Expensive mistakes
Date: 20 November 2009
Authors: Katherine Rees
Issue: Vol 159, Issue 7394
Categories: Features, Property
I suspect that, if you were to ask a lawyer in the throes of a large transaction what part of the deal featured in their nightmares, he or she would be most spooked by the fear of getting the intricacies of a complex provision wrong.
However, as recent cases have shown, claims are just as likely to arise from oversights or simple (but potentially expensive) mistakes as they are from subtle errors of legal analysis or judgment.
The economic crisis gives rise to its own particular claims, specifically those brought by lenders against solicitors and valuers, which tend to centre round the professional’s alleged failure to report information which would have affected the decision to lend.
While those claims abound, the more traditional claims against property lawyers also continue. Indeed, they look set to increase as mistakes made in the good times come to light during the downturn.
In this article I have selected three perennial sources of problems for solicitors which the courts have had to address: undertakings, overage clauses and the “exclusionary rule” in construction claims, and highlighted some risk management issues.
Undertakings: a cautionary tale
There has been a spate of recent decisions about undertakings, focusing on the unwelcome consequences for solicitors who acted for sellers and who gave routine undertakings to discharge charges on completion, but failed to obtain redemption figures. Although the solicitors in these matters raised a variety of ingenious arguments, the message from the court was consistent.
They must comply with their undertakings, redeeming the charges and paying the chargees for the full amounts they sought if necessary.
In Clark v Lucas [2009] EWHC 1953 (ch), the defendant solicitors acted for the seller, a property developer, on the sale to Mr and Mrs Clark of one of five newly built properties.
The whole site was subject to two charges, the first in favour of NatWest and the second of Mr Kenny. Lucas gave the standard replies to requisitions: they listed both charges, undertook to redeem or discharge them on completion and confirmed that they were authorised to act as the agents for both mortgagees. Completion took place and the buyers paid £532,000. Lucas were able to provide proof of discharge of NatWest’s charge, but not of Mr Kenny’s charge.
Mr Kenny said that he was not approached about the redemption of his loan until some time after completion. By then, NatWest had appointed a receiver. Under the terms of his charge, this permitted Mr Kenny to demand the full amount that the seller owed him, which was over £1m.
The Clarks applied for summary judgment, seeking specific performance of Lucas’ undertaking. Until Mr Kenny’s charge was removed, they could not register title to the property, sell or charge it.
Lucas accepted that they were in breach of their undertaking to the Clarks, but argued that performance of it was now impossible and should not be ordered. They were willing to compensate the Clarks, but argued that they should not be forced to comply with the undertaking and pay off Mr Kenny’s charge, when the sum he required was wholly disproportionate to the value of the house—double its value. They invited the court to exercise its discretion.
The judge rejected these (and other) arguments and granted summary judgment. She held that performance of the undertaking was not impossible; it could be performed by payment of a cheque, albeit a larger cheque than expected. She refused to exercise her discretion, on the basis that Mr Kenny’s demand could not be categorised as wholly unreasonable or outside Lucas’s contemplation when they gave the undertaking.
The risk management issues are straightforward:
Always obtain a redemption figure before giving an undertaking.
Do not assume that a charge over multiple properties will contain a clause obliging the mortgagee to release part of his charge in return for part payment (in Lucas there was no such requirement).
If the undertaking is breached do not expect any sympathy from the court, however disproportionate the outcome.
Overage clauses
Overage clauses are often included when land is sold for development. They provide for an additional payment to be made to the seller if certain conditions (often the grant of planning permission) are satisfied. This enables the seller to share in the development value of the land, if the developer/buyer can unlock it.
The sums at stake can be huge. Overage provisions are frequently negotiated by the clients themselves, or by other advisors. They can depend upon complex formulae so distilling these into a workable clause is not straightforward.
Small wonder, then, that such clauses are a frequent source of disagreement between the parties, and of claims against their lawyers. Such disputes do not usually emerge until some time after the agreement was made. Before turning to the mechanisms which can be used to “correct” faulty drafting, some clear risk management points arise:
If you are not responsible for drafting the overage provisions (but are simply importing clauses wholesale into the agreement), be clear about the delineation of responsibility between you and the client and/or other professional advisors responsible for any drafting.
If your firm is responsible for the drafting, consider “road testing” the clause by running it with different sets of figures. Check that this is how the client expects the provisions to work.
Do not assume that your clients will later be able to rely on precontractual negotiations to clarify any ambiguities (see below).
Choose terms with care. In a recent case, payment of the overage was triggered by the construction of “residential flats”. Holiday flats were built. Since people do not “reside” in holiday flats, the payment was not triggered (Walker v Kenley [2008] EWHC 370 (Ch)).
The “exclusionary rule”
A party faced with a disputed overage clause may well want to point to what was said in the pre-contractual negotiations, to prove that their interpretation is correct.
However, such evidence is inadmissible in the context of an application for construction. The boundaries of this rule were tested in the recent case of Chartbrook Limited v Persimmon Homes Limited and others [2009] UKHL 38.
In Chartbrook the parties, a developer and a landowner, disagreed over the interpretation of a clause in their agreement which provided for an additional payment to be made to the seller once the units had been built and sold. The parties had agreed that the seller would receive a percentage figure (23.4%).
The disagreement, crudely put, was “23.4% of what?” Should this percentage be applied to the difference between the figure which a unit was expected to fetch (say £228k) and the actual sale price (say £250k), or to the difference between the actual sale price and a much lower figure (£53,438) mentioned in the agreement? The answer made a huge difference to the figures.
On the seller, Chartbrook’s, interpretation the overage payment was approximately £4.4m: according to the developer, Persimmon, only about £900k was due. Chartbrook sought construction. Persimmon sought rectification.
A key feature of the case was that the pre-contractual negotiations between the parties made it “crystal clear” (in the words of Baroness Hale) that Persimmon’s construction was correct.
Evidence of these negotiations was admissible in relation to the rectification claim, but not the construction claim. This anomaly reflects the different tests for rectification and construction.
Rectification will be available where the court is satisfied that, by mistake, the instrument which the parties signed did not accurately reflect the agreement which they had reached. In that context, the court must consider the pre-contractual negotiations between the parties. But if the court is being asked to construe the clause, the exercise is different.
The test was described by Lord Hoffmann in Investors Compensation Scheme v West Bromwich Building Society [1998] 1 WLR 896. Essentially, the court is being asked to carry out an objective test: to ascertain the meaning which the clause would have to a reasonable person. In that context, evidence of what the parties intended is irrelevant.
This “exclusionary rule” has generated much academic debate. A key argument in its favour is that it promotes certainty. The agreement stands “on its own two feet” as a distillation of all the negotiations that came before it. The counter argument is that the court is prevented from hearing useful evidence which would enable it to reach the right decision.
In practice, if there is helpful evidence of the pre-contractual negotiations, a party will try to run applications for rectification and construction in tandem, (even if the rectification claim is tougher), to ensure that the evidence comes before the court.
Chartbrook was seen by many as a golden opportunity to do away with the exclusionary rule. The leading opinion in the House of Lords was given by Lord Hoffmann, who had been involved in many of the key cases on construction. As this was also his swansong, many commentators expected a reversal of the law. They were disappointed.
Lord Hoffmann construed the clause in line with Persimmon’s interpretation. Looking at the effect of the document as a whole, he found that this included an element of contingency. If the trigger for payment was set as low as £53,438, as Chartbrook argued, nothing short of a catastrophic fall in the market would prevent a payment from being made and there would be no real element of contingency.
Having reached that conclusion, strictly speaking, Lord Hoffmann did not need to tackle the exclusionary rule, but having been addressed on the point, he did so. Weighing up the arguments for and against the rule, he concluded that there was insufficient justification for the House of Lords to depart from it, although he did not rule out the possibility that empirical research (for example, by the Law Commission) might justify this.
Whatever the fate of the exclusionary rule, applications for rectification and construction remain a useful way for solicitors to turn back the clock and correct mistakes which could otherwise result in expensive claims. The merits of such an application need to be considered carefully, since the solicitor (or rather, his insurers) will often be asked to provide an indemnity for the costs.
In particular, solicitors (and their insurers) should consider these points.
Whether they are in a position to offer the client impartial advice about the options available or whether they are conflicted from doing so (and/or from acting in any application to the court). Is independent advice required?
The merits of the application (including the admissibility of relevant evidence). Does the sum at stake justify the costs and risks of the application?
Whether encouraging the client to make the application amounts to acknowledging that the solicitor has made a mistake. What are the implications for any potential professional negligence claim?
Katherine Rees is a partner at Reynolds Porter Chamberlain LLP.
E-mail: Katherine.rees@rpc.co.uk
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