A recent judgment has awarded a buy-to-let investor a large compensation payout based on lower-than-expected rental returns. Property surveyors - and their insurers - should watch out

A surprise legal ruling has sparked fears that the UK insurance sector could soon be hit by further fall-out from the property market crash.

According to leading law firms, the recent decision in the negligence case of Scullion v Colleys could leave professional indemnity (PI) insurers facing a wave of claims from investors in the buy-to-let market trying to recover lost rental income.

In particular, Beachcroft has described the case, which creates new responsibilities for property surveyors, as an “unjust extension of third-party liabilities”.

Great expectations

The trouble began in October 2002, when Emmett Scullion invested in a buy-to-let residential flat, having obtained a valuation from Andrew Collins of Colley, which is now part of the Bank of Scotland. Collins valued the property at £353,000, with rental income of £2,000 per month. However, Scullion was only able to let the flat for around £1,000 per month. He later sold the property in 2006, and received just £270,000 for it.

Scullion then sued Colleys, alleging that Collins had overvalued the flat and provided an inaccurate rental figure. The judge in the case dismissed the first part of the claim but agreed with the rental element, and in the quantum ruling on 8 October, Scullion was awarded compensation of £72,234.

Beachcroft professional risks partner Duncan Greenwood says the implications of the ruling are huge. “The reasoning behind that successful award could have serious implications for surveyors and their insurers.”

He adds that, up until now, surveyors did not have responsibility to guarantee rental income and, more importantly, they were not hired to advise on the potential success of the commercial venture.

“To make matters worse," Greenwood says, "while the property was actually worth what the borrower paid (resulting in his claim for the property's fall in value being dismissed), he successfully recovered the costs of ownership (ie mortgage payments and maintenance costs less the modest rental receipts) for the time that he owned the property, on the basis that he had been relying on the anticipated rental stream to fund these costs."

Duty of care expanded

Greenwood explains that, traditionally, surveyors' rental estimates have been based on current market values and have not been expected to take into account extenuating factors such as the supply of and demand for rental properties in the local area or additional expenses, such as services charges and the cost of managing the property.

In addition, there is the risk of 'void periods', when the property does not have tenants for certain parts of the year. However, the court failed to take these factors into account.

While the judgment is set to be appealed, leading PI insurer Zurich’s professional and financial lines manager, Gail Cook, warns that insurers need to take note of the potential implications of the ruling.

"This case does raise concern and presents questions as to the extent of the duty of care owed by a valuer to third party buy-to let-investors, where in the past this may have been viewed as a commercial trading risk,” she says.

Insult to injury

The level of damages is also causing confusion. Greenwood points out that the judge found the rental valuation was overstated by £900 per month, so logically the damages awarded should not have exceeded £38,700, ie £900 per month over the 43 months of ownership. However, the damages awarded were nearly double this amount.

Berrymans Lace Mawer professional negligence partner Caterina Yandell says: “To add insult to injury, the judge allowed this over an indefinite period during which an offer was made for the property and failed to apply any contributory negligence. In the context of what was to all intents and purposes a commercial investor, this looks to me remarkably like a loss-of-profits award.”

Yandell adds that the ruling has created a new class of claimant in the form of disgruntled investors. “These 'disappointed' purchasers have a whole new angle on which to base their claims. At the very least, insurers of those valuers involved in the buy-to-let bubble of 2006 and 2007 can expect claims from these individuals."

PI broker Lockton’s divisional director, Brian Boehmer, points out that if the Scullion v Colleys ruling stands, it will hit surveyors hard and encourage PI insurers to exit the sector. “It is already a very difficult market. This ruling is not going to assist the surveying community at all.”