Court of Appeal enforces fraudster’s claim against lawyers
In Stoffel & Co v Maria Grondona the Court of Appeal applied Lord Toulson’s judgment in Patel v Mirza to permit a fraudulent mortgagor to enforce her claim against her conveyancing solicitors. There may though be stronger grounds for the defence in other claims against professionals.
In 2016 in Patel v Mirza the Supreme Court looked at the illegality defence for the first time since Tinsley v Milligan in 1993. The illegality defence revolves around the principle that “no court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act”. In Tinsley the House of Lords set out a reliance based test barring claims where the claimant relied on his or her illegality to bring the claim. In Patel the Supreme Court overruled Tinsley. Lord Toulson explained that the central rationale of the defence was the public interest in declining to enforce claims where such enforcement would be harmful to the integrity of the legal system.
He set out three criteria to consider in determining that issue. The first is to look at the underlying purpose of the prohibition transgressed in the claim and determine whether that purpose would be harmed in the enforcement of the claim. The second is to consider any other public policy that the denial of the claim may have an impact on and the effect on it of denying the claim - “… any other relevant public policies which may be rendered ineffective or less effective by denial of the claim…”. The third is whether the denial of the claim would be a proportionate response to the illegality taking into account, amongst other things, the seriousness of the illegality, the centrality of it to the contract, whether it was intentional and the respective culpability of the parties.
Stoffel is the first occasion on which the Court of Appeal has applied Lord Toulson’s test to a claim against a professional services firm. The case arises out of a fraudulent scheme by the claimant. On 1 March 2000 the claimant entered into an agreement with her former landlord, Mr Mitchell, in which she agreed to raise loans secured on various properties on the basis that he would service the loans and, as between them, have all the rights associated with ownership of the properties. The claimant was to receive 50% of the net profit when the properties were sold.
In October 2002 she applied for a loan to purchase one such property from Mr Mitchell pursuant to that arrangement. The judge found that she “lent her good credit history to Mr Mitchell to enable him, behind the scenes and out of sight of the potential lender, to obtain finance. This finance was not in fact for the purpose of enabling [the claimant] to purchase the property. It was in order for Mr Mitchell to raise further finance”. The claimant made the mortgage application fraudulently. She lied to the lender representing that the sale was non-private, the deposit came from her own funds, and that she was managing the property.
The claimant entered into contract to purchase the property with Mr Mitchell “…with the object of deceiving institutional High Street lenders into thinking that [she] was the owner of the property and required mortgage finance for her own business purposes, in circumstances where apparently Mr Mitchell was unable to obtain such finance himself …”.
The defendant acted for the claimant, Mr Mitchell and the lender. The claimant did not disclose her intended fraud to her lawyers. The lawyers negligently failed to register the transfer and the charge. Accordingly, Mr Mitchell remained the registered proprietor and the prior chargee’s charge remained on the register. Mr Mitchell took out further loans from that chargee and failed to service the new loan to the claimant from the intended chargee.
The claimants’ lender obtained a money judgment against her and she in turn sought to pass on the totality of that loss to the lawyers. The judge at first instance permitted the claim to be enforced but held that the claimant’s loss was limited to the value of the property. The judgment was handed down prior to Patel and applied the reliance test in Tinsley.
The judgment of the Court of Appeal was given by Lady Justice Gloster with Lord Justice Flaux agreeing with her judgment. She held that the claimant was entitled to enforce her claim against the lawyers; the illegality defence failed.
Considering the first of Lord Toulson’s criteria, she identified mortgage fraud as a “canker on society” and said that it was important that “dishonest applicants for mortgages should not be empowered by the law to abuse the system”. However, she could not see that the purpose of that prohibition would be harmed by permitting the claim against the lawyers to continue. Indeed, she thought that it was more likely that that purpose would be assisted by allowing the claim to be enforced.
She went on to consider Lord Toulson’s second criterion. She said that this was engaged in the public interest in permitting clients to have redress for negligence. She put it like this “… there is a genuine public interest in ensuring that clients who use the services of solicitors are entitled to seek civil remedies for negligence/breach of contract against a defendant arising from a legitimate and lawful retainer which was entered into between them, in circumstances where the client was not seeking to profit or gain from her mortgage fraud, but merely to ensure that that the chargee's security was adequately protected by registration. …” [emphasis added].
She also held that it would be disproportionate to deny the enforcement of the claim to the claimant. She referred to the following factors (amongst others) - the lender did not allege fraud against the claimant but rather adopted the transaction; the lawyers themselves did not allege fraud in their witness statement; the claimant did not seek to profit from her fraud; and “the illegal conduct was not central, or indeed relevant, to the otherwise proper and legitimate contract of retainer between the claimant and the defendant or indeed to the claimant's claim in the present action; it was simply part of the background story …”.
For these reasons the Court of Appeal dismissed the lawyers’ appeal against the judge’s denial of the illegality defence. It dismissed the claimant’s appeal against the judge’s decision to limit her damages to the value of the property.
The focus of the prohibited conduct in this claim was on the fraudulent misrepresentation to the lender by the claimant. Insofar as there was analysis of the retainer the court held that it was a legitimate and lawful retainer and that the fraud on the lender was not central to it. In addition, the court found that the claimant was not profiting from her fraud.
The finding on the lack profiting appears to relate only to the litigation in which the claimant sought to extricate herself from her fraudulent scheme. She does though appear to have intended to profit from the fraud as a whole through her 50% entitlement to the net profit on sale of each of the properties. It is difficult to understand the logic of focusing on the litigation element alone.
The finding in relation to the retainer itself is the more troubling aspect of the decision. In most cases a retainer seeking to involve solicitors in a fraud will not be lawful and legitimate. It is not easy to tell from the judgment what arguments may have been available to the defendants on the facts. The defendants did not give evidence and if you type Stoffel and SDT into a search engine a regulatory history is revealed.
In the majority of cases a professional services contract will be induced by an implied representation from the putative client that the client is not intending to use the retainer for a fraudulent purpose. The relevant principles were set out by Christopher Clarke J in 2010 - “… The essential question is whether in all the circumstances it has been impliedly represented by the defendant that there exists some state of facts different from the truth. In evaluating the effect of what was said a helpful test is whether a reasonable representee would naturally assume that the true state of facts did not exist and that, had it existed, he would in all the circumstances necessarily have been informed of it: Geest plc v. Fyffes Plc  1 All ER (Comm) 672 , at 683 (per Colman J) …”. It will not be difficult in most cases for the solicitor or accountant to show that he or she naturally assumed that his client was engaged in a non-fraudulent transaction.
Equally, it should be possible in most cases to imply a term into the retainer that the client will behave honestly - "… As a matter of construction, it is hard to envisage any contract which would not reasonably be understood as requiring honesty in its performance. The same conclusion is reached if the traditional tests for the implication of a term are used. In particular the requirement that parties will behave honestly is so obvious that it goes without saying. Such a requirement is also necessary to give business efficacy to commercial transactions”.
These points give rise to two points that do not appear to have been available to the defendant in Stoffel. The first is that it may only be a rare case where it is possible for the court to conclude that a retainer misused to pursue a fraud is “legitimate and lawful”. If the retainer is itself unlawful and fraudulently induced this adds a further primary prohibition to the consideration of Lord Toulson’s first criterion. It also removes it completely from the second criterion, which appears to have been important to the Court of Appeal in Stoffel. The second point is that the misrepresentation and breach of the implied term gives rise to a circuity of action defence - the claimant’s case (even if permitted) is eliminated by the defendant’s own claim for the damages against the claimant for the loss that it has sustained as a result of the claimant’s breach and misrepresentation.
 Holman v Johnson (1775) 1 Cowp 341, 343
 Paragraph 54 of the judgment of Her Honour Judge Walden-Smith (at first instance).
 Paragraph 59 of the judgment of Her Honour Judge Walden-Smith (at first instance).
 Paragraph 37.
 Paragraph 38.
 Raiffeisen Zentralbank Osterreich AG v Royal Bank of Scotland Plc  EWHC 1392 (Comm),  1 Lloyd's Rep 123 at  to 
 And demonstrating subjective knowledge of dishonesty is no longer required following Ivey v Genting Casinos (UK) Ltd (trading as Crockfords Club)  UKSC 67
 See Mr Justice Leggatt in Yam Seng Pte Ltd v International Trade Corp Ltd  EWHC 111 (QB) at 137)
 See for example Mr Justice Evans-Lombe in Barings plc (in liquidation) and another v Coopers & Lybrand (a firm) and others  EWHC 1319 (Ch)