Lender's solicitors liable in fraudulent sale

When will a solicitor be liable to a mortgage lender for breach of trust? A Court of Appeal decision originally reported by the Lexis®PSL Dispute Resolution team back in February makes it clear that a solicitor will be liable for unreasonable conduct in connection with the lender’s loss, even if the fraud would have taken place anyway.

Original news

Santander v RA Legal Solicitors [2014] EWCA Civ 183, [2014] All ER (D) 216 (Feb)

The claim arose from a mortgage fraud. Santander (then Abbey National) arranged to lend £150,000 to a buyer against security by way of first legal charge on a property they understood he was to buy. RA Legal Solicitors (RA Legal) acted for the buyer and Abbey National (Abbey) on the proposed purchase and Abbey's proposed charge. They dealt with another firm of solicitors called Sovereign Chambers LLP (Sovereign), who presented themselves as acting for the seller, the registered owner of the property. Sovereign were fraudulent. RA Legal released the mortgage advance to them, but Abbey never obtained a charge over the property.

The High Court decided RA Legal was in breach of trust in releasing the mortgage advance to Sovereign, but they should be relieved from liability in respect of the breach.

The Court of Appeal allowed Santander’s appeal. RA Legal was in breach of trust and was not entitled to relief from liability.

Why did the court decide RA Legal were in breach of trust?

As in Markandan and Davisons (cases involving bogus ‘solicitors’ acting for the seller who were actually fraudsters), the mortgage advance was paid away without receiving genuine documents to complete transaction.

The Court of Appeal decided RA Legal had been in breach of trust the day before apparent completion when it sent the monies to Sovereign.

Where an intending lender transfers the loan money to an intending buyer's solicitors on terms that they hold the money on trust until completion, the buyer's solicitors have authority to:

deposit it in a bank of their choosing
deposit it in client account, and
(if necessary) move it to a client account of theirs in some other respectable bank than the bank to which the lender originally transferred the money

The buyer’s solicitors also have the lender's implied authority to transfer the money to the client account of solicitors acting for the seller prior to completion, to hold to the buyer’s solicitors' order pending completion. That was an ordinary incident of residential conveyancing in the modern world with which institutional lenders may be taken to be familiar.

However, it did not follow that the buyer's solicitors have the lender's implied authority to transfer the trust money pending completion to the client account of any other solicitor than the firm which is in fact acting for the owner and intending seller of the property. Sovereign did not fit that description. It was not acting for the owner of the property, had no instructions either to contract for or complete the sale and had no intention of using any part of the money transferred to its client account for the purpose of discharging the existing first mortgage on the property. The transfer of the money to Sovereign's client account the day before supposed completion was a breach of trust by RA Legal.

What are the principles involved in relieving a trustee from personal liability?

Under the Trustee Act 1925, s 61 (TA 1925) the court has a discretion to relieve (either wholly or partly) a trustee from personal liability for a breach of trust if it appears to it that the trustee:

is or may be personally liable for the breach, but
has acted honestly and reasonably, and
ought fairly to be excused for the breach of trust

There was no dispute that RA Legal had acted honestly.

In the context of mortgage fraud, this requires the trustee to prove it acted reasonably only in relation to those aspects of his conduct which are connected with the beneficiary lender's loss. The trustee must only show it has acted reasonably—not that it has necessarily complied with best practice in all respects.

‘The relevant action must at least be connected with the loss for which relief is sought and the requisite standard is that of reasonableness not of perfection.’

The Court of Appeal confirmed:

a strict causation test was too narrow—in most mortgage fraud cases, the effective, primary or predominant cause of the loss is the third party's fraud rather than the conduct of the solicitor trustee
it was also too restrictive to apply a 'but for' test which disregards conduct, however unreasonable, on the basis that even if the solicitor had acted reasonably in that respect, the fraud, and therefore the loss, would still have occurred
on the other hand, it would extend the net too wide to include every aspect and detail of the solicitor trustee's conduct which occurred, or played any part in, the process which began with the transfer of the loan money by the lender to the solicitor trustee and ended with its theft by the fraudster

Between those extremes, some element of causative connection will usually have to be shown and conduct (even if unreasonable) which is completely irrelevant or immaterial to the loss will usually fall outside the court's purview under TA 1925, s 61.

Finally, the Court of Appeal cautioned against an over-mechanistic application of the requirement to show the necessary connection between the conduct complained of and the lender's loss. There may be highly unreasonable conduct which lies at the fringe of materiality in terms of causation, and only slightly unreasonable conduct which goes to the heart of a causation analysis.

The standard of conduct connected with the loss is likely to be higher for a paid than for an unpaid trustee.

The Court of Appeal confirmed:

in deciding whether the trustee ought fairly to be excused for the breach of trust under TA 1925, s 61, regard must be had to the effect of the grant of relief not only upon the trustee, but also upon the beneficiaries
TA 1925, s 61 makes it clear that even if the trustee ought fairly to be excused, the court still retains the discretionary power to grant relief from liability, in whole or in part, or to refuse it
in the context of relief sought by solicitor trustees from liability for breach of trust in connection with mortgage fraud, much may depend at the discretionary stage upon the consequences for the beneficiary. An institutional lender may well be insured (or effectively self-insured) for the consequences of third party fraud. However, an innocent buyer may have contributed his life's savings to the purchase and have no recourse at all other than against his insured solicitor, where for example the fraudster is a pure interloper, rather than a dishonest solicitor in respect of whose fraud the losers may have recourse against the Solicitors' Compensation Fund
relief under TA 1925, s 61 is often described as an exercise of mercy by the court. The requirement to balance fairness to the trustee with a proper appreciation of the consequences of the exercise of the discretion for the beneficiaries meant this old-fashioned description of the nature of the TA 1925, s 61 jurisdiction should be abandoned. In this context mercy lay not in the free gift of the court. It came at a price

Why did the Court of Appeal allow Santander’s appeal?

The Court of Appeal confirmed the High Court had erred in law in adopting an over-lenient view about the requirement to show reasonable conduct. Its exercise of discretion could not stand.

Since RA Legal had not shown they acted reasonably in all respects connected with Santander's loss, the discretion did not, strictly, arise at all. Even if it had done, and fell to be undertaken afresh by the Court of Appeal, it would not have been fair to grant RA Legal any relief from liability for breach of trust.

The liability was for breach of trust, so the burden was on RA Legal to satisfy the court that, in all respects material to Santander's loss, it acted both honestly and reasonably (as opposed to a claim for breach of contract or negligence where, generally, the lender must prove the solicitor has been guilty of a breach of a duty of care).

Why was RA Legal’s conduct unreasonable?

The question whether a trustee has acted reasonably in respect of matters connected with the beneficiary's loss was not to be resolved purely by considering each specific complaint separately. The question was whether the trustee's relevant conduct was reasonable, taken as a whole.

Looking at the matter in the round, the judge took an altogether too lenient view of the seriousness of RA Legal's numerous departures from best practice, during the whole of the period from its request for the funds from Santander, until they were misappropriated from Sovereign's client account approximately two weeks later. Those which were connected with Santander’s loss were:

the making of inadequate requisitions on title
the receipt of inadequate replies
the failure to obtain Sovereign's written commitment to follow the Law Society's Code for completion by post (Completion Code) before transferring the completion money to Sovereign
the failure to appreciate completion had gone seriously wrong when no confirmation that the mortgage had been discharged was received in the post

The result was RA Legal:

had no written confirmation (by adoption of the Completion Code or in any other way), before transferring the completion money, of Sovereign's obligation to hold the completion money to RA Legal's order pending completion, or to return it if for any reason completion did not properly take place

had neither a written (or any other) undertaking from Sovereign to obtain a discharge of the charge on the property

had no means of summary enforcement of either of those obligations

When no executed discharge of the prior mortgage arrived with the post-completion letter alongside the forged contract RA Legal failed to appreciate this omission meant completion had not taken place as it should have. It did not appreciate something serious had gone wrong or take any remedial action despite the fact it also knew eight days before misappropriation of the money that:

possession had not been handed over

the prior charge had definitely not been discharged

Instead, the firm sent confusing letters to Sovereign, asserting on the one hand completion had taken place, while on the other hand threatening, and later serving, a notice to complete. It was clear from Daybells, that once a buyer's solicitor becomes aware of an apparent breach of undertaking by the seller's solicitor in relation to completion, he should ordinarily take prompt steps to have that undertaking summarily enforced.

RA Legal’s failings were unreasonable and sufficiently connected with Santander's loss. They:

‘...formed part of a larger picture of the shoddy performance of a conveyancing transaction from start to finish, which leaves me in no doubt that it would not be fair to excuse the firm from liability, in whole or in part.'

How did the court approach the ‘but for’ argument?

The Court of Appeal was prepared to assume the fraud would probably have been successfully achieved anyway. However, a conclusion that, but for those aspects where RA Legal's conduct fell seriously and unreasonably short of best practice, the fraud would probably have succeeded did not mean RA Legal's conduct was unconnected with the loss.

In the words of the Court of Appeal:

‘The current best practice for conveyancing solicitors has evolved over many years, in the light of developing experience, for the purpose (among others) of providing reasonable, albeit not cast-iron, protection from fraud, both to lenders and purchasers. In my judgment it would not be appropriate to exclude as irrelevant conduct which consisted of a departure from best or reasonable practice which increased the risk of loss caused by fraud, even if the court concludes that the fraudster would nonetheless have achieved his goal if the solicitor had acted reasonably.’

How did the court approach procedural issues?

The implications of much of RA Legal’s unreasonable conduct were not dealt with at trial. Nonetheless, the Court of Appeal confirmed it would not be unfair or unjust to RA Legal for the court to assess whether it had acted reasonably by reference to the evidence.

What are the lessons and practical implications for solicitors acting for lenders?

The decision sends a clear message to solicitors acting for lenders. They can no longer expect to be relieved from liability for unreasonable conduct causing loss even if the court accepts the fraud would have occurred anyway.

The Court of Appeal picked a number of holes in RA Legal’s conveyancing procedures, even those which did not cause the loss (eg the certificate of title confirmed the investigation of title had been concluded when it hadn’t been).

Solicitors should ensure they follow best practice and, perhaps as crucially, keep a record of their actions. The Court of Appeal confirmed:

‘In the context of a routine conveyancing transaction, the incidence of the burden of proof may frequently be crucial to the outcome. This is because such transactions are, in the working life of those involved, so routine and so frequent that a specific recollection of any part of one of them, not precisely recorded in contemporaneous correspondence, documents or attendance notes, will rapidly fade. Thus, if the reasonableness of the solicitor's conduct depends on anything not so recorded, the solicitor may simply be unable to discharge the burden of proof on that aspect of the matter, due to a perfectly understandable inability to recollect the detail. In such circumstances, the benefit of the doubt (or the burden of proof) is not to be given to the solicitor if the relevant question is as to the reasonableness, rather than the honesty, of his conduct. It is therefore likely that, in order to discharge the burden of proving that he acted reasonably under section 61, the solicitor will need to be able to provide a paper-trail demonstrating that the whole of his or his firm's conduct sufficiently connected with the loss satisfied the reasonableness test.’

Joanna Bhatia, solicitor in the Lexis®PSL Property team.

(note that subscribers to Lexis®PSL Dispute Resolution can find additional information by clicking the blue links)

First published on Lexis®PSL Dispute Resolution on 26 February 2014. Click here for a free one week trial of Lexis®PSL.