Mortgage or not: look at the substance of the transaction

In Warnborough Ltd v Garmite Ltd ([2003] Civ 1544, CA (Eng)) W sold property to G but the entire purchase price was left oustanding. G granted W a legal charge to secure the outstanding balance of the purchase price. G also granted W an option to re-purchase the property for the same price as that paid by G less the amount of the purchase price unpaid by G at the relevant time. The option could only be exercised if certain conditions were met. One of these conditions was that a specified amount of the purchase price was still outstanding. The effect of the exercise of the option would be to restore the parties to their original positions. W exercised the option and then sought specific performance of the contract. G argued that the option was a clog on the equity of redemption and so void (Samuel v Jarrah).

Jonathan Parker LJ reviewed the authorities. The court had to look at the substance of the transaction. If the true nature of the transaction was that it was a mortgage then the option was void ([73]). Here, it was more likely that the substance of the transaction was a contract for sale and purchase and not a mortgage ([76]). The option would then be perfectly valid:

‘Although it would clearly not be appropriate to attempt to lay down any absolute rule, it does seem to me that where the option to purchase which is sought to be challenged as a “clog” is granted against the background of a sale of the property by the grantee of the option, as owner of the property, to the grantor for a price which is to be left outstanding on mortgage, there must be a very strong likelihood that, on an examination of all the circumstances, the court will conclude, as it did in Davies v Chamberlain, that the substance of the transaction is one of sale and purchase and not one of mortgage.’ ([76])

Michael Lower

 

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