The Emptage case is worth a detailed look. Last October, the High Court overturned a decision by the Financial Services Compensation Scheme to limit its compensation for bad mortgage advice by excluding compensation for the associated investment advice.
The court ordered the FSCS to reconsider its decision. The FSCS then appealed to the Court of Appeal. In June this year, the Court of Appeal dismissed the appeal and upheld the judge’s decision.
Briefly, the facts were as follows. In 2005, Ms Charmaine Emptage and her partner, Mr Geoff Ball, lived in a property in Sandhurst, Berkshire. The property was in her name and subject to a repayment mortgage of about £40,000, with 10 years to run. They wanted advice on whether there were ways in which they could reduce both the balance of the mortgage and the number of years it had to run.
They consulted an IFA who suggested that they change from a repayment mortgage to interest only; increase the amount borrowed to £112,000; extend the term of the mortgage from the existing 10 years to 15; use the extra money raised to invest in a property scheme in Spain, which was still to be built and which would have a golf course ’designed by Jack Niclaus’. The scheme would provide rental and capital to service the mortgage and pay it off in due course, with cash to spare.
That advice did not address the problem on which the couple had sought advice. The IFA was under both a common law duty and a duty imposed by the FSA’s MCOB rules to ensure that its recommendation was suitable for its clients.
To be suitable, the recommended transaction must be such that the IFA reasonably believes that the clients can afford to enter into it, and that it is appropriate to the needs of the clients.
As Lord Justice Moore-Bick observed in the course of his judgment in the Court of Appeal “A mortgage will not be suitable for the customer if she does not have the means to repay the loan on the terms proposed.”
Neither Ms Emptage nor Mr Ball had the income or capital to pay off the loan. Thus, the only way of repaying the loan available to them was to sell the Spanish property. The advice was negligent. But they took the advice and bought into the scheme. The Spanish property bubble burst and by 2009 Ms Emptage and Mr Ball’s investment became virtually worthless. As a result, they had no means of paying off the mortgage. The IFA was insolvent, so they turned to the FSCS.
The FSCS was under a duty to provide fair compensation for losses falling within its rules. Under its rules, the applicable underlying principle was “to provide the level of compensation which is essential in order to be fair”. Generally this meant seeking to return the claimants to the position they would have been in had the negligence or bad advice not been given.
When Ms Emptage applied to the FSCS for compensation, it rejected the claim on the grounds that it was based on the advice to buy property in Spain, which was not a regulated activity and therefore not eligible for compensation under the rules.
Solicitors acting for the couple then wrote to say that the FSCS had misunderstood the position: the claim was based on improper mortgage advice and not improper investment advice.
After further correspondence, the FSCS decided that the purchase of the Spanish property was an unregulated transaction and there should be no compensation for that. Compensation should therefore be limited to the amount by which the original mortgage should have been reduced if the repayments had been maintained, plus the costs of the new mortgage. The effect of that decision was an offer of compensation of about £11,500. That left the couple with an outstanding balance on their mortgage of over £98,000 and no means of paying it other than by selling their home.
Ms Emptage applied to the court for a judicial review of that decision.
The court ruled that the advice could not be split into mortgage advice and investment advice; it was indivisible. In other words, it was mortgage advice which included investment advice. The latter advice being an essential element of the former because, without it, the mortgage was not feasible.
The FCSC decision failed to compensate the true loss as a result of the negligent mortgage advice, namely being left with a £110,000 mortgage liability which they could not afford to service or pay off. The FCSC compensation should restore Ms Emptage to the financial position in which she would have been had the negligent advice not occurred. As the judge stated, “if a mortgage is unsuitable because the borrower cannot afford it, the borrower’s loss will be the obligation she has assumed which she is unable to afford”.
The FSCS appealed. At the hearing in the Court of Appeal, the FSCS emphasised its point about the distinction between regulated and unregulated activities. It argued that the advice was not given to Ms Emptage and Mr Ball in their capacities as borrowers but as investors, and the loss suffered flowed from the failure of that investment and not from the advice about the mortgage.
Counsel for Ms Emptage submitted that the advice was bad because it inevitably involved putting their home at risk when there was no need to do so. Although the advice was to invest in property in Spain, the same risk would have been present whatever form of investment was contemplated. It would not have been possible to invest the proceeds in a way that would have produced a greater monthly income than the interest on the mortgage without some degree, possibly a considerable degree, of risk.
Lord Justice Moore-Bick gave the leading judgment in favour of Ms Emptage.
He said: “The first step must be to identify the breach of duty which has given rise to the claim, because without that it is impossible to make any principled assessment of what it is essential to pay in order to provide fair compensation.”
He added: “The central question was whether the breach of duty was to be characterised as giving bad advice in relation to a mortgage or giving bad advice in relation to an investment in land”. The advice “was unsuitable, not because she could not meet the monthly interest payments, but because she had no prospect of paying back the loan if her investment failed to live up to expectations… [The] bad advice in relation to the mortgage was given to Ms Emptage in her capacity as a borrower and exposed her to a risk which later came about, causing her to lose her capital and with it her home. Although the extent of the loss may have been unforeseen, the nature of the risk, and therefore the kind of loss likely to occur if it happened, was clear.”
That last sentence lies at the heart of the judgment: if the risk of a particular kind of loss is foreseeable and a loss of that kind occurs, even if the extent of the actual loss is not foreseeable, the wrongdoer is responsible for the full extent of that loss. The FSCS’ assessment of loss was wrong and must be reconsidered.
Peter Hamilton is a barrister specialising in financial services at 4 Pump Court and co-founder of moneymatterslegal.co.uk