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.
