Professional Indemnity Bulletin

Arrowhead Capital Finance Ltd (In Liquidation) v KPMG LLP

In July KPMG was successful in its application for summary dismissal of a claim worth more than USD$52 million.

Background

KPMG had been instructed by Dragon Futures Limited ("Dragon") to advise on creating/implementing due diligence procedures to enable Dragon to make VAT input tax claims on the sale and purchase of mobile telephones. In January 2004 the claimant, Arrowhead, agreed to make loans to Dragon on the strength of Arrowhead's business model which required these VAT input claims to be successful.

It transpired that the VAT input tax claims were connected to fraud, something Dragon should have been aware of, and accordingly HMRC rejected its claims for input tax. Dragon subsequently defaulted on the loan repayments, leaving a balance of some $52 million due to Arrowhead.

Assumption of duty/limitation

The claim by Arrowhead was for negligence in failing to carry out sufficient due diligence to identify the connection to fraud. Arrowhead argued that KPMG owed it a duty of care, because it had relied on that due diligence before agreeing to make loans to Dragon.

KPMG responded with a strike-out application. Arrowhead had never been its client, therefore it argued that it could not owe it a duty of care. The Court agreed, on the following basis:

There had been no direct communication between KPMG and Arrowhead prior to the loans being made; There was no evidence to justify a reasonable conclusion by Arrowhead that KPMG had assumed a responsibility to it (the engagement letter between KPMG and Dragon was crucial to this conclusion); Although KMPG would have known that its work would be considered by potential investors, it was not fair, just and reasonable to impose a duty of care on it in these circumstances. KPMG also argued that Arrowhead's claim was statute barred. More than six years had passed since the loans had been drawn down.

The Court concluded that Dragon's covenant to repay depended on its ability to reclaim the input tax. It stated that the loans could only be repaid to Arrowhead if the VAT claims had succeeded, but that those claims were always going to fail (particularly because by November 2004, they had all been rejected by HMRC). The Court therefore held that even if "actual damage" had not been suffered when the various loans were advanced, it had occurred by November 2004, namely more than six years before Arrowhead brought its claim.

Conclusion

The case underlines the importance of carefully drafted engagement letters with appropriate limitations on liability. This was a key part of KPMG's successful strike out application and the Court's conclusion that it would be unjust to impose a duty of care on the defendant.

The judgement also provides further guidance on the...