The fact that a solicitor's client had lost money because of the solicitor's dishonesty did not of itself entitle the client to be compensated from the Law Society's compensation fund, and if the client's loss was partly caused by other factors, such as a negligent or dishonest valuation or a fall in property prices, then the Law Society was entitled to refuse compensation.
The Court of Appeal allowed the Law Society's appeal against the decision of Mr Justice Ognall, on 30 July 1996, who granted an application for judicial review to quash its refusal to meet five claims by Mortgage Express Ltd for payments out of the Law Society's compensation fund under section 36 of the Solicitors Act 1974.
Genevra Caws QC and Rabinder Singh (Bindman & Partners) for the Law Society; Nicholas Patten QC and Timothy Harry (Lightfoots) for MXL.
Sir Thomas Bingham LCJ said the claims arose out of transactions in which MXL had made a loan on the security of real property. In each case a dishonest solicitor had acted for both MXL and the borrower. MXL relied on a professional valuation which substantially overvalued the property. The purchase being financed at the valuation price had been immediately preceded by another back-to-back sale and purchase transaction at a significantly lower figure, closer to the true value.
In each case the solicitor dishonestly caused MXL to believe that the transaction they were financing was a bona fide transaction at a genuine price, and paid out of the funds provided by MXL without authority and in breach of fiduciary duty. MXL obtained their mortgage security, but when the borrower defaulted and MXL repossessed the property they suffered loss, partly because of the overvaluation and an intervening decline in property prices.
Since the solicitor had been dishonest, and but for his dishonesty MXL would not have made the advances, the Law Society concluded that it had a discretion under section 36(2)(a) of the 1974 Act to make a grant. But it went on to say, in its decision letter of 6 June 1995, that:
whilst [MXL] made an advance of more than the property was worth, the function of the solicitor in acting for a commercial lender is usually to ensure that the commercial lender obtains an effective security for its loan.
The letter concluded:
this was not a case in which a solicitor had personally misappropriated money: the mortgage had been completed and [MXL's] security had been perfected. That the security proved to be inadequate was due to the poor valuation and/or to the fall in property prices. Consequently, whilst the solicitor's dishonesty was a cause of the loss, . . . it was principally suffered in consequence of the overvaluation and the subsequent fall in the property market.
The judge held that the Law Society misdirected itself in law by regarding the duty of a solicitor in a transaction of this kind as being limited to obtaining effective security for the mortgage lender.
Their Lordships disagreed. The Law Society clearly accepted that the solicitor's dishonesty was in law a cause of MXL's loss. To say that the function of the solicitor in acting for a commercial lender was usually to ensure that the lender obtained effective security for its loan was not to say the solicitor had no other function, and there was no reason to doubt that this was ordinarily the solicitor's main function.
The Law Society had always made it clear that the fund was first and foremost a source from which to replace money taken by dishonest solicitors for their own benefit. Their Lordships did not regard that as an unreasonable priority.
MXL had failed to show that the Law Society acted unlawfully in adopting and applying a policy which in effect disallowed claims where the lender's loss derived not from the failure to obtain security but from the inadequacy of the security when the lender came to realise it, whether such inadequacy was the result of overvaluation or decline in property prices or both.