“Undue Influence” Defences
We are seeing an increasing number of undue influence defences to commercial finance claims. Is there a compelling argument for commercial lenders to mandate that borrowers seek independent legal advice (‘ILA’) before entering into agreements?
What is the Current Position?
Different approaches are taken by different lenders. This often depends on the nature of the lending, be it commercial or non-commercial. It is the norm for the commercial lender to at least recommend (but not necessarily mandate) that the borrower takes ILA and signs a statement to this effect.
What is Undue Influence?
Undue influence can occur when one party exerts improper pressure on another, leading to an agreement that may not be in the influenced party’s best interests.
In Royal Bank of Scotland plc v Etridge (No. 2)  2 AC 773, Lord Nicholls explained that it “arises out of a relationship between two persons where one has acquired over another a measure of influence, or ascendancy, of which the ascendant person then takes unfair advantage”.
A party claiming to have been influenced is required to show  “proof that the [influenced party] placed trust and confidence in the other party in relation to the management of the [influenced party]’s financial affairs  coupled with a transaction which calls for explanation” (Lord Nicholls at ).
Such defences are raised most commonly by a co-borrower arguing that they were unduly influenced by their co-borrower or another third party into entering the commercial agreement or by personal guarantors arguing that they were unduly influenced by a company director to provide a guarantee.
A successful defence can mean that an agreement is found to be invalid vis-à-vis the influenced party.
Why an Increase in Undue Influence Defences?
In addition to developments in the law, which have seen a broader approach being taken by the Courts, social and professional relationships have become more complex meaning the potential for undue influence has grown. Likewise, more modern financial arrangements can make individuals more susceptible, especially those with economic vulnerabilities. A greater awareness of power imbalances in relationships has also led to a rise in investigation and defences.
How Does ILA Help?
ILA aims to address any borrower vulnerability and to ensure that agreements are entered into freely and with a full understanding. This promotes informed decision-making, transparency, and trust in the lending relationship. It also demonstrates proactive mitigation; the provision of ILA can be used to rebut a defence of undue influence because it is more challenging for a borrower to assert undue influence in such circumstances.
Risk Management v Business Prevention?
As above, a commercial agreement will often contain a term that the borrower has been advised to take ILA and has done so or has chosen not to do so. Mandating that a potential borrower obtains ILA pre-agreement goes one step further. Commercial lenders need to weigh up which approach is more beneficial to their business.
Mandating ILA demonstrates a strong risk management approach. A borrower is unlikely to establish undue influence in a commercial arrangement in circumstances where ILA has been provided. Whilst this step may well create an additional layer to the lending process, it reaps potential benefits in terms of informed decision-making and reduced legal risks.
Conversely, mandating ILA can act as a means of business prevention. Borrowers are often seeking immediate lending and/or do not wish to incur the additional cost of ILA. The requirement may introduce delays and so time-sensitive transactions could be adversely affected. Such a requirement may therefore mean that the potential borrower goes elsewhere for their borrowing. There is also a risk of uneven implementation when ILA is taken from different sources.
Commercial lenders will strive to strike a pragmatic balance between risk management and mitigation of legal risk and ensuring that this does not act as a bar to writing new business.
It is important to bear in mind that the absence of ILA prior to contracting offers no defence in law and that, per Lord Nicholls at , “those engaged in business can be regarded as capable of looking after themselves and understanding of the risks involved in the giving of guarantees”.
The risk of establishing undue influence in commercial relationships is therefore less than in non-commercial ones. Commercial lenders may take a view that risk is properly managed by using an internal financial limit to dictate when ILA should and should not be insisted upon.
Paul Luukas, Associate Director