Illegality Illuminated

On 30 October 2020, the UK Supreme Court handed down two contrasting judgments in Stoffel & Co v Grandona [2020] UKSC 42 and Ecilia Henderson v Dorset Healthcare University NHS Foundation Trust [2020 UKSC 43] confirming that illegality does not serve as an automatic bar to a successful claim and clarified how the policy based approach approved in Patel v Mirza [2016] UKSC 42 was to be applied.

Background

Stoffel & Co v Grandona

In 2000 the Respondent, Ms Grandona, had  entered into an agreement with her business partner, Mr Mitchell, to obtain mortgage loans in relation to various properties in her name but which were ultimately for Mr Mitchell’s benefit. Mr Mitchell had agreed to pay the monthly payments due under those mortgages and bear responsibility for the management of those properties.  In return, Ms Grandona was to receive a portion of the net profits from the proceeds of sale from those properties.

In furtherance of that arrangement, Ms Grandona subsequently purchased the leasehold interest in a property from Mr Mitchell. The purchase was funded in part by a mortgage provided by a high street lender to Ms Grandona that was to be secured by a charge over the property. The Appellant, Stoffel & Co, was engaged by Ms Grandona, Mr Mitchell and the high street lender to act as solicitors for all parties on the transaction. Following completion of the purchase, Stoffel & Co negligently failed to remove the existing mortgage on the property and register the transfer of the property to Ms Grandona and the high street lender’s charge.

Ms Grandona subsequently defaulted on her mortgage payments and was sued by the lender. She joined Stoffel & Co to the proceedings. Stoffel & Co admitted negligence but sought to rely on the doctrine of illegality to avoid liability because it alleged that it had been instructed by Ms Grandona to further the mortgage fraud.

Ecilia Henderson v Dorset Healthcare University NHS Foundation Trust

The Appellant, Ms Henderson, suffered from paranoid schizophrenia and had stabbed her mother to death whilst experiencing a serious psychotic episode. Ms Henderson was convicted of manslaughter by reason of diminished responsibility and was sentenced to a hospital order under section 37 and an unlimited restriction order under section 41 of the Mental Health Act 1983.

Ms Henderson subsequently brought a negligence claim against the Respondent, Dorset Healthcare, seeking various heads of damages. Ms Henderson was under the care of Dorset Healthcare at the time of the incident. Dorset Healthcare admitted it had been negligent in failing to return Ms Henderson to hospital on the basis on her psychotic state, which would have prevented the killing of her mother. However, Dorset Healthcare denied liability on the basis that the damages claimed by Ms Henderson were the direct consequence of her criminal act and the sentence imposed by the court and therefore irrecoverable on the basis of the doctrine of illegality. 

Policy-based approach set out in Patel

In Patel, the Supreme Court had previously held that the underlying policy question which needed to be answered when determining whether the illegality defence applied is, “whether allowing recovery for something which was illegal would produce inconsistency and disharmony in the law, so cause damage to the integrity of the legal system”. In order to determine the above question, the Supreme Court identified the following “trio of necessary conditions” which had to be determined by a court:

a) The underlying purpose of the prohibition which has been transgressed;

b) Other relevant public policies which may be rendered ineffective or less effective by denial of the claim; and

c) Whether denying the claim would be a proportionate response to the illegality.

In relation to the assessment of proportionality, the Supreme Court in Patel identified the following non-exhaustive list of factors: “the seriousness of the [illegal] conduct, its centrality to the contract, whether it was intentional and whether there was a marked disparity in the parties’ respective culpability”.

Despite explanation of the policy-based approach in Patel, it has nonetheless been unclear how a court should apply these principles to the facts of individual cases. In these two recent cases, the Supreme Court has provided helpful guidance in that respect.

Application of the policy-based approach

In Stokes, the Supreme Court gave the following specific guidance in relation to the application of the policy-based approach:

1. The application of the “trio of considerations” should not be a mechanistic approach;
    
2. In relation to stages (a) and (b), the courts will only have to determine the relevant policies at a high level, they will not be required to evaluate those policies;
    
3. Once the relevant policies have been determined, the court will have to ascertain whether allowing the claim would be inconsistent with those policies;
    
4. Where there are competing policies, the court will have to determine where the overall balance lies;
    
5. In determining stage (c), proportionality, the court will have to closely scrutinise the detail of the case;
    
6. It is not necessary in all cases to exhaustively determine all the stages, particularly where following an examination of stages (a) and (b) there is a clear conclusion as to whether the defence should be allowed (this was also stated in Henderson).
    

In Stokes, the Supreme Court also clarified following Patel, that while the criterion of whether the claimant had profited from the illegality would remain a relevant consideration, it is no longer the focus of the court’s inquiry.

The Supreme Court in Henderson gave the following more general guidance:

1. The policy based approached espoused in Patel does not apply to statutory illegality where the courts have to abide by the terms of the statute;
    
2. The policy based approached espoused in Patel is the “proper approach to the common law illegality defence across civil law more generally”; 
    
3. The principles identified in Patel are derived from previous case law and those cases continue to have precedential value unless they are incompatible with the reasoning set out in Patel;
    
4. In relation to the factors that a court would need to consider when determining proportionality, the centrality of the illegal conduct to the contract will often be the most important; i.e. “whether there is a causal link between the illegality and the claim, and the closeness of that causal connection”.
    

Conclusion

Both these cases have provided helpful guidance and direction as to how a court will determine whether a defendant should be allowed to rely on the doctrine of illegality as a defence. 

In Stokes, the Supreme Court denied Stokes & Co the ability to rely on the defence of illegality as they determined inter alia that although preventing mortgage fraud was important, this was unlikely to be effected by denying a remedy against property lawyers and that it was more important that those using legal services are entitled to a remedy for negligence.

In Henderson, the Supreme Court upheld Dorset Healthcare’s ability to rely on the defence of illegality as inter alia allowing Ms Henderson’s claim would lead to inconsistency and incoherence in the law – one branch of the law would be compensating for an act which another branch treated as being criminal – which would damage the integrity of the legal system.

Overall, these two decisions show that the courts will adopt a more flexible approach and would seek to balance out the various competing policy factors. The mere fact that a claimant may profit from an “illegal” contract does not necessarily mean that the court will not enforce the terms of that contract.

How Dechert can help

At Dechert we are available to help analyse whether the defence of illegality applies in various situations and we provide advice to claimants as to what effect if any, the defence of illegality may have on the quantum of their claim.