The Court of Appeal has confirmed that the New Zealand Bankers’ Association (NZBA) deed of priority, widely used in the market, limits a mortgagee’s priority only in a mortgagee/receivership sale. It does not apply if the mortgagor sells the property.
We think the decision is correct. The NZBA form is limited in scope. It does not limit mortgagees’ entitlements for all purposes at all times. If a financier wants to limit another mortgagee’s entitlement when the mortgagor sells the property, a further agreement is required.
In ASB Bank Limited v South Canterbury Finance Limited, the Court found that ASB Bank Limited (ASB), as first mortgagee, was entitled to retain the funds paid in repayment of its debt even though that amount was in excess of its priority amount under the deed of priority ASB had entered into with South Canterbury Finance Limited (SCF).
The deed entered by ASB as first registered mortgagee and SCF as second registered mortgagee provided for first and second mortgage priority amounts.
The mortgagor voluntarily sold the mortgaged property. By the time the sale was concluded, ASB had received more than $500,000 in excess of its priority amount.
In a case decided in the High Court before SCF was placed into receivership, SCF sued ASB seeking return of the excess funds. SCF was successful at the High Court level. The Court of Appeal has, however, recently reversed the decision.
At the High Court, Associate Judge Abbott found that the priority amount specified in an NZBA deed of priority applied to all money received from the sale of security, however sold. He decided that this construction made “better commercial sense” and recognised that “the parties contemplated specific entitlements from the value of the security”.
NZBA deed of priority is limited in scope
The Court of Appeal found that the agreed priority amounts under an NZBA deed of priority should apply only where the property is sold:
- by a mortgagee through exercise of its power of sale, or
- by a liquidator, official assignee, administrator, receiver, or similar person appointed or acting in respect of the mortgagor.
The Court based its conclusions on an analysis of the language in the deed and, in particular, the references to enforcement.
More powerfully, the Court said that, where a property is sold by the mortgagor, a first mortgagee is entitled to insist on full repayment of its debt in exchange for a release of the mortgage. The fact that the mortgagee has agreed a limit on its priority does not reduce the debt that the mortgage secures. If the owner wants a discharge of any mortgage, the owner must repay the whole debt, or any lesser sum that the mortgagee agrees to accept.
The second mortgagee has the same protection. It may also refuse to discharge its mortgage unless its debt is paid in full. That applies even if the first mortgagee has agreed to release its mortgage.
It follows then that the priority amounts in the deed are irrelevant in a sale by the mortgagor. Each mortgagee is entitled to insist on full repayment, or any lesser sum. Obviously, that lesser sum may be negotiated on the basis that the enforcement outcome is the practical alternative if there is no agreement.
The lesson for second and subsequent mortgagees
The NZBA deed of priority protects subsequent mortgagees on enforcement because such mortgages are automatically discharged when a prior mortgagee exercises its power of sale. The subsequent mortgagee has no control over the sale, or the discharge of its mortgage, so the deed provides useful protection in an enforcement situation.
The deed does not, however, operate in a voluntary sale by the owner of the land. It is possible to limit the amount a first mortgagee will receive on a voluntary sale by the mortgagor, but the NZBA form does not achieve that. Mortgagees should be careful, when entering into a deed of priority, to ensure that its terms reflect the expectations of the parties.