Solicitors’ PI: negligent solicitors not entitled to rely on illegality principle

The Court of Appeal recently dismissed an appeal by solicitors, upholding a decision that their client was entitled to damages of £78,000 caused by their negligent failure to file Land Registry documents, despite the fact that their client was complicit in a mortgage fraud. The solicitors’ argument of ex turpi causa (the illegality principle) failed. The Court of Appeal was not persuaded that for public policy reasons the client should be disallowed from recovering damages even where the solicitors’ negligence was in relation to documents which formed part of a wider fraud.

Background

Ms Grondona entered into a business agreement with Mr Mitchell whereby she agreed to purchase and take mortgage loans in her own name over four properties owned by Mr Mitchell on the understanding that Mr Mitchell would meet the mortgage payments under her loans and maintain the properties. In return, Mr Mitchell agreed to pay her 50% of the net profit when the properties were sold. In essence, Mr Mitchell was using Ms Grondona’s good credit rating to borrow money in circumstances where the bank would not have lent him the money directly.

A firm of solicitors, Stoffel & Co, acted for Ms Grondona in her purported purchase of one of the properties from Mr Mitchell. Ms Grondona financed the purchase with a mortgage from Birmingham Midshires which was secured by a charge over the property. Ms Grondona's loan from Birmingham Midshires was paid to the existing chargee of the property, BM Samuels, to release Mr Mitchell's charge.

The solicitors failed to register the TR1 transferring the property from Mr Mitchell to Ms Grondona or the DS1 releasing BM Samuels from the charge. They admitted negligence and breach of duty. As a result, Mr Mitchell remained the registered proprietor of the property and BM Samuels remained the registered proprietor of its charge (despite it being discharged).

Ms Grondona defaulted on her mortgage payments and Birmingham Midshires brought proceedings against her to obtain a money judgment. The solicitors were brought in by way of Part 20 claim. Whilst the solicitors admitted negligence, they argued that Ms Grondona was not entitled to damages because the purpose of the transaction (to put the property into her name and to obtain a mortgage from Birmingham Midshires) was illegal, because it was a conspiracy to obtain finance for Mr Mitchell by misrepresentation. The principle of ex turpi causa non oritur action (the illegality principle) therefore applied.

First Instance Decision

The first instance Judge held that Ms Grondona and Mr Mitchell had participated in a mortgage fraud to deceive Birmingham Midshires into making the advance to Ms Grondona via various misrepresentations which she made in her mortgage application form. The Judge held that the mortgage application/agreement was a sham arrangement whereby Ms Grondona lent her good credit history to Mr Mitchell to obtain finance, with no intention that she would become the beneficial and legal owner of the property.

The Judge applied Tinsley v Mulligan [1994] AC 240 and held that the correct test to determine whether Ms Grondona’s claim was defeated by the illegality principle was not whether the illegality was closely connected, or inextricably linked, with the claim against the solicitors, but whether she relied upon that illegality to found her claim (the reliance test). Ms Grondona was not relying on the illegal mortgage agreement to bring her claim: rather, she had lost the benefit of the property providing security for the mortgage advance from Birmingham Midshires as a result of the solicitors’ negligence. The fact that the mortgage was illegal made no difference to whether she could bring the claim. Therefore, the defence of ex turpi causa failed. The solicitors were ordered to pay £78,000 plus interest, which was the value of the unencumbered property when the negligence occurred.

Appeal Decision

The solicitors appealed. The issue on appeal was whether the fact that Ms Grondona was a participant in an illegal mortgage fraud designed to obtain monies for Mr Mitchell precluded her from recovering against the solicitors on the basis of the illegality principle.

As a preliminary point, the Court of Appeal over-turned two key findings of fact, first that the mortgage application/agreement was a sham, and second that there was no intention that Ms Grondona would become the legal owner of the property. Gloster LJ held that, even though the mortgage application was fraudulent, it did not follow that it was a sham transaction as between Ms Grondona and Birmingham Midshires. Similarly, the mortgage agreement, even if tainted by illegality, was not a sham. For there to be a sham, the parties must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating (per Lord Diplock in Snook v London and West Riding Investments Ltd [1967] 2 QB 786). There was a genuine intention of the parties to transfer the legal title of the property from Mr Mitchell to Ms Grondona, even if the TR1 was never registered (due to the solicitors’ negligence). The solicitors’ retainer itself was entirely lawful and legitimate.

It was common ground that, because Tinsley v Mulligan had been overruled by the Supreme Court in Patel v Mirza [2016] UKSC 42, the reliance test which the Judge at first instance had applied needed to be revisited. Gloster LJ applied the new test set out by Lord Toulson in Patel v Mirza. In order to assess whether allowing a claim which is tainted by illegality would be contrary to the public interest, Gloster J considered the following factors and came to the following conclusions:

1. The underlying purpose of the prohibition which has been transgressed: there was “no public interest in allowing negligent conveyancing solicitors (or, in financial terms, their insurers), who are not a party to, and know nothing about, the illegality, to avoid their professional obligations simply because of the happenstance that two of the clients for whom they act are involved in making representations to the mortgagee financier.”
2. Any other relevant public policies which may be rendered ineffective or less effective by denial of the claim: there was a genuine public interest in ensuring that clients who use the services of solicitors are entitled to seek damages for negligence/breach of contract arising from a legitimate and lawful retainer which was entered into between them, where the client was not seeking to profit or gain from her mortgage fraud but merely to ensure that the charge was adequately protected by registration.
3. Proportionality: it would be entirely disproportionate to deny Ms Grondona’s claim for a number of reasons including that her illegal conduct was not central, or indeed relevant, to the otherwise proper and legitimate retainer with her solicitors or to her claim against them for damages; it was simply part of the background story.

The Court of Appeal also rejected Ms Grondona’s cross-appeal on the calculation of damages, upholding the underlying decision that the relevant measure of loss was the sum which would have been raised on a forced sale of the property at the time of the negligence, had the TR1 and DS1 been registered, rather than the full extent of her indebtedness to Birmingham Midshires.

Comment

The decision to allow Ms Grondona to recover against her solicitors may seem unduly harsh in circumstances where she was clearly engaged in mortgage fraud with Mr Mitchell. The Court of Appeal’s focus was on the retainer between Ms Grondona and her solicitors which it said was proper and legitimate, even though the solicitors argued that the purpose of the documents they were instructed to prepare and file with the Land Registry was to facilitate and lend credibility to the fraud. It perhaps did not help the solicitors that there was undefendable negligence on their part in failing to register the documents, and the Court of Appeal was not prepared to let them walk away from their liability to Ms Grondona even once the fraud had been unravelled.

This case serves as a useful reminder to PI insurers that the courts can show reluctance to allow an illegality defence to succeed in all but the strongest cases.

Further reading: Stoffel & Co v Grondona [2018] EWCA Civ 2031.