The illegality principle: Patel (1)

Money or property transferred pursuant to an illegal transaction is recoverable following the seminal case of Patel v Mirza. Nicholas Strauss QC examines the case and its implications in the first of a two-part feature

Most lawyers remember, even if little else, Lord Mansfield’s dictum in 1775 ‘ex turpi causa non oritur actio... potior est conditio defendentis’ and many are aware of the ensuing 240 years of chaotic case law resulting, as Lord Sumption has said, from the courts’ distaste for applying their own rule. 

Patel v Mirza [2016] UKSC 42 represents a determined effort by the Supreme Court to sort this out, and will result in fewer frequent victories for lucky defendants.

The decision of the Supreme Court is important for two reasons:

  1. The court unanimously disapproved the much-criticised reasoning of the House of Lords in Tinsley v Milligan [1993] UKHL 3 and established that an unjust enrichment claim to recover money or property transferred under an illegal agreement will usually succeed, even if the claimant has to rely on the illegality to found the claim.
  2. By a majority, the court has preferred a flexible principle based on proportionality and a balance of public policy considerations to govern all illegality cases, instead of the strict ex turpi causa principle established by Lord Mansfield in Holman v Johnson (1775) 1 Cowp 341 at 343.

This article considers the first aspect; part two will consider what the Supreme Court said about the general principle in illegality cases.

Tinsley and the public conscience test

The facts of Tinsley are well known. Miss Tinsley and Miss Milligan were tenants in common of a house, but it was put in Miss Tinsley’s sole name to facilitate a social security fraud. Miss Milligan confessed and she and the Department of Social Security came to an arrangement. Then she sought to enforce her equitable right to half the house in answer to Miss Tinsley’s claim for possession.

In the Court of Appeal, the majority, Nicholls and Lloyd LJJ, applied the so-called public conscience test. In all the circumstances, would it shock the ordinary citizen to allow the claim? The answer was no: both parties were liable to criminal sanctions, but there was no justification for imposing a disproportionate extra penalty on one party.

The House of Lords unanimously disapproved the public conscience test, holding that it amounted to judicial discretion. It upheld the Lord Mansfield principle: an action founded on illegality must be rejected.If Miss Milligan had been Miss Tinsley’s mother, instead of a friend, her claim would have been barred because, since she would have had to rely on illegality to make it, it was founded on illegality. She would have lost her half of the house.

Thus, in a case in which the court was not asked to enforce the illegal transaction, and in which the authority responsible for prosecutions had decided that it was not in the public interest to prosecute, the House of Lords would in effect have overridden that decision and, by forfeiting the plaintiff’s property, imposed a far more severe penalty than any that a court would have imposed if there had been a prosecution. Theproperty would not have been forfeit to the state, but would have been given to the equally guilty defendant.And the House of Lords would have failed to do its day job, that is to do justice between the parties.

The House of Lords by a majority escaped from the unpalatable results of the illegality principle only by holding that Miss Milligan could rely on the presumption arising from her contribution to the purchase price.So framed, the claim was not founded on illegality. The court was of course fully aware of the illegality but that did not matter.The illegality rule – of all rules – was now described as ‘procedural’ only, and all depended on whether the plaintiff benefited from a presumption.

The later case of Collier v Collier [2002] EWCA Civ 1095 was father against daughter, and the presumption was that the transfer was a gift. The father had to rely on the illegal transaction and he lost.

Illegal transactions and restitution claims

Patel raised the same issue. The facts were that the parties had conspired to profit from illegal insider trading, using information which Mr Mirza expected to obtain. Mr Patel paid Mr Mirza £600,000 to finance the scheme, but no information was obtained and no trading took place. Mr Patel wanted his deposit back.

In the Supreme Court, the issue was whether Tinsley, Collier and other cases were right. If a claimant was not seeking to enforce the illegal transaction, but to recover money or property transferred under it, was the claim barred because it was founded on illegality? SinceMr Patel had to rely on the illegality to establish his claim, Lord Mansfield’s principle was an obstacle. The action was founded on illegality, and according to the prevailing principle should have failed, as Mr Patel had no presumption to fall back on.

The Supreme Court held that, as a general rule, a claimant can recover money or property transferred under an illegal transaction in an action for unjust enrichment, on the basis that the consideration for the payment has failed. Such a claimant is asking the court to undo the illegal transaction, not to enforce it.

Lord Sumption avoided Holman by a slight but neat alteration to the formulation of the principle. Instead of ‘no court will lend its aid to a man who founds his cause of action on an illegal act’ – Lord Mansfield – the principle stated by Lord Sumption was ‘... the courts will not give effect to an illegal transaction or to a right derived from it’. Even though Mr Patel’s claim was founded on an illegal agreement, he was not seeking to give effect to it, or to claim a right derived from it. He was seeking restitution of the property he would have had if he had never entered into the ineffective transaction.

The majority of the court applied the more flexible principles referred to earlier, but reached essentially the same conclusion. Lord Toulson, with whom four other justices agreed, said: ‘Mr Patel is seeking to unwind the transaction, not to profit from it.’

Thus, although there may be exceptional cases, an action for the restitution of property transferred under an illegal transaction will not in general be barred. Lords Neuberger and Sumption disagreed with a suggestion in Lord Toulson’s judgment that there might be an exception for money paid to finance heinous crimes such as murder or drug trafficking: they considered that the recipient of such a payment should be liable to repay it, whether or not the crime had been committed.

Possible defences

Nothing was said in the majority judgment as to what defences might be available, but in principle alteration of position should be a defence, and all the other four justices supported this.

However, two difficulties would arise if the alteration in the defendant’s position resulted from illegal dealings. For example, what would the court have decided if there had been illegal trading resulting in Mr Mirza’slosing £100,000. Would he have had a defence to the extent of the amount of the loss, £100,000, or perhaps for half of it, £50,000.

But for the illegality, Mr Mirza would have had the defence of alteration of position, but the first difficulty is that there is authority that the defendant to an unjust enrichment claim cannot rely on illegal dealings: see Barros Mattos Junior v General Securities [2004] EWHC 1188 (Ch).

Second, anything approaching the taking of an account between partners in crime would run up against that old chestnut, the ‘Highwayman’s Case’, Everet v Williams [1725], in which it was held that no claim for an account of illegal dealings was permissible. To allow such a claim would be tantamount to enforcing the illegal contract.

There is little in the judgments to help on this and the position is uncertain, but it does not seem right to allow the claimant to recover money paid under an illegal contract, whether or not performed, but then not to allow the defendant to rely on an alteration of position resulting from the same illegal contract. Also, it would be odd to disallow an alteration of position defence on public policy grounds, when the courts are obliged by statute to apportion liability between joint tortfeasors, and the tort will in some cases have involved illegality.

Apart from that quite important unresolved issue, this part of the law now seems clear. Tinsley is no longer good law. Money or property transferred pursuant to an illegal transaction is recoverable. Theillegality defence will no longer be available as an answer to such a claim

Contributor Nicholas Strauss QC, One Essex Court. The writer’s more detailed views are to be found in articles in 132 LQR 236 and 2016 Restitution Law Review 145

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Nicholas Strauss QC

Nicholas is a barrister, arbitrator and mediator practising at One Essex Court, Temple.