DMC Category Rating: Developed

This case note is based on an Article in the October 2004 Edition of the ‘Bulletin’, published by the Marine and Insurance teams at the international firm of lawyers, DLA. DLA is an International Contributor to this website

Background
In June 2001, Margaret Brennan issued proceedings against her landlord, the London Borough of Islington, claiming damages for personal injuries suffered as a result of two periods of exposure to carbon monoxide gas from a faulty boiler. Also named as defendants were two firms of solicitors she alleged had acted negligently when they represented her on the claim.

The two law firms applied to have the claim set aside on a technicality. The claim form had not been served within four months of issue, contrary to Part 7, Rule 5(2) of the Civil Procedure Rules. The court agreed to set aside, relying on the judgments of the Court of Appeal in Godwin v Swindon Borough Council [2001] 4 All ER 641 and the High Court in Anderton v Clwyd County Council [2001] EWHC QB 161. Margaret Brennan was advised against an appeal and, in February 2002, agreed to a consent order discontinuing her action against the council with no order for costs.

Two months later, in April 2002, the Court of Appeal overturned the decision in Anderton v Clwyd County Council. Margaret Brennan now argued that the compromise she had reached with the council to discontinue the proceedings was void because of a mistake of law.

At first instance, the High Court judge agreed. The parties had acted under the mistaken belief that the proceedings had not been validly served. The Court of Appeal, however, unanimously overturned that decision.

Re-opening settlements

A contract entered into under a common mistake will, in certain circumstances, be void at common law, but only if the mistake is such that it makes the contract essentially and radically different from what the parties thought it was and so renders performance of the contract impossible (Great Peace Shipping Ltd v Tsavliris (International Ltd) Ltd [2002] 2 Lloyd's Rep 653 ).

It used to be the case that a contract could only be set aside for mistake of fact, not law, but that changed with the ruling of the House of Lords in Kleinwort Benson Limited v Lincoln City Council [1999] 2 AC 349. Kleinwort Benson had made payments to a local authority under swap agreements, which were thought at the time to be legally enforceable. But a subsequent decision of the House of Lords established they were not, and Kleinwort Benson sought restitution (repayment) of the payments it had made. A majority of the House of Lords held it was entitled to recover the money and that the old distinction between mistakes of fact and mistakes of law should no longer apply.

Although the Kleinwort Benson case was a claim for restitution, not to set aside a contract, it has been generally accepted that the removal of the old distinction applies to contracts as well. A compromise or settlement in civil litigation is a contract, whether or not it is embodied in a consent order.

Where a settlement is reached on the basis of a settled understanding of the existing law and that understanding is subsequently overturned by a court, can - or should - it be set aside for mistake? It could be argued that at the time the agreement was made, there was no mistake, as both parties understood the law as it then was. In Kleinwort Benson, however, the House of Lords applied the declaratory theory of judicial decisions. This means that, when a judge states what the law is, he is simply interpreting what the law always has been (as opposed to creating new law). The net result of the application of this theory is that the judge’s decision has retrospective effect.

The other circumstance in which a settlement agreement will not bind the parties is when, as a matter of construction, its terms are found not to apply to matters that were outside the parties' contemplation at the time. In BCCI v Ali and Khan [2002] AC 251, the House of Lords held that compensation agreements reached "in full and final settlement" between BCCI and certain of its employees did not prevent those employees from reopening the agreements when, following BCCI's collapse, it became clear that a significant part of the bank's business had been run dishonestly and the employees found that they were stigmatised for having worked there.

The House of Lords in BCCI did not refer to Kleinwort Benson and approached the issue as one of pure contract interpretation. It found that the general release did not apply to matters that were not within the parties' contemplation at the time the release was given. Very clear language would be required to demonstrate an intention to surrender rights of which a party was unaware and could not have been aware.

Mistake of law

Had there really been a mistake of law in Margaret Brennan's case? A settlement is usually made on a give-and-take basis. When litigation is settled, there will often be a question of doubt about what would happen if the matter went to trial, but the parties choose certainty and finality now, rather than await that outcome. Margaret Brennan's agreement to discontinue her action against the council, in return for an agreement that there would be no costs claimed against her, was just such a compromise.

Judgment
The Court of Appeal found there had been no mistake of law. In Kleinwort Benson there was an unequivocal, though mistaken, view of the law. But that is not the same as a doubt about the law. The High Court's decision in Anderton clearly threw serious doubt on the validity of service of the claim form in the present case. But this was an area of procedural law that was developing and the Court of Appeal was reluctant to countenance as a mistake of law a situation in which it was generally known, or ought to have been known, that the law was about to be reconsidered (in the course of the appeal in the Anderton case). A simple enquiry could have ascertained this. In the give-and-take compromise of litigation, the risk of a subsequent judicial decision affecting matters was something that was accepted and bargained away by Margaret Brennan's solicitor.

Even if there had been a mistake of law, the Court of Appeal's recent decision in Great Peace Shipping Ltd v Tsavliris (International Ltd) Ltd [2002] 2 Lloyd's Rep 653 narrowed the circumstances in which a contract could be set aside for mistake to situations where the mistake made it impossible to perform the contract. This settlement had at all times remained performable, albeit that it turned out to be a bad bargain for Margaret Brennan.

Lord Justice Sedley agreed, but commented on the difficulty of applying the doctrine of mistake to settlement agreements. The Great Peace decision held that the non-existence of the state of affairs mistakenly believed to exist must render contractual performance impossible. That was easy to envisage in the case of the non-existence of goods or (as in the Great Peace) the location of a vessel. But it was more difficult to apply the same test to a mutual mistake of law. He thought a different test might be necessary in those circumstances and suggested that the appropriate question might be whether, had the parties appreciated that the law was what it is now known to be, there would still have been an intelligible basis for their agreement. Yet he acknowledged that this, in itself, could cause the unravelling of a good many litigation compromises. The root cause of the problem was the fiction that the law always was as it is now, adopted in Kleinwort Benson.

From a wider perspective, all three judges acknowledged that there were strong public policy reasons for encouraging parties to settle disputes and for upholding the finality of such settlements. Lord Justice Kay and Mr Justice Bodey suggested that, where a party wishes to reserve its right to reopen the settlement if there should be a future decision in another case, it is that party who should secure an express term to that effect. It is not the other party that has to stipulate that the agreement would stand in such circumstances.

In fact, so important is the principle of seeking to uphold contracts of compromise that Mr Justice Bodey would have found that the consent order should stand, even if the case had been argued solely on the grounds of public policy. In his view, the court should not allow settlements to be re-opened for a mistake of law created by the retrospective effect of the declaratory theory of judicial decisions, except where, for some truly exceptional reason, justice demanded it.