Scottish Court of Session Decisions

[1] This is one of two actions arising out of the disposal in 1999 by the defender - Mr Sutherland - of licensed premises, namely the Waterfront Bar, owned by him in Wick. The claim in this action is by the intending acquirers, Mr and Mrs Barry, in respect of damage said to have been suffered by them by reason of certain allegedly fraudulent representations made to them. The other related action is brought by Mr Sutherland against Mr and Mrs Barry, claiming certain sums due under the contract concluded between them.

[2] The pursuers' claim for damages arises out of certain allegedly fraudulent representations contained within a set of accounts relating to the business carried on by the defender in the premises which was sent by fax to the pursuers on 29 March 1999 at a time when the premises and business were being offered for sale by the defender. The relevance of the averments of fraudulent misrepresentation is not in issue at this stage but, put briefly, those accounts, which bore to relate to the financial year ending 30 April 1998, showed door takings in respect of the night-club element of the premises in a sum precisely £50,000 greater than the equivalent figure in a set of accounts of which the pursuers obtained sight subsequently to their taking entry to the premises. Those other accounts, which bore to be prepared by a well known firm of accountants, were for the year ending on 31 May 1998 but, apart from the difference in the year end date and the difference in the figures for door takings (with the consequential alterations resulting from the higher figure for door takings), the two sets of accounts are identical. The alleged overstatement of the door takings by the sum of £50,000 has the consequence that the net profit of the business is similarly overstated by £50,000. The net profit shown in the faxed accounts, incorporating that overstatement, was £115,272. The alleged fraudulent accounts sent to the pursuers were provided through an intermediary, acting on the defender's behalf. The defender's position in averment on his behalf is that he supplied trading figures with the lower door takings and consequential figures by fax to that intermediary on 26 March 1999.

[3] The pursuers aver that in reliance on the trading figures sent by fax to them by that intermediary on 29 March 1999 they subsequently entered into a contract with the defender. The contract concluded between the pursuers and the defender is to be found in the missives of 8 October 1999 (No. 6/2 of Process). Although the missives are somewhat lengthy, the basic arrangement was that the pursuers agreed to buy the premises with a date of entry, when the price would be payable, on the day in October 2000 (that is to say in the succeeding year) of the October 2000 meeting of the Caithness Licensing Board. In the meantime, during the period between 12 October 1999 and the date of the Caithness Licensing Board meeting in October 2000 the pursuers agreed to enter into a lease of the premises. The pursuers and the defender entered into the lease thus envisaged. The missives further provided (Clause 31) that the purchasers might resile from the bargain on giving notice to the seller on a date three months before the last date for applications for transfer of licences at the October 2000 meeting of the Caithness Licensing Board.

[4] It is averred on behalf of the pursuers that on taking entry under the lease they were surprised by the low level of the takings of the premises. They then apparently ascertained the existence of the accounts recording the relative figures for door takings (and consequential operating and net profit figures) in the smaller amount of precisely £50,000 less than shown in the faxed accounts upon which they had relied. In light of that and other matters supportive of the view that the faxed accounts were fraudulent they exercised their option under the lease to escape the commitment to purchase the premises. The sale element of the transaction accordingly never proceeded. That being so, the pursuers are not able to say that by reason of the alleged fraud of the defender they were induced to purchase an asset at an overvalue and consequently cannot measure the damage caused to them by that alleged fraud by regard to such an overvalue in capital terms.

[5] Given the fact that the sale provisions of the missives were thus never implemented the claim initially advanced by the pursuers proceeded on the basis of the trading losses said to have been suffered by the pursuers by reason of their having entered into a lease and operated the business, upon which contract, and operation, they would not have embarked but for the fraudulent representations of which complaint is made. In the course of the proceedings subsequent to the transfer of this action to the commercial roll, it became apparent that on the pursuers having entered into possession of the premises the business was not in fact conducted by them but rather by a company - Caithness Leisure Limited - of which the pursuers were the sole shareholders and directors at the material time. It is averred that as the sole directors and shareholders in Caithness Leisure Limited - "the Company" - the pursuers provided funds, principally by way of directors' loans, to the Company to enable it to operate the business in the Waterfront Bar. It is averred that the operation of the business during the period of the lease was not successful and it is said by the pursuers that the company has thereby become insolvent and the funds provided by them as individuals to the Company are now irrecoverable. A forensic accountant's report has been lodged and incorporated in the pleadings. Put briefly, it endeavours to analyse the personal losses to the pursuers through their endeavour to exploit the business through what is termed in the pleadings "the vehicle" of the Company. What is now claimed as damages suffered by the pursuers in consequence of the fraudulent representations concerning the door takings and consequent profitability of the business while under the defender's stewardship is the amount of the sums contributed to the company by the pursuers personally, now said to be irrecoverable.

[6] Mr Clive, who appeared for the defender, invited dismissal of the action on the ground that the averments of loss now made by the pursuers were irrelevant. The claim advanced was a delictual claim for damages. Where a person was induced by fraud to purchase an asset, the measure of damages was the difference in value, at the time of purchase, between the sum paid and the true value of the asset acquired. That measure was exemplified in Bryson & Co Limited v Bryson (1916) 1 S.L.T. 361 and Smith v Sim 1954 SC 357. That measure accorded with the principle that the loss flowing naturally from the misrepresentation must be the difference between the value received and the price paid. Counsel referred also to McConnel v Wright [1903] 1 Ch. 546, in particular the principle set out in that case at 554. Mr Clive then referred, somewhat briefly, to Smith New Court Securities Limited v Citibank N.A. [1996] 3W.L.R. 1051 (also reported at [1997] AC 254).

[7] Counsel for the defender observed that since the present pursuers did not, in the event, proceed to purchase the buildings and the goodwill of the Waterfront Bar, a claim for the difference between the value in the subjects purchased and the price paid was not capable of being advanced. The pursuers had concluded a contract of lease, under which they took entry, prior to the envisaged but unrealised purchase. By analogy with contract of sale induced by fraud the true measure of loss in the case of a contract of lease similarly induced ought to be the difference in the value given - that is to say the rent paid - and the value received - that is to say the true rent payable. No attempt had been made by the pursuers to aver and claim such a loss. While the pursuers relevantly aver that as a consequence of the alleged misrepresentations they had entered into the missives, and the lease, they did not aver losses arising from entering into that contract. The losses in issue arose from the trading operation and were sustained not by the pursuers but by the Company.

[8] The law looked to the proximate rather than the remoter cause. It was plain, on the pursuers' averments, that the primary loss had been suffered by the Company. Reference was made to the well known passage from the Opinion of Lord Kinloch in Allan v Barclay (1864) 2 M. 873, 874 which had been quoted with approval by the Lord President (Clyde) in Reavis v Clan Line Steamers 1925 SC 725. It was plain on the pursuers' averments that the trading losses had been suffered, not by them, but by the company. A loss thus suffered by a Company could not relevantly be claimed by an individual. In that regard counsel referred particularly to Young v Ormiston 1936 S.L.T. 79. There was no express averment that the representations complained of had induced the pursuers to lend money to the Company, a third party. The primary loss having been thus suffered by the Company, any secondary loss reflected in the irrecoverability of the pursuers' investment was too remote.

[9] Counsel for the defender then went on to examine some of the detail of the forensic accountant's report with a view to demonstrating that the losses had truly been suffered by the Company and he submitted that by claiming the loss of the investment, by way of loan, furnished to the Company, the pursuers were avoiding identification of the particular losses incurred simply by reason of the mis-statement of the earlier annual door takings, to which discrepancy any claim for damages ought to be tied.

[10] In his response to the attack on the relevancy of the pursuers' claim, Mr Hammond submitted that the approach of counsel for the defender was over-simplified and indeed mistaken. The pursuers' position was that they were induced by the alleged fraudulent representations to contract for the acquisition of the business of the Waterfront Bar as a capital asset after enjoying the lease of it for approximately a year. It had all along been the pursuer s' intention to use the Company as a vehicle with which to conduct the business. The Company was simply part of their overall decision to acquire and operate the business. Had the pursuers known the true position respecting the profitability of the business they would not have embarked upon that venture at all. Having discovered the fraud perpetrated upon them at a stage at which they were still tenants, the pursuers then used the contractual provision in the missives enabling them to withdraw from the transaction. This was a practical means of bringing the bargain to an end once they had discovered the fraud.

[11] While in many cases, such as a simple sale, it might be appropriate to use the value given and value received test as a measure of the damages sustained by the victim of the fraud who had acquired the asset, it was not always appropriate to do so. Under particular reference to the speeches delivered in Smith New Court Securities, Mr Hammond submitted that, in fraud, the maker of the fraudulent representation was responsible for all the loss directly and naturally flowing from the actings induced, whether or not reasonably foreseeable by the fraudster. In that case the House of Lords gave support to the approach adopted in Doyle v Olby (Ironmongers) Limited 1969 2 Q.B. 15. The same approach had been applied in East v Maurer [1991] 1 WLR 461. Mr Hammond further referred to Downs v Chappell [1996] 3 A.E.R. 344. In short, the principle was that where by reason of a fraudulent representation a person was induced to enter upon a transaction, or a venture, or a course of conduct, to his detriment and from which he would have refrained had he known the untruth of the representation in question, he was entitled to recover the whole losses suffered by him in embarking on that transaction, venture or course of conduct.

[12] Counsel for the pursuers then went on to stress that although the pursuers had inter-posed a company to carry on the business during their tenancy of the heritable property they were not seeking to make recovery in respect of injury done to and loss suffered by the Company. They were seeking recovery of their personal loss by reason of their investing in the Company, which would not have happened but for their being induced to embark upon the whole venture by reason of the fraudulent misrepresentations of which they made complaint. The notion that a person to whom a fraudulent representation of the profitability of a business, or a business opportunity, had been made might recover his loss of his subsequent investment in that business was vouched by authorities such as Gillies v Campbell Shearer & Co (1902) 10 S.L.T. 289 and Manners v Whitehead (1898) 1 F 171.

[13] The principle that the victim of a fraudulent representation concerning the viability of an existing business might recover his loss from his investment in that business was thus well established and the present pursuers could properly claim for the loss of their investment in the Company. Counsel for the pursuers recognised that, in terms of detail, questions would no doubt arise in accountancy terms respecting issues of the causation and the possible mitigation of the pursuers' loss. Those issues however could only properly be addressed after enquiry. The principle of recovery of investment losses was, however, clear.

[14] An enquiry into the nature of the pursuers' losses was therefore appropriate.

[15] In approaching the submissions advanced by counsel I would observe that while the courts and practitioners are relatively familiar with cases in which a basically straightforward sale of tangible business assets and the goodwill attaching thereto has been induced, or allegedly induced, by fraudulent representations on the part of the seller, the present case suffers two particular complications. The first is that the contract between the parties provided for their being in the relationship of landlord and tenant for approximately one year prior to implement of the sale element of their contract in the form of the passing of property or the payment of the price. The second complication is that, while taking entry under the lease provisions of the contract, the pursuers have throughout the period of their tenancy caused the business to be carried on by the Company.

[16] The fact that matters did not proceed to the stage of implementation of that element of the contract comprising the sale necessarily precludes any measurement of loss by reference to a value difference at the transaction date. However, the unavailability of that measure does not mean that there can be no recoverable loss. Counsel for the defenders indeed recognised that such was not the case and suggested that, insofar as the lease provisions were implemented, a claim based on rental values and other incidental losses might be advanced.

[17] I shall revert to the issue of the measure of loss, but it appears to me to be appropriate first to consider that part of the argument for the defenders which is to the effect that the pursuers' claim for the loss of their investment in the Company is too remote. I use the term loss of investment because, as the action is now formulated, the pursuers are not seeking recovery of the trading losses suffered by the Company. They are not seeking to recover, as shareholders or lenders, a loss suffered by the Company for a wrong done to the Company. Indeed, it is not suggested that the fraud was a wrong done to the Company. The pursuers accordingly seek reparation respecting a fraud or wrong done to them and affecting their individual patrimony. To that extent cases such as Reavis v Clan Line Steamers are not truly in point. I would add further that insofar as counsel for the defenders sought support from Young v Ormiston, the soundness of that decision was questioned by the Inner House in Vaughan v Greater Glasgow Passenger Transport Executive 1984 S.C. 32. While it may no doubt be true that the pursuers' loss of their investment in the Company stems initially from the Company's inability to operate the Waterfront Bar profitably, the action is nonetheless one based on the fraudulent representations made to the pursuers and the consequences to which they were led by those misrepresentations to the effect that the Waterfront Bar had a particular level of profitability, which on averment it did not in fact have.

[18] Counsel for the defender accepted that the pursuers had relevantly averred a case of their having been induced by the fraudulent misrepresentations to enter the missives. He contended however that it could not be said that they had relevantly averred their having been induced to lend money to the Company. In my view, although claims for damages in respect of fraudulent representations are commonly advanced where the recipient of the representations has been induced to enter into a contract with the maker of the representations it is plain that the recipient of a fraudulent representation may claim damages from the maker of that representation if he has been induced to act to his detriment by contracting with a third party. A representation concerning the profitability of a future or existing business may induce investment in a company to exploit that business and the investor may have a claim for recovery of his loss investment. Gillies v Campbell Shearer & Co appears to me to be such an example. In that case fraudulent representations by the owners of a gold mine as to its profitability were averred to induce the pursuer to take a shareholding in a company subsequently formed to acquire and operate the mine. A claim for the loss of the value of the shares which the pursuer had taken in the company was held to be a relevant claim arising from the misrepresentations communicated to him as to the profitability of the gold mine. Accordingly, had the present pursuers, by reason of the defender's fraudulent representations as to the profitability of the Waterfront Bar under his stewardship, been induced to become shareholders in a company formed to acquire the Waterfront Bar from the defender under a similar contract to that contained in the missives, the pursuers would in my view have had a relevant claim for the loss of their investment in that company. The essence of the pursuers' case is that they were induced to alter their position to their detriment by embarking upon the venture by reason of the defender's representations as to the profitability of the Waterfront Bar under his management. I do not consider that it can be said, at least in advance of hearing evidence, that the persuasive influence of the allegedly false representations must be confined to the pursuers' entering into a contract whereby they became tenants of the Waterfront Bar and cannot extend to a decision to provide funds to a company under their sole control which they used in order to exploit business carried on in those premises. Put another way, a fraudulent misrepresentation may cause its recipient to proceed upon a plurality of linked steps all stemming from the persuasive effect of the misrepresentation. I accordingly do not consider that at least at this stage it may be said that the pursuers' decision to invest funds in the Company was too remote.

[19] Adverting again to issues broadly subsumed under the concept of the appropriate measure of loss, counsel for the defender contended that the proper approach was confined to a comparison of the value given and the value received at the transaction date. Counsel for the pursuers characterised that approach as wrong in respect that it was an over simplification which would not always be appropriate. I think there is force in that characterisation.

[20] The decision of the Court of Appeal in England in Doyle v Olby (Ironmongers) Limited concerned a claim by the acquirer of a business who had been the victim of a fraudulent representation relating to the extent of the turnover of the business. Having acquired the business he was unable for some lengthy period to dispose of it and incurred substantial trading losses. The judgment given at first instance on his claim for damages awarded a sum judged equivalent to making good the loss of turnover (by comparison to the represented amount) or the deficiency in the value of the goodwill. On appeal that decision was reversed and the award of damages substantially increased. Denning M.R. said, 167:-

The decision in Doyle v Olby (Ironmongers) Limited was viewed approvingly by the House of Lords in Smith New Court Securities Limited v Citibank N.A., which concerned the purchase of shares. In his speech Lord Browne Wilkinson stated that Doyle v Olby Limited established four things:-

His Lordship considered that on all those points Doyle v Olby was rightly decided. He went on later to say, [1999] 3 W.L.R., 1060:-

I pause at this point to observe that in the present case the allegedly fraudulent representations by the defender may be seen has having continuing effect after the conclusion of the missives and inducing investment in the company for the exploitation of the business.

[21] Lord Steyn, who delivered the other leading speech in Smith New Court Securities also agreed (1075D) that the principles emerging from Doyle v Olby (Ironmongers) were good law. Having considered, among other things, the date of transaction rule Lord Steyn went on to say, at 1076H:-

[22] On the basis of those authorities it appears to me that, having been, on averment, induced by the allegedly fraudulent representations of the defender to embark on the commercial venture of exploiting the Waterfront Bar to their financial detriment, the pursuers are entitled to recover the financial loss to them which directly flows from their having embarked upon that course. As was pointed out elsewhere in Smith New Court Securities Limited, the assessment of the victim's loss is of course subject to the establishment of the proper causal link, to which concepts of remoteness may also apply and is also subject to the victim's duty to mitigate his loss.

[23] I did not understand counsel for the defender - who also cited Smith New Court Securities as part of his authorities - to suggest that Doyle v Olby (Ironmongers) or Smith New Court Securities depended on some particularity of English law which conflicted with the principles of Scots law on the liability of the fraudster, who, by his fraud, has induced the victim to proceed to his detriment on a course which the victim would not otherwise have pursued. The observations of the Lord President in Thin & Sinclair v Arrol & Sons (1896) 24 R. 198, 206 are consistent (insofar as they go) with that approach and I also note the views of Professor Thomson in the Stair Encyclopaedia, Vol. 11, paragraph 731, in which the professor expresses the view "that in a case of fraud, the defender's liability is not restricted to those losses which were reasonable foreseeable by the defender at the time the fraudulent conduct took place. He is liable to compensate for all losses directed arising from the fraud, whether those losses were foreseeable or not."

[24] In the circumstances I consider that the pursuers are entitled to an inquiry into their claim for their loss of investment in the Company and I shall put the case out By Order in order that arrangements for the Proof before Answer may be discussed.