LENDER BREACH OF TRUST CLAIMS GRANT CRAWFORD Radcliffe Chambers

Transcription

1 LENDER BREACH OF TRUST CLAIMS GRANT CRAWFORD Radcliffe Chambers 1. It was, surprisingly, not until the decision in Brown v IRC (1964) 42 TC 54 (HL), that it became clearly established that a solicitor holds his client s money upon trust for the client. In that case a solicitor was assessed to income tax on the interest earned on moneys in client account. The solicitor claimed earned income relief. The General Commissioners decided that the interest did not belong to the solicitor at all, but to the clients. The solicitor was bound to account to the Revenue for the tax on the interest, and the assessment was upheld. Appeals to the First Division of the Court of Session and the House of Lords were dismissed. The inconvenience of a solicitor being obliged to account to a large number of clients for small sums was remedied by section 8 of the Solicitors Act 1965, which provided that the Solicitors Accounts Rules could provide either for each client s money to be kept in a separate account, or for the solicitor to make payment of an amount equivalent to the interest which would have been earned in such an account out of his own moneys. The current provisions are contained in section 33 of the Solicitors Act 1974 and Part 3 of the SRA Accounts Rules By the time of the property crash in the early 1990s which exposed one of the periodic rashes of over-exuberant lending, banks and building societies sought to pass on the consequences of their imprudence to their solicitors and the solicitors insurers. But claims in negligence often faced problems of causation and contributory negligence: even if the solicitor had pointed out that the price of the property had been inflated by artificially inserted subsales, or that the borrower was financing the purchase with other borrowing secured on the property, wouldn t the loan have been made anyway? In their remorseless quest for increased market share, wouldn t the lenders have lent to anyone (provided the valuation was high enough), especially since their 1

2 own examination of the borrowers financial status ranged from cursory to non-existent? And wasn t part of the loss caused by the fall in the market rather than the solicitor s negligence? 3. Some clever lawyers thought the answer might lie in the fact that a solicitor held his client s moneys on a bare trust for the client, to apply them in accordance with his directions. Contributory negligence was not a defence to a claim for breach of trust; a trustee was under an unqualified duty to carry out his trust. And if he misapplied the trust funds, wasn t he bound to reconstitute them? So if a solicitor s authority was to apply his client s money in the purchase of property and to obtain a first legal charge over the property to secure the advance of the money to the purchaser, couldn t he be required to replace the money without further ado if, in fact, he applied the money without authority? In particular, couldn t he be required to replace the money if he applied it in a transaction which was different from the one authorised, for example, a purchase for 2 million, which, because of artificially inserted subsales, was really a purchase for much less? 4. Such claims met with initial success. The lenders strategy was to seek summary judgment or an interim payment or both, with a view to avoiding the expense of a trial. Perhaps the first example was Alliance & Leicester BS v Edgestop Ltd (1991) [1999] Lloyds Rep PN 868, where three mortgage loans had been obtained on the basis of purchase prices which had been artificially inflated by the interposition of sub-sales; Hoffmann J ordered interim payments to the lender. Target Holdings Ltd. v Redferns [1996] AC 421, (in which leading counsel for the lender in Edgestop again appeared for the lender) was another such case. There was an extravagant series of sub-sales even for those days, and the standard form claim was brought. But the solicitors files revealed what was believed to be an unexpected bonus: the solicitors had parted with the purchase moneys before the transfers had been received and the charges executed; neither occurred until some days later. 2

3 5. The facts of Target were briefly as follows. Nineteenth century commercial premises in the Jewellery Quarter of Birmingham, which were registered under two titles, and which were, no doubt, thought to be ripe for development, were purchased for 775,000. Two sub-sales followed, the first for 1,250,000, the second for 2 million. All three purchasing companies involved were controlled by the same individuals, from whom the solicitors took their instructions. The ultimate purchaser applied for mortgage loans of 1,706,000 on the basis of a total purchase price of 2 million, which was supported by a valuation. Of the loan moneys, 1,525,000 was to be applied in the purchases. That sum was paid by the lender to the solicitors acting for both it and the three purchasers. Two days later the first contract of sale and the transfers to complete it were executed. Over the next three days the solicitors paid the mortgage moneys to or at the direction of the various vendors in accordance with their instructions. Unfortunately, they did not receive the contracts and transfers vesting title in the ultimate purchaser, or the charges in favour of the lender, until a week later. 6. The lender s claim was originally formulated (in addition to a claim in negligence) on the basis that the solicitors authority was limited to applying the mortgage moneys in the acquisition of a charge over property which had been purchased for 2 million. Since (if the sub-sales between connected companies were ignored) the true purchase price was only 775,000, the lender s money had been applied without its authority, and accordingly in breach of trust. When the full picture emerged, it was apparent that an even more egregious breach of trust had been committed: when the solicitors had parted with the mortgage moneys they had not obtained any charges at all! Although they got them some days later, the lender s advisers argued that that didn t matter. The solicitors had parted with trust funds in breach of trust and immediately came under an obligation to reconstitute the fund. It didn t matter that the lender subsequently obtained its charges; the clock had stopped when the money was disbursed and the court could not have regard 3

4 to subsequent events. The application for summary judgment made on the original basis now seemed even more certain of success. 7. The lender s summons for summary judgment for both negligence and breach of trust and an interim payment came on for hearing before Warner J. He gave unconditional leave to defend the negligence claim, but conditional leave to defend the trust claim, on the basis that that claim had very nearly been made out, and he ordered a payment into court of 1 million. (In the language of the CPR, he dismissed the application for summary judgment on the negligence claim, but made a conditional order on the trust claim.) He may have been nearly, but not quite, persuaded by the lender s argument that the clock had stopped. On the other hand, he may have concentrated more on the argument which succeeded in Edgestop, namely that the mortgage moneys (of some 1.5 million) had been paid out in breach of trust because they had been applied in acquiring charges over property worth only 775,000 instead of 2 million. Since they were able to realise their security for 500,000, their loss was 1 million in round figures. 8. The solicitors appealed, seeking unconditional leave to defend the trust claim also, on the basis that, since the charges had in fact been obtained, albeit late, the lender had suffered no loss and was not entitled to reconstitution of the fund. The lender cross-appealed, seeking final judgment on the claim alleging a breach of trust in paying away the mortgage moneys before the charges had been obtained. 9. The appeal came on for hearing before Ralph Gibson, Hirst and Peter Gibson LJJ ([1994] 1 WLR 1089). Ralph Gibson LJ, displaying the robust approach of the common lawyer, dismissed both the appeal and the crossappeal. He declined to accept the lender s argument that its loss had been caused by the breach of trust because the mortgage moneys had been paid away as a result of it. He adopted the dictum of Street J in Re Dawson, decd [1966] 2 NSWR 211 at , that the proper inquiry was whether the loss 4

5 would have happened if there had been no breach. Peter Gibson LJ, on the other hand, accepted the submission on behalf of the lender that a trustee who paid away trust moneys in breach of trust came under an immediate duty to restore them. He accepted that that might be harsh, but it was necessary to keep trustees up to the mark. Hirst LJ agreed with Peter Gibson LJ, and the lender secured final judgment. Although Edgestop was referred to, the court did not consider the alternative claim of a breach of trust, namely the application of trust moneys in the acquisition of charges over property which was worth much less than it was represented to be worth, and which was accordingly unauthorised. 10. Sanity returned in the House of Lords, where Lord Browne-Wilkinson delivered the only reasoned speech. He rejected a new argument, namely that the solicitors were, at the date of the appeal, required to reconstitute the trust fund, following which the lender was entitled to have it paid out to it. By analogy with traditional trusts, he decided that, once the trust had come to an end (for example, by all the beneficiaries having become absolutely entitled), there was no right to reconstitution, but simply to compensation for the loss actually suffered as a result of the breach. As for the argument that the trust fund suffered an immediate loss when the mortgage moneys were paid away in breach of trust, Lord Browne-Wilkinson decided that the quantum of compensation payable was not fixed at the date of the breach (although the cause of action was then complete), but was to be assessed at the date of judgment as the sum then required to restore the trust estate to the position it would have been in had there been no breach. 11. As Sir Peter Millett (as he then was) pointed out in the Annual Lecture given to the Chancery Bar Association in 1997 entitled Equity s Place in the Law of Commerce (which was published in (1998) 114 LQR 214,225), although the result of that reasoning is eminently satisfactory, it is misleading in that it treats equitable compensation for breach of trust or fiduciary duty as the equitable counterpart of common law damages for breach of contract, and 5

6 is based on a misunderstanding of the remedy against a trustee who misapplies trust property. The primary obligation of a trustee is to account for his stewardship. The primary remedy of the beneficiary... is to have the account taken, to surcharge and falsify the account, and to require the trustee to restore to the trust estate any deficiency which may appear when the account is taken. The liability is strict. The account must be taken down to the date on which it is rendered. That is why there is no question of stopping the clock. If a trustee disburses trust funds in breach of trust by, say, acquiring unauthorised property, the beneficiary can falsify the account by asking for the disbursement to be disallowed, in which case the trustee must replace it. But the beneficiary is not bound to do so. He can choose to adopt the unauthorised investment (which then becomes authorised), in which case he must also accept the disbursement made to acquire it; he cannot blow hot and cold. 12. In Target, the mortgage moneys were laid out in breach of trust by being paid away without obtaining the charges which were to be obtained. Their disbursement would accordingly fall to be disallowed on the taking of a notional account. By the same token, they would be treated as continuing to be available, so that, when the charges were subsequently acquired, without the lender s instruction to apply the mortgage moneys in their acquisition having been revoked, their notional disbursement would be proper. The lender cannot require the acquisition of the charges without also allowing as a disbursement the means of acquiring them. 13. In fairness to their Lordships, the appeal was argued on behalf of the solicitors on the basis that the question was whether compensation in equity was recoverable by the lender for the solicitors admitted breach of trust, and that, for it to be recoverable, it had to be established that the lender s loss was 6

7 caused by the breach (in the sense that the loss would not have been suffered but for the breach). Since the loss was suffered because the charges were inadequate security for the loans, and since that would have been the case even if the charges had been obtained at the same time that the mortgage moneys were disbursed, that requirement was not satisfied. Unsurprisingly, that was also the approach adopted by their Lordships. But the unrealistic approach of the lender, which was accepted by the majority of the Court of Appeal, that rules of causation appropriate at common law have no place in equity, and that, accordingly, one looks at the position immediately the funds were disbursed without any regard to anything which happened afterwards, is perhaps more elegantly rebutted by reference to the undeniably equitable remedy of an account. 14. The difference between the analyses of the House of Lords and the future Lord Millett may not be of much practical importance. But since the former allows compensation for losses caused by a breach of trust, whereas the latter is based on the remedy of an account, consequential losses which do not involve a loss to the trust estate would be potentially recoverable under the former analysis but not the latter. At present a claimant can rely on the following dictum of Lord Browne-Wilkinson ([1996] AC 421 at436c-d): But the basic equitable principle applicable to breach of trust is that the beneficiary is entitled to be compensated for any loss he would not have suffered but for the breach. (emphasis added.) So, for example, the 181,000 balance of the loan which was not applied in the purchases (but in the purchase of insurance policies) would not be recoverable under the Millett analysis, but might conceivably be recoverable under the Browne-Wilkinson analysis. 15. The topic has recently been reconsidered by the Supreme Court in AIB Group (UK) Plc v Mark Redler & Co Solicitors, in which argument was concluded on 5 June and judgment is awaited. In that case a lender agreed to 7

8 lend 3.3 million on a first legal charge of a house valued at 4.5 million. There was an existing charge securing 1.5 million, which was to be redeemed on completion of the remortgage. By mistake, the lender s solicitors (who were also acting for the borrower) paid only 1.2 million to the prior mortgagee, and remitted the balance to the borrowers. As a result, the lender obtained only a second charge. The borrowers subsequently became bankrupt and the house was sold for 1.2 million, leaving nearly 900,000 for the lender (after the first charge securing 300,000 had been discharged), which therefore sustained a loss of about 2.4 million on the transaction. 16. At first instance ([2012] EWHC 35 (Ch)) the lender sought the reconstitution of the trust fund consisting of the entirety of the loan of 3.3 million. The judge decided that the solicitors had not acted in breach of trust in paying 1.2 million to the prior mortgagee, or in paying the balance (save for 300,000) to the borrowers, because that was what they had been instructed to do. The only breach of trust found by him was the payment of 300,000 to the borrowers rather than the prior mortgagee, and he awarded equitable compensation in that sum. 17. On appeal the Court of Appeal ([2013] EWCA Civ 45) decided that the solicitors were authorised only to release the mortgage moneys on completion of the remortgage, and that that had never happened, because the prior mortgagee had never committed itself to releasing its charge in return for the moneys paid to it. Accordingly the release of the whole of the 3.3 million was a breach of trust. Nevertheless, it dismissed the appeal, because the loss occasioned by that breach was limited to the 300,000 which should have been paid to the prior mortgagee; the remainder of the loss would have happened even if there had been no breach of trust. Following Target, the Court of Appeal rejected the claim for the trust fund to be reconstituted. (The leading judgment was given by Patten LJ, whose argument to that effect had been rejected by the House of Lords in Target.) 8

9 18. The remedy of an account seems not to have been the subject of argument in the Court of Appeal, but may have been in the Supreme Court. On that argument the lender might have rejected the unauthorised second charge and required the solicitors to restore the mortgage moneys applied in its acquisition, leaving them with the second charge. In that way it would have avoided the entirety of its loss, most of which was actually caused by the fall in the value of the house and the insolvency of the borrowers rather than the solicitors mistake. 19. That would be an unattractive result, and on the facts of this case would seem to be unjustified. For the lender, on discovering the continued existence of the prior charge, adopted the unauthorised second charge, which thereupon became authorised, by applying for its registration as a second charge, and accepting the balance of the proceeds from the sale by the prior chargee. It is difficult to see why permission to appeal to the Supreme Court was given: to allow reconstitution of the trust fund would require an unattractive departure from Target; and there seems to be a clear answer to the claim for the disbursement on the charge to be disallowed. But if the lender, immediately on discovering the true position, had required the solicitors to account for their trust, it might have been able to pass the whole of its loss onto them. It will be interesting to see whether the Supreme Court will address that point. Grant Crawford Radcliffe Chambers 30 th October