A recent case provides a worked example of the application of Nykredit when considering limitation in negligent overvaluation claims brought by banks against valuers. Banking Litigation and Professional Negligence specialist Sandip Singh explains.
The position in Nykredit
Nykredit Mortgage Bank Plc v Edward Erdman Group Ltd (No 2)  ("Nykredit") settled that the proper measure of loss in a "no transaction"  negligent overvaluation case is the difference between: (a) the amount of money lent by the lender plus interest at a proper rate; and (b) the value of the rights acquired by the lender, namely the borrower's covenant and the true value of the overvalued property.
In practice, this measure has been difficult to apply. Some of the figures involved, including the value of the security and the borrower's covenant, may change daily, and could require expert evidence.
Canada Square v KFH: Applying Nykredit
In Canada Square Operations Ltd v Kinleigh Folkard & Hayward Ltd , the court’s application of Nykredit confirms that banks and their solicitors need to look at the borrower's income, assets, and liabilities to assess covenant strength and therefore to determine when the lender actually suffers damage.
The burden of proof is initially on the claimant to prove accrual of a cause of action, but if a defendant can establish, by reference to the borrower’s covenant strength, that the first date upon which the claimant suffered loss was outside the relevant limitation period , then the defendant will escape liability.
In the Canada Square case, the claim was issued in October 2013. To be within the limitation deadline, therefore, the claimant needed to establish that it first suffered damage in October 2007. That was 8 months after the borrower first missed a payment. Recorder Halpern QC, applying Nykredit, considered the value of the property and the borrower's covenant strength to determine when the claimant actually first suffered damage.
1. Assessing the value of the security
The judge determined that:
- The property has to be taken in its actual condition. In Canada Square the parties were both unaware that the property lacked a right of way, which meant that it was worth 7.5% less than expected.
- It is necessary to focus on the value of the security, as distinct from the value of the property. That depends on the repossession and sale of the property, and so repossession costs should be taken into account. The judge considered that if the actual costs in a particular case were unexpectedly high, perhaps because of some unforeseeable supervening event, then they should not be taken into account in full. However where actual costs merely confirm anticipated repossession costs, then they may be taken into account. In this case a 3% deduction was made from the value of the property to take account of the costs of sale. (The borrower had handed back possession voluntarily. Arguably, if possession had been disputed, costs and the requisite deduction would have been higher.)
Value of Security – Sum Outstanding = Gap to be Bridged/Borrower’s Covenant
Once the value of the property is determined, it is then necessary to consider the amount that is owed by the borrower. A comparison can then be made to determine the gap to be bridged and that will, effectively, be the value of the borrower’s covenant.
2. Assessing the borrower's covenant – missed payments
In Canada Square the borrower first defaulted in February 2007. Between February 2007 and January 2008 the borrower made some payments; some payments were made late; some token payments were made; and some payments were missed altogether. No further payments were made after January 2008.
The court referred to the principle in DNB Mortgages v Bullock & Lees , that where a borrower meets their monthly payments, a rebuttable presumption is raised that their covenant strength is good. However the court found that it could not shut its eyes to the broken promises and missed payments throughout 2007, the cessation of payments in January 2008 and the borrower's eventual bankruptcy. The court held that the value of the borrower's covenant strength should be objective, using hindsight where it shed light on the borrower's actual financial circumstances at the time, and not just how it appeared to the lender. The court could therefore consider the borrower's bankruptcy in assessing his covenant strength. As a result, the borrower's covenant strength was found to be weak as from February 2007. The borrower could not bridge the gap of £18,000 that existed at that date.
As a general rule, a first missed payment followed by inconsistent payments would suggest the borrower's covenant strength was weak from the date of the first missed payment.
3. Assessing the borrower's covenant – the borrower's known financial worth
Having assessed the borrower's covenant strength in light of the missed payments, the court considered the defendant's expert evidence. Although the expert was not an expert in mortgage lending and valuation, he was an accountant governed by rules promoting honesty and competence and he applied recognised principles in assessing financial worth. The judge believed that that was sufficient, and the expert’s evidence was accepted. The valuer submitted expert evidence that:
- The borrower’s only source of income was his business, but that was insolvent by 2004. By 2006 there was a deficit of £49,000.
- The borrower's known assets and liabilities by March 2006 showed he had £28,130 in cash and no other known assets of value (other than a house and boat, both of which were heavily mortgaged).
- Once the borrower's estimated weekly expenditure was taken into account, he only had a surplus of just over £8,000.
The court took the view that the value of the borrower's covenant depended not just on the borrower's "balance sheet", but also on liquidity. The court therefore found that, in fact, the borrower could not bridge the gap from the date that the loan was made. As a result, limitation ran from the date that the loan was made and the claimant lender was out of time.
Canada Square goes further than any previous case in indicating how the courts may put a value on a borrower's covenant strength. When assessing when the lender first suffered loss, it is not enough to simply look at when payments were first missed, as the borrower's covenant strength could be weak before then. The case establishes that to definitively determine the borrower's covenant strength, the court will carry out an analysis of financial worth, as did the valuer's expert here. From information that lenders hold about borrowers, they should be able to determine financial worth and therefore the value of a borrower’s covenant themselves at any time. Searches at the Land Registry can establish whether borrowers’ properties are mortgaged and searches at Companies House can, in many instances, show whether borrowers’ businesses are profitable or not.
Going forward, we can expect that defendant valuers will seek to rebut the presumption that the covenant strength is weak at the point when the first payment was missed. Defendants will try to show that the date of loss was an earlier date and lenders may now find it more difficult to bring claims against negligent valuers in cases where a borrower has a large portfolio of properties or where it can be shown that the borrower's income was too low. That said, in practice Walker Morris has found that where a borrower has had a large portfolio of properties together with a low income, any claims for professional negligence have been brought well within time.