The Board of the Privy Council dismissed an undue influence complaint against a bank regarding a mortgage deed entered into as security for a loan made by the bank: Nature Resorts Ltd v First Citizens Bank Ltd (Trinidad and Tobago)  UKPC 10.
This decision will be of greater interest to financial institutions confronted with claims aimed at canceling financial contracts on the grounds of undue influence. It provides a useful application of the undue influence test set out in Royal Bank of Scotland plc v Etridge (No 2)  UKHL 44 . As a reminder, Etridge established that there are two conditions for establishing the (rebuttable) presumption of undue influence. First, there must be a relationship of influence. The second requirement is that the transaction should not be easily explainable by ordinary reasons. If these two conditions are met, such that there is a presumption of undue influence, the burden of proof shifts and it is up to the party seeking to confirm the transaction to rebut the presumption by demonstrating that the other party did not act under undue influence (i.e. exercised free and independent judgment) in entering into the transaction.
In this case, the Commission found that the Court of Appeal of Trinidad and Tobago was entitled to find that with respect to the mortgage deed, the client was not acting under the influence undue influence of the bank’s lawyer – on the facts, he exercised a free and independent judgment, which rebutted the presumption of undue influence which the Court of Appeal had established. However, the Board expressed concern with the approach taken by the Court of Appeal to establish that there was a presumption of influence which the Bank had to rebut. The Court of Appeal had found that the transaction was not easily explainable because the company had not derived any benefit from it. The board noted that viewing the company as separate from its sole shareholder (who had benefited from it) was the incorrect approach to take.
We examine the decision in more detail below.
The plaintiff company, with a sole shareholder, owned land in Tobago purchased in 2000 for the purpose of developing an eco-resort. The land was bought with the help of silent investors. In 2008, the shareholder agreed to sell 75% of the company’s shares to two people. In order to facilitate their purchase of the shares, the two individuals contacted the defendant bank (the Bank) for a loan. The Bank accepted the loan on the condition that there be a charge on the shares to be acquired and a mortgage as security on the land.
The Bank has appointed a Caribbean lawyer to prepare the mortgage deed and the transfer of shares. The mortgage deed was executed and signed by the shareholder as administrator of the company. However, the loan was not repaid by the two individuals. The Bank decided to exercise its power of sale under the mortgage and agreed to a sale of the land in July 2011.
The company subsequently brought an action against the Bank alleging that the deed of mortgage with the Bank was voidable (and had been canceled by the company) due to the undue influence exerted on the shareholder by the lawyer . Previously, the lawyer had been instructed by the shareholder to incorporate the company, and after its incorporation, he became a director.
The Bank rejected the claim.
Decision of the High Court of Trinidad and Tobago
The High Court ruled in favor of the Bank and dismissed the claim (see judgement).
The High Court noted that there were two categories of undue influence: actual and perceived. She concluded that there was no evidence of actual undue influence on the facts. She then examined whether there was a presumption of undue influence by applying the test of Etridge, namely (i) whether there was a relation of influence and (ii) whether the operation could be easily explained on ordinary grounds. The High Court also found that there was no presumption of undue influence. Neither of the two elements necessary to establish the presumption of undue influence had been established by the company. As for the first part of the test, there was no lawyer-client relationship between the lawyer and the company/shareholder. The lawyer had acted on the Bank’s instructions when drafting the mortgage deed. Moreover, there was no relationship of influence since the evidence did not show that the shareholder trusted the lawyer. Moreover, the lawyer had derived no benefit from the deed of mortgage.
As for the second branch of the test, the deed of mortgage was easily explained – that the sale of the shares which the loan and the mortgage facilitated – allowed the shareholder to pay money to his silent investors and allowed pay various debts of the company at a standstill.
The company appealed to the Court of Appeal.
Decision of the Court of Appeal of Trinidad and Tobago
The Court of Appeal ruled in favor of the Bank and dismissed the claim (see judgement).
The Court of Appeal upheld the trial court’s decision, but adopted a different reasoning. She decided that there was a presumption of undue influence, but that this was rebutted by the Bank.
The Court of Appeal declared that the two conditions required to establish the presumption of undue influence were met. First, the company/shareholder were clients of the lawyer and there was therefore an irrebuttable presumption of a relationship of influence. Second, the deed of mortgage was a transaction which called for an explanation. Indeed, the company derived no benefit from the deed of mortgage and it was the company that was exposed to the risk that its only asset could be sold by the Bank if the two people to whom the money was lent did not repay not the loan.
However, the Court of Appeal concluded that the presumption of undue influence was rebutted by the facts. The shareholder was an educated businessman who would have fully understood the risks involved in taking out a mortgage as security for the loan, and he would have appreciated that a sale of the land could affect the value of the shares he retained.
The company appealed to the board of directors. The Bank cross-appealed on whether the decision of the Court of Appeal was correct in concluding that there was a presumption of undue influence which the Bank had to rebut.
Privy Council Office Decision
The Board ruled in favor of the Bank and rejected the application for the reasons explained below.
The presumption of undue influence
The Board held that the Bank’s cross-appeal should be allowed because there was no alleged undue influence of the lawyer on the company/shareholder in relation to the mortgage deed .
The Commission noted that it was concerned with the reasoning of the Court of Appeal regarding the establishment of the presumption of undue influence. He noted that this could lead to situations where a lawyer provides advice to a client, if the client then enters into a disadvantageous business transaction with a third party, the client could invoke undue influence law to undo those transactions.
The Commission observed that an ordinary commercial transaction such as a mortgage should rarely be considered as one which is not readily explicable on ordinary grounds simply because it proves disadvantageous. On the facts, the Board noted that the mortgage allowed the shareholder to receive payment for his shares, otherwise the sale would have failed. It was unrealistic to ignore (as the Court of Appeal had done) the fact that the shareholder (as opposed to the company) benefited from the transaction, and the Court of Appeal was wrong to considered that the deed of mortgage was not easily explicable. Therefore, the Commission declared that there was no presumption of undue influence which had to be rebutted in this case since the transaction was easily explainable.
Right of the Court of Appeal to decide that the presumption of undue influence has been rebutted
The Commission stated that the Court of Appeal was entitled to decide that the presumption of undue influence (assuming it was established) was rebutted by the facts. The Court of Appeal had shown by the Bank that, with respect to the deed of hypothec, the shareholder was not acting under the undue influence of the lawyer, that is to say that he exercised free and independent judgement.
The Board underlined that it found it hard to believe that a businessman of the shareholder’s experience would not understand that the deed of mortgage which was being concluded with the bank could lead to the sale of the land and that this would affect the value of the shares of the company that the owner has retained. The Commission noted, in accordance with Etridgethat persons carrying on a commercial activity can be considered capable of supporting themselves and understanding the risks associated with the granting of a guarantee.
Accordingly, for all the above reasons, the Board ruled in favor of the Bank and rejected the application.