Setting aside of mortgages for undue influence

In examining the law on the setting aside of mortgages for undue influence, the situation in which mortgages will be affected by the misrepresentation or undue influence of a third party must be discussed. The law has been undergone several transformations in recent years. The landmarks cases are the House of Lords decision in Barclays Bank v O’Brien, [1] CIBC Mortgages plc v Pitt [2] and Royal Bank of Scotland v Etridge (No.2). [3] As we can see that the resolution of disputes of this area of law as being dependent upon the application of doctrine of agency and notice, it will therefore be useful to analysis the doctrine of agency and notice in more depth.

3.2 The Doctrine of Agency

Prior to the decision of O’Brien [1] and Pitt, [2] the court tend to emphasis on the law agency as a reason for preventing a mortgagee enforcing a mortgage transaction against a mortgagor who had been subjected to third party undue influence or misrepresentation. This can be seen in Turnbull Co v Duvall [3] where Lord Lindley held that the security was void since the creditor left everything to Duvall to arrange the transaction, it infers an agency relationship. The clearest statement of the application of the agency principle is found in Kingsnorth Trust Ltd v Bell, [4] where Dillon LJ suggested, the only way creditor could have avoided being treated as the husband’s principal is by ensuring that the wife had been given independent legal advice before agreeing to mortgage her home.

Bearing in mind that the principal debtor is the prime mover and he is the person who wants the loan, for his sake he secures the co-operation from the surety. [5] Clearly, this agency principle is very unrealistic as it only worked technically, by providing a mean to the creditor to take responsible for the wrongdoer’s action. Subsequently, Lord Browne-Wilkinson in O’Brien [6] held that agency will not apply save in exceptional cases. According to Lord Browne-Wilkinson, in reality, the third party would frequently have been acting for his own benefit, not for the creditor. This was reaffirmed by the Court of Appeal in Royal Bank of Scotland v Etridge [1] where Stuart-Smith LJ also doubted the justification of treating the husband as the creditor’s agent in cases where the husband is the principal debtor.

3.3 The Doctrine of Notice [2] 

Under the doctrine of notice, if a creditor had notice of a misrepresentation or undue influence and failed to take the necessary steps, the creditor will not be able to enforce the mortgage against the surety. There are two issues need to be addressed in discussing the doctrine of notice. First, the situation in which creditors will be found to have had notice of the undue influence or misrepresentation. Second, how creditors could protect themselves from being tainted by undue influence or misrepresentation. The law here has gone through some distinct stages before hitting upon the current acceptable one. The decision of O’Brien, [3] Pitt, [4] and subsequently Etridge, [5] all had a significant impact on both these points.

In O’Brien, [6] the wife joined in granting a mortgage over the matrimonial home to secure the indebtedness of a company in which her husband was interested but in which she had no interest. Her husband induced her to sign by significantly misrepresenting her the legal effect of the legal charge and that although she knew she was signing a mortgage of the matrimonial home she believed that the security was limited to £60,000 and would only last three weeks. The bank made no attempt to explain the transaction to her or to ensure that she understood it. Both the Court of Appeal and the House of Lords held that the wife was entitled to have the mortgage set aside as against the bank but with different reasoning.

After rejecting the special equity theory by the Court of Appeal, Lord Browne-Wilkinson in O’Brien [1] turned his attention to a proposal to use the doctrine of notice with the intention to provide a more certain and appropriate level of protection to sureties. It was held that when a transaction is not an ordinary joint advance, a creditor is put on inquiry when a person offers to stand surety for another's debts. In such situation, the creditor who is put on inquiry will have constructive notice of the surety's rights unless reasonable steps has been taken to make sure that the agreement to stand as surety has been properly obtained.

In Pitt, [2] a husband told his wife that he would like to borrow money on the matrimonial home to buy share on the stock market shares. The wife was unhappy about this but eventually agreed after being subjected to actual undue influence. The loan was made to both of them jointly, stating that the purpose of the loan was to pay off the existing mortgage and purchase a holiday home. The wife received no independent advice and signed it without reading. When the stock market crashed, the husband defaulted on the loan repayments and CIBC Mortgages applied for an order for possession of the house. The House of Lords in Pitt held that while a claimant who could prove actual undue influence was entitled to have the challenged transaction set aside, the creditor would only be affected if it could be established that they had actual or implied notice of the undue influence. Since there was nothing to indicate that it was anything other than a normal loan to husband and wife's joint benefit, according to Lord Browne-Wilkinson, the creditor is not required to puts on inquiry in this case, thus the claim was failed.

Both O'Brien [3] and Pitt [4] affirmed that the surety must first establish the exercise of undue influence and then that the bank had either actual or constructive notice of its exercise. There is constructive notice if the creditors know of a relationship between the surety and the principal debtor which give rise to the risk of an equitable wrong and the transaction is not, prima facie, to the surety's financial advantage. With notice, the bank should take reasonable steps to ensure that consent is voluntary, such as advising the surety to obtain independent legal advice. [1] 

3.3.1 Difficulties with O’Brien and Pitt

There are two difficulties with O’Brien [2] and Pitt. [3] First, it is unreasonable to require a creditor to inquire as to whether or not the parties had a sexual relationship. As noted by Scott V-C in Banco Exterior International v Thomas, [4] a creditor has no business inquiring into the personal relationship of his clients. Second, the creditors will have to determine the issue of financial disadvantage with reference to uncertain criteria. Although the issue of financial disadvantage is straightforward in certain cases, difficult cases had arisen where the purpose of the loan is to provide finance for the husband’s business in which the wife might be involved; the wife will be expected to benefit from the success of the company. [5] 

3.3.2 The decision of Etridge - When is a creditor put on inquiry?

The existence of the practical problems in applying the O'Brien principles led the House of Lords in Royal Bank of Scotland Plc v Etridge (No.2) [6] to re-examine the law relating to this area. [7] The case of Etridge involved eight conjoined appeals. Seven of the cases involved wives charging their matrimonial home to secure the business debts of their husband. The wives claimed that the transaction was entered under the undue influence of their husbands. The eighth case involved in a claim brought by a wife against the solicitor who advised her before she entered into the transaction. Lord Nicholls delivered the leading judgment with which Lords Bingham, Clyde, Hobhouse and Scott expressly agreed.

Lord Nicholls held that the threshold test of constructive notice in O’Brien has been completely misunderstood by practitioners and judges in all the cases decided since O’Brien, including the Court of Appeal in a number of cases culminating in Etridge itself. [3] According to Lord Nicholls, undue influence is a question of fact to be proven by the party so alleging. [4] The mere fact that a wife has stood surety for a husband is insufficient evidence of the exercise of undue influence without being further proof.

To avoid the first difficulty that aroused from O’Brien and Pitt, the House of Lords in Etridge had widened the types of relationship which would put creditors on enquiry. If the relationship is non-commercial, the bank must 'put on inquiry' as to possible undue influence and take steps to ensure that the individual guarantor is made aware of the risks which are being run. [5] Therefore, there is no obligation on creditors to probe into the parties’ personal relationship as required by the case of O’Brien and Pitt. This approach arguably reduces the evidential burden on the surety since the surety is no longer required to establish that the transaction is financially disadvantageous before the burden of proof is shifted to the bank. [6] 

Pertaining to the second difficulty, it was made clear that in every case when a wife is asked to take on the role of surety in respect of her husband’s debts then the precautionary measures must be taken unless purpose of the borrowing appears to be a joint enterprise, such as the financing of a holiday home or an improvement to the house. [1] This is so regardless of whether the borrowing is in respect of a business in which the wife has an interest. The creditor will only be affected if he knows of the intention of the husband to use the money for his own purposes.

3.3.3 The protective steps to be taken by the Creditors

The nature of the protective steps required of creditors was an issue considered in O’Brien and Pitt. Before O’Brien, it will depend on the facts of each case whether the steps taken by the creditor satisfy the test. [2] However, for future transaction, the creditors would be able to protect themselves by drawing the wife's attention to the risks involved in entering into the transaction and advising her to take independent advice. [3] In fact, Lord Browne-Wilkinson contemplated that a bank should hold a private interview with the wife. [4] 

Nevertheless, there is no clear elaboration of the steps outlined by Lord Browne-Wilkinson. What reasonable steps must the lender takes to see that the claimant has been independently advised? [1] Can the creditor discharge his liability by merely recommending the surety to take independent advice? The decision in Credit Lyonnais Bank v Burch [2] suggested that merely advising the surety to seek advice is insufficient if the claimant did not then seek or receive such advice Banco Exterior International v Mann [3] held that the creditor will be able to escape liability by relying on a solicitor’s certificate that the surety has been given advice even it is not true. Conversely, TSB v Camfield [4] provides that the creditor will still be held liable in such situation.

The suggestion that the bank should hold a private meeting with the wife in O’Brien has been criticised as being unreasonable from the point of view of the banks because it might expose the bank to great risks than those from which it wishes to be protected. [5] Such a meeting might give rise for an action for negligent misstatement against the bank under the Hedley–Byrne doctrine [6] or even give rise to allegations of undue influence on the part of the bank itself. [7] 

One matter which was helpfully clarified in Etridge (No. 2) was that the guidelines to creditors and solicitors on how sureties should be advised in future transactions. The focus of these guidelines is to ensure that the surety understands the transaction and they may be summarised as follows. [8] 

The creditor must take steps to check the solicitor’s name that acted on behalf of the surety.

The bank should in every case obtain from the surety’s solicitor a written confirmation to the effect that the solicitor has fully explained to the surety the extent of the liability into which he or she is entering.

The surety should have fully noticed the requirement that he or she should not be able to dispute once she has signed

Suitable non-technical language must be used to explain the impact of the proposed transaction

The bank must provide the solicitor with the financial information about the husband’s business that solicitor needs for the purpose of advising the wife especially the amount of debt which is being guaranteed

The solicitor should emphasise that the surety has a choice and the bank should not proceed with the transaction until it has received an appropriate response directly from the surety

If the bank believes or suspects that wife has been misled by her husband or is not entering into transaction of her own free will, the bank must inform the surety’s solicitor of the facts giving rise to its belief or suspicion

For future transaction, the practical steps laid down by the House of Lords in Etridge will give the lender the security they have bargained for and will essentially reduce the risk of a mortgage being set aside for misrepresentation or undue influence unless the creditor failed to follow the simple guidelines. The assumption that advice had been duly by relying on solicitor’s certificate will suffice unless the creditor is aware that the advice given to the surety was defective. [1] Besides, Lord Nicholls followed cases such as Halifax M.S v Stepsky [1] , Barclays Bank v Thomson [2] and National Westminster Bank v Beaton [3] and held that if the solicitor gives the wife deficient advice and gives the Bank a certificate that advice was duly given to her, the solicitor’s knowledge of his own deficient advice is not to be imputed to the Bank under Section 199 of the Law of Property Act 1925.

No doubt creditors cannot be expected to enquire in any real way whether there has been actual undue influence once having carried out the steps in Etridge, they have done everything that could reasonably be expected of them to protect the surety, it might have missed the point that the victim of undue influence had no freedom to choose, no matter how much information they have about its effect, the wife will still enter the transaction as a result of her husband's undue pressure or her blind trust in him. [4] 

3.3.4 Independent legal advice

As decided in O’Brien, if the lender is to escape from having notice of undue influence or misrepresentation, the lender must ensure that the surety is independently advised. As noted by Martin Dixon, [5] what is independent advice? Well, some case held by ensuring that the surety was advised by someone other than its own staff, [1] and conversely did not escape when the adviser was closely linked with the lender, [2] other cases suggested that such advice must be given independently from that given to the wrongdoer. [3] However, Richard de Lacy [4] suggests that recent decisions assume that, regardless of the quality and depth of the advice being tendered, the mere fact of joint instructions by the solicitor or his firm will prevent the advice from being regarded as independent. [5] 

To clarify the law in O’Brien, Lord Scott in Etridge held that the solicitor does not necessarily have to be an independent solicitor who does not act for the husband or the bank. The solicitor may act for all parties as long as there is no risk of any conflict of interest. [6] In a case where the Bank does suspect undue influence, it should insist that the husband’s solicitor does not advise the wife. [7] 

One possible note of criticism of the Etridge guidelines is that the solicitor need not be wholly independent. Although Lord Nicholls was view that the advantage to be gained from insisting on such independence was not worth the cost, it is very likely that surety wives being advised by their husband’s solicitors do not always feel that such advice is truly independent.

Conclusion

From the discussion above, it can be seen that the House of Lords in Etridge has succeeded in making a meaningful clarification to the law on undue influence. The risk being sued by a claimant because of undue influence can now be deflected by a bank on the shoulders of the solicitor that advises the victim. Failure to give advice, or the giving of negligent advice, will no longer result in the mortgagee losing its security. Thus, it may well result in the solicitor being by the victim. [1] However, it will not be easy for the victims because the burden of proving that inadequate advice falls upon the surety. [2]