Legal charge — Misrepresentation — Individual voluntary arrangement — Borrower securing loan with charge on parents’ house — Borrower entering into arrangement with creditors — Whether claimant lender reserving right to enforce charge after arrangement successfully completed — Whether charge obtained by misrepresentation — Whether claimant having constructive notice of impropriety — Part VIII of Insolvency Act 1986 — Appeal dismissed
The first defendant, D, was the son of the second and third defendants, Mr and Mrs S. The claimant offered an £80,000 loan to D to enable him to purchase a pub. The loan was to be repaid over 10 years and to be secured by charges over the pub and Mr and Mrs S’s house. Mr and Mrs S agreed to grant the necessary charge after D assured them that he was buying with the intention of reselling at a profit, and that the loan would be repaid within two years.
D’s solicitor, H, arranged for an adviser, T, to explain to Mr and Mrs S the implications of the proposed transaction. T informed Mr and Mrs S that they could lose the house if D defaulted on the loan, but did not explain the provisions of the loan, or spell out its amount or the period over which it was to run.
D fell into arrears with the loan repayments, and the claimant called in the loan. Although D sold the pub and paid the proceeds of sale to the claimant, a large sum remained outstanding. D subsequently entered into an individual voluntary arrangement (IVA) with his creditors, pursuant to Part VIII of the Insolvency Act 1986. The claimant stated in correspondence that its support for the IVA was conditional upon retaining the charge against Mr and Mrs S’s house. The terms of the arrangement expressly mentioned the existence of that charge.
The claimant later brought proceedings to enforce the charge against Mr and Mrs S’s house. Before that action concluded, the IVA came to an end, releasing D from any further obligations to his creditors.
At the hearing, the judge held that he was not permitted to look further than the terms of the IVA itself to establish its meaning. He found that it contained no term reserving the claimant’s right to enforce the charge against Mr and Mrs S after the release of D, and he accordingly held that the usual common law rule applied, namely that the release of the principal debtor also released the surety. He further found that the charge should be set aside in any event, since it had been obtained by undue influence and misrepresentation on the part of D, of which the claimant had constructive knowledge. The claimant appealed.
Held: The appeal was dismissed.
1. The circumstances in which Mr and Mrs S had granted the charge required explanation, since the charge had had the effect of putting Mr and Mrs S’s home and only significant asset up as security for their son’s business venture, conferring a gratuitous benefit upon D so large that it could not be accounted for on the grounds of friendship, relationship, charity or other ordinary motives: Royal Bank of Scotland v Etridge (No 2) [1998] 4 All ER 705 and Allcard v Skinner (1887) 36 ChD 145 applied. Accordingly, an evidential presumption of impropriety was raised. Moreover, there was evidence of actual misrepresentation by D. The claimant was fixed with constructive knowledge of the impropriety, since it had taken no steps to ensure that the risks of the transaction were brought home to Mr and Mrs S, and it had not advised them to seek separate advice. Neither the steps taken by H nor the advice given by T affected that finding, given the serious deficiencies in that advice. Accordingly, the judge had been right to set aside the charge.
2. However, the judge’s findings as to the effect of the IVA were flawed. There was authority for the proposition that the common law rule on sureties was displaced where, on a true construction of the arrangement, the creditor’s rights against a surety were reserved: Kearsley v Cole (1849) 16 M&W 128 and Cole v Lynn [1942] 1 KB 142 applied. In such a situation, the surety’s right to sue the principal debtor also remained.
3. In determining whether a creditor had reserved its rights against a surety, the court had to approach an IVA in the same manner as any non-statutory consensual arrangement: it had to construe it in the light of all the surrounding circumstances, including the parties’ dealings leading to the IVA. It was not necessary for the reservation of rights against the surety to be included as a term of the arrangement itself, and the judge had erred in so holding. The correspondence in the instant case conclusively showed that the claimant had reserved its rights against Mr and Mrs S. In any event, that reservation had become part of the IVA by virtue of the express statement in that document that the claimant had a guarantee from Mr and Mrs S secured on their house. It followed that the judge had been wrong to hold that they were released from the charge upon the release of D.
Dermot Woolgar (instructed by Stanley Tee, of Bishops Stortford) appeared for the claimant; Clifford Darton (instructed by EJ Moyle, of Littlehampton) appeared for the second and third defendants; the first defendant did not appear and was not represented.
Sally Dobson, barrister
