Alexandra Anderson sets out why, despite the challenging economic headwinds, valuers should not fear a recession in 2023 because of some of the lessons learnt from the last financial crash.
As house prices stagnate or fall, and the commercial sector faces increasing challenges with operating costs, adding to the pain of the Covid-19 years, many surveyors fear that there will be a significant increase in claims relating to valuations.
Those who were in the market in 2008 will recall the huge volumes of claims that were brought by lenders, particularly in the residential and buy-to-let markets, as banks sought to recover their losses following the credit crunch.
Even if the UK is entering a recession (although that is now under review, with many forecasters changing their predictions), we are confident that valuers are unlikely to see anything like the claims environment that followed the 2008 crisis, or indeed the previous recession in the early 1990s.
Since 2008, there have been several changes to the lending and legal landscape which have substantially reduced the risk of claims. In this article, we consider those changes and why valuers should take comfort from them.
Affordability
One of the biggest causes of claims following 2008 was the fact that many lenders had previously been making loans at very high loan-to-value ratios – 100%, or in some cases even higher.
Any fall in the value of the property on which such a loan was secured guaranteed that the lender would have insufficient equity to cover the loan and would be left looking to the valuer (and professional indemnity insurers) to make good their loss.
Following the financial crisis, not only did lenders scale back their LTVs, to reduce their potential exposure, but the Bank of England introduced the “affordability test”, to ensure that borrowers would still be able to afford to repay their mortgage if interest rates increased by 3%.
Further, they introduced a loan-to-income ratio of 4.5, which restricted the amount that lenders could lend to borrowers. These changes mean that, even with interest rates rising, it is less likely borrowers will go into default; even if they do and the property is repossessed, it is more likely that there will be sufficient equity in the property to clear the debt, eliminating the risk that the lender will bring a claim against the valuer.
One area in which claims were particularly prevalent following 2008 was the buy-to-let market. Prior to 2007, some lenders were prepared to make loans to BTL investors premised solely on the basis that the rental income would be sufficient to cover the mortgage, so they did not have to worry about the borrower’s ability to pay the mortgage from other funds.
Since 2017, the Prudential Regulation Authority has required that the monthly rental income derived from a BTL property must cover 125% of the mortgage payments. Further, the affordability test for BTL applies an increased rate of 5.5% compared to other residential properties. Again, these changes have the effect of significantly reducing lenders’ potential exposure to loans for BTL properties, in turn reducing the risk of claims against valuers.
The legal landscape
Since 2008, there have been several legal decisions that have been of assistance to valuers seeking to defend claims. In K/S Lincoln and others v CB Richard Ellis Hotel Ltd [2010] EWHC 1156 (TCC); [2010] PLSCS 156, the court confirmed the position that a valuer will not be found negligent simply because the valuation they provided was higher than the “true” value as decided by the court, so long as it falls within the permitted “bracket” or “margin of error”.
In Scullion v Bank of Scotland plc (t/a Colleys) [2011] EWCA Civ 693; [2011] 3 EGLR 69, the Court of Appeal confirmed that a valuer will not owe a duty of care to a BTL borrower where they are instructed by the lender, rather the borrower. Finally, in Tiuta International Ltd (in liquidation) v De Villiers Surveyors Ltd [2017] UKSC 77; [2018] EGLR 2, the Supreme Court held that a valuer could not be held responsible for any losses arising from a loan that had been refinanced in reliance on a valuation which the lender sought to criticise, because the loss would have occurred whatever figure the valuer had provided at the point of refinancing.
Changes to costs regime
Probably the most significant factor affecting the likelihood of claims against valuers is the change to the rules on what costs can be recovered in litigation.
Conditional fee agreements, also known as “no win, no fee” agreements, allow litigants to defer payment of their solicitor’s fees until the end of a claim, and even then, they only have to pay if they win the claim. Given the additional risk to lawyers who may have to wait to get paid, or not get paid at all if the claim fails, they charge an uplift to their costs, known as a “success fee”.
Such a fee can be up to 100% of their base costs. Claimants can also take out after the event insurance policies, to protect them against the risk of having to pay the defendant’s costs, in the event that their claim fails.
A significant number of the claims brought by lenders in 2008 to 2012 were funded using CFAs, backed by ATE policies. In the event that the defendant lost the claim or settled before trial, the claimant would add the success fee and the cost of the ATE policy to their claim. Certain lenders instructed lawyers to pursue claims in connection with every loan where they had incurred a loss, irrespective of the merits, on the basis that their exposure in the event that they lost the claim, would be limited to the ATE premium and that, when faced with the potential for costs to escalate out of proportion to the value of the claim, many insurers would settle as soon as possible, rather than defend the claim to trial. No matter how unmeritorious.
There were major changes to the costs regime in 2013 in England and Wales, following a review undertaken by Lord Justice Jackson in 2009. As a result, except in limited cases, success fees under CFAs are no longer recoverable from the paying party; and a defendant is no longer required to pay the claimant’s ATE premium, even if they lose the case. The effect of these changes is to make litigation far riskier and more expensive for lenders. Insurers are more likely to defend claims, knowing that they are not facing the risk of paying grossly inflated costs if they do so, and lose.
Progress within the profession
It is also important to note that both RICS and its members have been doing much to address risk management issues for valuation work.
In January 2014, RICS commissioned a review by Dr Oonagh McDonald CBE to identify the root causes of the issues facing the profession following the global credit crisis. Her report, Balancing Risk and Reward: Recommendations for a Sustainable Valuation Profession in the UK, was published in January 2014 and many of its recommendations have now been implemented.
For example, RICS has published guidance on conflicts of interest for commercial valuers, as well as guidance for panel managers for residential valuations. In July 2016, it also published a guidance note on complaints handling, to assist surveyors in providing a proactive response to complaints and prevent them from escalating into claims.
Alongside the McDonald review, RICS has been working to assist its members to understand the reasons why claims are made, and how to address them. In 2013, RICS published a guidance note, Risk, liability and insurance in valuation work, which was updated in 2018 and subsequently republished as Risk, Liability and Insurance in 2021. Valuers who follow the guidance set out in that note are far less likely to face claims, than those who do not.
There have also been significant changes in the insurance market, with amendments to the RICS minimum terms, which now allow insurers to provide cover in the aggregate, rather than on an “each and every claim” basis. Insurers are also now entitled to require that surveyors contribute their excess to the payment of defence costs, whereas previously they would only have to contribute to the payment of a claim.
Many of the large firms have also seen the level of their excess increase significantly, so that they have a larger exposure to any claims they face. While these developments have increased the financial risks faced by surveyors, they have also had the effect of driving change within the profession, increasing the emphasis on effective risk management to reduce the prospect of claims.
When combined with the elimination or reduction of many external factors that fuelled the claims environment in 2008, these changes are likely to reduce the risk of claims and we predict that surveyors will face a less challenging year than history would suggest, whatever the economic headwinds.
Alexandra Anderson is a partner at RPC
