Archive for the ‘Mortgages’ Category

Mortgage or not: look at the substance of the transaction

April 7, 2016

In Warnborough Ltd v Garmite Ltd ([2003] EWCA 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



Barclays Bank plc v O’Brien: the risk of failing to take steps to ensure informed consent

October 1, 2013

In Barclays Bank plc v O’Brien ([1994] 1 AC 180, HL) a married couple granted the bank a second charge over the family home as security for the overdraft facility of a company in which the husband had an interest. The wife signed the document without reading it; she did so because of her husband’s misrepresentation to the effect that the liability to the bank was limited to GBP60,000 and that the exposure under the arrangement would only last for three weeks. In fact, it was an unlimited guarantee. The bank took no steps to have the documents explained to the wife nor did it suggest that the wife should take independent legal advice.

When the company failed to meet its obligations, the bank sought an order for possession of the home. W sought to set the charge aside on the grounds that it was the result of H’s misrepresentation and undue influence.

Only the misrepresentation defence was relied upon in the House of Lords. Nevertheless, Lord Wilberforce (giving the only full judgment) spoke about undue influence and considered the steps that a lender must take to protect itself from a claim that its agreement with a surety might be set aside in the event that it is entered into as a result of misrepresentation or undue influence.

Lord Wilberforce prefaced his analysis with a reminder that there are policy considerations to be borne in mind in shaping the law. The law needs to strike a balance between the need to protect wives from an abuse of the trust and confidence that they place in their husbands, on the one hand, and the need to avoid the creation of a draconian regime that would render family homes unacceptable as security for loans (at p. 188).

Lord Wilberforce considered the proposition that wives enjoy some special equity and are the object of special tenderness on the part of equity. He accepted that there was a greater risk of undue influence ‘than in the ordinary run of cases where no sexual or emotional ties affect the free exercise of the individual’s will’ (at p. 191). At the same time, with an eye no doubt to the future rational and orderly development of the law, he rejected the broad proposition that wives should be accorded special rights in relation to surety transactions. He rejected then the idea of ‘a special equity applicable only to such persons engaged in such transactions.’ (at p. 195).

The judgment seeks to create a legal environment that properly balances the interests of wives and lenders (described below). It is not only applicable to wives. Towards the end of the judgment, Lord Wilberforce emphasises that the same principles apply ‘to all other cases where there is an emotional relationship between cohabitees.’ (at p. 198). Thus, the principles and procedures set out in the judgment are to be followed ‘if, but only if, the creditor is aware that the surety is cohabiting with the principal debtor’. (at p. 198). Marriage is only one instance of a broader category.

The core of the judgment is its consideration of the circumstances in which lenders will take subject to the prior rights of the person whose consent was procured by undue influence or misrepresentation.

In a case like this, it may sometimes be possible for W to argue that H was the bank’s agent. This would provide a basis upon which H’s undue influence or misrepresentation could be attributed to the bank. An agency analysis of this situation, however, would usually be highly artificial (at p. 194).

Rather, the doctrine of notice provides the key: did the lender have actual or constructive notice of the misrepresentation or undue influence (at pp. 194 – 5)? The question is whether the lender is aware of facts or circumstances that put him on enquiry as to the possibility that the surety might have a right to rescind on the grounds of undue influence or misrepresentation. If the lender is put on enquiry and does not take reasonable steps to satisfy himself that W’s agreement to stand surety has been properly obtained then it will have constructive notice of W’s rights (at p. 196).

When is a lender on enquiry (so that it needs to take further steps)?

‘[A] creditor is put on enquiry when a wife offers to stand surety for her husband’s debts by the combination of two factors: (a) the transaction is on its face not to the financial advantage of the wife; and (b) there is a substantial risk in transactions of that kind that, in procuring the wife to act as surety, the husband has committed a legal or equitable wrong that entitles the wife to set aside the transaction.’ (at p. 196).

When the lender is on enquiry it must ‘take steps to bring home to the wife the risk she is running by standing as surety and to advise her to take independent advice.’ (at p. 196).

The steps that a lender is expected to take are set out in this passage:

‘in my judgment a creditor will have satisfied these requirements if it insists that the wife attend a private meeting (in the absence of the husband) with a representative of the creditor at which she is told of the extent of her liability as surety, warned of the risk she is running and urged to take independent legal advice.’ (at . 196)

In exceptional circumstances, where the lender knows of circumstances that make the exercise of undue influence probable rather than merely possible, the lender will need to ensure that the wife is separately advised (at p. 197).

This procedure seeks a fair balance between the wife and the lender, even though it does not guarantee that the wife fully understands the transaction (at p. 197).

As the bank had not taken steps to ensure that Mrs O’Brien had been properly informed of the nature of the transaction, it was fixed with constructive notice of Mr O’Brien’s misrepresentation.

Michael Lower

Undue influence: bank not put on inquiry merely by disadvantageous transaction

September 26, 2013

In Bank of China (Hong Kong) Ltd v Leung Ngai Hang ([2006] HKCU 78, CA) Miss C and Miss L had been friends and business partners. They bought an investment property together. They borrowed money to fund the purchase into their names as joint tenants, the loan being secured by a legal charge. They subsequently remortgaged with the Bank of China replacing the fixed term loan with more general banking facilities. By this time, Miss C no longer had any business relationship with Miss L. One element of the loan package was the provision of open-ended banking facilities to Miss L’s business.

The loans were not repaid. The bank sold the property but there was an outstanding balance. Miss C relied on undue influence and misrepresentation as her defence.

This failed since there was nothing to implicate the bank in any wrongdoing (assuming there had been some impropriety). Was there anything to put the bank on inquiry ([14])? A disadvantageous transaction on its own was not sufficient to achieve this. There was nothing about the relationship between Miss C and Miss L to suggest that there was a risk that consent had been procured by some improper means ([17]).

In any event, it was not clear that the present transaction was manifestly to Miss C’s disadvantage. The money had been used to redeem an earlier charge. There were benefits in replacing a fixed term loan with general banking faclities ([18]).

Michael Lower

Undue influence: whether the lender is on notice has to be considered from its perspective

September 19, 2013

In Li Sau Ying v Bank of China (Hong Kong) Ltd ((2004) 7 HKCFAR 579, CFA)  a businesswoman (L) supplied goods on credit to X. X ran up an indebtedness to her of HK$1m. When pressed to pay, X suggested that L should, instead, act as surety for a loan to his business. She agreed and also gave a mortgage over her apartment as collateral. There were several re-mortgages culminating in the re-mortgage in favour of a lender later acquired by the Bank of China. When the principal borrower defaulted and the Bank exercised its rights under the surety agreement with L, she sought to have the agreement and documents set aside on the basis that they had been entered into as a result of X’s undue influence and that the bank was implicated in this.

Lord Scott echoed the view that the class 2B category is not a useful forensic tool:

‘I do not wish to leave this issue without expressing the hope that in future cases, where undue influence has to be proved but where the relationship between the parties is not a relationship that falls within Slade LJ’s Class 2A category, the parties will concentrate on whether the evidence justifies the inference that, on a balance of probabilities, the impugned transaction was procured by undue influence, that is to say, by an abuse by the allegedly dominant party of the trust and confidence reposed in him by the allegedly subservient party. References in such cases to, and attempts to invoke the assistance of, an alleged evidential presumption of undue influence are, in my opinion, likely to be, as they have been in this case, a source of confusion and an impediment to the evaluation of the available evidence.’ ([34])

Lord Scott explained that whether the bank is on notice depends on whether or not there are any circumstances that meant that knowledge of the initial impropriety could be attributed to the bank ([35]).

Where it is on notice, its duty is to take reasonable steps to ensure that the surety has had brought home to her, in a meaningful way, the potential implications for her of the proposed transaction (see Lord Nicholls in Etridge at [54]). What steps are reasonable is a question of fact in each case ([39]).

It is important to understand what these steps are trying to achieve and the limits of what is expected of the bank. The bank must take the reasonable steps needed to allow the surety to understand the transaction. It does not need to actually succeed in making the surety understand the transaction ([38]).

Lord Scott also commented on the category of ‘non-commercial’ surety arrangements established by Lord Nicholls, making the point that whether a case belonged to one category or another might not always be apparent to a bank unless it made unwarranted enquiries as to the nature of the relationship between the principal borrower and the surety. The lender is not expected to make any such enquiries and nothing that Lord Nicholls had said implied that such enquiries were necessary ([41]).

Lord Scott thought that the original surety agreement and mortgage may well have been the result of some undue influence ([30]).  So far as the Bank of China was concerned, however, this appeared to be a simple case of a borrower who wanted to re-mortgage on better terms. There was nothing in this to put the bank on inquiry. In any event, the solicitor acting for the bank had actually explained the documents to her and so the reasonable steps had been taken.

Michael Lower

Mortgagor in default: does default give rise to adverse possession?

May 21, 2013

In Common Luck Investment Ltd v Cheung Kam Chuen ((1999) 2 HKCFAR 229, CFA) C executed a mortgage assigning a property to X Bank as security for a loan. C defaulted in payment in 1965 but X Bank took no action and C remained in possession. X Bank went into liquidation and the property was assigned by the liquidator to CLI. The question was whether C had been in adverse possession since 1965 so that CLI’s title had been extinguished. C’s argument failed. C had a right to redeem even after default and he had remained in possession under the terms of the mortgage and not as a trespasser (236, Litton P.J.). As to the effect of the sale by the liquidator to CLI, it seemed likely that C had remained in possession as CLI’s licensee. Even if C were to be regarded as a squatter from the time of the sale, not enough time had passed from then to extinguish CLI’s title (238, Litton P.J.).

Michael Lower

Promissory estoppel: need for certainty

June 25, 2012

In Chekiang First Bank Ltd v Sino Legend International Enterprise Ltd ([2002] HKEC 264) a mortgagee sought possession of various properties over which it had a charge. The mortgagors claimed that a manager of the mortgagee had assured the mortgagors that they could handle the sale of the properties themselves provided the proceeds of sale were paid into the borrower’s account. They argued that as they had gone to the time and trouble of looking for buyers in reliance on this promise, the mortgagee was estopped from obtaining possession. This argument failed. The promise in promissory estoppel must be precise, clear, unambiguous. There was a lack of precision or certainty here. The limits on the price to be obtained and the length of time available to the borrowers to find buyers were not known (ie it was not clear how long the mortgagors were entitled to hold out in the hope of getting a better price than the mortgagee might obtain).

It is possible for a mortgagee to be bound by a collateral contract not to enforce its remedies but any conditions in this agreement must be strictly complied with. Even if the alleged promise had been made, the mortgagors had not complied with its terms since they had received deposits but not paid them into the borrower’s account.

The borrower also argued that the court had a discretion to postpone making an order for sale for a short time if there was a prospect that the indebtedness would be paid off in full. There was, however, no cogent evidence here to show that the loan could soon be paid off in full.

The borrower was concerned that the mortgagee would not get a good price for the properties but the court pointed out the mortgagee’s duty to get the best price reasonably obtainable.

Mortgagee in possession and tenant’s right of set-off

August 16, 2011

A mortgagee in possession receives rent in its own name. The tenant cannot set off against rent due to the mortgagee any claim that the tenant had against the mortgagor before the mortgagee went into possession. The liability to repay a rent deposit is a purely personal contractual arrangement; a mortgagee who goes into possession has no liability to repay the tenant’s deposit.

In Bank of China (Hong Kong) Ltd v Creative Far East Ltd ([2005] HKEC 403, CA) L granted a lease to T and a mortgage to M. M went into possession and later brought proceedings against T in respect of rent arrears and dishonoured cheques. T sought to set off an amount it claimed was due to it because of overpayments of management charge made to L; it claimed an equitable right to recover the overpayments based on mistake and misrepresentation. Relying on section 9 of the Law Amendment and Reform (Consolidation) Ordinance Cap. 23 and  Young v Kitchen ((1878) 3 Ex D 127) it claimed that there had been an assignment to M that was subject to its equitable right to recover the overpayments. The claim failed since M did not rely on any assignment by L but its own title to the rents as mortgagee in possession. There was no link between the sums due to M and the amounts claimed by T.

T also sought to enforce its right to recover the rental deposit against M. This failed too. The liability to repay the rent deposit was a purely personal contractual arrangement between L and T.

Actual undue influence: does it need to make a difference?

April 8, 2011

Once there has been a finding of actual undue influence there is no need to ask how the claimant would have acted in the absence of the undue influence.

In UCB Corporate Services Ltd v Williams ([2002] EWCA Civ 555, CA (Eng)) a wife executed a charge over the jointly-owned matrimonial home. The charge was to provide security for a loan to the husband’s business. At first instance, the judge found as a fact that the wife had executed the charge as a result of the husband’s actual undue influence and misrepresentation. The question was whether his finding that she would have signed the charge anyway was relevant. The English Court of Appeal found that it was not relevant to the question of whether or not there was actual undue influence. Once that finding had been made, the question as to whether or not she would have signed anyway was irrelevant. The bank’s rights were affected because they had not ensured that she had been properly advised

Receiver managing mortgaged property owes the mortgagor a duty of due diligence

April 7, 2011

A receiver managing mortgaged property owes a duty to the mortgagor (and anyone else interested in the equity of redemption) to do so with due diligence. If the receiver decides to carry on a business that was being conducted at the mortgaged property, this duty requires the receiver to try to run the business profitably.

In Medforth v Blake ([2000] Ch. 686, CA (Eng)) the plaintiff was a pig farmer. He borrowed money and gave the bank a mortgage over the farm. The mortgage gave the bank the power to appoint a receiver who could take possession of the farm and carry on the farm’s business. Receivers were appointed and they ran the farming business. Later the farm and business were returned to the mortgagor. Despite frequent prompting by the mortgagor, the receivers did not seek discounts from pig feed suppliers. The mortgagor claimed that the receivers owed him a duty of care and that their failure to secure the discounts was a breach of that duty or of their duty of good faith.

The Court of Appeal held that receivers managing mortgaged property owe duties to the mortgagor and anyone else interested in the equity of redemption. Their duties include a duty of good faith. In some cases, they may owe additional duties. The main duty is to try to ensure the loan principal and interest are repaid. They also owe a duty to manage the property with due diligence. This does not require them to carry on any business that the mortgagor ran from the mortgaged property. If they do run such a business, the duty of due diligence requires them to try to do so profitably.

Undue influence when guarantee signed without providing relevant information

March 28, 2011

A lender had not complied with the guidelines laid down by the House of Lords in Royal Bank of Scotland v Etridge (No 2) ([2002] 2 AC 773) where a guarantor had not been provided with adequate information as to the financial standing of the principal debtor nor with adequate time and opportunity to take advice and make up her mind as to whether or not to give the guarantee.

In The Royal Bank of Scotland plc v Chandra ([2010] EWHC 105 (Ch)) the Bank had provided finance for a company set up by Mr and Mrs Chandra to develop and run a hotel in Manchester. The Chandras each guaranteed the company’s debt and later each gave a further guarantee. One of the issues was whether Mrs Chandra was liable under the second guarantee. She alleged that she had signed as the result of her husband’s undue influence and that the Bank was on notice. The Court agreed. She was only told of the need to sign a further guarantee as she and her husband were driving to a meeting at which it was to be signed. She was given neither adequate financial information nor the real ability to take independent legal advice. The further guarantee was set aside as against her.