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AIB v Redler: Case summary

Introduction

Breach of trust provides a fertile battle ground for the war between banks and professional indemnity insurers about who should bear the cost of mortgage lending gone wrong.

Insurers were the victors last week (5 November 2014) when the Supreme Court delivered its judgment in the highly important case of AIB Group (UK) plc v Mark Redler & Co [2014] UKSC 58. The case yet further blurs the distinction between chancery and common law principles.

The facts

The case arises from a standard re-mortgage of a residential property. In June 2006 Mr and Mrs Sondhi applied to AIB for a loan of £3.3m to be secured as a first charge over their home. They had an existing mortgage with Barclays, and in the usual way the intention was to redeem the earlier charge using AIB’s loan.  The balance would be paid to the Sondhis.

Unfortunately the solicitors retained by AIB, Mark Redler & Co, who also acted for the Sondhis, negligently mistook a redemption figure from Barclays as relating to the whole of their charge, whereas in fact it related to only one of the two accounts it secured.  As a result the solicitors underpaid Barclays by £309,000 and overpaid the Sondhis by the same amount. The effect was that Barclays’ charge remained in place and AIB’s loan was secured only by a second charge over the property.

The Sondhis did not repay the additional balance paid to them and subsequently defaulted. When the property was sold in February 2011 for only £1.2m, there was a significant shortfall of some £2.5m.

It was common ground, at least by the time the case reached the Court of Appeal, that Mark Redler & Co acted in breach of trust when it released the AIB advance.  The issue was (i) whether AIB could recover from Mark Redler & Co the ‘full’ extent of its loss, including that attributable to a fall in the property market (and/or, perhaps, the fact it was initially overvalued); or (ii) whether its remedy was limited to compensation sufficient to put it in the position it would have been in but for the mistake.

At trial and in the Court of Appeal the issue was decided in Mark Redler & Co’s favour, in both cases on the basis that the court was bound by the reasoning of the House of Lords in Target Holdings Ltd v Redferns [1996] AC 421.  This established the principle that in certain contexts (perhaps somewhat crudely identified as those involving ‘commercial’ rather than ‘traditional’ trusts) equity will apply common law rules of causation and remoteness of damage when quantifying what remedy an errant trustee must provide to his beneficiary.

The Supreme Court judgments

The two judgments were given by Lord Toulson and Lord Reed.  As would be expected, both judgments considered in detail the speech of Lord Browne-Wilkinson in Target.

As Lord Toulson identified, the main criticism of Lord Browne-Wilkinson in Target is that he failed to give proper effect to the fundamental differences in the remedies provided by equity for breach of trust, and by the common law for breach of contract and tort.The former involved the court ‘falsifying’ or ‘surcharging’ the trust account by ordering the trustee to make good any deficiency in the trust assets arising from his misappropriation, with the amount of the award “measured by the objective value of the property lost” (per Millett NPJ in Libertarian Investments Ltd v Hall [2014] 1 HKC 368).  The latter, by contrast, was concerned purely with putting the defendant in the position he would have been in but for the breach of contract or tort.

Lord Toulson’s conclusion is that, notwithstanding the weight of scholarly criticism against Target:

“it would not… 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.”

He went on to reject AIB’s attempt to distinguish Target on the basis that, whereas the lender in that case obtained a first legal charge, it (AIB) never received the security it bargained for.  Lord Toulson said that this “constricts too narrowly” Lord Browne-Wilkinson’s essential reasoning.

In his concurring judgment Lord Reed analysed Target by reference to perhaps its biggest influence: the minority judgment of McLachlin J in the Canadian case of Canson Enterprises Ltd v Broughton & Co (1991) 85 DLR (4th) 129.  The core principle which Lord Reed drew from this analysis is perhaps best shown in the following extract:

“…the model of equitable compensation, where trust property has been misapplied, is to require the trustee to restore the trust fund to the position it would have been in if the trustee had performed his obligation.  If the trust has come to an end, the trustee can be ordered to compensate the beneficiary directly.”

In other words, in the context of ‘traditional’ trusts, where trust property is typically held for a multiple of beneficiaries and income paid out following the exercise of the trustee’s discretion, there can be no question of individual beneficiaries being compensated in the event of the trustee misapplying trust property.  By contrast, in the commercial context, where property is typically held on bare trust subject to a framework of contractual obligations, it makes more sense to consider the effect the breach has had on the beneficiary himself.

The conclusion drawn by Lord Reed is that Target is authority for a much broader proposition than claimed by AIB.  It is not limited to circumstances where the trustee ‘makes good’ his breach by obtaining for the beneficiary that which he bargained for (in that case, security by way of a first legal charge): rather, it requires the court to consider on much broader terms the nature of the loss caused by the trustee’s breach.  If, on such an analysis, the beneficiary would have suffered some or all of the loss claimed even if no breach of trust had been committed, the law does not require the trustee to provide a windfall.

In the result, AIB’s appeal was dismissed: it was only entitled to equitable compensation sufficient to put it in the position it received a first legal charge.

The Supreme Court’s decision will be welcomed by conveyancing solicitors and their insurers as reaffirming Target and further preventing banks from using breach of trust as a means to escape the consequences of deficient security.

The case will also be of great interest to legal academics. At the start of his judgment, Lord Toulson said that:

“140 years after the Judicature Act 1873, the stitching together of equity and the common law continues to cause problems at the seams.”

It remains to be seen whether the Supreme Court’s haberdashery will put an end to such problems.