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Freedman v Freedman: A review of the law on equitable mistake

Published November 2015

Clare Stanley QC acted for the claimant settlor; Judith Bryant appeared for the minor defendant; Jonathan Davey appeared for the fourth defendant.

The implications of the Supreme Court’s decision in Pitt v Holt on the law of equitable mistake are still being hammered out on the anvil of decided cases. Alongside the so-called ‘rule in Re Hastings-Bass, equitable mistake is a potentially powerful tool for claimants wishing to set aside voluntary dispositions, and Freedman v Freedman [2015] EWHC 1457 (Ch) is an important and notable example of a successful application to set aside a settlement on this basis.

The relevant settlement, containing two houses, had been established on the advice of the settlor’s father and professional solicitors, and had the broad purpose of preventing ‘predatory males’ from obtaining interests in the properties. Significantly, the settlement was entered into subject to an agreement that the settlor’s father, who had loaned money to the settlor to purchase the properties, would be repaid from the proceeds of sale of one of the properties. The relevant mistake by the settlor was that she (or, rather, her advisers) did not appreciate that certain Inheritance Tax charges would result from the settlement, meaning that she would not be able to repay the loan. Proudman J reviewed the law on equitable mistake and set aside the settlement.

In Pitt v Holt, the test for when a voluntary disposition (such as a gift or settlement) could be set aside on the grounds of equitable mistake was recast as follows. There must be a distinct and causative mistake (which is not mere ignorance, inadvertence, or a misprediction) which is sufficiently serious as to make it unconscionable on the part of the donee to retain the property. In assessing unconscionability, the Court must consider the circumstances in the round, including the seriousness of the consequences of the mistake.

Notably, in Pitt v Holt, Lord Walker stated that in some cases of artificial tax avoidance the Court might think it right to refuse relief, either on the ground that such claimants, acting on professional advice, must be taken to have accepted the risk that the scheme would prove ineffective or, more controversially, on the ground that discretionary relief should be refused on grounds of public policy. Moreover, it should be remembered that in cases where professional advice had been taken, there might well be an alternative course of bringing a claim against the relevant adviser (who, of course, will commonly have the benefit of professional indemnity insurers).

Against this backdrop, one might have expected a claimant in the position of Ms Freedman to face an uphill task, particularly in circumstances where HMRC actively opposed the application.  Indeed, as has been observed before, one of the factors in the ‘rule in Re Hastings Bass’ becoming so claimant-friendly was the fact that many applications invoking the doctrine went unchallenged by HMRC.  It was only when the Revenue intervened in Pitt v Holt and Futter v Futter that the doctrine received appellate attention.  The same point can be made about the law of equitable mistake. In one of the most famous examples of equitable mistake being successfully invoked – Re Griffiths deceased [2008] EWHC 118 (Ch) – Lewison J did not have the benefit of adversarial argument and the doctrine of equitable mistake was allowed to expand.

However, notwithstanding HMRC’s opposition, the application in Freedman succeeded. Proudman J held that there was a distinct mistake (as opposed to mere ignorance) in Ms Freedman ‘broadly understanding’ that the advice obtained from the solicitor indicated that there were no issues as to Inheritance Tax. Secondly, Proudman J held that the (unilateral) mistake as to the tax consequences of the settlement was sufficiently serious, particularly in circumstances where it had the result that the loan to the settlor’s father could not be repaid.

Each of these conclusions warrants scrutiny. As to the distinct mistake, in a situation where tax consequences had not been considered, the Court was willing to find a tacit assumption on the part of the settlor that tax would not present a problem.  HMRC, and future defendants in this type of case, may feel chastened by the Court’s approach to the evidence in this case. HMRC had elected in the circumstances of this particular case not to cross-examine any of the claimant’s witnesses, meaning (quite correctly) that Proudman J took HMRC to have accepted evidence which was not incredible.  However in different circumstances in future such cases, in situations where fine lines have to be drawn between ignorance and tacit understandings, it may be that stress-testing what exactly was (and was not) considered by the settlor will be the key to mounting a successful defence.

As to Proudman J’s second critical conclusion – that the tax consequences were sufficiently serious to make it unconscionable not to set the disposition aside – it should not come as a surprise that such an argument was capable of succeeding. Indeed, Lord Walker in Pitt rejected as “much too wide” HMRC’s submission that relief should always be refused where the mistake in question concerned the tax consequences of a transaction. (Of course, Mrs Pitt’s claim on this very basis proved ultimately successful in the Supreme Court.)

However, it is extremely difficult to glean much guidance as to what sort of adverse tax consequences will ground a successful claim. In Freedman, it was held to be important that the underlying agreement that the settlor’s father would be repaid with sale proceeds of one of the properties would no longer be possible if the relevant taxes had to be paid. However, the idea of ‘underlying objective’ cannot be taken too far.  In many commercial contexts, of course, the commercial objective of a transaction may depend to a great extent on tax consequences turning out as expected. Or, indeed, the tax consequences may be the commercial objective of setting up a structure such as a trust. In the current climate, one cannot escape the conclusion that value judgements are at play as to the type of voluntary disposition that is under consideration. One might ask whether Lord Browne-Wilkinson’s famous, but slippery, distinction of commercial and traditional trusts in Target Holdings v Redferns [1996] AC 421, might have a role to play in considering prospects of success of such applications.

One final matter of practical importance should be noted. The more receptive the Courts are to claims such as these, the more impact there will be on the related claims in professional negligence. A well-advised defendant facing a claim may require (and indeed fund) a claimant to attempt first to set the failed disposition aside. Otherwise, a claimant will face a credible argument that she has failed to mitigate her loss. In any event, cases such as Freedman will do much to encourage claims based on equitable mistake.

Written by James Goodwin

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