The defence of illegality has long been considered available to negligent practitioners where an underlying fraud has been committed by their clients, but the courts have shown they are no longer willing to let lawyers or their insurers use it as a get out of jail free card.
In a unanimous judgment handed down by Lord Lloyd-Jones last month, the Supreme Court considered the defence of illegality in Stoffel & Co v Grondona, developing the Court of Appeal’s application of the principles set down in the Supreme Court’s decision in Patel v Mirza.
Facts
The case centred around Ms Grondona, who gave Mr Mitchell authority to use her name on a series of mortgage applications as part of a conspiracy to defraud lenders.
In the transfer of a property from Ms Grondona to Mr Mitchell, Stoffel & Co were instructed to act for buyer, seller, the existing mortgagee BM Samuels and the new mortgagee Birmingham Midshires. Stoffel & Co failed to register the TR1 transferring the property to Ms Grondona, the DS1 releasing a previous charge, or the charge in favour of Birmingham Midshires. Accordingly, Mr Mitchell remained the registered proprietor of the property, and a third-party lender remained the registered chargee. Further advances were made pursuant to the unregistered charge.
Ms Grondona defaulted on payments to Birmingham Midshires who brought proceedings against her for breach of contract and, by way of Part 20, she brought proceedings against the Stoffel & Co for an indemnity or contribution for breach of duty and/or contract.
Admitting negligence, Stoffel & Co sought to avoid liability on the basis that the purpose of the transactions was to defraud Birmingham Midshires by putting the property into Ms Grondona’s name and obtaining mortgage monies by unlawful means. It was a conspiracy to fund Mr Mitchell by misrepresentation, and so the principle of ex turpi causa non oritur actio (that is, the defence of illegality) should duly apply.
At first instance, the judge applied the much-criticised reliance test set out in Tinsley v Milligan, and concluded that the claimant did not rely upon the illegality to found her claim, and therefore that the defence did not apply. This test relied on the principle that an absolute rule was required to provide certain application of the doctrine at common law.
By the time the case reached the Court of Appeal, Tinsley had been superseded by the Supreme Court’s approach in Patel, which required that in determining whether the public interest would be harmed in the enforcement of an illegal agreement, the following should be considered:
- The underlying purpose of the prohibition which has been transgressed, and whether that purpose will be enhanced by denial of the claim.
- Whether there is any other relevant public policy on which the denial of the claim may have an impact.
- Whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts.
Factors to be considered in respect of the third limb in Patel were said to include “the seriousness of the conduct, its centrality to the contract, whether it was intentional and whether there was marked disparity in the parties’ respective culpability” (per Lord Toulson).
Accordingly, the Court of Appeal dismissed the appeal on the basis that the lender had essentially adopted the transaction, that the borrower was not seeking to avoid her responsibility to the lender under the transaction, that the conduct was not central or relevant to the firm’s retainer and that there was no profit from the fraud resulting from the claim against the firm. In the circumstances, Lady Justice Gloster concluded there was “no risk that enforcement of [the] claim would undermine the integrity of the justice system”.
Decision
The Supreme Court has now affirmed this approach, unanimously finding that the test in Patel is correct, and that a claim should only be barred where it results in an “incoherent contradiction damaging to the integrity of the legal system” (per Lord Lloyd-Jones). Further, the court considered that denying Ms Grondona’s claim “would be a disincentive to the diligent performance by solicitors of their duties.”
An analysis of the motivations for the claim must be undertaken, in that “the motive for the wrongdoing which forms the background to this claim must … be distinguished from enlisting the court’s assistance to make a profit from that wrongdoing.”
Comment
Whilst yielding what some may consider an undesirable outcome in saving a fraudster from sustaining a loss, Stoffel will come as no surprise to practitioners who anticipated the court would double down on an approach to the defence of illegality on the basis of subjective principles, rather than the application of a formal approach. Scope of the illegality defence post-Patel and Stoffel remains highly fact-specific.
The courts have shown their unwillingness to allow the law to act as a shield for negligent professionals and their insurers, who may consider that they had a trump card to play if their clients are found to have committed a fraud that is distinct but related to their work. The fact that such financial liability will ultimately rest on the shoulders of insurers is no doubt a relevant factor. However, there will be cases which will pass much closer to the wind and will require the court to reflect on policy considerations.
The Supreme Court also gave judgment on the same day in Henderson v Dorset Healthcare University NHS Foundation Trust, in which the claimant sought damages for negligence after the defendant failed to stop her committing the manslaughter of her mother. The same test was applied but the defence of illegality was upheld.
Through these two cases then, the judiciary has given a strong indication that they will work within the Patel and Stoffel framework on illegality to produce flexible but predictable outcomes across the board. The relative paucity of these cases may mean that common law is slow to develop further, but there is scope for significant further consideration on what may amount to an “incoherent contradiction damaging to the integrity of the legal system”.
Banks, conveyancers and other transactional professionals need to be aware that there is no automatic safe haven for the negligent practitioner where their client has engaged in fraud. That is not to say, however, that a solicitor would not be well advised to consider whether the terms of their retainer may be amended to carve out liability for negligence where fraud is committed by their client in the underlying transaction. Indeed, indemnity insurers may move towards this outcome.
In the meantime, the more you know about your client, the better placed you will be to avoid ever needing to run the defence of illegality.
