Mortgage Express v McDonnell

Illegality does not defeat a claim to proprietary rights merely because the claimant acquired the property using money generated by an earlier unlawful transaction. The relevant question is whether the claimant must plead or rely on the illegality to establish the right claimed. A claim based on collateral proprietary rights may proceed unless the illegality necessarily forms part of the claimant’s case.

Where a later mortgage advances money used to discharge an earlier secured debt, the later lender may be subrogated to the earlier lender’s security to the extent of the discharged debt. That security does not extend to sums advanced for unrelated purposes.

Mortgage Express obtained an order for possession of a house occupied by Sandra McDonnell and others. The property had been acquired in Mr Robson’s name using funds derived from earlier mortgage transactions and was later remortgaged to Mortgage Express. The first-instance judge held that illegality prevented the McDonnells from establishing an equitable interest and, alternatively, that Mortgage Express was subrogated to Midland Bank’s prior security.

The appeal concerned the effect of illegality on the claimed beneficial interest, the extent of any subrogation, and the treatment of the remaining equity after sale.

1. Appeal allowed. Lady Justice Butler-Sloss, Lord Justice Robert Walker and Lord Justice Thorpe agreed with the judgment and order.
2. The first-instance judge had wrongly distinguished Tinsley v Milligan [1994] 1 AC 340 on the basis that this case involved money from an unlawful source rather than property acquired for an unlawful purpose. The distinction was not significant. The money contributed to the acquisition and improvement of the property was the McDonnells’ money, and no new illegality in acquiring the property had been alleged.
3. The governing principle was that a claimant may recover on a legal or equitable title if it is unnecessary to plead or rely on the illegality. A claim based on collateral proprietary rights is not barred unless the illegality necessarily forms part of the claimant’s case. The principle was applied with support from MacDonald v Myerson 2001 EWCA CIV 66 and Halifax Building Society v Thomas [1996] Ch 217.
4. Mortgage Express remained entitled to subrogation to Midland Bank’s security for the principal, interest and costs discharged from the Mortgage Express advance. That security had priority over Mrs McDonnell’s interest to that extent, but not in respect of money used by Mr Robson for other purposes.
5. There was no realistic prospect of relief from possession under Administration of Justice Act 1970, section 6, or Administration of Justice Act 1973, section 8. Possession therefore had to be ordered, followed by sale and reimbursement of Mortgage Express under the subrogation rights.
6. The remaining equity raised unresolved questions of equitable accounting. If the parties could not agree, those questions might be remitted to Newcastle upon Tyne County Court. Relevant issues included whether the provisional 76/24 ownership division was a finding, the value added by any granny-flat construction, and whether Mortgage Express, claiming through Mr Robson, was subject to the rule requiring a trustee-beneficiary guilty of breach of trust to satisfy co-beneficiaries first.

• Court of Appeal (Civil Division): Appeal from an order of His Honour Judge Walton in Newcastle upon Tyne County Court dated 10 November 2000. The appeal was allowed.