The Supreme Court last week handed down judgment in the case of Bank of Cyprus UK Limited v Menelaou [2015] UKSC66. The judgment confirms the 2013 decision of the Court of Appeal that a lender may take a subrogated interest in a property by way of a vendor’s lien, where the owner has been otherwise unjustly enriched at the lender’s expense by way of a defective security. 

The case is good news for lenders and therefore of interest for their solicitors when dealing with cases of ineffective security prejudicing the lender’s proprietary interest.

Background

The full facts of this case can be found here In brief:

The Menelaou parents (the “Menelaous”) were indebted to the Bank in the sum of GBP 2.2 million, an indebtedness which was secured by two legal charges on Rush Green Hall. In 2008 the Menelaous decided to sell Rush Green Hall in order to release funds to purchase a further, smaller property as the family home, Great Oak Court (the “Property”), as well as to provide funds to allow their eldest daughter Danielle to pay the deposit on a house. A purchaser for Rush Green Hall was found who agreed to pay a purchase price of GBP 1.9 million.

The Bank agreed that it would release its charges over Rush Green Hall upon receipt of GBP 750,000 out of the sale proceeds and in return for a charge over the Property to secure what would be the remaining indebtedness of GBP 1.45 million. This would thereby enable the Menelaous, on the strength of that undertaking by the Bank, to use GBP 875,000 out of the sale proceeds of Rush Green Hall for the purchase of the Property in the name of their daughter, Melissa (“M”).

M knew nothing of the Bank’s charge over the Property. Her signature on the mortgage deed documenting the Bank’s interest was a forgery. M sought an order that the registered charge in favour of the Bank over the Property was invalid and should be removed. 

The Bank counterclaimed that M had been unjustly enriched by way of the defective security, as she had received the Property without the burden of the security; the Bank’s remedy being an equitable charge as if it was entitled to be subrogated to an unpaid vendor’s lien over the Property.

The Bank’s solicitors (introduced as a Part 20 defendant by the Bank due to their error in failing to notice the mortgage deed had been improperly executed) admitted breach and provided an indemnity to the Bank for its losses.

Appellate history

At first instance the Bank’s counterclaim for subrogation was rejected, which left it with no charge over the Property and the Bank a remedy against its solicitors.

On appeal, the Court of Appeal overturned the decision. The Bank’s release of the charge over Rush Green Hall, and allowing the use of GBP 875,000 properly due to them under that charge, gave the Bank a claim for unjust enrichment against M when the charge was found to be defective.

Supreme  Court

M appealed the Court of Appeal’s decision on three points:

  1. That her enrichment could not be said to be “unjust” or at the Bank’s expense
  2. That the correct remedy for unjust enrichment was not the proprietary right of subrogation
  3. That the Bank had a more appropriate remedy against its solicitors who had failed to secure the Bank’s charge over the Property

The Supreme Court unanimously rejected the appeal.

The Supreme Court (minus Lord Carnwath who came to the same conclusion by different means) utilised the 4 stage test in Benedetti v Sawiris [2013] UKSC 50 to establish if M had been unjustly enriched;

  1. Had M been enriched? M had argued that her enrichment was not at the Bank’s expense as no funds had been advanced to her. This was rejected. Plainly she had, as she had received the Property free of any charge, increasing its value to her. The Supreme Court considered that the Bank was in the same position as if it had received the proceeds from Rush Green Hall and then advanced them to M to purchase the Property. The fact that the Bank dispensed with this formality made no difference to the “commercial reality” of the transaction. There had been a clear transfer of value between the Bank and M despite the lack of any direct contract
  2. Was the enrichment at the Bank’s expense? Again, plainly the answer was “yes”. The Bank allowed use of its funds on the expectation of a first legal charge over the Property. That this had not been achieved caused M’s enrichment at the expense of the Bank. The Bank had lost the value of their security, an essential element of the agreement to release the funds for the purchase
  3. Was M’s enrichment unjust? As the answers to 1. and 2. were in the affirmative, the answer to 3. must be “yes”. M had received the Property free of the Bank’s charge, contrary to its intention
  4. Are any defences available to M? None had been raised by M but Lord Neurburger did consider the possibility of a defence for a bona-fide purchaser without notice of the Bank’s interest. It was however considered an indirect recipient (such as a charity) could be subject to a similar subrogation as against M

The appropriate remedy was an equitable charge, in favour of the Bank, securing the GBP 875,000 advance over the Property, by way of subrogation to the unpaid vendor’s lien in the original purchase. This reflected the true intention of the transaction and placed the Bank in the position of a hypothetical unpaid vendor, who can refuse to convey title if payment is not received.

Finally, the court rejected the argument that the Bank should instead recover their loss from their solicitors. The question of the solicitors’ negligence was irrelevant for the purposes of establishing M’s liability, and in any event, the solicitors could have subrogated the Bank’s claim against M for their loss.

The Bank was granted an equitable charge against the Property for the GBP 875,000 advanced in the purchase and sought possession and an order for sale.

Analysis

The default position has been that a lender’s security will be invalid where the mortgage deed or other security document is incorrectly executed, leading to a claim against the lender’s solicitor due to its failure to secure a valid legal charge.

Menelaou has provided some clarity on the question as to whether a lender can seek a proprietary remedy for unjust enrichment, which to date has been the subject of some academic debate. The case confirms the previous position that subrogation of the vendor’s lien is the correct remedy in cases where a purchaser can be identified as having been unjustly enriched due to the failure to provide their lender with effective security. The principle will also extend to indirect recipients such as M with whom the lender has no direct contract. 

In Menelaou the solicitors involved had accepted liability and indemnified the Bank for any losses, which were significantly reduced by the Supreme Court’s decision. The correct measure of loss against the Bank’s solicitors would have been the lost value of the charge due to the defective security documents. In effect the bank achieved the security the solicitors had failed to provide, almost completely mitigating their loss (save for irrecoverable fees in this case).

In his judgment, at para 76, Lord Neurberger also noted that there was the possibility the solicitors could have been subrogated to the Bank’s claim had the Bank relied on the solicitors’ indemnity to recoup their losses.

Conclusion

While lenders’ solicitors should continue to take every precaution to ensure security documents are properly executed, Menelaou provides some comfort that mistakes may be rectifiable where a subrogated claim is possible.

In such circumstances lenders can achieve significant mitigation of otherwise potentially valuable claims, offering solicitors the option to indemnify such claims when negligence is likely to have occurred, minimising their own exposure in remedying the defect by way of the subrogated claim.