Kleinwort Benson v Lincoln City Council [1998] UKHL 38

Kleinwort Benson bank made payments to local authorities under interest rate swap contracts later held void in the Hazell case. The bank sought recovery of payments made under mistake of law. The House of Lords abolished the long-standing rule barring recovery of money paid under a mistake of law, establishing that such payments are recoverable in restitution.

Facts

Kleinwort Benson Ltd, a merchant bank, entered into interest rate swap contracts with several local authorities including Lincoln City Council, Southwark, Birmingham, and Kensington and Chelsea. Following the House of Lords decision in Hazell v Hammersmith and Fulham London Borough Council [1992] 2 AC 1, which held that such contracts were ultra vires local authorities and therefore void, Kleinwort Benson sought restitution of net payments totalling £811,208.90 made under these contracts. Of this sum, £388,114.72 was paid within the six-year limitation period and had been repaid. The remaining £423,094.18, paid outside the limitation period, was in dispute.

The Interest Rate Swap Market

Interest rate swaps had been used since about 1981, with local authorities participating from 1982. Until 1987, there was a general understanding in the money markets that such contracts were within local authorities’ borrowing and lending powers under the Local Government Act 1972. This assumption was not challenged until the Audit Commission raised concerns in 1987.

Issues

The House of Lords considered three main issues:

Issue 1: The Mistake of Law Rule

Whether the long-established rule that money paid under a mistake of law is not recoverable should be maintained as part of English law.

Issue 1A: Settled Understanding of the Law

Whether payments made under a settled understanding of the law, which is subsequently changed by judicial decision, should be irrecoverable.

Issue 1B: Honest Receipt Defence

Whether it should be a defence that the defendant honestly believed they were entitled to receive and retain the payment.

Issue 2: Completed Transactions

Whether money paid under void contracts that were fully performed could be recovered on grounds of mistake of law.

Issue 3: Limitation Act 1980

Whether section 32(1)(c) of the Limitation Act 1980, which postpones the limitation period in actions for relief from the consequences of a mistake, applies to mistakes of law.

Judgment

By a majority (Lord Goff, Lord Hoffmann, and Lord Hope; Lord Browne-Wilkinson and Lord Lloyd dissenting), the House of Lords allowed the appeals.

Abolition of the Mistake of Law Rule

Lord Goff delivered the leading judgment, holding that the mistake of law rule should no longer form part of English law. He traced the origin of the rule to Bilbie v Lumley (1802) and noted its basis in the maxim ‘ignorantia juris non excusat’, which he found inappropriate in the context of restitution:

“Once both had been recognised it became, in my opinion, also inevitable that the mistake of law rule should be abrogated, or at least reformulated, so that there should be a general right to recover money paid under a mistake, whether of fact or law, subject to the defences available in the law of restitution.”

The Declaratory Theory and Retrospectivity

On the question of whether payments made under a settled understanding of the law could constitute a mistake, Lord Goff addressed the declaratory theory of judicial decisions:

“When a judge decides a case which comes before him, he does so on the basis of what he understands the law to be… Moreover when he states the applicable principles of law, the judge is declaring these as constituting the law relevant to his decision.”

Lord Hoffmann agreed, stating:

“In each case it has turned out that the state of affairs at the time was not (or was deemed not to have been) what the payer thought. In the case of a mistake of fact, it is because things were actually not what he believed them to be. In the case of a mistake of law, it is by virtue of the retrospectivity of the decision.”

Dissenting Opinions

Lord Browne-Wilkinson dissented, arguing that retrospection cannot falsify history:

“if at the date of each payment it was settled law that local authorities had capacity to enter into swap contracts, Kleinworts were not labouring under any mistake of law at that date. The subsequent decision in Hazell could not create a mistake where no mistake existed at the time.”

Lord Lloyd similarly dissented, expressing concern about the consequences of allowing recovery where payments were made on the basis of settled law subsequently changed by judicial decision.

Section 32(1)(c) Limitation Act 1980

The majority held that section 32(1)(c), which postpones the limitation period for actions for relief from the consequences of a mistake, applies to mistakes of law. Lord Hope observed:

“There is nothing in the words used in it which restricts its application to a mistake of fact. The origin of the section suggests that the absence of restriction was intentional.”

Implications

This landmark decision fundamentally reformed the English law of restitution by:

• Abolishing the rule that money paid under a mistake of law is irrecoverable
• Recognising that the principle of unjust enrichment applies equally to mistakes of fact and law
• Confirming that the defence of change of position applies to mistake of law claims
• Establishing that section 32(1)(c) of the Limitation Act 1980 applies to mistakes of law

The decision aligned English law with developments in other common law jurisdictions including Canada, Australia, and South Africa. However, the majority acknowledged that the interaction with limitation periods might require legislative reform, recognising the potential for claims to be brought long after payments were made.

Verdict: Appeals allowed by a 3-2 majority. The House of Lords held that the rule precluding recovery of money paid under a mistake of law should no longer be maintained as part of English law. Kleinwort Benson’s claims founded on mistake of law fell within section 32(1)(c) of the Limitation Act 1980, with time running from discovery of the mistake.

Source: Kleinwort Benson v Lincoln City Council [1998] UKHL 38