In the recent Supreme Court of Queensland decision of Sun North Investments Pty Ltd as trustee v Dale & Anor  QSC 44, the Court confirmed that a transaction which operates to restrict a mortgagor’s right to redeem the mortgaged property will be voidable, without any requirement to demonstrate unconscionable conduct on the part of the lender.
The plaintiff, Sun North Investments Pty Ltd (Sun North) was in financial difficulty. The defendant, Dale, agreed to lend $500,000 to Sun North, secured by a fixed charge over shares owned by Sun North, and an option to purchase the shares for $2m, exercisable if the loan was not repaid by the due date. At the time the option was granted, the shares were worth approximately $5m.
Sun North failed to repay the loan on the due date, and Dale gave notice to exercise the option to purchase the shares. When Sun North subsequently attempted to repay the loan, Dale refused to accept the payment, insisting that the option had been validly exercised and that he was entitled to a transfer of the shares (which were then worth in excess of $4.5m).
Equity of redemption
It is long established that a mortgagor is entitled to redeem property subject to a mortgage. The “equity of redemption” may be exercised until the mortgagee’s power of sale has been exercised or a court has made an order for foreclosure.
To give effect to the equity of redemption, the Courts have traditionally granted relief against transactions which fetter or “clog” the equity of redemption. The rule against fettering the equity of redemption is founded on “the unconscionability inherent in ... allowing the lender to exercise rights amounting to a penalty or forfeiture. It is the nature of the transaction, if allowed, which is unconscionable. It is unnecessary to demonstrate fraud ... or other unconscionable conduct on the part of the [lender]”.
Justice Henry noted there was ample authority for applying the rule to an option arrangement entered into as part of the security transaction. He found that the option was entered into as part of the security transaction and had the effect of purporting to extinguish the plaintiff’s equity of redemption. On that basis, it was void from the outset.
Justice Henry confirmed that the traditional approach to transactions which fetter the equity of redemption still applies. He rejected (obiter) statements made by the New South Wales Supreme Court in Westfield Holdings Limited v Australian Capital Television Pty Ltd to the effect that the rule was only applicable where unconscionable conduct on the part of the lender could be demonstrated.
He also distinguished the rule from the rule as to collateral advantages (which has been relaxed in recent years to only render transactions void if they are found to involve unconscionable conduct).
The case reiterates that courts will look at substance over form in deciding whether a transaction can be construed as a fetter on the mortgagor’s equity of redemption.
Whilst it remains to be seen whether the Queensland approach will be followed in NSW and other jurisdictions, lenders looking to incorporate options as part of a security structure need to be mindful that the rules may apply and render the option unenforceable.
The decision also has implications for other security structures, such as limitation clauses often found in featherweight securities in the Australian market.