Illegality and restitution under English law

Steven Morris, a partner in the commercial litigation team at Howard Kennedy, examines the way in which the Courts have recently dealt with the issues of illegality and restitution

23 Apr 2019

In the Supreme Court Decision of Patel v Mirza [2016] ("Patel"), the Claimant was a party to an illegal insider trading contract which had not been implemented. The Supreme Court held that the Claimant should not be debarred from enforcing his claim because he was seeking to recover money paid pursuant to a contract to carry out an illegal activity.

In Patel, the Supreme Court went further and sought to set out principles applicable in other cases including claims to enforce contracts affected by illegality. The court was unanimous that to refuse to uphold a claim on grounds of illegality could be justified only on very limited grounds. A majority of the Supreme Court preferred a flexible principle allowing consideration of a range of factors in determining whether a claim is to be barred by illegality.

Lord Toulson expressed the principle as follows:

"The essential rationale of the illegality doctrine is that it would be contrary to the public interest to enforce a claim if to do so would be harmful to the integrity of the legal system …. In assessing whether the public interest would be harmed in that way, it is necessary (a) to consider the underlying purpose of the prohibition which has been transgressed and whether that purpose will be enhanced by denial of the claim, (b) to consider any other relevant public policy on which the denial of the claim may have an impact and (c) to consider whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts.Within that framework, various factors may be relevant, but it would be a mistake to suggest that the court is free to decide a case in an undisciplined way".

There have been a number of decisions post-Patel. In Tchenguiz v Grant Thornton [2016], Patel was applied to conclude that neither a settlement agreement nor its purpose or performance were illegal since it compromised disputed claims not illegal contracts.

The decision in Patel was cited in Henderson v Dorset Healthcare University NHS Foundation Trust [2016] ("Henderson").

In Henderson, the Claimant suffered from paranoid schizophrenia and stabbed her mother to death.She pleaded guilty to manslaughter on grounds of diminished responsibility.

The Claimant brought a claim against the Defendants for their failure to take appropriate action to protect her following her mental breakdown.Her claim was rejected on public policy grounds namely that all the various forms of loss resulted from her illegal conduct.The Judge rejected the argument that the new approach in Patel justified allowing the claim.That decision was upheld on appeal.

On appeal, it was explained in the Henderson case that "great caution" must be taken before holding that a binding decision on illegality has been impliedly overruled by Patel. The Court was bound by the decision in Clunis v Camden and Islington HA [1998] approved by the House of Lords in Gray v Thames Trains [2009]. There was no suggestion in Patel that Clunis and Gray were incorrectly decided.

In Singularis Holdings Limited v Daiwa Capital Markets Europe Limited [2018], a fraudulent instruction was given by the Claimant's director and sole shareholder to the Defendant stockbroker to pay the funds of the company to a third party. The Claimant argued that the stockbroker had been negligent in making the payment.

At first instance it was held that although the director had acted fraudulently the stockbroker was in breach of the relevant duty of care. The dishonest conduct of the director was not to be attributed to the company since it was not contrary to the public interest nor harmful to the integrity of the legal system to allow the claim to proceed.

The Court of Appeal upheld that decision. Vos C stated:

"The first question to ask is: in what circumstances should an appellate court interfere with the first instance application of the Patel v Mirza test?Both parties submitted that the court should only interfere in a trial judge's decision where the Judge made an error of principle or reached a conclusion wholly outside the range of reasonable possibilities …

It seems to me quite clear that an appellate court should not interfere merely because it would have taken a different view had it been undertaking the evaluation.The test involves balancing multiple policy considerations and applying a proportionality approach.Accordingly, an appellate court should only interfere if the first instance judge has proceeded on an erroneous legal basis, taken into account matters that were legally irrelevant, or failed to take into account matters that were legally relevant".

In XX v Whittington Hospital NHS Trust [2018] a woman had become infertile due to the defendant's negligence. The question was whether she was entitled to recover the cost of commercial surrogacy arrangements in California. She intended to enter into an arrangement which was lawful by the law of the place where it was made and she did not propose to do anything unlawful. The Court of Appeal applied Patel and held that the law did not impose a bar on recovery of damages on public policy grounds.

In Gujra v Roath [2018], the Claimant alleged that he had agreed with the Defendant to destroy two cars for £500.

The Claimant sued the Defendant for the tort of malicious prosecution on the basis of the concealment from the police of the Defendant's consent to the destruction of the cars.

The Court was entitled to infer that the purpose of the agreement was a conspiracy to defraud insurers. Therefore the claim could be struck out for illegality.The Court referred to the more nuanced test of illegality in Patel but concluded that it made no difference to the outcome.

It is clear that pre-Patel the law on illegality was in an unsatisfactory position, and although these developments are helpful and go some way to clarifying the scope of this very important principle of common law, Patel has not resolved all outstanding issues.

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