Supreme Court restates the illegality defence

Executive summary

This recent decision of the Supreme Court has restated the law in relation to the “illegality” defence. Illegality will no longer be an absolute bar to bringing a claim; instead, when faced with a claimant seeking to bring an action arising from illegal conduct, the court will consider multiple factors in reaching its decision.

In particular the court should consider a) the underlying purpose of the prohibition which has been transgressed 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 may have an impact and c) whether denial of the claim would be a proportionate response to the illegality.

The Supreme Court has not prescribed or limited the factors which could be relevant to that exercise of judicial discretion. Factors expressly identified as potentially relevant include the seriousness of the (mis)conduct, its centrality to the matters giving rise to the civil claim, whether it was intentional and whether there was marked disparity in the parties’ respective culpability.

Whilst formally approving a new, more flexible approach, the Supreme Court nonetheless requires a principled and transparent approach to the factors identified by the judge as relevant to a particular case. The overall aim of the court, when considering whether to refuse relief on grounds of illegality, will now be (i) to maintain the underlying objectives of the law (as engaged by the case in question, and the underlying illegality to which it refers) and (ii) consistency with public policy.

Previous position

Prior to this case, the law in England and Wales prevented a claimant from bringing a claim if in doing so he relied on facts amounting to illegal conduct on his part - such as the commission of a crime or entering into a contract to perform illegal activities. That (much criticised) rule is long-standing, being derived from the 1775 case of Holman v Johnson. More recently, the illegality defence has been applied by reference to the “reliance test”, set out in the judgment of Lord Goff in Tinsley v Milligan [1994] 1 AC 340. The reliance test gave effect to the principle that an absolute rule was needed to ensure certainty regarding the illegality defence at common law.

Facts

The Defendant, Mr Mirza, purported to have inside information on a government announcement that (if made) was likely to impact the RBS share price. The Claimant, Mr Patel, transferred to Mr Mirza a large sum of money for the purpose of purchasing RBS shares in order to profit from the expected move in the RBS share price at the time of the announcement. Such an arrangement amounts to a contract to commit a crime of insider dealing under section 52 of the Criminal Justice Act 1993. Following the transfer of the money, the government announcement did not materialise and Mr Mirza subsequently refused to pay back the money transferred.

In his defence, Mr Mirza claimed that Mr Patel was barred from making a claim on the basis that in order to make a claim; Mr Patel would be relying on the existence of a contract to commit a crime. The High Court, applying Tinsley, agreed that the reliance test barred Mr Patel from making such a claim. The Court of Appeal agreed with the High Court on the application of the reliance test but disagreed that the exception of voluntary withdrawal did not apply, instead finding that as the illegal contract was not executed, Mr Patel could bring himself within that exception. Gloster LJ in the Court of Appeal made convincing argument that it would not be just and proportionate for the Claimant to be denied the return of his money. On appeal, the Supreme Court then examined the rule of illegality in Tinsley due to the criticism it has received both in the Court of Appeal and from other sources.

Criticism of the reliance test

Many critics have argued that although the Tinsley reliance test is intended to provide certainty and consistency of the law, the inherent variability of illegal conduct means that an absolute test is difficult for the court to apply without constraining the court’s ability to do what it believed just and proportionate on the facts of a particular case. It should also be noted that, in coming to his decision in Tinsley, Lord Goff expressed his discontent with the result, when applied to that case, and recommended that there be legislative change (driven by the Law Commission) in respect of the illegality defence.

After Tinsley, the Law Commission did consider the illegality defence and, in its 2010 report, suggested statutory reform of the law of trusts and unjust enrichment. In its consultation, the Law Commission considered the more flexible approaches to illegality adopted in other jurisdictions such as New Zealand, Australia and the United States, finding that the more flexible approach seen in those jurisdictions did not result in greater uncertainty. In addition, the Law Commission considered recent domestic case law and noted that the reliance test was being applied inconsistently, thus undermining the certainty which it aimed to achieve. In spite of these findings and citing trust law as not being a priority, the government declined to consider the draft bill produced by the Law Commission.

Case analysis

Much of the discussion by the Supreme Court centred on whether the rule in Tinsley achieved the objective of legal certainty. Lord Toulson gave the leading judgment, supported by Lady Hale, Lord Kerr, Lord Wilson and Lord Hodge. Lord Toulson discusses the various merits and disadvantages of the rigid versus flexible approaches that can be taken to illegality, and their interplay with the court’s ability to achieve a proportionate and just result in individual cases. In doing so, he - much like the Law Commission - makes comparisons with jurisdictions such as Canada, Australia and the United States in which a more flexible approach is taken and notes that there is no apparent uncertainty in the law of illegality in any of those jurisdictions.

In his judgment, Lord Toulson also addresses the “integrity of the law” - the notion that a court should not enforce a claim which would undermine the objectives behind legislation and the legal system generally. This is recognised in a number of jurisdictions as a central policy objective of the illegality defence. It also brings into focus the importance of public policy considerations in this area. Lord Toulson explains that the court cannot be seen to be preventing profit from an illegal act on the one hand, yet allowing it on the other.

On the facts of this case, Lord Toulson found that if Mr Patel be barred from bringing a claim, Mr Mirza would be aided by the court in profiting, to his unjust enrichment, from a contract to commit a crime. From a public policy perspective, allowing this claim would not undermine the objectives of the law, as Mr Patel is not being permitted to profit from an illegal contract and permitting the claim prevents Mr Mirza from profiting from his intention to participate in such a transaction. On that basis, allowing Mr Patel’s claim was seen as consistent with maintaining the integrity of the legal system.

Not all of the nine sitting justices agreed with Lord Toulson’s dismissal of the Tinsley reliance test in its entirety. Lords Neuberger, Mance, Clarke and Sumption disagreed that the law has led to inconsistent results, so long as restitution is possible. They argue that, where an illegal arrangement has resulted in one party being benefitted to the detriment of the other, and where restitution, (defined as putting the parties in the position they would and should have been had the illegal arrangement not been made) is possible, a claimant ought to be able to bring a claim for restitution. Notably, Lords Neuberger, Mance, Clarke and Sumption express concern that a wholesale replacement of the existing law with a fluid and unsettled concept of multiple factors will lead to inconsistency and therefore only endorse the use of that more fluid approach where restitution is not possible. Their judgments dissent (in the minority) from Lord Toulson on the question of whether the flexible application of multiple factors is appropriate when restitution is possible.

It remains unclear as to how a court will approach the application of these principles in future cases. Given the rarity of claims based on an underlying illegal fact pattern, this lack of clarity may exist for some time. Nonetheless, the Supreme Court has taken positive action to restate the law in this area and Claimants seeking to rely on illegal conduct in support of their cause of action may now have greater latitude to do so.