The case is Law Society v Sephton & Co. (a firm) & Ors [2006] UKHL 22. To cut to the chase, the question, and the Lords' answer were as follows, in over-simplified terms. Q. In an action for negligence, an ingredient of that action is actual damage. Where negligence has caused a contingent loss – i.e. the possibility of damage – does the cause of action accrue when the contingent loss is incurred, or only when the contingency, the possibility, becomes a reality? A. The cause of action accrues when the contingent loss becomes a real loss, and not before.

The House of Lord was unanimous, and the three full judgments by Lords Hoffman, Walker and Mance are, with respect, mutually consistent. It looks like an example of masterful clarity in resolving a problematic issue. Whether matters do prove straightforward, only time will tell.

The majority of the Court of Appeal held the same as the Lords at Law Society v Sephton & Co. & Ors. [2004] EWCA Civ 1627.

The central facts are not complicated. By way of background, the Law Society manages a fund, under a statutory scheme, to compensate clients who become victims of dishonest solicitors. In Law Society v KPMG Peat Marwick [2000] 1 WLR 1921 the Law Society argued that the accountants who had audited the accounts of a solicitor, and reported on the accounts to the Law Society, owed a duty of care to the Law Society. If the accountants negligently failed to spot a problem in the accounts, then the Law Society could potentially look to the accountants for compensation of any losses it incurred. The Law Society would lose money if they ended up having to pay out compensation for problems which a non-negligent report would have prevented. The Court of Appeal agreed that there was sufficient proximity between the auditors and the Law Society for the Law Society to be owed a duty of care.

As an aside, the compensation fund has no enforceable obligation to pay compensation in any particular case. This never became an issue, because of course they do have to manage the fund in a fair way, and their exercise of discretion when they decide whether to make a payment is amenable to judicial review.

Law Society v Sephton is very much the same kind of claim as Law Society v KPMG. Sephton & Co. were accountants who audited a solicitor's accounts. The solicitor helped himself to substantial sums from the client account. That would have been obvious to any accountant who looked at the accounts properly. So Sephton & Co., or rather the relevant person at that firm, were if not dishonest, then negligent when he gave the solicitor a clean bill of health to the Law Society.

The case against Sephton & Co. dragged on. One reason was that parties agreed to wait for the outcome of Law Society v KPMG before litigating it. That seems sensible. There was an argument that this agreement meant that Sephton & Co. were estopped from pleading limitation by that agreement. The courts below found that there was nothing sufficiently clear-cut in the communications for that argument to run, and it did not reach the House of Lords, and need not detain us here. The moral is clear. If the parties agree to delay a case to await the outcome of a test case or the like, limitation issues must be considered and where necessary communicated between the parties.

Since this is a limitation case, I give the specific dates. Money was stolen 1988-1995. Law Society's investigator reported a problem on 20 May 1996. First claim against Law Society's compensation fund 8 July 1996. First payment made from the fund October 1996. Claim form issued 16 May 2002. A further claim, for fraud (not mentioned in the judgments in the Lords), was issued in December 2002.

As readers know, the limitation period for negligence is 6 years from date of damage, or 3 years from date of knowledge. Given that the Law Society had knowledge of the problem in May 1996, and claimed in May 2002 that '3 years from date of knowledge' rule was no help to them. So the only question was whether 16 May 2002 was more or less than six years after the date of damage. At what date did the cause of action accrue? Was it when the misleading certificate allowed the solicitor to continue stealing money – hence creating a liability for the Law Society to compensate the victims? That was more than six years before the claim. Was it when the claims were made against the Law Society (just within the six years), or when the Law society decided to pay the claim (also within the six years)? The answer was the 'damage' occurred on the date the Law Society decided to pay the first claim.

The logic is that the cause of action was not complete until the Law Society decided that they had to pay compensation. Until then there was always a chance that the lost money would be recovered or that the clients of the dishonest solicitor would be compensated from some other source. Under those circumstances it was premature to launch a claim, and time had not started to run.

To reach this conclusion the House of Lords distinguished a number of situations which appear to lead to the contrary conclusion. For example, in cases where some damage had occurred as soon as the wrong was committed, but where the substantial losses occurred later, time started to run when the wrong was committed. In the case of a mortgage lender who lent against a negligent undervaluation of the collateral, if the lender's security was worth less – even very slightly less – than the money they advanced, their 'net worth' was immediately diminished. If on the other hand the lender was induced to lend four fifths of the value of the collateral when they believed they were lending two thirds of the value, that was contingent loss. They had not lost anything when they advanced the loan, there was always a chance they would not lose. The distinction between a contingent loss and an immediate loss would seem to some people a bit artificial, though their Lordships did not find it so.

If you have a chose in action - a basis for suing someone – then, although your chances of winning are merely contingent, that chose in action is a thing of value, and loss is incurred the moment it is diminished in value by negligence, for example where a solicitor negligently allows the limitation period to pass before issuing proceedings. Therefore, if there is a chance you will make a claim, and a chance that claim will succeed, and the value of the claim is decreased or extinguished by negligence, at that date the cause of action accrues. If there is a chance that someone will make a claim against you, and the value of that claim is created or increased by negligence, no cause of action accrues at that date. The cause of action does not accrue until after the claim is made. More precisely, it accrues when you decide, or are obliged, to settle the claim. The House of Lords thought that the fact that an accountant might make financial provision for the possibility of a claim is neither here nor there. It does not affect your true 'net worth.'

The logic of this decision applies of course also to an action for fraud. It is trite law that damage is an essential ingredient of a cause of action for fraud. Bullen & Leake Precedents of Pleadings (2001) ch.48 cites House of Lords authority: Bradford Building Society. v. Borders [1941] 2 AllER 205 at 211. Viscount Maugham says, clearly, if laconically 'It must be proved that the plaintiff has acted upon the false statement and has sustained damage by doing so.' If there is no loss for the purpose of a negligence action until the contingent liability crystallises, the same is true of the fraud action. As well as claiming for negligence, The Law Society had claimed against the defendant accountants, Sephton & Co. for fraud (i.e. that the reports giving the dishonest solicitor a clean bill of health were made dishonestly). Not only did time begin to run for fraud on the same day that it begun to run for negligence. Until that day, neither cause of action was complete, and a claim for either would there have been unsustainable. The point is not explained in the Court of Appeal judgments, but evidently the reason the fraud action was time barred was because the claim was issued later than that for negligence, and after the Law Society had taken its first decision to pay compensation. The arguments in the Court of Appeal revolved around an attempt to extend the limitation period using the date at which the Law had or could reasonably have acquired knowledge. The argument was not strong, and there is no need to examine it here.

By way of footnote, the Court of Appeal judgment is potentially confusing because Neuberger LJ says, 'It was rightly common ground between the parties that, if the Society had a claim against Sephtons in fraud, a fresh cause of action arose out of each Report.' This does not mean that the cause of action accrued when the report was made, as the Court of Appeal Order (at the end of the judgment) shows. The cause of action in fraud as, well as in negligence, accrued when the Law Society first resolved to make payment out of the Compensation Fund. I should add that in the Order there is a typo which adds to the risk of confusing the casual reader: 'Fraud Action (1) Are the Claimant's claims against the Defendants statute barred by reason of the provision of the Limitation Act 1980? Answer: No.' That should clearly be 'Yes'. The order goes on to say, 'Accordingly there be judgment for the Defendant in the Fraud Action only.'

To summarise, if you have an economic loss which is purely contingent, time does not start to run for a negligence action or a fraud action until, at the earliest, the loss, of which the wrong created a risk, actually occurs. The argument fails if there is an sense in which contingent loss is not purely contingent, that is, if there was some real loss, or loss of 'net worth', in terms of recognizable assets and liabilities, which occurred before the main risk turned into a reality. It seems the value of a collateral security is net asset, but the risk of the secured creditor's default is not a net liability; a chose in action in an asset but a risk of being sued is not a liability.

Dr John Birchall - Professional English, Legal English, and Common Law Training