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Part II Grounds, 9 Third Party Wrongdoing

Dominic O’Sullivan

From: The Law of Rescission (3rd Edition)

Dominic O'Sullivan KC, Steven Elliott KC, Rafal Zakrzewski

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: null; date: 18 April 2024

Subject(s):
Third parties — Damages and contract — Illegality and contract — Performance of contract — Termination/unwinding of contract — Validity of contract

(p. 229) Third Party Wrongdoing

A.  Introduction

9.01  This chapter concerns the situation where A contends that his transaction with B is voidable because his consent was vitiated by some factor for which a third party, C, was responsible. The question to be addressed is how far B must be implicated in order for A to rescind. Provided A can implicate B, A’s right to rescind will be subject to the same bars and governed by the same principles that apply in an ordinary two party situation.1

9.02  An important example of this scenario occurs where A, a wife, seeks to rescind a security she gave to B, a bank, in support of finance the bank extended to a business operated by C, the husband. The special rules that have been developed to govern cases of this general type are discussed in Part C of this chapter.

B.  Contracts

(1)  The basic rule precluding rescission

9.03  The simple fact that the third party, C, has wrongfully caused A to contract with B will not entitle A to avoid that contract.2 If A has a claim it is against C, usually for damages or equitable compensation.

(p. 230) (2)  Agency

9.04  Of course if C was B’s agent or sub-agent then the case will be treated as if B had himself committed the wrongful act,3 and C’s knowledge will be imputed to B,4 provided that C made the representation within the scope of his actual or apparent authority.5 It makes no difference that the agent may have been acting in his own interests.6 B will also be responsible if he adopts C’s unauthorized misrepresentation before the contract is made,7 or if before that time the agent is given the authority necessary to make the representation in question.8

(3)  Knowledge of misconduct

9.05  A will also be entitled to avoid the contract if B knew before the contract was concluded of C’s misrepresentation or other wrongful inducement.9 Nothing more is required and nothing less will suffice. This applies to all of the grounds for rescission, even innocent misrepresentation,10 except that the Court of Appeal has recognized a qualification in a limited class of cases involving the abuse of fiduciary relations.11 Knowledge in this context means actual knowledge of the factual circumstances that are treated by the court as impairing A’s consent, such as a material misrepresentation or a relationship sufficient to raise a presumption of undue influence.12 Constructive knowledge is not enough, and nor is suspicion,13 but as in related areas of the law actual knowledge encompasses wilfully shutting one’s eyes (p. 231) to the obvious and wilfully and recklessly failing to make enquiries that an honest and reasonable man would.14 The onus of proving knowledge lies on the rescinding party.15

(4)  Relationship with unilateral mistake

9.06  Cartwright has pointed out that the entitlement to rescind on account of a counterparty’s knowledge of a third party’s misrepresentation sits uneasily with the established approach to mistake and duties of disclosure in the formation of a contract.16 In particular, since Smith v Hughes17 it has been understood that a vendor is under no obligation to inform the purchaser that he is in some way mistaken, provided the vendor himself is not responsible for the mistake. It is difficult to explain why the fact the vendor knows that the purchaser’s mistake has been induced by a third party’s misrepresentation should make a difference, though it clearly does on the authorities.

C.  Surety Contracts

9.07  In Barclays Bank plc v O’Brien18 the House of Lords fashioned special rules to govern a particular situation that has become increasingly prevalent. The central example of this situation occurs where a wife guarantees her husband’s business debts, often exposing her interest in the matrimonial home. There is a particular danger that in persuading his wife to stand surety, the husband will take advantage of the influence that he may enjoy over her, or else that he may misrepresent the state of his business or the extent of the guarantee.19

(1)  Constructive notice

9.08  On conventional principles the creditor would not be affected by the husband’s misconduct, and the wife would not be entitled to avoid the guarantee, unless the creditor or its agent actually knew of the circumstances in which her consent was procured. The courts have, however, long been especially concerned about the vulnerability of sureties such as wives and elderly relations. Before O’Brien this concern had been partially met by treating the husband as the agent of the creditor for the purpose of imputing his misconduct to the bank, but only where the bank entrusted him with the task of obtaining the wife’s signature.20

(p. 232) 9.09  In O’Brien21 the House of Lords held this approach to be artificial and unsatisfactory. While there may be cases in which the husband acts as the creditor’s agent, Lord Browne-Wilkinson said that these would be very rare.22 The mere fact that the creditor left the husband to procure his wife’s signature is not enough to constitute him as their agent without distorting that concept.

9.10  Instead the House of Lords held that the security would be vulnerable to avoidance at the instance of the wife if the bank had either actual or, what was novel, constructive notice of the facts giving rise to her equity.23 In broad terms, where the circumstances known to the creditor disclose a risk that the wife’s consent may have been improperly procured, the creditor will be fixed with constructive notice of any impropriety there may have been unless it takes certain specified steps designed to minimize that risk. Where the creditor is fixed with constructive notice, the wife will be entitled to avoid the security on proof that it was in fact procured by undue influence or misrepresentation.

9.11  While Lord Browne-Wilkinson spoke of the concept of constructive notice as if it would be familiar, it soon became clear that the concept is a new one, not to be equated with the conventional principles of constructive notice applicable in conveyancing transactions. Those conventional principles regulate the situation where a purchaser acquires from his vendor real property which is subject to the undisclosed interest of a third party. In this situation the purchaser is fixed with constructive notice of the third party’s interest, and takes subject to it, if that interest would have been uncovered by reasonable inquiries.24

9.12  By contrast the wife in the situation regulated by the doctrine of constructive notice recognized in O’Brien deals directly with the creditor. The creditor does not acquire her interest through her husband, and in the usual case where the wife offers as security a charge over her share in the matrimonial home, there is no defect in her title. Moreover, the measures a creditor must take in order to avoid constructive notice do not consist in making inquiries.

9.13  The novelty of this doctrine was recognized by the House of Lords eight years later in Royal Bank of Scotland plc v Etridge (No 2),25 a decision which has been largely successful in settling a number of difficult issues that had emerged in the wake of O’Brien. In particular, in that case their Lordships reformulated and clarified the scope of the O’Brien principle as well as the special measures that a creditor must take to immunize its security where the principle applies.

(2)  Circumstances in which special measures must be taken

9.14  It is now clear that the O’Brien principle applies to surety transactions where the relationship between the surety and the debtor is non-commercial and the transaction is not on its (p. 233) face financially advantageous to the surety.26 If the creditor knows that this is so, the burden of proof of which lies with the surety,27 it will only avoid being fixed with constructive notice of any impropriety by taking special measures. The two key circumstances will be discussed in turn, followed by a discussion of the special measures a creditor must take to immunize his security.

Non-commercial relationship

9.15  While the central example of a case to which the principle applies is the relationship between husband and wife, its scope is much wider than this. It encompasses all other familial relationships, such as the relation between parents and children and between more extended family members. Cohabitation is not necessary.28 The principle goes further still, and has been applied in a case where a junior employee provided security for her employer’s overdraft.29 In Etridge Lord Nicholls considered the scope of the principle and concluded that the only sensible limitation was that it should apply in all cases where the relationship between the surety and the debtor is non-commercial but not where their relationship is commercial in nature.30

Transaction not on its face financially advantageous to surety

9.16  A transaction by which one party stands surety for the debts of another, without more, will be treated by the courts as one that on its face is not to the financial advantage of the surety.31 By contrast, a transaction by which funds are advanced to a husband and wife jointly is on its face financially advantageous to the wife, though the principle will apply if the creditor is aware that the loan is being made for the husband’s purposes as distinct from joint purposes.32 In this regard the creditor cannot shut its eyes to what it knows, but it need not enquire as to the purposes of a joint advance.33

9.17  More difficult are cases in which the advance is made to a company in which the surety is involved. In Etridge the House of Lords held that the O’Brien principle would apply notwithstanding that the surety might be a shareholder or a director or officer, because these factors ‘are not a reliable guide to the identity of the persons who actually have the conduct of the company’s business’.34 There may be cases in which the creditor reliably knows that the surety actively participates in the actual conduct of the business, but it would rarely be prudent to assume on this basis that the O’Brien principle does not apply.

(p. 234) (3)  Special measures that immunize the security

9.18  In O’Brien, Lord Browne-Wilkinson said that for the future a creditor could avoid being fixed with constructive notice if it insists that the wife attend a private meeting with a representative of the creditor at which she is told of the extent of her liability as surety, warned of the risk, and urged to take independent advice.35 In practice lending institutions have been understandably reluctant to assume responsibility for advising intending sureties in this manner. They have instead insisted that the intending surety take independent advice from a solicitor.

9.19  Much of the focus in Etridge was on this practice in light of complaints that such advice could be perfunctory and inapt to protect vulnerable sureties. Notwithstanding these complaints, the House of Lords confirmed that a creditor’s security will usually be immunized from challenge if it insists that the surety obtain independent legal advice, provided certain safeguards are complied with.36 The burden of proving compliance rests with the creditor.37 The creditor proceeds at its own risk, however, if the creditor knows that the solicitor has not duly advised the surety or knows facts from which it ought to realize that the surety has not received appropriate advice.38 Absent special circumstances such as these, the creditor is entitled to assume that the solicitor has done his job properly and deficiencies in his advice are a matter between the surety and the solicitor.39

9.20  So far as the safeguards are concerned, Lord Nicholls identified four in respect of future transactions.40 First, the creditor should check directly with the surety the name of the solicitor she wishes to act for her, and not proceed until it has received an appropriate response directly from the surety. Secondly, the creditor should send the solicitor such financial information as it possesses relevant to the advice he is to give.41 Thirdly, if exceptionally the creditor believes or suspects that the surety’s consent has been improperly procured, then it should insist that the surety is advised by a solicitor independent of the debtor,42 and inform the solicitor of the facts on which this belief or suspicion is based. Fourthly, the creditor should obtain from the solicitor a written confirmation that he has given appropriate independent advice.43 The creditor is not required to advise the surety about the wisdom of (p. 235) entering the transaction or to give its opinion of the financial state or business prospects of the debtor.44

D.  Gratuitous Dispositions

9.21  Gifts and other gratuitous dispositions procured by the misconduct of a third party may be set aside without proof of knowledge or even constructive knowledge on the part of the donee. This is illustrated by cases involving third party misrepresentation,45 undue influence,46 and breach of fiduciary duty.47 This aligns with the proposition that a gratuitous disposition made by reason of a sufficient unilateral mistake may be set aside even though the donee did not know of the mistake,48 though the same mistake would not make a contract voidable.49(p. 236)

Footnotes:

1  TSB Bank Plc v Camfield [1995] 1 WLR 430 (CA) 437.

2  Sturge v Starr (1833) 2 My & K 195, 196; 39 ER 918, 919; Pulsford v Richards (1853) 17 Beav 87, 95; 51 ER 965, 968; Re The Liverpool Borough Bank (Duranty’s case) (1858) 26 Beav 268, 270–71; 53 ER 901, 902; Re The United Kingdom Ship Owning Company, Limited (Felgate’s case) (1865) 2 De G J & S 456, 465; 46 ER 451, 455; Bainbrigge v Browne (1881) 18 Ch 188, 197; Talbot v Von Boris [1911] 1 KB 854 (CA); Armagas Ltd v Mundogas SA (The Ocean Frost) [1985] 1 Lloyd’s Rep 1, 18–20; Royal Bank of Scotland plc v Etridge (No 2) [2002] 2 AC 773 [40], [144]; Chancery Client Partners Ltd v MRC 957 Ltd [2016] Lloyd’s Rep FC 578.

3  Mullens v Miller (1892) 22 ChD 194, 198; Lynde v Anglo-Italian Hemp Spinning Co [1896] 1 Ch 178, 182–83; Wauton v Coppard [1899] 1 ChD 92; Goldrei, Foucard & Son v Sinclair [1918] 1 KB 180 (CA); Anglo-Scottish Sugar Beet Corporation, Limited v Spalding Urban District Council [1937] 2 KB 607; Armagas Ltd v Mundogas SA (The Ocean Frost) [1985] 1 Lloyd’s Rep 1, 18–20; Krakowski v Eurolynx Properties Ltd (1995) 183 CLR 563, 582–84, applied in Spice Girls Ltd v Aprilia World Services BV [2002] EWCA 15 [57].

4  Archer v Hudson (1844) 7 Beav 551, 560–61; 49 ER 1180, 1183–84; aff’d (1846) 15 LJ Ch 211, 213.

5  Gordon v Selico Co Ltd [1986] 1 EGLR 71 (CA) 75; First Energy (UK) Ltd v Hungarian International Bank Ltd [1993] 2 Lloyd’s Rep 194 (CA) 204; MCI Worldcom International Inc v Primus Telecommunications plc [2004] 2 All ER (Comm) 833 [25]; Gaydamak v Leviev [2012] EWHC 1740 (Ch). As to the test for determining whether a fraud is committed within the scope of an agent’s authority, see Dubai Aluminium v Salaam [2003] 2 AC 366 [23], [122], [129]. Cf Armagas Ltd v Mundogas SA (The Ocean Frost) [1986] AC 717 (CA) 744–45, 755, 769, a case of bribery where the Court of Appeal held obiter that it would be sufficient that the agent was acting within the course of his employment, as to which see Chap 8, paras [8.65]–[8.66].

6  Bank of Credit and Commerce International SA v Aboody [1990] 1 QB 923 (CA) 972.

7  Bradford Third Equitable Benefit Buildings Society v Borders [1941] 2 All ER 205 (HL) 211.

8  Briess v Woolley [1954] AC 333, 353–54.

9  Stone v Compton (1838) 5 Bing NC 142, 156–57; 132 ER 1059, 1065; Spencer v Handley (1842) 4 Man & G 414, 418; 134 ER 169, 171; Cobbett v Brock (1855) 20 Beav 524, 528, 531; 52 ER 706, 707, 708; Kempson v Ashbee (1874) 10 Ch App 15, 21; Bainbrigge v Browne (1881) 18 Ch 188, 197; Lynde v Anglo-Italian Hemp Spinning Co [1896] 1 Ch 178, 183; Talbot v Von Boris [1911] 1 KB 854 (CA); Kesarmel v NKV Valliappa Chettiar [1954] 1 WLR 380 (PC—Malaya); O’Sullivan v Management Agency and Music Ltd [1985] QB 428 (CA); Barclays Bank plc v O’Brien [1994] 1 AC 180, 197; Credit Lyonnais Bank Nederland NV v Burch [1997] 1 All ER 144 (CA) 152; Royal Bank of Scotland plc v Etridge (No 2) [2002] 2 AC 773 [40], [144]; UBS AG v Kommunale Wasserwerke Leipzig GmbH [2017] 2 Lloyd’s Rep 621 (CA) [108], [110].

10  Lynde v Anglo-Italian Hemp Spinning Co [1896] 1 Ch 178, 183. See also Re Metropolitan Coal Consumer’s Association (Karberg’s case) [1892] 3 Ch 1 (CA) 13.

11  UBS AG v Kommunale Wasserwerke Leipzig GmbH [2017] 2 Lloyd’s Rep 621 (CA) [113]. See Chap 8, para [8.69].

12  Bainbrigge v Browne (1881) 18 Ch 188, 197.

13  UBS AG v Kommunale Wasserwerke Leipzig GmbH [2017] 2 Lloyd’s Rep 621 (CA) [120], [347].

14  Owen v Holman (1853) 4 HLC 997, 1034–35; 10 ER 752, 767; Logicrose Ltd v Southend United Football Club Ltd [1988] 1 WLR 1256, 1261; Royal Bank of Scotland plc v Etridge (No 2) [2002] 2 AC 773 [144], where Lord Scott referred in this connection to Commission for New Towns v Cooper (Great Britain) Ltd [1995] Ch 259 (CA) 281; Economides v Commercial Assurance Co plc [1998] QB 587 (CA) 601–02, 607; Donegal International Ltd v Zambia [2007] 1 Lloyd’s Rep 397 [464].

15  Talbot v Von Boris [1911] 1 KB 854 (CA).

16  J Cartwright, Misrepresentation, Mistake and Non-disclosure (5th edn, 2019) [4.81].

17  (1867) LR 6 QB 597, 607.

18  [1994] 1 AC 180.

19  The applicability of the special rules in cases of misrepresentation, including innocent misrepresentation, was confirmed in Annulment Funding Company Limited v Cowey [2010] BPIR 1304 (CA) [64] and Royal Bank of Scotland plc v Chandra [2011] Bus LR D149 (CA).

20  Eg Avon Finance Co Ltd v Bridger [1985] 2 All ER 281 (CA); Kings North Trust Ltd v Bell [1986] 1 WLR 119 (CA); Coldunell Ltd v Gallon [1986] QB 1184 (CA).

21  [1994] 1 AC 180, 195. The House of Lords also rejected the theory that a wife standing surety for her husband’s debts enjoys the ‘special equity’ against the creditor recognized by the High Court of Australia in Yerkey v Jones (1939) 63 CLR 649, 675. That theory has since been reconfirmed by the High Court of Australia in Garcia v National Australia Bank Limited (1998) 194 CLR 395.

22  [1994] 1 AC 180, 195.

23  [1994] 1 AC 180, 195.

24  Law of Property Act 1925, s 199.

25  [2002] AC 773 [39]–[41], [145]–[147].

26  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [41], [43]–[49], [87]. In Hong Kong, Li San Ying v Bank of China (HK) Limited (2004) 7 HKCFAR 579 (Lord Scott NPJ).

27  Barclays Bank plc v Boulter [1999] 1 WLR 1919 (HL) 1925.

28  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [47]; Massey v Midland Bank plc [1995] 1 All ER 929 (CA) 933.

29  Credit Lyonnais Bank Nederland NV v Burch [1997] 1 All ER 144 (CA).

30  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [87]–[89].

31  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [43].

32  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [48]; CIBC Mortgages plc v Pitt [1994] 1 AC 200.

33  Mortgage Agency Services Number Two Ltd v Chater [2003] EWCA Civ 490 [63]–[67].

34  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [49]. Eg, Mahon v FBN Bank (UK) Limited [2012] 2 BCLC 83, where the wife was the sole shareholder and company secretary. As to joint advances to husband and wife partnerships, see O’Neill v Ulster Bank Ltd [2016] BPIR 126 (NICA).

35  Barclays Bank plc v O’Brien [1994] 1 AC 180, 196. Though if the creditor knows facts indicating that impropriety is not only possible but probable, then it must insist on independent advice: 197.

36  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [56], [171].

37  Barclays Bank plc v Boulter [1999] 1 WLR 1919 (HL) 1925.

38  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [57]. See the discussion of the solicitor’s role and the advice that should be given in Padden v Bevan Ashford [2012] 1 WLR 1759 (CA).

39  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [78], [175]. In ordinary cases the solicitor will not be taken to act as the creditor’s agent when advising the surety even if the solicitor is also acting for the creditor in the transaction: [77], [178].

40  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [79]. In respect of past transactions, Lord Nicholls indicated at [80] that the creditor would usually be protected if a solicitor who was acting for the surety in the transaction had given the creditor confirmation to the effect that he had brought home to the surety the risk she was running by standing as surety.

41  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [189].

42  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773[174]. Except in this special case, the creditor may safely accept a confirmation of independent advice given by a solicitor who also acts for both the husband and the creditor itself.

43  See Kapoor v National Westminster Bank plc [2010] EWHC 2986 (Ch). In Hong Kong, Wing Hang Bank Limited v Kwok Lai Sim [2009] 4 HKC 71 (CA).

44  Royal Bank of Scotland plc v Etridge (No 2) [2002] AC 773 [172].

45  Scholefield v Templer (1859) 4 De G & J 429, 433–34; 45 ER 166, 168; Hunter BNZ Finance Ltd v CG Maloney (1988) 18 NSWLR 420, 433–34 (cheque).

46  Bridgeman v Green (1755) Wilm 58, 62; 97 ER 22, 25; Huguenin v Baseley (1807) 14 Ves 273, 288–90; 33 ER 526, 532–33; Bullock v Lloyds Bank Ltd [1955] Ch 317. See P Ridge, ‘Third Party Volunteers and Undue Influence’ (2014) 130 LQR 112.

47  Barron v Willis [1900] 2 Ch 121 (CA) 133.

48  Pitt v Holt [2013] 2 AC 108.

49  Riverlate Properties Ltd v Paul [1975] 1 Ch 133 (CA) 140–45. See Chap 29, para [29.19].