Chapter 2: Mortgages Flashcards
- Legal and equitable mortgages
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.
1.1 Legal mortgages
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.
LPA 1925, s 52
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.
1.2 Equitable mortgages
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.
1.2.1 Mortgage of an equitable interest
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.
1.2.2 Defective legal mortgage
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.
1.3 Discharge of mortgages
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.
- The equity of redemption
2.1 Introduction to the equity of redemption
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.
Equitable right to redeem & Equity of Redemption
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.
2.2 Postponement of the right to redeem
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.
Key case: Fairclough v Swan Brewery Co Ltd [1912] AC 565
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.
Key case: Knightsbridge Estates Trust Ltd v Byrne [1939] Ch 441
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.
2.2.1 Why was the postponement upheld in the Knightsbridge case but not in Fairclough?
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.
2.2.1 Why was the postponement upheld in the Knightsbridge case but not in Fairclough?
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.
Knightsbridge v Byrne
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.
2.2.2 Options to purchase
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.
Samuel v Jarrah Timber and Wood
Paving Corporation Ltd [1904] AC
323
An option granted at the same time as the mortgage will normally be declared invalid.
Reeve v Lisle [1902] AC 461
If an option is granted in a subsequent transaction it may be upheld if independent of the mortgage.
Warnborough v Garmite [2003]
EWCA Civ 1544
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.
2.3 Collateral advantages
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
2.3 Collateral advantages
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
Key case: Noakes & Co Ltd v Rice [1902] AC 24
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.
Key case: Biggs v Hoddinott [1898] 2 Ch 307
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.
2.4 Unconscionable terms
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.
Key cases
- 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.
Key case: Cityland and Property Holdings Ltd v Dabrah [1968] Ch 166
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%.
Key case: Cityland and Property Holdings Ltd v Dabrah [1968] Ch 166
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.
Key case: Multiservice Bookbinding Ltd v Marden [1979] Ch 84
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.
Key case: Multiservice Bookbinding Ltd v Marden [1979] Ch 84
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.
2.4.1 Statutory regime cases now applied by analogy
Falco Finance v Gough
(unreported)
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.
Davies v Directloans Ltd [1986] 1
WLR 823
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.
Paragon Finance v Nash [2002]
WLR 685
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.
2.5 Summary
- 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
2.5 Summary
- 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.
- Undue influence
[…] 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.
RBS v Etridge (No 2) [2002] 2 AC 773
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.
3.1 Taking advantage of influence or ascendancy in a relationship
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
No definitive list of relationships of influence or ascendancy
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.
There is an irrebuttable presumption
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.
3.1 Taking advantage of influence or ascendancy in a relationship
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.
3.2 Proof of taking advantage of influence or ascendancy in a relationship
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
3.2 Proof of taking advantage of influence or ascendancy in a relationship
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.
3.3 Limits on equitable relief
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’.
3.4 Risk to a lender
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.
3.4 Risk to a lender
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
3.5 How then does the bank ensure it has priority?
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.
3.6 Etridge guidelines
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.
The independent solicitor must:
(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.
3.7 Summary
- 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.
3.7 Summary
- 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.
- Priority of mortgages over registered land
4.1 The legal issue of priority of mortgages
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
4.2 Legal mortgages
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.
4.2 Legal mortgages
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.
4.3 Equitable mortgages
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).
4.3 Equitable mortgages
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)).
Example: Priority of mortgages
(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.
Example: Priority of mortgages
(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.
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?
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.
Example: Priority of mortgages
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.
4.4 Postponement
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.
4.4 Postponement
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.
4.5 Summary
- 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.
5 Rights of the lender
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.
- Rights of the lender
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.
5.1 Debt action
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.
Negative Equity
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.
5.2 Possession
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.
5.3 Sale
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.
5.4 Receiver
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.
5.5 Foreclosure
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.
Lender’s Point of View
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.
Borrower’s point of view
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.
Draconian Remedy
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.
5.6 Summary
- 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.
- The lender’s right to possess
6.1 Legal mortgagee
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.
Possession is thus strictly a right of the lender, and not simply a remedy
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.
6.2 Exercising the right to possess
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’).
6.2.1 Limits on the right to possess
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
Pre-Action Protocol for Possession Claims 2008
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.
6.3 Statutory jurisdiction to postpone
Administration of Justice Act (AJA) 1970, s 36:
(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 […]
Powers conferred in s 36(2)
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.
6.3.1 The scope of AJA, s 36
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.
The section does:
- 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.
6.3.2 Case focus
National & Provincial Building Society v Lloyd [1996] 1 All ER 630:
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.
Bristol and West Building Society v Ellis (1996) 73 P&CR 158
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!
Target Home Loans Ltd v Clothier [1994] 1 All ER 439
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.
Mortgage Services Funding plc v Steele (1996) 72 P&CR 40
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!
6.4 Summary
- 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.
- The lender’s right to sell and duties when selling
7.1 Legal mortgagee: the right to sell
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.
7.2 Lender’s right to sell: does it exist?
7.2.1 Express power of sale
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.
7.2.2 Implied, or statutory, power of sale
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
7.3 Lender’s statutory right to sell: when does it arise?
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).
7.4 Lender’s statutory right to sell: when is it exercisable?
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
Criteria: Notice requiring payment of the whole loan has been served by the lender and the borrower has defaulted.
Notes: No arrears are necessary here: the lender can request the full loan at any time!
Criteria: Interest is unpaid and in arrears for at least two months.
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!
Criteria: There has been some breach of another mortgage provision such as a covenant to
keep the mortgaged property insured or in good repair.
Notes: Examples: failure to insure the property or allowing it to fall into disrepair: basically something which could affect the value of the
security
7.5 Lender’s duties when exercising the right to sell
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.
7.6 Key cases on lenders’ duties
Cuckmere Brick Co Ltd v Mutual
Finance Ltd [1971] Ch 949
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.
Michael v Miller [2004] EWCA
Civ 282
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’.
Tse Kwong Lam v Wong Chit Sen
[1983] 1 WLR 1349
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.
Silven Properties Ltd v Royal Bank
of Scotland plc [2004] 4 All ER
484
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.
