Tuesday, 2 December 2014

Lender and client relationship and the potential for conflict



Article by Georgie Harrington - Trainee Lawyer 

Where a client seeks the aid of a mortgage, they are no longer the only party legally represented. Where the same firm of solicitors represents the client and lender, there are many scenarios in which a conflict of interest may arise.

This article will focus on the unusual, yet extremely important scenario whereby the client creates a charge in the property in favour of the lender for the purpose of providing financial support and benefit to another party. This scenario is known to the conveyancing industry as “third party security”.

What is third party security?

A modern example is that of a second mortgage against a property to create a source of capital to finance the start-up of a new business. It is obvious to assume this arrangement may be between a married couple or partnership, but this is not always the case.

The potential for conflict

(1) The danger within such an arrangement is largely associated with the right the lender has to reclaim possession of the property from the third party for default in payment.

(2) Furthermore, a “client conflict” may arise if a solicitor opts to act for the third part, borrower and the lender.  Chapter 3 of the SRA handbook describes client conflict as: “any situation where you owe separate duties to act in the best interests of two or more clients in relation to the same or related matters, and those duties conflict, or there is a significant risk that those duties may conflict”.


Case Law

The topic of third party security cannot be discussed further without reference to the leading judgment of Royal Bank of Scotland plc v Etridge (No.2). The House of Lords declared how lenders are to operate under these circumstances as well as steps to be satisfied by the acting legal representative.

The case involved a wife acting as the third party, who sought her property for security to account for her husband’s debts. The loan was not repaid to the lender and repossession was claimed on the property. The wife attempted to sue the solicitors for professional negligence on the grounds that they had not acted within their duty to advise accordingly. The question considered by the Court of Appeal was: Had the wife been properly advised, would she have signed the necessary documents to enter into such a transaction? The Court of Appeal held that the solicitors firm were in breach of their duty as they has failed to evaluate and advise the wife of the risks.


Judgment requirements

Lender responsibility
Solicitor responsibility
Write to the third party informing that for their own protection, the lender will require written confirmation from the solicitors that the nature of the charge will be explained.
Explain to the client that the lender may rely on the written confirmation from them that the nature of the transaction and charge has been sufficiently explained.
Ask that the third party instruct a solicitor. It is for the solicitor to decide whether there is a potential conflict of interest in taking on the instruction for the third party, borrower and lender and whether this is in the best interests of the client.
Seek confirmation that the third party is happy for legal representation under the circumstances and advise accordingly thereafter of the legal and practical implications.
Provide the third party with the financial information necessary for advice to be provided accordingly.
Check that no earlier lending is secured under the third party’s guarantee.
Provide the solicitors with any information that is reasonably considered may evidence the fact that the third party has been mislead in coming to such a decision.
Explain the nature of the documents to be executed by the client and the consequences of entering into the transaction. The solicitor must obtain consent from the client to write to the lender confirming this has been explained to the client.
Do not proceed on the transaction without written confirmation from the solicitor.
Discuss the client’s financial means and whether any other assets may be the subject of repayment in place of third party security. The solicitor can at this point offer to negotiate the terms of the transaction with the lender under instruction of the client.

Meet with the client face to face without the borrower present. An attendance note of the meeting is necessary.


Decision in Etridge

The consideration of Lord Neuberger M.R. was that the length of the client meeting in relation to third party security did not necessary satisfy the duty the solicitor has in advising the client. Mere advice to proceed was simply not sufficient: “…she should have been told in clear terms that a hurried short meeting was simply inappropriate, bearing in mind the importance, riskiness and probable pointlessness of the transaction she was about to enter into…”. The solicitor acting on behalf of the wife did not recall the meeting with her and therefore was not able to give any real evidence that the advice provided was satisfactory for the purposes of his duty to the client. All the solicitor was able to offer was that of what his usual practice with clients would be. The court founds that, had the wife been properly advised, the wife would not have signed the documents to the transaction.

Conclusion

The requirements listed within the table above were considered to bet he core minimum to be obliged by the lender and solicitor in their relationship and capacity to the third party, to ensure they enter into the transaction with realistic understanding of the implications and risks involved. Equally allowing the lender the comfort to make the necessary loan without fear that the transaction will be set-aside in the future. The solicitor must exercise their due skill and judgment in every individual case of such a nature and whether to act on the matter. It is a modern day requirement of a solicitors firm, acting in this capacity, to check their insurer’s conditions that they may even be covered to proceed in doing so.

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