A victory for substance 'over form

The Supreme Court gave judgment in Bank of Cyprus v Menelaou [2015] UKSC 66 in November 2015. ?The case will be of interest to property practitioners because it concerns the fluid interplay between unjust enrichment, proprietary interests in sale proceeds, and the pre-conditions for a party to be subrogated to a vendor’s lien where purchase monies have not flowed directly from that party to the secured creditor.

The Bank of Cyprus had charges over a property called Rush Green Hall that was owned by Ms Melissa Menelaou’s parents. The Menelaou parents resolved to sell Rush Green Hall and sought to use £875,000 of the sale proceeds, which were subject to the charges in favour of the bank, towards purchasing a smaller house called Great Oak Court. This property was to be registered in the name of their daughter Melissa. The bank agreed on condition that a third-party legal charge over Great Oak Court was executed.

Unfortunately, Melissa’s signature was forged, rendering the third-party charge void. The bank claimed Melissa had been unjustly enriched and sought a lien in the sum of £875,000.

Four questions

In its decision, the Supreme Court reiterated the four questions a court must ask ?itself when faced with a claim ?for unjust enrichment, as set ?out in Benedetti v Sawiris [2013] UKSC 50: 

• Has the defendant been enriched? 

• Was the enrichment at the claimant’s expense? 

• Was the enrichment unjust? and

• Are there any defences available to the defendant? 

Having answered the first three in the affirmative and the last in the negative, their Lordships’ discussion moved on to whether subrogation to a vendor’s unpaid lien was available where the bank had not directly advanced the purchase monies used to discharge the vendor’s lien over the property. 

Counsel for the appellant argued that the application of subrogation was fettered by the decided cases and judicial dicta in the area, all of which involved money coming from the person who establishes subrogation being used to pay off the chargee or creditor. In this case, the bank had merely agreed ?that sale proceedings from Rush Green Hall, in which, by dint of its charges, it had an interest, could be used to fund the purchase ?of Great Oak Court. The money never actually passed through the bank’s hands. 

Economic reality 

This contention was rejected unanimously by the Supreme Court. However, the process by which the bank was entitled to ?be subrogated, was more divisive. For Lords Clarke, Neuberger, ?Kerr, and Wilson, it was sufficient that there was a close ‘causal connection’ between the sale ?and purchase of the respective properties. Although the money used to discharge the secured creditor (i.e. the unpaid vendor) did not emanate from the bank itself, it had released its charge over Rush Green Hall in return ?for a defective charge over ?Great Oak Court. 

Lord Carnwarth, however, ?felt this approach ‘extended’ ?or ‘distorted’ the principles behind subrogation. Instead, he concluded that it should only be applied if a claimant could prove that the money used to pay off the loan was ‘their’ money. Tracing is the process by which this should be done. He held that the money used to purchase Great Oak Court was money ?held on trust for the bank and, accordingly, the necessary ‘tracing link’ was established. 

The decision is a victory for substance over form. However, the position taken by the majority of the court, namely that the bank’s entitlement to be subrogated to the lien is to ?be determined by reference ?to the ‘economic reality’ of the transaction rather than ‘the tracing process’ advocated by Lord Carnwarth. This broadens the principles that determine whether subrogation is the appropriate remedy where unjust enrichment is found. This will, in turn, place greater emphasis on whether there are policy grounds for denying the remedy sought. 

Thus, in practice, when facing a claim such as this, defendants are likely to place increasing reliance on defences to unjust enrichment (i.e. change of position or bona fide purchaser) and bars to equitable remedies ?(i.e. acquiescence).

Rupert Cohen is a barrister practising from Hardwicke @hardwickelaw www.hardwicke.co.uk

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