Smith v. Governor and Company of the Bank of Scotland

The House of Lords allowed the appellant's appeal and held that Scots law should be developed so that a creditor who seeks to enforce a cautionary obligation over the matrimonial home may be under a duty of good faith to warn and advise a proposed cautioner to obtain independent advice where the circumstances are such as to put a creditor on inquiry. The decision extended the principles applied in Barclays Bank Plc v. O'Brien [1994] 1 AC 180 to Scotland in relation to cautionary obligations over matrimonial homes, but the House framed the basis of the duty in terms of the creditor's obligation of good faith (and, in Scottish terms, personal bar) rather than by adopting directly the English doctrine of constructive notice.

The court explained that the duty arises only where a reasonable person would believe, from the personal relationship between debtor and proposed cautioner and the nature of the transaction, that the cautioner's consent may not be fully informed or freely given. Where that duty arises, reasonable steps to remain in good faith are to warn the cautioner of the consequences and to advise obtaining independent legal advice; the duty does not require an investigation of whether undue influence or misrepresentation has actually occurred, nor does it convert the creditor into a participant in any misrepresentation.

The appellant wife sought reduction of a standard security granted by herself and her husband over their jointly owned matrimonial home, given to the Bank of Scotland to secure overdraft facilities for the husband's partnership. She alleged she had been induced to sign by misrepresentations of her husband and had not been advised to obtain independent legal advice. At first instance the Lord Ordinary (Lord Johnston) dismissed her action and the First Division refused her reclaiming motion. The appeal reached the House of Lords.

The central issues were (i) whether Scots law should be extended so that a creditor is treated as on inquiry (or otherwise under a duty) where a spouse offers to stand as cautioner for the other in circumstances that give rise to a risk of undue influence or misrepresentation, and (ii) what form any duty on the creditor should take in Scotland.

The House examined existing Scots authorities on cautionary obligations, duties of disclosure, the treatment of undue influence and misrepresentation, and the English decision in Barclays Bank Plc v. O'Brien [1994] 1 AC 180. The majority concluded that a corresponding extension of Scots law was desirable, but that the appropriate legal basis in Scotland is the creditor's obligation of good faith (and personal bar) rather than a direct adoption of English constructive notice. The Lords held that where circumstances would lead a reasonable person to believe that because of the personal relationship the cautioner's consent may not be fully informed, the creditor must take reasonable steps to remain in good faith. Reasonable steps consist of warning the proposed cautioner of the consequences of entering the obligation and advising the cautioner to take independent legal advice; full disclosure remains required where relevant. On that basis the appeal was allowed and the action remitted for proof before answer.

The House emphasised that the duty is limited in scope: it arises only in particular circumstances, it does not require the creditor to investigate or prove undue influence or misrepresentation, and it should not be extended beyond cautionary obligations over family or similarly intimate relationships without careful consideration.

Appeal allowed. The House held that Scots law should be developed in line with the policy in Barclays Bank Plc v. O'Brien so that, where circumstances would lead a reasonable person to believe that a proposed cautioner may not be acting with fully informed and free consent because of a close personal relationship with the debtor and the transaction is not to the cautioner's financial advantage, the creditor must act in good faith by warning the cautioner of the consequences and advising independent legal advice. On that basis the case was remitted for proof before answer.

The Lord Ordinary (Lord Johnston) dismissed the pursuer's action; the First Division of the Court of Session refused the pursuer's reclaiming motion. The case was then appealed to the House of Lords, reported as Smith v. Governor and Company of the Bank of Scotland [1997] UKHL 26; [1997] 2 FLR 862.