Stoffel & Co v Grondona: UK Supreme court applies policy-based approach to illegality defence

Summary

The recently-clarified common law illegality defence has been considered by the Supreme Court in the context of a professional negligence claim brought against a solicitor by a mortgage fraudster, providing an example of the Supreme Court's approach to a relatively new test in an area of potentially broad application.

Legal background

There is a long-standing principle that the courts will not assist a party whose case is based upon an unlawful act.  The correct application of that principle was, however, at least until quite recently, somewhat uncertain: were the courts required to apply relatively rigid rules, or could they adopt a more flexible principle-based approach?

In its 2016 judgment in Patel v Mirza¹, the Supreme Court resolved that uncertainty in favour of a more flexible approach.  The core question for the courts to determine is whether permitting the claim would be contrary to the public interest, damaging the integrity of the legal system.  The "trio of necessary considerations" in assessing this are as follows:

1. Identifying the underlying purpose of the prohibition which has been transgressed, and considering whether that purpose would be advanced by providing a defence to the claim.
2. Identifying the public policy grounds against granting a defence.
3. Considering whether, in the circumstances of the claim, granting the defence and denying the claim would be a proportionate response to the unlawfulness.

Stoffel & Co v Grondona

The Supreme Court recently considered the Patel test in Stoffel & Co v Grondona².  The facts are relatively straightforward.  Ms. Grondona was buying a London flat.  She applied for, and was granted, a mortgage from a building society, on the basis that the funds would be used to pay the seller and to release a charge over the property.  Stoffel & Co, a law firm, was engaged to advise on the transaction by Ms. Grondona, the building society and (peculiarly) also the seller. 

After the transaction completed, Stoffel negligently failed to make the Land Registry filings required to register the transaction.  As a result of that failure, legal title did not pass to Ms. Grondona, the mortgage was not registered, the seller remained the registered owner, and the pre-existing charge remained in place, on the basis of which further advances were made to the seller.

Ms. Grondona subsequently defaulted on mortgage repayments and was sued by the building society for a money judgment.  She in turn sought to pass the claim on to Stoffel, on the basis of its admitted negligence.

Stoffel defended the claim on the basis of illegality.  It transpired that Ms. Grondona had fraudulently misled the building society: she had in fact been colluding with the seller, who had bought the property for a third of the sale price only three months earlier, and was using the transaction as a means to access funds which he was unable to borrow himself.  Stoffel claimed that Ms. Grondona's claim should be denied as a result. 

The County Court judgment (handed down before the judgment in Patel) found that the illegality defence did not arise under the law as previously formulated.  The Court of Appeal reconsidered the position on the basis of the test in Patel and also concluded that the defence did not arise, on the basis of similar grounds to those ultimately relied upon by the Supreme Court.

The Court's Approach

The Supreme Court's judgment was delivered by Lord Lloyd-Jones, with whom the other Justices agreed.

1. Factors in favour of denying the claim

The Court accepted that there was a clear public policy in favour of condemning and deterring mortgage fraud, a serious criminal offence.  However, the court doubted that permitting Ms. Grondona to bring a negligence claim would be likely to undermine that policy. 

There was also a public policy interest in preventing the victims of mortgage fraud from suffering loss, although that was not relevant to the claim as the fraud had already been perpetrated.  In reality, it was in the building society's interests that the claim succeeded, as Ms. Grondona would then have assets to meet or reduce her liability under the mortgage.

2. Factors against denial of the claim

The Court then considered the policy factors in favour of permitting the claim, of which three were particularly significant.

First, the law should incentivise solicitors to perform their role diligently and non-negligently.

Secondly, clients of negligent solicitors should have a remedy for any loss they have suffered as a result of that negligence.  That remedy should only be denied when it would lead to a "legally incoherent" result.

Thirdly, legal title to property can pass under an unlawful contract.  Ms. Grondona had an equitable interest in the flat by virtue of the seller's execution and delivery of the transfer agreement, notwithstanding the mortgage fraud.  It would be incoherent, the Court held, for the law to hold that Ms. Grondona had acquired that equitable interest despite her fraud, and then to deny her a remedy for Stoffel's failure to protect that interest on the grounds of the same unlawfulness.

Conclusion

The Supreme Court felt able to determine the appeal on the basis of the first two stages of the Patel test.  Granting Stoffel a defence would not advance the public policies in favour of criminalising mortgage fraud.  Denying the claim, on the other hand, would harm the victim of the fraud, run counter to other important public policies, and result in the incoherence of the law recognising the existence of a property right but declining to protect it. 

For those reasons, the Court denied Stoffel's appeal, without needing to consider the third stage of the test. However, the Court nevertheless considered the question of proportionality as well. 

3. Proportionality

The key point here, the Court found, was that the illegal conduct was not central to Ms. Grondona's claim.  It simply provided the background to the claim.  That finding was based on two factors which distanced Stoffel's negligence from Ms. Grondona's fraud:

• By the time Stoffel was required to register the transactions, the fraud was already complete.
• By that time, equitable title had already passed to the respondent.

The central facts founding the claim could have been set out without referring to the illegality, and her claim was conceptually separate from her fraud.  The fact that the fraud was not central to the claim, or relied upon as founding it, was not determinative (as it would have been under previous case law), but it remains a relevant factor. 

Similarly, it would have been a relevant factor if Ms. Grondona had been seeking to profit from her own unlawfulness.  The courts will not allow a claimant to recover losses representing the intended result of a fraudulent scheme.  However, that was not what Ms. Grondona was seeking to achieve.

In sum, the Court concluded that denying the claim would be a disproportionate response to the unlawfulness.

Implications of the judgment

The judgment in Stoffel does not suggest any change in the Court's approach to illegality, but it does provide an example at Supreme Court level of how the Courts will apply the relatively new test set out in Patel.  Illegality can arise in an "infinite possible variety of cases", which may involve very different policy conditions.

Illustrating that point, on the same day as it delivered the judgment in Stoffel, the Supreme Court delivered a judgment in an unrelated case³ which applied the Patel test in a completely different context (that case involving a claim by a patient, who had committed a serious crime, against the health authority with responsibility for treating her mental health). 

In the financial services context, we have already seen the test applied in cases involving allegations of misappropriation of assets (Singularis Holdings Limited v Daiwa Capital Markets Europe Ltd⁴, our report of which can be found here), bribery (Bank St Petersburg PJSC v Arkhangelsky⁵), tax evasion (Al-Dowaisan v Al-Salam⁶) and fraud (Grove Park Properties Ltd v The Royal Bank of Scotland Plc⁷).

The common thread in all of these scenarios will be the Court's approach to weighing the relevant policy considerations.There are perhaps five general points to take away:

1. After Patel, the courts will methodically assess the policy considerations for and against granting a defence. Claims involving illegality will not come down to the straightforward application of blanket rules.
2. The pre-Patel case law remains relevant, even if it is now likely to be applied in a principle-based rather than a rule-based way (and, as the Supreme Court observed in Henderson, many of the earlier authorities involve an assessment of policy considerations anyway).
3. The centrality of the unlawfulness remains a relevant factor, and may be judged in part by reference to the question of whether the facts supporting the claim could be pleaded without referring to the unlawfulness.
4. Similarly, it will also be relevant, but not determinative, if the claimant is seeking to profit from their own unlawfulness.
5. In Patel itself, Lord Sumption expressed the concern that reformulating the principle might convert a legal principle into an exercise of judicial discretion. In terms of its practical effect, that concern may be valid. The open-textured nature of the Patel test does appear capable of allowing a court to reach the result which it wants to achieve (at least in cases which are not clear-cut). Formulating a persuasive case as to why, taken in the round, the defence should or should not apply (as appropriate) is likely to remain important.