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Mutual Matters – Autumn 2016

Mutual Matters – Autumn 2016

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The latest in an ‘interest’ing line of authority… Associate Louise Smith has acted on behalf […]

The latest in an ‘interest’ing line of authority…

Associate Louise Smith has acted on behalf of a lender in a summary judgment application, swiftly dispensing with a claim in reliance on a recent line of Court of Appeal authorities dealing with the Brocklesby principle [1] and third party assertions of overriding interests.

Walker Morris has reported previously on the Wishart v Credit & Mercantile and Mortgage Express v Lambert decisions. In Louise’s case a husband and wife alleged that they held a beneficial and overriding interest in a mortgaged property owned by the husband’s brothers. The husband and wife argued that their interest arose under an express, constructive or resulting trust albeit no notice or restriction was placed on the Land Register, and was overriding by virtue of their occupation at the time of a remortgage. On behalf of the lender, and following Wishart, Lambert and a Privy Council decision Abigail v Lapin [2], however, Louise successfully argued that because the husband and wife had allowed the brothers to become registered owners without registering any notice or restriction over the title, the Brocklesby principle applied to prevent the husband and wife from asserting an overriding interest as against the lender’s security.

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[1] The principle in Brocklesby v Temperance Permanent Building Society [1895] AC 173 is that when a owner has given the borrower the means of representing himself as the beneficial owner, the borrower effectively has authority equivalent to absolute ownership (involving the right to deal with the property as owner), and any limitations on this must be brought to the knowledge of the mortgagee in order for the owner’s interest to be capable of being an overriding interest.
[2] [1934] UKPC 33

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Walker Morris data protection expert speaks to the CML

On 27 September 2016 Walker Morris’ data protection experts spoke at the CML’s Mortgages and Data Protection Regulation seminar about the practical implications of the new General Data Protection Regulation (GPDR), including imminent changes required to lenders’ processes. For more information, see our recent briefing on the subject.

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Walker’s Walk and Movember

On Saturday 24 September, members of our Banking Litigation team took part in ‘Walkers Walk’ to raise money for the Firm’s chosen charity of the year for 2015-16, the Bone Cancer Research Trust.

The 15 mile walk began at the Walker Morris offices in the city centre and followed the Leeds and Liverpool canal, finishing in Saltaire. Half way along the route, at the Railway Inn in Rodley, the Walker Morris Team met up with the representatives from the Bone Cancer Research Trust to continue the walk together.

The fundraising continues this month with Movember. Our Banking Litigation team’s moustaches have become legendary as the photos will prove. Several members of the team will yet again be discarding the razor for a month as part of Movember to raise money for men’s health charities.

The duty to advise: A welcome change for financial services?

Duty to advise – standard of care? For nearly sixty years the standard of care […]

Duty to advise – standard of care?

For nearly sixty years the standard of care expected of a professional has been the Bolam test – namely, whether the adviser acted in accordance with practice accepted as proper by a responsible body of professionals [1]. In this recent case [2], Mr and Mrs O’Hare claimed that Coutts, their financial adviser, had failed to exercise reasonable skill and care when providing advice in respect of investments which subsequently lost value. To decide whether or not Coutts had been negligent, the High Court concluded that an alternative test – that set out in the 2015 Supreme Court case of Montgomery [3] – should be applied instead.

A new and alternative approach

The Montgomery test is concerned with whether the adviser has taken reasonable care to ensure that any material risks involved in, and any alternatives to, a proposed course of action have been fully explained to and understood by the claimant. As a corollary to that, the test for materiality of risk is whether, in the circumstances of the particular case, a reasonable person in the claimant’s position would be likely to attach significance to the risk, or whether the adviser is or should reasonably be aware that the particular claimant would be likely to attach significance to it.

The Montgomery test and the O’Hare v Coutts case are concerned with situations in which a client exercises discretion in making a decision following receipt of professional advice. These cases acknowledge that the client is entitled to decide the risks that he or she is willing to take and will be responsible for their own mistakes. In other words, the Montgomery test acknowledges the role of the client and does not require the professional advisor to ‘save’ the client from him- or herself. The Montgomery test therefore shifts the focus away from a recognised body of opinion and on to whether an adviser fully explains the type and level of risk, and any alternative options, to its client.

In finding that the Montgomery test was to be preferred over Bolam, the High Court was influenced by the fact that expert evidence suggested that there was little consensus in the financial services industry as to how clients’ risk appetite should be managed by a financial adviser (and therefore the scope and extent of an adviser’s proper role); and by the Financial Conduct Authority’s Conduct of Business Sourcebook rules (COBS), which make no reference to a responsible body of opinion but which do prescribe a duty to explain which is similar to that required in Montgomery. (The judge also acknowledged that, in this particular case, the basis of the relationship between the O’Hares and Coutts was commercial – in particular because the contract allowed Coutts to sell its own or third parties’ products to the O’Hares.)

Implications?

In terms of financial services and investment advice, this decision is hugely significant and will be welcomed by financial advisers and their insurers. It provides certainty that what is required is full disclosure and explanation of material risks and gives comfort that financial advisers and firms should no longer need to grapple with unclear and inconsistent views as to the scope and extent of an adviser’s role and responsibility.

The question arises: does this case open the door for the Montgomery test to be applied in place of Bolam test in other professional negligence scenarios? Quite possibly. Montgomery itself was a medical negligence case and there is currently no authority which specifically restricts the types of negligence claims in which the test might apply.

It seems possible that Montgomery might be appropriate in the solicitor/client relationship where the client exercises discretion in decision-making based on legal advice. That might, perhaps, not least be the case where the client is experienced in a particular area and/or (as is common today) where there is a blurring of the lines between legal and commercial advice. The same might also be said in relation to the accountant/client context.

Whether or not the Montgomery test applies is also likely to turn on the nature of expertise that is in issue and the existence and quality of any expert body of opinion. However it is too early to tell whether a paucity of expert evidence in other/non-advice professional negligence claims would merit preference of the Montgomery test over Bolam.

WM Comment

O’Hare v Coutts certainly represents an exciting progression in professional negligence law and a welcome change in the financial services context. No doubt this case will prompt fresh attempts to reconsider the scope of a professional’s standard of care in other areas, and Walker Morris will monitor and report on developments.

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[1] Bolam v Friern Hospital Management Committee [1957] 2 All ER 118
[2] [2016] EWHC 2224 (QB)
[3] Montgomery v Lanarkshire Health Board[2015] UKSC 11

Acting for a fraudster: Scope of solicitors’ liability

Reports from both the UK Fraud Costs Measurement Committee and the Law Society suggest that […]

Reports from both the UK Fraud Costs Measurement Committee and the Law Society suggest that mortgage fraud is on the increase. During 2016 alone, mortgage fraud has caused an estimated loss of at least £1.3 billion. The increasingly thorough professional and regulatory initiatives designed to ascertain the identity of clients to help prevent fraud have been matched by the increasingly sophisticated methods deployed by fraudsters to circumvent these measures to defraud their victims. This raises the difficult question of how far a solicitor can be held accountable for the fraudulent acts of its client.

The recent case of P&P Property Ltd v Owen White [1] clarifies the scope of a solicitor’s liability in fraudulent transactions and provides useful developments in relation to the law of breach of warranty of authority and breach of trust.

The Facts

The purported seller of a property, Mr Harper, wished to arrange a quick sale to fund the purchase of another property abroad. To facilitate this, Mr Harper was willing to sell the property at a discount. One of two defendants, the solicitors acting for the purported seller (“the Solicitors“), completed their money laundering checks and met with Mr Harper to verify their client’s passport photograph and identity. The claimant, a property developer, agreed to purchase the property in cash for £1,030,000. The transaction purportedly completed and Mr Harper was paid the purchase price through the Solicitors’ client account.

The fraud became apparent when the genuine Mr Harper returned to his property and saw major building works taking place. The Land Registry refused to register the claimant as the owner, who consequently lost over £1m. The claimant attempted to pursue the purported seller, but he could not be traced. The claimant then sought to recover his losses from the Solicitors, alleging that it had acted in breach of warranty of authority and negligently, and that payment to the seller had been in breach of trust and breach of undertaking.

Breach of Warranty of Authority

The claimant argued that the Solicitors were in breach of warranty of authority as it represented that it had authority to act for the owner of the property, and specifically that it was instructed by the genuine Mr Harper, when in fact it was not. The claimant argued that it had agreed to purchase the property in reliance on the Solicitors’ warranty of authority.

The well-established doctrine of warranty of authority has oscillated between a reluctance and a readiness to hold solicitors strictly accountable. Although recent case law has suggested the courts will take a stricter approach [2], P&P Property represents a return of reluctance from the courts to hold solicitors as strictly accountable for the fraudulent actions of their client…

The judge held that the court will not construe an implied warranty of authority as operating more broadly than as “representing that the agent has authority to act on behalf of his client“. Furthermore, the court held that an agent does not, simply by acting as agent, promise that it had the authority of the true owner of the property. As such, it was held that the Solicitors did not their breach warranty of authority.

As an aside…

It bears noting, however, that the case does not deal with the question of whether there were elements to this transaction which should, nevertheless, have rung alarm bells for the Solicitors and, if there were, whether the Solicitors might be liable as a result [3].

Negligence

In this case the Solicitors had not accepted a direct responsibility to the claimant to take reasonable care to ascertain the fraudulent seller’s identity or to ensure that he was the true owner. The court held that there were no special circumstances in this case to justify imposing such a duty to the claimant, and so the allegation of negligence failed.

Breach of Trust

The claimant argued that the purchase monies were held on trust for them in the Solicitors’ client account, to be paid to the seller on completion. It claimed that because the transaction was a fraud, no completion took place and thus the transfer of purchase monies to the seller was in breach of trust.

The court emphasised the importance of considering the circumstances of the case. To establish whether the Solicitors were liable for breach of trust depended on “the basis upon which they received the monies” and “in what circumstances they were permitted to release them”. Therefore, the terms of the Solicitors’ relevant obligations must be considered to determine whether the completion monies were held on trust.

The court found that, in this case, the relevant provisions were to be found in the 2011 edition of the Law Society Code for Completion by Post (“the Code“). The relevant obligations of the Code did not establish that the purchase monies were held on trust by the Solicitors.

Breach of Undertaking

The buyer claimed that, under the Code, the Solicitors undertook to have the seller’s authority to receive the completion money at completion and undertook to complete the purchase on receipt, such that the Solicitors breached both undertakings. The court rejected both claims on its interpretation of the Code but lenders should note that it is crucial to this element of the claim to highlight a key distinction between the wording of the 2011 and 2008 editions of the Code. Had the 2008 edition of the Code applied, the outcome could have been different

WM Comment

P&P Properties provides valuable guidance to determine whether a purported vendor’s solicitor has breached warranty of authority and whether completion monies are held on trust.

A warranty of authority provides only the basic representation that the agent has authority to act for another. The courts will not imply a warranty of authority as having an effect beyond that basic representation unless the conduct of the parties makes it clear that an additional promise has been made.
Completion monies are held on trust by a vendor’s solicitors where the particular provisions of the relevant obligations make it clear that the monies are to be held on trust.

Although the court stressed the importance that facts have on the outcome of a case, this is an unfortunate decision for the victims of ID and mortgage fraud. For building societies and other lenders, breach of warranty of authority cases will become more difficult but they should consider whether they can recover their losses from other parties and/or whether there are other causes of action.

On the other hand, this is a helpful decision for the conveyancing solicitors, estate agents and professional indemnity insurers who are all at the transactional front line. The decision sets a high evidential bar for establishing breach of warranty of authority or breach of trust. The decision underlines that “the checks that solicitors are required to undertake are designed to reduce the risk of fraud and cannot reasonably be thought to eliminate it”.

Lenders’ solicitors might seek to protect their clients by enquiring about the right of the seller to sell (but by the same token, sellers’ solicitors are unlikely to agree to provide such warranties); and care should be taken to check which edition of the Code applies to a transaction when any claim for breach of undertaking is considered.

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[1] [2016] EWHC 2276 (Ch)
[2] LSC Finance v Abensons [2015] EWHC 1163 (Ch) and see our earlier briefing..
[3] Please see our recent article, which flags some key indicators of fraud which conveyancers can watch out for.

Lender litigation: an application of key principles for mutuals

In Connaught Income Fund v Hewetts [1] the High Court has reviewed and applied some […]

In Connaught Income Fund v Hewetts [1] the High Court has reviewed and applied some of the key principles in lender litigation. This article explains a recent case that will be of interest to building societies and their professional advisers.

Case and key principles

The loan arrangement in this case was a complex commercial scheme whereby a funder (the claimant) loaned money to a short term lender (the intermediate lender) for onward lending to the borrower for the purchase of a commercial property, however the legal principles apply equally in relation to straightforward retail mortgage lending.

When the borrower defaulted on the loan, the claimant sued the intermediate lender’s solicitors (the defendant) for professional negligence. The claimant alleged that the defendant owed a Bowerman [2] duty (which required the defendant to advise the claimant of any information which a reasonably competent solicitor would realise might have a material bearing on the lender’s security) and that the defendant breached that duty when completing the certificate of title (COT). The judge carefully considered the essential elements of a lender claim:

Duty – The court held that, in the absence of special circumstances, the defendant did not owe the claimant a Bowerman duty and instead had assumed a more limited responsibility only to complete the COT with due skill and care. This was because:
- there were two different elements to the lending transaction and the defendant was not privy to the basis for the claimant’s lending decision;
- although the COT was addressed to both the claimant and the intermediate lender, the instructions were clear that the defendant was acting for the intermediate lender and the defendant was not asked to, nor given any means to, speak to the claimant beyond completion of the COT; and
- it would have been open to the parties to have expressly agreed that the defendant owed wider duties to the claimant and that had not been done.
Breach – On the facts the court held that the defendant had committed a breach of duty when it failed to complete a section of the COT to refer to the fact that the security had been sold at an undervalue. Duty and breach alone, however, cannot found a claim, and the judge reiterated that a claimant must also establish reliance and causation of loss.
Reliance – the judge was satisfied that the claimant had relied on the COT when it decided to advance the loan…
Causation – … however he decided that the breach did not cause any loss because even if the COT had been completed to refer to the undervalue, that would not have caused the loan to be rejected and so the transaction would have proceeded in any event.
Calculation of damages – A failure to establish causation was fatal to the claim, but the judge nevertheless went on to confirm that this was a case in which the defendant’s duty of care was limited to the provision of information and did not extend to a duty to advise. The SAAMCO [3] cap would therefore apply and any recoverable damages would have been limited to the consequences of information given being incorrect.

WM Comment

This case represents a comprehensive application of some of the key principles underpinning lender litigation. The judge’s clear explanation of how a claim will be established and how any damages will be assessed is relevant to claims in the retail context and will therefore be of interest to building societies.

Of particular interest is the implication that the Bowerman duty is less likely to apply in more complex, multi-party cases, and the indication that lenders may wish to expressly set out in their instructions to solicitors any intended more wide-ranging duties.

(As an aside, the judge also found that in a layered funding or bridging loan arrangement such as this, there is no reason in principle why a relationship of creditor/debtor could not coexist alongside a relationship of principal/agent. Mutuals and their legal advisors should ensure that the implications of this are dealt with appropriately in the drafting of the respective loan agreements.)

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[1] Connaught Income Fund, Series 1 (in liquidation) v Hewetts Solicitors (a firm) [2016 EWHC 2286 (Ch)
[2] Mortgage Express ltd v Bowerman & Partners [1996] 2 All ER 836. See Walker Morris’ earlier briefing for more on the Bowerman duty.
[3] South Australia Asset Management Corporation v York Montague [1996] UKHL 10, in which the House of Lords held that surveyors who provide negligent overvaluations are only liable for loss caused by the negligent valuation itself, and not for loss caused by any extraneous factor(s). That proposition has become known as the SAAMCO principle or cap, and can be relied upon to limit liability in negligence where the duty is to provide information.

Negligence and contributory negligence: Valuer and lender conduct matters

In Barclays v Christie & Co [1] the claimant bank had a longstanding banking relationship […]

In Barclays v Christie & Co [1] the claimant bank had a longstanding banking relationship with its customer, the borrower. When the borrower, the owner of a seaside arcade, applied for a loan to purchase a neighbouring arcade and to carry out building works so that the adjacent businesses could be operated together, the bank instructed the defendant to value each of the trading properties. The bank then made the loan and the borrower went ahead with the purchase and the works. Following the borrower’s subsequent administration, the arcades were sold and the bank suffered a significant shortfall. The bank sued the valuer, alleging that the arcades had been negligently overvalued. As part of its defence, the valuer alleged that the bank had been contributorily negligent in its lending and that any damages should be reduced as a result.

Key takeaways

The following key takeaways arise from the judgment:

Trading property valuations should be conducted on an EBITDA basis [2] unless there is evidence of an accepted alternative methodology.
The judge did not depart from the experts’ consensus that the appropriate margin of error for the properties was 15% [3].
Although no specific finding was necessary in this case (as valuations of the properties both separately and on a combined basis fell outside the 15% margin of error), the court indicated that in portfolio lending it is the aggregate value of all properties which matters most.
Reliance and causation were established in this case because the bank proved that it had relied on the valuations when making the loan; and that but for the valuations the transaction would not have proceeded, the loan would not have been made and the bank would not have suffered loss.
When deciding to lend, the bank relied (alongside the valuations) both on its longstanding commercial relationship with the borrower and on its consideration that it could still make money out of that relationship. In doing so, the bank overlooked the fact that the borrower’s integrity had been impugned when it had dishonestly misused a prior loan. The bank was therefore contributorily negligent and damages awarded to it were reduced by 40%.
In determining damages the court was prepared to accept a common sense approach to a claim for interest as damages and the judge was in little doubt that an award for cost of funding was appropriate in the case of this commercial lender.

WM Comment

Although this case concerned the somewhat unusual scenario of commercial lending secured against two seaside arcades, the majority of issues addressed are of general application and will be of interest to lenders, valuers, professional indemnity insurers and legal advisors alike.

The case is further High Court authority that a property will have to be very unusual indeed if a margin of error of more than 15% is to be appropriate. The judge’s clear view that, where lending is to be secured against multiple properties, it is the aggregate value which is to be of utmost importance when it comes to any subsequent negligent overvaluation allegation is important for valuers and claimant-lenders to note.

Whilst the bank’s substantive claim succeeded because it was able to establish the all-important (but often overlooked) elements of reliance and causation in respect of the negligent valuation, the case is a salutary reminder of how essential it is for a claimant also to consider its own conduct. Although the judge in this case acknowledged that the bank/customer relationship is a commercial one, and that a successful longstanding relationship may reasonably count for something when it comes to the lending decision, the message is clear that that is not enough. The court considered that a reasonably competent lender would not have made the loan in light of the borrower’s historical dishonesty or, at the very least, it would have required closer scrutiny of the borrower’s finances, proposals and projections. As such, a very significant 40 % reduction in damages was made.

Practical advice

Whilst there is ever-present pressure on mutuals and other retail financial services providers to make loans and thereby to facilitate growth both in terms of internal commercial success and in relation to the wider socio-economic, business and property market context, this case suggests that lenders and valuers will be well advised to ensure that their underwriting criteria and valuation procedures respectively specifically address (and challenge if necessary):

the appropriate valuation methodology, depending on the property-type on a case-by-case basis;
aggregate values in portfolio lending; and
borrower history and integrity, even where there is a longstanding/ongoing customer relationship.

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[1] Barclays Bank plc v Christie Owen & Davies (t/a Christie & Co) [2016] EWHC 2351 (Ch)
[2] i.e. trading properties should be valued by assessing earnings before interest, tax, depreciation and amortisation of a reasonably competent operator and then applying a multiplier derived from considering the EBITDA of comparable properties (RICS Appraisal and Valuation Standards (“the Red Book”) and the RICS Guidance Note 1 concerning Specialised Trading Property Valuations and Goodwill).
[3] Ibid paras 55 and 85. See K/S Lincoln v CB Richard Ellis [2010] PNLR 31 (TCC): for a standard residential property, the margin of error may be as low as plus or minus 5 per cent; for a valuation of a one-off property, the margin of error will usually be plus or minus 10 per cent; if there are exceptional features of the property in question, the margin of error could be plus or minus 15 per cent, or even higher in an appropriate case.

Financial regulation matters for mutuals

Underwriting standards for BTL The PRA has issued a policy statement on underwriting standards for […]

Underwriting standards for BTL

The PRA has issued a policy statement on underwriting standards for buy-to-let (BTL) mortgages and a supervisory statement which outlines minimum expectations for firms. Where amendments to policies and systems are required to bring all lenders up to prevailing standards, firms have until 1 January 2017 in relation to the more straightforward changes and 30 September 2017 for all remaining expectations. It is anticipated that the new standards may have a significant impact on the BTL sector, bringing it more into line with the regulated mortgage market.

Safeguards against fraudulent bank transfers

Which? has filed a super-complaint to the PSR calling for lenders to take greater responsibility for protecting consumers against fraudulent bank transfers. In particular, the complaint calls for formal investigation into the scale of bank transfer fraud and new measures and greater liability for lenders when customers are tricked into making a bank transfer to a fraudulent individual. The PSR is due to respond to the complaint before the end of the year. On the issue of fraud more generally, please see our recent briefing.

Financial services and the ageing population

Earlier this year the FCA published a discussion paper on how financial services meet the needs of our ageing population. In an update published in September 2016 the FCA explains its findings so far and its proposed next steps for making the industry work well for older consumers, in particular in relation to pensions; the provision of advice and guidance; mortgages; vulnerability; access; the risk of scams and fraud; and the improvement of consumer communications.

Contacts

Richard Sandford, Partner, Banking Litigation

Richard Sandford
Partner
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