CASE COMMENT: McCLEAN v. THORNHILL

By Joel Nitikman, K.C.

In Part II of my article “I Am Sure I Am Right (But I Might Be Wrong): A Tax Professional’s Duty to Warn a Client About Weaknesses in a Tax Opinion”,1 I referred to the U.K. trial decision of David McClean v. Andrew Thornhill QC [now K.C.].2 That decision has now been affirmed by the Court of Appeal for England and Wales. What follows is a summary of the appeal decision.

The appellants (plaintiffs below) were some of the persons who had invested in a film tax shelter involving various limited liability partnerships (“LLPs”). The LLPs were formed for the purpose of participating in the distribution of films. Participation in the LLPs was marketed to investors on the basis that, for income tax purposes, they would be entitled to deduct losses that the LLPs were anticipated to incur and thereby shelter their regular employment or business income. Because of new U.K. tax decisions handed down between the time the LLPs were formed and the time they were audited, the tax scheme failed. Her Majesty’s (at the time) Revenue and Customs (“HMRC”) denied almost all of the appellants’ (and all other investors’) claimed tax deductions. HMRC made a settlement offer to the investors, all of whom accepted.

Thornhill was a tax barrister, although here he was acting as a solicitor. The promoter of the LLPs retained him to give the promoter an opinion on whether the tax shelter “worked”—that is, whether the LLPs would have losses that the investors could deduct. He said “yes” in an unqualified opinion. Thornhill knew that his opinion would be given to the investors. However, the information memorandum (“IM”) under which the LLPs were marketed said that the investors were advised to obtain their own tax advice in respect of the tax shelter and, in fact, had to sign a form confirming that they had received such advice before they could purchase units of the LLPs.

When HMRC denied most of the tax deductions, the appellants sued Thornhill. The appellants claimed that Thornhill owed them a duty of care in respect of the advice he gave to the promoter. The appellants had (they claimed) relied on that advice in acquiring LLP units and argued that Thornhill breached that duty of care.

The trial court concluded that Thornhill did not owe a duty of care to the appellants (then plaintiffs) for his advice in relation to the tax losses. Thornhill was not engaged to advise the plaintiffs and they were not his clients. Thornhill could assume, reasonably, that the plaintiffs would obtain independent tax advice, as the IM advised them to do (and indeed as they were required to confirm that they had done).

Insofar as the claim was based on Thornhill’s failure to warn the plaintiffs that there was a significant risk that his opinion might be wrong, the trial judge found that the promoter had represented, implicitly, to the investors that the promoter’s understanding of Thornhill’s tax analysis (that the tax shelter worked) was consistent with Thornhill’s opinion. But, the trial court held, this told the investors nothing about the terms in which Thornhill’s opinion had been expressed or the extent (if any) to which it was qualified by any risk warnings. Therefore, Thornhill had not, directly or indirectly, represented to the plaintiffs that his opinion was right absolutely, so he had no duty to warn them that it might be wrong.

Moreover, even if Thornhill owed the plaintiffs a duty of care, he would not have breached it. On a detailed review of the tax law as it stood at the time and as it had developed since then, the trial court concluded that Thornhill’s opinion was one that a reasonably competent tax Q.C. could have given.

In addition, the plaintiffs had not established that Thornhill caused their losses. As a matter of law they could not claim, and as a matter of fact they could not prove, that the schemes would not have been promoted at all if Thornhill had advised the promoter correctly.

The plaintiffs appealed. The Court of Appeal dismissed the appeal in a lengthy judgment by Lady Justice Simler. Lady Justice Carr wrote a much shorter concurring opinion. Sir Julian Flaux, Chancellor of the High Court, agreed with both.3

On appeal, the appellants’ arguments were as follows: i) The judge was wrong to treat this case as raising a question whether an adviser on one side of a commercial transaction owed a duty of care to the opposing party. Mr Thornhill was not acting as an advising barrister in any ordinary sense. He was intentionally making himself part of the sale process in relation to its most critical aspect. As the judge found, there was no conflict of interest. ii) Correctly characterised, this is a prospectus case, which is distinguishable on the facts from NRAM.[4] A prospectus such as the IM is a classic source of pre-contractual representations despite seller and buyer being on “opposite sides of the transaction”. Mr Thornhill was essential to the selling of the Scheme and expressly consented to the contents of his opinions being reflected in the wording of the IM (which he approved) without any disclaimer of responsibility. iii) In relation to the language and legal effect of the IM and core documents, Scotts [the promoter] properly accepted responsibility for the contents of the IM and represented that: a) it believed the tax benefits would be available to appropriate individuals; b) it had taken reasonable steps to check this position; c) those reasonable steps included taking advice from Mr Thornhill; d) Mr Thornhill had given unequivocal advice that the position was as set out in the IM. iv) Neither the warranties set out in the subscription agreement, nor the statements signed by investors for SAD2 and SAD3 [the LLPs] in the checklist, nor the statement in the IM that prospective investors are “advised to consult their tax advisers” affect this analysis. In particular, the judge was wrong to treat relevant provisions of the IM and subscription agreement as requiring investors to obtain duplicative tax advice covering the same ground as covered by Mr Thornhill’s opinions, namely the likely availability of the tax benefits as a matter of general principle. On a proper construction of the relevant provisions, they only required investors to take advice on their own individual tax positions against the backdrop of the advice provided by Mr Thornhill. v) The judge was wrong to conclude that it was unreasonable for investors to rely on Mr Thornhill’s advice without making independent inquiry in relation to the likelihood of the Scheme achieving the tax benefits and that Mr Thornhill could not reasonably have foreseen they would do so. Independent inquiry plays no part in the NRAM test at paragraph 19 properly construed. Even if it did, the inquiry would have to be of an adviser of equivalent status. As the judge himself emphasised, any such inquiry by an investor or their adviser, would to Mr Thornhill’s knowledge, absent a disclaimer of responsibility, start with reasonable reliance on Mr Thornhill’s unequivocal endorsement of the tax benefits. These facts accordingly supported the existence of a duty of care and did not prevent a duty of care from arising. vi) Accordingly, it was reasonable for the appellants to rely on the representations and assertion that there was no doubt that the Scheme would work to obtain the tax benefits; and further, it was reasonable for Mr Thornhill to have foreseen that the investors would do so. He was an expert whose conclusions were central to the investments which the investors were being persuaded to make and chose to allow himself and his advice to be used to sell the Scheme. He voluntarily chose to act in a way which most barristers would never act and allow his definitive advice to be identified as the basis for investment. vii) The judge was also wrong to draw any distinction between the investors who saw (or whose IFAs [independent financial advisers] saw) Mr Thornhill’s opinions and those who did not. Given the express acceptance of responsibility by Scotts, the naming of Mr Thornhill, the availability of his advice and the statements as to the taxation effects on investment, the IMs were informing the investors of the material terms of Mr Thornhill’s opinions. If those opinions had been qualified in any way, the terms of such qualification would have had to be set out in the IMs but they were not. viii) The judge was also wrong to decide that UCTA 1977 [Unfair Contract Terms Act 1977] did not apply so as to make the warranties in the subscription agreement subject to the requirement of reasonableness within section 2. The warranties were in substance and effect, a “no reliance” clause, intended to exclude liability on the part of Scotts and Mr Thornhill. Had the judge correctly concluded that UCTA 1977 applied, he ought then to have decided that the warranties did not satisfy the requirement of reasonableness given their terms, their lack of clarity and the drastic consequences of a requirement that investors were required themselves to investigate whether the tax benefits of the Scheme would be achieved.5

Significantly, the appellants did not argue that Thornhill had a duty to warn them that his opinion might be wrong. But see below under “Breach of Duty”.

COURT OF APPEAL’S DECISION Justice Simler

Justice Simler analyzed and dismissed each of the appellants’ arguments.

Duty of care

On Thornhill’s potential duty of care, the important point was that the investors were, in essence, the opposite party to the LLP transaction on which Thornhill was advising. The issue, therefore, was whether the facts met the NRAM test for a professional having a duty of care to the opposite party. Justice Simler held that, generally, a lawyer does not owe a duty of care to the opposite party, but one might “exceptionally arise” where the lawyer makes representations to the other party on which the other party relies.

However, such reliance is not enough to create a duty of care. In addition, it must have been reasonable for that party to have relied on the lawyer’s representation and the lawyer should have foreseen reasonably that it was likely that the other party would do so. It is “presumptively inappropriate” for a party to rely on opposing counsel’s opinion and it will be for the plaintiff to show that the plaintiff was entitled to rely on it without investigating independently whether the lawyer’s representation was accurate.

On a related point, Thornhill neither stopped being a tax advisor to the promoter nor became a neutral or independent tax expert on which all parties could rely. He was at all times the promoter’s tax advisor, so that the rules above for opposite parties applied. That conclusion was not affected by the fact that everyone had a common interest in the tax shelter working and the tax benefits being achieved. The investors and promoter remained “commercial counterparties to an arm’s length transaction”. It was reasonably to be expected that anyone in the investors’ position (i.e., “with sufficient wealth and potential tax liabilities to be a potential investor in a tax avoidance scheme of this kind”) would and could obtain “easy and convenient access” to independent tax advice.

The conclusion was that, in these circumstances and absent good reason to the contrary, the “default expectation” was that the appellants would not rely on Thornhill but would obtain their own tax advice.

Nor did the IM, on a fair reading, promise that the tax deductions would be allowed by HMRC. The IM stated that its tax analysis was based on the promoter’s “understanding of current UK tax legislation and published practice”. This qualified any representation being made. It made it clear that the promoter was saying simply that it believed Thornhill’s tax advice to be correct, not that either the promotor or Thornhill represented or promised that it was correct. The promoter represented that it believed that the tax shelter would work and the tax benefits would be available. It did not say that the promoter was right to have that understanding (or belief) and “there is nothing that can fairly be construed as any sort of guarantee that the tax benefits would materialize”.

The IM’s only representations as to Thornhill’s advice were that the IM’s tax analysis was based on the promoter’s understanding of current law and practice, that it had obtained advice from Thornhill and that the IM’s tax analysis was (by implication) consistent with his advice. That did not morph into a representation that his advice was correct and “still less that his advice was unequivocal” (although in fact it was—see below).

Nor did Thornhill’s agreement with the IM’s tax advice create an “unequivocal representation” that HMRC would allow the claimed deductions: “His unequivocal statements of legal opinion about the legal effects of the Scheme were not statements of fact that there was no doubt that the Scheme would work to obtain the tax benefits”.

And, on that point, Justice Simler rejected the argument that any doubts that Thornhill had on the ability to claim the deductions had to be stated in the IM. If he had such doubts but nevertheless thought that they could be overcome on a correct legal argument, such doubts did not have to be stated expressly in the IM’s summary of the tax ramifications of the investment.

Breach of duty

Having held that there was no duty of care, Justice Simler went on to ask if Thornhill would have breached his duty had he had one. She held he would have.

Thornhill’s opinion turned on whether the LLPs were trading on a commercial basis with a view to profit. According to Justice Simler, the proper way to ask the breach question was as follows: “could a reasonably competent tax silk [“silk” is a U.K. term for a K.C.] have advised that there was no doubt that the LLP was trading on a commercial basis with a view to profit without any qualification at all?”

Justice Simler emphasized that this was not the same as asking if there was a separate duty to warn that Thornhill’s opinion might be wrong, but rather a question of what Thornhill should have advised investors on a reasonable basis had he owed them a duty to give them advice (which he did not). According to Justice Simler, Thornhill knew (or, in this hypothetical scenario, would have known) that the investors would rely on him for advice on this critical point. While the IM contained certain risk warnings, they were general in nature; there were no specific warnings as to the satisfaction of the three critical tax issues. Accordingly, Justice Simler concluded that Thornhill’s unequivocal opinion would have been a breach of duty (had there been one):

In the circumstances of this case and in light of his findings, it seems to me that had the judge addressed the gravamen of the appellants’ case on breach, he could not but have concluded that no reasonably competent tax silk could have expressed such an unequivocal view in relation to the three statutory tests, even on the strength of Ensign Tankers [the leading U.K. decision at the time Thornhill gave his opinion]. This unequivocal view did undermine the accompanying warnings in the IM. Non-negligent advice would, at least, have acknowledged that no two cases are factually the same, and accordingly no existing authority could be said to cover the circumstances of the LLPs’ case exactly; and that the three statutory tests each engaged a risk of challenge by HMRC. Accordingly, notwithstanding the presence of IFAs and the requirement for investors to take their own tax advice on the tax consequences of the Scheme, I consider that reasonably competent tax advice should have identified the risks. To this extent only, in my judgment the judge was wrong to conclude that had a duty of care been owed by Mr Thornhill to the appellants, it would not have been breached.6

Speaking for myself, I think Justice Simler drew a very fine line here. She did not say that Thornhill had (or would have had) a duty to warn that his opinion might be wrong, but that there was (or would have been) a duty to say that, in light of the case law as it stood at the time, Thornhill could not say unequivocally that the facts were covered by precedent, so that HMRC might challenge the deductions (even if he honestly and reasonably believed that it would lose that challenge). Intellectually, I see the distinction. In practice, it appears to me to amount to very much the same thing.

Causation and reliance

However, had Thornhill had a duty of care and had he breached it, it would not have mattered because the appellants could not prove causation. They argued that, had Thornhill drafted his opinion to the promoter properly, the IM and its tax advice “could not have been expressed in the terms they were” and so the deal never would have occurred; no investor would have invested in the LLPs.

Justice Simler was not persuaded: Even if Mr Thornhill negligently overstated his advice, I am not persuaded that non-negligent advice would have warned that there was a significant risk of a successful challenge to this Scheme. This was the appellants’ own self-imposed threshold for success on causation on the above basis. The appellants came nowhere close to establishing this or that the IM would have had to be differently worded, for the reasons given by the judge. As the judge held, Mr Thornhill could at one and the same time hold and express a very firm view as to the answer to the trading question, while acknowledging that an alternative view might be taken by others. On this basis I cannot see that the IM would have required any different wording. In my view the judge’s conclusion on this aspect of the case on causation cannot be impugned.7

Again, Justice Simler drew a very fine line. She held that Thornhill’s opinion (had he owed the appellants a duty of care) should have said that HMRC might challenge the deductions because the application of the law to these facts was uncertain, yet also held that Thornhill could warn of a challenge without believing it had any real hope of succeeding and so the tax advice in the IM was appropriate.

Justice Carr

In her concurring opinion, Justice Carr held (despite her initial reservations to the contrary) that Thornhill had no duty of care to the plaintiffs. In her view:

A specialist professional who voluntarily provides unequivocally positive advice to their client in the knowledge: i) that the advice would be made available to a third party without any express disclaimer of responsibility; and ii) that the third party would be likely to “take comfort” from that advice and (with their advisers) be assisted by it in deciding whether to enter into a financial transaction, exposes themselves to the risk of a claim that they owed the third party a duty of care based on an assumption of responsibility.8

However, despite there being “multiple factors pointing in favour of the existence of a duty of care”, at the end of the day they were “not enough to get the appellants home”. The IM was the “gateway” to Thornhill’s opinion. By telling the investors to get their own tax opinions and, probably more importantly, by telling Thornhill that no investor could buy LLP units with- out confirming in writing that they had obtained such advice, the IM negatived any duty that Thornhill might otherwise have owed to the appellants.

Conclusion

The takeaways from this appellate decision are as follows:

1. a tax shelter in the form of an unregulated scheme that can be accessed only through authorized professionals is more akin to an arm’s length sale transaction than a prospectus case;

2. opposing counsel do not, as a general rule, owe a duty of care to the other side in a commercial transaction;

3. to have a duty of care, it must be reasonable to assume that the other party will not make independent inquiries as to the correctness of the lawyer’s representations;

4. a party’s statement that it believes its views on a particular point to be true after having taken legal advice on the point is not a statement that the advice is correct; in fact, it is implicitly an invitation to obtain independent advice on the point;

5. a party’s requirement to certify that he or she has obtained independent advice, particularly where that party has (or can be assumed to have) a high net worth and suitable investment sophistication, will, in most cases, absolve the opining lawyer from having a duty of care to those so certifying; and

6. when the state of the law or the application of the law to the facts is uncertain, an opinion must say so or otherwise acknowledge that the opinion could be challenged; there is no requirement to say it could be challenged successfully, if a competent tax lawyer in the same position reasonably would not think it would be.

Endnotes

1. (2023) 81 Advocate 349.

2. [2022] EWHC 457 (Ch).

3. [2023] EWCA Civ 466 [McClean].

4. Steel v NRAM Ltd (formerly NRAM Plc), [2018] UKSC 13, a decision that restated the test for when a person has assumed responsibility toward another.

5. McClean, supra note 3 at para 85.

6. Ibid at para 167 [emphasis added].

7. Ibid at para 170 [emphasis added].

8. Ibid at para 175.