Freedman v Freedman & Ors

This is an application made by Part 8 Claim for an order that the above settlement dated 4 February 2013 and made between the claimant of the one part and the first and second defendants of the other part be set aside on the ground of equitable mistake.

Various representation orders have been made by Deputy Master Jefferis on 27 October 2014 in respect of all the beneficiaries with the exception of future discretionary beneficiaries under clause 1.4 (d) (“such other persons or Charities as are added under clause 3”).

The first and second defendants have filed acknowledgments of service saying that they do not intend to contest the claim. The second defendant has filed a witness statement. All the parties represented before me support the claim with the exception of Her Majesty’s Commissioners for Revenue and Customs (“HMRC”) who oppose it.

The claimant, Melanie Freedman, (whom I shall call “Melanie” without intending any disrespect) entered into the settlement in 2013 on the advice of her father, Charles Freedman (who died on 27 June 2013), and Mr Peter David Fraser, a solicitor with OGR Stock Denton LLP. Melanie is now aged 53.

The terms of the settlement are as follows. Melanie is the life tenant (clauses 1.3 and 5.1); there is a power of appointment in favour of a discretionary class comprising Melanie, the third defendant, the children of Melanie’s parents of whom there are three and their issue and such other persons or charities as are added under the provisions of the settlement (clause 1.4) and subject thereto the capital and income is held upon trust for the third defendant (clause 5.3). The third defendant is Melanie’s minor son by a relationship which she had with a Mr Anthony Bakir who was at the time of the birth in about 1999/2000 married (with children) to someone else.

Despite the power to accept additional property contained in clause 2, the property subject to the settlement solely comprises two houses, which I shall respectively call “St Leonard’s Close” and “Gibbs Green”.

In 2001 her father helped Melanie buy St Leonard’s Close for her to live in with the third defendant. Her father lent her the price of £279,950 and all of the costs of purchase subject to a charge on St Leonard’s Close. In about 2004-5, when her relationship with Mr Bakir had ended, her father agreed to forgo the loan and the charge was removed. Then in about April 2010 Melanie left St Leonard’s Close to be nearer the third defendant’s then school where she worked as a dinner lady. She let St Leonard’s Close and moved into rented accommodation. She found Gibbs Green but had difficulty selling St Leonard’s Close. The unchallenged evidence is that Melanie has very little money and very little earning power. By contrast, her father was a rich man as his inheritance tax account shows. Melanie again approached her father who agreed to lend her the purchase price (£525,000) for Gibbs Green and the acquisition costs of £5,000.

In her witness statement Melanie says (at [9]),

There is a considerable amount of evidence in the form of witness statements from members of her family and also from the family accountant, Lynton Stock, corroborating Melanie’s statements,

that the purpose of the settlement was to protect Melanie from Mr Bakir and others perceived by Melanie’s family to be predatory males: see [3] and [4] of Dorian Nineberg’s statement, [4] of Lynton Stock’s statement and [3] of Ruth Freedman’s statement,

that Melanie should not be able to retain both St Leonard’s Close and Gibbs Green for her own benefit: see [6] of Dorian Nineberg’s statement, [4] of Lynton Stock’s statement, [9] and [12] of Mr Fraser’s statement and the inference from [3] of Ruth Freedman’s statement,

that the settlement was entered into subject to an agreement between Melanie and her father to repay the loan out of the proceeds of sale of St Leonard’s Close: see [6] of Dorian Nineberg’s statement, [3] of Lynton Stock’s statement, [15] of Mr Fraser’s statement and [2], [3] and [4] of Ruth Freedman’s statement,

that the loan would be enforced: see [6] of Dorian Nineberg’s statement, [3] of Lynton Stock’s statement and [5] of Ruth Freedman’s statement, and

that one of the reasons why the loan was to be repaid was because Melanie’s father wished to maintain equality between his children: see [7] of Dorian Nineberg’s statement, [22] of Mr Fraser’s statement and [3] of Ruth Freedman’s statement.

St Leonard’s Close has now been sold and although the difference (£82,441) between the sale price of St Leonard’s Close and the loan for Gibbs Green will be left outstanding until Melanie eventually downsizes and sells Gibbs Green, the amount of the tax charged on entering into the settlement, some £156,000 (plus interest), will not.

HMRC did not require Melanie or any of the other witnesses to be cross-examined and therefore, provided their evidence is credible (see National Westminster Bank Plc v. Daniel[1993] 1 WLR 1453), which it is, HMRC must be taken to have accepted it.

Mr Fraser failed to appreciate the effect of s. 49(1A) of the Inheritance Tax Act 1984 (“IHTA”) on interests in possession to which a person becomes entitled on or after 22 March 2006, and advised Melanie’s father that the full value of the settled property remained part of Melanie’s estate. He admits (at [16] of his witness statement) that he failed to realise and thus explain that the transfer of assets into the trust would be a lifetime chargeable transfer for inheritance tax purposes and (to the extent that the net value exceeded the nil rate band) there would be an immediate entry charge of 20%. He also admits that he failed to realise or explain that there would be a 10-yearly charge and (counter to the intention that the proceeds of St Leonard’s Close would be appointed to Melanie to pay off the loan from her father) exit charges.

Ms Jane Anne-Marie Faulkner on behalf of HMRC points out that if the loan was intended to be repaid from the sale proceeds of St Leonard’s Close, it seems odd that St Leonard’s Close was settled at all, since Melanie was giving the trustees a discretion whether or not to use the proceeds of sale for this purpose. While the trustees could not bind themselves to appoint to Melanie in the future, the sale of St Leonard’s Close has now occurred and the trustees have not changed their mind. Melanie trusted her trustees and has been proved right to do so in the circumstances: see also [20] of Mr Fraser’s statement. The settlement was set up for the benefit of Melanie and the third defendant so that it was understood by the trustees that the other beneficiaries would only benefit in the unlikely event of their premature deaths.

Mr Fraser’s failures appear from a letter which he sent to Melanie’s father on 6 November 2012 and which Melanie confirms that she saw. Mr Fraser followed this up with a letter dated 23 November 2012 addressed to Melanie’s father and to Melanie which does not mention tax at all. On 16 January 2013 there is an attendance note on Melanie from which it appears (and again Mr Fraser confirms at [20] of his statement) that no different advice was given. Mr Fraser says in his witness statement (at [19]) that Melanie’s father told him that he had discussed the matter with Melanie. Melanie also refers to the meeting on 16 January 2013 in her witness statement (at [13]) and says about the settlement that, “Its taxation consequences and the effect those taxation consequences would have on my ability to repay my Father was not discussed at all.”

Melanie is part of a very close family. Melanie’s mother Ruth Freedman is the litigation friend of the third defendant and Melanie’s parents had three children who are Melanie, the first defendant and the fourth defendant, who is married to the second defendant. Melanie was very close to her father to the extent that if he recommended a course of action to her she would follow it without question. He was evidently very concerned about her relationship with Mr Bakir who still had contact with Melanie. She says (at [5]),

The claim and the opposition to it both rely on the Supreme Court’s decision in Pitt v. Holt, Futter v. Futter[2013] UKSC 26; [2013] 2 AC 108. In Kennedy v. Kennedy[2014] EWHC 4129 (Ch) Etherton C said (at [36]),

To this the Chancellor added (at [39]),

Thus in order for relief to be given, there must be a distinct mistake, a serious mistake, and it must be unconscionable not to set the settlement aside. In addition, it is likely that relief will not be given if the transaction is part of a tax avoidance scheme.

All counsel except counsel for HMRC said that these requirements are plainly satisfied in the present case. The mistake relied on is twofold but interdependent. First, it is said that Melanie made a mistake, induced by Mr Fraser, about having to pay tax on and as a result of the settlement and, secondly, it is said that the tax payable means that Melanie is unable to repay the loan, both because of the tax charge on entry into the settlement and because of the exit charge on any appointment to her. It is also said that the mistake is sufficiently grave and unconscionable to give rise to the remedy and thirdly it is said that the beneficiaries such as the third defendant are volunteers who have not changed their position as a result of the mistake and it is plainly unconscionable for them to take advantage of Melanie’s mistake.

Mr Slater challenged all these submissions. He made the general point that it would be strange if, while restricting the test in Hastings-Bass, the Supreme Court in Pitt v. Holt intended to allow tax mistakes (similar to those which were previously relieved by Hastings-Bass) to be corrected through a simple application of the law of equitable mistake. Thus, he submitted, the test for equitable mistake was intended to be more stringent than Miss Stanley QC, Miss Bryant and Mr Davey contended. However, those counsel said that the test for equitable mistake was simply different from that in Hastings-Bass, not more or less stringent, so that the rule in Hastings-Bass did not impinge on equitable mistake in any way. They were two completely different strands in the law which developed in a different way but happened to come together in Pitt v. Holt. As Lord Walker said at [12], “similar issues arise…and in practice they sometimes overlap”.

Miss Bryant submitted (see Lloyd LJ in the Court of Appeal in Pitt v. Holt at [102] and following) that Hastings-Bass depended on trustees’ breach of the duty to act properly for the benefit of the beneficiaries, so that if the trustees had taken proper advice they were not in breach of duty and had to look for their remedy against their advisers. Whereas, said Miss Bryant, rescission on the ground of mistake derives from the much older case of Ogilvie v. Littleboy(1897) 13 TLR 399 which does not depend on breach of duty but is much more general in its scope. The passage cited by Lloyd LJ in the Court of Appeal (at [167]) and Lord Walker in the Supreme Court (at [101]) in Pitt v. Holt is of Lindley LJ giving the judgment of the Court of Appeal in Ogilvie v. Littleboy (approved by the House of Lords) at 400,

I now turn to the individual matters raised by Mr Slater.

First, he said that Melanie made no distinct mistake in the sense meant by Lord Walker. The mistake she made was one of ignorance or disappointed expectation, a general feeling that everything would be all right, which does not give rise to the remedy. Melanie trusted her father implicitly and simply did what he said. There is no other explanation for giving up her autonomy over St Leonard’s Close as well as Gibbs Green to trustees. It is human nature, he submitted, when one realises with hindsight that a mistake has been made, to say, as Melanie does in her witness statement (at [11]),

Thus, Mr Slater submitted, “I broadly understood”, is consistent with a finding of ignorance, and in the circumstances is insufficiently distinct to qualify as the sort of mistake that Lord Walker was describing. Again, nowhere does it say that Melanie read or understood the advice given by Mr Fraser. In the evidence she only says (in her first witness statement) she “received” it and (in her second) that she “saw” it. In a case where the existence of a conscious belief turns only on the letter, Mr Slater says that clearer evidence is necessary than what he describes as “an equivocal and generalised” statement, especially in circumstances in which Melanie has (see Pitt v. Holt at [127]) “a lively personal interest” in establishing that there was a causative mistake. He submitted that this is to be contrasted with Kennedy, where the evidence was clear that Mr Kennedy, who was the driving force behind the transaction, believed that the appointment complied with his instructions.

In Pitt v. Holt the Supreme Court disapproved the distinction between the effect (in the sense of legal effect, the legal character or nature: see [119]) and the consequences of a transaction, replacing it (see [122]) with the test of causative mistake of sufficient gravity. The Court also considered the distinction between on the one hand mere causative ignorance and on the other a mistaken conscious belief or a mistaken tacit assumption. Lord Walker said at [108],

Miss Stanley asked rhetorically what the distinction was between ignorance and a tacit assumption. Ignorance meant that the person simply did not think about the consequences of an action. However, a tacit assumption does not involve a thought process involving a series of steps culminating in the thought, “I believe I will be able to comply with the loan agreement”. That would be a conscious belief and there are some things that are simply taken for granted. Melanie’s assumption is to be inferred because she proceeded on the basis of legal advice coupled with a belief that her father would not advise her to do something dangerous. Accordingly there was at the least a tacit assumption that entering into the settlement did not involve any impediment to compliance with her agreement to repay the loan.

It is clear from Pitt v. Holt at [129]-[132] that a mistake as to the tax consequences of a transaction may, in an appropriate case, be sufficiently serious to warrant rescission and Mr Slater did not seek to argue to the contrary. There is no justification for a different approach to mistakes about tax and other types of mistake. However, Mr Slater submitted that there is in this case no evidence to support any inference of conscious belief or tacit assumption.

Mr Slater relied on the remarks of Lord Walker (at [110]-[113]) about In Re Griffiths deceased[2008] EWHC 118 (Ch). In that case Mr Griffiths had taken advice about tax planning which recommended potentially exempt transfers with seven-year term insurance. Mr Griffiths settled shares without the term insurance but was diagnosed with lung cancer and died only about a year after the settlement. Had he done nothing, the shares would have formed part of his residuary estate in which his wife took a life interest and no inheritance tax would have been payable on his death. Lewison J set aside the settlement for mistake, a mistake about Mr Griffiths’ state of health. Lord Walker said (at [113]),

Mr Slater’s point is that if Mr Griffiths had been asked he would have said, “I broadly understood that there were no adverse health concerns that I needed to worry about.” In other words, whether or not there is a mistake involves inquiry as to the settlor’s state of mind and that state of mind in Melanie’s case was causative ignorance rather than any kind of conscious belief or tacit assumption.

However if Mr Griffiths had had a full medical and been given a clean bill of health it would have been easier for him to say that he had a conscious belief based on that report. In the present case Mr Fraser admittedly gave wrong advice and such advice was seen by Melanie. It is therefore entirely reasonable for her to say, as she does, that based on that advice she broadly understood that there would be no adverse tax consequences for her in entering into the settlement. I do not accept Mr Slater’s analysis that “saw” does not equal “read”. He did not cross-examine Melanie and on that basis it must follow that her broad understanding was based on a reading of the letter of 6 November 2012.

Accordingly it seems to me that Melanie made a distinct mistake of the kind described by Lord Walker.

Although a unilateral mistake is sufficient in the case of a unilateral transaction (such as a voluntary settlement) the fact that it is a unilateral mistake may be a good reason for the court to apply a more stringent test as to the seriousness of the mistake before granting relief and avoiding the settlement: see Pitt v. Holt at [114].

Mr Slater contended that for a mistake to be sufficiently grave it had to go to the heart of the transaction and that in this case it did not. He relied on [103] of Pitt v. Holt where Lord Walker said that,

The Court put to Mr Slater that Pitt v. Holt itself was about a case where neither the settlor nor her advisers had considered the issue of compliance with inheritance tax legislation upon the transfer of the assets into a discretionary trust or the trust’s subsequent operation, with the result that large inheritance tax liabilities arose.

Mr Slater distinguished Pitt v. Holt on three grounds. First he said that as a matter of practicality the facts of Pitt v. Holt were such that the Court would necessarily consider that relief ought to be given since the merits were so strong.

Secondly, it was possible in Pitt v. Holt for tax to have been avoided by the simple expedient of executing a settlement which complied with the requirements of s. 89 IHTA. In the present case there was no such possibility since the choice was between fulfilling the requirements of the purpose of the settlement and having no settlement at all. And thirdly (overlapping with the second reason) Melanie’s mistake was not causative in any relevant sense, neither did it go to the heart of the transaction.

Dealing with these reasons together, he pointed out that the purpose of the settlement was asset protection alone. There was not even a mention of the loan agreement in the Letter of Wishes accompanying the settlement, although it did feature in the HMRC inheritance tax account, “Debts due to the estate”. Thus Mr Slater said that payment of tax was not a mistake as to the “essential nature of [the] transaction”, the “legal character or nature of the transaction” or “a matter of fact or law basic to the transaction”. This was to be contrasted with Lady Hood of Avalon v. Mackinnon [1909] 1 Ch 476 in which Eve J set aside an appointment under a settlement on the basis that Lady Hood had forgotten the existence of a pre-existing appointment in favour of one of her daughters. Lady Hood’s mistake related to a point which lay at the heart of the transaction: see Lord Walker at [121]. This was because the “predominating idea” and “sole origin” of the transaction (using Eve J’s words at p. 479 and p. 481 respectively) was to achieve equality between Lady Hood’s two daughters.

Again, Mr Slater says that in Kennedy (see [37]-[40]) it was a fundamental feature of the tax planning, as instructed by Mr Kennedy and understood by his professional advisers, that the appointment concerned should not give rise to a charge to CGT. And in Wright v. National Westminster Bank PLC[2014] EWHC 3158 (Ch), Mr Wright’s declared aim in setting up a discretionary trust was to provide for his family in a tax-efficient manner. The effect of the trust was that Mrs Wright would not during Mr Wright’s lifetime or even after his death be able to receive income and there was a large amount of contemporaneous evidence (which Norris J accepted: see [19] of his judgment) that he believed that the income from the settlement would be available to Mrs Wright so that they would not lose the income from the settled assets on which they currently relied to maintain their standard of living.

Mr Slater was unrepentant when the Court pointed out that it followed from his submission that in tax planning cases relief could be given for tax mistakes but that it was in those very cases that the Court was likely to refuse relief in its discretion and HMRC was likely to press for such refusal. He said that relief was indeed available in tax avoidance cases where the mistake was a tax mistake, because the mistake would have the requisite “degree of centrality to the transaction”, but that this would be limited to cases of unexceptionable tax avoidance, such as in Pitt v. Holt where the statute itself provided a means of avoiding tax by virtue of s. 89 IHTA or in Kennedy (at [39]): “a perfectly legitimate way of conferring benefit…in a tax efficient manner that was contemplated by express provisions in FA 2006.”

However Mr Slater’s submission amounts to a restatement of the rules in Ogilvie v. Littleboy and Pitt v. Holt. When describing the mistake Lord Walker merely says that it has to be “serious”, “of sufficient gravity”, and it is not helpful to restate it using some other epithet, despite the fact that Lloyd LJ used the word “fundamental” in the Court of Appeal (at [206]) quoted by Lord Walker at [121]. Indeed, Lord Walker disapproved the use of this concept at [115].

In each case, the issue is whether or not the mistake is sufficiently serious. A mistake about the effect of a transaction can meet that test, and although it is true that a matter of fact or law basic to the transaction is required in most cases, it is strongly arguable in any event that the test is met in the present case since the tax consequences have the effect that the loan from Melanie’s father cannot be repaid. I suspect that (although “consequences (including tax consequences) are relevant to the gravity of the mistake, whether or not they are (in Lloyd LJ’s phrase) basic to the transaction”: see Pitt v. Holt at [132]) if the consequence were only that inheritance tax were payable, I would have more sympathy with Mr Slater’s submissions. However, the fact that the tax charge means that the loan cannot be repaid makes all the difference. The settlement was so affected by the tax consequences that its effect was entirely different from that which Melanie believed it to be. It seems to me that this element fulfils Lord Walker’s analysis at [126],

Mr Slater decided not to argue about the legal test for causation, whether the “but for” test applied or not, on the basis that such argument was unnecessary on the facts. I therefore say no more about it.

The court must undertake an objective evaluation of whether it would be unconscionable for the donees to insist on their rights: see Pitt v. Holt at [125]. It must (see [128]),

Mr Slater’s submission is that there is no injustice in maintaining the status quo. The fundamental purposes of the settlement have been achieved despite the inheritance tax charge, namely asset protection and the provision of a home for Melanie and the third defendant. If on the other hand the application succeeded, the third defendant’s remainder interest (as well as his interest as an object of the power of appointment) would be removed and the risks which led to the creation of the settlement would revive.

I propose to deal with these submissions in turn. First, it is not the case on the evidence that Melanie and the third defendant will retain their home as the tax charge is likely to prevent this, bearing Melanie’s asset and earning position in mind and the fact that the loan will be enforced.

Ms Faulkner suspects that it is unlikely that Melanie will in fact be deprived of her home if the transaction is not set aside. She says that it is more than likely that the loan for the purchase of Gibbs Green will be waived. However that is not the evidence, which is that Melanie’s mother Ruth Freedman has no present intention of waiving the loan as this would be inconsistent with her aim of treating all her children equally, and the case has to be decided on the evidence at trial. Indeed, as Miss Stanley pointed out, speculation as to what may happen in the future is futile. As a matter of speculation, Melanie could fall out with her mother which would make her mother even more determined to enforce the loan.

Again, Mr Slater says (in [27 (b)] of his skeleton argument) that Melanie may repay the loan “from other resources”. This is inconsistent with the evidence and the argument is not open to Mr Slater in the absence of successful cross-examination.

Secondly, the risks which led to the creation of the settlement will not revive. The evidence is that the mischief at which the settlement was addressed was Melanie owning two houses. While she only had one, her father removed his charge and forgave the loan. She has now sold St Leonard’s Close and the proceeds will go to Melanie’s father’s estate in accordance with their agreement.

Thirdly, while it is true that the third defendant’s interest will be negatived, and this is an important factor in the exercise of my discretion, the third defendant is a volunteer and Miss Bryant, who acts for him and other beneficiaries in the same position, says that neither he nor they have changed their position in any way which might affect unconscionability. Indeed unravelling the settlement will be for the third defendant’s benefit since if the settlement remains he will inevitably, on the evidence, lose his home. As I have said, Miss Bryant supports Melanie’s claim.

There is also the evidence of Ms Faulkner. She says that if the advance of the purchase price for Gibbs Green was to be a loan then the advice to Melanie’s father in Mr Fraser’s letter of 6 November 2012, “can be interpreted as advice to disguise the loan as a gift for the purposes of avoiding inheritance tax”, and thus as a fraud on HMRC. The part of the letter to which she objects is the passage on the third page. I do not believe that the letter is necessarily to be read in this way. It could be that Mr Fraser was suggesting some arrangement other than a formal loan agreement, even advising that there should be a gift: contrast [15] of his witness statement. In any event Melanie’s father’s intentions (let alone Mr Fraser’s) are irrelevant to Melanie’s intention in settling St Leonard’s Close and Gibbs Green. I do not consider that she would have read the letter in such a way as to understand that a fraud was contemplated (if such was indeed the case): see [24] of Mr Fraser’s witness statement.

The position is that Melanie has made a distinct and serious mistake. The settlement was not created for the benefit of the beneficiaries but to protect Melanie. She now has a large tax liability which affects her ability to repay the loan which she took on the basis that it would be repaid. Taking the matter in the round, it would be unconscionable for the donees to profit from that mistake and insist on their rights under the settlement.

Accordingly I grant the relief sought in the Part 8 claim, setting aside the settlement on the ground of equitable mistake.