Put another way, how does the court balance two competing policies: (1) clients who have suffered loss as a result of a professional’s negligence should be entitled to recover damages, and (2) a claimant should not be allowed to benefit from their own wrongdoing; the law should not condone illegality.

Having redefined the illegality defence (also known by the Latin maxim ex turpi causa ) in Patel v Mirza in 2016, the Supreme Court has now provided a valuable example of how the competing policy considerations should be applied in a professional negligence context in Stoffel & Co v Grondona (2020). Whilst it is a claim involving a solicitor defendant, the Court’s approach is relevant to all professionals, including accountants.

The illegality defence – Patel v Mirza test

In Patel v Mirza, the Supreme Court introduced a new test, holding that an illegality defence should only succeed if allowing a claim tainted by illegality would damage the integrity of the legal system, giving consideration to:

• the underlying purpose of the prohibition which has been transgressed and whether that purpose would be enhanced by denial of the claim,
• any other relevant public policy on which the denial of the claim may have an impact and
• 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.

At stage (c), potentially relevant factors could include the seriousness of the conduct, its centrality to the contract, whether it was intentional and whether there was marked disparity in the parties' respective culpability. Unfortunately, the flexibility of the test has led to uncertainty as to how it may be applied.

Stoffel & Co v Grondona – facts and decision

Ms Grondona (G) made fraudulent misrepresentations to Birmingham Midshires (BM) to obtain a mortgage (as part of a scheme where she used her good credit history to raise capital for Mr Mitchell (M), in return for 50% of the profit when a property was sold). Stoffel & Co (Solicitors) acted for G, M and BM, but negligently failed to register the transfer to G and the charge, leaving M as the registered owner, and BM without a charge. G defaulted on the mortgage and BM obtained judgment against her, following which G sought damages from the Solicitors. The Solicitors’ illegality defence failed.

Stoffel & Co v Grondona - the Supreme Court’s reasoning

The Supreme Court had to balance the competing policy considerations.

The Supreme Court doubted that permitting a civil remedy against a negligent solicitor would significantly undermine the criminalisation of mortgage fraud, as the risk of being left without a civil remedy was unlikely to feature in the fraudster’s thinking. Refusing relief would not therefore enhance the deterrent effect of the prohibition against mortgage fraud

Conversely, it was important that conveyancing solicitors should perform their duties to clients diligently, without negligence, and clients should be entitled to recover losses arising from a negligent breach. To allow the Solicitors to escape liability would run entirely counter to this policy. The Supreme Court considered there was more chance of mortgage fraud being prevented if the defence failed and solicitors appreciated that they should question any potential irregularities in a transaction.

Central to the Court’s decision was the need to avoid inconsistency which would damage the integrity of the legal system. The law allowed an equitable interest in the property to pass to G despite the illegality, so it would be incoherent to disallow the claim against the Solicitors on the grounds of the same illegality.

In addition, denying the claim would be disproportionate as the illegal conduct was not central to the breach of duty by the Solicitors.

What does this mean for the illegality defence going forward?

The outcome in Stoffel is disappointing to professionals and their insurers. The Solicitors had already reached a settlement with the lender and the claimant – a knowing participant in mortgage fraud - was allowed to recover from solicitors who, whilst incompetent, were not complicit in the fraud.

Against that, the fraud was not central to the negligence claim and merely provided the background to it. The transactions were genuine and the Solicitors were not retained to further the fraud itself. G was not seeking to profit from the claim but simply to discharge or reduce her liability to BM. The Court may also have been influenced by the number of potential irregularities in the transaction which should have put the Solicitors on notice of the possibility of fraud.

The Supreme Court has provided some guidance on how the “trio of necessary considerations” in Patel v Mirza should be applied. The evaluation should not be mechanistic, and at stages (a) and (b) should be at a relatively high level of generality. If that evaluation suggests the claim should be denied, only at stage (c) should the court give close scrutiny to the detail of the case.

The decision in Stoffel was reached because of the importance the Court attached to the consideration that professionals should perform their duties without negligence and that clients should have a civil remedy in the event of negligence.

Whilst the Stoffel case concerned solicitors, the accountancy profession has its own history of the application of the illegality doctrine, most famously with the House of Lords case of Stone & Rolls v Moore Stephens in 2009, where the doctrine was successfully applied on somewhat extreme facts - the claimant, insolvent, company, was set up to undertake the very same, large, fraud at the heart of the claim. Whether the courts will side again with auditors facing claims brought by companies brought down by fraud looks questionable in light of the Supreme Court’s decision in Stoffel. In Stone & Rolls, the illegality defence was founded upon a neat application of legal principles very different to the public policy considerations underpinning the tests in Patel v Mirza. The thorny question for the courts of when out of pocket creditors of insolvent companies should be left without a remedy against the auditors (who failed to spot, but were also the victims of, the fraud), is ripe to be re-tested.

Going forwards, it will be harder for a negligent professional to defend a claim on the basis of illegality, but not impossible. The door has been left open, but the balancing act now feels further tilted against the professional.