Hughmans Solicitors v Central Stream Services Ltd & Anor

This is the judgment of the Court.

The issues on this appeal are whether a contract compromising legal proceedings created a proprietary interest in property owned by the defendant in the proceedings and, if so, whether it took priority over a later charging order over the property. Notice of the charging order, but not the contract, was entered against the registered title to the property under the Land Registration Act 2002.

At first instance, Briggs J held that the contract created a proprietary interest in the property and that it took priority over the charging order. The creditor with the benefit of the charging order appeals, with the permission of the Judge.

As argued before the Judge, the second issue, priority, raised an important question under section 29 of the Land Registration Act. It was argued that the charging order did not enjoy priority because it had not been created for valuable consideration. Relying on United Bank of Kuwait PLC v Sahib [1997] Ch 107, the Judge held that the charging order, which did no more than secure a judgment debt, was not created for valuable consideration for the purposes of section 29 and hence did not enjoy priority over an earlier but unregistered equitable interest. We were told that this had excited considerable interest and comment among property lawyers. However, the appellants do not challenge this part of the Judge’s decision. They argue that they did enjoy priority but on a narrow ground based on arrangements made between the parties.

The principal area of argument has therefore been on the first issue, whether the effect of the compromise agreement was to create a proprietary interest in the property or only an unsecured personal obligation of the defendant. While this issue turns on the particular terms of the agreement, it requires a consideration of some basic equitable principles.

The agreement compromised proceedings brought in the Chancery Division by the respondents to this appeal, Central Stream Services Limited (the company) and its liquidator, against John Christopher Davidson, a former director. The claim was for over £10.2 million but it appeared from disclosure given by Mr Davidson under the terms of a freezing order that the value of his assets and the extent of his liabilities was such that the company had little or no chance of recovering anything approaching the sum claimed. The compromise agreement was scheduled to a Tomlin Order in conventional form, staying the proceedings save for the purposes of enforcing the agreement.

The agreement, in which the company and Mr Davidson were respectively described as the Claimant and the Second Defendant, contained the following recital:

“The Second Defendant and the Claimant have agreed that the Second Defendant shall pay and the Claimant shall accept in full and final settlement of its claims all of the net sale proceeds of the property known as 3 Tisdale Place London SE17 1QQ, Title Number TLG 166189 (“the Property”) following the payment of certain debts of the Second Defendant, provided always that the Claimant shall receive not less than £100,000.00”.

By clause 1, Mr Davidson confirmed that there was no material misstatement in his affidavit disclosing his assets and agreed that, if there were any such misstatement, the company would be entitled “to enforce”, by which was meant “to enter”, judgment for the amount claimed in the action, less any sum already paid in compliance with the agreement.

Clauses 2 to 7 provided:

“2.

The Property shall be sold for such price as may be agreed by the parties or in default of agreement as determined by the Court.

3.

The Second Defendant shall have the conduct of the sale.

4.

Hughmans shall have the conduct of the conveyancing work relating to the sale and shall keep the Claimant fully advised as to the progress of the sale of the property.

5.

The Property shall be offered for sale by such estate agents as may be agreed between the parties or in default of such agreement as nominated by the Court.

6.

The proceeds of sale of the Property shall be applied as follows and in the following order of priority (save for the avoidance of doubt provided always that the Claimant shall receive not less than £100,000.00).

6.1

to discharge the mortgage secured thereon in favour of National Westminster Bank;

6.2

in payment of £100,000 to the Claimant;

6.3

in payment of Hughmans’s reasonable conveyancing costs and disbursements in connection with the sale;

6.4

in payment of the estate agent’s fees;

6.5

in payment of the following debts of the Defendant;

(a)

any shortfall showing on the completion statement in relation to the sale of 52 Park View Road;

(b)

the reasonable fees and disbursements of Hughmans in connection with this action;

(c)

debt owing to National Westminster Bank in connection with personal loan account, the subject of a Judgment in the Northampton County Court under claim number 8QR50189;

(d)

debt owing to National Westminster Bank in connection with credit card account reference 5522 1395 0007 7395;

(e)

debt owing to MBNA in connection with credit card account reference 4129850349499133;

(f)

debt owing to Egg in connection with credit card account reference 4627654919450309.

6.6

In payment of any remaining balance to the Claimant.

7.

Upon receipt of payment pursuant to paragraph 6 above, the Claimant shall take all such steps as are necessary for the removal of the restriction registered against the Property.”

Clause 9 provided that the agreement was in full and final settlement of all claims between the company and Mr Davidson.

The structure of the agreement was, therefore, that the property would be sold by Mr Davidson, using his solicitors, Hughmans, who would report on progress to the company, and an estate agent agreed between the parties or in default of agreement nominated by the court. The proceeds of sale after discharge of the mortgage would be applied in accordance with the provisions of clause 6. The rights of the company were to receive the first £100,000 and the whole of the residue remaining after the payment of the costs and debts listed in clauses 6.3 to 6.5. Put another way, the entire net proceeds of sale were to be paid to the company, subject to the satisfaction of the costs and liabilities listed in clauses 6.3 to 6.5.

The property was put up for sale but falls in property values meant that it could not be sold at a price sufficient to pay the full sum of £100,000 to the company under clause 6.2, let alone any of the amounts payable to the creditors listed in clause 6.5.

One of the creditors was Hughmans, the solicitors who acted for Mr Davidson in the proceedings and in connection with the compromise and who signed the Tomlin Order on his behalf. Under clauses 6.3 and 6.5(b), they were entitled to be paid their reasonable conveyancing costs and disbursements in connection with the sale of the property and their reasonable fees and disbursements in connection with the proceedings against Mr Davidson, in each case after the payment of £100,000 to the company under clause 6.2 but ahead of the payment of the residue under clause 6.6.

On 12 April 2010 Hughmans entered judgment in default of defence against Mr Davidson for just over £19,000 in respect of unpaid fees. They obtained an interim charging order over the property to secure the judgment debt on 29 April 2010 and a final charging order on 29 August 2010, which was registered against the title to the property. A charging order takes effect as an equitable charge, by virtue of section 3(4) of the Charging Orders Act 1979.

The property was finally sold in the early part of 2011 at a price which left only £49,104 available after the discharge of the mortgage in favour of National Westminster Bank. Hughmans claimed that their charging order ranked ahead of any right of the company under the agreement, either because the agreement did not create a proprietary interest in favour of the company or because, by virtue of registration, their charging order enjoyed priority. Hughmans agreed to remove their unilateral notice from the registered title prior to the sale on the basis that the sum of £25,000 would be retained by the company’s solicitors to await the outcome of the present proceedings. The proceedings were commenced by an application in the liquidation of the company issued by Hughmans.

We deal first with the effect of the compromise agreement.

Before the Judge, as recorded by him in his judgment at [11], the company submitted that

“…. the property and its proceeds of sale constituted a fund from which, pursuant to a contract for valuable consideration, the Company was to be paid £100,000, in priority to all other claims upon it, save only the first mortgage of National Westminster Bank plc. The Company’s rights in relation to the £100,000 therefore had all the traditional characteristics of an equitable charge”.

Hughmans submitted that the agreement did not contain language which was by any means sufficient to show an intention to create an equitable charge over the property and that in any event, if did create any proprietary interest, it was limited to the proceeds of sale and did not extend to the property itself.

Reading the agreement as a whole including the recital, the Judge identified its object and intent as being to give to the company, in lieu of its claim in the proceedings, the whole of Mr Davidson’s beneficial interest in the property, subject only to the payment of certain of his debts out of any net proceeds of sale in excess of £100,000. The Judge continued:

“16.

In my judgment that sufficiently disclosed an intention on the part of the parties to the Schedule that, thenceforth, the Company shall be the beneficial owner of the Property subject to the National Westminster Bank charge, save only for that part of any net proceeds of sale in excess of £100,000 necessary to discharge the debts of Mr Davidson identified in Paragraph 6. The result is not an appropriation of the Property, or even of its proceeds of sale, by way of security for some debt of Mr Davidson to the Company. The Company received a share of the proceeds in lieu of Mr Davidson’s alleged liability. Paragraph 6.2 of the Schedule is simply part of the mechanism designed to ensure that Mr Davidson’s reservation of rights to use the proceeds of sale for payment of certain debts should not impact upon the Company realising at least £100,000 (if otherwise available after satisfying National Westminster Bank’s legal charge) from the proceeds of sale.

17.

There is in my judgment nothing in the point that the detailed description in the Schedule of the Company’s and Mr Davidson’s rights in relation to the Property is expressed by reference to its proceeds of sale. It is common for a declaration of trust of real property to be expressed by reference to proceeds of sale, rather than by reference to the property itself, without thereby depriving the intended beneficiaries of proprietary interests in the property

18.

Accordingly, I consider that the Schedule confers a beneficial interest upon the Company in relation to the Property, not by way of equitable charge, but by way of trust ......”.

In his submissions on this appeal, as before the Judge, counsel for Hughmans stressed the need for clear words in order to create a proprietary interest. In Tradegro (UK) Ltd v Wigmore Street Investments Ltd [2011] EWCA Civ 268, [2011] BCLC 616 Lord Neuberger MR said at [36]:

“…. the courts are not too ready to hold that, where A and B agree an arrangement whereby A’s money is held in a specific account, or by a third party, to protect B’s prospective claim, the money is to be treated as held on trust for B, or as security for B’s claim. Clear words are needed to show that this was the intention of the arrangement before the court will hold that is its effect”.

Tradegro concerned an undertaking to hold money on deposit and not to take any steps to transfer or otherwise deal with it until the satisfaction in full of additional consideration under a sale agreement. Like a freezing order, it was a classic case of an obligation restraining the use of money without a positive obligation to pay the debt out of it: see also Flightline Ltd v Edwards [2003] 1 WLR 1200.

Although in the passage cited above, the Master of the Rolls is referring to arrangements for the protection of prospective claims, the need for an intention to create a proprietary interest to be clearly shown is of general application. The general proposition that the creation of a trust or the creation of equitable interests will not readily be found in a commercial context is important, for at least two reasons. First, the creation of such interests runs counter to the rateable distribution of assets on an insolvency, which is for the most part the occasion on which the creation or otherwise of proprietary interests will be of significance. Secondly, there is a “general disinclination of the courts to see the intricacies and doctrines connected with trusts introduced into everyday commercial transactions”: Neste Oy v Lloyds Bank Plc [1983] 2 Lloyds LR 658 at 655 per Bingham J. See also Snell’s Equity (32^nd ed.) at para. 22-015.

Counsel for Hughmans submitted that the agreement did not contain terms sufficient to create any equitable interest in the property in favour of the company. He submitted that its effect was to do no more than provide for a sale and for the subsequent application of the proceeds of the sale. The operative parts of the agreement, as shown by the references to “net sale proceeds” in the recital and to “the proceeds of the sale of the property” in the opening words of clause 6, did not purport to create a proprietary interest in the property but only to impose a personal obligation on Mr Davidson to sell the property and to apply the proceeds of sale in the manner required by the agreement. Counsel submitted further that the suggested beneficial interests under the agreement were insufficiently spelt out and that the waterfall provisions of clause 6 created a curious sort of beneficial interest. These were factors which told against the effect of the agreement being to create proprietary interests, as did the uncertainty as to whether the creditors identified in paragraphs 6.3 to 6.5 could enforce the terms of the agreement.

Counsel for the company supported the Judge’s conclusion for the reasons given in his judgment. In addition, the company had filed a respondent’s notice, supporting the decision on the alternative ground that the agreement created an equitable charge in favour of the company. This had been the company’s primary submission before the Judge.

We consider that the principles which must guide the resolution of this issue appear in a short passage in the judgment of Lord Wrenbury in Palmer v Carey [1926] AC 703, a decision of the Privy Council on appeal from the High Court of Australia. It was cited to the Judge in this case and relied on by both parties. The issue was whether a commercial lender had security over goods purchased by the borrower with the monies advanced by it and over the proceeds of sale of such goods. The borrower became bankrupt and the Privy Council, reversing the decision of the High Court of Australia, held that the particular agreement did not create an equitable charge in favour of the lender. The general principle was stated by Lord Wrenbury at pp 706-707:

“An agreement for valuable consideration that a fund shall be applied in a particular way may found an injunction to restrain its application in another way. But if there be nothing more, such a stipulation will not amount to an equitable assignment. It is necessary to find, further, that an obligation has been imposed in favour of the creditor to pay the debt out of the fund. This is but an increase of a familiar doctrine of equity that a contract for valuable consideration to transfer or charge a subject matter passes a beneficial interest by way of property in that subject matter if the contract is one of which a Court of equity will decree specific performance”.

This passage is expressed as applying to the payment of debts out of a fund and is therefore directly addressing the issue of the creation of an equitable charge to secure the debts. We agree with the Judge’s conclusion that the agreement in this case cannot be analysed as creating an equitable charge, for the simple reason that there was no debt due from Mr Davidson to the company for which a charge could stand as security. The agreement did not impose an obligation on Mr Davidson to pay a particular sum of money to the company, which could then be secured by a charge. If it had done, it would have been open to Mr Davidson to pay the debt from some other source, upon which any charge of or interest in the property in favour of the company would be discharged. The agreement creates not a debt, but an obligation to sell the property and to apply its proceeds in a particular manner. Even the requirement under clause 6.2 to pay the sum of £100,000 to the company is not a free-standing obligation but arises solely as part of the obligation to apply the proceeds of sale of the property.

Nonetheless, the passage from Palmer v Carey illustrates a more general principle that if for valuable consideration the owner of property agrees to hold the property on terms which appropriate it for the benefit of another party, and the agreement is one which the court will enforce by an order for specific performance, the effect of the agreement is to create an equitable interest in the property in favour of the latter party. The Judge was right to analyse the agreement as one which gave the company the whole of Mr Davidson’s net equity in the property, subject only to the application of some part of the proceeds of sale in the payment of identified debts. From the date of the agreement not only was Mr Davidson not free to deal with the property as he wished, he was under a positive obligation to sell the property and to apply the proceeds for the benefit of the company, subject to the discharge of the mortgage and to the payment of other debts in the order provided by the agreement. It was an agreement which the court would enforce by an order for specific performance.

If, as is clearly the case, an equitable charge creates an equitable interest in the charged property, it would be strange indeed if the agreement in this case did not also create an equitable interest in favour of the company. The essential element of an equitable charge is that, in the event of a default by the debtor in the payment of his debt, the chargee is entitled to an order for the sale of the charged property and for the payment of his debt out of the proceeds of sale. As earlier noted, the debtor nonetheless remains free to discharge the debt out of other resources, thereby automatically releasing the charge. The present case is in our view a stronger case for the creation of an equitable interest. The obligation under the agreement is an unqualified one to sell the property and to pay the proceeds of sale to the company, subject to other calls upon those proceeds, in settlement of the company’s claim against Mr Davidson. The property is wholly appropriated to that settlement.

We see nothing strange in the beneficial interests created by the agreement. There is no difficulty in the concept of property being held for the benefit of a number of different persons in different proportions and in different orders of priority. It is unnecessary to decide whether individual named creditors in the agreement could themselves enforce the terms of the agreement. Like the Judge we would not regard the agreement as a declaration of trust in favour of those creditors. Rather, Mr Davidson was entitled to retain for himself a sufficient sum out of the net proceeds of sale with which to pay certain debts. The application of that sum in the payment of those debts is a matter which on the face of it the company could enforce; the company might have a legitimate interest in seeing the performance by Mr Davidson of the precise terms of clause 6. We did not hear argument, and we express no view, on the impact, if any, of the Contracts (Rights of Third Parties) Act 1999.

We turn to the second issue, whether the proprietary interest created by the agreement in favour of the company ranked in priority to the charging order in favour of Hughmans.

As earlier noted, this no longer raises any question of general principle. It is accepted by Hughmans that the charging order was not “made for valuable consideration” within the meaning of section 29(1) of the Land Registration Act 2002. Even assuming, as the Judge was invited to assume, that the obtaining of a final charging order is a registrable disposition of a registered estate for the purposes of section 29(1), the basic rule as to priorities provided by section 28 applies. The effect of section 28 is to apply the rule of equity that equitable interests rank in priority according to the time of their creation, save where section 29 or 30 provides otherwise. Accordingly, the interest created in favour of the company by the agreement ranks in priority to Hughmans’ charging order, unless Hughmans can point to some particular feature of the facts of this case which reverses that order of priority.

Hughmans’ argument on priority proceeds as follows. They correctly assert that if the sale of the property had proceeded without the prior removal of their unilateral notice, the title transferred to the purchaser would have been subject to their charging order, whereas the purchaser would have taken free of the company’s interest which was not registered. Hughmans’ agreement to remove their unilateral notice was without prejudice to their rights. Accordingly, it is submitted, one of the rights reserved was the right which they would have enjoyed as against the property if it had been transferred without the prior removal of their unilateral notice.

The problem with this submission is that it ignores the company’s right, as the holder of a prior equitable interest, to require Hughmans, as the holder of a subsequent equitable interest, to remove the unilateral notice protecting their interest. The agreement made for the removal of the unilateral notice, on terms that the company’s solicitors would retain a sum sufficient to meet Hughmans’ claim if established, was reached against the background of a stated intention by the company to take proceedings requiring Hughmans to remove their unilateral notice. Once it is established, as it has been, that the agreement created an equitable interest in favour of the company, Hughmans never enjoyed a right to maintain their unilateral notice in the face of a proposed sale of the property. There was therefore no such right reserved in their favour and their claim to priority must fail.

For the reasons given in this judgment, we dismiss the appeal.