Barclays Bank Plc v TBS & V Ltd [2016] EWHC 2948 (QB)

Introduction

Unusual properties are the source of many a headache for surveyors asked to value them. Assessing the similarities and differences between a subject property and other comparable properties is usually an integral part of any valuation. This task is obviously made very much more difficult if there are no comparable properties in the same geographical area as the subject property, or at all. These issues are compounded where there are unusual features to what is being valued beyond its mere physical characteristics – planning permission and development value, rights over the land, or an atypical form of interest in the property, for example. In these circumstances, it is hardly surprising if such a valuation later transpires to be wide of the mark.

Such a situation was at the heart of Barclays Bank Plc v TBS & V Ltd [2016] EWHC 2948 (QB), where the Claimant bank had loaned against the security provided by an unusual commercial property, and the Defendant had carried out a valuation of that property. The Claimant claimed for the loss resulting from its lending, and the issues for Mr Justice Dove to decide were:

1. Was the valuation negligent?
2. Was the valuation causative of any loss?
3. Was any liability of the Defendant overtaken by a subsequent restructuring of the lending?
4. Was there any contributory negligence?

The Court’s finding on the first of these issues was determinative of the case, and it is upon that issue that this case note focusses.

The facts

The property at the centre of the dispute was Manor House in Lynmouth, Devon. It is a Grade II listed building with views of the sea and substantial grounds. There were two other buildings in the grounds which formed part of the subject property: Manor House Cottage, which at the time consisted of a four-bedroom flat and 2 two-bedroom flats; and the Stables, a two-storey building, used for storage at the relevant time.

The seller, Mrs Lovell, occupied the property under a 40-year lease for commercial use from the landlord, Lynton and Lynmouth Town Council. It was in use as a 17-bed care home, Mrs Lovell and her sister were living in one of the two-bedroom flats, and a staff member was living in one of the remaining flats. Mrs Lovell was in her 70s, and wished to sell the care home business as a going concern so that she could retire.

The Watsons approached the Claimant (via their broker) for a loan of £250,000 to purchase the property at the agreed price of £350,000. It was proposed that the loan would be secured on the property, with a period of 15 years and a 12-month capital repayment holiday, with the Claimant contemplating a maximum loan to value ratio of 70%. The Claimant instructed the Defendant to value the property afresh, notwithstanding a previous valuation.

Ultimately, the Claimant advanced loan moneys to the Watsons, who took over the running of the care home. The business then failed, and the Claimant (acting on professional advice) forfeited the lease.

The valuation

The Defendant’s previous valuation informed the fresh valuation, but was entirely superseded by it, with the Defendant re-inspecting the property.

The property’s value was based on the care home business’ value as a going concern. The basic methodology was to calculate a figure for the net annual profit (as multiplicand), and fix an appropriate multiplier having regard to a number of features of the property.

The Defendant had the accounts for the business for the years ending 2003 to 2006, though it made its own calculations of the business’ profitability. The staff costs included overnight cover which was provided by Mrs Lovell at no cost, and management costs amounted to £10,000. The business as trading at that time had staff costs of £130,000, but the Defendant adjusted these to £115,000 on the basis of a two person owner/operator team providing live-in cover. On this basis, the Defendant arrived at a projected profit figure of £75,000. The valuation also gave a notional rental value for the Cottage and the Stables of £18,000 per year.

There were very few comparable properties, because the property was under a short lease not equivalent to freehold (i.e. 125 years or more). The comparables identified were not in the same area as the property, and had multipliers of between 2.4 and 3.7.

In fixing the multiplier, the report noted the following: there was scope for internal redecoration; the lease was relatively secure, having just been re-granted; the Council was likely to be less hard-nosed than a commercial landlord, which was attractive; the market for care homes was fairly buoyant; there was a need for a qualified manager of the care home; there was a proposal to apply for planning permission to link the Manor House with the Cottage and expand the care home; there were reports from the Commission for Social Care Inspection identifying a number of shortfalls which it was assumed the Watsons could address.

The overall valuation produced for the property was £350,000.

The report did not make explicit what multiplier was used, contained a deal of material about notional freehold values, and frequently referred to the agreed sale price (either to justify that price, or rely on it as valuation evidence), all of which was criticised by the Claimant.

The variation of the loan

The Watsons disputed the meaning of the repayment holiday, and so made no payments at all during the first year of the loan. Consequently, the loan was then restructured. In effect, the Claimant advanced a further sum of money, clearing the overdraft which had accrued, and the Watsons’ repayments were increased for the remainder of the term of the loan. The result of this was that the loan to value ratio reached approximately 76%.

The expert evidence

Both experts agreed the correct approach was to multiply the projected net profit of the reasonably efficient operator by a figure representing the time over which the lease allowed that profit to be made. It was agreed that selecting a multiplier is an exercise of judgment, and is not a formulaic process. The figures provided by each expert as to the fee income and non-wage costs of the business were very similar. Each took the figure of £150,000 as a starting point for gross wage costs.

The differences between the experts can be summarised as follows:

The judge’s decision

The law was uncontroversial. The starting point is whether the valuation falls outside the permissible margin of error. If it does, that is an indicator of negligence only (albeit a strong one), and it is open to a defendant to argue that it did discharge its duty of care notwithstanding the result. If the valuation does not fall outside the permissible margin of error, no further inquiry arises.

The first step for the court is therefore to produce its own valuation for the subject property, and then to decide what the permissible margin of error is in the particular case. The permissible margin of error can vary from 5-15% depending on the nature of the subject property, but could be even higher in appropriate cases where the subject property has exceptional features (following K/S Lincoln v CB Richard Elis Hotels [2010] PNLR 645).

Though both parties submitted that the other’s expert evidence ought to be disregarded, the Judge did not accept this. He acknowledged that the Defendant valuers had been faced with challenging circumstances in this case: it was unusual for a care home to be under a lease of this length, and the physical properties of the property were highly unusual. Despite this, the appropriate margin of error was 15%, as the property was not exceptional enough to justify any higher margin.

It was uncontroversial that the profitability of a business should be assessed on the basis of a hypothetical reasonably efficient operator, which may well differ from its profitability under the current operator. Any profit or turnover attributable to the identity of the current operator ought to be excluded from this assessment.

As a matter of fact, it was likely that the property would be purchased by a two-person owner/operator team, and its profitability ought to be assessed on that basis. The care home was small, with on-site accommodation, and the owner/operators would likely be actively involved in running the care home. The Judge rejected the conclusions of the Claimant’s expert in relation to the need for a manager, as the owner/operators would likely simply acquire the requisite qualifications to manage the care home, and a manager was only employed at the time of the valuation due to Mrs Lovell’s wish to retire and her waning interest in the business. There was no need to include the cost of a manager in the wage costs.

Though the Judge found that the cost of a manager should be excluded from wage costs, he did not accept the wage costs figure of the Defendant’s expert, finding that £5,000 or so of the deductions applied included some speculation. The correct wage costs figure was £115,000, producing a projected profit £77,500.

As to the additional floor space, it is correct as a starting point only to attribute value to floor space which adds to the business’s revenue. However, that was not appropriate in this case: the residential floor space produced a saving in accommodation costs for staff and the owner/occupiers, and the Defendant’s expert was correct that the terms of the lease allowed it to be used for holiday lets, for example. Its planning potential should be ignored, however, as no costs had been calculated for this. The additional floor space was relevant, and justified increasing the multiplier.

As to the multiplier, positive factors were: a 40 year lease is a long term investment; the identity of the landlord; the seafront location; the fact that the property is an elegant listed period home; the buoyant care home market. The state of repair of the property was a neutral factor, as any costs incurred increasing the standard of accommodation in the care home would likely generate higher fees. The Judge accepted that an inspection had identified a number of issues with the care home, but these related more to its management than the property itself, and were capable of being remedied. For the most part, the Judge preferred the evidence of the Defendant’s expert, stating that a multiplier of 4.25 was appropriate. The Claimant’s expert also conceded in evidence that a multiplier of 3.5 would be appropriate if excluding the additional floor space – the same position as adopted by the Defendant’s expert in his cross-checking calculations.

The value of the property was £330,000, rounded up. The Defendant’s valuation of £350,000 was therefore within the permissible margin of error, and could not have been negligent, whatever complaints the Claimant levelled at its methodology.

Briefly disposing of the remaining issues, the Judge found that a negligent valuation would have caused loss, as (although the loan offer preceded the valuation) there would be an implied term in the loan offer that it was conditional upon receipt of a satisfactory valuation. The restructuring of the loan was not relevant as (contra Preferred Mortgages v Bradford and Bingley PLC [2002] EWCA Civ 336) the charge was not redeemed in this case and the restructuring was in reality an accounting exercise which did not extinguish the Defendant’s duty. Contributory negligence was purely an academic point in the circumstances, and was not considered.

Conclusion

This case is not a controversial development in the law so much as a useful example of how to approach the valuation of an exceptional property. It will likely be some comfort to those representing defendant valuers to see a fair degree of indulgence afforded to the Defendant in this case, in line with a number of pro-valuer decisions in the second half of 2016. As for potential claimants, the case drives home the importance of establishing that the end result of the valuation is wrong, and just how drastically wrong it may have to be when dealing with an unusual property. What is notable here is that even when faced with a subject as exceptional as the Manor House – for which no truly satisfactory comparable properties could be found – the court was still not willing to find that the permissible margin of error exceeded 15%.