Chapter 2: Mortgages

Question 1

1. Legal and equitable mortgages

Answer 1

This chapter will explore the law of mortgages in detail. As you know, a mortgage is a bundle of proprietary rights granted to the lender (the mortgagee) as security for a loan.
But, how do you create a mortgage?
What formalities must be used?
If mortgages can be both legal and equitable interests, how do you determine the status of a particular agreement? These questions will be answered in this part of the chapter.

Question 2

1.1 Legal mortgages

Answer 2

Per LPA 1925, s 1(2)(c) a mortgage is capable of being a legal interest in land. In order to be recognised as a legal interest, the mortgage must be created in compliance with the
formalities for a legal interest over registered land.

Question 3

LPA 1925, s 52

Answer 3

Per LPA 1925, s 52, all legal interests must be created by deed. In order to be valid, the deed must comply with the requirements of LP(MP)A 1989, s 1. As a reminder (you have already come across the requirements of a deed in chapter 1) these are:
* A deed must be clear on the face of the document that it is intended to be a deed.
* The deed must be validly executed.
* The deed must be delivered.
The mortgage deed must then be registered at the Land Registry (LRA 2002, s 27(2)(f)).
If it is not registered, the mortgage will not take effect as a legal mortgage in the land (s 27(1)) but
could still be an equitable interest.

Question 4

1.2 Equitable mortgages

Answer 4

An equitable mortgage can arise for a number of reasons. The two you are most likely to encounter are:
* Mortgage of an equitable interest; and
* Defective legal mortgage.

Question 5

1.2.1 Mortgage of an equitable interest

Answer 5

Where the borrower holds an equitable interest in the land (ie they are not a legal owner, eg a beneficiary of a trust in land), any mortgage of that interest will be equitable in nature. Such a
mortgage can be created very informally. In accordance with LPA 1925, s 53(1)(c) such a mortgage need only be in writing and signed by the grantor in order to be validly created.

Question 6

1.2.2 Defective legal mortgage

Answer 6

A mortgage over the registered estate which is not granted by a valid deed or that is not completed by registration will not take effect as a legal mortgage (it will be defective).
However, it may be regarded as an equitable mortgage if it complies with LP(MP)A 1989, s 2. Equity will recognise it as a ‘contract to grant a legal mortgage’ providing it is in writing, contains all the agreed terms and is signed by both the mortgagor and mortgagee.

Question 7

1.3 Discharge of mortgages

Answer 7

Once a mortgage has been repaid in full, the mortgage entries at the Land Registry must be cancelled. A mortgage is only considered to be fully discharged when all reference to it has been removed from the charges register at the Land Registry Discharge of a registered charge is done by using a specific Land Registry form. A DS1 form is used to discharge a mortgage over the whole of the land in a title. If only part of the land in the title is being released from the mortgage, for example if only part of
the land is being sold to a buyer, a DS3 form is used.

Question 8

2. The equity of redemption

2.1 Introduction to the equity of redemption

Answer 8

Historically, a mortgage arrangement was governed by the law of contract. Every mortgage deed had a date specified on which the borrower had to repay the loan in full, known as the legal date for redemption. If payment was not made on that date, the borrower forfeited the property
to the lender, even if the amount owed was small compared to the overall value. Equity intervened
to soften this harshness by allowing the borrower to repay the loan at any time after the legal date for redemption had passed.

Question 9

Equitable right to redeem & Equity of Redemption

Answer 9

This is known as the equitable right to redeem, and recognises that a mortgage is security for a loan and not an opportunity for the lender to gain something more. Equity recognises the borrower as the true owner of the property and protects the borrower’s rights as owner. These rights, which include the equitable right to redeem, are collectively known as the equity of redemption: essentially they prevent the borrower from exploitation by the lender.

In addition to recognising the equitable right to redeem, the equity of redemption protects the
borrower from clauses postponing or preventing redemption, collateral advantages and unconscionable terms. The equity of redemption has a financial value, commonly referred to as the ‘equity’ that people
have in their homes, being the market value less the outstanding debt.

Question 10

2.2 Postponement of the right to redeem

Answer 10

It seems obvious to say that lenders only make money from borrowers whilst the loan is outstanding. It is in the lender’s interest to keep the borrower ‘on the hook’ for as long as possible. One way of doing this is to push back the legal date for redemption as far as possible, as that date is the first day on which the loan can be repaid: the equitable right to redeem arises on the following day.

Courts look at clauses which postpone the legal date for redemption very closely and will not
allow a clause which prevents redemption altogether: Toomes v Conset (1745) 3 Atk 261. They
may allow a lender to postpone the date, but bear in mind the equitable rule that there must be no clog or fetter on the equity of redemption. This is a question of fact and degree. Two contrasting cases illustrate the point perfectly.

Question 11

Key case: Fairclough v Swan Brewery Co Ltd [1912] AC 565

Answer 11

Facts: Fairclough mortgaged the lease of his pub to Swan Brewery. At the time of the mortgage the lease had 17.5 years left to run. A clause in the mortgage deed postponed the legal date for redemption (and therefore the equitable right to redeem too) until six weeks before the lease
expired. The borrower wished to redeem early.

Held: The clause postponing redemption was struck out and the borrower was permitted to redeem earlier. The clause was a fetter on the equity of redemption because it prevented the borrower from getting back anything of any value. A lease with only six weeks left to run would be virtually worthless, making the mortgage in reality irredeemable.

Question 12

Key case: Knightsbridge Estates Trust Ltd v Byrne [1939] Ch 441

Answer 12

Facts: The borrower mortgaged the freehold of a hotel. The legal date for redemption was postponed for 40 years from the date of the loan. The borrower wanted to redeem early.

Held: The court upheld the postponement of redemption and would not allow early repayment.
The borrower would (eventually) get back exactly what had been mortgaged and the borrower
had been given a favourable low rate of interest as part of the mortgage deal.

Question 13

2.2.1 Why was the postponement upheld in the Knightsbridge case but not in Fairclough?

Answer 13

Fairclough:
* The estate being mortgaged was a leasehold – a depreciating asset.
* The borrower could not get back exactly what it had mortgaged on redemption. A lease with 17.5 years left to run on the term is very different in value to a lease with six weeks left to run.

Question 14

2.2.1 Why was the postponement upheld in the Knightsbridge case but not in Fairclough?

Answer 14

Knightsbridge:
* The estate being mortgaged was freehold (and was commercial premises).
* A freehold estate is enduring and rarely loses value. The borrower would get back exactly what
they mortgaged on redemption.
* The deal also favoured the borrower – it got something in return for the postponed redemption
date.

Question 15

Knightsbridge v Byrne

Answer 15

The outcome in Knightsbridge v Byrne may have been different if the mortgage had been granted
over a domestic property. Although domestic borrowers are often ‘locked in’ for a period of time, this rarely exceeds a few years. It is also possible for the borrower to redeem during the ‘lock in’ period, but inevitably a fee would be payable for the privilege. These arrangements are unlikely to be declared void as long as the borrower is offered a clear advantage, usually in terms of a low interest rate, in exchange for the lock in, understood precisely what was involved and made an
informed decision to proceed.

Question 16

2.2.2 Options to purchase

Answer 16

A mortgage may include an option for the lender to purchase the mortgaged property. This is a
proprietary right for the lender to require the borrower transfer the property to it at some point in
the future (an estate contract). Such terms may be declared void as preventing the exercise of the
equitable right to redeem. If the lender has the opportunity to buy the property, the borrower
inevitably loses the right to take the property back free of the loan, which is fundamental to the
nature of a mortgage as security. This is a ‘clog’ on the equity of redemption, and equity will strike
such terms down, especially in domestic cases.

Question 17

Samuel v Jarrah Timber and Wood
Paving Corporation Ltd [1904] AC
323

Answer 17

An option granted at the same time as the mortgage will normally be declared invalid.

Question 18

Reeve v Lisle [1902] AC 461

Answer 18

If an option is granted in a subsequent transaction it may be upheld if independent of the mortgage.

Question 19

Warnborough v Garmite [2003]
EWCA Civ 1544

Answer 19

If the mortgage and option are granted on the same day, but are in fact completely separate, the equity of redemption is irrelevant, and the option can be upheld. The court said that it must look at the ‘substance of a transaction’ to ascertain whether it is substantially a mortgage or not. The label given at the time to the
transaction is irrelevant.

Question 20

2.3 Collateral advantages

Answer 20

Lenders are entitled only to the repayment of capital advanced plus interest. If a lender tries to extract additional value from the borrower, the offending term in the mortgage deed may be struck out as being contrary to the equity of redemption. The mortgage is not to be regarded as an opportunity to take anything from the borrower other than the repayment of money. A collateral advantage will be struck out if it is unconscionable, in the nature of a penalty, or if it is repugnant to the equitable right to redeem

Question 21

2.3 Collateral advantages

Answer 21

A typical example of a collateral advantage in commercial transactions is the solus tie. In these
cases, the lenders are often breweries or oil companies. The lender makes it a condition of the
mortgage that the borrower buys all its supplies from the lender. For example, if a borrower borrows from a brewery to fund a pub purchase, the lender will impose a solus tie in the mortgage conditions obliging the borrower to buy all beers, wines and spirits from the lender. The interest
rate may well be lower than in a deal which does not involve the solus tie, so the borrower is getting something in return too.
Generally, solus ties are upheld in commercial transactions if they end within the mortgage
term

Question 22

Key case: Noakes & Co Ltd v Rice [1902] AC 24

Answer 22

Facts: The borrower mortgaged his leasehold pub to a brewery. The pub was a freehouse, meaning that beers from any brewery could be sold there. The mortgage included a solus tie requiring the borrower to sell only beer brewed by the lender. This tie was to last for the lease
term, even if the loan had been repaid.

Held: The solus tie was void as it exceeded the mortgage term. The borrower would not get back
what he had mortgaged, because at the end of the term what had been a freehouse would be a pub still subject to the solus tie.

Question 23

Key case: Biggs v Hoddinott [1898] 2 Ch 307

Answer 23

Facts: The borrower mortgaged his freehold pub to a brewery. The mortgage included a covenant
by the borrower to buy beer exclusively from the lender for the duration of the mortgage, which
could not be redeemed for five years. After two years the borrower argued the solus tie was a clog on the equity of redemption.

Held: Lord Justice Chitty refused to declare the tie void, saying that it is possible for the lender to
gain a collateral advantage to himself, as long as it is not unconscionable or oppressive.

Question 24

2.4 Unconscionable terms

Answer 24

The equity of redemption gives the borrower protection from unconscionable terms.
Courts have a well-established inherent equitable jurisdiction to strike out oppressive and
unconscionable terms. For courts to interfere, the term in question must be more than simply ‘unfair’ or ‘unreasonable’. Not surprisingly, it is high interest rates which have attracted most attention.

Question 25

Key cases

Answer 25

* Cityland and Property Holdings Ltd v Dabrah [1968] Ch 166 * Multiservice Bookbinding Ltd v Marden [1979] Ch 84 Mortgages have historically been the subject of complex statutory regimes which have now been simplified. Statutory supervision is now carried out by the Financial Conduct Authority (FCA) using rules in its FCA Handbook. Cases decided under the previous statutory regimes are not obsolete, the principles established by these cases may still be applied by analogy by courts exercising their equitable jurisdiction today.

Question 26

Key case: Cityland and Property Holdings Ltd v Dabrah [1968] Ch 166

Answer 26

Facts: The borrower was a tenant of the lender for 11 years. The lender had refused to renew the lease and had threatened the tenant with eviction. The tenant had limited means, so the lender offered to lend him the money to buy the property. The mortgage deed did not clearly state the interest rate, but it was approximately 19%. The arrangement included payment of a premium of 57% of the original sum lent if the borrower defaulted on payments. When this was factored into the calculation, the overall interest rate was 38%.

Question 27

Key case: Cityland and Property Holdings Ltd v Dabrah [1968] Ch 166

Answer 27

Held: The interest rate was an unconscionable term and was reduced to 7%. Goff J emphasised the clear imbalance of bargaining power between the parties. The borrower was in a vulnerable position, being threatened with homelessness, which the lender had exploited. He said that the lender was entitled to charge a higher rate of interest than market rate, but the imposition of the premium was unconscionable as it wiped out any chance of surplus sale proceeds for the borrower.

Question 28

Key case: Multiservice Bookbinding Ltd v Marden [1979] Ch 84

Answer 28

Facts: A borrower company mortgaged its premises to a private individual. One term of the loan was that the level of repayments would be linked to the value of the Swiss franc. This meant that if the value of the pound fell against the franc, the repayments would be much more expensive as it would cost more to ‘buy’ sufficient francs to pay each instalment. The pound duly fell, and the borrower claimed that the term was void.

Question 29

Key case: Multiservice Bookbinding Ltd v Marden [1979] Ch 84

Answer 29

Held: Browne-Wilkinson LJ said that a mortgage term would be unconscionable if it were imposed in a ‘morally reprehensible manner […] which affects [the lender’s] conscience’. Here, there was no unconscionability. There was equality of bargaining power and the borrower had simply entered into what turned out to be a bad bargain with its eyes open.

Question 30

2.4.1 Statutory regime cases now applied by analogy Falco Finance v Gough (unreported)

Answer 30

If a penalty interest rate imposed in the event of borrower default far exceeds the lender’s losses in the circumstances then it will be void.

Question 31

Davies v Directloans Ltd [1986] 1 WLR 823

Answer 31

A lender will not have acted improperly and a higher interest can be justified if the borrowers have a poor credit history and are a credit risk. The lender may be justified in charging a higher rate in certain circumstances.

Question 32

Paragon Finance v Nash [2002] WLR 685

Answer 32

The lender is entitled to take its own commercial needs into account and may be justified in imposing a higher interest rate where it is in financial difficulties itself, providing it is not exercising any discretion for an improper purpose.

Question 33

2.5 Summary

Answer 33

* The equity of redemption is the name given to the bundle of rights which the borrower has. There are four basic rights: - The equitable right to redeem the loan - Protection from clauses which postpone or prevent redemption - Protection from clauses which give collateral advantages to the lender - Protection from unconscionable terms in mortgage deeds

Question 34

2.5 Summary

Answer 34

* Redemption can only be postponed if the borrower gains some benefit from any ‘lock in’ and gets back exactly what was mortgaged. * Options for the lender to purchase the property will be void unless they are genuinely part of an independent transaction. * Collateral advantages will be void if they extend beyond the mortgage term unless they are genuinely part of an independent transaction. * Unconscionable terms must be more than simply hard bargains: they must be imposed in a morally reprehensible way, for example in a way which takes advantage of the borrower’s vulnerable position.

Question 35

3. Undue influence

Answer 35

[…] If the consent to a transaction was produced in a way such that the consent ought not fairly to be treated as the expression of a person’s free will, then the transaction will not be allowed to stand. It is impossible to be more precise or definitive.

Question 36

RBS v Etridge (No 2) [2002] 2 AC 773

Answer 36

In Etridge the court set out two types of undue influence. Firstly, there are instances of overt acts of improper pressure or coercion such as unlawful threats. This type has much overlap with the idea of duress. Secondly, there are situations where one party has influence or ascendancy over the other, and the first party takes advantage of that influence / ascendancy. In these cases there may be no specific or overt act of pressure or coercion, but the underlying relationship is sufficient for the undue influence to be exercised. It is this situation that we will focus on in the context of a mortgage loan.

Question 37

3.1 Taking advantage of influence or ascendancy in a relationship

Answer 37

This type of undue influence is more common and the majority of recent authorities are concerned with this type in the context of a mortgage loan. A common situation is where a husband or wife (the ‘business owner’) wants their spouse to enter into an agreement with the effect that the spouse’s share in the matrimonial home is used as security for a loan to the business owner’s business. The effect is that the spouse might lose their interest in the home if the business fails. If the spouse has placed trust and confidence in the business owner and the business owner abuses this trust in seeking the spouse’s consent to the transaction (for example, by misrepresenting the nature of the transaction), then this can amount to undue influence. Note the absence of a specific act of coercion or pressure

Question 38

No definitive list of relationships of influence or ascendancy

Answer 38

Commonly, the influence will come from the trust and confidence which one party has in the other. However, a relationship where one party is very vulnerable or dependent might also allow the other party to have significant influence, even if the innocent party has not positively placed trust or confidence in the other party.

Question 39

There is an irrebuttable presumption

Answer 39

There are a number of relationships in which there is an irrebuttable presumption that one party has influence over the other. In these cases, the court will not allow any argument that, in fact, there was no influence in that relationship. Such relationships include those between parent and child, guardian and ward, trustee and beneficiary, solicitor and client and doctor and patient. However, parent and adult child, or (crucially) husband and wife do not give rise to this presumption. The influence will therefore need to be positively shown.

Question 40

3.1 Taking advantage of influence or ascendancy in a relationship

Answer 40

Note that it is not every transaction between parties to such a relationship that gives rise to undue influence. It is only where the relationship is taken advantage of that there will be undue influence, for example because the party with influence has deceived the innocent party, or simply taken a decision entirely in their own interests.

Question 41

3.2 Proof of taking advantage of influence or ascendancy in a relationship

Answer 41

If a party wishes to allege it has been the victim of undue influence, the burden is on them to prove this. The court has established some basic principles as to how this might be proved. If a party can show that there is a relationship of trust and confidence (or presumably one of the categories of irrebuttable presumption) and also a transaction which requires explanation, then this will be enough for the court to determine that the transaction is the product of undue influence, unless the alleged wrongdoer can produce evidence to convince the court that there was no such undue influence

Question 42

3.2 Proof of taking advantage of influence or ascendancy in a relationship

Answer 42

A transaction will require explanation if it does not fit with what would usually be expected in the relationship concerned. It might be a suspicious type of transaction or be for a suspiciously high value. Note. The court has indicated that, in the majority of cases, a husband / wife offering their interest in the matrimonial home as security for a loan to their spouse’s business is not a transaction which requires explanation, so the party alleging undue influence would need to prove that unfair advantage had been taken of the relationship.

Question 43

3.3 Limits on equitable relief

Answer 43

Where undue influence is proven, a contract (or gift by deed) may be set aside. However, this relief is equitable and, therefore, discretionary. The court may not allow this relief where the innocent party has delayed making its claim because ‘delay defeats equity’. Also, it may be disallowed where the claimant’s conduct has been underhand because ‘you must come to equity with clean hands’.

Question 44

3.4 Risk to a lender

Answer 44

What is hopefully clear from the above, is that where a person (the ‘business owner’) wants their spouse (or indeed anyone they own a home with in which there is a relationship of ‘trust and confidence’) to enter into an agreement with the effect that the spouse’s share in the matrimonial home is used as security for a loan to the business owner’s business, then there is a real risk of the spouse later claiming undue influence. Whether the spouse will be able to do this, will of course depend upon the facts of the case.

Question 45

3.4 Risk to a lender

Answer 45

If the spouse can successfully argue that they were unduly influenced into entering the mortgage deed, then the effect is that the mortgage will be unenforceable against them (Barclays Bank plc v O’Brien [1994] 1 AC 180) because the clause which postpones the spouse’s interest in favour of the bank’s is ineffective; and the spouse’s interest in the land will still rank ahead of the lender’s. This presents a real problem for the lender as it means it will not be able to exercise its right possess or power of sale to recover the balance of the loan

Question 46

3.5 How then does the bank ensure it has priority?

Answer 46

In RBS v Etridge (No 2) [2002] 2 AC 773 Lord Nicholls stated that the only practical way forward is to regard banks as put on inquiry of the risk of undue whenever one party in a non-commercial setting is standing as surety for the other party. If a bank is put on inquiry (or notice) of undue influence, it must follow the guidelines laid down in this case. Providing it does this, the lender is protected from future claims of undue influence. Note. The lender is not put on inquiry/notice of undue influence if the purpose of the loan is for the joint benefit of the co-owners. For example, in CIBC Mortgages plc v Pitt [1994] 1 AC 200 the mortgage application said that the loan was for a holiday cottage, there was nothing to put the lender on notice that the transaction was anything other than a normal advance for the couple’s joint benefit.

Question 47

3.6 Etridge guidelines

Answer 47

Where the bank is put on inquiry/notice of undue influence, it must: (a) Write to the spouse who is granting the mortgage not for their benefit explaining that it needs confirmation from an independent solicitor that they have explained the transaction to the spouse; (b) Ask that party to nominate an independent solicitor, provide all information to that independent solicitor; and (c) It must not proceed to lend until confirmation is received from the independent solicitor that the transaction has been fully explained.

Question 48

The independent solicitor must:

Answer 48

(a) Meet the party who is entering into the mortgage not for their own benefit face to face, on their own (ie not with the partner for whose benefit the mortgage loan is for); (b) Explain why they have to come to see the spouse ie to stop them from being able to claim undue influence later; (c) Explain the documents and transaction in a meaningful way using non-technical language; (d) Point out the risks; (e) Emphasise that the spouse has a choice; (f) Keep a detailed attendance note and confirm everything in writing; and (g) Send a certificate to bank.

Question 49

3.7 Summary

Answer 49

* Where a party enters into a loan which grants security over their home and the loan is not for their direct benefit (ie it is securing the debts of someone else they have a relationship of trust and confidence with) there is a risk the party could later claim they were unduly influence into entering into the loan. * In this situation, the lender if put on enquiry/notice of the risk of undue influence.

Question 50

3.7 Summary

Answer 50

* A lender is not put on enquiry/notice of the risk of undue influence where the purpose of the loan is for the joint benefit of the parties entering into it. * If undue influence can be shown, the mortgage will be unenforceable against the party who has been unduly influenced into entering it. The means the lender is unable to exercise its right to possess and power of sale over the land. * If the lender if put on enquiry/notice of the risk of undue influence, it must follow the guidelines laid out in Etridge. These include ensuring the party giving the security for whose benefit the loan is not for, meets with an independent solicitor who explains the risks of the transaction.

Question 51

4. Priority of mortgages over registered land 4.1 The legal issue of priority of mortgages

Answer 51

Consider this scenario: a number of different mortgagees lend money on the same property. The borrower defaults and the property has to be sold, but the proceeds of sale are less than the total outstanding under the mortgages. Which lender will be paid first? Which lender will get nothing? The rules that determine these questions are the rules on priorities of mortgages

Question 52

4.2 Legal mortgages

Answer 52

Under the LRA 2002 all mortgages over registered land must themselves be registered substantively in order to attain the status of a legal mortgage (LRA 2002, s 27(2)(f)). Once registered, they take effect as a registered charge under the LRA 2002. A mortgage over registered land which is not completed by substantive registration will not take effect as a legal mortgage (s 27(1) LRA 2002). Under LRA 2002, s 48 priority between registered charges depends upon the order in which they are entered on the register. This is regardless of the order in which the mortgage deeds may have been signed.

Question 53

4.2 Legal mortgages

Answer 53

Where two or more mortgages are created at the same time (ie first and second mortgage simultaneously), the application for registration will specify the order of priority. Priority between registered charges therefore depends upon the order in which they are registered.

Question 54

4.3 Equitable mortgages

Answer 54

As against another equitable mortgagee, equitable mortgages rank in order of creation (LRA 2002, s 28). This is the basic rule of priority that applies to all equitable interests because an equitable interest in the land can be validly created and exist without registration. Although not required in order to validly create the interest, an equitable mortgage over registered land can be protected by the entering of a notice on the charges register (LRA 2002, s 32).

Question 55

4.3 Equitable mortgages

Answer 55

If protected by the entry of a notice, an equitable mortgage over registered land will take priority over a subsequent legal mortgage (LRA 2002, s 29(1)). As between competing equitable mortgages, the entry of a notice does not affect the priority, which will always be determined by creation. However, an equitable mortgage not protected by a notice, will not take priority (ie lose its priority) to a subsequent registrable disposition of either a registered estate or a registered charge (ie a transfer of the legal estate for value or the grant of a legal mortgage) (LRA 2002, s 29(1)).

Question 56

Example: Priority of mortgages

Answer 56

(a) A borrower grants a mortgage to Lender A. Although the mortgage is granted by a valid deed, Lender A fails to register the mortgage at the Land Registry – it is a defective legal mortgage. However, because it is in writing, signed by both the borrower and Lender A and contains the agreed mortgage terms, the mortgages take effect as an equitable mortgage. (b) The borrower subsequently enters into a second mortgage with Lender B. The mortgage is granted by valid deed, which Lender B registers. The mortgage therefore takes effect as a valid legal mortgage. As a registrable disposition of a legal charge over a registered estate, the legal mortgage in favour of Lender B will rank ahead of the equitable mortgage in favour of Lender A.

Question 57

Example: Priority of mortgages

Answer 57

(c) The borrower then enters into a further mortgage with Lender C. Although the borrower and Lender C enter into a document labelled as a deed, the borrower’s signature is not witnessed. There is no valid execution and the legal mortgage is defective. As the document is in writing, contains all the agreed terms and is signed by the borrower and Lender C, there is an equitable mortgage, which Lender C proceeds to note on the charges register of the borrower’s registered title.

Question 58

If the borrower defaults in their mortgage repayments and the land has to be sold, who then gets paid first? Which mortgage ranks in priority?

Answer 58

Lender A has an equitable mortgage which was created first, but not protected. Lender B has a legal mortgage. Lender C has an equitable mortgage which has been duly protected. Lender B will get paid first. It takes priority over Lender A’s equitable mortgage because the equitable mortgage was not protected by notice at the Land Registry.

Question 59

Example: Priority of mortgages

Answer 59

Lender A will then get paid second because Lender A and C both have equitable mortgages and as between competing equitable mortgages, the order of creation determines priority. The fact Lender C protected its equitable mortgage by the entry of a notice, does not affect priority here. However, if a subsequent legal mortgage were entered into by the borrower, Lender C would take priority over this because it has protected its interest. You will explore the rules of priority further in the chapter five, enforcement of interests over registered land.

Question 60

4.4 Postponement

Answer 60

The priority rules can be modified to allow a mortgage to take priority over a pre-existing interest which could otherwise enjoy priority if there is a postponement of that pre-existing interest. Lenders can agree to alter the position that would apply according to the priority rules by entering a deed of priority or intercreditor deed. Any agreement would need to be registered at the Land Registry.

Question 61

4.4 Postponement

Answer 61

Mortgagees will also often require an express waiver or postponement to be included in a mortgage agreement so that the rights of any person living at the mortgaged property with the mortgagor are postponed to the interests of the mortgagee. This is important for the lender to be able to enforce their security and take possession of the mortgaged property in the event of default. If the lender’s interest in the land does not rank in priority to the interest of a person in occupation (not a party to the mortgage) then the lender would not be able to take possession of the land in order to exercise its power of sale.

Question 62

4.5 Summary

Answer 62

* Priority is important in the event of a default and the mortgagee exercising its power of sale. It determines which lender gets paid first from the proceeds of sale. * Priority of legal mortgages is determined by registration. * Priority of equitable mortgages is determined by creation. * If an equitable mortgage is protected by the entry of a notice at the Land Registry, it will rank in priority to a subsequent lender, even if that subsequent lender holds a legal mortgage. * If an equitable mortgage is not protected by the entry of a notice at the Land Registry, it will rank in priority to any subsequent equitable mortgage, but a subsequent legal mortgage will take priority once registered. * Lenders can expressly agree between themselves the order of priority.

Question 63

5 Rights of the lender

Answer 63

It is inherent in the nature of a mortgage that the lender’s right to repayment of the loan is secured against the mortgaged property itself. This security is very important to lenders, as without it, they may take the view that it is simply too much of a risk to advance large sums of money to borrowers. If the mortgagor fails to make the mortgage payments, the lender will wish to take steps to protect itself against losses. The lender can always sue the borrower in contract for the debt, but this can be a long and ultimately fruitless process if the borrower has insufficient money. The fact that a mortgage is a proprietary right in the lender’s favour means that the lender has several remedies available to it.

Question 64

5. Rights of the lender

Answer 64

There is no obligation for a lender to exercise any particular remedy, or indeed any remedy at all. The choice of remedy is a matter for the particular lender in the particular circumstances. However, if the lender does decide to pursue a remedy, it will be under a duty to act fairly and reasonably, and may be subject to additional duties to the borrower, depending on the remedy sought. The lender who holds the security of a legal mortgage, rather than an equitable one, has a wider choice of remedies. An equitable mortgagee has the same rights to bring a debt action under the mortgage contract for money owed, to apply for foreclosure, and to appoint a receiver. However, the equitable lender does not, generally speaking, have the right to repossess or sell without a court order. The legal lender has five courses of action open to it: sue on the contract for the outstanding debt; repossess the property; sell it; appoint a receiver; or foreclose.

Question 65

5.1 Debt action

Answer 65

The contractual debt action is a personal action against the borrower. As the lender has a proprietary right and can enforce it against the property itself, it may be thought that the contractual right to sue for the outstanding debt is rarely used. If a borrower is unable to make their mortgage repayments, they are unlikely to be able to pay damages awarded by the court.

Question 66

Negative Equity

Answer 66

This remedy is therefore used in addition to, not instead of, one of the other remedies. In recent years, a debt action has been used if the value of the mortgaged property is less than the outstanding mortgage debt. In this situation there is said to be negative equity. The lender may take possession of and sell the property, but if the sale proceeds do not cover the outstanding debt, the lender will wish to pursue a debt action against the borrower for the shortfall.

Question 67

5.2 Possession

Answer 67

A legal lender may wish to enforce its security by taking possession of the mortgaged property as a precursor to sale. Taking physical possession of the property is a practical step which enables the lender to offer the property for sale with vacant possession, free from any rights of the borrower. Since 2008, the Pre-Action Protocol for Possession Claims makes clear that in residential cases, possession must be a last resort. The mortgage lender is expected to explore alternative arrangements with the borrower, such as extending the mortgage term and/or scheduling a new payment plan.

Question 68

5.3 Sale

Answer 68

The power of sale is the strongest right which the lender can use against a defaulting borrower. If exercised, the borrower loses all rights to the property. The sale proceeds are applied towards the outstanding debt. If there is a surplus, this will be forwarded to the borrower; but if there is a shortfall, the borrower may be sued personally by the lender for the outstanding contractual debt. Because the power of sale has such drastic consequences for the borrower, there are procedural steps which must be adhered to, which are explored below.

Question 69

5.4 Receiver

Answer 69

A receiver acts as manager of the mortgaged property and is used by a lender as an alternative to seeking possession where a property needs management. For example, dealing with tenant issues and/or finalising any development of the mortgaged land. The power to appoint a receiver arises under LPA 1925, s 101(1)(iii). The receiver is an administrator whose function is to get an income from the land before sale, and will apply any income (eg rent received from tenants in occupation) towards the outstanding mortgage debt. The receiver is deemed to be the borrower‘s agent. This may seem odd, as the receiver is appointed by the lender, but it means that the lender is not liable for the receiver’s negligence. Thus the appointment of a receiver is a safer option for the lender than taking possession and running any business from the property itself. A receiver must act with due diligence, subject always to the main duty of paying off the mortgage debt.

Question 70

5.5 Foreclosure

Answer 70

Foreclosure is a historic way of enforcing a mortgage which is rarely used nowadays. It allows a lender to take the mortgaged property in satisfaction of the debt, meaning that the freehold will vest in the lender, and the borrower will lose all rights to the property. This could happen even though there may be only a very small amount outstanding on the mortgage security, when compared to the value of the property as a whole.

Question 71

Lender's Point of View

Answer 71

From the lender’s point of view, the procedure is lengthy and complex. The court may order a sale in lieu of foreclosure, and almost certainly will do so if the property is worth a lot more than the outstanding debt. Even after the final decree of foreclosure, the borrower can re-open the case if they can show that they have the means to pay.

Question 72

Borrower's point of view

Answer 72

From the borrower’s point of view, there are some advantages in that an order of foreclosure extinguishes all other mortgages secured on the property. It also extinguishes the mortgagor’s contractual debt, so the lender cannot pursue the borrower for any surplus debt over and above the value of the property.

Question 73

Draconian Remedy

Answer 73

Today, foreclosure is viewed as a particularly draconian remedy and is rarely encountered in practice. The Law Commission has recommended that it be abolished and replaced by wider powers for the lender to sell the property.

Question 74

5.6 Summary

Answer 74

* There are various rights and remedies available to a lender. The appropriate remedy depends on the circumstances. The lender may: - Sue for the contractual debt, although this is of limited use if the borrower is already in arrears; - Take possession of the property as a precursor to selling it with vacant possession; - Sell the property and apply the proceeds towards the outstanding debt; - Appoint a receiver to generate income from the property to pay towards the outstanding debt; or - Apply for foreclosure, but this is very rare, and a sale would usually be ordered instead. * In exercising its rights, the lender must comply with its duties to the borrower.

Question 75

6. The lender’s right to possess 6.1 Legal mortgagee

Answer 75

LPA 1925, s 95(4) acknowledges ‘the right of a mortgagee of land […] to take possession’, and in Four Maids v Dudley Marshall (Properties) Ltd [1957] Ch 317 it was confirmed that the right arises as soon as the mortgage is granted, ‘before the ink […] becomes dry’ on the mortgage deed.

Question 76

Possession is thus strictly a right of the lender, and not simply a remedy

Answer 76

Having said that, lenders do not exercise the right arbitrarily. It is a last resort, used when the borrower is in default with little hope of repayment. Mortgage deeds almost always contain a term which recognises that the right to possess is postponed for as long as the borrower pays the agreed instalments.

Question 77

6.2 Exercising the right to possess

Answer 77

As the right to possess is exactly what it says: a right, it is not therefore strictly necessary for the lender to obtain a court order prior to taking possession, it can choose to physically take possession (‘self-help’).

Question 78

6.2.1 Limits on the right to possess

Answer 78

The Criminal Law Act 1977, s 6 makes it a criminal offence to use or threaten violence for the purpose of gaining entry to property. This means that exercising the right to repossess by ‘selfhelp’ is risky, unless the lender is certain that the property is unoccupied at the time. A prudent lender will make an application to the court for an order for possession, even though this may not be strictly necessary

Question 79

Pre-Action Protocol for Possession Claims 2008

Answer 79

The Pre-Action Protocol for Possession Claims 2008 sets out the steps which a court will expect a lender to have taken before resorting to possession of residential property, which should be a last resort. For example, lenders should try to discuss the debt with the borrower and accept reasonable requests for a new payment plan. Most lenders observe the Protocol. However, if they do not, they can suffer delays in obtaining possession and may be ordered to pay the borrower’s legal costs.

Question 80

6.3 Statutory jurisdiction to postpone Administration of Justice Act (AJA) 1970, s 36:

Answer 80

(1) Where the mortgagee under a mortgage of land which consists of or includes a dwellinghouse brings an action in which he claims possession of the mortgaged property […] the court may exercise any of the powers conferred on it by subsection (2) below if it appears to the court that […] the mortgagor is likely to be able within a reasonable period to pay any sums due under the mortgage […]

Question 81

Powers conferred in s 36(2)

Answer 81

The powers conferred in s 36(2) include a power to postpone the date for delivery of possession for such period as the court thinks reasonable. Any postponement may be subject to such payment or conditions regarding payment as the court thinks fit. It is important to understand how this section operates.

Question 82

6.3.1 The scope of AJA, s 36

Answer 82

The section does not: * Enable the court to prevent the lender from exercising its right to possess altogether; * Enable the court to postpone possession in cases where there has been no application for an order for possession: Ropaigelach v Barclays Bank plc[2000] QB 263; * Enable the court to prevent a lender from exercising a power of sale without first obtaining a court order: Horsham Properties Group Ltd v Clark [2009] 1 WLR 1255.

Question 83

The section does:

Answer 83

* Apply where the property is wholly or partly residential, although need not be the borrower’s home. * Enable the court to: - Adjourn possession proceedings; or - Stay or postpone execution of the possession order. * In order to be able to do this, it must appear to the court that the borrower is likely to be able to pay any sums due (or remedy any other default) within a reasonable period.

Question 84

6.3.2 Case focus National & Provincial Building Society v Lloyd [1996] 1 All ER 630:

Answer 84

A borrower requesting a postponement of possession should present a detailed financial plan to the court, showing how the loan and arrears will be paid off before the term expires.

Question 85

Bristol and West Building Society v Ellis (1996) 73 P&CR 158

Answer 85

A postponement was granted to allow the borrowers to achieve a sale of the property themselves. The court needed to see that the sale proceeds would be sufficient to cover the debt due. An estate agent’s optimistic estimate of the price likely to be achieved would not be enough!

Question 86

Target Home Loans Ltd v Clothier [1994] 1 All ER 439

Answer 86

The court awarded a short, three-month postponement of possession to allow the borrower to sell the property. There was evidence from an estate agent that a genuine offer had been received.

Question 87

Mortgage Services Funding plc v Steele (1996) 72 P&CR 40

Answer 87

In order to grant a postponement to allow the borrower to sell, the court required firm evidence of an imminent exchange of contracts. Simply instructing a solicitor to handle the conveyancing will not be enough: courts are suspicious of mortgagor’s delaying tactics, enabling them to stay in possession for longer!

Question 88

6.4 Summary

Answer 88

* A legal lender has a right to possess mortgaged property from the outset. * This is in practice not exercised unless there is a breach of mortgage terms. * Although the right can be exercised without a court order, lenders almost always apply for a court order. * Courts have a statutory jurisdiction to postpone possession for a long period if the property is residential or partly residential. * AJA, s 36 gives the court the power to postpone possession of residential property if all sums due can be paid within a reasonable period. * ‘Sums due’ and ‘reasonable period’ have been interpreted generously to assist the borrower. * The court may impose conditions on the borrower.

Question 89

7. The lender’s right to sell and duties when selling 7.1 Legal mortgagee: the right to sell

Answer 89

The right to sell is the strongest of the lender’s rights and there are strict rules as to when the power arises and when it becomes exercisable. As this power of sale is a right of the lender, no court order is required. The power of sale must, however, exist, have arisen and become exercisable. The law regarding the lender’s power of sale explored below relates to a legal mortgagee only.

Question 90

7.2 Lender’s right to sell: does it exist? 7.2.1 Express power of sale

Answer 90

Most mortgage documents will include an express power of sale and will set out exactly how and when the power will be exercised. The lender will not need to rely on any statutory provisions, although it will be subject to duties on sale, in the same was as a lender relying on statutory powers.

Question 91

7.2.2 Implied, or statutory, power of sale

Answer 91

In the absence of an express power, a right to sell can be implied into a legal mortgage under LPA 1925, s 101(1)(i) unless it is excluded or modified in the mortgage deed. 101(1) A mortgagee, where the mortgage is made by deed, shall […] have the following powers: (i) A power,when the mortgage money has become due, to sell […] the mortgaged property […] either together or in lots, by public auction or by private contract

Question 92

7.3 Lender’s statutory right to sell: when does it arise?

Answer 92

The lender’s statutory power of sale arises when the mortgage money has become due (LPA 1925, s 101(1)(i)). If a borrower has a capital and interest repayment mortgage, Payne v Cardiff [1932] 1 KB 241 confirms that the power of sale arises as soon as one portion of capital is due, meaning that it arises as soon as one payment is due. Where a mortgage is an interest-only mortgage, the capital is not due until the end of the loan term. In these cases, the mortgage money will ‘become due’ at the legal redemption date, usually about six months from the start of the mortgage. If the lender sells after the power has arisen but before it is exercisable, a sale to an innocent purchaser will be valid, but the lender will be liable in damages to the borrower (LPA 1925, s 104).

Question 93

7.4 Lender’s statutory right to sell: when is it exercisable?

Answer 93

Where the right to sell has been expressly conferred, the wording will set out in what circumstances the power can be exercised. If the power arises under LPA 1925, s 101(1)(i), the power will become exercisable only when at least one of the criteria in s 103 applies

Question 94

Criteria: Notice requiring payment of the whole loan has been served by the lender and the borrower has defaulted.

Answer 94

Notes: No arrears are necessary here: the lender can request the full loan at any time!

Question 95

Criteria: Interest is unpaid and in arrears for at least two months.

Answer 95

Notes: This does not mean that two months’ interest must be owed: there must be some interest outstanding for two months: it does not need to be a large sum!

Question 96

Criteria: There has been some breach of another mortgage provision such as a covenant to keep the mortgaged property insured or in good repair.

Answer 96

Notes: Examples: failure to insure the property or allowing it to fall into disrepair: basically something which could affect the value of the security

Question 97

7.5 Lender’s duties when exercising the right to sell

Answer 97

When the lender exercises its right to sell mortgaged property, whether the right is conferred expressly or by statute, it owes duties to the borrower. The lender’s basic motive is to recover the debt due, meaning the capital sum, interest and costs. It is not necessarily interested in achieving the best possible price. However, as the following cases show, the lender cannot simply consider its own interests, these must be balanced against the interests of the borrower. After the sale, the lender is trustee of the surplus proceeds of sale (LPA 1925, s 105) and must hand them to the person next entitled. That may be another lender, or the borrower.

Question 98

7.6 Key cases on lenders’ duties Cuckmere Brick Co Ltd v Mutual Finance Ltd [1971] Ch 949

Answer 98

Facts: Two planning permissions had been granted for the mortgaged property. The lender repossessed the property and sold it at auction. Just before the auction, the lender discovered that the sales particulars only mentioned one of the planning permissions but decided not to reprint the brochures. Damages were awarded amounting to the difference in the price actually obtained and the price which could have been obtained had the planning permission been disclosed. Principle: The Court of Appeal said that the lender owed the borrower a duty to take reasonable care to obtain the ‘true market value’ or ‘proper price’ for the property.

Question 99

Michael v Miller [2004] EWCA Civ 282

Answer 99

Facts: The lender accepted £1.625 million for land valued between £1.6 million and £1.9 million. Principle: Perfection as to price is not required: the lender will not be liable for losses if the price is within the correct bracket or within an acceptable ‘margin of error’.

Question 100

Tse Kwong Lam v Wong Chit Sen [1983] 1 WLR 1349

Answer 100

Facts: The lender sold the property by auction. The successful bidder was the lender’s wife, acting on behalf of a company owned by the lender and his family. An auction was unsuitable in the circumstances. The court said that it would scrutinise a sale very closely where the property is sold to a buyer who is closely associated with the lender. Principle: A lender cannot simply put the property ‘under the hammer’ as a matter of course. Lenders are under a duty to take expert advice as to the method of sale, the marketing strategy and the reserve price.

Question 101

Silven Properties Ltd v Royal Bank of Scotland plc [2004] 4 All ER 484

Answer 101

Facts: The lender repossessed and sold several properties. The value of some could have been enhanced had the lender applied for planning permission to develop them. The borrower argued that the lender was in breach of duty by not delaying the sales pending planning applications. The court held the lender was not in breach. Principles: A lender has an ‘unfettered discretion’ as to when to sell and cannot be expected to delay in order to improve the property or wait for an upturn in the property market.