Illegality defence further evolves into natural justice: Victus Estates and others v Munroe and others
Once upon a time, as a matter of public policy, a transaction affected by illegality could not be relied upon as enforceable.
Then along came Patel v Mirza  UKSC 42. That Supreme Court decision gave us the modern formulation, taking a new policy-based approach that invited a judge determining such a case to consider:
- The underlying purpose of the illegality and whether that purpose would be enhanced by denying the claim.
- Whether there are other public polices on which denying the claim might have an impact.
- Whether denying the claim would be a proportionate response to the illegality.
This approached was to be supplemented by a ‘range of factors’ non-exhaustively stated to include: the seriousness of the conduct, its centrality to the contract, whether it was intentional and whether there was a disparity in the parties’ respective culpability. The civil courts were there to determine private rights and obligations, and not to punish.
Thus, the courts now have a far greater degree of discretion and may apply common sense and natural justice in deciding whether illegality should found a defence.
Fast forward five years to the recent case of Victus in August 2021. The claim was brought to determine the rights of two mortgage lenders over two properties charged to them as security.
The two properties in question had originally been owned by a man ‘C’ as legal and beneficial tenant in common with a woman ‘M’ (first property) and a second woman ‘B’ (second property).
C had executed a TR1 in relation to each property purporting to transfer them to transferees who then borrowed money from the lenders, granting charges over the properties. The TR1 forms, however, were fraudulent, with forged signatures from M and B who had not consented to the transactions. C had forged the signatures and the transferees knew it
At first instance the County Court held that the TR1s were shams, and that the transferees had acquired no interest, with the result that the lenders had no charge.
The case was appealed to the Chancery Division and heard by Morgan J who applied s.63(1) Law of Property Act 1925 to achieve a more instinctively fair outcome for the lenders. That section provides that a conveyance is effectual to pass all the interest the conveyancing party had in the property which they had the power to convey. As a result of an earlier bankruptcy the joint tenancies had been severed, and so C had the power to convey his half share in the properties to the transferee and that transaction was effective. The lenders therefore had effective charges over that share.
The transaction was not a sham, because the question of sham was a question of intention, and C, along with the transferee, had intended the transaction to have legal effect.
The difficulty in the case might have been the complex web of benefits and disbenefits to each of the parties involved that the different potential outcomes could result in. Was there a risk that a fraudster would end up benefitting from their illegality, or that an innocent party might be left the worse off?
The judge applied Patel v Mirza in a very broad fashion which, in the end, sounded a lot like a search for natural justice. By applying s.63 he noted the outcome to the different parties:
- M and B retained their half shares and were therefore no better or worse off.
- The lenders got a charge over half of each property, giving them as an innocent party some security. Though they had bargained for a charge over the whole that could not fairly come at the cost of the innocent M and B.
- C, who had perpetrated the fraud, did not retain any interest in the properties (as had been the unfortunate result of setting aside the transactions as a sham).
- The transferees (borrowers) who had also been party to the fraud, did retain an interest in half of the properties, which might at first blush have seemed an unattractive outcome on public policy grounds, but those interests stood charged for sums which exceeded their current value.
Overall, the judge concluded that this was an acceptable outcome for the purposes of the integrity of the legal system, public morality and the purpose of the policy against upholding fraudulent transactions.
Natural justice was the winner in this case, but as is often the case at law, that comes at the cost of certainty. In the days before Patel a lawyer might have advised with reasonable certainty that a transaction tainted by fraud would be given no effect by the courts. Now it seems that increasingly a lawyer must advise based upon their best judgment of what will be seen as the natural justice of the case.
It is therefore likely that cases involving aspects of illegality will be the more likely to be fought to trial, with litigants having very different feelings on where the justice in a case might lie, but by that same token we as advisors will be keen to stress the plain risks of judicial caprice, for not all cases will be decided with such Solomonic wisdom.
This article was written by Matthew Hodson.
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