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Factual Background

The ryan_dolby-stevens_phcase concerned a re-mortgage transaction which went awry. AIB Group (UK) plc had agreed to provide Mr and Mrs Sondhi (the “borrowers”), who were both medical practitioners, with a £3.3m business loan in order to expand and develop their care home business. The loan was to be secured against their private home (valued at £4.25m). The borrowers’ home was already subject to an existing first legal charge in favour of Barclays Bank plc in the sum of £1.5m, and it was therefore a condition of AIB’s mortgage offer that Barclays’ charge was to be redeemed on or before the mortgage advance and that AIB would be granted the first legal charge over the property.

Mark Redler & Co (“MRC”), as is routinely the case in these transactions, was a firm of solicitors instructed to act on behalf of both AIB and the borrowers. The borrowers had informed MRC that the property was mortgaged to Barclays and MRC had been informed of the proper amount (£1.5m). With completion imminent AIB transferred the funds the MRC, such funds to be held on trust by MRC pending completion. There was then a misunderstanding. MRC telephoned Barclays to request a redemption statement; the figure provided by Barclays represented just one account out of the two the borrowers held, but MRC took it to represent the full amount. As a consequence, the figure which MRC remitted to Barclays was about £300,000 short of the amount required to redeem the mortgage. The remainder of AIB’s loan, consequently about £300,000 more than the correct amount, was sent to the borrowers.

As a result of this shortfall, Barclays refused to release its first charge over the property. AIB contacted the borrowers to request repayment of the £300,000 which had been sent in error but, having initially agreed to do so, the borrowers failed to return the excess funds. MRC was eventually forced to admit its error to AIB, who then contacted Barclays and entered into a deed of postponement which acknowledged the primacy of Barclays’ first charge and enabled AIB to register a second (subordinate) charge over the property.

The borrowers later defaulted and the property was repossessed and sold for £1.2m (a figure far lower than the previous valuation of £4.25m). After Barclays (as the highest ranking creditor) was repaid the outstanding £300,000 owed under its first legal charge, AIB received only £867,697. AIB subsequently brought proceedings against MRC for, inter alia, negligence, breach of contract and breach of trust.

Issues

It was common ground between the parties that the error was due to MRC’s negligence. Whilst MRC undoubtedly acted in good faith, it should have realised based on the information previously provided by both Barclays and the borrowers that the figure provided by Barclays did not represent the whole amount of the mortgage. The issue for the court to decide was how much AIB was entitled to recover from MRC, being either:

  1. the full amount of AIB’s loan less the amount it eventually recovered from the sale of the property: around £2.5m (as contended by AIB); or
  2. the amount which AIB actually lost as a result of MRC’s negligence in not securing a first legal charge over the property: around £300,000 (as contended by MRC).

Under the heads of negligence and breach of contract, there was no doubt that the measure of damages to which AIB was entitled would be limited to £300,000, this being the amount by which AIB’s position was worse than it would have been but for the negligence or the breach of contract. AIB claimed it was entitled to a greater measure of relief under the breach of trust head, as the law of equity (so AIB argued) requires that the trust fund is reinstated in full.

Appellate History

At first instance the High Court found that MRC had indeed acted in breach of trust in releasing funds to the borrowers, but the breach of trust only extended to the excess £300,000 which was released to the borrowers (rather than the entire loan amount of £3.3m):

“The difference between what the defendant did and what it ought to have done if it had complied with its instructions was the £300,000 that should have been paid to Barclays but was instead paid to the borrowers. That in my judgment was the extent of the breach of trust committed . . . The breach consisted of the failure to retain an additional £300,000 and apply that to discharge of Barclays debt.” [1]

It was therefore held at first instance that AIB could only recover under the second of the two options above and therefore AIB was awarded equitable compensation amounting to a total (with interest) of £323,501.38. AIB appealed this decision to the Court of Appeal.

The Court of Appeal allowed AIB’s appeal in part, finding that the breach of trust was not limited to the excess £300,000 which was incorrectly applied, but rather it extended to the entire amount of the loan. However on the much more significant issue of determining loss, the Court of Appeal dismissed AIB’s appeal and affirmed HHJ Cooke’s decision regarding the basis on which relief should be granted. On an application of the House of Lords judgment in Target Holdings Ltd v Redferns [2], the Court of Appeal held that equity must look to what loss the beneficiary actually suffered as a result of the trustee’s breach of trust and “to base the compensation recoverable on a proper causal connection between the breach and the eventual loss.”[3]

On the present facts, AIB’s loss stemmed from the fact that the secured portion of its loan to the Borrowers was about £300,000 lower than it should have been. Put another way, had MRC acted properly AIB would have benefitted from an additional £300,000 worth of security for its loan to the Borrowers. As a result of MRC’s breach of trust, Barclays’ entitlement to be repaid out of the sale proceeds ranked ahead of AIB’s, meaning the amount AIB recovered was around £300,000 lower than it should have been. AIB brought a further appeal to the Supreme Court.

Supreme Court Decision

The Supreme Court’s judgment, handed down on 5 November 2014, upheld the decisions of the courts below in unanimously dismissing AIB’s appeal. The lead judgment was given by Lord Toulson, with Lord Reed giving a secondary judgment and Lord Neuberger, Lady Hale and Lord Wilson agreeing with the findings of both.

The Supreme Court again considered Lord Browne-Wilkinson’s judgment in the case of Target Holdings (above). That case was decided on the fundamental principle that any award of equitable compensation for breach of trust should be based either on the loss caused or the profit gained by the wrongdoer; to hold otherwise would be “penal”[4]. The beneficiary under a trust has the right to expect that the trust is properly administered. Where there is a breach of trust, equity dictates that there is an obligation to restore the trust fund to the position it would have been in but for the breach. Per Lord Toulson at paragraph 65:

“The purpose of a restitutionary order is to replace a loss to the trust fund which the trustee has brought about. To say that there has been a loss to the trust fund in the present case of £2.5m by reason of the solicitors’ conduct, when most of that sum would have been lost if the solicitors had applied the trust fund in the way that the bank had instructed them to do, is to adopt an artificial and unrealistic view of the facts.”

The Court (per Lord Reed at paragraph 136) was also keen to stress that, whilst similar in both structure and end result, the basis for the liability of a trustee for breach of trust is not the same as the liability in damages for tort or breach of contract (“as in mathematics, isomorphism is not the same as equality”. [5])

Lord Reed held that AIB’s case was founded on “three fallacies”: (i) that MRC misapplied the entire £3.3m rather than just the £300,000 which was incorrectly transferred to the Borrowers, (ii) that the measure of MRC’s liability was fixed at the date of the breach of trust, and (iii) that MRC’s liability does not depend on a causal link between the breach of trust and the loss. On the first issue (which AIB did not appeal to the Supreme Court), Lord Reed registered his disagreement with the Court of Appeal’s finding. In other words, it was the Supreme Court’s view that the extent of MRC’s breach of trust was indeed limited to the misapplied £300,000. The remaining two arguments made on behalf of AIB were dismissed by reference to previous case law (principally Target Holdings, with reliance also placed on the Canadian case of Canson Enterprises Ltd v Boughton and Co [6]).

Comment

The Supreme Court’s decision affirms rather than develops the existing case law in this area. As well as being a well-founded principle of the law of trusts, it seems instinctively right and fair that any compensation payable by a trustee in breach of trust should be limited to the loss actually caused by his breach.

The case should also serve as a reminder to solicitors that the consequences of not correctly following the formalities when executing a re-mortgaging transaction can be catastrophic.

 

[1] AIB Group (UK) Plc v Mark Redler & Co Solicitors [2012] EWHC 35 (Ch), per HHJ Cooke at paragraph 24

[2] Target Holdings Ltd v Redferns [1996] AC 412

[3] AIB Group (UK) plc v Mark Redler & Co Solicitors [2013] EWCA Civ 45, per LJ Patten at paragraph 47

[4] AIB Group (UK) plc v Mark Redler & Co Solicitors [2014] UKSC 58, per Lord Toulson at paragraph 64

[5] ibid., per Lord Reed at paragraph 137

[6] Canson Enterprises Ltd v Boughton and Co (1991) 85 DLR (4th) 129, per McLachlin J