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Illegality in the Supreme Court: Three Lessons for Property Lawyers from Stoffel & Co v Grondona [2020] UKSC 42

Articles | Fri 6th Nov, 2020

Property lawyers are well-versed in the difficulties the defence of “illegality” presents. Tinsley v Milligan itself concerned whether a party could establish a resulting trust if they did not need to rely on an unlawful motive behind putting property into the name of another. That decision was subject to extensive criticism; the outcome depending on whether the presumption of advancement, which increasingly seemed out of place with modern life, applied or not.

In R (Best) v Chief Land Registrar [2016] QB 23 the Court of Appeal adopted a policy-based approach when granting judicial review of the Chief Land Registrar’s refusal to register the applicant with title gained by adverse possession because they had committed a criminal offence by squatting in a residential building.

This policy-based approach to illegality was approved by the Supreme Court in Patel v Mirza [2016] UKSC 42 and the reliance-based test of Tinsley v Milligan rejected. Last week the Supreme Court ruled on the application of the Patel v Mirza approach to illegality in the context of a solicitor’s negligence claim arising out of a mortgage fraud. Here we offer three thoughts on Stoffel from a property law perspective.


Vindication of Property Rights in Illegality Claims

A striking aspect of Stoffel is the explicit recognition given to the importance of property rights when weighing the policy considerations under the Patel v Mirza approach.

The vindication of property rights is important because property rights not only affect the person claiming the right but third parties to whom those rights might be transferred or to whom a derivative interest might be granted, such as the lender in a mortgage fraud case.

When addressing the first part of the Patel v Mirza test (“Would the underlying purpose of the prohibition which has been transgressed be enhanced by a denial of the claim?”) the Supreme Court looked beyond the fraud committed by Ms Grondona and recognised that the victim of the fraud would not be protected from the consequences of the solicitor’s negligence in failing to register Ms Grondona as the legal owner of the property if the claim was denied [paras 30-31]. Indeed, on the facts of a case like Stoffel, the ability of the fraudulent borrower to make good on the personal covenant to the mortagee may depend on the fraudster’s ability to recover damages from the solicitor [para 31].

The importance of property rights was also recognized at the second stage of the Patel v Mirza test (“Is there any other relevant public policy on which the denial of the claim may have an impact?”). The Supreme Court recognized that unless a statute provides otherwise expressly or by necessary implication, property can pass under a contract which is illegal as a contract. If Ms Grondona had a property right there would be an incoherent contradiction in the law if the loss of that right was not protected from the solicitor’s negligence because it had been acquired through illegality.


Analysis of “Sham” transactions

Whether or not Ms Grondona had a property right at all depended on whether her transaction with Mr Mitchell was “a sham”. The Supreme Court refused permission to the solicitor’s to appeal on this point but there is an important lesson to be taken from the Court of Appeal’s analysis.

At first instance the judge had not accepted that Ms Grondona had a property right because the arrangement had been “a sham”; a vague expression that has come to acquire a precise definition from the words of Diplock LJ in Snook v London and West Riding Investments Ltd [1967] 2 QB 786 when he said:

I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the “sham” which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. But one thing, I think, is clear in legal principle, morality and the authorities (see Yorkshire Railway Wagon Co. v. Maclure and Stoneleigh Finance Ltd. v. Phillips), that for acts or documents to be a “sham,” with whatever legal consequences follow from this, all the parties thereto 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.

The Court of Appeal in Stoffel ([2018] EWCA Civ 2031) found that the transaction was not a sham. The fact that Ms Grondona had deceived the bank into lending to her did not mean that both she and the bank intended their relationship to be something other than mortgagor/mortgagee (CA [para 26]).

The Court of Appeal also concluded that the TR1 was not a sham as the transfer of legal title to Ms Grondona by Mr Mitchell was the “very essence of the transaction as between them”. Ms Grondona therefore had an equitable interest in the property.

However, the position as between Ms Grondona and Mr Mitchell was less straight forward than the Court of Appeal’s reasoning suggests. There were three elements to their arrangements: (1) They had a written agreement made in March 2000 by which Ms Grondona agreed to have mortgage loans in her name provided that Mr Mitchell would manage the properties and that she would receive 50% of the profit on a sale. This was their true agreement; (2) There was a sale agreement made in October 2002; and (3) There was the TR1 to transfer the property into Ms Grondona’s name.

It seems to me, that sale agreement (rather than the TR1) probably was a sham.  If after execution of the October 2002 sale agreement Mr Mitchell had rescinded the agreement for delay and sued for the payment of the deposit he would have been met by the argument that the sale agreement was a mere device to procure a mortgage advance and was only entered into because the conveyancing solicitor was not a party to the fraud.  The true arrangement was contained in prior March 2000 agreement and the essence of that agreement was the Ms Grondona would take loans in her name not that she would purchase properties.

On the facts of Stoffel, this did not make a difference as the execution of the TR1 was all Ms Grondona required to give her an equitable interest in the property.

However, if the solicitor’s negligence had been that they failed to ensure that Mr Mitchell executed the TR1 then it would have been relevant that the sale agreement was a sham because then Ms Grondona would not have had an unpaid vendor’s lien over the property and would not have had a property right capable of vindication.

It is therefore important to remind ourselves not only of what Diplock LJ said “a sham” was but also of the need to carefully investigate each part of a multi-faceted transaction when “sham” is alleged.


What about the presumption of advancement?

Although Tinsley v Milligan would be decided the same way under the Patel v Mirza test we have yet to see what the court will make of the Patel v Mirza test for illegality when the presumption of advancement applies.

There are indications in Stoffel that both parties’ conduct will be relevant to the outcome. Although the first and second stages are to be considered at a relatively high level the third stage of the Patel v Mirza test (“Proportionality of the response to the illegality”) requires the court to give  “close scrutiny to the detail of the case in hand” [para 26]. Thus although it was accepted that the solicitor in Stoffel was not aware of the fraud, the Supreme Court appear to have accepted that Ms Grondona’s case on proportionality would have been still stronger if the solicitor had been aware of the fraud [para 38]. Even the second stage, (“Is there any other relevant public policy on which the denial of the claim may have an impact?”) may invite a high-level consideration of a defendant’s conduct. In Stoffel the solicitor’s failure to identify the obvious signs of mortgage fraud was highlighted at the second stage as a reason for refusing the claim on policy grounds [para 32].

While the expectation is that the step away from a mechanical reliance-based test to a policy test will favour a party required to rebut the presumption of advancement the Patel v Mirza approach will provide less certainty of outcome. Especially, if there are contested issues of fact relating to either parties’ blameworthiness.

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