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Michaelmas Term [2014] UKSC 58 On appeal from [2013] EWCA Civ 45
JUDGMENT
AIB Group (UK) Plc (Appellant)
v
Mark Redler & Co Solicitors (Respondent)
before
Lord Neuberger, President
Lady Hale, Deputy President
Lord Wilson
Lord Reed
Lord Toulson
JUDGMENT GIVEN ON
5 November 2014
Heard on 5 June 2014
Appellant Respondent Jeremy Cousins QC Graeme McPherson QC Nicholas Davidson QC John Brennan
Sian Mirchandani Nicole Sandells (Instructed by Moran & Co, Tamworth)
(Instructed by Mills and Reeve LLP)
The letter of instruction included copies of the bank’s offer to the borrowers and its conditions of offer.
- The solicitors were told by the borrowers that the property was mortgaged to Barclays. On 31 July Barclays provided them with information about the two accounts, which showed the total balance due as a little over £1.5m, but this was not a redemption statement. Meanwhile the solicitors asked the bank to forward the funds because completion was imminent. The bank did so on 1 August, and the solicitors telephoned Barclays for a redemption figure. Unfortunately there was then a misunderstanding. The solicitors were given a redemption figure for one of the two Barclays accounts which they mistakenly took to be the total figure. They were at fault because they should have realised from the information supplied by Barclays that the figure related only to one account. However, on 1 August the solicitors remitted to Barclays the figure which they wrongly believed was the total necessary to redeem the Barclays mortgage and remitted the balance of the £3.3m less expenses to the borrowers. The borrowers had executed what was intended to be a first charge over the property in favour of the bank, but there remained due to Barclays a debt of approximately £309,000 secured by the prior Barclays charge.
- Barclays naturally refused to release its charge unless the outstanding debt was paid in full. At first the borrowers promised to pay the necessary sum to Barclays but they failed to keep their word. The solicitors did not immediately tell the bank of their error, as they should, because they hoped to be able to resolve it. When eventually they informed the bank there were negotiations between the bank and Barclays with the result that the bank executed a deed of postponement acknowledging the primacy of the Barclays charge and Barclays consented to the registration of the appellant bank’s charge as a second charge.
- Subsequently the borrowers defaulted, and the property was repossessed and sold by Barclays in February 2011 for £1.2m, of which the bank received £867,697.
- The issue is how much the bank is entitled to recover from the solicitors. The bank claims that it is entitled to the full amount of its loan less the amount recovered by it. The solicitors contend that their liability is limited to the amount by which the bank suffered loss by comparison with its position if the solicitors had done as they should, which was to have paid Barclays the full amount of the Barclays debt so as to redeem the Barclays charge. The difference, leaving interest aside, is between £2.5m and £275,000 in round figures.
The action
- The bank alleged that the solicitors acted in breach of trust, breach of fiduciary duty, breach of contract and negligence. It claimed relief in the forms of (i) reconstitution of the fund paid away in breach of trust and in breach of fiduciary duty, (ii) equitable compensation for breach of trust and breach of fiduciary duty, and (iii) damages for breach of contract and negligence, in each case with interest. The solicitors admitted that they acted negligently and in breach of contract but denied the other allegations and they claimed relief under section 61 of the Trustee Act 1925 if found to have acted in breach of trust.
- At the trial, before His Honour Judge Cooke, the bank accepted that the solicitors had acted in good faith.
- The judge found that the solicitors acted in breach of trust, which he analysed as follows:
“23. In the present case,... what the defendant’s instructions authorised them to do with the funds paid to them was to pay to Barclays (or to its account) such sum as was required to procure a release of its charge, and pay the balance to the borrowers or to their order. Had they complied with their instructions they would have paid (taking all the figures in round terms) £1.5m to Barclays and £1.8m to the borrowers. In the event they paid £1.2m to Barclays and £2.1m to the borrowers. In my judgment, in so doing they committed a breach of trust in so far as payment was made contrary to the authority they had been given.
- It does not however in my judgment necessarily follow that the whole of the payment of £3.3m was made in breach of trust. 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. It was not a breach of trust to pay £1.2m to Barclays; that payment was made as partial performance of the authority and obligation to discharge Barclays’ secured debt. It was not a breach of trust to pay £1.8m to the borrowers, as that was the sum to which they were entitled. The breach consisted of the failure to retain an
if he had held that the bank was prima facie entitled to recover the entire amount of the loan.
- The Court of Appeal (Arden, Sullivan and Patten LJJ) held that the judge was wrong to treat the breach of trust as limited to that part of the mortgage advance which was paid to the borrowers instead of being used to discharge their liability to Barclays on the second account. The judgment of the court was given by Patten LJ. Citing earlier authorities and the provisions of the CML Handbook, he held that the solicitors had no authority to release any part of the funds advanced by the bank unless and until they had a redemption statement from Barclays coupled with an appropriate undertaking which enabled them to be sure that they would be able on completion to register the bank’s charge as a first charge over the property. The solicitors have not challenged the Court of Appeal’s reasoning on that point. However, the Court of Appeal upheld the judge’s decision regarding the relief to which the bank was entitled and dismissed the bank’s appeal.
- In reaching its conclusion the Court of Appeal applied what it understood to be the reasoning of the House of Lords in Target Holdings Ltd v Redferns [1996] AC 421. It held that where the breach of trust occurred in the context of a commercial transaction such as the present, Target Holdings established that equitable principles of compensation “although not employing precisely the same rules of causation and remoteness as the common law, do have the capacity to recognise what loss the beneficiary has actually suffered from the breach of trust and to base the compensation recoverable on a proper causal connection between the breach and the eventual loss” (per Patten LJ at para 47).
- Applying that principle to the facts found by the judge, Patten LJ said at para 49:
“If one asks as at the date of trial and with the benefit of hindsight what loss AIB has suffered then the answer is that it has enjoyed less security for its loan than would have been the case had there been no breach of trust. If [the solicitors] had obtained from Barclays a proper redemption statement, coupled with an undertaking to apply the sums specified in the statement in satisfaction of the existing mortgage, then the transaction would have proceeded to complete and AIB could have obtained a first legal mortgage over the Sondhis’ property. But although that did not happen, AIB did obtain a valid mortgage from the Sondhis which they were eventually able to register as a second charge and use to recover part of their loan
from the proceeds of the security in priority to the Sondhis’ other creditors. Even had there been no such mortgage they would have been subrogated to Barclays’ first charge insofar as they discharged part of the Sondhis’ indebtedness by the payment of the £1.2m. In my view all of these are matters to be taken into account in considering what loss has ultimately been caused by the solicitors’ breach of trust. In the light of the judge’s findings it is not open to AIB to contend that but for the breach of trust it simply would have asked for its money back.”
- As to the point made by the bank that in the present case the breach of trust was never made good because the bank never obtained a first charge over the intended security (by contrast with the position in Target Holdings ), Patten LJ considered this irrelevant to the question of principle about how the bank’s equitable compensation was to be calculated. Target Holdings stood as authority for the broad principle identified by Lord Browne-Wilkinson as follows:
“Equitable compensation for breach of trust is designed to achieve exactly what the word compensation suggests: to make good a loss in fact suffered by the beneficiaries and which, using hindsight and common sense, can be seen to have been caused by the breach.”
Like the trial judge, the Court of Appeal did not find it necessary to express any views about section 61 of the Trustee Act.
Target Holdings
- The present case bears a close similarity to Target Holdings , but there is one factual difference which the bank submits is of critical importance. Both parties rely on Target Holdings in support of their respective cases. Neither party has expressly asked this court to depart from its reasoning, but part of the bank’s argument involves a re-interpretation of the reasoning in Target Holdings which is in truth a dressed up attack on it. The reasoning in Target Holdings has attracted a considerable amount of commentary, partly supportive but mostly critical. There was only one speech, given by Lord Browne-Wilkinson. In view of the arguments to which it has led, it is necessary to look at his speech in some detail.
which the solicitors’ equitable duty arose. If, having regard to the relationship and its purpose, the obligations of the parties, its purpose and the obligations of the parties within it, it appeared just to regard the breaches as having caused no loss, because the loss would have happened if there had been no breach, the court should so hold.
- Lord Browne-Wilkinson began his speech by saying that the appeal raised a novel point on the liability of a trustee who commits a breach of trust to compensate beneficiaries for such breach. He framed the issue in this way:
“Is the trustee liable to compensate the beneficiary not only for losses caused by the breach but also for losses which the beneficiary would, in any event, have suffered even if there had been no such breach?”
- He observed that at common law there are two principles fundamental to an award of damages. First, the defendant’s wrongful act must cause the damage of which complaint is made. Second, the plaintiff is to be put “in the same position as he would have been in if he had not suffered the wrong for which he is now getting his compensation or reparation” ( Livingstone v Rawyards Coal Co (1880) 5 App Cas 25, 39, per Lord Blackburn). Equity, he said, approaches liability for making good a breach of trust from a different starting point, but the same two principles are applicable as much in equity as at common law. Under both systems liability is fault-based: the defendant is only liable for the consequences of the legal wrong he has done to the plaintiff and to make good the damage caused by such wrong. He therefore approached the consideration of the rules of equity relevant to the appeal with a “strong predisposition” against holding that Redferns should be held liable to compensate Target for a loss caused otherwise than by the breach of trust.
- Lord Browne-Wilkinson examined two arguments made on behalf of the finance company. First, he considered whether Redferns were under a continuing duty to reconstitute the trust fund by paying back into client account the monies paid away in breach of trust (argument A). Secondly, he considered the argument accepted by the majority of the Court of Appeal that there was an immediate right to have the trust fund reconstituted at the moment of the breach of trust, which gave rise to a cause of action regardless of later events (argument B).
- Lord Browne-Wilkinson prefaced his consideration of the arguments by some important observations about the nature of a beneficiary’s rights under a trust. His starting point was that the basic right of a beneficiary is to have
the trust duly administered in accordance with the provisions of the trust instrument, if any, and the general law. It followed that in relation to a traditional trust where a fund is held in trust for a number of beneficiaries having different, usually successive equitable interests, the right of each beneficiary is to have the whole fund vested in the trustees so as to be able to satisfy his equitable interest.
- The “equitable rules of compensation for breach of trust”, he said, have been largely developed in relation to such traditional trusts, where the only way in which all the beneficiaries’ rights can be protected is to restore to the trust fund what ought to be there. (As will be seen, some commentators have criticised his use of the term “compensation for breach of trust” in this context. They say that it confuses compensation with the primary accounting responsibility of a trustee.)
- In such a case, according to Lord Browne-Wilkinson, the basic rule is that a trustee in breach of trust must either restore to the trust the assets which have been lost by reason of the breach of trust or pay monetary compensation to the trust estate. In so doing, courts of equity did not award “damages” but would make an in personam order for the payment of equitable compensation: Nocton v Lord Ashburton [1914] AC 932, at paras 952, 958, per Viscount Haldane LC.
- Having thus considered how courts of equity would enforce the basic right of a beneficiary to have the trust duly administered in a case where the trust was subsisting and where the only right of each beneficiary was to have the trust fund reconstituted as it should be, Lord Browne-Wilkinson went on to consider the position if at the time of the action the trust had come to an end, for example by the beneficiary becoming absolutely entitled to the trust fund. In such a case, there was no need for restitution to the trust fund in order to protect other beneficiaries. The normal order would therefore be for the payment of compensation directly to the beneficiary. The measure of compensation would be the difference between what the beneficiary had in fact received and the amount which he would have received but for the breach of trust.
- That analysis (which I will refer to as Lord Browne-Wilkinson’s fundamental analysis) provided the foundation for all that followed.
- Lord Browne-Wilkinson rejected the argument that a beneficiary had automatically a continuing right to the reconstitution of the trust fund (argument A). He repeated that in relation to a “traditional trust”, a
“In summary, compensation is an equitable monetary remedy which is available when the equitable remedies of restitution and account are not appropriate. By analogy with restitution, it attempts to restore to the plaintiff what has been lost as a result of the breach, ie, the plaintiff’s loss of opportunity. The plaintiff’s actual loss as a consequence of the breach is to be assessed with the full benefit of hindsight. Foreseeability is not a concern in assessing compensation, but it is essential that the losses made good are only those which, on a common sense view of causation, were caused by the breach.”
Lord Browne-Wilkinson added:
“In my view this is good law. Equitable compensation for breach of trust is designed to achieve exactly what the word compensation suggests: to make good a loss in fact suffered by the beneficiaries and which, using hindsight and common sense, can be seen to have been caused by the breach.”
On that approach Lord Browne-Wilkinson held that Target was not entitled to the summary judgment which the Court of Appeal had ordered.
The arguments
- There were two branches to the arguments advanced on behalf of the bank by Mr Jeremy Cousins QC and Mr Nicholas Davidson QC. I have referred to the first in para 35.
- The second was advanced partly by Mr Cousins but in greater detail by Mr Davidson, who reinforced his argument by reference to the Solicitors’ Accounts Rules.
- Mr Davidson adopted in his argument the views expressed by Lord Millett (then Sir Peter Millett) in his article “Equity’s Place in The Law of Commerce” (1998) 114 LQR 214 and more recently in his judgment in Libertarian Investments Ltd v Hall [2013] HKCFA 93; [2014] 1 HKC 368. A trustee owes a duty to hold trust funds and apply them for the purposes of the trust (a stewardship or custodial duty). He is bound to answer for his stewardship when called on by the beneficiary to do so. If for any reason he misapplies the trust fund, or part of it, he must immediately reconstitute the trust fund in full. If he fails to do so, the court will order him to reconstitute
the fund in specie, if that is possible, or pay the equivalent sum in money so as to produce the same result in financial terms. So in Target Holdings, where the solicitor wrongly paid out the funds before obtaining an executed mortgage, he remained liable to restore the fund; but he was deemed notionally to have done so and to have paid out the money properly at the moment when the preconditions for an authorised disposal of the fund were met.
- The present case is different, it was submitted, because the solicitors failed on discovering their mistake to pay Barclays the additional sum necessary to redeem its charge. They could and should have done so, in which case their position would have been indistinguishable from that of Redferns. But it was now too late. This, Mr Davidson submitted, is the correct analysis of Target Holdings.
- Solicitors’ Accounts Rules are made under section 32 of the Solicitors Act 1974 (amended by the Legal Services Act 2007). At the material time the relevant Rules were the 1998 Rules. (On 6 October 2011 the Solicitors Regulation Authority made the SRA Accounts Rules 2011, which replaced the 1998 Rules.)
- The payment out of the bank’s money to the borrowers on 1 August 2006 was unauthorised by the bank and so was a breach of rule 22 of the 1998 Rules regarding the operation of a solicitor’s client account. Rule 7 obliged the solicitors to remedy the breach on its discovery. The rule provided:
“(1) Any breach of the rules must be remedied promptly upon discovery. This includes the replacement of any money improperly withheld or withdrawn from a client account.
(2) In a private practice, the duty to remedy breaches rests not only on the person causing the breach, but also on all the principals in the practice. This duty extends to replacing missing client money or controlled trust money from the principals’ own resources, even if the money has been misappropriated by an employee or fellow principal, and whether or not a claim is subsequently made on the Solicitors’ Indemnity or Compensation Funds.”
- Mr Graeme McPherson QC submitted on behalf of the solicitors that the Court of Appeal was right to see the case in terms of causation of loss, and it was also right in concluding that the proper measure of the bank’s loss was
relationship with common law principles and remedies, particularly in a commercial context. The parties have provided the court with nearly 900 pages of academic writing. Much of it has been helpful, but to attempt even to summarise the many threads of argument which run through it, acknowledging the individual authors, would be a lengthy task and, more importantly, would not improve the clarity of the judgment. Nor is it necessary to set out a full historical account of all the case law cited in the literature reaching back to Caffrey v Darby (1801) 6 Ves Jun 488.
- In the present case the solicitors owed a compendium of duties to the bank. Their relationship was governed by a contract but they held the money advanced by the bank on trust for the purpose of performing their contractual obligations. They broke their contract and acted in breach of trust when they released to the borrowers the money advanced by the bank, less a part of the sum required to redeem the Barclays mortgage, when they should have paid to Barclays the full amount required for that purpose, in return for an undertaking to issue a redemption certificate, and should have released the diminished balance to the borrowers.
- The determination of this appeal involves two essential questions. The more important question in the appeal is whether Lord Browne-Wilkinson’s statement in Target Holdings of the fundamental principles which guided him in that case should be affirmed, qualified or (as the bank would put it) reinterpreted. Depending on the answer to that question, the second is whether the Court of Appeal properly applied the correct principles to the facts of the case.
- Two main criticisms have been made of Lord Browne-Wilkinson’s approach. They have been made by a number of scholars, most recently by Professor Charles Mitchell in a lecture on “Stewardship of Property and Liability to Account” delivered to the Chancery Bar Association on 17 January 2014, in which he described the Court of Appeal’s reasoning in this case as incoherent. He expressed the hope that “if the case reaches the Supreme Court their Lordships will recognise that Lord Browne-Wilkinson took a false step in Target when he introduced an inapt causation requirement into the law governing … substitutive performance claims.” He added that if it is thought too harsh to fix the solicitors in this case with liability to restore the full amount of the loan (subject only to a deduction for the amount received by the sale of the property), the best way to achieve this is “not to bend the rules governing substitutive performance claims out of shape”, but to use the Trustee Act 1925, section 61, to relieve them from some or all of their liability.
- The primary criticism is that Lord Browne-Wilkinson failed to recognise the proper distinctions between different obligations owed by a trustee and the remedies available in respect of them. The range of duties owed by a trustee include:
(1) a custodial stewardship duty, that is, a duty to preserve the assets of the trust except insofar as the terms of the trust permit the trustee to do otherwise;
(2) a management stewardship duty, that is, a duty to manage the trust property with proper care;
(3) a duty of undivided loyalty, which prohibits the trustee from taking any advantage from his position without the fully informed consent of the beneficiary or beneficiaries.
- Historically the remedies took the form of orders made after a process of accounting. The basis of the accounting would reflect the nature of the obligation. The operation of the process involved the court having a power, where appropriate, to “falsify” and to “surcharge”.
- According to legal scholars whose scholarship I have no reason to doubt, in the case of a breach of the custodial stewardship duty, through the process of an account of administration in common form, the court would disallow (or falsify) the unauthorised disposal and either require the trust fund to be reconstituted in specie or order the trustee to make good the loss in monetary terms. The term “substitutive compensation” has come to be used by some to refer to a claim for the value of a trust asset dissipated without authority. (See the erudite judgment in Agricultural Land Management Ltd v Jackson (No 2) [2014] WASC 102 of Edelman J, who attributes authorship of the term to Dr Steven Elliott.)
- In a case of breach of a trustee’s management stewardship duty, through the process of an action on the basis of wilful default, a court could similarly falsify or surcharge so as to require the trustee to make good the loss resulting from the breach. The phrase “wilful default” is misleading because, as Brightman LJ explained in Bartlett v Barclays Bank Trust Co Ltd (Nos 1 and 2) [1980] Ch 515, 546, conscious wrongdoing is not required. In this type of case the order for payment by the trustee of the amount of loss is referred to by some as “reparative compensation”, to differentiate it from “substitutive
that other person would have been liable. Bowen LJ’s example is far removed in terms of causation of loss from the present case, where the loan agreement involved the bank taking the risk of the borrowers defaulting, and the fault of the solicitors lay in releasing the funds without ensuring that the bank received the full security which it required, with the consequence that the amount of the bank’s exposure was greater than it should have been.
- In Bank of New Zealand v New Zealand Guardian Trust Co Ltd [1999] 1 NZLR 664 Tipping J rightly observed that while historically the law has tended to place emphasis on the legal characterisation of the relationship between the parties in delineating the remedies available for breach of an obligation, the nature of the duty which has been breached can often be more important, when considering issues of causation and remoteness, than the classification or historical source of the obligation.
- Tipping J identified three broad categories of breach by a trustee. First, there are breaches of duty leading directly to damage or to loss of trust property. Secondly, there are breaches involving an element of infidelity. Thirdly, there are breaches involving a lack of appropriate skill and care. He continued at para 687:
“In the first kind of case the allegation is that a breach of duty by a trustee has directly caused loss of or damage to the trust property. The relief sought by the beneficiary is usually in such circumstances of a restitutionary kind. The trustee is asked to restore the trust estate, either in specie or by value. The policy of the law in these circumstances is generally to hold the trustee responsible if, but for the breach, the loss or damage would not have occurred. This approach is designed to encourage trustees to observe to the full their duties in relation to trust property by imposing on them a stringent concept of causation [ie a test by which a “but for” connection is sufficient]. Questions of foreseeability and remoteness do not come into such an assessment.”
- According to the bank’s argument, the responsibility of the solicitors is still more stringent. It seeks to hold them responsible for loss which it would have suffered on the judge’s findings if they had done what they were instructed to do. This involves effectively treating the unauthorised application of trust funds as creating an immediate debt between the trustee and the beneficiary, rather than conduct meriting equitable compensation for any loss thereby caused. I recognise that there are statements in the authorities which use that language to describe the trustee’s liability. For example, in Ex p Adamson; In
re Collie (1878) 8 Ch D, at paras 807, 819, James and Baggallay LJJ said that the Court of Chancery never entertained a suit for damages occasioned by fraudulent conduct or for breach of trust, and that the suit was always for “an equitable debt, or liability in the nature of a debt”. This was long before the expression “equitable compensation” entered the vocabulary. Equitable monetary compensation for what in that case was straightforward fraud was clothed by the court in the literary costume of equitable debt, the debt being for the amount of the loss caused by the fraud. Whatever label is used, the question of substance is what gives rise to or is the measure of the “equitable debt or liability in the nature of a debt”, or entitlement to monetary compensation, and what kind of “but for” test is involved. It is one thing to speak of an “equitable debt or liability in the nature of a debt” in a case where a breach of trust has caused a loss; it is another thing for equity to impose or recognise an equitable debt in circumstances where the financial position of the beneficiaries, actual or potential, would have been the same if the trustee had properly performed its duties.
Conclusion
- There are arguments to be made both ways, as the continuing debate among scholars has shown, but absent fraud, which might give rise to other public policy considerations that are not present in this case, it would not in my opinion be right to impose or maintain a rule that gives redress to a beneficiary for loss which would have been suffered if the trustee had properly performed its duties.
- The same view was expressed by Professor Andrew Burrows in Burrows and Peel (eds.), Commercial Remedies , 2003, pp 46-47, where he applauded Target Holdings for impliedly rejecting older cases that may have supported the view that the accounting remedy can operate differently from the remedy of equitable compensation. Despite the powerful arguments advanced by Lord Millett and others, I consider that it would be a backward step for this court to depart from Lord Browne-Wilkinson’s fundamental analysis in Target Holdings or to “re-interpret” the decision in the manner for which the bank contends.
- All agree that the basic right of a beneficiary is to have the trust duly administered in accordance with the provisions of the trust instrument, if any, and the general law. Where there has been a breach of that duty, the basic purpose of any remedy will be either to put the beneficiary in the same position as if the breach had not occurred or to vest in the beneficiary any profit which the trustee may have made by reason of the breach (and which ought therefore properly to be held on behalf of the beneficiary). Placing the
