This recent Supreme Court 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 for breach of trust against solicitors who acted for lenders and borrowers in respect of conveyancing transactions that have gone awry.

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.

On the day of completion, the solicitors telephoned Barclays and were given a redemption figure of approximately £1.23m. Upon completion, the solicitors paid that amount to Barclays and provided the balance of the loan advance of approximately £2.07m to the Borrowers.

Unfortunately, the solicitors failed to notice that the redemption figure given by Barclays related to only one of the 2 Barclays accounts held by the Borrowers, and was therefore not enough to redeem Barclays’ mortgage over the Property.

As a result of the solicitors’ negligence, AIB’s charge was not registered until almost 2 years later in April 2008 and only then after it had independently reached agreement with Barclays that it should be registered as a second charge, with Barclays charge continuing to be registered as first charge over the Property.

The Borrowers subsequently defaulted on the loan 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 in the transaction was negligent and there was no suggestion that the solicitors acted otherwise than in good faith. However the bank’s claim against the solicitors included a claim that the solicitors acted in breach of trust by paying away the advance without obtaining a first charge and that, as a result of this breach of trust, the solicitors 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 in their defence that the payment of the loan funds was not a breach of trust or, in the alternative, if it was a breach of trust 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, as opposed to breach of retainer or negligence, is that the usual defences of contributory negligence and failure to mitigate cannot be raised, meaning that if they are successful in their breach of trust claim, the lender may potentially 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 the amount that the solicitors had in fact paid to the Borrowers but which should have been paid to Barclays (which was approximately £300,000). On appeal, the Court of Appeal agreed with the original decision in respect of the relief to which the bank was entitled. In reaching this decision, the Court of Appeal applied the reasoning of Target Holdings Ltd v Redfernsregarding equitable principles of compensation.

The bank then appealed to the Supreme Court on the question of whether it was entitled to compensation in the amount of the entirety of the loan advance or whether the Court of Appeal’s decision that it was only entitled to recover the amount by which it was worse off (i.e. approximately £300,000) was in fact correct.

The Supreme Court’s Reasoning

Completion

In Target Holdings, Lord Browne-Wilkinson stated that “[u]ntil the underlying commercial transaction has been completed, the solicitors can be required to restore the client account monies wrongly paid away”. In the present instance, the Supreme Court held that although the transaction was not completed in the precise manner required, it was nevertheless “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. Further, to argue that the bank had suffered a loss of £2.5m in this instance would be to “adopt an artificial and unreasonable view of the facts”.

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 beneficiary is therefore entitled to recover any losses sustained as a result of a breach of this duty which, in this instance, was the approximately £300,000 of the bank’s loan advance for which it failed to obtain adequate security.

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.

Commentary

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”. This decision of the Supreme Court seeks to provide clarity as to the relationship between common law and equitable damages and affirms and clarifies previous case law on breach of trust. The decision 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.