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Session 1997-98
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Judgments - Smith v. Governor and Company of the Bank of Scotland  continued

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      The pursuer in this case is thus seeking to reduce a contract of caution against the cautioner on the ground of misrepresentations made by the debtor. The general rule in the law of Scotland is that misrepresentations by a debtor which induce another person to enter into a cautionary obligation have no effect on the contract of caution. Indeed, the proposition may be stated more generally that a voluntary obligation is not rendered open to challenge simply on the ground that it has been entered into as the result of a misrepresentation made by a third party. To the generality of the rule there are apparent exceptions, as where the third party is acting as the agent for the contracting party so that the misrepresentation is attributable to the latter as the principal, or where the contracting party may be treated as having in some way participated in the making of the representation so that it is regarded as having been made by him. An example of the former case can be found in Mair v. Rio Grande Rubber Estates Ltd., 1913 S.C. (H.L.) 74 and an example of the latter case can be found in Falconer v. North of Scotland Banking Co. (1863) 1 M. 704. The general rule appears to hold in cases of undue influence, (Forbes v. Forbe's Trustees, 1957 S.C. 325, 333) and in cases of fraudulent misrepresentation (Universal Import Export GmbH v. Bank of Scotland 1995 S.L.T. 1318, 1321). But in relation to fraud a further principle may come into play at least where there has been a gratuitous benefit. The principle here, as formulated in Scholefield v. Templer (1859) 28 Ch. 452 and quoted by Lord Shand L.J. in Clydesdale Bank v. Paul (1877) 4 R. 626, 628-629 is: "a person cannot avail himself of what has been obtained by the fraud of another, unless he is not only innocent of the fraud but has given some valuable consideration". So also in cases of facility and circumvention the reduction of an onerous contract requires proof that the acts of circumvention were those of the other party or of an agent for him (Gloag on Contract 2nd ed., (1929) 486). The rule should, however, not apply where the complaint made is not simply that the contract is open to reduction as voidable but that it is void as having been entered into without any true consent. Thus where a contract has been induced by means of extortion such as to exclude consent and prevent the constitution of a valid contract the participation of the third party may be relevant. In Trustee Savings Bank v. Balloch 1983 S.L.T. 240 a wife was allowed to argue that an agreement should not be enforced against her, where unknown to the creditor, the contract had been induced by force and fear of her husband.

      In the context of cautionary obligations it is well settled that as a general rule the cautioner is expected to look to his own interest and to make such inquiries as he considers necessary or appropriate. There is thus in general no obligation on the creditor to make any disclosure to the cautioner about the financial position of the debtor. The rule was affirmed in Hamilton v. Watson (1845) (Bell's App. 87, 103) where Lord Campbell pointed out the impracticability of requiring the creditor to disclose all that the surety ought to know. The rule is well established in Scotland (Young v. Clydesdale Bank Ltd. (1889) 17 R. 231 and Royal Bank of Scotland v. Greenshields, 1914 S.C. 259) as well as in England (e.g. North British Insurance Co. Ltd. v. Lloyd (1854) 10 Exch. 523). But the rule is not absolute. One exception arises in cases of fraud. In the English case of Owen and Gutch v. Homan (1853) 4 H.L. C. 997 discussed in Gloag & Irvine, Law of Rights in Security p. 713 Lord Carnworth L.C. stated, at pp. 1035-1036:

    "Without saying that in every case a creditor is bound to inquire under what circumstances the debtor has obtained the concurrence of a surety, it may safely be stated that if the dealings are such as fairly to lead a reasonable man to believe that fraud must have been used in order to obtain such concurrence, he is bound to make inquiry, and cannot shelter himself under the plea that he was not called upon to ask, and did not ask, any questions on the subject. In some cases wilful ignorance is not to be distinguished in its equitable consequences from knowledge. If a person abstains from inquiry because he sees that the result of inquiry will probably be to show that a transaction in which he is engaging is tainted with fraud, his want of knowledge of the fraud will afford no excuse. . . ."

      Another exception is where the creditor does make some representation to the potential cautioner, either spontaneously or in response to a question. The representation then made by the creditor must be full and fair. The creditor must not mislead the cautioner by withholding part of the truth. Again, if there is some fact in the relationship between the creditor and the debtor which is material to the risk and that is a fact which would not be expected to exist and of which the cautioner is excusably ignorant, the creditor must disclose it. Again, if the guarantor makes a statement in the presence of the creditor which demonstrates that he entirely misunderstands the position of the debtor, that also will require the creditor to give a true and accurate explanation. These limitations are recognised in the law both of Scotland and England. Indeed in the consideration of them both in Gloag and Irvine (Cautionary Obligations, p. 708 ff.) and in Halsbury's Laws of England, 4th ed. vol. 20 (1993), p. 26, paras. 126 and 127) reference is made to reported cases from both Scotland and England.

      Lying behind these examples of situations where the creditor is obliged to take steps in the interest of the cautioner is the basic element of good faith. As was recognised by Gloag & Irvine (p. 706) there must be perfect fairness of representation on the part of the creditor in the constitution of the contract. Thus if the creditor misleads the cautioner either by his silence or by some positive representation he will be acting in bad faith and may thereby lose the right to enforce the contract.

      It is apparent that the law of Scotland has broadly developed in harmony with the Law of England. Historically no doubt their respective roots have been distinct but the general principles which are applied are nearly the same (Bell's Comm. I 364). It was observed in Aitken's Trustees v. Bank of Scotland, 1944 S.C. 270, 279 that the decisions on the English cases on matters of general principle may have persuasive authority in Scotland and in Royal Bank of Scotland v. Brown 1982 S.C. 89, 100 it was observed that such decisions are entitled to be treated with great respect. On the other hand due regard has to be paid to the differences in the specialties of the two systems.

      In the present case the pursuer seeks to extend to Scotland the decision in the recent case in this House of Barclays Bank Plc v. O'Brien [1994] 1 A.C. 180. In that case a bank was seeking to enforce a mortgage over the matrimonial home granted by a husband and wife. The transaction was not to the wife's advantage and carried with it a substantial risk of the husband committing a legal or equitable wrong such as which would entitle the wife to set the transaction aside. This House held that the mortgage was not enforceable against the wife who had signed the deed without reading it in reliance on her husband's misrepresentation as to the effect of it. It was held that in the circumstances the bank had constructive notice of the wrongful representation made by the husband and that the wife was entitled to have the legal charge set aside. This House went further and decided that the principle should apply not only to cases of husband and wife but to all cases where the creditor is aware that the relationship between the surety and the debtor is such that the former will be reposing trust and confidence in the latter in relation to the financial affairs of the debtor. The view was expressed that in all such cases the creditor should be put on his inquiry. The First Division of the Court of Session in Scotland correctly recognised that the decision goes beyond the present situation of the law in Scotland, and, applying the existing Scottish law, declined to follow it. In O'Brien this House consciously sought to extend the law of England, The question for your Lordships is whether a corresponding extension should be made to the law of Scotland.

      My Lords, it is not easy to identify any major distinction between the law in England in this matter as it stood before the decision in O'Brien and the corresponding law of Scotland. It is evident that there was concern in England about the uncertainties which were being experienced in formulating clear guidance in the circumstances of cases such as the present. But the general position appears to have been otherwise comparable. It was accepted before us that the principles on caution in Scotland were the same as those governing surety in England and that the general rules as to the duties of a cautioner were identical in both jurisdictions. It was also recognised that at least on a broad basis the policy considerations which lay behind the decision in O'Brien were applicable North of the Border. The use of the matrimonial home as a security for the business debts of one of the spouses must be a matter of practical experience on both sides of the Border. The only area in which issue was seriously joined was in relation to the proposition put forward by the pursuer to the effect that the law in relation to undue influence was in essence the same in each jurisdiction. The only substantial ground on which counsel for the bank argued that there was a difference between the two systems which could justify a decision not to apply the decision in O'Brien to Scotland related to the law regarding undue influence. While the decision in O'Brien touches on what was referred to in English law as the "invalidating tendency" or the law's "tender treatment" of married women that does not seem to be at the heart of the decision and was not prominent in the argument before the House in the present case.

      Now it has to be noticed that in the present case the pursuer bases her case solely on misrepresentation. In the course of the argument her counsel confirmed that that was the sole basis and that she was not presenting a case based on undue influence. However, the reasoning in O'Brien does touch upon the matter of undue influence and it was in that context that the principal dispute in the present appeal arose. The point of difference between the two jurisdictions which counsel for the bank sought to draw was that in England there was a recognised rebuttable presumption of undue influence arising out of certain relationships while in Scotland there was no such presumption. The point was focused by Professor Walker (Civil Remedies, (1973) p. 155) under reference to a scholarly article by W.H.I. Winder entitled Undue Influence in English and Scots Law (1940) 56 L.Q.R. 97. However, in Harris v. Robertson (1864) 2 M. 664 Lord Kinloch referred to "a presumed undue exercise of the influence which an agent possesses over his client", although, as Professor Walker observes in his work on The Law of Contracts and Related Obligations in Scotland, para. 15.29, his Lordship founded only on English authority. It appeared from the study of a number of Scottish cases which counsel for the bank reviewed that no obvious recognition is given in Scotland to any established presumptions in this area of the law. But on the other hand in Honeyman's Executors v. Sharp, 1978 S.C. 223, Lord Maxwell without defining the limits of the kinds of cases to which the principle of undue influence might arise recognised, at p. 230, that:

    "there must be cases where the facts as proved raise a prima facie inference that a gift has been acquired by abuse of a position of trust and which at least cry out for an explanation even though the precise mode of abuse is not known and might indeed be too subtle to be readily capable of precise expression."

The reception from England of the concept of undue influence as a ground of action distinct from fraud was clearly established in Gray v. Binny (1879) 7 R. 332, but in relation to contracts between close relations the necessity for fairness and avoidance of undue pressure had already been recognised. In Fraser v. Fraser's Trustees (1834) 13 S. 703, 710, the Lord President, Lord Hope, observed:

    "where bargains and contracts are entered into between persons standing in the relationship to each other, such as that of husband and wife, parent and child, every thing ought to be done as fairly, equally, openly and candidly as possible."

It is unnecessary to explore all the kinds of relationships in which the possibility of undue influence may now be admitted. At least in the context of wills close personal relationships may prompt a perfectly proper influence towards the benefit or support of those who are dependent upon a testator (M'Kechnie v. M'Kechnie's Trustees, 1908 S.C. 93). if influence is exercised in genuine devotion to the interests of the person influenced reduction may not lie (Forbes v. Forbes' Trustees 1957 S.C. 325). But if the required elements are present to establish an abuse of a trusted and influential position there seems to be no good reason why reduction of a contract should not be available where the contracting parties are husband and wife. And so far as the recognition of any presumption is concerned, even if it be the case that Scotland has never accepted that there is a presumption of undue influence in the formation of contracts between husband and wife, it is evident that despite the so-called "invalidating tendency" England did not recognise any such a presumption in the case of a husband and wife (Bank of Montreal v. Stuart [1911] A.C. 120, 137), so that in that respect at least the position seems to have been the same. In any event the existence of any such presumption in the context of undue influence is primarily of evidential significance and does not seem to be of such general materiality as to prevent development of the Scottish law on the substantial issue which is now before the House.

      Counsel for the bank cautioned against the imposition of a change in the law of Scotland where, as was recognised in Invercargill City Council v. Hamlin [1996] A.C. 624, a monolithic uniformity might be destructive of the individual development of a distinct common law system. But in the present case we are dealing with an area of the law whose development has for a long time been influenced by decisions on the other side of the Border. I am not persuaded that there are any social or economic considerations which would justify a difference in the law between the two jurisdictions in the particular point here under consideration. Indeed when similar transactions with similar institutions or indeed branches of the same institutions may be taking place in both countries there is a clear practical advantage in the preservation of corresponding legal provisions. Furthermore, the development which is here proposed is one which is of clear advantage and usefulness to those who may be prompted to join with a spouse or other close companion in the granting of a security over their home or other property with grave disadvantage to themselves, which they may not even fully appreciate, and with a particular benefit to the business interests of the companion. Of course, in many cases such transactions may be entered into with full knowledge and understanding. It is not to be supposed or presumed that simply because there is a close personal relationship the security will be given otherwise than with a full and free consent, that is to say with a full understanding and a truly voluntary consent. But to require the creditor to take some initiative where the circumstances of the case may reasonably seem to give rise to the risk that the cautioner's consent is not full and free does not necessarily create as matter of the law of evidence any presumption in the proving of any ground of reduction. What it does is to render it less easy for the creditor to challenge a reduction of the security if the cautioner seeks to take that course.

      I have not been persuaded that there are sufficiently cogent grounds for refusing the extension to Scotland of the development which has been achieved in England by the decision there in Barclays Bank Plc. v. O'Brien [1994] 1 A.C. 180. On the contrary I take the view that it is desirable to recognise a corresponding extension of the law in Scotland. But the basis on which that might be done requires consideration. The route which this House took in developing the law in O'Brien related substantially to the concept of notice. It was pointed out that such a concept is not unknown in Scotland and reference was made in particular to Rodger (Builders) Ltd. v. Fawdry, 1950 S.C. 483. But the basis on which the Court proceeded in that case was not in terms the doctrine of notice, which is properly a development of the English principles of equity, but rather a recognition of the requirement of good faith on the part of the second purchaser. As was noticed in Trade Development Bank v. David W. Haig (Bellshill) Ltd. 1983 S.L.T. 510, 517, the decision in Rodger (Builders) Ltd. v. Fawdry rested upon the broad principle in the field of contract law of fair dealing in good faith. The point can, as the Lord President observed in the present case, be expressed in Scotland in terms of personal bar. That approach may serve as a defence to enforcement against the cautioner by the creditor. But in the present case the cautioner is seeking reduction of the contract against the creditor. This could be expressed in terms of a legal fiction that the bank should be treated as a party to the misrepresentation. But that may only be describing the effect and not explaining the principle.

      It was not disputed that effect could be given in Scotland to the decision in O'Brien by the use of the concept of constructive notice. Reference was made to a footnote in paragraph 13A of Bell's Principles, 10th ed., where it is indicated that notice of fraud which may prevent a third party from taking benefit from a fraudulent transaction includes knowledge of facts and circumstances which ought to have put them on their inquiry. But it seems to me preferable to recognise the element of good faith which is required of the creditor on the constitution of a contract of cautionary and find there a proper basis for decision. The law already recognises, as I have sought to explain, that there may arise a duty of disclosure to a potential cautioner in certain circumstances. As a part of that same good faith which lies behind that duty it seems to me reasonable to accept that there should also be a duty in particular circumstances to give the potential cautioner certain advice. Thus in circumstances where the creditor should reasonably suspect that there may be factors bearing on the participation of the cautioner which might undermine the validity of the contract through his or her intimate relationship with the debtor the duty would arise and would have to be fulfilled if the creditor is not to be prevented from later enforcing the contract. Such a duty does not alter the existing law regarding the duty, or the absence of a duty, to make representations. Nor does it carry with it a duty of investigation. This is simply a duty arising out of the good faith of the contract to give advice. It is unnecessary on the approach which I have suggested to deem the creditor a potential participant in any misrepresentation by the debtor.

      In extending to Scotland the development of the law which was achieved in Barclays Bank Plc. v. O'Brien it is desirable to say something more about what the effect of it should be. In the first place the duty which arises on the creditor at the stage of the negotiation of the contract should only arise on the creditor if the circumstances of the case are such as to lead a reasonable man to believe that owing to the personal relationship between the debtor and the proposed cautioner the latter's consent may not be fully informed or freely given. Of course if the creditor, acting honestly and in good faith, has no reason to believe that there is any particularly close relationship between the debtor and the proposed cautioner the duty will not arise. It is unnecessary to attempt any further classification or analysis of the range of personal relationships. Given the range of circumstances in which persons may be prepared or prevailed upon to act as cautioners it seems to me unwise to endeavour to make any more precise formulation but to leave the matter to the application of common sense to the circumstances.

      Secondly, if the duty arises, then it requires that the creditor should take certain steps to secure that he remains in good faith so far as the proposed transaction is concerned. Whether there has in fact been or may yet be any conduct by the debtor directed at the cautioner which might vitiate the contract is not a matter necessarily to be explored by the creditor. All that is required of him is that he should take reasonable steps to secure that in relation to the proposed contract he acts throughout in good faith. So far as the substance of those steps is concerned it seems to me that it would be sufficient for the creditor to warn the potential cautioner of the consequences of entering into the proposed cautionary obligation and to advise him or her to take independent advice. Of course, in accordance with the existing law, he will still have the duty to make a full and honest disclosure if occasion arises for that to be done. But apart from that it seems to me that the giving of the warning and the advice should be sufficient so far as Scots law is concerned to fulfil the duty on the creditor and secure that he remains in good faith in relation to the proposed transaction. As was recorded by the Lord President a practice has been recognised by banks and building societies of advising private individuals proposing to act as guarantors or cautioners for the liabilities of another to issue a warning regarding the consequences and to point out the importance of receiving independent advice. This practice may extend more widely than is required by the duty which I have described in so far as it may not be limited to cases where a close personal relationship exists, but adoption of the wider practice would clearly help to obviate any practical problem in deciding whether or not the duty arises in any given case.

      In my view the appeal should be allowed so that the case may proceed to a proof before answer.


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