What, FSMA in possession proceedings? Lessons from Dhillon v Orchard

When the law of property and financial services meet, which prevails?  This question was at the heart of a recent Court of Appeal case.  The essential background was as follows:

• Mr and Mrs Orchard (the successful defendants below) entered a sale and rent back agreement with Red 2 Black Properties Ltd (‘R2B’) in late 2010. This involved selling their home to R2B and taking an assured shorthold tenancy back from R2B.  R2B was co-owned by Ms Dhillon and her then husband, Mr Chadda, but some time after the transaction was transferred to Ms Dhillon’s sole name as part of their divorce settlement.
• Entering this type of arrangement is a regulated activity under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001. Mr Chadda was authorised to carry out this activity under the Financial Services and Markets Act 2000 (FSMA); R2B was not.  Because it was R2B that actually entered the sale and rent back rather than Mr Chadda personally, R2B breached the “general prohibition” under s.19 FSMA.
• After the divorce, Ms Dhillon bought the property from R2B. The Orchards thereafter paid rent to her, and entered a new tenancy agreement. R2B was dissolved.
• Later on, the Orchards stopped paying rent. Ms Dhillon served notice seeking possession, followed by possession proceedings.

The Orchards defended the proceedings.  Possession proceedings in respect of an AST is, one might think, an unlikely scenario for FSMA to be raised.  But one of the Orchards’ defences challenged the sale and rent back under FSMA.

FSMA provides at s.26 that an agreement made by someone in breach of the general prohibition is unenforceable against the other party, and that other party is entitled under s.26(2)(a) to recover “any money or other property paid or transferred” under the agreement.  The court has a discretion under s.28 to allow the agreement to be enforced.  Note too, s.28(8), which provides that if “property transferred under the agreement has passed to a third party”, reference to the property should “be read as a reference to its value at the time of the transfer under the agreement”.

At trial, the circuit judge found that Ms Dhillon had not been carrying out the regulated activity herself.  He therefore ordered possession and payment of rent arrears.

On appeal to the High Court, the Orchards contended, for the first time, that they had a mere equity under s.26 FSMA. They argued that this overrode Ms Dhillon’s purchase due to their being in actual occupation.  That point succeeded, subject potentially to relief under s.28.

The high court judge considered that s.26 and 28, taken together, essentially provided that an offending contract was “voidable but not void” and that the innocent party’s rights were analogous to a party’s rights where a contract was liable to be set aside for fraud – in other words, a property law analysis.

In essence, the High Court sought to unify the two areas by interpreting FSMA in line with the law of rescission.  It made, “greater sense” if the s.26 right to recover property could bind a third party.  He did not see why a simple transfer by the party in breach of the general prohibition ought to debar recovery of the property.  This was particularly so where the third party was far from arm’s length, being the owner of the company that breached the prohibition.

In the High Court, in other words, property law won.

The analysis in the Court of Appeal was different.  There was no binding authority on the point, but the court discussed s.6 of the Financial Services Act 1986 which had been applied to FSMA in other cases.

Lord Justice Newey gave the only judgment, observing that s.26 does not expressly specify that recovery is not available against anyone other than the contractual counterparty. He found that s.28(8) was inconsistent with the Orchards’ case, because it gave a right to recover value, not property.  He rejected the Orchards’ suggestion that s.28 required an absolute (ie not a voidable) transfer.  The wide FSMA regime did not expressly provide for successors in title at all.  For example, in exercising its s.28 discretion, the court did not expressly have to have regard to a successor in title’s belief or knowledge.  FSMA’s silence concerning successors in title, considering the many complexities that could arise (in other scenarios that do not involve registered land), indicated that Parliament did not intend for successors in title to be vulnerable.

While it follows that FSMA does not provide an effective remedy where the general prohibition has been breached by, say, a shell company that has transferred property to a third party with which it was colluding, there were other potential regulatory remedies against the third party, or insolvency or company law remedies.  Perhaps, he observed, the economic torts would also assist, in the right circumstances.

For good measure, Lord Justice Newey also found that the new point should not have been permitted on appeal.

In this battle, therefore, financial services law came out the eventual winner.  The warning is that, as naturally as a property dispute might seem to call for a property law analysis, this will not always lead to the right answer.

Article by Jack Dillon