Paying the forfeit—the importance of mitigating losses (LSREF III Wight Ltd v Gateley LLP)

The Court of Appeal has handed down judgment in LSREF III Wight Ltd v Gateley LLP, a case which concerned a forfeiture clause in a lease and whether the claimant had unreasonably failed to mitigate its loss. John de Waal QC, barrister at Hardwicke Chambers, says the case shows that judges want to achieve a fair result.

Original news

LSREF III Wight Ltd v Gateley LLP [2016] EWCA Civ 359, [2016] All ER (D) 145 (Apr)

The Court of Appeal, Civil Division, allowed the defendant solicitors’ firm’s appeal and allowed the claimant’s cross appeal from an order made after the quantum only trial of a professional negligence claim against the defendant. The judge had made an error of principle in having confined his assessment of loss to the transaction date, rather than the trial date and none of the judge’s reasons justified the conclusion that the claimant had not unreasonably failed to mitigate its loss. Nonetheless, the defendant was liable for the full cost which the claimant had incurred in curing a defect in a lease, albeit after trial, in the sum of £157,100.

What was the background to the application, briefly?

In 2007 Gateley provided a report on title to a subsidiary of AIB who were considering lending £1.1m to a special purposed vehicle (SPV), Method Investments Ltd, against the security of various properties including a 199-year lease of a mixed use development in Leicester. Gateley negligently (as it admitted) failed to advise the bank about the forfeiture clause in the lease which provided for the lease to be forfeited in an insolvency event—in passing, it is surprising both that Gateley missed the point and that the bank was not aware that this is a standard provision in commercial leases. This reduced the value of the legal charge as security, as the bank appreciated when it came to enforce its security in 2012.

The claimant, which had taken an assignment of the bank’s cause of action, sued Gateley for damages for negligence. The freeholder offered to vary the lease for a price of £150,000 which Gateley offered to pay. The claimant declined the offer. At trial it was argued that the claimant had acted unreasonably in failing to mitigate its loss. The judge rejected that argument and awarded the claimant damages of £240,000—part of which it promptly used to pay the freeholder £150,000 and mitigate its loss.

What were the legal issues the Court of Appeal had to decide in this application?

The Court of Appeal had to decide two things:

  • first, at what date to assess the transactional loss suffered by the bank—was it the date of the transaction, or the date when the security is realised when the loss crystallised, or some other date such as the trial date?
  • second, had the claimant acted unreasonably in failing to mitigate its loss?

What were the main legal arguments put forward?

The argument for the claimant on the first point was that events happening after the date of the transaction were collateral (in the old language, res inter alios acta) and thus the claimant did not have to credit Gateley for the benefit it had obtained when it obtained the variation of the lease. It argued that that the question of whether it had mitigated its loss was a matter of fact the judge had been entitled to decide as he did and that negotiating with the freeholder was a complex and risky business, so it should not be criticised for not achieving the result it later achieved at an earlier date.

As is often the case, the judgment did not summarise the arguments of the successful party, Gateley, in any detail—since they are subsumed into the court’s reasoning—but it is clear that Gateley pointed out the obvious fact that the deal it had been prepared to fund before trial was made very quickly after trial, and that this should be taken into account when assessing the claimant’s relevant recoverable loss.

What did the Court of Appeal decide, and why?

The leading case on the question of how and when one quantifies loss caused by a negligent report on title remains the decision of the House of Lords in Nykredit Mortgage Bank plc v Edward Erdman [1998] 1 All ER 305. The Court of Appeal referred to this and held that the best date for quantification of transaction loss in a lender’s negligence claim against solicitors is the trial date. It then went further and decided to calculate the loss at the date of the appeal hearing, taking into account the facts then known—that the lease had been rectified at a cost of £150,000.

On the mitigation point it decided that the judge’s conclusions could not be justified—the offer to vary the lease was there, the benefit exceeded the outlay and the bank was in funds to pay the freeholder. It was unreasonable to reject the offer.

To what extent is the judgment helpful in clarifying the law in this area?

The judgment reminds us of two things:

  • first, the process of clarifying loss caused by a negligent report on title remains difficult, but that the court is going to look at the question at the date of trial, and, exceptionally, afterwards
  • second, that if a defendant—in effect—offers to fund a mitigation exercise, it may well be unreasonable to reject it

What practical lessons can those advising take away from this case?

Quite simply, judges want to reach a fair result. The effect of the judgment in this case was to over compensate the claimant at Gateley’s expense. In a lender’s claim, consider loss at the date of trial and be very careful before rejecting an offer by the defendant—or its insurers—to fund a mitigation exercise.

LexisPSL Property practical point

It may be considered surprising that the 199 year lease contained the forfeiture clause providing for forfeiture on an insolvency event and that this was not picked up in later due diligence. Long leases (which usually have a minimal ground rent) are considered more akin to freeholds and so often do not include forfeiture clauses—reflected perhaps in the landlord’s willingness to vary the lease (for a price). However, many do include forfeiture clauses—though often providing for forfeiture only on material breach of the lease covenants. Even then, a mortgagee should ensure that the lease contains ‘mortgage cure rights’.

A mortgagee can apply for relief from forfeiture. It claims relief as if acting as a subtenant.

In cases of forfeiture for breaches of covenant (other than non-payment of rent), the court has a discretion to grant a mortgagee of the property relief from forfeiture or to make a vesting order.

However, these rights of relief are only of potential use if the mortgagee is aware that forfeiture is in hand. The landlord is under no obligation to notify the mortgagee of its intentions or to serve it with a copy of any notice under section 146 of the Law of Property Act 1925. Therefore, a mortgagee may not find out about forfeiture of its security until it is too late.

A mortgage cure or mortgagee protection clause:

  • provides that the landlord cannot forfeit without first giving any mortgagee (whose details it has been given) written notice (irrespective of the grounds of forfeiture) of its intention to do so
  • allows the mortgagee a reasonable period of time to remedy the breach to avoid forfeiture occurring
    It may also provide for a new lease to be granted to the mortgagee if it undertakes to remedy a breach that has given rise to forfeiture of the lease

John de Waal QC is a barrister specialising in property and professional negligence(@johndewaalqc).

Interviewed by Anne Bruce.

The views of our Legal Analysis interviewees are not necessarily those of the proprietor.

Further Reading

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Insolvency issues for landlords

Lifting the administration moratorium—for forfeiture

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First published on LexisPSL Restructuring and Insolvency

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