Where a principal debtor defaults and the lender obtains payment of the debt from a guarantor, the guarantor can claim, by way of subrogation, the rights the lender previously enjoyed against the debtor. Those may include a lender's security rights under a mortgage. From the mortgagee's standpoint the security is gone, but from the guarantor's standpoint the mortgage still subsists in equity. But equity cannot take that view where the mortgagee has already exercised its rights against the borrower, because the rights to which the guarantor would be subrogated are now spent. Instead, the guarantor's right to subrogation then “operates … by imposing on the creditor the obligation to account to the surety for any recovery in excess of the full amount of his debt”: Liberty Mutual Insurance Co. (UK) Ltd. v. HSBC Bank plc. [2001] Lloyd's Rep. Bank. 224, 225.
The creditor's obligation to account to the guarantor was crucial in Bofinger v. Kingsway Group Ltd. [2009] HCA 44, (2009) 260 A.L.R. 71. The claimants were guarantors who had discharged part of the debt owed by the mortgagor company to the first of three mortgagees. The first mortgagee then exercised its power of sale, took what it was owed from the proceeds, and paid the surplus to the second mortgagee. The claimants argued, eventually succeeding in the High Court of Australia, that their right of subrogation obliged the first mortgagee to account to them, rather than the second mortgagee, for the surplus. That obligation was breached when the first mortgagee paid the proceeds to someone else, but the breach was remedied by an award of equitable compensation.
Several points of interest emerge. First, subject to the remarks below about the conceptual basis of the decision, the guarantor's right of subrogation should apply to registered land in England, and to unregistered land, just as it did no violence to the Torrens registration system in Bofinger (at [12]): see, e.g., Boscawen v. Bajwa [1996] 1 W.L.R. 328.
Secondly, the first mortgagee was held accountable as a constructive trustee of the surplus, but the court found it unnecessary to decide whether that accounting obligation supported a trust or equitable lien (as in A.-G. for Hong Kong v. Reid [1994] 1 A.C. 324, 331–332 and Napier & Ettrick v. Hunter [1993] A.C. 713, 738-739, 744–745, 752 respectively) with proprietary characteristics enforceable against third parties: the accounting party in Bofinger remained solvent and no tracing or following exercise was necessary. It was sufficient that the accounting party was a constructive trustee, liable to account personally as if he were a trustee (Paragon Finance plc v. DB Thakerar & Co. [1999] 1 All E.R. 400, 409).
Thirdly, a constructive trustee is not necessarily a fiduciary (Lonrho v. Fayed (No. 2) [1992] 1 W.L.R. 1, 12), but the first mortgagee's obligations were held to be so in this case. The fiduciary nature of the accounting obligation is consistent with the approach English law has taken where powers of sale exercised under other kinds of security interest generate a surplus (Mathew v. TM Sutton Ltd. [1994] 1 W.L.R. 1455, 1462). The first mortgagee breached its fiduciary duty by entering into and performing arrangements with the second mortgagee which conflicted with its duty to account to the guarantors. That breach caused the guarantors loss, for which the first mortgagee had to pay equitable compensation.
Bofinger leaves untouched the question whether the mortgagee's fiduciary obligation to account might also include administrative and investment duties such as trustees often owe (as to which, see the concerns raised in Napier at pp.738, 744 and 752). This seems unlikely: the primary obligation would be to pay the money over to whomever is entitled in order of priority.
Fourthly, because the first mortgagee had acted in breach of a fiduciary obligation to account, the guarantors also potentially had a claim, under the “assistance” limb of Barnes v. Addy (1874) L.R. 9 Ch.App. 244, against solicitors who had helped the first mortgagee enter into and perform inconsistent obligations towards the second mortgagee (at [51]).
Finally, the High Court emphasised, again, that the concept of unjust enrichment is not a principle supplying a sufficient premise for direct application in Australian cases (at [85]-[98]). This is not an “unacceptably formalistic … step away from principle and back into the dark age of rigid formalism” (cf. [2008] C.L.J. 469, 470). Rather, it recognises that common law principles are to be found in the cases themselves, taking into account the context within which those cases were decided, and that the development of common law doctrine over centuries means it cannot be corralled into very few principles. The fact that a broad concept might explain many of those cases does not mean that it is a test for liability. Further, the common law's development over time in several different jurisdictions means that even if a test of liability based on unjust enrichment is now part of English law, it need not be so in Australian law. Equally, the fact alone that the Australians have not adopted a test of liability based on unjust enrichment does not mean that the English are wrong to have done so.
In addition to this general point of jurisprudence, the High Court doubted (at [97]) the sufficiency of unjust enrichment analysis as a justification for subrogation, particularly the proprietary consequences thereof. The proprietary consequences could potentially be justified as preventing the mortgagor from being enriched to the extent that the payment would otherwise immunise his equity from being realised at the lower value that a mortgagee's sale normally generates. However, accepting that as a relevant enrichment takes unjust enrichment analysis a considerable distance from its heartland in the money counts, and could prove a dangerous step if the enrichment analysis is intended to identify other situations where proprietary remedies are sought in novel cases.
Further, even if unjust enrichment analysis might provide a sufficient explanation for subrogation, that does not mean that it is a necessary explanation, as Bofinger shows, nor that it accurately reflects the way that courts have reasoned towards the conclusion that a guarantor should be able to claim security by way of subrogation. The English courts have themselves doubted the necessity of unjust enrichment analysis in conventional subrogation cases (Cheltenham & Gloucester plc. v. Appleyard [2004] EWCA Civ 291 at [49]), although they do now seem committed to it as the explanation underpinning subrogation (Filby v. Mortgage Express (No. 2) Ltd. [2004] EWCA Civ 759 at [62]). Uniformity in the common law is desirable, but it seems this is another instance where “the common law is no longer monolithic” (B. v. Auckland District Law Society [2003] UKPC 38 at [55], [2003] 2 A.C. 736).
