Succumbing to wrongful payment demands: what can borrowers do?

This article explains why there is limited scope for recovery where a borrower accedes to a demand despite believing it to be invalid.

Introduction

The law of unjust enrichment has been described as existing “to correct normatively defective transfers of value, usually by restoring the parties to their pre-transfer positions” (Carr LJ in Dargamo Holdings Ltd v Avonwick Holdings Ltd [2022] 1 All ER (Comm) 1244). This provides the fundamental conceptual framework, but it does not resolve a practical issue arising frequently in finance disputes. A lender asserts that an event of default has occurred and demands payment. The borrower considers the demand to be legally unfounded, but nevertheless pays because the commercial consequences of non-payment are intolerable.

Even though the borrower may have acted under huge financial pressure, the doctrine of duress is unlikely to assist where there has been a threat of a lawful act: see our earlier article, ‘The final word on lawful act duress? Times Travel v Pakistan International Airlines and its impact on the banking sector’ (2021) 10 JIBFL 678. Are there any other routes to recovery? In this article, we consider the broader question of whether, if at all, the borrower may be able to recover a payment made in response to an invalid demand.

Wrongful demands as legal nullities:Concord Trust

The starting point is Concord Trust v Law Debenture Trust Corporation plc [2005] UKHL 27 (Concord Trust). The case arose out of a Eurobond issue. The bond trustee was asked by bondholders to serve a notice accelerating the bonds on the basis that an event of default had occurred. The issuer and guarantor disputed that any event of default had occurred and indicated that they would challenge the notice if served. The trustee therefore sought an indemnity against the potential liability to the issuer and guarantor in the event the acceleration notice was wrongful.

For present purposes, the important point is the House of Lords’ analysis of what follows if an acceleration notice is served in the absence of a valid event of default. Lord Scott rejected the proposition that the trustee would thereby incur a substantial liability in damages. He reasoned that an invalid notice would simply be ineffective as against the issuer: it would not accelerate the bonds and would not, without more, constitute a breach of contract. The notice is, therefore, a nullity – ie it is of no legal effect.

Consequential acts and orthodox remedies

While an invalid demand may be a nullity, a lender may take consequential steps in reliance upon it. This is where the possibility of a contractual remedy may come in. The steps the lender might take include refusing to make further advances under a committed facility, termination of an otherwise continuing facility, or enforcement of security. If the contract does not permit those steps in the absence of a valid event of default, the act (but not the earlier declaration) may constitute a breach of contract: Mulvenna v Royal Bank of Scotland plc [2003] EWCA Civ 1112.

One potential avenue for the borrower in this scenario is a quia timet injunction to restrain enforcement, applying ordinary American Cyanamid principles. However, an injunction seeking to prevent the declaration itself would be difficult to justify. The irony of the situation is that borrowers often succumb to the lender’s demand precisely to prevent these consequential steps being taken. The result is that there has been no breach of contract by the lender that would otherwise support a claim for damages or injunctive relief.

Restitution after payment: Marine Tradeand the mistake threshold

If the borrower pays and later seeks to recover the money, the obvious route is a claim in unjust enrichment. But English law does not recognise a freestanding action to recover money merely because it was not due (see Lord Goff at 172 in Woolwich Equitable Building Society v IRC [1993] AC 70, (Woolwich)). The borrower must plead a recognised ground of restitution. In disputed payment cases of the type we are considering, the usual candidate is mistake. (The position is different in civil law jurisdictions, where a claim for a refund of wrongly paid money is recognised under the doctrine of condictio indebiti.)

The difficulty for making a claim founded upon mistake is showing that the borrower’s payment was mistaken, which is not the same as begrudging or expressed to be under protest. Moreover, as the modern authorities explain, a state of doubt is not enough. A payer who pays while uncertain may still be mistaken if, on balance, it believes it is liable. But a payer who believes that it is more likely than not that it is not liable, yet pays to avoid adverse consequences, has not paid under a mistaken belief of liability. Rather, it has made a calculated decision to pay.

The limitations of the claim based upon a mistake are demonstrated by the decision of Flaux J in Marine Trade SA v Pioneer Freight Futures Co Ltd (BVI) [2009] EWHC 2656 (Comm) (Marine Trade). The parties were counterparties under an umbrella agreement and a series of cash-settled freight derivative transactions. A payment demand was made which Marine Trade disputed. It paid under protest because it feared the consequences of non-payment. Flaux J dismissed the unjust enrichment claim because the claimant could not show that it paid because it believed it was liable. Rather, it paid despite believing it was probably not liable, in order to avert commercial consequences.

The case also shows why declaring that payment is being made “under protest” is not a solution. If anything, doing so may provide contemporaneous evidence that the payer did not believe the money was due, ie that they were not acting under a mistake.

Beyond mistake: compulsion, honest claims, and Woolwich

If mistake is unavailable, what else is left? The alternatives are limited. In some cases, English law allows restitution of payments made under compulsion, most commonly where money is paid to avoid unlawful interference with goods or property. In Maskell v Horner [1915] 3 KB 106, unlawful tolls were paid under threat of seizure and closure, and it was held that the payer could recover because the payment was made under compulsion (namely, the threat of duress to goods).

The difficulty for borrowers is that the pressure created by a lender’s demand is usually a level of commercial leverage that does not cross the line into actionable compulsion. The threatened consequences, including termination, enforcement, margin calls and loss of access to funding, often arise from the contract itself.

Even where the borrower has no realistic commercial alternative, it is highly unlikely that the lender’s conduct would cross the line into the realm of economic duress. As noted above, in Times Travel (UK) Ltd v Pakistan International Airlines Corp [2021] UKSC 40, the Supreme Court held that, although the threat of a lawful act can, in principle, amount to duress, its scope in commercial negotiations is extremely limited (per Lord Hodge JSC at [28]). There is no doctrine of inequality of bargaining power and no general principle of good faith. The defendant must instead be guilty of the sort of unconscionable conduct that would historically have allowed a court of equity to set aside an agreement on the ground of undue influence (per Lord Hodge JSC at [2]).

Another obstacle is that payments made in submission to, or settlement of, an honest claim are generally irrecoverable (see, for example, Simantob v Shavleyan [2019] EWCA Civ 1105). That matters in this context because a lender will often make a demand in the genuine belief that it is entitled to do so, even if that belief is later shown to be wrong.

The position is different under public law. In Woolwich, the taxpayer paid sums demanded under regulations it contended were ultra vires, and the House of Lords recognised a right to repayment based on the unlawfulness of the demand itself, without requiring the taxpayer to show that the payment was made under a mistake or compulsion (though a mistake may be required in order to attract an extended limitation period under s 32 of the Limitation Act 1980).

The House of Lords decided this for fundamental constitutional reasons: money may not be exacted by the executive without lawful authority. By contrast, English private law has not developed an equivalent principle for contractual demands between private parties.

Subjective defaults and MAC clauses: why the problem arises

The problem of borrowers paying in response to a demand they believe to be invalid often arises in disputes about evaluative or subjective events of default, especially MAC (material adverse change) clauses.

Grupo Hotelero Urvasco SA v Carey Value Added SL [2013] EWHC 1039 (Comm) contains frequently cited guidance on the meaning of material adverse change in a borrower’s financial condition. The Judge in that case, Blair J, emphasised that materiality is not met by minor or temporary adverse change; the change must significantly affect the borrower’s ability to perform its obligations, in particular its ability to repay.

Reference may also be made to Lombard North Central plc v European Skyjets Ltd [2022] EWHC 728 (QB). This case arose from a secured aircraft loan and a long history of payment issues and forbearance. The MAC clause provided:

“There shall be default if … in the opinion of the Lender, a material adverse change occurs in the business, assets, condition, operations or prospects of any of the relevant borrower companies.”

Foxton J (as he then was) accepted that the lender only needed to prove it had honestly and rationally formed the opinion that a material adverse change had occurred. Whether such a change had occurred in objective terms was immaterial: see Cukurova Finance International Ltd v Alfa Telecom Turkey Ltd [2013] UKPC 2. This approach means that borrowers will often find it difficult to challenge the validity of a lender’s invocation of a MAC clause. The borrower would have to prove not only that there had not, in fact, been a material adverse change, but also that it was irrational for the lender to have believed otherwise.

Where the trigger is subjective (that is, based on the lender’s opinion), and the consequences of being wrong are severe, the commercial incentive on the borrower to pay first and argue later is obvious. But those are also the circumstances in which the law of unjust enrichment is least accommodating, because the borrower’s communications are likely to record that it disputed liability and paid only to avert adverse consequences.

Conclusion

Because a wrongful acceleration notice is generally regarded as a legal nullity rather than an actionable breach of contract, the possibility of a contractual remedy depends upon the lender taking further steps in reliance upon the asserted default. This creates a high bar for a claim in unjust enrichment: if a borrower remits payment while believing the demand to be unfounded, it will struggle to prove the requisite mistake at the time of payment. While lawful act economic duress exists as a doctrine, it is an exceptional one, and far from a general solution to the disputes over payment demands that may typically arise.

The current legal framework may appear stringent; however, absent a significant shift in the law of unjust enrichment, this position is likely to remain.