Kleinwort Benson v Lincoln City Council [1998] UKHL 38

Kleinwort Benson sought to recover payments made to local authorities under interest rate swap agreements declared void in Hazell. The House of Lords, by majority, abolished the mistake of law rule, allowing recovery of payments made under a mistaken view of settled law subsequently overturned by judicial decision.

Facts

Kleinwort Benson Ltd, a merchant bank, had entered into numerous interest rate swap agreements with four local authorities: Lincoln City Council, Southwark London Borough Council, Birmingham City Council, and Kensington and Chelsea London Borough Council. Following the decision of the House of Lords in Hazell v Hammersmith and Fulham London Borough Council [1992] 2 AC 1, such agreements were held to be ultra vires local authorities and void. Kleinwort Benson commenced proceedings to recover net payments totalling £811,208.90. Of this sum, £388,114.72 was paid within the six-year limitation period and was repaid on the basis of total failure of consideration. The remaining £423,094.18, representing earlier payments, was prima facie time-barred under section 5 of the Limitation Act 1980.

To avoid the limitation bar, Kleinwort Benson framed its claim in mistake of law, seeking to invoke section 32(1)(c) of the Limitation Act 1980, which postpones the running of time in cases of mistake until the mistake is, or could with reasonable diligence have been, discovered. Langley J, bound by Court of Appeal authority, held at first instance that no cause of action in mistake of law was available and granted a leapfrog certificate.

Issues

The House of Lords considered: (1) whether the rule precluding recovery of money paid under a mistake of law should remain part of English law; (1A) if abolished, whether a defence should exist for payments made under a settled understanding of the law subsequently overturned by judicial decision; (1B) whether a defence of honest receipt should be recognised; (2) whether recovery was precluded because the swap contracts had been fully performed; and (3) whether section 32(1)(c) of the Limitation Act 1980 applied to mistakes of law.

Arguments

Kleinwort Benson argued that the mistake of law rule was indefensible, should be abrogated, and that the retrospective effect of Hazell meant the payments had been made under a mistake of law at the time of payment. They contended section 32(1)(c) applied without restriction to mistakes generally.

The local authorities did not seek to defend the mistake of law rule in its traditional form, but submitted that abrogation should be left to Parliament following the Law Commission’s Report (Law Com No 227). Alternatively, they argued for a ‘settled understanding of the law’ defence, and an ‘honest receipt’ defence derived from the dissenting judgment of Brennan J in David Securities Pty Ltd v Commonwealth Bank of Australia (1992) 175 CLR 353.

Judgment

The House unanimously held that the mistake of law rule should no longer form part of English law. Lord Goff traced the rule’s origin to Bilbie v Lumley (1802) 2 East 469 and Brisbane v Dacres (1813) 5 Taunt 143, observing that it had been rejected throughout the common law world and could not survive recognition of the principle of unjust enrichment and the defence of change of position in Lipkin Gorman v Karpnale Ltd [1991] 2 AC 548.

Settled Understanding of the Law (Issue 1A)

By a majority (Lord Goff, Lord Hoffmann, Lord Hope), the House rejected the ‘settled understanding of the law’ defence proposed by the Law Commission. Lord Goff held that the declaratory theory of judicial decisions, though reinterpreted, meant that judicial decisions operate retrospectively, so that a payer who pays on an understanding later shown by judicial decision to be wrong has indeed paid under a mistake of law. He stated that the payer believed at the time of payment that he was bound in law to pay, and is now told he was not so bound on the law as applicable at the date of payment; the payment was therefore made under a mistake of law.

Lord Browne-Wilkinson and Lord Lloyd dissented on this point, holding that retrospective judicial change of the law cannot create a mistake where none existed at the time. Lord Browne-Wilkinson stated that retrospection cannot falsify history and that a payer acting on then-settled law is not mistaken. Lord Lloyd would have adopted the Law Commission’s settled law safeguard as a defining feature of what constitutes a mistake.

Honest Receipt (Issue 1B)

The House unanimously rejected Brennan J’s proposed defence of honest receipt as too wide, noting it would effectively negate recovery in most mistake of law cases, including those where the mistake was shared.

Completed Transactions (Issue 2)

The House held that full performance of a void contract did not preclude recovery on the ground of mistake. The cause of action accrues at the time of each payment (Baker v Courage & Co [1910] 1 KB 56). The ultra vires doctrine, designed to protect the public, would be undermined if completed transactions were treated as binding.

Section 32(1)(c) Limitation Act 1980 (Issue 3)

The House held that section 32(1)(c) applies to mistakes of law as well as of fact. The pre-existing equitable rule applied to all mistakes, and the statutory language contained no restriction. Consequently, time did not begin to run until the mistake could have been discovered, namely on the House’s decision in Hazell on 24 January 1991.

Implications

The decision abolishes the long-standing rule that money paid under a mistake of law is irrecoverable, bringing English law into line with other major common law jurisdictions and integrating restitution for mistake within the unifying principle of unjust enrichment. A payer may now recover money paid under a mistake of law on the same footing as a mistake of fact, subject to defences including change of position, compromise, and settlement of an honest claim.

Significantly, the majority held that a mistake may arise where the law was commonly understood in one way at the time of payment but is later declared otherwise by judicial decision. This reflects an acceptance that judicial decisions operate retrospectively even where they represent a development or clarification of existing law. The dissenting views of Lord Browne-Wilkinson and Lord Lloyd highlight the tension between this approach and the security of settled transactions.

The application of section 32(1)(c) means limitation will not run until discovery of the mistake, which may significantly extend exposure where judicial decisions unsettle long-held understandings of the law. The House expressly acknowledged this may call for legislative reform to introduce an appropriate long-stop.

The decision is of central importance to the law of restitution, to banks and commercial parties dealing with public authorities, and to any party whose transactions may be affected by subsequent judicial reinterpretation of the law. It leaves open important evidential questions about when a payer can be said to have made a mistake as opposed to having assumed the risk of legal uncertainty.

Verdict: The appeals were allowed. The House of Lords held that money paid under a mistake of law is recoverable in restitution; that no defence of settled understanding of the law or honest receipt applies; that completed performance of a void contract does not bar recovery; and that section 32(1)(c) of the Limitation Act 1980 applies to mistakes of law, postponing the limitation period until discovery of the mistake.

Source: Kleinwort Benson Ltd v Lincoln City Council [1999] 2 AC 349