Trust game

By the time of the property crash in the early 1990s, banks and building societies sought to pass on the consequences of their imprudence to their solicitors and the solicitors’ insurers.

But claims in negligence often faced problems
of causation and contributory negligence: even if the solicitor had pointed out that the price of the property had been inflated by sub-sales, or that
the borrower was financing the purchase with other borrowing secured on the property, wouldn’t the loan have been made anyway? Wouldn’t the lenders have lent to anyone (provided the valuation was high enough)? And wasn’t part of the loss caused by the fall in the market, rather than the solicitor’s negligence?

Some clever lawyers thought the answer might lie in the well-established principle that a solicitor holds his client’s moneys on a bare trust for the client, to apply them in accordance with his directions. Contributory negligence is not a defence to a claim for breach of trust: a trustee is under an unqualified duty to carry out his trust. And if he misapplies the trust funds, isn’t he bound to reconstitute them? So, if a solicitor’s authority is to apply his client’s money in the purchase of property and to obtain a first legal charge over the property to secure the advance of the money to the purchaser, couldn’t he be required to replace the money without further ado if, in fact, he applies
the money without authority, for example, in a transaction which is materially different from
the one authorised because of artificially inserted sub-sales?

Unexpected bonus

Perhaps the first example of this was Alliance
& Leicester BS v Edgestop Ltd (1991) [1999]
Lloyds Rep PN 868. Another was Target Holdings
Ltd v Redferns [1996] AC 421, in which there
was an extravagant series of sub-sales. But
the solicitors’ files revealed what was believed
to be an unexpected bonus: the solicitors had parted with the purchase moneys before the transfers had been received and the charges executed; neither occurred until some
days later.

The lender’s summons for summary judgment
on the breach of trust claim eventually arrived
at the House of Lords. The lender sought reconstitution of the mortgage moneys because
the solicitors had committed a breach of trust
in paying them way before a charge had been obtained. The solicitors argued that, as the charge had in fact been obtained, albeit late, the lender had suffered no loss and was not entitled to reconstitution of the fund.

Lord Browne-Wilkinson, delivering the only reasoned speech, decided that the quantum of compensation payable was not fixed at the date of the breach (although the cause of action was then complete), but was to be assessed at the date of judgment as the sum then required to restore the trust estate to the position it would have been in had there been no breach. As
there was then no loss to the trust estate, no compensation was payable. (For reasons which are difficult to discern, however, an interim payment of £1m was ordered).

As Sir Peter Millett (as he then was) has pointed out, the primary obligation of a trustee is to account for his stewardship and the primary remedy of the beneficiary is to have an account taken, to surcharge and falsify the account, and to require the trustee to restore to the trust estate any deficiency which may appear when the account is taken. Accordingly, the better analysis is probably that, as there is no deficiency in the trust estate at the date of the account (namely the date of judgment), no sum is then due.

The mortgage moneys were laid out in breach
of trust by being paid away without obtaining
the charges which were to be obtained. Their disbursement would, accordingly, fall to be disallowed on the taking of a notional account. However, they would be treated as continuing
to be available, so that, when the charges were subsequently acquired, without the lender’s instruction to apply the mortgage moneys in their acquisition having been revoked, their notional disbursement would be proper. The lender
cannot require the acquisition of the charges without also allowing as a disbursement the
means of acquiring them.

It was recognised in Target that any liability on the part of the solicitors to repay moneys wrongly paid out of their client account in breach of trust would be subject to the court’s discretionary power to relieve a trustee from liability under section 61 of the Trustee Act 1925. Before the jurisdiction can be exercised, however, the breach
of trust sought to be relieved against, and the trust which has been breached, must be identified.

Beneficial interest

A solicitor holds his client’s moneys upon a bare trust for the client. He is bound to apply them in accordance with the client’s instructions, but those instructions do not constitute the trusts upon which the moneys are held. The beneficial interest remains in the client until it is transferred following the execution of his instructions.

Where the Law Society’s Code for Completion by Post is used and a purchase and mortgage are successfully completed, the mortgage moneys will undergo the following operations. First, they will move from the lender’s account to its solicitors’ client account. These solicitors will usually also be the purchaser’s solicitors. Next, the moneys will be transferred from the lender’s (and purchaser’s) solicitors’ client account to the vendor’s solicitors’ client account. There will be no change in the beneficial ownership on those occasions: it remains with the lender. There will then occur a change in
the trusts on which the moneys are held (without any movement of the moneys themselves) on completion: the beneficial interest in the moneys will be transferred to the vendor (and also, possibly, his mortgagor). Finally, the legal and beneficial ownership of the moneys will be united when the moneys are transferred from the vendor’s solicitors’ client account to the vendor’s (or his mortgagee’s) own account.

Relieving power

The exercise of the relieving power in section 61 has been the subject of three recent decisions of the Court of Appeal, all of which involved some form >> >> of identity fraud. In two, Lloyds TSB Bank Plc v Markandan & Uddin [2012] EWCA Civ 65, [2012] PNLR 20; and Santander UK Plc v RA Legal Solicitors [2014] EWCA Civ 183, [2014] PNLR 20, relief
was refused because the solicitors had acted unreasonably, but in the third, Nationwide Building Society v Davisons Solicitors [2012] EWCA Civ 1626, [2013] PNLR 12, relief was granted. Relief was also granted at first instance in another case, Ikbal v Sterling Law [2013] EWHC 3291 (Ch), [2014] PNLR 9, but that seems to be inconsistent with the approach of the Court of Appeal.

In yet another case in which a lender is pursuing
a trust claim against its solicitors, the argument on an appeal to the Supreme Court has concluded, and judgment is awaited. AIB Group (UK) Plc v Mark Redler & Co Solicitors [2013] EWCA Civ 45, [2013] PNLR 19 concerns a remortgage. An advance, to
be secured by a first legal charge, was to be partly applied in discharging a prior charge. The full amount secured by the prior charge was not paid, with the result that the lender obtained only a second charge. The balance was paid to the borrowers, who became bankrupt. The release
of the mortgage moneys without obtaining a discharge of the prior charge was a breach of trust, and the lender claimed repayment of the whole advance, but equitable compensation was awarded only in respect of the sum required to redeem the prior mortgage. The claim for relief was not pursued.

The lender may have been better advised to rely on the remedy of an account. It could have refused to accept the second charge obtained by the solicitors, who could have been required to bring into account the sum which they should have applied in acquiring the authorised charge. They would have been entitled to retain, for their own benefit, the second charge, but, on its realisation, they would have suffered the loss occasioned by the decline in value of the property on its sale.
It may be that the Supreme Court will consider
that argument, which was not advanced in Target. Watch this space.

Keeping clients (and insurers) happy

• Ensure you have done proper client due diligence at the outset. Meet the clients face to face and do your own verification of documents. Do not rely on checks by others. Do not delegate this task to junior or administrative staff. Keep client due diligence under review even for regular clients.
• Educate all your staff who are involved in conveyancing about the hallmarks of mortgage fraud such as sub-sales, cash-backs, price incentives/discounts and direct payments between the seller and buyer. The Law Society issued guidance in 1990 which has been updated since, most recently in July 2014.  
• Check out the solicitors who are acting on the other side if you do not know them. Check the Law Society website and call the Solicitors Regulation Authority (SRA), and document what you do.  
• Senior practitioners should properly supervise junior practitioners and unqualified staff. Only senior, authorised practitioners should sign certificates on title. 
• Only senior, authorised practitioners and senior finance staff should have access to the movement of client funds and only using strict and agreed procedures.
• Read all instructions carefully and thoroughly, especially those from lenders. Do not assume that once read you will never need to do so again; they change regularly.
• Solicitors should remember that when acting for a buyer and the buyer’s mortgagee they owe the same duties to both clients and should not prefer the interests of one client over the interests of the other client. Be vigilant about lenders who extract waivers of privilege in their conditions signed by the borrower.
• All of the above should be recorded in the firm’s manual on handling conveyancing transactions. Keep that manual up to date with plenty of copies conspicuous in the office, not gathering dust in cupboards.  

SJ

Grant Crawford, pictured, and Peter Dodge are barristers practising from Radcliffe Chambers