Debenture. Why Wouldn’t You? – Jonathan Newman.
You Would. Why Wouldn’t You?
The true value of a debenture may go over and beyond its intrinsic asset value.
While most of the nation became obsessed with heat, air conditioning, and whose journey to work was most intolerable, Appeal Court judges were hard at it making law, and looking after the short-term finance industry. July saw an important judgment which brought increased clarification to the nature, force and effect of floating charges.
Lawyers tend to get excited about security documents, lenders do not! Intermediaries know what they are, not necessarily what they do, or how important they can prove to be.
What makes Saw(SW)10 and Another v Wilson & Others (2017) exciting (how sad am I?) is that this judgment brings debentures, and floating charges back into the spotlight. It highlights the strategic, not just monetary value, in a debenture, which is often overlooked by inexperienced underwriters who can be persuaded by experienced commercial borrowers to do without. With so much short term finance being advanced to companies and special purpose vehicles, the importance of the debenture is worth emphasising.
Let me explain.
Saw SW (10) was essentially a fight about administrators and the validity of their appointment under a debenture. In 2007, Capital Home Loans lent £1.25m to a company by the name of PELL. The loan was secured by six fixed charges over individual flats in a block. Each fixed charge contained a floating charge clause over the assets, existing and future, of the company. Each charge also included an automatic crystallisation clause which triggered in the event that the borrower created other security interests without lender’s consent. In 2008, PELL borrowed £3.9m, this time from a different lender, Salt (succeeded by Nationwide) to develop an altogether different property, and granted a debenture to them, in breach of its security document with CHL which required lender consent. Nationwide appointed administrators under their debenture, and their appointment was challenged on the grounds (1) that the debenture crystallised the first lender’s charge, which then became fixed as to the second property, and (2) the debenture (later charge) was unenforceable by reason of there being no assets to attach to (these having been caught by the first floating charge).
So, here’s the exciting bit………….
The Court of Appeal held that;
• The validity of a debenture/ floating charge is not dependent on the existence of uncharged assets
• Automatic crystallisation affected the priority but not the validity of later debentures
• A floating charge remained enforceable if any condition precedent to enforcement has been satisfied and there remains a debt for which the floating charge has been given for security
What does that mean in English?
• A debenture can gain extra value by attaching to later acquired assets
• Even a later and second debenture can have real value by enabling a lender to appoint administrators over a company, and gain control
Why is this so important for lenders?
Because, with legitimacy for a second charge debenture affirmed, lender’s should appreciate how powerful a weapon the debenture can be, not just in monetary, but also in strategic terms.
This brings to mind two fairly complicated and litigious matters I have personally been involved with in the last 12 months which illustrate this very point; the first had the benefit of a debenture, the second did not.
Case Study 1
A lender lent to a single asset, special purpose vehicle, and took fixed charge security and debenture. A complicated multi-party piece of litigation ensued, the detail of which for this piece is not particularly relevant. Settlement on terms acceptable to all parties was agreed, but the defendants, two of whom were professional firms, and insurance backed, would not sign off settlement with the lender without borrower/guarantor consent, seeking to protect themselves against potential future claims by the borrower/ guarantor. The borrower, a company, with sole director held the key, and he/ they knew it. He could not repay the lender, but he could prevent the lender recovering elsewhere. And the borrower wanted reward to cooperate, even though he could not repay.
The lender appointed administrators under the debenture, as entitled so to do, and administrators stepped in, agreed terms, settled with all parties, with no ransom paid.
The debenture held no intrinsic asset value, (certainly no more than the fixed charge) but strategically its existence unlocked the door to lender recovery because the borrower was removed from the legal equation. And of course, as debenture holder, the lender had first priority over any recovery under any borrower claims settled by administrators.
Case Study 2
This again involved a piece of lending to a single asset, SPV. In this case a lender was persuaded by the borrower to rely upon fixed charge security only. No debenture was taken. Default arose, the lender sought to recover. Dispute arose between directors as to director authority, and use of company monies. The remaining director argued as against the lender, that the company had not received total benefit of monies advanced, and should not be liable for the entire advance. The lender was dragged into a dispute not of their making, and though the lenders position was completely defensible, there was no alternative but to incur internal time and resource in answering unsustainable allegations, as well as significant external legal cost. The borrower clearly had an interest in getting to the best bargaining position he could, by pursuing every allegation, complaint and dispute, in an effort to exhaust the resolve of the lender. But a lender who had taken a debenture, could have appointed an administrator under the powers contained therein. Administrators would have been obliged to sensibly assess the costs and risks of pursuing weak claims with little prospect of success, before embarking on costly litigation – I doubt that sensible administrators would have pursued the same claims. And so, recovery would have been significantly faster and cheaper, costs saved, had a debenture been in place and administrator appointed.
So there you have it………
A floating charge can
• Give security over later acquired assets.
• Allow a lender to place a company into administration, and take control.
• Fix recovery problems sooner rather than later, and avoid spurious claims being taken.
• Provide the lender with an additional route to recovery via company claims which an Administrator can advance for the benefit of debenture holder (e.g. surveyor negligence claims), claims which the company may have but are disinclined or unable to pursue.
Why wouldn’t you?
Development Lending – Developing Problems
A recent High Court case highlights the issues which can arise in development lending and the circumstances in which a lender will fail to recover losses from its monitoring surveyor. Governors and Company of Bank of Ireland & Others v Watts Group (2017) is one of the first cases which looks at the responsibilities of monitoring surveyors in development lending and provides important guidance as to good practice on when to lend, and how to manage drawdowns in a successful development loan.
Bank of Ireland approved a £1.4m facility for a development of 11 apartments in York in 2007. Its customer was a SPV owned jointly by a key client and a development contractor. The Bank had a £20m exposure to its key client, and likely would try to accommodate the client’s needs where it could, for its own commercial reasons; key consideration, according to the judgment, in the lender’s decision to lend. The loan was made up of £210,000 for the land purchase, the balance for development costs. The lender relied upon a Savill’s report (who had already been commissioned by the borrower to report) for the loan approval, and a monitoring surveyors report for the loan drawdowns. In addition to its charge, the Bank took a capital guarantee from its key client, and both the long-established client and the contractor entered into a costs overrun agreement and interest shortfall guarantee. The contractor entered into a fixed price contract for the construction works. The cost of the development was c £1.8m. The GDV was c £2m, leaving a profit of a mere £200,000 on the development, if all was successful and everything ran to plan (no pun intended). Notably, the lending exceeded the Bank’s own underwriting parameters on loan to cost, loan to GDV, and site value to development cost ratio.
So, it would appear, the Bank covered all bases, security-wise at least.
Post loan completion, the Bank instructed an independent monitoring surveyor to report on
• The developer’s costs construction estimate
• The developer’s build programme time estimate
• Developers cashflow
The report was intended to provide the Bank with comfort as to the feasibility of the project before further drawdowns were sanctioned, the land acquisition having already taken place.
An acceptable report was received, and the Bank proceeded to advance drawdowns.
When things go Wrong
By 2009, the key client was no longer so key, having entered into administration. This resulted in the developer becoming insolvent, and the construction ceased. The security was realised and the bank suffered losses of c £750,000.
The Bank looked to recover its losses. The Bank claimed its losses from the monitoring surveyor, who, it said, had underestimated construction costs, the time required for construction, and who failed to identify discrepancy between drawings of the proposed scheme and planning permissions granted. Had they competently reported, so said the Bank, drawdowns would not have been made.
The Bank based its claim on the original report, but made no claims in relation to the subsequent monitoring inspections and reports.
And the Court Found
On the expert evidence, the court concluded that the monitoring surveyor had not been negligent in
• approving the costs estimate, which had been based on the developers own estimate which was not unreasonable.
• approving the cashflow
• confirming that the developers time estimate was reasonable
• failing to identify discrepancies between drawings and planning. The monitoring surveyor had not been provided with accurate and up-to-date drawings by the lender, and had notified the Bank that insufficient documents had been provided
The monitoring surveyor received a fee of £1,500 which suggested that it had not been expected to perform a detailed forensic analysis at that price.
The Court did confirm that the Bank could place reliance on the report, and determined that the loss that could have been recovered if negligence had been proven would have been reduced by 75% by reason of the Bank’s own contributory negligence.
Lessons to Learn
Although at first glance, this case is not helpful to the lending community. However, it is important. The specialist finance community has only fairly recently entered the development space, and I am now seeing problems and issues surfacing in this particular area. So, this case is important because it serves to highlight a problem area, and a new litigation trend. It also offers guidance on good practice and how to behave, and not to behave, when transacting in this area. There are a number of key lessons to be learned from this piece of 2007 lending, albeit, by an institutional source.
• No matter the relationship with the client, no matter the exposure, every lending piece should be unwritten on its own facts and circumstances.
• Each lending piece must and should meet underwriting criteria. A monitoring surveyor does not underwrite the risk where criteria are ignored.
• Carefully consider the client experience. In this case the key client had never transacted a joint development of this character and nature.
• You get what you pay for. If a detailed forensic analysis is necessary and is what is required, then a commensurate fee is appropriate and operates to indicate the significance of the report.
• When instructing a monitoring surveyor, always provide detailed instructions which should outline exactly what is required. Instructions should include a full suite of documentation including development plans and up-to-date planning permissions and drawings.
• And following first report, regular reports should be commissioned on the same basis and understanding. A lender will often have a more intimate knowledge and engagement with the development, so consider attending inspection to avoid confusion and misunderstanding.
New Pre-action Protocol for Debt Claims
The Ministry of Justice has now released the final version of the new pre-action protocol for debt claims. It will come into force on 1 October 2017 and business creditors will need to revise their pre-action processes to ensure that they are compliant with the new procedure.
To see the new protocol, click here: https://www.justice.gov.uk/courts/procedure-rules/civil/pdf/protocols/pre-action-protocol-for-debt-claims.pdf
The Protocol will apply to any business (in limited form, partnerships, sole traders and public bodies) when claiming payment of a debt from an individual, including a sole trader. It does not cover correspondence already covered by another protocol (e.g. mortgage arrears).
Aims of the Protocol
The aims of the Protocol are to:
‘(a) encourage early engagement and communication between the parties, including early exchange of sufficient information about the matter to help clarify whether there are any issues in dispute
(b) enable the parties to resolve the matter without the need to start court proceedings, including agreeing a reasonable repayment plan or considering using an Alternative Dispute Resolution (ADR) procedure
(c) encourage the parties to act in a reasonable and proportionate manner in all dealings with one another (for example, avoiding running up costs which do not bear a reasonable relationship to the sums in issue) and
(d) support the efficient management of proceedings that cannot be avoided.’
Letter of Claim
The initial step is for the creditor to send a letter of claim to the debtor before proceedings are started, which must include:
• information about the debt and any interest or other charges
• details of the agreement under which the debt arises
• details of any assignment of the debt
• details of any installments that are currently being offered/ paid and an explanation of why the offer is not acceptable and why a claim is still being considered
• details of how the debt can be paid and how to proceed if the debtor wishes to discuss payment options
• the address to which the completed reply form should be sent
Creditors must include the following documents in that letter:
• an up-to-date statement of account;
• an Information Sheet (annexed to the Protocol)
• a Reply Form (annexed to the Protocol), and
• a Financial Statement form (annexed to the Protocol).
The letter of claim must be dated and posted on the same day or following day.
A debtor will have 30 days to reply to the Letter of Claim (though a creditor should account for ‘the possibility that a reply was posted towards the end of that period’) and they may:
• agree with / deny the debt or say that they simply ‘don’t know’;
• make payment or seek time to pay;
• take the opportunity to seek debt advice; or
• request further documents/information from the creditor.
If the debt is disputed the parties should exchange information and disclose documents sufficient to enable them to understand each other’s position and the creditor must provide any document or information requested (or explain why the document or information is unavailable) within 30 days of receipt of the request.
A creditor should not issue proceedings until 30 days after the date on which requested documents are provided to the debtor. A creditor must also allow a reasonable period of time for a debtor to seek legal advice.
If, following discussions, no agreement is reached, the creditor may give the debtor at least 14 days’ notice of their intention to start proceedings, unless there are exceptional circumstances (eg. the expiry of a limitation period).
The protocol includes a ‘taking stock’ provision which requires the parties, following compliance with the protocol, to undertake a review of their respective positions to see if proceedings can be avoided and to, at the very least, narrow the issues between them.
Failure to comply with the Protocol may result in a claim being “stayed” (i.e. put on hold) to allow a period for compliance or, alternatively, sanctions being imposed. Such sanctions may be substantial and can include:
• an order that the party at fault pays the costs of the proceedings, or part of the costs of the other(s);
• an order that they pay those costs on an indemnity basis;
• an order depriving the party at fault of interest, or awarding at a reduced rate; and
• an order awarding a higher rate of interest (up to 10% above base rate).
What is clear is that the Protocol is designed to further protect the rights of debtors by encouraging the sharing of information and promoting settlement wherever possible.
You should consider taking the following steps to align your internal procedures with the Protocol:
• revise standard form letters of demand to assess whether these could be expanded to comply with the Protocol;
• update debt collection policies and provide internal training on the same;
• tailor litigation strategies to include a more conciliatory approach to the preliminary phases of handling debt actions; and
• particularly for businesses which enter into agreements supported by personal guarantees, note that actions to recover under the guarantee should be handled in accordance with the Protocol.
If you require further information on anything covered in this briefing please contact Rehka Chelvendra by email or on 020 8731 3080 where Rehka will be happy to answer your queries.
The Challenge for Challenger Banks
Being the sad couch potato, Man Utd fan that I am, I subscribe to MUTV. That’s a TV station where United never lose, always score (unlike today) and cover themselves in glory. And in the very limited schedule which is MUTV, they re-run classic games from the 70’s and 80’s.
What on earth has that got to do with short term lending?
muddy pitches, x
full backs that don’t cross the half way line x
the absence of diving x
and anything goes tackling x
Answer: perimeter advertising
Look at the perimeter advertising at a football ground in those halcyon days, and you will see companies and businesses which were the leading lights of the day advertising their wares. Radio Rentals, Blockbusters, Austin Reed, and Midland Bank. In the 70’ s and 80’s, they were at the top of their game, brand recognition, huge market share – seemingly impregnable and set for the future. It was unthinkable then, that in a relatively short time they would no longer be around; their position usurped by fresher determined competitors able to innovate and deliver, but just as importantly, learn good lessons from the leading players, take the best bits and improve on the qualities that brought the establishment, their success.
And that’s just what short term lenders did when they arrived, when they came up against high street banks, and institutional lenders 5, 10,15 years ago.
And here lies the most significant and immediate challenge for the short-term lending market, as the major most successful players continue their upwards growth curve, expanding their businesses.
Reasons for Success
The short-term lending sector has outperformed almost every other sector of the lending market over the last 5 years. And there are good reasons for this:
• The space is filled with clever, clever people, people I hugely respect and admire, who saw opportunity and grasped it.
• Lenders knew and understood what the market, customer base and distribution wanted and needed, and they met that need in a commercial and direct way.
• Lenders underwrote based on their own knowledge and property know how, backing their expertise, over more institutional, inflexible criteria- driven process being exhibited by institutions run by underpaid, de-motivated staff; short term lenders took commercial views, on commercially viable lending.
• Lenders, ran tight easy to steer ships, quick to react to market conditions and needs, and easily outperformed the traditional money supply on delivery, execution and delivery, at rates that provided real and sustainable returns.
• Lenders found their property niche and areas of expertise, and concentrated their efforts in those areas, developing that expertise and layering it with real transactional experience.
• Key members were empowered to make decisions quickly and back their judgment.
• Lenders put together close teams of professional partners with the correct and appropriate level of transactional experience and expertise, horses for courses, professional partners who, importantly, understood, and shared the ethos for delivery, execution and certainty. Communication lines were open and easy.
These are just some of the reasons behind success.
Truly, it was not about taking risks or lending where others would not. Short term lenders succeeded. Traditional banks and lending institutions outdated thinking and processes failed to keep up with the times, weighted by regulation, compliance and bureaucracy, but at other times, simply failing from a lack of vision and foresight.
If you agree with that analysis, in whole or in part, you will not be surprised at how the market flourished and the short-term lending sector succeeded. For success was built on profit not growth. It was grammar school not private school. It was about recognising a spade and then calling it a spade. It was about pricing correctly, and sensibly, and being unafraid to charge a premium for a premium service.
And guess what?
Notwithstanding the premium price, the market grew, and short term lending became mainstream and acceptable. More and more sophisticated borrowers looked to access funds at rates they were not used to because they were prepared to pay a premium for that premium service. Commercial businesses opted to go the bridging route, because bridging lenders were displaying the same kind of commerciality in their lending that they, as commercial organisations themselves, understood and displayed in their own businesses.
Simply put, bridging companies attacked the banks and beat them, not on price, not on risk, but on service, execution and delivery.
The challenge now for the main players is to retain the qualities that set them on the road, and to build on these and innovate from there.
Benign market conditions, an ability to raise funding from all manner of sources, and well thought out exit strategies has increased the appetite to lend, leading to bigger and expanded lending businesses. The larger the business, the more difficult the corporate governance, the more difficult effective recruitment. Add to that compliance, and regulation and the ever-increasing needs to internally monitor for risk, and the challenge facing the larger sector players becomes ever clearer.
How to maintain and continue to deliver at the same level on service, in a larger more corporate, more rigidly structured model. In effect, how to not evolve into a “bank”, with all the deficiencies and faults that lost banks’ their pre-eminence in this lending space. Fail in this, and face disappointing your distributors, your end user, your customer base If that’s the challenge, what’s the solution?
I am no business guru, just a simple lawyer, but a lawyer with over 20 years’ experience in the transactional space of short term lending. I have seen businesses flourish, and business fail. I have seen market conditions change, and product development at an ever-increasing pace, and my sense is that the market is nearing a pivotal time.
I offer no solution to the challenge, but I believe there are some fundamental principles that are worthy of consideration
• Delivery and execution remain the most important usp for distributor/ customer
• Specialist teams, whether underwriting or credit collection, must be filled with knowledgeable and empowered decision makers
• Surround yourself with the right professional partner relationships, those who understand not just their business but your business and business needs as well. In your professional partners; technical competence from lawyers is a gimme, but in addition to that you should look for and expect to receive practical guidance which only comes with ability and experience
• Retain and cascade the culture on which success was founded
• Business heads remain involved and active
• Recruitment; fill round holes with round pegs, people with requisite not generic experience
So here lies the challenge for the larger lenders, and here also lies the opportunity for new entrants, who come to a more developed market, focussed, contained, compact and less restricted, and now armed with considerable market intelligence from the last few years.
Austin Reed, Blockbusters, Midland Bank failed to read the warning signs and react. Lest hope our sector players do not.
HOW TO BEAT THE TAXMAN AND LOOK AFTER YOUR KIDS!
A new and positive development in reducing the Inheritance Tax burden for you and your family is being introduced from April 2017.
What is the benefit?
The Residence Nil Rate Band will allow less Inheritance Tax to be paid on the family home when it is left to children, grandchildren and some other individuals. It will sit alongside the existing Nil Rate Band (currently £325,000) to allow an additional allowance to be claimed against the property thus reducing the Inheritance Tax due on your estate.
How will I benefit?
By structuring your affairs to take advantage of the new rules there is the potential to save up to £140,000 in Inheritance Tax, which can pass to your children instead of being paid in tax.
So what should I do now?
If you want to take advantage (and why wouldn’t you) of the new rules then make an appointment to come and see us. The conditions for claiming the Residence Nil Rate Band are complicated and we will ensure that you are given tailored advice so that you and your family are able to benefit from the enhanced allowance as far as possible.
We recognise that making a will is not an activity that you look forward to. We aim to make the process easy to understand and as stress free as it can be. You don’t even need to take time out of the office to come and see us. We are able to come to you in the evening and discuss everything fully in the privacy of your own home. In our experience, ensuring that your affairs are in order brings the peace of mind that your family will be protected and that your estate will pass in accordance with your wishes, in a tax efficient way.
Dreamvar (UK) Ltd v Mishcon de Reya & Others has created quite a stir.
The headlines present a well-known, long established city practice as being financially responsible for losses suffered by their client defrauded when a property purchase failed, and the purchase monies were siphoned off to a mysterious bank account in China.
Behind the sensationalist headline, is the legal story.
The Court held that in law, Mishcons had not been negligent. And that the Sellers solicitors who had in fact, not been acting for the true owner, but an imposter, and who had palpably failed to obtain sufficient identity evidence to identify their own client, owed no duty of care to the buyer or their solicitors.
Mishcons, however, were found to be liable in breach of trust. This was because the purchase monies were received by them from their client on trust, to be paid over for completing their client’s purchase; completion meaning obtaining and providing title to the property for their client – which they failed to do when Land Registry uncovered the fraud prior to registration. Significantly, and departing from previously decided cases, the Court declined to give Mishcons relief against remedy even though they had been found not to be negligent in spotting the fraud, and had no obligation to warn against the risk of fraud. But they were still held financially responsible for the loss suffered by their client.
On its face this seems a surprising result on the facts, and from a practising lawyer’s perspective, a touch unfair. No one cries for lawyers!
But before bridging lenders rub their hands, and begin their celebrations, thinking that their own solicitors will pick up the tab on a vendor fraud, a sober word of
Because the Court seems to have arrived at their determination, most notably because, they stated;
• Mishcons was better placed to consider and achieve greater protection against fraud than its client, and
• The buyer had no recourse against the seller’s solicitors, and no practical likelihood of tracing the fraudster, or making recovery, and
• Mishcons was in a better position, being insured, to absorb the loss
It followed, as far as the Court was concerned, that the only practical remedy was to allow the buyer to obtain financial remedy from its own solicitors.
So good news for the defrauded buyer, bad news for solicitors and their professional indemnity insurers.
Cause for celebration?
This case did not involve a mortgage lender.
Mortgage lenders, and bridging loan lenders have long been acutely aware of the significant risk of fraud in their space. Fraudsters have often targeted short term lenders in the belief that high-speed bridging loan transactions, means lighter touch due diligence, and increased opportunity. Prudent lenders have been, or should be aware, of the availability of sophisticated, tried and tested insurance products available to them, to cover risk of fraud. Therefore, this Court may well have reached a different conclusion on the same facts, had the Claimant been a professional short term lender with a hefty loan book and balance sheet, rather than a recently established and comparatively small development company funded by family members. Short term lenders are aware of the fraud risk, whereas this buyer claimed not to be.
An application for permission to appeal has been lodged – so watch this space. This particular story may not be at its end.
What do we learn?
Without dismissing the legal significance of this judgment, there must be lessons to be learned for the bridging loan lender, the short-term market, and the legal profession who continue to transact in cases many of which bear some or all of the hallmarks present in Dreamvar.
What were the facts and circumstances?
Dreamvar came to its purchase through a known agent. The story told was of a seller seeking to dispose of a tenanted property quickly and at keen price. The need for speed arose out of a divorce situation. The seller required a sale within 3 days, before he said, he was to file for divorce or was to be petitioned in divorce. The property was in Earls Court, London. The seller’s solicitor was based in Salford, Manchester. The seller gave his residential address as a property in SE6, London (Catford) but not the property address. The seller’s solicitors procured ID information for their client; in this case copies of a driving licence and TV license. They never met the client. They relied on certified ID, copies certified as being true and accurate by another solicitor based in Barking, Essex. The driving licence had been issued only a short time before the transaction. On completion, the purchase monies were paid, in their entirety, by the seller’s solicitors to another firm for the purpose of an unrelated independent transaction. The monies were then paid on by that firm to a bank account in China, the same firm that the certifying solicitor was employed by. Completion took place in the usual way, and application for registration of title was submitted. Land Registry, making periodic checks, sought clarification from the buyer’s solicitors as to what steps were taken by them to verify the identity of their client. Having reviewed the documentation, Land Registry was unable to link the seller to the address given on the ID evidence, and the fraud was uncovered. Application for registration was rejected and the buyer, left with no property, and his purchase money gone and irrecoverable. The buyer sought to recover from his solicitors, Mishcons, and the seller’s solicitors.
Why is the Sniff Test so important?
At Court, the buyer identified 10 features of the transaction which they said should have alerted a competent solicitor to a potential fraud, and argued, had the buyer been alerted to the possibility of fraud, which he said he should have been, then he would have taken the view not to proceed, and consequently he would have suffered no loss.
These ten features are listed in the judgment as follows;
1. the property’s high value
2. the absence of mortgage debt
3. vacant occupation
4. the seller’s address did not correspond with the property address
5. the seller had no proprietary interest in his residential address
6. it was surprising that someone residing in Catford should be the owner of a high value property in Earls Court
7. seller had instructed a Manchester firm to act
8. the sale was being rushed through
9. the seller had little or incomplete information on the annual charges at the property or indeed the name of the management company
10. the transfer documentation was dealt with by post
The Court rejected that Mishcons had been negligent in not suspecting a fraud, or alerting their client to the potential of fraud, notwithstanding all these features were present.
Most law firms practising in the short-term lending space would surely have raised at least one eyebrow, at the incidence of so many characteristics commonly regarded as warning flags. It should be second nature to apply a sniff test to unusual features in a transaction, and even more so, when there are so many features collected in one single transaction.
There are even more features present than those listed by the seller,
For example, it is notable that;
• the transaction did not proceed to the timeline demanded by the seller, but there was no suggestion of the seller pulling out, or applying pressure
• most sellers today, armed with online valuation resources, recognise the true value in their property and are reluctant to discount for speed
So, in the hands of an experienced transactional lawyer, I strongly suspect that these warning signs would have been brought to the attention of a lender client, who may well have identified the warning signs themselves. Having reached that point, enhanced due diligence would surely have followed.
Never stop learning
In this case the buyer obtained remedy, it would appear, because he had nowhere else to go. The result may well have been different for a commercial lending company, with a healthy bank balance, long experience in the short-term space, and with the option and availability of specific insurance options.
But no lender wants to have to rely on insurance, or suffer the uncertainty of lost security. Even when a title insurance claim is successful, there is a significant in house cost and administrative expense in pursuing the claim, which cost and expense will not be indemnified and never recovered. So, a number of lessons can still be learned and processes strengthened.
First, ensure that you engage with the right professional advisers, with not only the right level of technical competence but also, as importantly, the right level of specific transactional experience to perform the sniff test, lawyers who are familiar with this space, short-term business and fraud risk.
Second, your relationship with your lawyers is key. There must always be open and frank dialogue between the two. Pick up the phone if you have concerns. We do. Lawyers must be competent and confident enough to go beyond the documents, and have no fear of alerting the risk, even if the transaction later proves to be genuine.
Third, go behind the transaction, and dig deep at application stage. Seek as much seller information, both ID and purpose, as you can from the borrower, and or the seller’s solicitors. Undertakings from seller’s solicitors would be ideal but are unlikely to be offered or made available. Worth a try at least.
Fourth, consider and pursue independently, fraud insurance options – if you haven’t already got these in place. These are available in the market. Some providers are tried and tested, and are invaluable.
Charges of part and the dangers
We come across this situation quite often. A borrower wants to borrow money against his land. The land is vast, say for example, 5 acres. The main building is in the middle of this land and it is only that building that is to be mortgaged and perhaps the immediate garden.
Mr Borrower calls the lender and says he will only grant a charge over part of the land containing the building and immediate garden (the Security Property) and that he will retain the rest (the Retained Land). Perhaps he wants to be able to charge the rest to a different lender and raise further funds.
This creates a potential issue with easements. Unity of Seisin (or ownership) is when both dominant and servient land are in common ownership as in our example above. New easements cannot be created (i.e. granted to oneself) as they will not be valid.
Therefore, in our example, if the Security Property does not directly adjoin the public highway, in a default situation, the lender will have issues as the land is likely to be land-locked. I have not even mentioned potential issues with easements in relation to services.
The lender or the buyer from the lender, will then be forced to negotiate with the borrower for the grant of an easement over his land leading to the public highway to be completed simultaneously with the sale. Having just had the Security Property repossessed, I am guessing he may not be very approachable.
Some will suggest that the borrower can grant easements in favour of the lender within the legal charge. This however, simply amounts to a contractual obligation on the borrower to grant said easements if necessary. This will again be difficult to enforce if the borrower chooses to be unhelpful which one must assume will be the case.
Some have suggested that the lender can be granted Power of Attorney to enable it to grant easements over the Retained Land which is also riddled with potential issues (sale of the Retained Land, insolvency of the borrower etc.).
The two main solutions here would be either:
1. Charge the entire title. This is the simplest and safest option for the lender.
2. Arrange for either the Security Property or the Retained Land to be transferred to another party (for example, the borrower and his wife) whilst the other title remains in the name of the borrower. This will enable rights to be granted or reserved as applicable. The danger with this option however is if the land is then transferred back into the borrower’s sole name at some stage, Unity of Seisin will apply again to extinguish the rights.
This is a common problem for lenders and until the law is changed, the safest option when asked to charge only part of a title is to refuse and insist on charging the whole.
Mortgagee Sales and Vacant Possession
The contract for the sale of residential property usually contains a Special Condition in the Contract that the sale is with vacant possession. This is usually the arrangement unless the sale was agreed on another basis, for example where the buyer wants to retain tenants already occupying the property.
As a purchaser, you will of course expect to see such a Special Condition and as a vendor, you will usually be happy to provide it.
The situation does change slightly when the seller is a mortgagee in possession or a Receiver appointed by a mortgagee. Most mortgagees we act for do agree to provide vacant possession but I have some reservations.
I have previously, with consent of my client, refused to guarantee that vacant possession will be provided on completion. On occasion, I have also seen contracts that state the seller will give vacant possession but can make no guarantees that the property will be vacant or words to that effect.
There is a reason for this. The property remains unoccupied whilst it is in possession of the mortgagee and although the selling agents are required to make regular inspections, once contracts are exchanged, the agents may lose interest as they know it is a “done deal” and they will be paid their commission.
My concern is the fact that between exchange and completion, anyone could break into the property, be it 3rd party squatters or the mortgagors and whilst my expertise in litigation is limited, I know it takes time to evict said squatters/mortgagors. The client will then be in breach of contract if unable to evict them before the completion date.
Thankfully, I have yet to face this problem personally and it is only a small risk but it only takes one such occurrence for a mortgagee to change its policy.
Failure to provide a guarantee of vacant possession is not something most purchasers would readily accept but there is a way around this. The best solution is to exchange and complete on the same day and the buyer can of course inspect the property immediately before exchange and completion takes place to ensure it is vacant.
When Aldermore completed a mortgage advance in January 2013 to Mrs Rana, there was nothing particularly remarkable about the transaction.
This was a loan facility to be secured over 3 properties registered in the name of the borrower’s sister and already charged to the Clydesdale Bank. The properties were to be transferred into the borrower’s name, the existing debt to Clydesdale be repaid, and Aldermore to take first legal charges over the security properties. Mrs Rana the borrower and transferee was raising additional capital from the transaction.
Lender’s solicitors released funds to the borrower’s solicitors against undertakings for completion.
Although solicitors did pay over the balance directly to the borrower, regrettably they misappropriated the sums which were required to pay off the Clydesdale. Clydesdale were not repaid, and understandably refused to discharge their security.
Aldermore sought and recovered £1.796 million compensation from the Law Society Compensation Fund which covered the majority but not all of their losses. In fact Aldermore were still looking at an actual losses of £368,000 and they sought to recover these from the mortgage borrower.
At first instance, in the High Court, their claim against the borrower was dismissed, although the Court agreed that the borrower should repay £78,193.64 being the sum received by her from the transaction. But the Court maintained that the borrower could not be contractually liable for any of the losses as the mortgage transaction had never been completed. Aldermore appealed. The Court of Appeal agreed.
• The essential element of a remortgage transaction included the redemption of prior mortgages.
• Unlike with a purchase transaction, the event of completion is the transfer of title to the property, in a refinance transaction the essential element is the creation of a new, first legal charge.
• As completion had not taken place the borrower had no contractual liability to Aldermore.
An update on Etridge
Mrs Brown was the legal owner of a welsh farm. Though registered as the owner to the legal title, the farm was in fact occupied by her son. Mrs Brown had not lived there since 1987. She regarded the property as her sons. So when her son requested her to enter into a mortgage of the property to secure facilities he had obtained from HSBC, she agreed. Following default by the son, HSBC issued possession proceedings, placing reliance on a certificate of independent legal advice obtained, confirming, that Mrs Brown had received independent legal advice. The certificate was provided by the solicitor who also acted for the son in connection with the borrowing.
The doctrine of undue influence allows a Court to intervene where a relationship of trust, confidence, reliance, dependence or vulnerability exists. Specifically in relation to lending cases, it is common for a party to charge their asset for the benefit of a family member. Etridge stands as the leading case and main guidance for banks who are said to have been put on enquiry as to risk of undue influence in every case where the relationship between the guarantor/mortgagor of the property and the debtor is a non-commercial one.
Mrs Brown argued that the mortgage was unenforceable by reason of fact that HSBC had failed to meet the minimum requirements set out in Etridge. She maintained that she had received no direct contact from the Bank, nor the solicitor, before signing up to the charge. She also maintained that she had received no legal advice notwithstanding the certificate produced.
HSBC argued that having received the certificate from a solicitor which confirmed that independent legal advice had been given they were entitled to rely on it. Any failings in the advice given, they said, was a matter for Mrs Brown to take up with her solicitors, but having complied with Etridge, they said, the charge was enforceable; Mrs Brown’s claims lay elsewhere.
HSBC’s documentation and records were sadly lacking. They may well have taken the steps required by Etridge but they were unable to show this.
The charge was determined as being unenforceable by reason of the Bank’s failing to meet or show that it had met Etridge guidelines. HSBC was unable to obtain possession. In a helpful judgment, further clarification on Etridge was given, which included the following recommendations which all banks and lenders would be well advised to follow.
1. The lender should engage with the mortgagor directly to obtain details of the solicitor of her choice,
2. The lender should notify the chargor directly that it will require written confirmation from a solicitor that the nature, content and effect of the documents and transaction have been fully explained to her,
3. The lender shall explain directly to the mortgagor that their reason for so doing is to preclude the mortgagor from disputing the legally binding effect of the charge.
4. The lender should record and document all of the above.
5. As regards the solicitor providing certificate, that solicitor should consider all conflicts of duty and confirm, inter alia, that they have explained the reason for the advice, the nature and seriousness of the documents, and alternatives which arise. The meeting between solicitor and client should take place face to face.
Advice to Lenders
1. Consider internal documentation, and the recording of your contact with mortgagor in these circumstances. Engagement should take place as early as possible in the process, certainly in advance of execution, and of course any such engagement should be independent of the borrower.
2. Ensure that certificates of advice are up to date, comprehensive, and fit for purpose.