A Supreme Court ruling in relation to damages for breach of trust claims has significant implications for both lenders and solicitors specialising in the mortgage market.

The decision of the Court in the case of AIB Group (UK) PLC v Mark Redler & Co. Solicitors, seeks to clarify the relationship between common law and equitable damages and affirms previous case law on breach of trust. Rosling King Partner, Georgina Squire, explains the ramifications of the case.

As stated by Lord Toulson in the opening paragraph of his judgment, ‘140 years after the Judicature Act 1873, the stitching together of equity and the common law continues to cause problems at the seams.’

The judgment serves as a salutary reminder of the dangers for solicitors who fail to comply with the necessary formalities in conveyancing transactions. In particular, solicitors who fail to achieve completion of the underlying commercial transaction (for example, by failing to register a charge) may still be liable to reconstitute the trust fund in its entirety. However, if the underlying transaction has completed, lenders should be aware that rather than recovering their entire loan advance in the event of a breach of trust, they will generally only be able to recover the losses sustained as a result of the breach by way of equitable compensation.

Background

This case arose out of a remortgage transaction in 2006, in which the solicitors Mark Redler & Co acted for the bank AIB Group and the Borrowers in connection with a remortgage advance of £3.3m on the Borrower’s home, which was valued at the time at £4.25m.

The bank’s instructions to the solicitors included a requirement that the existing mortgage in favour of Barclays Bank be discharged out of the advance. The Barclays charge secured borrowings of approximately £1.5m across 2 accounts.

The solicitors were given a redemption figure of approximately £1.23m, which they paid to Barclays, however failed to notice that the figure related to only one of the two Barclays accounts held by the Borrowers, and was therefore not enough to redeem Barclays’ mortgage over the property.

Therefore, AIB’s charge was not registered until almost two years later in April 2008, with Barclays charge continuing to be registered as first charge over the property.

The Borrowers subsequently defaulted and the bank obtained possession and sold the property for £1.2m, of which the bank received only approximately £860,000 once Barclays’ first ranking charge was paid out of the sale proceeds.

The solicitors admitted that their conduct was negligent however they had acted in good faith. However the bank’s claim against them included that the solicitors acted in breach of trust by paying away the advance without obtaining a first charge and as a result, they were liable to reconstitute the trust fund of the loan advance of £3.3m with interest, with credit being given for the £860,000 received by the bank from the sale proceeds when the property was sold.

The solicitors argued that the payment of the loan funds was not a breach of trust or, if it was then their liability was limited to the loss in the value of the bank’s security caused by their failure to pay off the whole of Barclays’ secured debt, being the amount of £300,000.

The benefit for lenders in pursuing a claim for breach of trust is that the usual defences of contributory negligence and failure to mitigate cannot be raised, meaning that if they are successful, the lender may seek as an equitable remedy that the trust fund (i.e. the loan advance) be reconstituted and the full loan advance be refunded.

The Court at first instance found that although the solicitors had acted in breach of trust, the bank could recover only what the solicitors had paid to the Borrowers but which should have been paid to Barclays (which was approximately £300,000).

On appeal, the Court of Appeal (CoA) agreed with the original decision in respect of the relief to which the bank was entitled. In reaching this decision, the CoA applied the reasoning of Target Holdings Ltd v Redferns, a case I acted in which went to the House of Lords in 1995, regarding equitable principles of compensation.

The bank then appealed to the Supreme Court over whether it was entitled to compensation in the amount of the loan advance entirety or whether the Court of Appeal’s decision that it was only entitled to recover the amount by which it was worse off was in fact correct.

The Supreme Court held that although the transaction was not completed in the precise manner required, it was “completed” as a commercial matter when the loan funds were advanced to the borrowers, thus creating a relationship of lender and borrower.

The Test for Causation

The Supreme Court applied the House of Lords judgment in Target Holdings in relation to the principles of equitable compensation outlined in that case. The Court considered that a monetary award which reflected neither the loss caused nor profit gained by the wrongdoer (such as that argued for by the bank), would be penal.

The rationale for monetary compensation for a breach of trust arises from the beneficiary’s entitlement to have the trust properly administered. Where a breach of trust occurs, an equitable obligation arises to restore the trust fund to the position it would have been in but for the breach and the measure of compensation should be assessed on that basis.

The Decision

The Supreme Court found that the bank’s argument on appeal rested on 3 fallacies, namely: (i) it assumes that the solicitors misapplied the entire £3.3m as opposed to approximately £300,000; (ii) it assumes that the measure of the solicitor’s liability was fixed as at the date of the breach of trust, and; (iii) it assumes that liability does not depend on a causative link between breach of trust and loss.

The Court rejected these assumptions and unanimously found that the bank should recover its actual loss, which was approximately £300,000.

This ruling provides clarification as to the correct causation test and measure of damages for breach of trust claims and will be of particular interest to lenders who may have claims against solicitors who acted in respect of conveyancing transactions that have gone awry.