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Supreme Court backs existing test for calculating 'equitable compensation'

Lenders can only be compensated for actual losses that stem from a breach of trust in commercial transactions, the Supreme Court has confirmed.

Allied Irish Banks (AIB) had claimed that a firm of solicitors should be forced to compensate it for losses it said it would have made on a property deal it was mortgage provider for had the solicitors made the correct payments between the bank, borrowers and another lender, Barclays, which held first legal charge over the property as a provider of a security for the main mortgage.

The firm of solicitors, which was acting as a trustee of funds in the transaction, had, however, failed to pay Barclays approximately £300,000 it was owed as part of the deal and instead transferred those funds, loaned by AIB, to the borrowers instead.

When the borrowers failed to pay Barclays the money that was erroneously transferred to them and defaulted on their loan to AIB, their property was repossessed. Some of the proceeds from the sale went to AIB but it claimed that the firm of solicitors was liable for approximately £2.5 million it said it had lost from the deal as a result of the solicitors' breach of trust.

AIB said it was owed compensation that equated to the full amount of its loan, £3.3m, less the £867,697 it had collected from the sale of the property.

The solicitors, however, argued that it only owed AIB approximately £275,000. They claimed that its liability for compensation should only extend to the amount that AIB lost out on as a result of its failure to clear Barclays' debt on the property when it erroneously released the funds to the borrowers instead. Clearing Barclays' debt would have redeemed Barclays' charge on the property and meant that AIB would have been entitled to approximately £275,000 in additional proceeds from the property sale.

AIB's claim that it should be reimbursed for full amount of its £3.3m loan, less what it had received from the property sale, was rejected. The Supreme Court said the solicitors could not be forced to compensate AIB for losses that stemmed from the reduced-price sale of the property.

"There is … no satisfactory logical reason why the question of the solicitors’ liability to provide redress to the bank for a loss which it would have suffered in any event should turn on their compliance or non-compliance with their obligations under [the Solicitors Regulation Authority Accounts Rules 2011]," Lord Toulson said in his leading judgment (45-page / 348KB PDF) in the case.

"Equitable compensation and common law damages are remedies based on separate legal obligations. What has to be identified in each case is the content of any relevant obligation and the consequences of its breach. On the facts of the present case, the cost of restoring what the bank lost as a result of the solicitors’ breach of trust comes to the same as the loss caused by the solicitors’ breach of contract and negligence," he said.

Banking litigation expert Michael Isaacs of Pinsent Masons, the law firm behind Out-Law.com, said that the Supreme Court had upheld a previous legal test for determining how 'equitable compensation' should be calculated.  Isaacs said the Target Holdings v Redferns case before the House of Lords (HoL) in 1995 had established that equitable compensation should only put a beneficiary in the position they would have been in but for a breach of duty. The HoL had rejected the argument that a defaulting trustee should be forced to fully restore trust funds to what they had been prior to a breach of trust and not just to restore the amount lost by a beneficiary owing to that breach.

"The Supreme Court, in upholding the decision in Target, has given a common sense view of the need to link compensation – even equitable compensation – with actual loss," Isaacs said. "Lenders who are pursuing professional negligence claims against solicitors at the moment will need to look carefully at whether, in the light of this Supreme Court ruling, they can really sustain a claim for the full advance."

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