The illegality principle: Patel (2)

The new principle introduced by the Supreme Court to govern civil claims (other than for restitution) affected by illegality is likely to result in fewer claims being barred, argues Nicholas Strauss QC in the second part of this two-part article

This article examines how the Supreme Court has resolved the fundamental difference of view (apparent in several recent cases in the Supreme Court) between supporters of, respectively, the rule-based principle expressed by Lord Mansfield in Holman v Johnson (1775) 1 Cowp 341, 343, and a more flexible rule based on an assessment of all the relevant factors in any given case and proportionality. 

In Bilta v Nazir [2016] AC 1, Lord Neuberger said that the earliest opportunity should be taken to address the proper approach to the illegality principle with a seven- or nine-member court. Patel was that opportunity.

As explained in part one of this article (Counsel, April 2017), the court unanimously decided that a party to an illegal transaction could undo it and recover money or property transferred under it in an action for unjust enrichment. It also considered the general principle in all cases involving illegality, including cases in which the claimant sought to enforce, rather than undo, the transaction.

Starting principles

Despite a radical difference of view between the majority, expressed in Lord Toulson’s judgment, and the minority (Lords Sumption, Mance and Clarke), the starting point for all nine judges was the principle formulated by McLachlin J in the Canadian case of Hall v Hebert [1993] 2 SCR 159 at 175-180, that it was the court’s duty to enforce the rights of the parties, unless to allow the claim would undermine the integrity of the law. Lord Sumption said that the court should fulfil its duty to provide remedies in support of the parties’ legal rights, subject only to the principle that ‘for reasons of consistency the courts will not give effect, at the suit of a person who committed an illegal act... to a right derived from that act’: this was the ‘narrowest possible’ formulation of the illegality rule.

However, the majority view that has prevailed is that, even where to allow the claim would give effect to a right derived from an illegal act, it is still necessary to consider whether to refuse a remedy would be against the public interest or disproportionate. The decisions of the Supreme Court in Hounga v Allen [2014] 1 WLR 2889 and of the Court of Appeal in Parkingeye Ltd v Somerfield Stores Ltd [2013] QB 740 to similar effect were approved.

In the key passage in his judgment, Lord Toulson identified what he called the ‘trio of considerations’:

‘... in assessing whether the public interest would be harmed… it is necessary to consider (a) the underlying purpose of the prohibition… and whether that purpose will be enhanced by denial of the claim (b)... any other relevant public policy on which the denial of the claim would have an impact and (c) whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts.’

He also approved the ‘range of factors’ approach suggested by Professor Burrows in his Restatement of the English Law of Contract, which included factors such as how serious the illegality was, how central to the transaction and how serious denying the claim would be for the claimant. There was no limit on other factors that might also be relevant, including for example a ‘marked disparity in the parties’ respective culpability’. He also cited the dictum of Lord Wright in Vita Food Products Inc v Unas Shipping Co Ltd [1939] AC 277, 293 that the public interest might be better served by refusing to nullify a contract save on serious and sufficient grounds.

There has thus been a move away from a strict rule disallowing claims based on illegality to a much more open one that takes into account the detailed facts of the case and the importance, where possible, of doing justice between the parties.

In another important passage, Lord Toulson stressed that part of the harmony of the law was the division of responsibility between the criminal and civil courts. Punishment was not generally the function of the civil courts; they should not undermine the effectiveness of the criminal law, but nor should they impose what would in substance be an additional penalty which might be disproportionate to the seriousness of the wrongdoing. Since almost all civil cases involving illegality issues arise from a breach of the criminal law, this means that it will be now necessary to consider first, whether it would undermine the criminal law to allow the claim, and, secondly, even if it would, whether it would be disproportionate to disallow it. No detailed help is to be found in Patel as to where the line is to be drawn.

Other means of satisfying the public interest

There are also indications in the judgments that a court might be able in some cases to satisfy the public interest in upholding the criminal law by inviting an application under the Proceeds of Crime Act 2002, or possibly by some other form of payment for the public good, as suggested in the Australian case of Nelson v Nelson (1995) 184 CLR 538. More simply, it is almost always open to a court to send the papers to the Director of Public Prosecutions or the Crown Prosecution Service, or to an appropriate regulator, for them to consider whether it is in the public interest to bring criminal or disciplinary proceedings resulting in or proportionate penalty.

The minority strongly disapproved of the new principle, on the same ground (amongst others) that the House of Lords had in Tinsley v Milligan [1994] 1 AC 340 objected to the public conscience test, namely that it substituted judicial discretion for a principled rule. It has been suggested that first instance decisions, unless irrational, will now be unappealable in the same way as are case management decisions. But nothing to that effect was said in Patel and in the writer’s view, while decisions may be discretionary in nature, they will not be discretionary in law: cf Les Laboratoires Servier v Apotex Inc [2015] AC 430 at [14] per Lord Sumption.

Binding decision or obiter?

How far Patel is binding is doubtful. The decision that illegality will not affect restitution claims is clearly binding. But there are passages in the judgments of both Lord Neuberger and Lord Mance suggesting that everything else may be obiter. Lord Mance said pointedly that it was unnecessary for the court, in order to reach its decision, to rewrite the whole law of illegality.

Therefore, if there is already an appellate decision based on Lord Mansfield’s principle, indistinguishable on the facts, should a first instance judge treat it as binding or reconsider it applying the new flexible approach? This arose in Henderson v Dorset Healthcare University NHS Foundation Trust [2016] EWHC 3275 (QB). The claimant had stabbed her mother to death when suffering from mental illness, and pleaded guilty to manslaughter on the ground of diminished responsibility: she had no significant personal responsibility. The event was caused by the defendant’s negligence in failing to respond to her mental collapse.

Jay J held that there was binding appellate authority, Clunis v Camden and Islington Health Authority [1998] QB 978 and Gray v Thames Trains & Ors [2009] 1 AC 1339, which could not be distinguished and which precluded recovery of several heads of the damages claimed on the ground of public policy. He rejected a submission that, while the decision of the Court of Appeal in Clunis was not expressly disapproved in Patel, it was inconsistent with the flexible approach established in it and was impliedly overruled. He held that the doctrine of precedent required a court to apply the explicit reasoning of a higher court on the facts before it. It did not permit a court to draw logical inferences from statements of general application, in order to justify departing from other binding authority. He cited the dictum of Lord Halsbury in Quinn v Leatham [1901] AC 495 to the effect that the generality of expressions in a judgment are not intended to be explanatory of the whole law, but are governed by the particular facts of the case. Clunis and Gray had to be followed.

If Jay J is right, Patel may be of limited application in first instance decisions. There has been a great deal of binding appellate authority over the past two centuries based on Lord Mansfield’s principle, covering many different fact situations. It may be necessary – as in Henderson – to get to the Court of Appeal or the Supreme Court for effect to be given to the trio of considerations and proportionality.

If this is the position, it is a paradoxical result. The nine-member court in Patel was convened precisely in order to resolve, once and for all, the longstanding differences between appellate judges as to the applicable principle. Lord Toulson’s judgment clearly was intended to be an exposition of the whole law. But the Supreme Court has not, so far, altered the doctrine of precedent. Lord Toulson’s judgment will be very persuasive authority where there is no existing binding authority. However, in many cases first instance judges will have to follow previous decisions which were based on the very principle that has been rejected by the majority in Patel.

A worked example: HMRC tax fraud

For example, contracts of employment where the parties have defrauded the tax authorities by paying salary in the guise of expenses: if a claim for wrongful dismissal came before a court, unaffected by previous authority, it would have no difficulty in enforcing the contract, while dealing with the illegality simply by reporting it to the tax authorities. HMRC is the authority whose job it is to enforce tax law and it has ample powers to prosecute or to impose penalties proportionate to the offence, as it considers appropriate in the public interest.

Allowing the claim while leaving it to HMRC to deal with the tax fraud would not involve giving effect to the illegal agreement to evade tax, and it would respect the integrity of the law and the division of responsibility between different parts of the state’s machinery for law enforcement. It would not be justifiable for the court to impose an additional penalty on the employee by disallowing his claim, which would simultaneously have the undesirable effect of rewarding the even more blameworthy employer.

But there are two Court of Appeal decisions, Miller v Karlinski (1945) 62 TLR 85 and Napier v National Business Agency Ltd [1951] 2 All ER 264 in which the employee’s claim has been dismissed on public policy grounds and which could not be distinguished. In both cases, the court refused to sever the unlawful part of the contract and allow the claim to the extent that it was based on legitimate wages.

Therefore, if Jay J was right in Henderson, Miller and Napier would have to be followed by a first instance judge. Possibly the court might apply an exception to stare decisis set out in Young v Bristol Aeroplane Co Ltd [1944] 1 KB 718 on the basis that, even though these Court of Appeal authorities have not been overruled, they cannot stand with the decision in Patel. But an argument to that effect failed in Henderson and would founder if what is said about the general illegality principle in Patel is not part of the ratio. The case would have to go to the Supreme Court before the law could be reconsidered.

Addressing the illogicality

The judgments in Patel seek to address the illogicality that has arisen in this area of the law, and will result in the courts being readier than formerly to decide the issues between the parties and to find other means of dealing with illegality than by barring the claim.

That will certainly be so where the claim is for recovery of money or property transferred under illegal transactions. And in the writer’s view it will often be so in other cases. The starting point will be the old principle, as restated by Lord Sumption. Is the court being asked to give effect to the illegal transaction or to a right derived from it? But even if it is, it may be disproportionate or not in the public interest to bar the claim. And it may sometimes be possible, even if the claim is barred, to find a way to deprive defendants of their gains. 

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.