Essay: Legal rights of mortgagee and mortgagor

The mortgagee may only exercise their right to possession to enforce or preserve their security. If the lender exercises their right for reasons other than to enforce or preserve his security, the courts of equity have the power to intervene: “The courts of equity …declared it to be unreasonable and against conscience that the mortgagee should retain as owner for his own benefit what was intended as a mere security.”
The mortgagee is free to act in accordance with its own interests, unless such acts are restricted by the mortgage deed. The mortgage property is only a security for the money provided by the mortgagee and so it follows that the mortgagee must be diligent in realising the amount due in order that he may restore the property to the mortgagor.
It is suggested that the parties do not have competitive bargaining powers. Lenders can and continue to include terms and conditions in a mortgage deed for collateral advantage to endure redemption . Although the collateral advantage cannot be unfair and unconscionable, or in the nature of a penalty clogging the equity of redemption, or inconsistent with or repugnant to the contractual or equitable right to redeem; there is much freedom in business contracts and Lender’s in possession do attempt to restrict the equitable right to redeem.
In Alexander v West Bromwich Mortgage Co Ltd , a mortgage agreement conferred on the lender a right to unilaterally change the product from a buy to let to a sale unlet should the borrower enforce the specially agreed term; that the borrower had to produce sums it had contracted to repay over a 25 year period on one month’s notice from the Lender. The courts held that the specially agreed term was inconsistent and unreasonable.
During proceedings, the court considered evidence of the parties intentions; the terms by which the parties had bound themselves including what is written in the offer letter, mortgage conditions and the mortgage deed itself. In cases were terms have been found to be substantially greater or different from those necessary to make the property adequate security for the liabilities secured by the mortgage, lenders have not been able to rely on them if they were inconsistent with the purpose of the mortgage.
Inconsistencies in this context does not relate to the rights of each party to the mortgage agreement but rather to the terms found within the mortgage deed and other related documents. The exercise of finding inconsistencies is not a balancing exercise between the rights of the parties but an exercise to determine whether the terms in question cannot be given effect, if they cannot then they are deemed inconsistent.
This paper suggests that this exercise should lend itself to situations where the Lender has greater rights than the borrower, or different rights to those necessary to make the property adequate security, or powers Lenders wish to exercise with an improper motive or in bad faith.
The courts should find in such circumstances that there is an inconsistency. The courts should intervene in cases where the Lender has powers expressed in the mortgage deed likely to cause a Borrower’s default as seen in Alexander v West Bromwich Mortgage Co Ltd.
This paper cannot define greater rights but proposes that the courts consider the circumstances in which the terms were agreed; if any limitations or restrictions have been imposed upon the exercise of the right and the likelihood of the borrower redeeming the property if the right is exercised. All three limbs should be satisfied before the court exercises its discretion to vary or set aside a Lender’s right.
The current approach to inconsistencies should still be applied: “Inconsistencies should be approached without any pre-conceived assumptions. One should not strive to avoid or to find inconsistency. Rather one should “approach the documents in a cool and objective spirit to see whether there is inconsistency or not”.
When a mortgagee is treated as being in possession, a mortgagee can continue to carry out the commercial activities of the mortgagor or alternative activities in order to settle the full outstanding sum owed by the mortgagor .
It is by choice that a lender carries on the borrower’s business whilst in possession and management of the business should be done in good faith : a lender who manages a business to fulfil some dishonest or improper motive; some element of bad faith which is distinct from mere negligence will be in breach of their duty to act in good faith; see Medforth v Blake.
As such when a mortgagee takes possession of the mortgage property they are entitled to rents and profits generated . A mortgagee has the right to receive rents from existing tenants or grant new leases.
Section 99(2) LPA gives a Lender the right to grant new leases unless it is expressly excluded. On the other hand, a mortgagee will be bound by an existing tenancy if:
(a) The tenancy was granted before the mortgage; or
(b) It is an express term of the mortgage deed that the mortgagor could grant tenancies; or
(c) In a separate agreement the mortgagee agreed to the mortgagor granting a tenancy for the property.
If the mortgagee is not bound by an existing tenancy they may still choose to receive rents from the existing tenant. Once in possession, there is no duty on the Lender to consider the interests of the Borrower. However, ‘a mortgagee will be restrained from getting possession except when it is sought bona fide and reasonably for the purpose of enforcing the security and then only subject to such conditions as the court thinks fit to impose.
In Quennell v Maltby, the lender refused to bring proceedings against the tenants of the borrower because the borrower wanted to sell his house with vacant possession. The Borrower’s wife paid the full sum owing to the bank and became the Lender’s successor. When she sought possession of the property from the tenants, the court held that it was entitled to investigate the purpose of the legal relationship formed between the lender and borrower before granting a lender possession. It held that a lender must only enforce its security in good faith and that the bank was correct not to bring the action against the tenants.
A mortgagee who takes possession, leaves the mortgagor without control over the property. The mortgage property itself or the business being carried out generates rents and profits that the Borrower would use to repay the secured debt to the Lender.
Equity imposes upon a Lender a duty to account to the borrower the rents and profits received whilst the Lender is in possession. The purpose of this duty is to discourage wilful default and serves as a safety measure to ensure that the property is being managed with due diligence. The accounts for rents and profits received from the property is limited to the property itself, business, money, security and any other assets that form part of the mortgage property . The mortgagee does not have to account for profits made in the course of business connected to the property.
There are no other duties imposed upon a Lender that safeguards a Borrower’s right of redemption save for the general duty to act in good faith and fairly towards a mortgagor in a Lender’s pursuit to obtain repayment. Lenders often have little or no experience in managing the mortgage property let alone a Borrower’s business. Lenders must simply demonstrate that they were active.
It is recommended that if Lenders are able to take possession, the courts should impose a similar duty on a Lender who seeks to control the mortgage property as a Lender selling a mortgage property: the Lender should take reasonable care to obtain the best rental price for the mortgage property and/or generate profits similar to a reasonable businessman carrying on the same business.
The recommendation would reinforce a mortgagee’s duty to take reasonable care of the property . Reasonable care must be exercised by the mortgagee acting to enforce or safeguard it’s securities, in so much that that mortgagee must not take undue risk when exploiting the mortgage property in pursuit of rents and profits. The account must also include rents and profits the Lender would have received had it not been for their own wilful default or neglect; that is, for everything which he has received, or might or ought to have received, whilst being in possession . The mortgagee will be liable for the rents and profits it ought to have received had it not been for its own wilful default or neglect.
The recommendation would encourage the Lender to maximise the return, but without taking undue risks or less than satisfactory efforts.
The Lender has the right to sell the mortgage property with or without possession if the term is included in the mortgage deed. In Michael v Miller , Parker LJ shed commented on the extent of the a Lender’s autonomy when exercising their power of sale; ‘ an exercise of informed judgement on the part of the mortgagee, in respect of which there can, almost by definition, be no absolute requirements’.
Nonetheless, amongst the duties a Lender must discharge in relation to sale , Lenders have a duty to take reasonable care to obtain the best price even if they choose to bid or purchase the property with the purpose of selling it or retaining it .
That duty extends to connected party transactions. In a sale that gives rise to a risk of a conflict of interest and duty, the mortgagee has the burden of proof to show that it has discharged its duties.
In Alpstream AG an others v PK Airfinance and Another the borrowers alleged that the Lenders had breached their duty by failing to get the true market value for the collateral and since the lenders were selling to themselves to show that it complied with its duty. It was also alleged that they failed to act in good faith and for proper purposes.
In any event if the lender breached its duty by not obtaining the best price at the point of sale, then the lender must rectify the shortcomings by amending the mortgages accounts to reflect a reasonably obtained amount that should have been obtained on sale.
Thus Lenders who intend to buy the mortgaged property should ensure that they properly expose the property to the market place in an attempt to obtain the best price. To discharge their duty to market the property, Lenders should consider the prevalent sale practices in the market place best suited to the mortgage property they wish to sell.
Clarke LJ also went on to comment that although it is not a duty, a lender should consider a buyer’s perception in choosing how to conduct the sale; for instance a sale by auction may be perceived as a quick sale is intended and an expectation for the property to be heavily discounted. Lenders should try to avoid creating such perceptions.
Where the borrower alleges that the property is sold at an undervalue; Alpstream is an illustration that the court will be looking for the cause of the sale price. The court will consider all the circumstances of the case including the dynamics of the market, the perceptions the lender caused potential buyers to have, the effect of those perceptions on the sale price, evidence that the lender discharged his duty to act in good faith and any breaches committed by the lender in relation to the sale.
This paper supports the notion that buyer or a lender should not pay a price that exceeds the market value of the property, nor that a Lender should have to delay a sale to give the Borrower an opportunity to redeem the property. The Lender is and should continue to enforce its security through sale for had it not been for the borrower’s default the borrower would be in control of the mortgage property.
The right to appoint a receiver can be dated back to 1860 and the right as we know it today could only be exercised if it had been included in the mortgage deed. It became common practice to include a term in the mortgage deed that a Lender should reserve the right to appoint a receiver.
The purpose of this power is to save the Lender from taking possession of the mortgage property and the liabilities that arise with it. The Lender can enjoy all the benefits he would have as a mortgagee in possession without needing to personally control the property to enforce or safeguard his security whilst the Borrower retains his equitable right of redemption.
The right to appoint a receiver can be restricted as much as it can be widened in the mortgage deed and conditions . It is a precondition of the statutory right that the mortgage money should become due and that a default should occur before a lender may exercise their right to appoint a receiver.
Furthermore, a lender does not owe a duty of care to the Borrower so far as their interests are protected, but a duty to ensure that the receiver appointed is competent to the standard of a competent receiver.
A receiver’s duties to the Borrower and Lender are not equal in nature; on the one hand the receiver’s primary duty is to act for the benefit of the lender and on the other, their duty as an agent of the borrower is secondary to that owed to the Lender.
When a receiver acts for the benefit of the lender, their primary objective is to recover the full outstanding sum owed (the loan, interests and costs incurred) to the Lender even if the acts are detrimental to the borrower’s circumstances.
In this tripartite relationship, the Borrower finds themselves responsible for the receiver’s actions and defaults. It has been suggested that the relationship and duties bestowed on a Borrower are unfair and some may even argue oppressive when the Lender appointed the receiver.
In fact, when a commercial borrower and lender negotiate the terms of the mortgage they are held to have equal bargaining power . The Borrower is therefore free to alter or add restrictions to the lender’s right to appoint a receiver. Furthermore, if not expressly written into the mortgage deed, it is the LPA that implies into the mortgage agreement that the borrower shall be solely responsible for the receiver’s acts or defaults unless the mortgage deed provides otherwise .
Thus the Lender cannot be regarded as acting unfairly by including a right to appoint a receiver in the mortgage deed simply because it may cause a detriment to the borrower in the future. Afterall the borrowers default can be described as the action or omission that triggered the appointment.
The receiver is no ordinary agent. The borrower is a principal with no knowledge of the competencies or identity of their agent prior to appointment and whilst appointed cannot instruct nor dismiss them because the borrower and receiver have no legal relationship. There exists no enforceable contract between the two but the receiver does owe the borrower equitable duties as discussed below.
The purpose of relationship is to make the mortgagor liable for the receiver’s acts in managing the mortgage property and not the lender ;in Silven Properties Ltd v RBS plc , it was held: ‘… the receiver is not managing the mortgagor’s property for the benefit of the mortgagor, but the security, the property of the mortgagee, for the benefit of the mortgagee’.
The following equitable duties are not owed by the receiver exclusively to the borrower but are also owed to anyone else with an interest in the equity of redemption. Therefore, a receiver will have to account to all who have an interest in the equity of redemption if they breach their duties.
If a receiver takes over the borrower’s business, the receiver’s relationship with the borrower is equitable as are their duties. In Medforth v Blake and Others the receivers managed a pig farming business until the borrower brought proceedings alleging that the receiver failed to request and obtain discounts for the purchase of pig feed which constituted a breach of their duty of care owed to the borrower.
The receiver in such circumstances owes more than a duty of good faith; when conducting business, the court of appeal held that expecting receiver’s to manage the borrower’s business to a standard of a competent receiver did not compromise nor cause a detriment to their primary duty owed to the lender and made ‘commercial sense’ in their pursuit to generate a profit to repay the debt owed by the borrower.
However, in managing the business, a receiver had no duty of care in dealing with the assets of the borrower and any other additional duty, it’s scope and extent, owed beyond good faith were to be determined on the circumstances of each case.
Furthermore, a receiver has a duty to practice due diligence in his management of the mortgage property. This paper recommends that the same due diligence be exercised when a receiver decides to take over a borrower’s business.
Part VI Receivers and sale
The receiver has no general duty to exercise the power of sale. However, the equitable duty of care owed to the Borrower when carrying on the Borrower’s business applied to the exercise of the sale as well; the judge concluded in Medforth v Blake that no sensible distinction could be drawn between exercising the power of sale and the exercise of a power to manage a business, that the power to manage was ancillary to the power of sale and that the equitable duty of care was applicable to both.
A receiver exercising the power of sale is under no greater duty than a lender; they owe the same duties to the borrower as a lender would exercising that power. A receiver must take reasonable care to obtain a proper price on sale . However, no general duty of care extends to dealing with a company’s assets. Receivers should exercise caution for if they sell and do not obtain a reasonable price, they may be held liable and not the borrower for their actions.
In Bell v Long , the receiver had four properties to sell and were advised to market the properties separately, later on the same advisers told them to market the properties altogether. The properties were sold for £775,000 and subsequently sold on for £1.12m. It was decided that reasonable price was not based on the value of the property, nor was it determined by comparing what the mortgage property was sold for or ought to have been sold for but whether the receiver had acted reasonably.
The duty is also equitable in nature, therefore it is unlikely that anyone who has an equitable interest will be able to bring a successful claim at common law against a receiver; see American Express International Banking Corp V Hurley . The Borrower was not able to claim against a receiver at common law but were entitled to compensation for the negligence of the receiver because the receiver had become the agent of the bank.
The substance of the case is whether or not the receiver was negligent in selling as he did.
The company had gone into liquidation therefore the receiver’s appointment had ceased but the court held that although the receiver carried on in his post, the lender would not have automatically become his principal . Secondly, the sale was for the company’s assets to which the receiver owed no general duty of care. The court did not provide guidance in the event that the receiver had been an agent of the Borrower.
In Standard Chartered Bank Ltd. v Walker and Another , Lord Denning M.R in obiter expressed his disagreement that a receiver should not be liable in equity to a mortgagor if they did not exercise a duty of care when handling assets: ‘If it should appear that the mortgagee or the receiver [has] not used reasonable care to realise the assets to the best advantage, then the mortgagor, the company, and the guarantor are entitled in equity to an allowance. They should be given credit for the amount which the sale should have realised if reasonable care had been used. Their indebtedness is to be reduced accordingly.”
It is suggested that a duty of care should be extended to include a company’s assets: ‘The concept of a fact sensitive equitable duty of care may be seen to be more flexible than a common law duty, and better able to be applied sensitively in the various difficult factual situations which may arise’ . Furthermore, the sale of the company’s assets will also be for the benefit of the Lender so a proper price should be obtained for assets as failure to do so will delay and deprive the lender of the monies owed by the borrower.