Residential: checking a seller’s solvency

Listen to good advice

13 January 2016

Is there a duty on the conveyancing solicitor to check a seller’s solvency, asks Fiona Pearson

A High Court decision earlier this year resulted in headlines suggesting that there is no duty on a purchaser’s solicitor to check a seller’s solvency.

What the court was in fact considering in the case concerned, Kandola v Mirza Solicitors LLP [2015] All ER (D) 26 [Mar], was how far beyond the normal pre-contract searches and enquiries the solicitor should go. It was held that there is no general duty on a solicitor to check the credit status of the seller in a conveyancing transaction unless expressly instructed. In most situations, the solicitor will of course become aware of a seller’s insolvency as a notice or restriction on the title will be revealed on the official search of the registered title.

However, in Kandola, a bankruptcy petition was registered against the property the day after exchange.
Unfortunately, the timing meant that the official copies supplied pre-contract did not reveal the creditor’s notice, which would otherwise have shown up on the title. Had a bankruptcy search been undertaken at the Land Charges department of the Land Registry, this would have revealed any registered or pending bankruptcy petition against the seller.

In addition, the purchaser, Kandola, had agreed to pay an unusually large deposit of £96,000 (22% of the £425,000 purchase price) on exchange to the seller’s solicitors as agents for the seller, rather than as stakeholder. Kandola’s solicitors had warned him of the risk of paying the deposit on this basis, given the risk of losing it if the seller became bankrupt or was otherwise unable to complete, but he proceeded regardless. As a result of the bankruptcy petition, the sale failed to complete and Kandola lost his deposit.

Professional negligence

Kandola, an experienced property investor, brought a professional negligence claim against his solicitors. He alleged they should have undertaken a bankruptcy search or Land Registry priority search prior to exchange, either of which would have revealed the existence of the bankruptcy petition. Counsel for Kandola accepted at trial that it was not normal procedure for either search to be carried out by a purchaser’s solicitor before exchange, and indeed that there was no recommendation to do so in the Law Society’s Conveyancing handbook. However, it was argued that the circumstances of the transaction required the solicitor to go beyond the handbook and take steps to assist in gauging the extent of the credit risk being run. He contested that any reasonable solicitor would have taken such steps. The defendant solicitors argued that Kandola was fully and properly advised throughout the retainer, which included specific written advice not to exchange contracts on the basis agreed. Kandola failed to heed that advice. In addition, the solicitors were not aware of all aspects of the transaction and many of the negotiations were going on directly between Kandola and the seller.

Just because a solicitor (or other professional) could take a particular step does not mean that it is his duty to do so. His duty is always defined by his retainer

Court decision

The court found the solicitors were not in breach of duty.

First, it was not ordinary conveyancing practice (nor suggested by the handbook) for a bankruptcy search to be carried out prior to exchange. In any event, there was little point in doing so, because the seller could have become bankrupt after exchange of contracts.

In the circumstances, there was no duty on the solicitors to have delved further by making a pre-contract bankruptcy search or Land Registry priority search unless they had been expressly instructed to do so; in this regard, the judge commented that just because a solicitor could take a particular step did not mean it was their duty to do so. In addition, it was clear that the solicitors had adequately warned Kandola of the risks associated with paying a deposit on an agent, rather than stakeholder basis.

The court found on the evidence that Kandola had understood the advice he had been given and if he had wanted to check the seller’s solvency, he could have done so himself. However, the judge commented that even if Kandola had not understood the advice, his claim would still have failed if it was given in terms suitable for a person of his experience.

The court reinforced the proposition that the solicitor’s duty to explain matters to his client takes account of the client’s own experience; the solicitor is not required to explain matters that should be obvious to a person with the client’s experience or background. If the client asked for further explanation or appeared not to understand, the solicitor might have to go into more detail. However, as the judge explained, the solicitor was not a guarantor of his client’s subjective understanding and would have fulfilled his duty if:

'he gives an explanation in terms the client reasonably appears to him to be able to understand, and to have understood, even if the client later alleges that he did not in fact understand what was said'.

In dismissing the claim, the judge concluded:

'Just because a solicitor (or other professional) could take a particular step does not mean that it is his duty to do so. His duty is always defined by his retainer. If he advises his client of a risk, it is a matter for the client to decide whether he wishes to take that risk, or to obtain further information or security before doing so. The solicitor is not, in general, obliged to seek out such further information unless instructed to do so.'

Reducing risk

The Kandola decision reinforces the standard procedure as set out in the handbook. A prudent solicitor may still consider it sensible to carry out a bankruptcy search prior to exchange of contracts. This is particularly so in circumstances where the deposit is to be released to the seller or where the sale is at undervalue (and so there is a risk that the transfer might be set aside).

A bankruptcy search at the Land Charges department of the Land Registry will identify whether there are any registered or pending bankruptcy petitions or other similar orders against individuals or companies. Every bankruptcy petition in England and Wales will be registered at the department. A search is valid for three weeks from the date of issue and the cost is just £2 for each name searched. It would be cautious to undertake a search at the outset of the transaction, just prior to exchange and before completion.

Clearly, diligent solicitors should take all relevant steps to protect themselves from the risk of a claim. Being cross-examined in the witness box and having to justify the steps taken several years after the event is not something to be relished.

These steps will of course, be fact-dependent to reflect the circumstances as they arise. One of the key points in this case was that Kandola was considered to be an experienced and commercially astute client. In such circumstances, the court considered that the level of information required was different to where a solicitor was advising an inexperienced client, or one dealing in matters with which they were not familiar.

The judgment makes clear that an inexperienced client, or one dealing in matters with which they are not familiar, may require more explanation before they can sufficiently understand the risk they are about to take. An experienced client, however, is likely to need less explanation or even none at all. In part, this is because the decision as to whom to trust in business is a commercial decision for the client and not the solicitor.

For commercial clients, there is a greater expectation that they would be astute and appreciate the risks of property transactions once these were adequately explained to them.

Fiona Pearson is an Associate at Bond Dickinson LLP

Further information