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AIB v Redlers: the extent of a lender’s loss caused by solicitors’ breach of trust

Mortgage Application with a set of keys Print publication

17/11/2014

The Supreme Court has denied lenders a claim for equitable compensation for a solicitors’ breach of trust that exceeds that of the actual loss caused.

Facts

The Appellants, AIB Group (UK) Plc (AIB) agreed to lend Mr and Mrs Sondhi £3.3 million to be secured by a first legal charge over their home which was valued at £4.25 million. The loan was on condition that the existing first legal charge over the Sondhis’ home in favour of Barclays Bank plc (Barclays), due to borrowings on Barclays’ accounts amounting to £1.5 million, was to be redeemed on or before completion. Mark Redler & Co solicitors (Redlers) were instructed to act for both the Sondhis and AIB.

With completion imminent, Redlers remitted to Barclays an amount they thought necessary to redeem the Barclays mortgage and £3.3 million to the Sondhis. In fact, the amount they remitted to Barclays was approximately £300,000 less than what was necessary to redeem the Barclays charge, the result being that AIB did not obtain a fully enforceable first charge over the Sondhis’ home.

When AIB realised the mistake, it negotiated with Barclays, which resulted in AIB executing a deed of postponement acknowledging the primacy of the Barclays charge and the registration of the AIB charge as a second charge.

Five years later, the Sondhis defaulted and Barclays repossessed and sold their home for £1.2 million, of which AIB received £867,697, approximately £300,000 less than it would have received if Redlers had remitted the correct amount to Barclays and AIB had a first charge over the property.

Subsequently, AIB brought proceedings against Redlers for, amongst other things, breach of trust. AIB argued that it was entitled to recover the full amount of its loan, less the amount recovered, approximately £2.5 million. It argued that if for any reason a trustee (Redlers) misapplied the trust fund, or any part of it, the trustee must immediately reconstitute the trust fund in full. Effectively AIB’s argument was that Redlers were only entitled to pay away the £3.3 million mortgage advance in defined circumstances i.e. in exchange for a first legal charge over the property. They argued that if Redlers failed to obtain that first legal charge then Redlers had acted outside of their authority and therefore had to reconstitute the whole of the trust fund irrespective of the fact that AIB’s actual loss or level of under-security was closer to £300,000.

Redlers were successful at first instance and in the Court of Appeal. Both courts decided that although the solicitors had acted in breach of trust, AIB could only recover the amount that Redlers paid to the Sondhis but which should have been paid to Barclays, £300,000. AIB appealed to the Supreme Court.

Supreme Court decision

The Supreme Court unanimously dismissed AIB’s appeal, finding that AIB was only entitled to the amount by which it suffered actual loss (approximately £300,000).

In coming to that decision, the Supreme Court was required to review the reasoning of the House of Lords in Target Holdings v Redferns [1996] AC 412 (Target) and in particular Lord Browne-Wilkinson’s analysis of the principles of equitable compensation following a breach of trust. The doctrine of equitable compensation requires the trustee to restore the trust fund, or to pay the beneficiary where the trust has ended, to the position it would have been in if the trustee had performed his obligation. A monetary award to AIB which did not reflect either the loss caused by the breach of trust (or the profit gained by a wrongdoer) would be penal. It concluded that AIB’s argument that is had suffered a “loss” of £2.5 million to be unrealistic and an artificial view of the facts. AIB’s case was flawed because:

  • it assumed that Redlers misapplied the entire £3.3 million as opposed to approximately £300,000
  • it assumed that the measure of Redlers’ liability fixed at  the date of the breach of trust, whereas equitable loss is assessed at the date of trial
  • it assumed that liability for breach of trust does not depend on a causal link between the breach of trust and the loss.

The Supreme Court looked at the rationale behind an equitable remedy for breach of trust. A beneficiary of a trust is entitled to have it properly administered and so is entitled to recover losses suffered by reason of the breach of duty. Here, the loss due to Redlers’ breach of trust was approximately £300,000 of AIB’s loan which it failed to obtain security over. The vast majority of AIB’s loss was not due to Redlers’ breach of trust but due to the fact they took security over an inadequate asset, once valued at £4.5 million but sold for just £1.2 million five years later following the recession. The property market crash would have caused the lender a shortfall on repossession of the property regardless of Redlers’ mistake, so to allow for equitable compensation that went further than recompensing the bank for its shortfall in security of £300,000 would be an unjust windfall for AIB.

While endorsing Lord Browne-Wilkinson’s approach in Target, the Supreme Court clarified that, despite structural similarities when assessing equitable compensation and common law damages, liability for breach of trust is not generally the same as liability in damages for tort or breach of contract. But, while it did not have the exact same rules of causation and remoteness that contract and tort have, equitable compensation for breach of trust does identify what loss was actually suffered and base what is recoverable on a proper causal connection between the breach and the loss.

By claiming it was entitled to the full amount of its £3.3 million loan to the Sondhis (less the recovery of £867,697), AIB was arguing that Redlers should be responsible for the loss AIB would have suffered if Redlers had done what they were instructed to do and performed their trust obligations in paying off Barclays and allowing for AIB to be first charge holders over the property for the full amount of its loan. This effectively involved the creation of an immediate debt at the time of the breach of trust, rather than remedying the conduct which caused the breach of trust. In fact, Lord Toulson observed that the massaging of the facts to fit the amount of recovery AIB claimed it was due would make…” it necessary to create fairy tales.”

The Supreme Court’s decision clarifies the nature and extent of the equitable remedy for breach of trust. It confirms that lenders (as trust beneficiaries) cannot recover losses which they would have suffered in any event, whether or not the solicitors (the trustees) had performed their obligations properly. They can only be compensated for the loss actually caused by and flowing from the breach of trust, in this case, the shortfall in the value of the security by approximately £300,000.

Comment

The Supreme Court has brought the assessment of loss for a breach of trust in line with similar assessments of loss for breach of contract and breach of duty of care cases.

Breach of trust claims tend to fall into two categories; (a) cases where the charge has not been obtained at all, usually due to the mortgage advance having been misappropriated or lost to fraud or (b) cases where the lender has some security but not the first legal charge it expected. This case makes clear that in the second category the assessment of loss is not the return of the whole of the mortgage advance but is effectively the level of under-security that the lender has been left with.

In the first category, the lender is still likely to recover the whole of the mortgage advance given he has obtained no security at all.

For further advice, contact Walker Morris Real Estate and Banking Litigation team.

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