In Stoffel & Co v Grondona [2020] UKSC 42, the Supreme Court was asked to decide whether a firm of solicitors could escape liability for its negligent failure to register a property transfer and related charge, in circumstances where the transaction formed part of an illegal mortgage fraud. In this decision, the Supreme Court considered the correct application of the defence of illegality as established in Patel v Mirza [2016] UKSC 42 (“Patel”).
The decision is important as representing a continuation of the Supreme Court’s ongoing commitment to a flexible approach to the illegality defence as established in Patel, emphasising the focus as the need to avoid inconsistencies that compromise the integrity of the legal system. It provides some important clarifications on the proper consideration and application of the “trio of necessary considerations”, as well as the correct use of previous rationales for and formulations of the test for illegality, such as that a party should not be allowed to profit from their own wrong and the test for reliance, stemming from Tinsley v Milligan [1994] 1 AC 340 (“Tinsley”).
Facts
In 2000, Mrs Grondona (the “Respondent”) entered into an agreement with an associate, Mr Mitchell, whereby:
After a third party purchased one of the properties, Mr Mitchell re-purchased a leasehold of part of that property, financed by a loan facility secured by a legal charge over the property with BM Samuels (“the BM Samuels charge”). Both Mr Mitchell’s interest and this charge were duly registered at the Land Registry.
In October 2002 the Respondent purported to purchase this leasehold for three times the price paid by Mr Mitchell, financed by an advance from Birmingham Midshires intended to be secured by a charge over the property (“the Birmingham Midshires charge”). This advance was procured by fraud by the Respondent owing to a number of misrepresentations on the mortgage application form.
Mr Mitchell delivered the transfer of registered title form (TR1) to Stoffel & Co (the “Appellants”), a firm of solicitors acting for the Respondent, Birmingham Midshires and Mr Mitchell in this transaction. The Respondent discharged the BM Samuels charge with the monies advanced by Birmingham Midshires, and BM Samuels provided in return a DS1 form releasing its charge. However, the Appellants failed to register at the Land Registry either the TR1, the DS1 or the Birmingham Midshires charge, meaning Mr Mitchell remained the registered leasehold proprietor of the property and the BM Samuels charge remained on the title.
The Respondent defaulted on her payments to Birmingham Midshires, who then brought recovery proceedings against her. The Respondent thereafter brought proceedings against the Appellants by means of a CPR Part 20 claim for an indemnity and/or a contribution and/or damages for breach of duty and/or breach of contract.
The Appellants ultimately admitted negligence for its failure to register the relevant forms, but sought to defend the claim on the grounds of illegality on the basis that the purpose of the transaction had been to commit mortgage fraud, and that the purpose of their instruction was to further that fraud.
Judgment at First Instance and in the Court of Appeal
The court at first instance concluded that the Respondent’s mortgage application was a sham arrangement enabling Mr Mitchell to obtain finance, and that there was no intention to transfer title to the leasehold between them. Applying the reliance test for illegality as set out in Tinsley, the court held that the Respondent did not have to rely on her mortgage fraud to establish the claim against the Appellants for failing to register the forms, which was conceptually entirely separate, and thus rejected the illegality defence.
In the Court of Appeal, the Vice-President Gloster LJ, with whom Flaux LJ agreed, dismissed the appeal, holding as follows:
The Appellants sought permission to appeal to the Supreme Court on four grounds, such permission being granted on the sole ground that the Court of Appeal erred fundamentally in its application of the Patel guidelines.
Judgment of the Supreme Court
Consideration of Patel
In disposing of the appeal, Lord Lloyd-Jones, with whom the other Lords unanimously agreed, considered the “trio of necessary considerations” for illegality per the judgment of Lord Toulson in Patel at [120], being:
The Supreme Court further cited Lord Toulson’s observations at [107] on the third consideration, that:
“Potentially relevant factors include the seriousness of the conduct, its centrality to the contract, whether it was intentional and whether there was marked disparity in the parties’ respective culpability”.
Public Policy Considerations under the First Two Factors
On the first consideration, the Supreme Court accepted the Appellants’ submissions that it was an important policy that the law ought to condemn mortgage fraud, that fraud is a criminal offence, and that deterrence is one underlying policy of the criminal law against fraud (at [29]).
However, the Supreme Court did not consider that the denial of this civil claim would have any deterrent effect on potential fraudsters. The Supreme Court further found there is an underlying policy of protecting the public in general and mortgagees in particular from fraud. This protection to the mortgagee, i.e. Birmingham Midshires, would not be enhanced by denying the claim as by the time the Appellants’ negligent omissions occurred, the fraud had already been completed and the funds advanced. By this stage it was in the interests of both the Respondent and Birmingham Midshires that the Appellants comply with their duties and that the transfer and charge be registered (at [29]-[30]).
On the second consideration, the Supreme Court held that there is an important policy that solicitors should perform their duties to their clients diligently and without negligence. Not only would permitting the Appellants to escape liability run contrary to this policy, but requiring solicitors to perform their duties with diligence actually increases the likelihood that mortgage fraud is uncovered and prevented. In the present case, where the Appellants acted for the vendor, purchaser and mortgagee, and where the leasehold was created and resold in the space of three months and for three times the initial price, the Appellants ought to have been alert to the possibility of a fraud (at [32]).
Further, given the mortgage application and agreement were not a sham, the Respondent obtained equitable title to the property as soon as Mr Mitchell executed and delivered the TR1. The Supreme Court held at [34] that it would be incoherent for the law to recognise the Respondent’s equitable interest on the one hand and deny a claim against a third party for failure to protect that interest on the other. These first two considerations leant strongly in favour of allowing the claim.
Considerations of Proportionality
While it was not necessary, the Supreme Court considered third consideration in Patel, the issue of proportionality. On this point the Supreme Court noted that the issue of whether a party must rely on the illegal conduct for its claim or has profited from its own wrongdoing are no longer determinative of illegality under Patel, although they may still go to the issue of centrality of the wrongdoing to the claim.
On reliance, the court at first instance, following the then binding authority of Tinsley, had correctly held that the essential facts supporting the claim could be established without reference to the illegal conduct (at [43]). Further, on the issue of profiting from wrongdoing, the Supreme Court distinguished the present situation from one where the court is asked to assist a wrongdoer to recover profits it would have made under an illegal scheme (at [45]).
The Supreme Court thereby unanimously dismissed the appeal.
Comment
Following Patel, the Supreme Court continues to develop a flexible policy-based test for illegality. This latest decision further clarifies the correct approach to the “trio of necessary considerations”. It also continues the trend of recent decisions to apply and explain the role of previous rationales for and formulations of the test for illegality.
Another recent example is Singularis Holdings Limited (In Official Liquidation) v. Daiwa Capital Markets Europe Limited [2019] UKSC 50 (discussed further here). In that case the Supreme Court considered the application of illegality as a defence to a bank’s breach of its Quincecare duty to prevent misappropriation of a company’s funds. The Supreme Court there considered the purpose of the prohibitions of breaches of fiduciary duties, making false statements and failing to prevent misappropriations by the bank, and the impact of either allowing or denying the claim on those policies. After applying the principled approach set out in Patel, the Supreme Court held that denying the claim would be a disproportionate reaction to the illegality, and a reduction for contributory negligence was a more suitable response.
Further, on the same day that judgment in Stoffel & Co v Grondona was handed down, the Supreme Court issued another decision on the defence of illegality: Ecila Henderson (A Protected Party, by her litigation friend, The Official Solicitor) v Dorset Healthcare University NHS Foundation Trust [2020] UKSC 43. The Supreme Court considered whether a woman suffering paranoid schizophrenia could claim damages from an NHS body for losses suffered as a result of her conviction for manslaughter of her mother during a psychotic episode, on the basis that the NHS body ought to have returned her to hospital when her condition worsened prior to her mother’s death.
Applying Patel, it was held that the policies of compensating victims of torts and encouraging NHS bodies to care competently for the vulnerable were greatly outweighed by the policies of (i) avoiding inconsistency between the punishment of the criminal law and the award of damages at civil law, (ii) the proper allocation of NHS resources and (iii) the need for a clear rule that unlawful killing never pays. Further, denial of the claim was entirely proportionate, given the seriousness, centrality to the claim and intentional nature of the illegal act, as well as the marked disparity between this wrongdoing and that of the NHS body. This decision also contained the interesting observation that decisions on illegality made prior to Patel remain of precedential value so long as in light of Patel they were decided correctly. Therefore, a well-established approach to the treatment of the defence of illegality in a specific set of circumstances may be found to be “how Patel v Mirza plays out in that particular type of case.”[1]
As all these cases demonstrate, the Supreme Court continues to apply the landmark ruling in Patel through a flexible and principled approach as to when claims ought to be denied for illegality.
[1] Okedina v Chikale [2019] EWCA Civ 1939; [2019] ICR 1653, referring to the approach to the illegal performance of an employment contract as set out in Hall v Woolston Hall Leisure Ltd [2001] ICR 99 and its consistency with Patel.)
