Judgment in default—failure to file defence to counterclaim

This article was first published by LexisNexis on August 3, 2016

Original news

Goldcrest Distribution Limited v McCole and others [2016] EWHC 1571 (Ch)

What is the background to this case?

The claimant lender, C, sought possession of residential property owned jointly by D1 and his partner D2 (the property) pursuant to a purported legal charge entered into by both the D1 and D2 (the charge). The charge secured D1’s liability to C arising under a guarantee whereby D1 had guaranteed the indebtedness of his company, "Ascot" to C.

The charge was entered into after a bankruptcy petition had been presented against D1 (and C was aware of the petition). D1 was subsequently made bankrupt on that petition.

D2 defended the possession proceedings on four grounds:

• the charge was a regulated mortgage contract and, as C was not licensed by the Financial Services and Markets Act 2000 (FSMA 2000) to perform regulated services, the charge was therefore unenforceable
   
• the charge was void under section 284 of the Insolvency Act 1986 (IA 1986)
   
• the property was subject to a trust in favour of D1 and D2’s daughter
   
• D2 was induced to enter into the charge by D1’s undue influence, of which C was aware

By her counterclaim, D2 sought declarations that the charge was "unenforceable as a regulated mortgage contract or void as a disposition after presentation of a bankruptcy petition or voidable by reason of undue influence" and an order that the charge be set aside.

C did not file a defence to D2’s counterclaim. D2 issued an application for default judgment in respect of her counterclaim and C made a cross application to amend its particulars of claim. Deputy Master Rhys considered both applications and gave judgment for D2 on her counterclaim, dismissing C’s claim against D2 and its application to amend its particulars of claim.

Deputy Master Rhys set aside the charge as against D2’s legal and beneficial interest and declared that the charge was void pursuant to IA 1986, s284 (the order).

C (acting by new solicitors) applied pursuant to CPR 13.3 to set aside the default judgment and to vary the order on the basis that C had a real prospect of defending D2’s counterclaim or there was some other good reason why C should be allowed to defend D2’s counterclaim.

What was the court’s decision in relation to whether the charge was a regulated mortgage transaction?

C argued that where security is given for credit provided to a corporate borrower, the transaction is not a regulated mortgage contract by virtue of:

• FSMA 2000, ss19, 26(1)
   
• article 61(3) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, SI 2001/544 (Regulated Activities Order), and
   
• paragraphs 4.4.1 and 4.4.2 of the Perimeter Guidance Manual

Regulated Activities Order, art 61(3)(a) defines a regulated mortgage contract as one where a lender ‘provides credit to an individual’ with the obligation of the borrower to repay to be secured by a mortgage on land and at least 40% of the land is a dwelling. "Credit" for this purpose includes a cash loan and any other form of financial consideration. The court held that it was "well arguable" that C’s only financial accommodation or lending was to Ascot and therefore to a corporate borrower. It followed that C had a real prospect of succeeding on the point at trial.

What was the court’s decision in relation to whether the charge was void under IA 1986, s284?

It was properly arguable that D2’s defence that the charge was void pursuant to IA 1986, s284 would fail at trial. D1 held the property as one of two trustees, either on trust for himself and D2 or, in D2’s case, on trust for D1 and D2’s daughter. Who the property was held on trust for was a mixed question of fact and law (and therefore a triable issue). However, if D1 and D2 held the property on trust for each other, then following Bateman v Hyde [2009] EWHC 81 (Ch) and Cadlock v Dunn [2015] EWHC 1318 (Ch), [2015] All ER (D) 115 (May) (see para [33]), D2 would have created a charge over her own equitable interest in favour of C.

Alternatively, if D1 and D2 held the property on trust for their daughter, then if C was correct that it had no knowledge of any trust and was not bound by it, C could have a legal charge over the property because IA 1986, s284(6) provides that nothing in the section affects any disposition made by a person of property held by them on trust for another person.

The court therefore held that C had an arguable case and that it had either a legal claim over the property or an equitable charge over D2’s interest—in each case there were triable issues and therefore the test for CPR 13.3(1) was met.

What was the conclusion as to whether the court should make declarations on an application for default judgment?

After consideration of the each of the judgments in the Court of Appeal in Wallersteiner v Moir [1974] 3 All ER 217 and the comments of the Lord Maughan and Lord Russell in New Brunswick Railway Co Ltd v British and French Trust Co Ltd [1939] AC 1, [1938] 4 All ER 747, Master Matthews concluded that there is no rule that declarations cannot be given on default judgments. The rule is better stated as being that declarations should not be given without argument inter partes except in the clearest of cases. So long as the declaration can be given without injustice to those affected by it, the court is not prevented from making a declaration sought on an application for default judgment.

In this case, the deputy master had heard submissions from counsel for both C and D2 before making the declarations sought, and he had had regard to all of the relevant factors (including that five months after D2 filed her counterclaim, no defence to counterclaim had been filed). There was no submission before him that there was a good equitable charge created by the charge and therefore it was not surprising that the deputy master made the declaration that the charge was void under IA 1986, s 284.

How did the court exercise its discretion to set aside the default judgment under CPR 13.3?

The court declined to set aside the default judgment. Following the decisions of the Court of Appeal in Regione Piemonte v Dexia Crediop SpA [2014] EWCA Civ 1298, [2014] All ER (D) 125 (Oct) and Gentry v Miller and another [2016] EWCA Civ 141, [2016] All ER (D) 107 (Mar), Master Matthews first considered whether the express requirements of CPR 13.3 were satisfied, that is whether:

• C’s claim had a real prospect of success
   
• there was some other good reason for the default judgment to be set aside, and
   
• C had made its application promptly—however, since the application is one for relief from sanctions (the sanction being the entry of judgment in default), the Denton test applied (see Denton and others v TH White Ltd and another [2014] EWCA Civ 906, [2014] AII ER (D) 53 (Jul))

The test of whether there was a serious and significant breach applied not to the delay in making any application to set aside under CPR 13.3, but to the default in filing a defence to D2’s counterclaim, which gave rise to the sanction of a default judgment in the first place. The question of promptness of C’s application arose under CPR 13.3(2) and in considering all the circumstances (the third stage of the Denton test).

C had issued its application just over two weeks after the order. The application was supported by brief grounds in the application notice. A witness statement in support was not served until three weeks later and a draft defence to D2’s counterclaim was not served until the eve of the hearing of the application. Notwithstanding that C had changed solicitors, it had failed to make the application promptly.

Moreover, considering the first stage of Denton, six months after the defence to counterclaim was due, C had not filed such a defence despite having been chased for it and an application for default judgment being issued. The failure meant that D2 did not know what was in issue and what was not and so the litigation could not progress. The failure on C’s part was a serious one.

The burden was on C to show that there was some good reason for the failure. C’s evidence was inadequate. In particular, it gave little detail and the explanation was inconsistent with the reasons for failure given by C’s counsel at the default judgment hearing. Simply relying on alleged failures by legal representatives may not be sufficiently good reason, but since C blamed its previous solicitors, it should have waived privilege and enabled a full explanation to be given but it did not. Master Matthews held that C had not discharged the burden of showing that there was some good reason for the failure to file a defence to counterclaim.

Notwithstanding that he had found that on some issues, C had defences to D2’s counterclaim which were more than illusory, in the circumstances, given C’s ‘cavalier disregard for the procedural rules in relation to the defence to counterclaim’, Master Matthews held it was not a case in which the court should exercise its discretion to give relief.

What was the effect of the default judgment on C’s claim against D2?

Applying Pugh v Cantor Fitzgerald [2001] EWCA Civ 307, [2001] All ER (D) 67 (Mar), a judgment entered in default of a defence gave rise to an estoppel only in respect of what must necessarily have been determined by that judgment.

C argued that the order only gave rise to an estoppel in respect of the legal charge which the charge was intended to create and not did not bar any claim founded on an equitable charge over D2’s interest, even if it arose out of the same transaction. Master Matthew’s rejected this submission as being based on a misconstruction of the words used in the defence and counterclaim. The references to ‘legal charge dated 2 July 2014’ were to identify the charge. The order set aside ‘the transaction’ as against D2’s ‘legal and beneficial interests in the property’. The order went on to declare that the charge was void against D2. Accordingly, the court held that the necessary and precise determination of the default judgment was that the charge did not create any valid security in favour of C which was binding on D2.

The default judgment for D2 was in respect of a counterclaim which mirrored the defence and sought declarations of non-liability for in respect of C’s claim. The factual position was therefore very different from one where the default judgment was obtained in relation to a different transaction or contract than that which the claim was based on—had that been the case, it is unlikely that the default judgment would have rendered C’s claim res judicata.