England and Wales High Court (Administrative Court) Decisions

IN THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
ADMINISTRATIVE COURT

		Royal Courts of Justice Strand, London, WC2A 2LL
		11/10/12

Mr Justice Haddon-Cave:

INTRODUCTION

1. This case raises issues regarding the approach to be taken by the Financial Services Compensation Scheme Limited ("FSCS") to assessing claims for compensation for negligent mortgage advice when coupled with investment advice said to make the mortgage 'affordable'. This case may have implications for other similar cases.
2. By this claim for judicial review, Ms Charmaine Emptage seeks an order quashing a decision by FSCS dated 13 January 2010 awarding her £11,522.98 under the compensation scheme administered by it on behalf of the Financial Services Authority pursuant to the Financial Services and Markets Act 2000 ("the Scheme").

THE FACTS

3. In 2005 the Claimant, Ms Emptage, and her partner, Mr Ball, lived in a property in Owlsmoor, Sandhurst, Berkshire. Ms Emptage, who was then in her mid-forties, was employed in manufacturing and earned about £22,000 a year. Mr Ball, who was then in his mid-fifties, worked as lorry driver and earned about £32,000 a year. The property was in Ms Emptage's name. It was subject to a repayment mortgage with Abbey National with an outstanding balance of £39,633.13 and some 10 years to run. The repayment date was in 2015.
4. In early 2005, Ms Emptage and Mr Ball sought financial advice regarding their mortgage. They approached Mr Peter Sharratt, who had been their insurance and mortgage broker for some years. They sought advice from him as to whether there were ways they could reduce both the balance of the mortgage and the number of years it had to run. Mr Sharratt was employed by Berkshire Financial Services Limited ("BFS"). BFS was an appointed representative of Berkeley Independent Advisers Limited ("BIA"). BIA was authorised and regulated by the Financial Services Authority under the Financial Services and Markets Act 2000 ("the 2000 Act").
5. Mr Sharratt had a meeting with Ms Emptage and Mr Ball. The notion of buying a Spanish property appears somehow to have emerged at the meeting (probably on Mr Sharratt's initiative) because on 11 February 2005 Mr Sharratt wrote to them enclosing his report "detailing the benefits and process of buying a Spanish Property". The report read in main part as follows:

"CHARMAINE EMPTAGE & GEOFF BALL

Discussion notes regarding buying a Spanish Property

The purpose of this report is to look at the viability of buying a property in Spain as an investment and for your own personal use.

We have found a number of clients are interested in buying in Spain and have therefore established a relationship with a company called Quy who are experienced at recommending and sourcing Spanish properties.

Their current favoured development is a Polaris development (as advertised on TV & National press) and is the Hacienda Riquelme Golf Resort which is in the Murcia Region. There will be a total of 3 developments in the area, all with golf course designed by Jack Nicklaus, which you and your guests/tenants will be able to use. I have enclosed a brochure for this development along with some more detailed plans of properties on the development.

From a rental perspective Quy recommend that you buy two bed apartments on the basis that they are easier to fill. The prices will vary depending on which build stage you buy at but it should be possible to buy a property in the region of 180,000 euros i.e £125,000. To do this you would need to have available cash initially of £54,000 which you could get by borrowing more on your current mortgage.

The Options as I see it are (please note all of the following assume property increases at a rate of 4%pa):

1) Stay as you are

I.e. do not buy another property and keep the mortgage the same.

Assuming you did this your mortgage payments would stay roughly the same as they are now and in 9 or nearly 10 years the mortgage would be paid off and the property would be worth about £269,000.

2) Remortgage now and borrow enough to fund the deposit for a Spanish property

To borrow £54,000 on an Interest Only Mortgage would cost £208pm more than your current mortgage. Alternatively you could convert the entire mortgage to interest only and the total monthly payments would be £391pm i.e. £70pm less than you pay now.

Assuming you did borrow the extra and the entire mortgage was Interest Only and you purchased a property worth £125,000 with the help of a Spanish mortgage you would get back £37,000 of your initial deposit which could then reduce your own mortgage and the situation could be as follows in 10 years:

Your house would be worth £269,000 with a mortgage of £57,000 outstanding giving you equity of £212,000.

The Spanish Property would be worth £256,000 and the mortgage would have reduced to £92,000 (assumes 25 year repayment mortgage) giving you equity of £164,000.

So the total property values would be £525,000 and the total mortgages outstanding would be £149,000 giving a total equity of £376,000

£107,000 more than staying as you are. And this just assumes that the rent only covers the mortgage and other costs, it ignores any excess rental income. If the property is consistently rented out for 70% of the year the excess rental could total £50,000. Also by converting your entire mortgage to Interest Only you would be saving a total of c£8,400 over the next 10 years.

There are obviously lots of variables and assumptions in the above but they would have to be drastically incorrect in reality for you to be worse off than staying as you are. "...

6. In essence, Mr Sharratt's advice to Ms Emptage and Mr Ball was not 'to stay as you are' but to re-mortgage their home by replacing the existing repayment mortgage (which only had an outstanding balance of £39,633.13) with a new, interest-only, mortgage for £110,000 and to invest the extra money raised in a yet-to-be-built Spanish property development recommended by their associated, Quy which would provide rental and capital to service and pay off the increased interest-only mortgage, with cash to spare. Mr Sharratt's report added the following rider:

"There are obviously lots of variables and assumptions in the above but they would have to be drastically incorrect in reality for you to be worse off then staying as you are. "

7. Ms Emptage and Mr Ball were persuaded by Mr Sharratt's blandishments and decided to accept his advice to take on the large, interest-only mortgage backed by the Spanish property investment as he suggested. As Ms Emptage explained in her witness statement:

"I and my partner are not experienced investors. We relied entirely on Mr Sharratt to advise us as to mortgage matter and believed that he was giving us good advice. "

8. In May 2005, Ms Emptage and Mr Ball re-mortgaged their home by redeeming the existing Abbey National repayment mortgage, the balance on which was £39,633.13, and taking out a fresh, larger interest-only mortgage of £111,810.67 with Standard Chartered with a 15 year term. They used the balance of over £70,000 to invest in the property scheme in Spain as advised by Mr Sharratt, i.e. on the basis that the income and capital from it would be available to service and pay off the mortgage when the time came, with cash to spare.
9. In April 2006, again on Mr Sharratt's advice, the claimant replaced her Standard Life mortgage with a Woolwich mortgage in substantially the same amount.

Spanish property crash

10. Unfortunately, Mr Sharratt was "drastically incorrect" and the Spanish property investment proved most ill-advised. The Spanish property market crashed and by 2009 the value of Ms Emptage and Mr Ball's Spanish property had plummeted to virtually nothing. In fact, the proposed development was never completed and the developers which Mr Sharratt had recommended, Quy, went into voluntary liquidation in 2006. A guarantee given by a fresh company, appropriately named "Albatross Invest S.p.A. ", proved worthless.
11. This left Ms Emptage and Mr Ball in a very unfortunate position. It meant that their only means of repayment of the new mortgage was no longer available to them. Thus, instead of having a modest £39,633.13 repayment mortgage which they were on track to repay by 2015, they were saddled with a much larger, interest-only mortgage of £111,810.67 on their home which they had no prospect of paying off since neither had the income or means to do so. Accordingly, absent redress, their only way out would be to sell their home itself.

BIA insolvent

12. It was clear and is common ground that Mr Sharratt's advice was negligent and that Ms Emptage and Mr Ball had a valid claim for damages in tort against BIA. BIA was, however, insolvent and there was no professional indemnity insurance which would respond to Ms Emptage's claim. Thus, in September 2009, Ms Emptage and Mr Ball made a complaint to the Financial Ombudsman Service ("the FOS"). The FOS passed the papers on to FSCS.

Correspondence with FSCS

13. It is helpful to consider the correspondence between the parties in order better to understand how the decision of FSCS came about and the nature of the parties' respective arguments.
14. On 6 October 2009, FSCS wrote to Ms Emptage inviting her to complete a claim application form. On 3 November 2009, Ms Emptage's solicitors, Messrs Manley Turnbull, duly submitted a completed claim form to FSCS on behalf of Ms Emptage and Mr Ball. Some 7 months later, on 9 June 2010, FSCS responded rejecting Ms Emptage and Mr Ball's claim for compensation on the basis that it was based on Mr Sharratt's advice to purchase property in Spain which was not 'regulated' advice and gave no entitlement to compensation under the Scheme administered by FSCS. On 15 June 2010, Messrs Manley Turnbull wrote on behalf of their clients suggesting that FSCS has misunderstood the position and that the claim, properly viewed, was based on improper mortgage advice given by Mr Sharratt, not improper investment advice.
15. FSCS, however, remained unmoved. On 8 July 2010, FSCS wrote to Ms Emptage and Mr Ball in the following terms:

"The crux of your claim relates to the investment of the mortgage proceeds. If you had invested the proceeds into a designated investment (which meets the requirements of the COMP rules which govern our procedures and are contained within the FSA handbook), we would have been in a position to consider the advice you received. However, as previously explained, any losses which arise from the purchase of Spanish land or property do not fall within the definition of a designated investment and are not protected by FSCS... This is because we cannot compensate investors for any losses which may be incurred by using your mortgage proceeds to fund a non-designated investment. "

16. On 20 July 2010, Messrs Manley Turnbull wrote back to FSCS at length lodging a complaint regarding their refusal and setting out a detailed analysis of the legal position as they saw it on behalf of their clients. The letter included the following paragraph which summarises the crux of the Claimant's argument rather well:

"The obvious and fundamental error into which you and the author of the letter dated 9 June 2010 have fallen is in taking the approach that advice as to suitability of a mortgage does not involve considering the client's ability to meet its obligations under the mortgage. You say that 'the crux of your claim relates to the investment of the mortgage proceeds'. It does not. The crux of our clients' claim is that Mr Sharratt advised them to enter a re-mortgage which was totally unsuitable for them. Ability to meet obligations is part of suitability: see by way of example, MCOB 4.7.4(1)(a) and (b) and MCOB 4.7.7(1)(a)-(c). Indeed, it is clear from MCOB 4.7.5 that the advisor is to make an assessment of the clients ' ability to afford a particular mortgage. That is particulary the case where advising clients with modest incomes and within sight of retirement to switch from a repayment mortgage to an interest-only mortgage. "

17. On 10 August 2010, FSCS responded that it had conducted a review of the matter and concluded that Ms Emptage and Mr Ball did in fact have a case:

"We have given very careful consideration to the contents of your letter of 20 July 2010, and the rules as set out in the [FSA 's] Mortgages and Home Finance: Conduct of Business sourcebook (MCOB) which were applicable at the time the advice was given. Accordingly, I can confirm that we have concluded that the adviser [Mr Sharratt] did not adequately consider and advise on the interest- only mortgage in the light of [Ms Emptage and Mr Ball's] circumstances, their ability to afford the lump sum payment at redemption and the recommended repayment method using the Spanish property investment".

18. FSCS asked for details of both the old and new mortgages and redemption statements to enable it to calculate the loss. Messrs Manley Turnbull duly provided these details on 6 September 2010.

FSCS Internal Memorandum

19. An internal FSCS Memorandum dated 19 August 2010 prepared by a Senior Claims Officer at FSCS, Mr Christiaan May, recommended the proposed approach which FSCS should take regarding the assessment of compensation in relation to a number of similar mortgage claims which FSCS had received involving elements which were potentially not protected, namely mortgage claims involving (i) 'Overseas Property Purchase', (ii) 'Right to Buy", (iii) 'Buy to Let' and (iv) 'Protected mortgage and investment advice'. The Memorandum stated in relation to Ms Emptage and Mr Ball's claim as follows:

"Claims issues

15. This claim incorporates both protected and unprotected elements; the mortgage advice is protected whereas the advice to purchase the Spanish property is unregulated.

16. The mortgage advice appears to be in breach of MCOB on the grounds of affordability and suitability.

17. The interest only mortgage runs beyond the retirement age of Mr Ball and the only method of repaying the mortgage was linked to the success of the Spanish property purchase.

18. This claim is therefore considered to be eligible for compensation on the grounds that Mr Ball and Miss Emptage received negligent mortgage advice. However, quantifying the loss is complicated and the main element of their loss are [sic] the costs associated with the Spanish property purchase.

Proposed basis of compensation

19. The claimants will receive a refund of broker fees relating to the mortgage advice plus any mortgage interest incurred on these fees.

20. In addition a loss assessment will be conducted that will compare the position of their repayment mortgage had this been maintained with the payments made to the interest only mortgage.

21. FSCS will not compensate for any losses associated with the Spanish property purchase as this was an unregulated transaction. "

20. On 8 September 2010, an internal FSCS meeting took place at which the proposed approach to compensation set out in the above Memorandum was discussed and agreed by FSCS's Director of Corporate Affairs, Mr Alex Kuczynski, and Head of Legal, Mr James Darbyshire.

FSCS Decision letters

21. On 10 December 2010, in a 'Decision Letter' sent to Ms Emptage, FSCS stated that it had calculated the compensation payable to her as £11,522.98. The letter explained the calculation of this 'compensation figure' had been reached as follows: (a) the reduction in the Abbey National mortgage balance had this been maintained to date, less (b) the mortgage repayments that should have been made to maintain the Abbey mortgage, plus (c) the mortgage payments made to the Standard Life and Woolwich mortgages, plus (d) any fees incurred, plus (e) interest, if applicable, equals (f) the compensation figure. The starting figure was explained as £22,912.11, being the difference between the outstanding balance on the original Abbey National mortgage of £39,780.00 when redeemed less the reduced balance if that mortgage had been maintained todate being £16,867.89. The letter set out the suggested rationale for this approach (which reflected the above Memorandum) as follows:

"FSCS can only compensate for losses which relate to regulated business; as stated in previous correspondence FSCS cannot offer compensation for the purchase of property or losses stemming directly from the property purchase. We are therefore unable to compensate for the capital released from the Standard Life mortgage that was subsequently used to invest in Spanish property. "

22. Ms Emptage was unhappy with FSCS's letter and offer of compensation and refused to accept the cheque for £11,522.98 offered. Messrs Manley Turnbull wrote to FSCS on 16 December 2010 inviting FSCS once again to reconsider.
23. On 13 January 2011, the Head of Operations at FSCS wrote to Messrs Manley Turnbull following a further review stating:

"As our letter of 10 December 2010 explained, we can only compensate for losses that have arisen as a direct result of the mortgage advice. ...

We can only compensate for the reduction in the balance of the Abbey mortgage if Ms Emptage had continued with this. ...

Whilst you may not agree with the methodology used, I am satisfied that the amount of £11,522.98 has been calculated in accordance with our rules and policies, and represents the loss that Ms Emptage has incurred from the mortgage advice given by the firm. Although we are very sympathetic to the other losses that she has incurred, these arose from the property purchase. As outlined above, I regret that we are unable to compensate for these losses, as they are not protected under our rules. "

24. She also explained that the original decision letter of 10 December 2010 had only been sent to Ms Emptage and not to Mr Ball because the mortgages were held in her sole name and she was, therefore, the sole claimant. Mr Ball's claim has been held in abeyance pending the outcome of Ms Emptage's claim.
25. In a subsequent letter dated 18 February 2011, the Head of Legal at FSCS, Mr James Darbyshire, set out very clearly (and, in my view, accurately) the real basis of Ms Emptage's claim against BIA in breach of MCOB 4.7.2R as follows:

"It is FSCS's view that the firm's recommendation to remortgage your client's (Ms Emptage) home on an interest only basis for 25 years, with no apparent consideration as to how that liability would be paid off, no evidence to support the firm's view that the regulated mortgage contract recommended was '... the most suitable of those that the firm has available to it within the scope of the service provided to the customer' (MCOB 4.7.4(1)(c)R), nor how your client might be able to afford the repayment of that liability in the future given her age at the time of the advice (MCOB 4.7.4(1)(a)R and MCOB 4.7.7.E) was in breach of MCOB 4.7.2R... "

26. He nevertheless re-iterated FSCS's position on the level of compensation stating that, "exercising its discretion", FSCS was only able to compensate for losses arising "directly" from the unsuitable regulated mortgage contract that had been recommended and was not able to compensate for losses arising from the purchase of the Spanish property.
27. FSCS's proposed figure for compensation of £11,522.98 left an outstanding balance on the re-mortgage of over £98,000 which Ms Emptage and Mr Ball were unable to pay off save by sale of their home. In these circumstances, Ms Emptage brought a challenge to FSCS's second decision letter dated 13 January 2011 in which it refused to increase the amount of compensation.

THE LEGAL AND REGULATORY FRAMEWORK

28. The legal and regulatory framework is somewhat labyrinthine and would benefit from simplification by the FSA. It comprises five levels:

(A) The Financial Services and Markets Act 2000 ("the 2000 Act");

(B) Statutory instruments (S.I. 2001/544 and S.I. 2003/1475);

(C) Compensation Rules ("COMP") contained in the Financial Services Authority

Handbook;

(D) Mortgages and Home Finance: Conduct of Business sourcebook ("MCOB");

and

(E) Policy MAA/3: Basis of compensation issued by FSCS.

(A) (A) The Financial Services and Markets Act 2000

29. The Financial Services Authority ("the FSA") was established by the Financial Services and Markets Act 2000 ("the 2000 Act"). The 2000 Act requires the FSA to discharge its "general functions" in a manner which is both "compatible with the regulatory objectives" and "which the Authority considers most appropriate for the purpose of meeting those objectives" (s. 2(1)(a)-(b)). The FSA's "general functions" include its function of "making rules under this Act (considered as a whole)" (s. 2(4)(a)); and "giving of general guidance (considered as a whole)" (s. 2(4)(c)).
30. The "regulatory objectives" include "(a) market confidence", "(b) financial stability", "(c) protection of consumers" and "(d) the reduction of financial crime" (s.2(2), as defined in s.3, s.3A and s.5). The "market confidence" and "financial stability" objectives are both defined by reference to the concept of "the UK financial system", which includes "regulated activities" (s.3(1)-(2)(b) and s.3A(1))."Regulated activities" are such activities as may be specified by order made by H.M. Treasury pursuant to s.22(5), and which may not lawfully be carried on within the United Kingdom other than as provided for in s.19(1). The "protection of consumers" objective is defined in s. 5 as follows:

5. - The protection of consumers

(1) The protection of consumers objective is: securing the appropriate degree of protection for consumers.

(2) In considering what degree of protection may be appropriate, the Authority must have regard to -

(a) the differing degrees of risk involved in different kinds of investment or other transaction;

(b) the differing degrees of experience and expertise that different consumers may have in relation to different kinds of regulated activity; ...

(c) the needs that consumers may have for advice and accurate information; and

(d) the general principle that consumers should take responsibility for their decisions.

[(3) Sections 425A and 425B (meaning of "consumers") apply for the purposes of this section.]

(See also in relation to consumers and "regulated activities" s.425A(3)(a) and s.425B(2)).

Section 53A

31. The 2000 Act was amended in 2004 by the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) (No. 1) Order 2003/1475 Pt 2 art. 13 (October 31, 2004) to bring "regulated mortgage contracts" ("the RMC") within its ambit by the addition of s. 53A.
32. Section 53A provides:

"53A.- Advising on regulated mortgage contracts

(1) Advising a person is a specified kind of activity if the advice:

"(a) is given to that person in his capacity as a borrower or potential borrower; and

(b) is advice on the merits of his doing any of the following-

(i) entering into a particular regulated mortgage contract, or

(ii) varying the terms of a regulated mortgage contract.

33. Two conditions, therefore, must be fulfilled in order for the business of advising a customer to constitute a "regulated activity". The first relates to the content of that advice, i.e. it has to relate to the "on the merits" of the person entering into the RMC. The second relates to the capacity in which the person is given that advice, i.e. it has to be as "a borrower or potential borrower".

Part II - Chapter XV - Regulated mortgage contracts

34. Part II, Chapter XV, sets out the provisions relating specifically to Regulated Mortgage Contracts ("RMCs"). Section 61(3)(a) defines the term "regulated mortgage contract" to mean a contract under which "the lender" provides credit to "the borrower", with the repayment obligation "to be secured by first legal mortgage on land", and "at least 40% of that land is used as a dwelling by the borrower".
35. Section 64 empowers the FSA to "issue statements of principle with respect to the conduct expected of approved persons" (s.64(1)), and to "issue a code of practice for the purpose of helping to determine whether or not a person's conduct complies with the statement of principle" (s.64(2)).

Part XV - The Financial Services Compensation Scheme

36. The provisions relating to the Financial Services Compensation Scheme are set out in Part XV of the 2000 Act. Section 212(1) requires the FSA to establish a "scheme manager" to exercise functions conferred on it under Part XV. The FSA established FSCS as "scheme manager". Section 213(1) requires the FSA to establish a "scheme for compensating persons in cases where relevant persons are unable, or are unlikely to be unable to satisfy claims against them". Section 213(9) of the 2000 Act provides that "relevant person" means:

"...a person who was -...

a. an authorized person as at the time the act or omission giving rise to the claim against him took place; or

b. an appointed representative at that time. "

(B) Statutory instruments - S.I. 2001/544 - Specified "regulated activities"

37. The "regulated activities" referred to in the 2000 Act are those specified in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (S.I. 2001/544) ("the Regulated Activities Order 2001"), in amplification of s.22(2)-(3) and Schedule 2 of the 2000 Act. It is common ground that advising on the sale or acquisition of land, whether situated in the UK or overseas, is not "specified", and is consequently not a "regulated activity". (See above as to S.I. 2003/1475).

(C) Compensation Rules (COMP)

38. The Scheme is governed by the Compensation Rules contained in the FSA Handbook ("the COMP Rules"). The COMP Rules set out inter alia, who is an eligible claimant, what type of business is protected and how claims may be quantified and paid by FSCS. Words in italics under the COMP Rules are defined in the glossary to the FSA Handbook ("the Glossary").
39. COMP 1.1.9 and COMP 1.1.10 explain the purpose of the scheme and provide as follows:

COMP 1.1.9: "This sourcebook is one of the means by which the FSA will meet its regulatory objectives of securing the appropriate degree of protection for consumers, contributing to the protection and enhancement of the financial stability of the United Kingdom and maintaining confidence in the UK financial system. "

COMP 1.1.10: "By setting up FSCS and making rules that allow FSCS to provide compensation at a level appropriate for the protection of retail consumers and small businesses, the FSA enables consumers to participate in the financial markets with the confidence that they will be protected, at least in part, should the relevant person with whom they are dealing be unable to satisfy claims against it. "

40. COMP 2.2.2(1) provides that:

COMP 2.2.2(1): "...FSCS may pay compensation to eligible claimants or secure continuity of insurance for eligible claimants when a relevant person is unable or likely to be unable to meet claims against it in accordance with the sourcebook".

41. The qualifying conditions for compensation are as follows (and it is not in dispute that Ms Emptage's claim satisfies each of these conditions):

(1) The claimant must be an eligible claimant', see COMP 4.2;

(2) The claimant must have a protected claim: see COMP 5.2;

(3) The claimant must be claiming against a relevant person: see COMP 6.2.1R;

(4) The relevant person must be in default: see COMP 6.3.

42. COMP 12.2.2 provides as follows:

COMP 12.2.2: "COMP 12.2.1R is, however, subject to the other provisions of COMP, in particular those rules that set limits on the amount of compensation payable for various types of protected claim. The limits are set out in COMP 10. "

43. COMP 10.2.3 sets out the limits on compensation sums payable by FSCS for protected claims. The limit for the present type of protected claim, i.e. for "protected home finance mediation", is £48,000 per person per claim against a relevant person.
44. Chapter 12 of the COMP Rules sets out the different ways in which FSCS is to calculate the amount of compensation. In particular, COMP 12.2.1 provides that:

COMP 12.2.1: "The amount of compensation payable to the claimant in respect of:

i. Any type of protected claim other than a claim for a protected deposit is the amount of his overall net claim against the relevant person at the quantification date; "

45. Ms Emptage's claim against BIA is a "protected claim". "Claim" is defined in the Glossary as "a valid claim made in respect of a civil liability owed by a relevant person to the claimant
46. The COMP Rules also contain specific rules as to payment of compensation for breach of MCOB. In particular COMP 12.4.17 provides as follows:

COMP 12.4.17: "FSCS may pay compensation for any claim made in connection with protected home finance mediation only to the extent that FSCS considers that the payment of compensation is essential in order to provide the claimant with fair compensation. " (emphasis added)

47. The central issue in the case is whether FSCS complied with COMP 12.4.17 in offering Ms Emptage the sum of £11,522.98 by way of compensation for her claim under the Scheme in respect of Mr Sharratt's breach.

(D) Mortgages and Home Finance: Conduct of Business sourcebook ("MCOB")

48. The Mortgages and Home Finance: Conduct of Business sourcebook ("MCOB") sets out the requirements and standards applying to firms with mortgage business customers. MCOB 4.7.2R is the key rule and provides:

"A firm must take reasonable steps to ensure that it does not make a personal recommendation to a customer to enter into a regulated mortgage contract, or to vary an existing regulated mortgage contract, unless the regulated mortgage contract is, or after the variation will be, suitable for that customer. " (emphasis added)

(see also MCOB 4.3.4 R (2), MCOB 4.3.5 G and MCOB 4.3.6 G).

49. The definition of "Personal recommendation" is to be found in the Glossary, viz.'. "advice on a home finance transaction ... presented as suitable for the person to whom it is made, or is based on a consideration of the circumstances of that person".
50. MCOB 4.7.4R defines "suitable" as follows:

"For the purposes of MCOB 4.7.2 R:

(1) a regulated mortgage contract will be suitable if, having regard to the facts disclosed by the customer and other relevant facts about the customer of which the firm is or should reasonably be aware, the firm has reasonable grounds to conclude that:

(a) the customer can afford to enter into the regulated mortgage contract;

(b) the regulated mortgage contract is appropriate to the needs and circumstances of the customer; and

(c) the regulated mortgage contract is the most suitable of those that the firm has available to it within the scope of the service provided to the customer;

(2) no recommendation must be made if there is no regulated mortgage contract from within the scope of the service provided to the customer which is appropriate to his needs and circumstances; [...]"

51. Suitability includes a customer's ability to afford to enter a particular mortgage contract (see MCOB 4.7.2R). MCOB 4.7.7.E provides:

"(1) In assessing whether a customer can afford to enter into a particular regulated mortgage contract, a firm should give due regard to the following:

(a) information that the customer provides about his income and expenditure, and any other resources that he has available;

(b) any likely change to the customer's income, expenditure or resources; and

(c) the costs that the customer will be required to meet once any discount period in relation to the regulated mortgage contract comes to an end (on the assumption that interest rates remain unchanged).

(2) Contravention of MCOB 4.7.7 E(1) may be relied upon as tending to show contravention of MCOB 4.7.4 R(1)(a). "

52. MCOB 4.7.10(G) provides that, in complying with its obligations under MCOB 4.7.4(R) to assess whether a RMC is "suitable" for a customer, a firm is not required to consider whether the potential borrower might be better served by (a) using savings instead of borrowing, (b) renting instead of buying, or (c) deferring purchase to a later date by which time property prices or interest rates might be expected to have fallen.
53. MCOB 4.7.11(E) provides that, in complying with its obligations under MCOB 4.7.4(R)(1)(b) to assess whether a the RMC is "appropriate" to the needs and circumstances of the customer, a firm "is required to consider", inter alia, whether the customer should have an interest-only mortgage, a repayment mortgage, or a combination of the two (MCOB 4.7.1 l(1)(b)(E)).
54. MCOB 4.7.12(1)(G) makes it clear that MCOB 4.7.11(E) does not require a firm to provide advice on investments and goes on to provide that "[w]hether such advice should be given will depend upon the individual needs and circumstances of the customer" and a firm can refer a customer to another source of investment advice.
55. It is common ground that Mr Sharratt was under an obligation to comply with "MCOB" and he was in breach of MCOB 4.7.2R in failing to take reasonable steps to satisfy himself that a mortgage which he recommended was "suitable " for Ms Emptage and Mr Ball. Suitability included the ability of the client to repay.

(E) Policy MAA/3: Basis of compensation

56. FSCS's policy regarding the basis of compensation is contained in its policy document MAA/3 approved by FSCS Board in July 2009. MAA/3 sets out the appropriate bases of compensation for protected home finance mediation claims.
57. In respect of compensation for claims for "Negligent/bad advice", MAA/3 states as follows:

"The underlying principle is to provide the level of compensation which is essential in order to be fair. Generally the basis of compensation will seek to return claimants to the position they would be in had the negligence or bad advice not occurred, as far as is possible or practicable under the Scheme's rules and the complementary polices approved by the Board of Directors. " (emphasis added)

58. FSCS's compensation policy is therefore based on 'fairness' and the tortious approach of seeking to 'turn the clock back' to restore the claimant to the position he/she would have been in if the negligent/bad advice had not been given.

Questions

59. There are, therefore, two questions which FSCS has to determine when considering claims for compensation under the Scheme: First, has there been a breach of the COMP Rules giving rise in principle to an entitlement to compensation under the Scheme? Second, what sum should be awarded to the claimant which would constitute fair compensation for that breach? Only the second question is in issue in the present case; however, it is necessary to re-visit the first question in order to have a clear understanding of the nature of the breach giving rise to the right to compensation.

SUBMISSIONS

Claimant's Grounds of Challenge

60. The Claimant, Ms Emptage, challenges FSCS's decision on two Grounds:

(1) Ground 1: FSCS's decision as to what constituted fair compensation for Ms Emptage was flawed in that FSCS wrongly decided and misdirected itself that compensation should not be awarded to make good the loss suffered by reason of having incurred a liability which she had no prospect of being able to meet. FSCS wrongly concluded that that loss was suffered as a result of "an unprotected element" and "unregulated advice''. As a result, FSCS took into account an irrelevant consideration, namely whether Ms Emptage had some other claim for bad advice about the Spanish property which was not regulated or compensatable by FSCS.

(2) Ground 2: If and insofar as FSCS was purporting to assess fair compensation for Mr Sharratt's breach of MCOB 4.7.2R and/or to exercise a discretion as to what would constitute fair compensation, it acted irrationally and/or its decision to assess compensation at £11,522.98 was not a proper exercise of its discretion.

61. Counsel on behalf of Ms Emptage, Mr Mark Cannon QC and Mr Can Yeginsu, submitted in summary:

(1) Ground 1 was based upon how the decision came to be made to assess compensation at £11,522.98 as shown by FSCS's contemporary documents. These show that FSCS misdirected itself, taking the view that it had no power to award compensation for loss caused by the failure of the investment in the Spanish properties. Despite what its own documents show, FSCS now asserts, wrongly, that it was exercising a discretion rather than deciding that it had no power.

(2) Ground 2 was based upon the wider picture: FSCS's position is that it was entitled to form the view that £11,522.98 was what was essential to provide Ms Emptage with fair compensation for her claim. Once it is appreciated what the claim is for (i.e. for recommending a mortgage which was unsuitable), it is clear that the decision was wholly irrational and did not involve a proper exercise of discretion.

Defendant's response

62. Counsel on behalf of FSCS, Mr Andreas Gledhill, submitted that FSCS had not taken into account irrelevant considerations or misdirected itself or could be said to have been Wednesbury irrational when assessing 'fair' compensation. Mr Gledhill submitted that both Grounds stood or fell together and argued the following points in summary: (i) The Scheme was not intended to compensate for losses sustained in connection with nonregulated activity, irrespective of whether such activity was conducted in conjunction with some other, regulated, activity, (ii) The proximate or 'dominant' cause of the loss was the decline in the Spanish property market (c.f Wayne Tank & Pump Co. Ltd. v. Employers Liability Assurance Co. Ltd. [1974] Q.B. 57). (iii) It was open to FSCS to form the view that the greater part of Ms Emptage's loss had 'in substance' been caused by unregulated property investment activity and not regulated mortgage advice, the latter merely being 'ancillary' to the former, (iv) FSCS were enjoined by COMP 12.4.17(R) to pay compensation "only to the extent...essential in order to provide the claimant with fair compensation ". (v) It would be inequitable for levy-payers if losses sustained by one subclass were to be 'foisted' onto a different sub-class, (vi) If FSCS did proceed on the basis that it had no power to compensate for 'the property investment element of the claim', it was fully entitled to do so.
63. Mr Gledhill relied heavily on the House of Lords decision in R. v. Investors Compensation Scheme Ltd, ex parte Bowden [1996] 1 A.C. 261 which made it plain that FSCS had a broad discretion to decide on what compensation was properly payable. Mr Gledhill also submitted that, as an independent delegee with particular specialised experience of the financial services sector, FSCS has a wide 'margin of appreciation' in attributing losses as between the Scheme's sub-classes (c.f. Beatson J. in R. (ABS Financial Planning Ltd.) v. FSCS [2011] EWHC 18 (Admin), at paras. [61]-[62]).

ANALYSIS

64. It is correct to say that both Grounds of challenge essentially stand or fall together and I shall consider them together.

Ex parte Bowden [1996]

65. I turn first to consider Ex parte Bowden (supra). The facts of that case were briefly as follows. A regulated firm, Fisher Prew-Smith, ran a scheme whereby elderly homeowners were persuaded to invest money in equity-linked funds by mortgaging their homes on terms that the interest would roll up unless and until the total mortgage debt reached a stated percentage of the then current value of the investors' home. Investors could retain part of the money raised on the mortgage and/or receive the income from the investments if they wanted. The scheme began to unravel when interest rates rose, thereby increasing the speed at which interest rolled up, whilst simultaneously both property prices and investment values fell. Fisher Prew-Smith became insolvent and the investors claimed against the predecessor to FSCS, the Investors Compensation Scheme Ltd ("ICS"). Rule 2.04(1) of the Financial Services (Compensation of Investors) Rules 1990 ("rule 2.04(1)") was drafted in similar terms to COMP 12.4.17, viz. investors' claims were "to be met only when [ICS] considers that it is essential in order to provide fair compensation to the investor". (It should be noted, however, that the word "only" is placed differently in COMP 12.4.17 such as arguably to change the emphasis of FSCS's discretion to compensate to "only to the extent" it considers compensation is essential.)
66. At that time, mortgage advice was not regulated under the Financial Services Act 1986 nor within the scope of the compensation scheme administered by ICS. ICS nevertheless decided that the measure of compensation "essential in order to provide fair compensation to the investor" should be the amount of the outstanding mortgage, less (a) the current value of the investment and (b) any sums received, whether at the outset or by way of income from the investment, i.e. "personal receipts" (see ibid, at 275E-276B). It is noteworthy that ICS appear to have taken the the view that the advice to make the investment was so linked to the advice to mortgage (the money invested was raised by roll-up mortgages on the investors' homes), that compensation should not be limited merely to the fall in the value of the investment itself.
67. The investors challenged ICS's decision to deduct "personal receipts" from their compensation on Wednesbury unreasonable grounds. The House of Lords held that ICS's decision was not susceptible to challenge because rule 2.04(1) gave ICS:

"...a broad discretion to include within the definition of a compensatable claim either the claim as a whole, or those elements of the claim which [ICS] considers essential in order to provide fair compensation and to exclude those elements which do not meet that requirement. "

Principles and approach

68. The principles and approach to be adopted in the light of COMP 12.4.17, MAA/3 and Ex parte Bowden (supra) are, in my view, straightforward and can be summarised in the following propositions:

(1) FSCS has a broad discretion to compensate claimants with valid claims under the Scheme (only) to the extent that it considers that the payment of compensation is essential in order to provide the claimant with 'fair' compensation (COMP 12.4.17).

(2) It is for FSCS to determine, in its discretion, which elements of the claim it considers essential in order to provide 'fair' compensation and to exclude those elements which do not meet that requirement (Ex parte Bowden (supra))

(3) 'Fair' compensation means compensation which fairly compensates for the mischief and loss caused by the particular breach in question. This requires a classic two-stage analysis, viz. (i) first, identification of the precise nature of the breach complained of and (ii), second, assessment of the actual losses directly flowing from that particular breach.

(4) 'Fair' compensation for negligent or bad advice designed to return a claimant, so far as possible, to the position the claimant would have been had the breach not occurred means what it says, i.e. that losses should be calculated in such a way as to restore the claimant so far as possible to the financial status quo ante (see MAA/3).

Application to the present case

69. In my judgment, FSCS failed to approach the assessment of compensation in this case correctly, or in accordance with the above principles. In particular, FSCS were not faithful to the third and fourth principles. In essence, FSCS failed to compensate Ms Emptage for the relevant breach in question, namely Mr Sharratt's negligent mortgage advice which left her with a large mortgage which she had no means of repaying, or properly restore her to the position she would have been in had the negligent mortgage advice not occurred.
70. FSCS appears to have fallen into error for two related reasons. First, FSCS allowed its initial mistaken understanding of the true nature of Ms Emptage's claim (viz. that her claim related to unregulated property losses which were not compensatable under the Scheme) to continue to affect its view as to the fair compensation payable. Second, FSCS approached the claim as having both 'protected and unprotected elements' and failed to view Mr Sharratt's negligent advice as an indivisible 'package', i.e. mortgage advice which included investment advice (the latter being an essential element of the former because, without it, the mortgage was not feasible).

Reasoning

71. The following points are pertinent.
72. First, FSCS initially rejected Ms Emptage and Mr Ball's claim because of its misunderstanding as to the true nature of the claim. FSCS initially took the view that the claim was not compensatable because it related to Mr Sharratt's advice to purchase property in Spain which was not 'regulated' advice under the Scheme and the 'crux of their claim' related to the investment of the mortgage proceeds in a 'non-designated' investment (see FSCS's letters dated 9 June 2010 and 8 July 2010 above). FSCS were, however, quickly put straight by Messrs Manley Turnbull. The latter explained that the 'crux of the claim' was Mr Sharratt's advice to enter into a re-mortgage which was 'unsuitable' because of affordability (see Messrs Manley Turnbull's letter dated 10 July 2010 above).
73. Second, on review of the matter, FSCS changed its mind and accepted that the claim gave rise to an entitlement to compensation. In my judgment, FSCS was right to do so. The gravamen of the complaint related to mortgage advice, not investment advice. As FSCS itself put it, the breach was Mr Sharratt's failure "adequately [to] consider and advise on the suitability of the interest-only mortgage in the light of [Ms Emptage and Mr Ball's] circumstances, their ability to afford the lump sum payment at redemption and the recommended repayment method using the Spanish property investment" (emphasis added) (see FSCS's letter dated 10 August 2010 above; see also the Head of Legal's letter dated 18 February 2011 above).
74. Third, subsequently, however, when FSCS came to consider the question of compensation it did not re-calibrate its thinking and approach the matter correctly through the prism of bad mortgage advice as opposed to bad investment advice. Had it done so, it would have reached the following simple conclusion: 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. FSCS continued to view 'the claim' with an idee fixe, namely that it included both 'protected and unprotected' elements, one compensatable and the other not (see FSCS's memorandum dated 19 August 2010 above).
75. Fourth, FSCS also failed to appreciate that the two elements were inextricably linked and formed a 'package' of negligent advice by Mr Sharratt which gave rise to the admitted claim under MCOB 4.7.2R. Correctly analysed, Ms Emptage's claim under MCOB 4.7.2R was for Mr Sharratt personally recommending a mortgage which was not 'suitable' and since 'affordability' is an essential element of 'suitability' (see MCOB 4.7.4R), the negligent advice as to 'suitability' included the negligent advice as to 'affordability'. The negligent 'mortgage' advice was a package of advice which included the negligent 'investment' advice, the former being dependent on the latter (C.f. the meaning of 'package' in another context: Association of British Travel Agents Ltd v Civil Aviation Authority [2006] EWCA Civ 1356, [2007] 2 Lloyd's Rep 249).
76. Fifth, it is apparent that FSCS continued to approach the matter On the mistaken basis that it had no power to compensate Ms Emptage fully because it had no power to compensate for the unregulated property losses (see the Decision letters dated 10 December 2010 and 13 January 2011 which are redolent with references to FSCS being "unable to compensate" for unregulated property losses).
77. Sixth, having accepted that Ms Emptage had a valid claim for breach of MCOB 4.7.2.R for an unsuitable mortgage, in my judgment, FSCS was in error in purporting to compensate on a basis which ignored the very reason for that unsuitability, namely that the mortgage was wholly unaffordable. In other words, it was "essential", in order to achieve "fair compensation", for FSCS to compensate Ms Emptage for the unaffordability of the mortgage itself, since this was the very reason why Mr Sharratt was in breach of MCOB 4.7.2R.
78. Seventh, FSCS's flawed approach is apparent from e.g. the following passage in its second decision letter of 13 January 2011 (cited in full above) which the Head of Operations states in terms:

"... I am satisfied that the amount of £11,522.98... represents the loss that Ms Emptage has incurred from the mortgage advice given by the firm. Although we are very sympathetic to the other losses that she has incurred, these arose from the property purchase. " (emphasis added)

79. Ms Emptage was not claiming for losses arising from the property purchase. As FSCS accepted, Ms Emptage's claim was for negligent mortgage advice which left her saddled with a £110,000 mortgage which she could not afford (see e.g. the Head of Legal's letter of 18 February 2011). FSCS should have been faithful to the admitted basis of claim and its concession (rightly made) and compensated on that basis. Its failure to do so was, in my judgment, flawed and irrational (any margin of appreciation notwithstanding).
80. Eighth, the flaw in FSCS's case is also apparent from Mr Gledhill's submissions on behalf of FSCS. He submitted that whilst general advice as to trends in the property market or interest rates, or as to the likely performance of investments required to fund redemption, may be highly material to the "merits" of any given RMC from the potential mortgagor's perspective, it is not addressed to him specifically "in his capacity" as a mortgagor, and as such, is not regulated as mortgage advice (see paragraph 12 of the Defendant's skeleton). In the present case, however, it is plain that Mr Sharratt's advice regarding the Spanish property market was addressed to Ms Emptage in her capacity as potential re-mortgagor because the proposed Spanish property investment was intended to be her mortgage redemption mechanism - and her only available mortgage redemption mechanism - since there was no other way in which she could have afforded to service and repay the increased £110,000 mortgage. Mr Geldhill also submitted that the loss did not flow from borrowing but from what was done with then money once it was borrowed. This viewed the matter from the wrong perspective and ignored the real mischief, namely Mr Sharratt's bad mortgage advice which saddled Ms Emptage with a mortgage which was "unsuitable" for her because it was unaffordable (other than by risky investments). In order to be a "borrower" Ms Emptage had to be an investor.
81. Ninth, the figure awarded of £11,522.98 in no way represented 'fair' compensation for the breach of COMP 4.7.2R because (a) it bore no relation to reality and Ms Emptage's true loss as a result of the negligent mortgage advice, namely being left with a £110,000 mortgage liability which she could not afford to service or pay off, and (b) it took no account of the reason why the £110,000 interest-only mortgage was unsuitable (as admitted by FSCS), namely its unaffordability. FSCS was not simply excluding an 'element' of Ms Emptage's claim; it was, in effect, ignoring the claim itself and, thereby, failing to restore Ms Emptage to the financial position in which she would have been had the negligent or bad advice not occurred.
82. In conclusion, therefore, I accept the submissions of Counsel on behalf of Ms Emptage, Mr Mark Cannon QC and Mr Can Yeginsu, and reject those of Mr Gledhill for FSCS.

THE RESULT

83. For the above reasons, therefore, in my judgment, FSCS misdirected itself and acted irrationally in awarding only £11,522.98 by way of compensation to Ms Emptage for her losses flowing from Mr Sharratt's breach of COMP 4.7.2R.
84. In the result, in these circumstances, I quash the decision of FSCS awarding Ms Emptage only £11,522.98 by way of compensation for Mr Sharratt's negligent mortgage advice and order FSCS to reconsider the question of compensation in the light of the foregoing judgment and principles.
85. I am grateful to all Counsel and their legal teams for their able submissions and assistance.