The consequences of conveyancing fraud on innocent law firms – Court of Appeal to review the Dreamvar decision

In January 2017 the decision in Dreamvar -v- (1) Mischon de Reya (2) Mary Monson Solicitors Ltd considered the consequences of ID checks failing to uncover fraud in a conveyancing transaction. Despite findings that neither firm of solicitors involved in a transaction was at fault in failing to uncover the fraud, the court still awarded damages to the claimant when the first defendant failed in its application for relief from breach of trust.

Background

Dreamvar believed it had purchased a property for £1.1 million from its registered owner. Its solicitors, Mischon de Reya (MdR) completed the transaction, transferring funds to the purported seller’s solicitor, Mary Monson Solicitors Ltd (MMS). However, unbeknownst to all involved, MMS had been instructed by a fraudster impersonating the true owner of the property. The fraud was uncovered by Land Registry enquiries two months after the transaction, Dreamvar having taken possession, but not yet registered as owner. By this point both the fraudster and purchase funds had disappeared. Dreamvar lost both the property and its £1.1 million purchase funds. It sought to recover its loss.

Claims

Dreamvar brought claims against its own solicitors, MdR, and the purported seller’s solicitor, MMS. It was common ground that neither firm of solicitors had participated in the fraud. 

The claims against MdR were for negligence and breach of trust. Dreamvar alleged that MdR should have advised of the risk of ID fraud alleging that it was aware of a number of points about the transaction which should have put it on notice of the risk. Points included the value of the property and fact that it was unoccupied, the urgency of the sale, the fact that the seller was living in a property that he did not have an interest in, and that emails between MMS and MdR indicated that MMS would not meet its client. The court considered that MdR was entitled to take a view on the totality of the facts known to it about the sale and any risks, and that the view formed by MdR was in line with that of a competent solicitor acting reasonably. It had not been negligent in failing to advise of the risk of ID fraud.

Dreamvar also alleged that MdR should have sought an undertaking from MMS that it had taken reasonable steps to establish its client’s identity. The court rejected this claim concluding that this was not an exceptional case where not seeking an undertaking was either unreasonable or illogical.

Dreamvar’s claims against MMS for breach of warranty of authority, breach of trust, negligence, and breach of undertaking were also dismissed.

However, MdR could not defend the claim for breach of trust. The court found that it was only authorised to release completion funds on genuine completion. As this had not occurred, MdR had breached the terms of the trust upon which the funds were held. Its only option was to apply for relief under section 61 of the Trustee Act 1925.

Application for relief

MdR’s application for relief was crucially important. It represented MdR’s only prospect of avoiding paying damages to Dreamvar.

Section 61 requires the court to consider excusing a breach of trust using a two stage test. Stage one involves considering whether the trustee acted honestly and reasonably. The burden of proving this is on the trustee seeking relief. Stage two involves two discretionary matters – should the trustee be fairly excused of the breach of trust and, if so, should the court grant relief in whole or in part? It is notable that even if the court finds in favour of the trustee at stage one and also on the first element of discretion in stage two, it may still decide not to exercise its discretion to refuse relief. That is what happened here.

The court found that MdR had, without question, acted honestly. There was no suggestion that this was not the case. Dreamvar proposed that MdR may not have acted reasonably, and using an argument based on reversal of the burden of proof in relief claims from that in negligence that this could be the case despite the fact that MdR had defended the negligence claims. The court disagreed concluding that defence of the negligence claims demonstrated that MdR had acted reasonably.

In deciding whether to exercise its discretion under stage two, the court balanced the effects of the fraud on Dreamvar with those on MdR. The effect on Dreamvar was ‘disastrous’ and the court noted that Dreamvar neither had insurance against the prospect of fraud nor the ability to self-insure. Dreamvar’s sole shareholder, Mr Vardar, was unaware of the fraud. At the point of trial, while Dreamvar remained solvent, it had creditors of £1.2 million, the bulk of which the court inferred was the result of this ‘catastrophic transaction’. The court discussed the fact that Mr Vardar had been referred to as being a high net worth individual, and accepted that the position of a sole shareholder may be relevant. However in this instance it could reach no conclusion on the evidence other than that the transaction had ‘significant financial effect on Dreamvar (and Mr Vardar).’

Dreamvar’s position stood in stark contrast with MdR’s position with sufficient insurance cover for events like this. In deciding not to exercise its discretion, the court noted that MdR was in a far better position to absorb the loss, with or without insurance. It also considered that it was ‘not irrelevant’ that MdR had been better placed to achieve greater protection from fraud (albeit reiterating that MdR was not liable for failing to take further steps). Other factors considered by the court were that there was no recourse against MMS, and that there was ‘no practical likelihood’ of recovering from or even tracing the fraudster. This reasoning led the court to conclude that MdR ought not to be fairly excused, and that it should, in any event, decline to grant relief.   

Comment

An appeal hearing of this decision is expected in the Court of Appeal in February 2018. It will be listed with another case in which ID checks came under the spotlight, and which was referred to in this decision, P&P Property -v- Owen White & Caitlin LLP. For now, in a climate in which instances of identity fraud are increasing, there is concern amongst the conveyancing community, and their professional indemnity insurers, at the prospect of being held liable to recoup an innocent buyer’s losses, where little, if anything, more could have been done to protect against the risk. Other similar cases are waiting in the wings for the outcome of this appeal. Insurers will be particularly concerned at the emphasis placed on them as the most appropriate fund of last resort in such cases.

In terms of what may be done by solicitors to avoid finding themselves in this position, suggestions include limiting liability in higher value transactions (albeit a limit could not legally have been set at or below the limit of this transaction), and/or including a contractual term setting out the basis upon which funds held on trust may be released including provision that the seller’s solicitor can offer no guarantee about the risk of fraud. However, whether either of these options would prove to be commercially acceptable, especially in higher value transactions, remains an open question.