Can a lender with defective security be subrogated to an unpaid vendor’s lien even though it has not advanced the purchase monies?
In Bank of Cyprus UK Ltd v Menelaou  UKSC66 (4 November 2015) the Supreme Court considered this point on an appeal of the decision of the Court of Appeal. This is an important case as there appears to be no previous authority, prior to the Court of Appeal decision, of subrogation applying in circumstances where a lender had not provided the purchase monies.
M’s parents owned a property (Property 1), which was subject to two legal charges in favour of the Bank of Cyprus (the Bank).
They decided to sell Property 1 in order to purchase, a smaller property (Property 2). On completion of the purchase, Property 2 would be registered in M’s name. The Bank agreed to release the charges that it held against Property 1 on the basis that part of the debt would be repaid and it would obtain a new legal charge over Property 2. M had not been aware that the Bank would be taking a charge over Property 2 and had not signed the charge. The purchase of Property 2 completed in September 2008 and a charge in favour of the Bank was registered in October 2008. M only realised in 2010 that Property 2 was subject to the Bank’s charge. M brought proceedings seeking rectification of the register and the removal of the charge. Those proceedings were successful at first instance and the Bank’s counterclaim seeking an equitable charge over Property 2 on the basis that it was subrogated to the unpaid vendor’s lien was unsuccessful. The Bank appealed, and its argument was upheld by the Court of Appeal in 2013.
M appealed to the Supreme Court. The court commented that this was a case of unjust enrichment and the issues to be decided were (i) whether M had been enriched, (ii) if so, was the enrichment at the Bank’s expense, (iii) had the enrichment been unjust and (iv) were there any defences available to M.
Dismissing M’s appeal it was held that the Bank was entitled to be subrogated to the unpaid vendor’s lien and that M had been enriched when she became the owner of Property 2, and as a result of the failure of the Bank to obtain enforceable security over Property 2, M had obtained a property free of security where this had not been the intention.
The Bank had expected to obtain a first registered legal charge over Property 2 securing the debts of M’s parents. M was unjustly enriched at the expense of the Bank as the Bank was central to the scheme which enabled the purchase of Property 2. M only became the owner of Property 2 as a result of the Bank’s actions/agreement.
There was discussion around whether there had to be a direct causal connection between the loss to the Bank and the benefit received by M and whether a narrow or flexible approach should be taken. It was concluded that whichever test was adopted, the result would likely be the same as the position was clear on the facts. It was concluded that M had been enriched at the Bank’s expense and there was no defence available. In order to rely on the remedy of subrogation the Bank had to be able to show a “tracing link” between its money and the transaction, and it was concluded that its interest in the purchase money for Property 2 was clear. Therefore the fact that the Bank’s money had not been used to pay off the vendor was not an issue as the Bank had made out its unjust enrichment claim.
The Bank’s remedy for the unjust enrichment (once it had been concluded that M had been unjustly enriched at the Bank’s expense) was that it was entitled to be subrogated to the unpaid vendor’s lien. Subrogation is sometimes known as restitutionary subrogation in this context. This is not a case where property rights are being enforced, rather it is a case where the remedy is an interest in a property in order to reverse what would otherwise be an unjust enrichment.
In circumstances where a bank’s charge has not been registered, or where there is a question over the validity of its security the equitable remedy of subrogation to the unpaid vendor’s lien (as well as subrogation to the prior charge) should be considered. Subrogation is a flexible, equitable remedy, and we see the court using the remedy in this unjust enrichment case in order to ensure that the Bank did not suffer a detriment as a result of the deal and obtained an equitable interest in Property 2 in circumstances where the intention of the parties in the transaction were clear, but the Bank had not contributed its own funds to the purchase of the property
Can the assignee of a charge exercise a power of sale in order to realise the asset despite not having been registered as the proprietor of the charge, and therefore only holding an equitable interest in that charge?
The court considered this question in Skelwith (Leisure) Limited v Armstrong  EWHC 2830 (Ch) and the case is noteworthy due to the court’s examination of “owner’s powers” under Sections 23 and 24 Land Registration Act 2002 (LRA 2002), and consideration of the application of Sections 101 and 106(1) Law of Property Act 1925 (LPA 1925).
The facts of the case are complicated due to the number of parties involved, however the main parties are S, the registered proprietor of the property, a golf club, A, the original chargeholder and P the assignee of the charge.
S had purchased the golf club from a family partnership, A. A took a charge over the property pending payment of the full purchase price which was to be paid in instalments. S defaulted on the loan and A called in the debt. At the same time as calling in the debt, A assigned its charge to P. P then contracted to sell the golf club to another party. S issued an application for an injunction restraining the sale claiming that the Deed of Assignment, Transfer and Sale Agreements were not valid and/ or effective as P had (i) failed to serve notice of the assignment on S, (ii) was not the registered proprietor of the charge and therefore did not have the power of sale and/or (iii) was not in possession of the property as mortgagee or otherwise.
The question was whether P, who was not the registered proprietor of the charge, was able to sell the legal estate in the golf club despite only having a beneficial interest in the charge. P defended the claim on the basis that they were entitled to enter into the Sale Agreement under the power of sale given to mortgagees by LPA 1925 and the particular terms of the charge. P also relied on sections 23 and 24 LRA 2002 saying that they had acquired “owner’s powers” under the LRA 2002 as they were “entitled to be registered as the proprietor of the charge” and as they were “entitled to receive and give a discharge for the mortgage monies” under section 106 LRA 1925 then they were entitled to sell the club either under section 101 LPA 1925.
S said that as P had not been registered as the proprietor of the charge it did not have the relevant power of sale, and the “owner’s powers” under sections 23 and 24 LRA 2002 only enabled P to dispose of or encumber the charge itself, not the freehold interest in the property.
The judge decided that he would deal with the matter by way of summary judgment as the application raised points of law and no further evidence was necessary.
(i) The question of Possession
It was held that P did not have to be in possession of a property in order to exercise its statutory power of sale under Section 101 LPA 1925 (Horsham Properties Group Ltd v Clark 1 WLR 1255).
(ii) The question of “owner’s powers” under sections 23 and 24 LRA 2002
There was considerable discussion around the question of “owner’s powers” and whether P, as the beneficial owner of the charge, had acquired the necessary owner’s powers to enable it to exercise the statutory power which A had enjoyed (and possibly continued to enjoy as A remained the registered charge holder).
S relied on section 27(1) LRA 2002 and argued that P did not have the necessary “owner’s powers” as it had not been registered as the proprietor of the charge and therefore could not exercise a power of sale. S claimed that if a disposition of a registered estate or charge is required to be completed by registration it does not operate at law until it is registered. Therefore for the transfer of the charge to P to be effective, P must be registered as the proprietor of the charge.
P said that as it was entitled to be registered as the proprietor of the charge (section 24(b) LRA 2002) it followed that it was also entitled to exercise the “owner’s powers” under section 23(2)(a), being the “power to make a disposition of any kind permitted by the general law in relation to an interest of that description, other than a legal sub-mortgage”, which would include the power to sell.
The court accepted that “owner’s powers” extended to powers to deal with the charged property as well as the charge itself, but the extent of those powers depended on whether P had acquired ownership at law of the estate/charge. If P had not, it could not grant a greater interest than it possessed (The Mortgage Business Plc v O’Shaughnessy 1 WLR 1521 applied). Section 24 LRA 2002 could not automatically provide a person who is entitled to be registered as a proprietor with the same powers as a person who is the registered proprietor. P therefore had no power to sell the club, as equitable owner of the charge, under section 101 LPA 1925 unless it was able to do so under section 106 LPA 1925 and/or under the power of attorney granted by the charge.
(iii) The application of section 106 LRA 1925
Section 106 provides a power of sale to a person who is entitled to receive and give a discharge for mortgage money. It was found that P was not able to exercise the power of sale under section 101 LPA 1925, or the express power contained in the charge, merely as a result of it being entitled to be registered as the proprietor of the charge under section 24 LRA 2002. However, P as the equitable assignee, did have the legal right to sue for the assigned debt. It was found that P must be recognised as being entitled to receive and give a discharge for the mortgage money, and that therefore, as a result, P could exercise the power of sale under section 101 LPA 1925.
(iv) Could P exercise a right under the Power of Attorney?
It was concluded that although the charge contained a number of powers they only authorised someone to transfer an interest in the name or on behalf of a corporation, which was not applicable in this case and the powers of attorney could not validate the sale agreement. However, this did not affect the outcome of the case given the court’s conclusion on the application of section 106.
The court’s analysis of sections 23 and 24 LPA 1925 is interesting, and the decision may be subject to appeal as there appears to be a conflict between the application of section 106 LPA 1925 which does allow P to have the power of sale compared with the provisions of LRA 2002 which do not allow for P to have the benefit of the “owner’s powers”. Pending its registration as the registered charge holder of the charge P did not have a legal interest or therefore the ability to sell the registered estate, however, section 106 greatly assisted P who, as an equitable assignee, was able to receive and give good discharge and therefore could exercise the power of sale.
This case reminds us that lenders should take care to register the transfer of a charge promptly at the Land Registry, especially in cases where large portfolios are being transferred, as the rights of a holder of an equitable interest in a legal charge are not as extensive as the rights of a legal owner, and an equitable owner does not automatically acquire the same rights as a legal owner.
Should solicitors pass on information, which casts doubt on the valuation, to the lender?
In Goldsmith Williams Solicitors v E Surv Ltd  EWCA on 11 November 2015, the Court of Appeal upheld a High Court decision that if a solicitor instructed under the terms of CML Handbook, came into possession of non-confidential information which a reasonably competent solicitor would realise might adversely affect title to the security or the valuation, the solicitor was under a duty to report this information to the lender.
When acting for a mortgage lender in a residential mortgage transaction, solicitors must take into account:
- Their instructions from the lender
- The CML Handbook provisions
- The Bowerman duty: which is a duty pursuant to the decision in Mortage Express Ltd v Bowerman and Partners  2 ALL E.R. 836 to report information which a reasonably competent solicitor would recognise as impacting on the valuation or some other ingredient of the lending decision. However, the Bowerman duty does not apply when it is inconsistent with or excluded by the terms of the solicitor’s retainer.
In September 2005 the borrower purchased the property for £390,000.
In November 2005 E Surv (the Surveyors) were instructed to produce a re-mortgage valuation of the property. Their instructions recorded that the estimated value of the property was £850,000 and the loan required was £500,000. During the valuation inspection, the borrower told the Surveyors that he had purchased the property six months earlier for £600,000. The Surveyors valued the property at £725,000.
In December 2005 the borrower applied to the lender for a re-mortgage but stated that the loan required was £580,000 and that he had purchased the property in October 2005 for £450,000.
The lenders’ underwriters, who were also in receipt of the Surveyors’ valuation, did not query the fact that the property had increased in value by £275,000 in the space of two months.
Goldsmith Williams (the Solicitors) were instructed by the borrower and the Lender in February 2006 and were provided with a copy of the Surveyors’ valuation of £725,000.
The relevant CML Handbook provisions in force at the time stated:
Clause 1.3: The Lenders’ Handbook does not affect any responsibilities you have to us under the general law or any practice rule or guidance issued by your professional body from time to time; and
Clause 5.1.2: If any matter comes to the attention of the fee earner dealing with the transaction which you should reasonably consider important in deciding whether or not to lend to the Borrower (such as whether the borrower had given misleading information to us or the information which you might reasonably expect to have been given to us is no longer true) and you are unable to disclose that information to us because of a conflict of interest, you must cease to act for us and return our instructions stating that you consider a conflict of interest has arisen.
The Solicitors obtained Office Copies which revealed that the borrower had actually purchased the property in September 2005 for £390,000. The Solicitors failed to report to the Lender that the borrower had purchased the property less than six months previously and for significantly less than the amount of the Surveyors’ valuation.
Subsequently, the borrower defaulted on the loan and the lender suffered a loss. The lender pursued a professional negligence claim against the Surveyors for an over valuation of the property. The Surveyors and lender settled the claim for £200,000.
The Surveyors then pursued a contribution claim against the Solicitors and claimed that:
- The Solicitors were under a Bowerman duty to report to the Lender the purchase within 6 months of the remortgage and the purchase price of £390,000.
- The Solicitors’ breach of this duty was a contributory cause of loss because had the Solicitors advised the lender of the above facts, the lender would have referred the information back to the Surveyors, who would have been able to adjust their valuation accordingly. The lender would not have made the advance and would not have suffered a loss.
The Solicitors argued that:
- The Bowerman duty did not apply and that instead the CML Handbook requirements applied and these should be interpreted narrowly to mean that the Solicitors were only required to report such information where there was evidence of fraud.
- In the alternative, even if such a duty did exist, it was not causative of loss as the Lender had already been informed on the application form that the purchase price in October 2005 was £450,000 and it had still made the advance. The Solicitors claimed that even if they had informed the Lender of the September 2005 “true” purchase price of £390,000, this information would not have made a difference to the outcome and the Lender would still have made the advance.
The judge at first instance found that the Bowerman duty applied to the Solicitors on the basis that their retainer did not exclude this duty and it was not inconsistent with the reporting provisions of the CML Handbook which applied even without evidence of fraud. The judge also found that if the Solicitors had not breached this duty, and had advised the Lender of the September 2005 purchase price, then the lender would not have made the advance.
The Solicitors appealed the High Court decision on two counts (1) scope of duty (2) causation.
On 11 November 2015 the Court of Appeal allowed the appeal on causation but upheld the decision of the High Court on the Solicitors’ duty.
The Court of Appeal found that the starting point for deciding whether or not the Solicitors were under a Bowerman duty was the terms of the retainer and the instructions given by the lender. It held that the terms of the CML Handbook, and specifically Clause 1.3 were inconsistent with the CML Handbook as being a “comprehensive and exclusive” statement of Solicitors’ duties. It found that Clause 5.1.2 could not be explained on any other basis than as a duty to report non-confidential information to the lender which would be relevant to the lending decision. It rejected the suggestion that the provisions of the CML Handbook are inconsistent with the Bowerman duty.
However, the Court of Appeal did not accept that the Solicitors’ breach had actually caused loss. Instead it found that the information the Solicitors had failed to pass on was not materially significant in that it differed little to information already with the lender and upon which the lender based its lending decision. The Solicitors’ breach was not therefore causative of the loss and the Surveyors’ contribution claim therefore failed on causation.
- Whilst the case is a cautionary tale for solicitors and the requirement to report information casting doubt on the valuation to the lender, it highlights the need for lenders to properly scrutinise the information in an application form and compare it with the valuation prior to making an advance.
- The decision also suggests that whether or not the Bowerman duty applies is dependent on the terms of the retainer between lender and solicitor. The judgment makes it clear that it does not expect solicitors to act as “detective or bloodhound”. Therefore as a belt and braces approach lenders should consider checking that their instructions make it explicitly clear that information within the scope of the Bowerman duty is to be reported.
- Lenders should also ensure that solicitors physically obtain a copy of the valuation.
Hindsight is a wonderful thing…
In Canada Square Ltd v Kinleigh Folkard and Hayward Ltd (Unrep) Central London County Court 17 September 2015 the Central London County Court provided guidance on the application of Nykredit in order to identify the point in time when a cause of action arose. The court also confirmed that it was possible to apply the benefit of hindsight when carrying out this exercise if a subsequent event “confirmed a pattern which was readily apparent”.
Although it deals primarily with a limitation issue, the case is also a reminder of the fundamental need in a valuation claim of being able to prove reliance on the valuation.
Section 2 of the Limitation Act 1980 sets out a limitation period of six years from the date on which the cause of action arose for claims in tort. However the actual date when the cause of action arises is an issue that has been the subject of much debate.
The House of Lords decision in Nykredit Mortgage Bank plc v Edward Erdman Group Ltd (No 2) 1997 held that in a negligent valuation the basic measure of comparison for assessing loss is the difference between the amount of money advanced by the lender which he would still have had he not made the loan, plus interest; and the value of the bundle of rights acquired by the lender, which is the value of the borrower’s covenant to repay the loan and the true value of the property. This is the “basic comparison test”.
In Nykredit, the House of Lords had to determine when interest was calculated from as this was the date that damage occurred. The House of Lords held that this date would vary across cases, and would sometimes be on the making of the advance, and sometimes would be the date of default by the borrower, which could be a much later date. The effect of this decision cast a life line to claims which might otherwise have been statute barred particularly if the date of default was at a much later date than the date of the advance.
In the Canada Square case, the borrowers applied to Canada Square Ltd (CS) in November 2005 for an interest only selfcertified re-mortage equivalent to 90% of the value of their home.
On 23 December 2005 Connells provided a written valuation of £475,000.
On 25 January 2006, Kinleigh Folkard and Hayward (KFH) provided a valuation of £500,000.
In February 2006, CS wrote to Connells informing it of the KFH valuation and asking whether Connells’ valuation needed to be adjusted. Connells informed CS that it disagreed with KFH’s comparables and that its valuation remained unaffected.
In February 2006 CS made an advance based on 90% of £475,000 – the equivalent of the Connells’ valuation figure.
The borrowers defaulted in January 2007. Sporadic payments were made by credit card during 2007 and the last payment that CS received from the borrowers was in January 2008. The borrowers surrendered the property to CS in August 2008. The borrowers were eventually declared bankrupt.
Having first served a Letter of Claim in March 2009, CS issued a negligence claim against KFH on 23 October 2013. KFH argued that the negligence claim was statute barred as the six year limitation period had expired.
The issue which the court had to decide was whether CS’ cause of action arose before 23 October 2007. In other words: when did CS first suffer a loss?
The trial judge applied Nykredit reasoning to establish whether CS had suffered a measurable loss prior to 23 October 2007. He applied the basic comparison test referred to above, and considered whether the court could take into account facts unknown to the parties when measuring the loss and also whether the court could make use of hindsight.
The court distinguished between two forms of hindsight:
- Sudden or unexpected facts for example: a lottery win or a job loss.
- Subsequent events which confirm or throw light on trends or risks which were apparent at the relevant date.
The value of security:
The court held that the value of the security must include all factors which affected the security at the relevant time whether or not they were known to the parties. In this case the court decided that the impact of a right of way affecting the property which was not discovered until post possession could be taken into account and applied a deduction in respect of this. It decided that the discovery of the right of way was an example of hindsight which confirmed rather than altered the previous position. The court also considered whether it should take the costs of repossession and sale into account and determined that a deduction should be made to reflect the costs of sale on the basis that these were anticipated costs. The court indicated that there could be a distinction applied to this approach if the costs were unusually large because of an unforeseen event.
The value of the borrowers’ covenant:
The court found that this should be valued in light of all the admissible evidence, and in this case tested whether the covenant appeared good and whether the interest payments were made. The court decided that the starting point was to compare the value of the security with the amount outstanding from time to time and to question: if there was a gap - was the value of the borrowers’ covenant sufficient to bridge it?
The court applied the test of whether the covenant “appeared good” and whether interest payments were being “duly made”. In doing so, the court rejected the defendant’s argument that the cause of action accrued on day one of the loan as the covenant was insufficient to ever bridge the gap. When rejecting this argument the court relied on the fact that a direct debit had been set up from inception and regular payments were made for 10 months.
Instead, the court looked to the date of the first default in February 2007. The court considered the question of hindsight and on the facts of this case found that subsequent events regarding the borrowers’ finances and that of their building company confirmed or threw light on risks which were apparent by February 2007. The court found that the subsequent bankruptcies merely “confirmed a pattern which was readily apparent by at least early 2007”.
The date of first default in February 2007, whilst not rendering the covenant worthless, made it necessary to look at the subsequent payment history. Whilst there were sporadic payments between February 2007 and January 2008, there was also irregularity and unfulfilled promises. In February 2007, the gap between the value of the property and the sum outstanding was £18,550 and the court held that CS had failed to provide compelling evidence that the borrowers’ covenant was worth at least that amount and at that date. Even if the court was wrong about the February 2007 date, it held that on any analysis CS had failed to show that the loss had not accrued in the subsequent months, in particular by June 2007 - given that the borrowers by this point had not made any payments since March 2007. Therefore, the court held that the claim was statute barred by at least February 2007.
The court did not actually consider any expert evidence in reaching its conclusion about loss accruing from the date of default in February 2007.
However, as a precaution it took the additional step of reviewing CS’ expert evidence. CS had instructed a chartered accountant and the court found that a chartered accountant, although not an expert in mortgage lending was a suitable expert. The judge found that the expert had sought to “ascertain the position as best he could” but was critical of the Lender who was “presumably in a position to provide much more information but has not done so”.
As an additional point, the court considered the fact that CS had taken the step of obtaining two valuations and whether CS had relied on one of them or both. The court found that CS had put together unsatisfactory evidence and that even if CS had succeeded on limitation the claim would have failed because it would not have been able to prove reliance on the KFH valuation.
- The use of hindsight reinforces the importance of lenders properly scrutinising the Statement of Account and subsequent arrears history. We recommend that as a “belt and braces” approach a sensible rule of thumb is to use the date of first default for calculating the six year limitation period. It also highlights the need, when pursuing a negligence claim, for lenders to provide their solicitors with a Statement of Account and arrears history with their initial instructions.
- The case demonstrates the importance of taking a proactive approach to limitation issues and not to delay. In this case, the Letter of Claim was actually served in March 2009: 4 years prior to the claim being issued.
- The case is an example of the importance of equipping an expert with as much information as possible. The trial judge implied that the lender could have provided its expert with more information than it actually did.
- Where two valuations are obtained lenders should keep a clear audit trial to confirm which valuation has been relied on. In this case the judge actually commented that “the Lender has at the eleventh hour tried to cobble together a case on reliance which is based largely on speculation with no real foundation”.