By Law Teacher
THE LAW ESSAY PROFESSIONAL
10.1.1 Mortgages – Creation and Rights of Both Parties
Introduction
Welcome to the tenth topic in this module guide – Mortgages. When an individual wishes to pay for the purchase of a property, it is very unlikely they will have sufficient free assets to buy the property outright. Therefore, they will seek a loan to finance this up-front purchase. In return for the loan, the lender will take ‘security’ over the property. In other words, if the borrower of the money does not pay their loan back, the lender can take the property and sell it in order to get the money they lent back plus interest. This is called a mortgage and there are a variety of different types to understand.
At the end of this section, you should be comfortable understanding the difference between legal and equitable mortgages, as well as the respective rights of the parties involved.
This section begins by outlining what a mortgage actually is, before considering the different types considering the relevant time periods. The rights of the mortgagor and mortgagee are then discussed before turning to the remedies each party may seek. Finally, the mortgagee’s liabilities are outlined as well as the formalities for ending a mortgage.
Goals for this Section
- To understand what a mortgage is
- To understand the relative rights and remedies both parties have
Objectives for this Section
- To be able to differentiate between an equitable and legal mortgage
- To understand the different types of mortgage that may occur
- To understand the different applications of the relevant legislation
- To understand registration and its effect on mortgages
10.1.2 Creating a Mortgage Lecture
The different types of mortgages
If a legal interest is used as security, the mortgage can be legal or equitable. If equitable interest, the mortgage can only be equitable.
Pre-1926 mortgages
This mortgage would be made by the borrower transferring his legal estate to the lender in exchange for the loan. If the borrower defaulted on a payment, the lender would then sell the property – reformed by LRA 1925.
Legal mortgage under the LRA 1925 S85
S85 allows the mortgagor to grant a long lease of the property to the mortgagee. The lease will be terminable once the loan is repaid.
Legal mortgage of a term of years under the LRA 1925 S86
Under S86 the lease no longer needs to be assigned, but instead the creation of a sub-lease would create a mortgage. An attempt to use the pre-1926 method of assigning the lease will result in the lease being converted into a sublease for the current unexpired period of the main lease, minus 10 days. This period of ten days allows a second sub-lease to be granted for a second mortgage.
Charge by deed under the LRA 1925 S87
A deed will be executed by the mortgagor confirming that there is a mortgage/charge over his land by way of legal mortgage, the condition being repayment of the loan plus interest.
S87 gives the same powers and remedies to the mortgagor as would be given if the property had been leased or subleased by S85 or S86.
Registered land
Under the LRA 2003 S23(1)(a) the power to create a legal charge is provided. A charge should be created by the completion of a deed. The charge must be registered before it will have legal effect (but it will operate in equity).
Cityland and Property (Holdings Ltd) v Dabrah [1968] Ch 166 – a legal charge is created by simple words showing an intention that the land is to be mortgaged with the repayment of a loan. S25 of the LRA 2003 confirms this along with the LRR 2003 rule 103.
First registration
S4(1)(g) LRA 2002 – creation of a ‘first protection legal mortgage’ of a qualifying estate means the property will then be required to be registered.
Once registered, the charge will take effect as a charge by deed by way of a legal mortgage.
Equitable Mortgages
This principle operates where there has been a contract to create a legal mortgage but it has not yet been executed as a deed. This will give rise to an equitable mortgage from the date the contract is formed. This contract must be in writing as per S2 Law of Property (Miscellaneous Provisions) Act 1989.
Informal mortgage by deposit of deeds
Equity will also protect an individual where it was clear that the owner of the property intended to charge their property in relation to a loan – Russel v Russel(1783) 1 Bro CC 26.
S2 of the Law of Property (Miscellaneous Provisions) Act 1989 requires there to be an agreement made in writing – United Bank of Kuwait plc v Sahib [1997] Ch 107.
Equitable mortgage of an equitable interest
An equitable mortgage is created by the pre-1926 method of transferring the whole legal estate to the mortgagee. This transfer must be made in writing to pass the equitable interest.
Rights of the mortgagor
The right to redeem
The right of redemption refers to the right of the borrower to ‘redeem’ the mortgage once the loan and all of the interest has been repaid. Following this repayment, the mortgage ends and the lender no longer has any right over the property.
Redeeming at law
The right to redeem at law is a contractual right. The contractual provisions cannot be altered or ignored – Kreglinger v New Patagonia Meat & Cold Storage Co Ltd [1914] AC 25.
Redeeming at equity
Equitable redemption is possible as long as the loan and any interest has been repaid.
The equity of redemption
In an equitable mortgage, where the legal estate has been transferred to the mortgagee, the mortgagor owns the ‘equity of redemption’. This refers to the mortgagor’s equitable interest in the property, which is an interest in land – Pawlett v Attorney General(1667) Hardres 465.
Protection on the equity of redemption
Equity protects the rights of the mortgagor, and does not allow any arrangement that prevents the mortgagor from redeeming, and prevents any burdens imposed on the property during the term of the mortgage operating once the mortgage is redeemed.
Prevention of redemption
If a provision in an equitable mortgage prevents a mortgagor from redeeming it will be void – Toomes v Conset(1745) 3 Atk 261.
Postponement of redemption
A provision that postpones a redemption in such a way that the right to redeem is worthless will also be void. There is no equitable right to redeem before the date of redemption.
Other advantages for the mortgagee
The mortgagee may also insist on terms which are unrelated to the actual mortgage, but provide a benefit to the mortgagee.
These kinds of agreements are valid so long as they are not in breach of competition law or unconscionable. However, they are only usually valid for the duration of the mortgage (Biggs v Hoddinott [1898] 2 Ch 307), even if the mortgagor has agreed that the agreement will continue after the redemption of the mortgage.
Oppressive or unconscionable agreements may be invalid even whilst the mortgage agreement is in effect – Cityland & Property (Holdings) Ltd v Dabrah[1968] Ch 166.
Right to grant a lease
S85 and S86 powers require the mortgagor to grant a lease to the mortgagee. Therefore, it would be impossible to grant a second lease over this property. The same would apply for a S87 mortgage.
S99 of the LRA 1925 gives a statutory power to the mortgagor to create a lease that is binding on the mortgagee.
Right to sue
The mortgagor also has a right to sue in relation to their land, despite the estate being subject to the rights of the mortgagee. S98 of the LRA 1925 alleviates any potential problems with the mortgagor bringing any action.
Right to surrender
The mortgagor may accept the surrender of a lease but only where a new lease is to replace this surrendered lease within one month of termination – S100 of the LRA 1925
Rights of the mortgagee
The right to title deeds and charge certificates
In relation to unregistered land (pre-1926 mortgages), the mortgagee has the right to possession of the title deeds of the property.
As per Section 27(2)(f) of the Land Registration Act 2002, the charge must be registered with the mortgagee’s name as the proprietor.
The right to possession
S85, S86 and S87 mortgages have the effect of giving a lease or sublease to the mortgagee. Therefore, the mortgagee has right to possession of the land from the date of the mortgage (National Westminster Bank plc v Skelton [1993] 1 WLR 72). There may be restrictions on this right.
The right to insure
Terms relating to the mortgagor providing insurance for the property are commonplace. In absence of these terms, S101(1)(ii) of the LRA 1925 implies a term allowing a mortgagee to insure the property against fire loss/damage.
The right to lease
Once a mortgagee takes possession of a property, they then have a right to lease the property. This lease binds the mortgagor.
Remedies of the mortgagee
Foreclosure
The remedy of foreclosure cannot be effected until the contractual obligation of the mortgagor to keep up with the mortgage repayments has been broken – Williams v Morgan [1906] 1 Ch 904.
The first step of foreclosure is for the mortgagee to obtain a court order – Re Farnol Eades Irvine & Co Ltd [1915] 1 Ch 22, and then possession of the property transfers to the mortgagee as settlement of the mortgagor’s debt. The mortgagee can then sell the property.
Possession and sale
There may be certain circumstances in which the mortgagee may use any income generated from the property to repay the debt.
Section 101(1)(i) of the LRA 1925 grants the mortgagor the power to sell the land, even if it is not explicitly given in the deed. The power arises when the mortgage money is due, which is usually the contractual date of redemption. However, there are three further conditions imposed by S103 of the LRA 1925:
- The mortgagee must serve a notice that payment is required on the mortgagor and this default continues for three months; or
- The interest payable is two months in arrears; or
- A covenant of the mortgage deed has been breached
Target Home Loans Ltd v Clothier [1994] 1 Ell ER 439 provides for an interesting advantage to the mortgagor. The court may delay an order for possession if they believe the mortgagor can obtain a higher price by selling the property themselves.
What happens once the property has been sold?
When a mortgagee sells a mortgaged property, they transfer good title to the purchaser free of any of the mortgagor’s interests and rights. However, the property will be subject to estates and interests which were in effect prior to the mortgage.
If the mortgagee has sold the property to a purchaser whilst the mortgagor retains occupation in the property, the new owner will be able to obtain an order of possession against the mortgagor.
What happens to the proceeds of sale?
S105 of the LRA 1925 states that the mortgagee selling the property becomes a trustee of the proceeds of sale. The proceeds of sale must then be distributed in this particular order:
- The payment of any money required to discharge encumbrances prior to the mortgage which the sale is not subject to;
- Payment of costs and expenses incurred in arranging the sale;
- The amount required to discharge the mortgage debt, including interest and any other payments required
- The balance is to be paid to the mortgagor or anyone else entitled (British General Insurance Co Ltd v Attorney-General (1945) 12 LJNCCR 113
As you can see, this is a huge difference from foreclosure, as the mortgagor will actually be able to retain any balance of the proceeds of sale left after the discharge of the debt.
If the proceeds of sale are insufficient to discharge the mortgage debt after all of the other repayments, the mortgagee retains the power to sue the mortgagor for the remainder of the debt – Rudge v Richens(1873) LR 8 CP 358.
Protection for the mortgagor
Ability to pay debts
The first protection afforded to the mortgagor is where they can provide evidence that despite being in arrears to the mortgagee they will be able to pay their debts shortly. This will prevent the mortgagee from forcing a sale at this point.
Obtaining of possession
This may not be done by force, as it would be a criminal offence as per S5 and 6 of the Criminal Law Act 1977. The mortgagee must make an application to the court, this will give a further period of time for the mortgagor to pay their debts and the court even has a power to extend this, despite being used rarely (Cheltenham & Gloucester plc v Krausz [1997] 1 Ell ER 21).
Dwelling-houses
If the property includes or is a dwelling-house, the Administration of Justice Act 1970 S36 protects the inhabitants. The mortgagee will have to produce an application for possession, and the court will decide what action to take. For this to be applicable the mortgagor must continue paying the current instalments (First National Bank plc v Syed [1991] 2 All ER 250).
If the house is vacant, the mortgagee may repossess without an order (Ropaigealach v Barclays Bank plc [1999] 1 QB 263.
This protection is not afforded to the mortgagor if they give up possession of the property only to later realise that they may use this protection to delay the sale – Barclays Bank plc v Alcorn [2002] All ER (D) 146
Reasonable period of time
The courts take a holistic approach, considering the circumstances of each case.
Mortgagee’s duty to obtain a proper price
The mortgagor is also afforded protection by the mortgagee’s duty to obtain a proper price for the property – Raja v Lloyds TSB Bank plc(2001) Lloyds Rep Bank 113.
Protection where the mortgagor has leased the property
The Mortgage Repossessions (Protection of Tenants) Act 2010 has given some protection to the tenant, only applicable to dwelling houses. Service of a notice is now required before a mortgagee can enforce an order for possession. The tenant may apply to the court and postpone the repossession for up to two months, giving them sufficient time to find alternative accommodation.
Mortgagee’s power to appoint a receiver
S101(1)(iii) LRA 1925 – the power arises when the power to sale arises.
The receiver must be appointed by written document executed by the mortgagee, and this receiver becomes an agent of the mortgagor (not the mortgagee!), as per S101. Any income generated by the receiver must be applied in this order:
- Payment of any outgoings on the land, such as the current mortgage repayments;
- payment of the insurance premiums;
- payment of interest on the loan;
- payment of capital on the loan if the mortgagee agrees; and
- payment of any balance shall go to the mortgagor
Remedies in equitable mortgages
Foreclosure
Requires the permission from the court, therefore, nothing changes for equitable mortgages.
Possession
Contention – it seems possession can only be taken with a court order, demonstrated in Barclays Bank v Bird.
Sale
The statutory power of sale is only granted to mortgages by deed. Therefore, to exercise the power of sale an execution of a memorandum or deed evidencing the transaction would be required.
See Re Hodson and Howe’s Contract (1887) 35 ChD 668.
Appointment of a receiver
The statutory power to appoint a receiver is only applicable where the mortgage is made by deed. Therefore, without a deed, the mortgagee must apply to the courts for the appointment of a receiver
Liability of mortgagees and other parties
Silven Properties v Royal Bank of Scotland plc [2004] 1 WLR 997
Mortgagee’s duties
The mortgagee does not have to exercise any of their powers, they can simply do nothing.
Duty to take reasonable care of the property
When the mortgagee is in possession of the property, they must take reasonable care of it – Downsview Nominees Ltd v First City Corporation Ltd (No. 1)[1993] AC 295.
Not to be a trustee of his powers
A trustee must do everything to the maximum benefit of the beneficiaries. A mortgagee is under no obligation to maximise the benefit of the mortgagor – they can sell the property when the like, irregardless of whether a different time of sale would have been more beneficial – Raja v Austin Gray (a firm) [2002] EWCA Civ 1965.
A mortgagee may have a number of motives for choosing to sell a repossessed property at a particular time. So long as one of these motives is to enforce the security and repay their debt, the sale will be valid – Meretz investments NV v ACP Ltd [2007] Ch 197.
Duty to obtain market value
Silven confirmed that the mortgagee has an equitable duty to obtain a ‘fair’ or ‘true’ market value for the property on the date of sale. The transaction must not be rushed through a low sale price – Palk v Mortgage Services Funding plc [1993] Ch 330.
Modern cases have confirmed the duty is in equity.
Receiver’s duties
Selling the property
The receiver’s duty is identical to what the mortgagee’s would be when selling. They must obtain a proper market value – Medforth v Blake [2000] Ch 86
Acting in relation to the property
Unlike the mortgagee, who may remain passive and not actually sell the property, the receiver is under a duty to not remain passive – they must take positive steps to sell or maintain the value of the property.
Setting aside
Where the sale of a property is fraudulent, the sale can be set aside.
Ending a mortgage
Formalities
- The mortgage will end either if a remedy is used to terminate, or the mortgagor has repaid his debt. On termination by repayment the mortgagor needs evidence of the repayment.
- For registered land once the registrar has received documents as evidence of the discharge of the mortgage, they will remove the charge from the register.
- For unregistered land, the mortgagee must execute a memorandum of discharge which should be endorsed on the back of the mortgage deed.
Time
Ashe v National Westminster Bank plc [2008] 1 WLR 710 – 12 years under the Limitation Act 1980.
Priorities
The general rule for equitable interests is that if the interests are equal, the one which was made first will take priority. This is fairly straightforward.
Priorities of legal interests
Registered title – S28 LRA 2002. The first one created takes priority, unless one of the exceptions apply.
The first exception is contained within S29.
There are also two further rules:
- The later disposition must be a disposition for value.
- If the earlier disposition is not registered, but is protected by notice or is a Schedule 3 interest, it will take priority despite not being registered.
For unregistered title, there are a number of considerations.
- If the mortgagee holds the title deeds of a legal mortgage, it takes priority against all other mortgages
- If the mortgagee holds the title deeds of an equitable interest, and a later interest is legal, the legal interest has priority unless the mortgagee knew of the earlier interest. If the later interest is equitable, the one created first prevails
- If the mortgagee does not hold the title deeds of a legal mortgage, it will take priority if registered as a class C(i) land charge
- If the mortgagee does not hold the title deeds of an equitable mortgage, it will take priority if registered as a class C(iii) land charge
10.1.3 Creating a Mortgage Lecture – Hands on Examples
This section will give you a change to review your knowledge of mortgages by assessing a practical scenario covering many of the issues you might face in relation to a mortgages exam question or coursework. You should have knowledge of the different types of mortgages, how they are created, the rights of the mortgagor and mortgagee, the remedies of the mortgagee, the protection for the mortgagor, the liabilities, how a mortgage is ended and priorities where there are two mortgages. The information from this chapter will allow you to answer this question fully with reference to relevant legal principles and cases.
Identifying a mortgage question should be straightforward. You will be looking for a scenario where an individual has borrowed money off a lender of some sort and in return a lien has been created over some kind of property the individual owns (likely to be their land).
It is difficult to develop a catch-all approach to mortgage questions, as there are various distinct areas, you will need to learn how to identify each separate issue, for example, are you looking at the remedies of the mortgagee or the rights of the mortgagee?
Scenario
Rob inherited a property from his parents 20 years ago. The property is unregistered land, and is free from any other interests. Rob wants to start his own business up so needs quite a large loan. He is considering mortgaging his unregistered property in order to raise the funds required.
If Rob creates a legal mortgage over his unregistered property, is there anything important he will need to do once the mortgage has been granted?
Rob negotiates a mortgage deal with Mortgages R Us bank. Rob intends to create a business that sells computers. As it happens, Mortgages R Us own a company who sell computer processors. The bank insist on a term which requires Rob to buy computer processors from Mortgages R Us’ company. The mortgage agreement is a six year agreement. Rob ends up winning the lottery and pays his mortgage off after only three years.
Can the bank enforce the term requiring Rob to buy computer processors from them, and what effect does the paying off of the mortgage have on the agreement?
Rob eventually runs out of money due to a gambling addiction and re-mortgages his property to fund his gambling. Unsurprisingly, he defaults on his mortgage repayments.
What is the favourable remedy for the bank and what steps must they take before they can take action? What will happen to the money from the sale of the property?
Before he defaulted on his mortgage repayments, Rob actually put a second mortgage on the property. The two banks are now arguing over who should get priority. Mortgages R Us’ charge came first, but was not correctly registered. The second mortgage was with Lenders 24/7, who did register their charge correctly.
Which mortgage takes priority?
- The grant of a legal mortgage over unregistered land is a trigger for first registration of the property as per S4(1)(g) of the Land Registration Act 2002. Therefore, he will need to register his property with the land register. Furthermore, the charge must also be registered.
- This term of the mortgage provides a benefit to the mortgagee. The basic rule in relation to these terms is that they are enforceable so long as they don’t breach competition law, but are usually only valid for the duration of the mortgage as per Biggs v Hoddinott. In this case, there are not enough facts to know whether it breaches competition law, therefore we can assume the term is valid and enforceable.
However, as Rob pays off the mortgage early, it may be suggested that the term would be unenforceable once the mortgage is redeemed. The case of Kreglinger v New Patagonia Meat & Cold Storage Co Ltd. Involves an example of this with similar facts. The court held that the agreement would continue for the full period despite the early redemption of the mortgage, as the term was reasonable, for a short period and could be seen as a separate agreement to the mortgage. The same would seem to be applicable to this term. In the case, it was a five year agreement and it was redeemed after two years, therefore the similar time scales would suggest the same outcome. The agreement does not seem oppressive or unconscionable either, therefore it would be valid (Cityland & Property (Holdings Ltd) v Dabrah)
- The bank may use the remedy of foreclosure, which involves taking possession of the property. However, a court order is required and Rob would be able to prevent foreclosure under S91(2) of the Law of Property Act. Therefore, the favourable remedy for the bank is possession and sale. This involves the bank taking possession of the property and selling it to repay their debt. In order to effect this, the bank must serve a notice on Rob that payment is required and the failure to repay must continue for three months, or the interest payments must be two months in arrears.
Once the bank take possession of the property and sell it, the proceeds of sale must be distributed as per S105 of the Law of Property Act 1925:
- Payment to discharge any encumbrances prior to the mortgage
- Payment of costs/expenses arranging the sale
- Discharge of the mortgage debt plus interest
- The balance (if any) must be paid to Rob.
- The land is registered, therefore, S28 of the Land Registration Act 2002 applies. The general rule is that the first mortgage takes priority unless an exception applies. The S29 exception will apply in this case, because Mortgages R Us have incorrectly registered their charge. This means that Lenders 247 have priority, and will be able to get their debt repaid before Mortgages R Us’. This is assuming the mortgage with Lenders 247 was a disposition for value.