(iii) Subrogation

(1) The Function of Subrogation

Subrogation[1] is a remedy[2] which is designed to ensure ‘a transfer of rights from one person to another... by operation of law’.[3] [4] Essentially, the function of the remedy is to enable the claimant to rely on the rights of a third party against a defendant. This is often described as the claimant being allowed to ‘stand in the shoes’ of the third party.

In the leading case of Banque Financiere de la Cite v Parc (Battersea) Ltd33 the House of Lords acknowledged that two forms of subrogation are recognized in English law, which have been said to be ‘radically different’.[5] The first is that which arises by virtue of the express or implied agreement of the parties.[6] For example, an insurer who has paid a claim under an indemnity insurance policy in respect of a particular loss will have a right to be subrogated to, and to enforce the rights of, the insured person against any third person who caused the loss. Since this right to subrogation arises by virtue of contract, it has nothing to do with the law of restitution.[7] Secondly, the equitable remedy of subrogation may be awarded by operation of law as a restitutionary remedy.[8] The typical case where subrogation will be an appropriate remedy in the context of a proprietary restitutionary claim is where the claimant’s money is used by the defendant to discharge a debt which the defendant owed to a secured creditor. In such circumstances the claimant can be subrogated to the secured creditor’s charge and gain the benefit of that security as against other creditors of the borrower. In effect the benefit of the charge is treated as though it had been assigned to the claimant[9] so that the claimant will obtain the benefit of that charge.

The basis for awarding the remedy of subrogation has proved to be controversial. It has sometimes been suggested that it is a response to the defendant’s unjust enrichment at the expense of the claimant.[10] [11] Significantly, in Menelaou v Bank of Cyprus plc40 the Court of Appeal specifically recognized that the equitable remedy of subrogation operated to reverse unjust enrichment. If this is correct, it follows that it will be necessary to establish that the defendant was enriched at the expense of the claimant and that a ground of restitution can be identified, which might be difficult to establish. In that case unjust enrichment was easier to establish, since the claimant bank had mistakenly released charges on one property which enabled funds to become available to enable the defendant to purchase another property. The defendant was considered to have been indirectly enriched at the expense of the claimant,[12] with the ground of restitution being mistake. As a consequence the claimant was subrogated to the vendor’s unpaid lien against the defendant.

But, in the light of the approach to equitable proprietary claims that is adopted in this book, the preferable view is that the equitable remedy of subrogation operates to vindicate the claimant’s equitable property rights. Such a conclusion has been endorsed by the High Court of Australia.[13] Consequently, the normal conditions for proprietary claims need to be established, namely that the claimant has an equitable interest in property that can be traced into property received by the defendant. Then it will be appropriate to consider how best the claimant’s property rights can be vindicated. The proprietary remedy of subrogation does, however, work differently from the other proprietary remedies that we have examined. Those remedies assume that the defendant has retained property in which the claimant has an equitable proprietary interest. The typical scenario in which subrogation will be relevant is where the claimant’s value has been used to discharge a debt. As we have already seen,[14] the discharge of a debt will defeat the tracing exercise.[15] But it is still possible to trace into the discharged debt, and then, if the conditions for awarding subrogation are satisfied, the proprietary rights that have been destroyed through the discharge of the debt can be resurrected by allowing the claimant to stand in the shoes of another creditor of the defendant and obtain the benefit of any security that that creditor had against the defendant. In other words, subrogation provides a mechanism with which to obtain a charge over the defendant’s property in circumstances under which the claimant has not been able to trace into property that remains in the defendant’s possession, and so the claimant will gain priority over the defendant’s general creditors if the defendant is insolvent. It is the defendant’s insolvency that is usually the reason why the claimant seeks to be subrogated to the security of a third party against the defendant.

The reason why subrogation has been analysed as a remedy to reverse the defendant’s unjust enrichment derives from the decision of the House of Lords in Banque Financiere de la Cite v Parc (Battersea) Ltd.[16] But the facts of that case were highly unusual and actually the remedy itself was personal rather than proprietary, since the claimant only obtained priority over the defendant and not as regards any of the other creditors of the debtor company.[17] Usually, however, subrogation will operate as a proprietary remedy since the claimant will obtain the benefit of the third party’s security completely. Consequently, to the extent that the third party had priority over other creditors of the defendant, the claimant will gain equal priority. Indeed, in Cheltenham and Gloucester plc v Appleyard[18] Neuberger J considered that the classic form of the subrogation remedy is proprietary, in that it enables a lender who expects to obtain a security to claim subrogation to another security and that the reference to Banque Financiere is unlikely to be of assistance in a conventional case.

Banque Financiere remains an important case, however, to determine the correct operation of subrogation. In that case the claimant had lent a sum of money to the debtor company, which used the money to pay off part of a debt owed by it to a third party, this debt having been secured by a charge over property. The defendant company, which was in the same group as the debtor, had a second charge over the same property. When the claimant lent the money to the debtor company, the claimant received a letter of postponement which stated that the claimant’s debt would be paid off in priority to any other company in the group. Clearly the intention behind this letter was to give the claimant priority over the defendant, but it was ineffective to give the claimant priority as a matter of law. The debtor company became insolvent and the question for the House of Lords to resolve was whether the debt which that company owed to the claimant should be discharged before that which was owed to the defendant. The court concluded that the defendant had been unjustly enriched at the expense of the claimant. The defendant was enriched at the claimant’s expense because the claimant’s money was used partially to discharge the liability of the third party, and this improved the chances of the defendant being repaid. This enrichment was unjust because the claimant had mistakenly believed that the effect of the letter of postponement was that it had priority over the defendant and, had it not made this mistake, it would not have lent the money in the first place.[19] The court concluded that the most appropriate remedy to reverse the defendant’s unjust enrichment was to subrogate the claimant to the rights of the third party against the debtor company. This meant that, as between the claimant and the defendant, the claimant had the benefit of the third party’s charge so that the claimant obtained priority over the defendant. The particularly important feature of the remedy of subrogation in this case was that it operated as a personal remedy, since the claimant only obtained priority over the defendant and not as regards any of the other creditors of the debtor company.[20] Generally, however, subrogation operates as a proprietary remedy which is good against the world, so it should be recognized that it is only applicable where the claimant has an equitable proprietary interest which can be traced into a discharged secured debt.

  • (2) The Principles Underlying the Remedy of Subrogation
  • (a) Operation of Law

The remedy of subrogation arises by operation of law and does not depend on the parties’ intention that the remedy should be available.[21]

(b) Resurrection of Discharged Security

The claimant may still get the benefit of a creditor’s security against the defendant by means of the subrogation remedy even though that security has been discharged.[22] This was recognized in Boscawen v Bajwa by Millett LJ,[23] who accepted that a discharged security can be resurrected. So, for example, if the claimant’s money has been used by the defendant to discharge a secured debt owed by the defendant to a third party, it will be possible for the claimant to get the benefit of the security even though it has been discharged.

An aspect of the decision of the Court of Appeal in Re Diplock’s Estate[24] appears, however, to suggest a contrary conclusion. The executors of the testator’s estate had mistakenly paid some money to the Leaf Homeopathic Hospital, which it used to discharge a mortgage over the hospital’s property. It was held that the claimants could not trace into the discharged debt and so be subrogated to the mortgage, because the mortgage had ceased to exist once the debt had been discharged. The denial of the remedy in this case could be justified on the basis that the hospital had innocently changed its position by using the money to discharge a liability.[25] But this explanation is dubious for two reasons. First, it has been recognized in the law of unjust enrichment that the defence of change of position is not available where the defendant has used money paid by mistake to discharge a debt, because the defendant will not have suffered any detriment by discharging the debt since he or she is simply substituting one creditor, the claimant, for another.[26] Secondly, the defence of change of position is probably not available to proprietary claims in which the claimant seeks a proprietary remedy.[27] The result in Re Diplock’s Estate is better explained as turning on a question of evidence rather than law, namely that it simply could not be shown that the claimant’s money had been used to discharge the mortgage. If the money could not be traced into the mortgage, it would not be possible to be subrogated to the discharged security.[28]

Subrogation will be available even where the chargee’s original charge was void for illegality, at least where the chargee was not party to the illegality.[29]

(c) Intentional Transfer

Where the claimant has intentionally lent money that has been used to discharge a secured debt, the claimant will be subrogated to the discharged security only if the claimant had intended the loan to be secured, but for some reason the security was not valid.[30] The award of the subrogation remedy can be justified on the ground that it is unconscionable to frustrate the claimant’s intention that he or she was to obtain the benefit of a security.

The application of this principle is illustrated by Boscawen v Bajwa,[31] in which the Abbey National lent money to the purchaser of a house, with the loan being secured by a legal charge. This money was paid to the purchaser’s solicitors. In breach of trust, that firm of solicitors transferred the money to the vendor’s solicitors before completion and the money was used to discharge the vendor’s mortgage with the Halifax. The sale of the house fell through. The creditors of the vendor had obtained a charging order against the property that was sold, with the proceeds of sale paid into court. The creditors claimed the proceeds of sale, but the Abbey National claimed that it was entitled by subrogation to the security right of the Halifax, being the vendor’s former mortgagee, and so it was entitled to a charge on the proceeds of sale that ranked above the vendor’s creditors. The

Court of Appeal found for the Abbey National for the following reasons. An equitable proprietary base could be identified because the money was held on trust by the purchaser’s solicitors for the Abbey National. It could trace its money in Equity into the payment that was used to discharge the mortgage by the vendor, despite mixing with other money in the vendor’s solicitor’s client account, including some of the vendor’s money. Subrogation was awarded to enable the Abbey National to vindicate its property rights because it was held that the vendor’s solicitor must have intended to keep the mortgage alive for the benefit of the Abbey National. The Court of Appeal emphasized that it focused on the vendor’s solicitor’s intention to keep the security alive rather than the intention of the Abbey National when lending the money in the first place, because the Abbey National’s money had not been paid directly to discharge the vendor’s mortgage, but had been transferred via the purchaser’s and the vendor’s solicitors. This seems unnecessarily complicated. The key question should simply have been what the Abbey National’s intention was in paying the money in the first place, and since it had clearly intended to obtain the benefit of a security, it followed that a subrogation remedy was entirely appropriate.

(d) Unintentional Transfer

Where the claimant has not intentionally lent money, but the money has been misappropriated and has been used to discharge a secured debt, subrogation may be available even though the claimant was ignorant of the transfer and could not have intended to obtain any security. In this situation, the remedy will be triggered because it would be unconscionable for the defendant to deny the claimant’s proprietary interest.[32] So, for example, if the defendant trustee misappropriates trust money and uses this to discharge a mortgage, the claimant beneficiaries can be subrogated to the mortgagee’s security interest by virtue of the defendant’s unconscionable conduct.

(e) No Better Position

The claimant cannot obtain subrogation to put him or her in a better position than that in which he or she would have been had the claimant obtained all of the rights for which he or she had bargained.[33]

(f) Exclusion of the Remedy

It is possible to exclude the remedy of subrogation expressly by contract. Similarly, the contract between the claimant and the defendant may impliedly exclude the remedy of subrogation. This is illustrated by Capital Finance Co Ltd v Stokes,[34] in which the claimant and the defendant had agreed that the claimant should obtain a security by way of a legal charge. This charge was unenforceable because it had not been registered, but it was held that, because a legal charge was a better interest than an equitable charge, the agreement between the parties prevented the claimant from being subrogated to a third party’s equitable charge against the defendant. In other words, the intention that the claimant should have the benefit of a legal charge prevented the claimant from being subrogated to a lesser equitable charge.

(g) Negligent Failure to Register Security

A lender of money could be subrogated to a charge that had been redeemed in circumstances under which the lender had intended the loan to be secured, but had negligently failed to register the charge. This was recognized in Anfield (UK) Ltd v Bank of Scotland pic.[35] Where, however, the borrower of the money had acted to its detriment in the reasonable, but false, belief that the loan was unsecured, as a consequence of the lender’s negligence, subrogation might not be available. This was justified on the ground that the borrower’s enrichment would not then be unjust, which was consistent with the unjust enrichment analysis of subrogation adopted in that case and the application of a defence of change of position. The preferable view, however, and one that is consistent with the analysis of subrogation as remedy to vindicate property rights, is that the justice of the case is not relevant to the operation of the law of subrogation and so the borrower’s detrimental reliance on the assumed unsecured nature of the loan should be irrelevant.

(h) Public Policy

The claimant may not be awarded the remedy of subrogation for reasons of public policy. This is illustrated by Orakpo v Manson Investments Ltd[36] where the claimant was not subrogated to the rights of a third party because this would have been contrary to the policy of the Moneylenders Acts.

  • [1] For detailed analysis, see C Mitchell and S Watterson, Subrogation: Law and Practice (Oxford: OxfordUniversity Press, 2007).
  • [2] Sander v Pearson [2013] EWCA Civ 1822, [15] (Arden LJ).
  • [3] Orakpo v Manson Investments Ltd [1978] AC 95, 104 (Lord Diplock); Re TH Knitwear (Wholesale) Ltd
  • [4] [1988] Ch 275, 284 (Slade LJ). 33 [1999] 1 AC 221.
  • [5] Banque Financiere de la Cite v Parc (Battersea) Ltd [1999] 1 AC 221, 231 (Lord Hoffmann). See alsoCheltenham and Gloucester Plc v Appleyard [2004] EWCA Civ 291, [32] (Neuberger LJ).
  • [6] This has been described as ‘subsisting rights subrogation’: Mitchell and Waterson, Subrogation: Law andPractice, para 1.07. See Alliance Bank JSC v Aquanta Corp [2011] EWHC 3281 (Comm), [22] (Burton J);Ibrahim v Barclays Bank Plc [2011] EWHC 1897 (Ch), [2012] 1 BCLC 33, [7] (Vos J).
  • [7] Hobbs v Marlowe [1978] AC 16, 39 (Lord Diplock). See p 141, above.
  • [8] Mitchell and Watterson, Subrogation: Law and Practice, describe this as ‘extinguished rights subrogation’. See Syed Ibrhaim v Barclays Bank plc [2011] EWHC 1897 (Ch), [7] (Vos J).
  • [9] Banque Financiere de la Cite v Parc (Battersea) Ltd [1999] 1 AC 221, 236 (Lord Hoffmann). See alsoBoscawen v Bajwa [1996] 1 WLR 328, 333 (Millett LJ).
  • [10] Boscawen v Bajwa [1996] 1 WLR 328, 335 (Millett LJ); Banque Financiere de la Cite v Parc (Battersea) Ltd[1999] 1 AC 221; Liberty Mutual Insurance Co (UK) Ltd v HSBC Bank plc [2002] EWCA Civ 691; Cheltenhamand Gloucester plc v Appleyard [2004] EWCA Civ 291, [33] (Neuberger LJ); Filby v Mortgage Express (No 2) Ltd[2004] EWCA Civ 759, [62] (May LJ); Lehman Commercial Mortgage Conduit Ltd v Gatedale Ltd [2012]EWHC 848 (Ch); Sandher v Pearson [2013] EWCA Civ 1822. In Anfield (UK) Ltd v Bank of Scotland [2010]EWHC 2374 (Ch), [2011] 1 WLR 2414, [10], Proudman J proceeded, at [11], to emphasize that subrogationrequired proof of some unconscionable conduct or unjust factor.
  • [11] [2013] EWCA Civ 1960, [2014] 1 WLR 854.
  • [12] See p 109, above.
  • [13] Bofinger v Kingsway Group Ltd [2009] HCA 44. See also Halifaxplc v Omar [2002] EWCA Civ 21, [2002]
  • [14] 2 P & CR 377; Eagle Star Insurance Co Ltd v Karasiewicz [2002] EWCA Civ 940. See S Midwinter, ‘SubrogationFinds Some “Well-settled Principles”’ [2003] LMCLQ 6. 43 See p 623, above.
  • [15] Unless the doctrine of backward tracing is recognized, so that the claimant will be able to trace into thepreviously acquired asset in respect of which the debt was incurred. See p 624, above.
  • [16] [1999] 1 AC 221, 231 (Lord Hoffmann). See also Boscawen v Bajwa [1996] 1 WLR 328, 335 (Millett LJ);Investment Trust Companies (in liquidation) v HMRC [2015] EWCA Civ 82, [53] (Patten LJ).
  • [17] Banque Financiere de la Cite v Parc (Battersea) Ltd [1999] 1 AC 221, 228 (Lord Steyn) and 237 (LordClyde).
  • [18] [2004] EWCA Civ 291. 48 See Chapter 9 for examination of mistake as a ground of restitution.
  • [19] 49 Banque Financiere de la Cite v Parc (Battersea) Ltd [1999] 1 AC 221, 228 (Lord Steyn) and 237 (Lord
  • [20] Clyde). See also Filby v Mortgage Express (No 2) Ltd [2004] EWCA Civ 759.
  • [21] Banque Financiere de la Cite v Parc (Battersea) Ltd [1999] 1 AC 221, 231 (Lord Hoffmann).
  • [22] That the claimant can obtain the benefit of a creditor’s undischarged security was recognized by theHouse of Lords in Banque Financiere de la Cite v Parc (Battersea) Ltd [1999] 1 AC 221.
  • [23] Boscawen v Bajwa [1996] 1 WLR 328, 341.
  • [24] [1948] 1 Ch 465, 549-50.
  • [25] Boscawen v Bajwa [1996] 1 WLR 328, 341 (Millett LJ). See p 696, below.
  • [26] Scottish Equitable plc v Derby [2001] 3 All ER 818. See further p 684, below.
  • [27] See p 696, below.
  • [28] See LD Smith, ‘Tracing Into The Payment of a Debt’ (1995) 54 CLJ 290, 295.
  • [29] Lehman Commercial Mortgage Conduit Ltd v Gatedale Ltd [2012] EWHC 848 (Ch).
  • [30] Banque Financiere de la Cite v Parc (Battersea) Ltd [1999] 1 AC 221. See also Cheltenham and Gloucester
  • [31] plc vAppleyard [2004] EWCA Civ 291, [40] (Neuberger LJ); Butler v Rice [1910] 2 Ch 277; Ghana CommercialBank v Chandiram [1960] AC 732. 60 [1996] 1 WLR 328.
  • [32] Ibid, 335.
  • [33] Cheltenham and Gloucesterplc v Appleyard [2004] EWCACiv291, [41] (Neuberger LJ); Filby v MortgageExpress (No 2) Ltd [2004] EWCA Civ 759, [63] (May LJ).
  • [34] [1969] 1 Ch 261. See also Liberty Mutual Insurance Co (UK) Ltd v HSBC Bank plc [2002] EWCA Civ 691.
  • [35] [2010] EWHC 2374 (Ch), [2011] 1 WLR24 1 4. 65 [1978] AC 95.
  • [36] 66 Kuwait Airways Corp v Iraqi Airways Co (Nos 4 and 5) [2002] 2 AC 883, [77] (Lord Nicholls); OBG Ltd v
 
Source
< Prev   CONTENTS   Source   Next >