For Richer For Poorer Until Debt Do Us Part

Seven years on from Barclays Bank plc v O’Brien the Law Lords, on 10 October 2001, revisited undue influence in Royal Bank of Scotland plc v Etridge (No.2) [2001] UKHL 44. Lord Nicholls set out a new blueprint for solicitors and bankers advising those who give security for the debts of another, and provided a review of basic principles.

What is undue influence?

Undue influence is the term used to describe the relief developed by the courts of equity to protect those who enter into transactions as a result of the improper influence of another. Since 1990 the courts and lawyers have used the labels "Class 1" and "Class 2" to distinguish between cases of actual undue influence (Class 1) and cases where undue influence is presumed from proof of a relationship of trust and confidence and manifest disadvantage to the complainant (Class 2).

Class 2 is sub-divided between:

• Class 2A - where certain prescribed relationships give rise to an irrebutable presumption of trust and confidence and
• Class 2B - where the complainant has to prove the relationship.

Once undue influence is established the relief usually comprises setting aside the transaction.

The substantial recent interest in undue influence cases is in respect of Class 2 cases, and in particular those where a wife stands surety or provides other security for her husband’s indebtedness to a lender. In such cases the lender is put on inquiry as to the risk of undue influence and will be fixed with notice of the wife’s equity to set aside the transaction if it fails to make reasonable inquiries to allay such suspicions.

In O’Brien the House of Lords set out the steps that a lender put on inquiry should take in order to ensure that it is not affected by any claim that the wife’s agreement was procured by undue influence. Lord Browne-Wilkinson said that a bank can reasonably be expected to take steps to bring home to the wife the risk she is running by standing as surety and to advise her to take independent legal advice. The bank were to do this at a private meeting with the wife and without the husband present.

Banks did not adopt this. For the most part they continued to require the wife to obtain independent legal advice and provide written confirmation that she had done so. The courts subsequently approved this course - it was sufficient that the bank had urged the wife to take independent advice, particularly if the solicitor had confirmed that she had done so to the bank. Further, the bank did not (ordinarily) need to concern itself with the sufficiency of the legal advice.

In the Etridge (No.2) appeals there was much criticism of the sufficiency of the legal advice given to wives in these transactions. They alleged that it was perfunctory in the extreme and the system was a charade which provided little or no protection to them.

The Court of Appeal outlined in some detail the law applicable to the various elements of undue influence surety claims. In dealing with the question of legal advice they went significantly further than expected. The solicitor not only had to ensure that the wife understood the nature and effect of the transaction, but also had to satisfy himself that she was free from improper influence. If the transaction was not one which she could sensibly be advised to enter if free from any undue influence then the solicitor’s duty was to advise her not to enter into it. If she declined to accept the advice the solicitor was to refuse to act any further for her. He should then inform the bank and other parties that he had seen his client and given her certain advice as a result of which he had declined to act.

In this way, the solicitor would have the burden of coming to a conclusion as to whether the transaction was in the wife’s best interest and then vetoing it if his conclusion was negative. Understandably, this approach attracted a substantial body of criticism. It placed on the solicitor an impracticable task in assessing the strength of the relationship, the business competence of the husband, etc.

Lord Nicholls gave the leading speech. Although the remaining four Law Lords gave their unqualified agreement with it there are notable divergences.

The Law Lords rejected the Court of Appeal’s approach. It was neither desirable nor practicable that banks should be required to attempt to discover for themselves whether a wife’s conduct had been procured by undue influence. Nor to require confirmation from a solicitor that the solicitor had satisfied himself of the absence of undue influence.

Instead, Lord Nicholls set out a new and detailed procedure for banks and solicitors to follow. The most striking features for banks will be the requirement for initial communications directly between them and the wife and the subsequent obligation to disclose documents to the wife’s solicitor. For solicitors, the procedure sets out in detail minimum core areas of advice.

The objects of the new procedures were most forcibly set out by Lord Hobhouse. His concern was that in eliding the two stage process contemplated in O’Brien, banks had created confusion about the role of the solicitor. The result of this, he said, could be seen in the cases where the wife did not appreciate that she had any solicitor acting for her "or that she was being advised" and also did not know of the existence of the solicitor’s certificate to the bank or its significance. This had led to the fiction of "free and informed consent" where none existed and no steps had been taken to discover the true position.

Lord Nicholls observed that the starting point for determining the scope of the solicitor’s responsibilities was the retainer. In this type of case the retainer arose out of the bank’s concern to receive confirmation from the solicitor that he has brought home to the wife the risks involved in the proposed transaction.

The preliminary stage therefore, is for the solicitor to explain the purpose for which he has become involved and that "should it ever become necessary, the bank will rely upon his involvement to counter any suggestion that the wife was overborne by her husband or that she did not properly understand the implications of the transaction".

Following this, the solicitor must obtain confirmation from the wife that "she wishes him to act for her in the matter and to advise her on the legal and practical implications of the proposed transaction".

Once he has those instructions, the next and key step is the advice. This should take place at a face-to-face meeting with the wife and in the absence of the husband. The solicitor’s explanations should be in plain language. The advice which the solicitor should give will depend on the facts of each case, but Lord Nicholls set out a detailed "core minimum" which the solicitor will typically be expected to cover. In summary these fall into four areas:

• an explanation of the nature of the documents and the practical consequences that they will have if she signs them - including (if applicable) the possibility of losing her home and being made bankrupt;
• an explanation of the seriousness of the risks involved including the purpose and details of the new facility, the ability of the bank to change the terms or increase the facility without reference to her, the amount of her liability under the guarantee, her financial means and understanding of the value of the house, the availability of other resources in the event that the business fails;
• an explanation that she has a choice and that the decision is hers alone –this will call for discussion of the present financial position including the husband’s current indebtedness and the amount of his current overdraft facility; and,
• confirmation that she wishes to proceed - this will include (1) asking whether or not she is content that the solicitor should write to the bank confirming that he has explained to her the nature of the documents and the practical implications they may have for her and (2) enquiring whether she would prefer the solicitor to negotiate with the bank on the terms of the transaction, for example, on the sequence in which the various securities will be called upon or on limits to her liabilities.

Any solicitor engaged in advising in this capacity will need to study the full detail of Lord Nicholls’ guidance.

In order to follow Lord Nicholls’ procedure the solicitor will additionally need to receive from the bank any information that he needs. This requirement has its corollary in the bank’s procedure where there is an obligation to disclose specific documents to the wife’s solicitor.

Lord Nicholls also considered whether the wife’s solicitor should be precluded from acting for the husband and/or the bank. Ultimately he decided against this, but only after emphasising that in advising the wife the solicitor is acting for the wife alone and is only concerned with her interests. He stressed that in every case the solicitor must "consider carefully whether there is any conflict of duty or interest and, more widely, whether it would be in the best interests of the wife for him to accept instructions from her". Obviously, where the solicitor does have such concerns he must cease to act for her.

Lord Nicholls outlined four specific steps that the bank must take where it was relying on the fact that the wife had been independently advised by a solicitor.

First, it must communicate directly with the wife:

• to inform her that for its own protection it will require written confirmation from her solicitor that he had fully explained to her the nature and effect of the documents and the practical implications they will have for her;
• to inform her that the purpose of the requirement is that she should not subsequently be able to dispute that she is legally bound by the documents once she has signed;
• to ask her to nominate a solicitor whom she wishes to instruct to advise her separately from her husband and to act for her in giving the necessary confirmation to the bank;
• to tell her, that if she wishes, the solicitor may be the same solicitor as is acting for the husband in the transaction; and,
• to ask, where a solicitor is already acting for her and her husband, whether she would prefer that a different solicitor should act for her regarding the bank’s requirement.

The bank should not proceed any further until it has received appropriate responses to these enquiries directly from the wife.

The second stage is to send the wife’s solicitor the necessary financial information. In the ordinary cases this will include:

• information on the purpose for which the new facility was requested;
• the current amount of the husband’s indebtedness;
• the amount of his current overdraft facility and the amount of any new facility; and,
• a copy of any written application for a facility that has given rise to the bank’s request for the security.

The bank will have to obtain the husband’s consent to release this information. Without that the bank cannot proceed any further with the wife.

The third stage concerns the exceptional case where the bank believes or suspects that the wife has been misled by her husband or is not entering into the transaction absent of undue influence. In this case the bank must inform her solicitor of the facts giving rise to that suspicion or belief.

The fourth stage is to ensure that it has received from the wife’s solicitors the required confirmation in writing.

By following this procedure the bank can protect itself against constructive notice of undue influence by forming a reasonable belief that a solicitor is acting for the wife and has advised her about the nature and effect of the transaction. Written confirmation from the solicitor acting for the wife that he has so advised her will in the ordinary case be sufficient to establish the reasonable belief. As the solicitor will not be the lender’s agent, the lender will not be fixed with the solicitor’s knowledge where the solicitor wrongly certifies the advice.

The same protection may also be achieved where the advice is given by a senior official of the lender. However, in those cases the lender would almost invariably be fixed with the knowledge of the official. Accordingly, where the advice was deficient the lender may have no protection.

For this reason, and the bank’s existing disposition against advising directly, the practice of insisting that the wife is advised by a solicitor rather than the bank will remain.

The Law Lords criticised the Class 1, 2A and 2B categorisation derived from BCCI v Aboody [1990] 1 QB 943 as being the source of much subsequent confusion. In particular in relation to Class 2B cases.

Lord Nicholls described the two forms of undue influence in terms of those involving overt acts or improper pressure and those arising out of the relationship between two people, where one has acquired a measure of influence or ascendancy over the other which he then takes unfair advantage of. He stated that the classes of relationship are not restricted to those of trust and confidence but might include those of "reliance, dependence or vulnerability on the one hand and ascendancy, domination or control on the other".

He was also keen to correct what he saw to be a misconception arising out of the term "presumed undue influence". The burden of proving undue influence was on the claimant alleging it. A claimant who established so called "presumed undue influence" did so because the court had drawn appropriate inferences of fact based on the whole of the evidence at trial.

Normally, the evidential burden would be discharged by proof that the claimant placed trust and reliance in the other party in relation to her financial affairs and that the transaction "called for explanation". It would then be for the defendant to show why the inference of undue influence should not be drawn.

Lord Nicholls rejected arguments that the second ingredient should be dispensed with altogether. However, he also rejected the often cited label "manifest disadvantage" to describe that requirement because of the uncertainty highlighted in applying it to the situation of a wife guaranteeing her husband’s business debts where the wife’s fortunes were tied up with those of the husband. He preferred Lindley L J’s test in Allcard v Skinner, 36 Ch D 145 "……the gift is so large as not to be reasonably accounted for on the grounds of friendship, relationship, charity, or other motives on which ordinary man act …….".

Lord Nicholls was quite clear in his speech that his new procedures applied to cases in the future and that in past transactions the bank would usually have discharged its obligations if a solicitor who was acting for the wife gave the bank confirmation that he had brought home to the wife the risks she was running by standing as surety.

This requirement for solicitor confirmation is seemingly stricter than the Court of Appeal judgment where it was "normally sufficient" that the bank had urged the wife to take independent legal advice.

Lord Hobhouse went further still. He stated that the guidance should not be "…regarded as something which will only apply to future transactions…". For him "it has represented, and continues to represent, the reasonable response to being put on enquiry".

Lord Scott expressed the view that the failure of the bank to comply with Lord Nicholls’ disclosure stage would not operate against the bank in past cases.

These divergences will give rise to uncertainty and legal argument. It is clear from Lord Goff’s judgment in Kleinwort Ltd v Lincoln Council [1998] 4 All ER that the fiction that the appellate courts merely discover the law as it has always been is no longer maintained. Nonetheless, their decisions are retrospective - they apply to cases where the relevant facts occurred before the decision. Lord Nicholls appears to depart from that and it seems likely, at the very least, that the obligations consequent on the disclosure stage will not have retrospective effect. The other steps are perhaps less certain. However, it must be remembered that all the Law Lords expressly agreed with Lord Nicholls’ speech.