London Clarity for Commercial Trusts? Overview The recent decision of AIB Group (UK) PLC v Mark Redler & Co (A Firm)  UKSC 58 provided the Supreme Court with an opportunity to clarify the law relating to the measure of liability for breach of trust and equitable compensation. Following the decision reached in Target Holdings Ltd v Redferns  AC 421 (HL), where a claim to have a trust fund reconstituted after an admitted breach of trust was limited to the extent of the claimant’s loss, the law has been in some turmoil. The Supreme Court has, however, now confirmed this decision, but only in the context of commercial trusts. In these cases, a monetary award for breach of trust must therefore reflect the loss actually caused by that breach and not extend further afield. Factual background In 2006, Mark Redler & Co. Solicitors (“MRC”) were instructed by AIB Group (UK) plc (the “Bank”) and Dr Ravindra Sondhi and Dr Salma Sondhi (the “Borrowers”) in connection with a remortgage advance of £3.3 million to finance the Borrowers’ care home business. The loan was to be secured against the Borrowers’ home, valued at £4.25 million. As the property was subject to an existing mortgage in favour of Barclays for £1.5 million, on two accounts (the “Barclays Charge”), a condition of the loan was redemption of the existing mortgage on or before completion of the mortgage advance. With completion imminent, MRC requested that the Bank forward the funds, with such an amount to be held on trust by MRC pending completion. Despite requesting a redemption statement for both Barclays accounts, MRC were given a redemption figure for only one of the accounts which they mistakenly took to be the total figure. As a result, MRC’s remittance was approximately £300,000 less than was necessary to redeem the Barclays Charge. The error passed unnoticed and MRC paid £1.2 million to Barclays, with the balance less expenses sent to the Borrowers. However, as Barclays had not received the full redemption amount, they refused to discharge the Barclays Charge. MRC were therefore only able to register the Bank’s charge as a second legal charge. The Borrowers subsequently defaulted on the Bank’s loan and in July 2010, the Bank obtained an order for possession. The house was sold for £1.2 million, significantly under the earlier valuation of £4.25 million. After Barclays, as highest ranking creditor, was repaid the outstanding £300,000 owed under its first legal charge, the Bank received only £867,697. The Bank therefore brought proceedings against MRC, arguing that the solicitors had acted in breach of trust by paying away the advance without obtaining a first legal charge. The Bank submitted that MRC were liable to reconstitute the trust fund of £3.3 million plus interest (less the £867,697 proceeds of sale which the Bank had received). The High Court’s decision The High Court agreed that MRC had acted in breach of trust, and therefore the issue that fell for the court to determine was the amount the Bank was entitled to recover. This would be either: • a full reinstatement of the trust fund, as contended for by the Bank. This amounted to approximately £2.5 million, which was the full sum of the Bank’s loan less the amount it recovered from the sale of the property; or • the amount by which the Bank’s position was worse than it would have been but for the negligence or breach of contract, as argued by MRC. This calculation represented the amount that the Bank actually lost as a result of MRC’s negligence in not securing a first legal charge, approximately £300,000, but no additional amount stemming from the fall in valuation of the property. In its decision, the High Court held that MRC’s breach of trust only extended to the value of the monies paid to the Borrowers. As the Bank was therefore entitled to reconstitution of the trust fund to the extent of that amount wrongly paid away, it was awarded equitable compensation of £300,000 plus interest. The Bank, however, appealed the decision. The Court of Appeal’s decision Allowing the appeal, the Court of Appeal held that the breach of trust was not limited to the part of the mortgage advance wrongly paid to the Borrowers, but extended to the entire amount of the loan. On the issue of determining loss, however, the Court upheld the judge’s decision regarding the equitable basis on which relief should be granted. Applying the case of Target Holdings Ltd v Redferns, the Court held that in the context of a commercial trust, equity must look to the loss actually suffered by the beneficiary as a result of the breach of trust and “to base the compensation recoverable on a proper causal connection between the breach and the eventual loss”. In this case, had MRC acted properly, the Bank would have benefitted from an additional £300,000 of security for its loan to the Borrowers. The Court of Appeal therefore reached the same conclusion as the lower court, albeit by a different route. The Bank’s appeal to the Supreme Court The Bank further appealed to the Supreme Court, arguing that if a trustee misapplied a trust fund, it had to reconstitute the fund in full and immediately. It sought to distinguish the case from that of Target Holdings v Redferns in which a solicitor had wrongly paid out funds to a borrower before obtaining an executed mortgage. Although the solicitor remained liable to restore the fund, he was deemed notionally to have paid out the money at the moment when the preconditions for an authorised disposal of the fund were met. Here, however, MRC had failed, on discovering their mistake, to pay Barclays the additional sum necessary to redeem the Barclays Charge. The underlying commercial transaction was therefore never completed. The case, the Bank maintained, fell within Lord Browne-Wilkinson’s statement in Target Holdings v Redferns that “[until] the underlying commercial transaction has been completed, the solicitor can be required to restore to the client account monies wrongly paid away”. The Supreme Court unanimously dismissed the appeal, holding that MRC were only liable to pay compensation for loss which would not have occurred but for their breach of trust. In the absence of fraud, it was not right to give redress to a beneficiary for loss which would have been suffered in any event, even if the trustee had properly performed its duties. Further, a monetary award reflecting neither loss caused nor profit gained would be penal and inappropriate. The Supreme Court confirmed that a commercial trust differs from a typical traditional trust in that it arises out of a contract, rather than the transfer of property by way of gift. Whilst Lord Browne-Wilkinson in Target Holdings v Redferns did not suggest that the principles of equity differ according to the nature of a trust, he observed that as the scope and purpose of the trust may vary, this may have a knock-on impact to the appropriateness of the type of relief sought in the event of a breach. In relation to completion of the transaction, the Supreme Court also found that the Court of Appeal had correctly applied the reasoning in Target Holdings v Redferns. Although MRC did not complete the transaction in compliance with the requirements of the Council of Mortgage Lenders’ Handbook, commercially the transaction was completed when the loan monies were released to the Borrowers. The key factor to be identified in each case is the content of any relevant obligation and the consequences of its breach. © 2015 Baker & McKenzie. All rights reserved. Baker & McKenzie LLP is a limited liability partnership registered in England and Wales with registered number OC311297. A list of members’ names is open to inspection at its registered office and principal place of business, 100 New Bridge Street, London, EC4V 6JA. Baker & McKenzie LLP is a member of Baker & McKenzie International, a Swiss Verein, with member law firms around the world. In accordance with the common terminology used in professional service organisations, reference to a “partner” means a person who is a member, partner, or equivalent, in such a law firm. Similarly, reference to an “office” means an office of any such law firm. Baker & McKenzie LLP is regulated by the Law Society of England and Wales. Further information regarding the regulatory position is available at http://www.bakermckenzie.com/london/regulatoryinformation/. This may qualify as “Attorney Advertising” requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome. www.bakermckenzie.com For more information, please contact: Louise Oakley Associate +44 20 7919 1160 firstname.lastname@example.org Devina Shah Trainee Solicitor +44 20 7919 1831 email@example.com Comment This case is a useful reminder to the trust industry that where a breach of trust occurs in a commercial context, any compensation payable by a trustee is likely to be limited to the loss actually caused by the breach. Commercial trusts are to be treated differently from traditional trusts in determining the sum a beneficiary can recoup. This liability (in the absence of fraud) is therefore likely to be equivalent to the amount recoverable if the claim were brought in contract or tort. The case also highlights the importance of adhering to the appropriate formalities when executing a re-mortgaging transaction, notably ensuring that the lender provides a redemption figure in writing relating to all accounts secured by the charge, and an undertaking to redeem on receipt of that sum.