UK Supreme Court considers proper approach to awarding compensation for breach of trust in a commercial context

The Supreme Court has confirmed that equitable compensation for breach of trust in the context of a commercial transaction, and in the absence of fraud, should reflect the claimant's actual loss resulting from the breach. It should not extend to losses the claimant would have suffered even if there had been no breach: AIB Group (UK) plc v Mark Redler & Co Solicitors [2014] UKSC 58.

In breach of trust, solicitors acting for a lender (AIB) failed to discharge a prior mortgage held by Barclays before releasing the mortgage advance to the borrowers. The borrowers defaulted some years later, when the secured property realised £1.2 million on sale (of which approximately £300,000 had to be paid to Barclays). AIB sued the solicitors, claiming its £3.3 million mortgage advance minus the sale proceeds it had received. The Supreme Court held that the solicitors were liable only for the amount paid to Barclays for its prior security, not for loss attributable to the fall in the value of the property – that loss would have been suffered regardless of the breach of trust.

The decision should give some comfort to financial institutions and others who may take on the role of trustee in commercial transactions, as it suggests their liability for a (non-fraudulent) breach of trust is unlikely to be radically different from their liability in contract or tort. Gary Milner-Moore and Andrew Cooke comment on the decision below.

	Gary Milner-Moore Partner +44 20 7466 2454
	Andrew Cooke Associate +44 20 7466 7566

Factual background

In June 2006, Mr and Mrs Sondhi (the "Borrowers") applied to borrow £3.3 million from AIB, secured by a first ranking security over the Borrowers' £4.25 million home. At that time, Barclays Bank held first ranking security over the Borrowers' home, securing borrowings on two accounts totalling about £1.5 million. AIB agreed to lend to the Borrowers on the condition that Barclays' security was discharged as part of the transaction.

Mark Redler & Co Solicitors (the "Solicitors") were instructed to act for both the Borrowers and AIB in relation to the re-mortgage.

On 31 July 2006, Barclays provided the Solicitors with information regarding the Borrowers' two accounts. That information confirmed the amount due to be about £1.5 million.

On 1 August 2006, the Solicitors requested a redemption figure from Barclays. Barclays provided a redemption figure based on one of the Borrowers' accounts (a debt of about £1.2 million) but not the other account. The Solicitors completed the re-mortgage on the basis of the redemption figure they received, paying £1.2 million to Barclays and the balance of the £3.3 million advance to the Borrowers.

Barclays refused to release its security because it was still owed a £300,000 debt by the Borrowers. As a result of discussions between them, AIB agreed with Barclays that it would take second-ranking security over the property, acknowledging the primacy of the Barclays security.

The Solicitors accepted that they should have realised that the redemption figure provided by Barclays did not reflect the entire amount secured by Barclays' security.

When the Borrowers eventually defaulted, Barclays enforced its security and sold the property for £1.2 million. After Barclays' security was satisfied, AIB received approximately £867,700 under its second-ranking security.

High Court decision

AIB commenced proceedings against the Solicitors, claiming that it was entitled to recover the entire amount of its loan less the amount recovered, a total of approximately £2.5 million. The Solicitors admitted negligence but argued that their liability was limited by comparing the position of AIB had the Solicitors done what they ought to have done and discharged the Barclays security with the actual position in which AIB now found itself. On the Solicitors' case, AIB's loss (excluding interest) was approximately £275,000 – it would still have sold the secured property for £1.2 million but would have kept the entire proceeds, rather than paying any amount to Barclays to discharge its secured debt, so that AIB's net loss was equal to the amount paid to Barclays upon enforcement.

His Honour Judge Cooke held that AIB could recover only £275,000 because:

• AIB had authorised a payment of £1.5 million to Barclays and payment of the surplus to the Borrowers.
• The Solicitors were therefore authorised to pay £1.2 million to Barclays.
• The Solicitors had only committed a breach of trust in relation to the £300,000 that was paid to the Borrowers that should have been paid to Barclays. To remedy that breach, the Solicitors were required to restore that sum less an amount reflecting interest already received, resulting in an order that the Solicitors must pay £275,000.

Court of Appeal decision

The Court of Appeal (Arden, Sullivan and Patten LJJ) held that the judge was wrong as to the nature of the breach by the Solicitors but not the extent of the compensation to which AIB was entitled.

The breach of trust was not the payment of £300,000 to the Borrowers not Barclays, but rather the release of any of AIB's funds from the Solicitors' client account before receipt from Barclays of a full redemption statement. The Solicitors were specifically instructed by AIB to comply with the Council of Mortgage Lenders' Handbook ("CLMH"). Under the CMLH, the Solicitors were required to obtain an undertaking from Barclays that its security would be discharged upon completion of the re-mortgage before any of AIB's funds were released. This finding was not challenged in the Supreme Court.

However, it did not follow from this conclusion that AIB was entitled to have all of its funds that had been distributed without this undertaking reconstituted. The Court of Appeal held that in commercial transactions such as the present, where a trustee performs a particular function as part and parcel of the transaction (contrasted with a traditional trustee that holds, invests and manages trusts for beneficiaries, usually over long periods), the Court must "recognise what loss the [claimant] had actually suffered from the breach of trust and…base the compensation recoverable on a proper causal connection between the breach and the eventual loss". The Court of Appeal therefore upheld the Judge's order for compensation in the amount of £275,000.

Supreme Court decision

The detailed judgments were given by Lords Toulson and Reed (with whom Lord Neuberger, Lord Wilson and Lady Hale unanimously agreed). Both Justices considered in detail the decision of the House of Lords in Target Holdings Ltd v Redferns [1996] AC 421, which raised similar issues.

In Target Holdings, the Court of Appeal had held that the basic liability of a trustee was to restore to the trust any part of the fund that had been paid away in breach of trust. As it was accepted in AIB that the Solicitors had applied the entirety of the trust fund in breach of trust, through their failure to obtain an undertaking from Barclays before making any payment, on this analysis the Solicitors would have been liable for the entire mortgage advance (less the amount actually recovered by AIB upon sale of the property).

The House of Lords in Target Holdings overruled the Court of Appeal. Lord Browne-Wilkinson held that a trustee was liable to compensate the beneficiary only for losses caused by the breach, not losses that the beneficiary would have suffered even if there had not been a breach. A beneficiary has no automatic right to reconstitution of a trust fund once the transaction for which purpose the trust was created has been completed. Instead, upon completion, the right of reconstitution transferred into a right of the beneficiary to seek compensation.

Lord Browne-Wilkinson stated that "[e]quitable compensation for breach of trust is designed to achieve exactly what the word compensation suggests: to make good a loss in fact suffered by the beneficiaries".

The Supreme Court in AIB followed the decision of the House of Lords in Target Holdings. Lord Toulson considered academic criticism that Target Holdings had moved away from orthodoxy. Some academics have suggested that other tools could be used to limit a trustee's liability in appropriate cases (such as the discretion of the court under section 61 of the Trustee Act 1925). Others consider that Target Holdings improperly introduced a concept from the common law that a defendant's liability should reflect the position had no breach occurred, whereas the only consideration should be the objective value of the property that was paid out in breach of trust, assessed as at the date of the payment (i.e. strict liability) but with the benefit of hindsight and taking into account any offsetting benefit received by the beneficiary.

The thrust of the academic criticism was that the liability for breach of fiduciary duty ought to be sufficiently onerous to deter trustees from breach and better protect the interests of beneficiaries. Lord Toulson rejected that criticism – absent fraud, public policy did not require fiduciaries to be liable for losses that would have been suffered by the beneficiary even had no breach occurred. He said that:

"The purpose of a restitutionary order is to replace a loss to the trust fund which the trustee has brought about. To say that there has been a loss to the trust fund in the present case of £2.5m by reason of the solicitors' conduct, when most of that sum would have been lost if the solicitors had applied the trust fund in the way that AIB had instructed them to do, is to adopt an artificial and unrealistic view of the facts."

Accordingly, the order for compensation in the sum of £275,000 was upheld by the Supreme Court.

Lord Reed noted that this result brought equity more into line with contract and tort, though stopped short of equating the two. Whereas in contract and tort, the foreseeability of loss and the claimant's response to that loss (e.g. mitigation) will generally be relevant, the measure of compensation in equity will be judged at the date of trial, with the benefit of hindsight, but factors such as foreseeability will be irrelevant. Lord Reed stressed that any "structural similarities" did not mean "that the relevant rules are identical: as in mathematics, isomorphism is not the same as equality."

Comment

The Supreme Court's decision brings welcome clarity to this issue. By confirming that compensation should reflect the true nature of the loss suffered by AIB, the Supreme Court ensured that for trustees in commercial transactions, their liability in equity will not be analysed in a way that is radically different to their liability at common law (under which trustees often owe concurrent duties in contract and tort). Had AIB been permitted to recover £2.5 million, it would have obtained a windfall from the transaction – effectively, the entire risk of the re-mortgage transaction would have passed to the Solicitors.

If AIB's argument had succeeded, that could have resulted in added complexity in cases of this nature. For example, the precise characterisation of the breach of trust could have had a dramatic impact in quantifying the funds lost as a result of that breach. The different conclusions reached by the High Court and the Court of Appeal in this case demonstrate the challenges that would have faced judges on that question.

Though the Supreme Court's judgment brings welcome clarity, it also leaves open a number of issues. Of them, the three most important are as follows:

1. The Supreme Court's decision was expressly limited to trusts created for the purposes of specific commercial transactions. Such trusts usually fall away upon completion of the transaction. Will the Supreme Court's decision be followed in cases where the trust remains in existence after the breach, including in more traditional trust contexts (such as family trusts and wills)? In the past, in such cases the trustee has usually been made to reconstitute the assets of the trust. It appears that, following AIB, where the trust has fallen away and its beneficiaries have become absolutely entitled to the trust fund, they cannot seek reconstitution (since they are no longer beneficiaries) and are limited to a claim for compensation (which is measured by reference to actual loss), but the same cannot be said for trustees in a continuing trust.
2. Where trustees owe concurrent duties in common law (contract and tort) and in equity, the consequences of a breach of duty (at least for a non-fraudulent breach of trust by a trustee in a commercial transaction case) in common law and equity are unlikely to differ radically. It is well established that trustees are permitted to shape the scope of their duties in contract and it might undermine that principle if liability in equity remained greater than in contract. But had the Solicitors committed a breach only of their fiduciary duties but not their duties in contract and tort, could they have argued that assessment of their liability in equity should accord with common law principles?
3. Lord Toulson based his conclusion on public policy considerations where the fiduciary's breach of trust is not fraudulent. But what will be the position in a fraud case? It may be that the courts conclude that fraudulent trustees should face greater liability as an increased deterrent. That could lead claimants to plead fraud more regularly in order to access more substantial relief. However, this division of the measure of damages between fraudulent and other breaches of duty has been part of the common law for many years without any significant judicial or academic criticism (for example, the difference between the measures of damage in the torts of deceit and negligence), so it may be that equity can accommodate an equivalent differentiation.

Further clarification from the appellate courts on these issues would be welcomed.