim was, in effect, an allegation that Ernst & Young as auditors were responsible for the fall in the value of Equitable’s goodwill during the period from September 1998 to February/March 2001.

The law requires a claimant to plead a more sophisticated case than simply ‘but for the defendant’s negligence this would not have happened’. The fall in the value of Equitable’s goodwill between 1998 and 2001, even if proved, was not a consequence for which Ernst & Young was responsible. It is not something which properly falls within the general scope of an auditor’s duty. To find otherwise would be to impose upon Ernst & Young a wider obligation and a greater liability than it could reasonably have thought it was undertaking.

Key findings: bonus claim
The bonus claim was shown to have ‘many basic flaws’. The calculation of the alleged bonus savings at £1.6 bn remained a matter of some obscurity notwithstanding Equitable’s attempts to explain it in the particulars of claim, several witness statements, written submissions and at the hearing itself. The amount of the bonus claim was ‘fanciful’.

Equitable’s thesis, that had Ernst & Young insisted on higher provisions for GARs from 1997 Equitable would have cut terminal bonuses in the dramatic manner alleged, was not accepted. The effect of such cuts in terminal bonuses would have been to frustrate the differential bonus policy and assume defeat in Hyman at a time when victory was expected. It was ‘fanciful’ to suppose that the directors would have taken such a step and that, if they had, the goodwill of Equitable would not in any event have been destroyed.

Equitable was not able satisfactorily to deal with a number of other attacks on the bonus claim, in particular the argument that the remedial action taken by the directors post-Hyman mitigated Equitable’s loss or the substantial part of it. The judge considered it right to give Equitable an opportunity within a defined time scale to address these issues in a proper pleading. However, if Equitable is unable to meet the judge’s challenge, the bonus claim will be struck out.

Other findings of interest
The board of Equitable was made aware in September 1998 that the maximum potential cost of losing Hyman was £1.5bn. The documents demonstrate that, provided regulatory solvency requirements were met, the directors were determined to remain a mutual and to resist any approach to merge.

From 1998 the Government Actuary’s Department insisted that substantial reserves for GAR liabilities be included in the regulatory return in any event.

In this context, when the Hyman litigation was under way, the judge found that there was ‘considerable force’ in the argument that the directors would never have resolved to sell the business unless and until the Hyman litigation was lost.