Revisiting Undue Influence – Lexology

This article examines the recent decision of Nature Resorts Ltd v First Citizens Bank Ltd [2022] UKPC 10 where the Privy Council considered the application of the undue influence doctrine in the context of a mortgage on commercial property.

Background

The Culloden Estate (“the domain”) is an area of ​​land occupying approximately 148 acres in Tobago. The estate is owned by Nature Resorts Limited (“NRL”). The sole shareholder of NRL was Patrick Dankou (“Mr Dankou”) which incorporated NRL with the aim of buying the estate and developing it as an eco-resort.

On January 8, 2008, a Mr. Simon Paler (“Mr Landing”) and Mr. Christopher James (“Mr James”) signed a share purchase agreement under which they undertook to buy 75% of the NRL shares held by Mr. Dankou for 2.75 million dollars. $275,000 was paid upon signing the agreement and the balance was due by March 14, 2008.

Mr Paler and Mr James filed an application with First Citizens Bank Ltd (“the bank”) for a loan to facilitate the purchase. However, the Bank was only willing to lend US$1.925 million to be secured by a mortgage on the estate and a charge on the shares to be acquired.

Mr. Richard Wheeler (“Mr Wheeler”), a partner at Lex Caribbean, was commissioned by the Bank to prepare the security documents. MM. Dankou, Paler and James also instructed Mr. Wheeler to: (a) complete the share transfers transferring the NRL shares to Messrs. Paler and James; and (b) prepare a promissory note pursuant to which Messrs. Paler and James promised to pay Mr. Dankou US$975,000.

The documents were executed and signed at the offices of Lex Caribbean.

MM. Paler and James defaulted on the loan and the Bank attempted to exercise its power of sale under the mortgage.

NRL continued its claim as follows:

  • The mortgage deed was voidable on the basis of Mr Wheeler’s undue influence over NRL/M. Danku. This argument failed at first instance and before the Court of Appeal;
  • The deed of mortgage was voidable following false declarations made by Mr. Wheeler to Mr. Dankou. This argument was rejected at first instance and there was no appeal against this decision.

The appeal to the Privy Council therefore concerned:

  • The claim for undue influence; and
  • Is there an argument that the Deed of Mortgage violated Sections 56 and 57 of the Trinidad and Tobago Companies Act (“the act”) on financial aid.

In the High Court, Justice Pemberton found that the presumption of undue influence was not based on the facts. She noted (among other things) that:

  • While Mr Wheeler (who was also a director of NRL) had previously acted for NRL/M. Dankou, he did not act for NRL/M. Dankou vis-à-vis the deed of mortgage;
  • Mr. Wheeler had derived no benefit from the mortgage deed; and
  • The deed of mortgage was not to the manifest disadvantage of NRL/M. Dankou, namely that the sale of the shares allowed Mr. Dankou to pay the investors and the debts of the company.

The Court of Appeal came to the same conclusion but by a different route; they concluded that there was a presumption of undue influence, but that it was rebutted:

  • Mr. Wheeler was the Bank’s agent in obtaining the deed of mortgage;
  • The solicitor-client relationship was irrefutably presumed to be one of influence;
  • The deed of mortgage was a transaction which required an explanation insofar as NRL was exposed to the risk that its only asset would be sold in the event of default;
  • However, Mr. Dankou entered into the transaction knowing what he was doing and he appreciated the risks involved.

decision

On the question of undue influence, the Privy Council began by considering the conditions required to establish the presumption of undue influence, namely that: (a) there must be a relationship of influence; and (b) the transaction must not be readily explainable on ordinary grounds. When these requirements are met, the presumption applies and the onus is shifted so that the party seeking to confirm the transaction is required to demonstrate that there was no undue influence. The Privy Council has recognized that the primary method of rebuttal is proof that the other party has obtained the fully informed and competent opinion of a qualified person.

The Privy Council held that the Court of Appeal was entitled to find that the presumption of undue influence was rebutted by the facts: (a) it was likely that Mr. Dankou understood the risks associated with the mortgage deed; and (b) there is no indication that Mr. Wheeler offered advice to Mr. Dankou regarding the mortgage deed.

However, the Privy Council was concerned that the Court of Appeal’s reasoning would increase clients’ reliance on undue influence simply because a transaction may be disadvantageous:

26. The Commission is concerned that the Court of Appeal’s reasoning suggests that in many situations where a solicitor (or solicitor) provides professional advice to a client, and the client then enters into a disadvantageous commercial transaction with a third party, the client could invoke the law of undue influence (including agency law) to cancel the transaction. There are many cases where, for example, the lawyer is acting for both a buyer of land and a lender of the money for the purchase where this relationship should not work to give rise to a presumption of undue influence for either client to use against the other. This is the case when the lawyer derives no personal benefit (beyond his normal fees) from the transaction.

27. In the Commission’s view, where the other party to the transaction is not the lawyer obtaining a benefit from the client but rather a third party, an ordinary commercial transaction such as a mortgage, entered into by a person exercising a commercial activity, should rarely be regarded as behavior which is difficult to explain on ordinary grounds, simply because it is, or proves to be, disadvantageous. It is easily explicable that the client will enter into such a transaction without being under the undue influence of the lawyer(emphasis added).

I note for completeness that, on the issue of financial assistance, the majority held that it was not appropriate for a breach of sections 56 and 57 of the Act to be considered part of the appeal. Significantly, the financial aid arguments had not been considered at first instance or by the Court of Appeal. Lady Arden (dissenting) took a different view. She stated that:

  • The financial assistance consisted of charging the estate in favor of the Bank to guarantee the debts of MM. Paler and James;
  • The domain was NRL’s sole asset. There was a shortage of free assets and the prohibition under section 56 of the Act applied;
  • The Bank could not avail itself of section 57 of the Act since it was not a lender for the purposes of this provision; and
  • The Board should not assist in enforcing the mortgage.

Comments

The Privy Council’s decision indicates the continuing difficulties in successfully pursuing claims based on undue influence and even more so when we are involved in commercial relationships.

With corporations and commercial parties, courts are more likely to find that they were better informed of the risks before entering into the transaction; thus, although the test for undue influence is the same, a complaint of undue influence in a commercial context is often difficult to prosecute.

However, even in the case of commercial parties, the indications provided in Royal Bank of Scotland plc v Etridge (No 2) [2002] 2 AC 773 remains relevant and represents good practice. In addition, the Privy Council has outlined other factors that a court may consider in determining an undue influence claim, both in the context of real estate transactions and more broadly. While each case is fact specific, it is helpful to keep the following factors in mind when advising on undue influence:

  • The experience of a party claiming undue influence is relevant. In Nature Resorts Ltd, the Privy Council considered this to be an important factor even though there was no evidence that Mr. Dankou had ever entered into a mortgage transaction before [22]. Therefore, it is clear that courts are likely to take into account the knowledge and experience of a party in general and not just knowledge and experience in a specific area;
  • A lawyer’s opinion is not the only means of demonstrating that free and independent judgment was exercised;
  • A distinction must be made between an operation underpinned by undue influence and a purely anti-commercial operation. A transaction that is not commercial does not necessarily mean that it was obtained through undue influence, although other remedies may be available; and
  • There is a need to take a more holistic approach and consider whether the party seeking to rely on undue influence has drawn a “substantial benefit” or even any advantage of the transaction. Where there is a substantial benefit, the transaction may be “explainable” and undue influence may not be available.

In the context of financial assistance, the majority did not come to a firm conclusion, although Lady Arden’s discussion provides a useful analysis of when prohibitions on financial assistance may impact enforcement. of a mortgage. Practitioners do not often face undue influence and financial assistance in tandem, particularly as the provisions of Sections 678 to 680 of the Companies Act 2006 largely relate only to public companies. However, it should be considered whether the prohibitions apply when it comes to advising clients on the acquisition of shares.

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