The Law Commission consults on a proposal to treat mortgagees differently to other claimants by limiting the ability of mortgagees to obtain an indemnity from the Land Registry

On 31 March 2016 the Law Commission published its consultation paper setting out proposals to amend and update the Land Registration Act 2002 (the LRA 2002) which governs the regime of land registration in England and Wales. The consultation paper, Updating the Land Registration Act 2002, runs to almost 500 pages.

The Department for Business Innovation and Skills is separately consulting on the question of whether the Land Registry’s operation should be moved into the private sector. Anyone interested in that issue should consider the consultation paper.

While the consultations are separate, it is clear that there is potential for significant change within the Land Registry in the not-too-distant future.

Overview of the consultation: Updating the Land Registration Act 2002

The stated aim of the consultation is to improve the operation of specific aspects of the legislation within the existing legal framework (i.e. not to reformulate the LRA 2002).

The Law Commission’s scoping (at the initiation and pre-consultation stages) revealed a range of issues impacting upon those engaged in the property market. It was noted that dealings and disputes which engage the land registration regime can be complex and may require expert advice, and that uncertainty in the regime makes advising difficult, incentivises litigation, and increases costs. Additionally, the landscape within which land registration operates has changed since the LRA 2002 came into force. Incidents of fraud have increased, the consequences of which have been difficult to resolve, while technology has not developed in the way that was predicted at the time the legislation was drafted (relevant to issues of electronic conveyancing).

The consultation paper considers a wide range of issues, including:

  • interests that can be registered
  • how interests are protected on the register
  • how the land registration system responds to instances of fraud and whether more can be done to help detect fraud and to prevent it from happening in the first place
  • alteration and rectification of the register and indemnity
  • general registration issues (a catch-all expression for a raft of issues)
  • electronic conveyancing
  • jurisdiction of the Land Registration Division of the First-tier Tribunal (Property Chamber)

The above issues are expansive and far reaching and full reference should be made to the consultation document.

This note will consider only one discrete aspect of the consultation which is, in the context of indemnity claims, whether mortgagees should be treated differently from other claimants.

Indemnity

The register operates as a guarantee of title, but that guarantee is not absolute. The register can be changed, for example, when it is found to contain a mistake. This tension, that a registered title is guaranteed but the register can be changed, is reconciled through the entitlement to an indemnity.

This note considers, in particular, the entitlement to an indemnity at LRA 2002, Schedule 8, paragraph (1)(1)(a) and (b) and the provision of paragraph 1(2)(b) (as these are most relevant to lenders) as set out below:

1 (1) A person is entitled to be indemnified by the registrar if he suffers loss by reason of—

(a) rectification of the register,

(b) a mistake whose correction would involve rectification of the register,

(2) For the purposes of sub-paragraph (1)(a)

(b) the proprietor of a registered estate or charge claiming in good faith under a forged disposition is, where the register is rectified, to be regarded as having suffered loss by reason of such rectification as if the disposition had not been forged.

Whether mortgagees should be treated differently from other claimants

The indemnity scheme provided in the LRA 2002 (as partly set out above) draws no distinction between different claimants, either in respect of entitlement to an indemnity or the circumstances in which an indemnity is payable. The Law Commission is considering whether a specific provision should be made in relation to mortgagees (i.e. a provision not to treat all claimants equally) noting that, while this would be a significant step (“an idea which we approach with significant caution…”), it is a step which has been taken in some jurisdictions (notably Canada) and the Law Commission questions whether the same approach could be taken in England and Wales.

The fact that other jurisdictions have determined to treat mortgagees differently to other claimants has lead the Law Commission to consider that a debate must have taken place in those other jurisdictions which has not yet happened here.

The Law Commission briefly considers the arguments for and against treating mortgagees differently from other claimants. The arguments are, on the one hand, that lenders are regarded as being best placed to prevent identity fraud (see below) and that risk management is an integral aspect of their business (i.e. such that a lender, and not the Land Registry, should bear the risks) whereas, on the other hand, there is a clear desire to facilitate the operation of the mortgage market by increasing lenders’ willingness to lend and not to trigger any adverse and wider repercussions for the property and financial services markets.

These competing arguments have been condensed into the following question in the consultation: “We invite consultees to provide evidence as to the significance of the indemnity scheme in lending decisions (in the residential and commercial sectors) and of the potential repercussions of reforms that limit its availability to lenders”.

The question seeks to ascertain the extent to which a lender’s right to an indemnity impacts upon its business (of lending). If the proposal, to remove or limit the operation of the indemnity scheme, has or will have any adverse consequences which will or may impact upon the availability of mortgage finance, underpinning access to home ownership (which has been a central plank of the housing policy of successive governments), then the proposals for change, considered below, are likely to be viewed unfavourably.

The consultation proposes two possible changes to the indemnity scheme. These are called Option 4A and Option 4B.

Option 4A

Option 4A is a proposal to limit the ability of mortgagees to obtain an indemnity where the mortgage itself creates the mistake. To explain, where a fraudster, purporting to be the owner of a property, grants a mortgage over the property to a bank, the registration of the charge is a mistake because the mortgage has not in fact been granted by the owner of the property. The fraudster and the registered proprietor are different people. This is an identity fraud and, as above, the key consideration (which is being explored in the consultation) is that the mortgagee, and not the Land Registry, is arguably best placed to uncover the fraud.

The above is contrasted with a situation where the fraudster procures a transfer of the owner’s title into his name (becoming the registered proprietor) and then grants a mortgage over the property to a bank. In this situation the fraudster is exactly who he or she purports to be. Any checks carried out by the mortgagee will simply confirm the fraudster’s identity (as registered proprietor).

Option 4A is proposed only to apply to the first situation, where there is no mistake on the register at the time the mortgage is granted. This situation, albeit here in a simplified form, was considered in Swift 1st Ltd v Chief Land Registrar in which, under LRA 2002, the mortgagee was held to be entitled to an indemnity.

The effect of Option 4A would be that a mortgagee in Swift’s position would no longer be entitled to an indemnity. However, Option 4A would not affect the availability of an indemnity to a party other than a mortgagee in such circumstances. Therefore, as noted in the consultation, Option 4A rests upon a policy decision to treat mortgagees differently (and less favourably) to other indemnity claimants.

This founds the following question in the consultation: “We invite consultees’ views on whether the ability of mortgagees to obtain an indemnity should be limited to claims arising from mortgages granted on the basis of a mistake already contained in the register”.

Option 4B

The second option for reform, Option 4B, is to place mortgagees under a specific statutory duty to verify the identity of mortgagors. The mechanics are, at this consultation stage, unclear. However, the duty will require a lender to take reasonable steps (it is yet to be established what this will constitute) to verify the identity of mortgagors, and mortgagees who act in breach of the duty will be unable to obtain an indemnity. Part of the underlying rationale (it is said) is to incentivise those who are best placed to prevent fraud (arguably the mortgagee) to develop best practice as they will bear the financial costs of fraud.

This founds the following question: “We invite consultees’ views on whether the entitlement of mortgagees to obtain an indemnity should be subject to compliance with a statutory duty to take reasonable care to verify the identity of the mortgagor”.

What this means for you

Seeking an indemnity from the Land Registry under schedule 8 is a significant avenue for lenders to recover some of their losses arising when a fraud occurs. Removing this avenue of recovery will undoubtedly be detrimental and lenders are therefore likely to want to make time to respond to the consultation. The above questions, in bold, are at 22.82, 22.83 and 22.84 of the response form.

The last date for responding to the consultation is 30 June 2016. The Law Commission have stated that their aim is to consider all responses to the consultation and to publish a report and draft Bill in late 2017.