Real Property II Tutorial 7: Mortgages

Introduction
To mortgage: (verb) to put up property as security for a loan. The person who puts up
the property is the mortgagor, and the person who lends the money is the mortgagee.

The traditional mortgage is actually a conveyance (transfer) of the property from the
mortgagor to the mortgagee. The mortgagor has the right of redemption: after the
money has been repaid, the mortgagee executes a “release and re-conveyance”.

In Barbados and Belize mortgages take effect as charges. The property is not actually
conveyed to the chargee, but, by law, the chargee is given the same remedies as the
traditional mortgagee.

The contractual right to redeem is exercisable only on the specified date and not
before or after. This date was usually set at six months after the date of the mortgage.

Such rigidity was repugnant to equity. It would not allow the mortgagor to redeem
before the specified date (unless the mortgagee had demanded payment or taken
possession). However, the Courts of equity would permit the mortgagor to redeem
after the date provided that all monies owing were paid (he who seeks equity must do
equity).

Equitable Right of Redemption vs Equity of Redemption

The equitable right of redemption only arises after the contractual redemption date.
This is in contrast to the legal right of redemption which only exists on the contractual
date.

The equity of redemption is the extent of mortgagor’s interest in his property, and
represents his aggregate rights to dispose of, devise and remortgage his land. The
value of the equity of redemption is the value of the property less the amount owed on
the mortgage.

Equity = Property Value – Mortgage

Hence, where the mortgage is $200,000 and the property is worth $500,000, the
equity is $300,000.

(In divorce proceedings, it is the equity which is divided between the parties. Hence
the departing spouse would not expect to get 50% of $500,000, but rather 50% of
$300,000 – the bank’s interest takes priority. The same would happen if the house
were sold – the mortgage would be paid first, and then the parties could split whatever
remained.)

Clogging the Equity of Redemption

Equity is very careful to ensure that the mortgagee does not take away the
mortgagor’s right to redeem. Thus the mortgagee is not to be allowed to oppress the
mortgagor or to take advantage of his financial circumstances.

The following, in particular, are not generally permitted:

1. reserving the right to purchase the mortgaged property,
2. postponing the right to redeem to an unreasonable time, or
3. reserving certain benefits to be enjoyed after the redemption.

Exclusion of redemption
Any express stipulation which is inconsistent with the right of redemption will be
ineffective. No mortgagee can secure, as a condition of the mortgage, that the property
shall become his absolutely when some specified event occurs. In all such cases, the
mortgagor may redeem as if there had been no such restriction. If a term of the
mortgage agreement gives the mortgagee an option to purchase the property, that term
is void, as repugnant to the equity of redemption, even though the transaction is not in
itself oppressive to the mortgagor. In so far as the term gives such a right before the
equitable right to redeem has arisen, or preserves such a right after the exercise of the
contractual right, it is inconsistent with the mortgage contract and may be held invalid
at law: Jones v Morgan [2001] EWCA Civ 995. (Note that a mere right of first-refusal
is probably unobjectionable since the mortgagor cannot be compelled to sell: Orby v
Trigg (1722) 9 Mod 2.)

These rules sometimes cause the Court some discomfort because they go against the
principle of freedom of contract. If the two parties are business entities on equal
footing who have freely entered into an agreement, why should the Court now set it
aside as being unfair?

Hence Lord Macnaghten said in Samuel v Jarrah Timber [1904] 1 A.C. 323, “The
directors of a trading company in search of financial assistance are certainly in a very
different position from that of an impecunious landowner in the toils of a crafty
money-lender.” And Lord Halsbury said in the same case: “A perfectly fair bargain
made between two parties to it, each of whom was quite sensible as to what they were
doing, is not to be performed because a mortgage arrangement was made between
them.”
In Samuel, the mortgagee was given the option to purchase the property at 40% of its
value within 12 months. It sought to exercise this option. The mortgagor succeeded in
its claim to redeem and to have the option to purchase declared null and void.

Once the mortgage has been made, however, the Court is no longer so concerned to
protect the mortgagor. Hence, if he enters into a similar option even one day later, so
long as it is in a separate transaction from the mortgage, equity will not intervene.

Postponing the right to redeem

Recall that the mortgagor is not generally permitted (either by law or equity) to
redeem his mortgage before the contractual date. This means that even if he sells the
property or wins the lottery, he does not have the right to pay off the mortgage and
redeem his property. It is very likely for this reason that the customary redemption
date remains at six months.

The mortgagee can actually specify any redemption date, but equity may intervene if
the circumstances of the mortgage are oppressive. The Court is concerned to ensure
that the right to redeem is not illusory. This is especially the case where the asset is a
wasting one.

In Fairclough v Swan Brewery [1912] AC 565, the mortgagor had a 20 year lease
which he transferred to the mortgagee to secure a sum of money. The redemption date
was set as six weeks before the end of the lease. The mortgagor sought to redeem
early and the mortgagee. The Court ordered the redemption of the lease. It gave
weight to the fact that the remainder after the mortgage (the six-week lease) would be
almost worthless.

On the other hand, in Knightsbridge Estate Trust v Byrne [1939] Ch 491, where the
company sought to redeem a substantial 40-year mortgage after 6 years, the Court
refused to assist. The mortgage was on very special terms e.g., it was payable by half-
yearly instalments, and the mortgagee waived the right to call in the money in
advance of the due dates. The Court felt that the agreement was a proper business
transaction between two important corporations who were experienced in such
matters, and it had none of the features of an oppressive bargain. It was a significant
investment on the part of the mortgagee, and also, it would have been unfair to them
given that they did not have the corresponding right to call in payments.

Collateral advantages
Sometimes terms are inserted which give the mortgagee a benefit beyond the security
and interest. These are called collateral advantages. The Court will only interfere if
the advantage was imposed in a morally reprehensible manner, especially where there
is inequality of bargaining power. Such will not be said of a transaction between
businessmen who have their eyes open.

Collateral advantages are not usually valid after the mortgage has been redeemed.
Hence inBiggs v Hoddinott [1898] 2 Ch 307, where the mortgagor covenanted to sell
only the mortgagee’s beer, the Court said he was free from the requirement after
redemption, even though the requirement was for a fixed term. To hold otherwise
would mean that he would be redeeming a ‘tied house’ when he had originally
mortgaged a ‘free house’.

On the other hand, in Kreglinger v New Patagonia Meat and Cold Storage [1914] AC
25, where the collateral advantage was only fixed for five years and the mortgage was
redeemed in two years, the Court held that the mortgagor remained bound. The House
of Lords said that the advantage was separate from the mortgage.

Foreclosure
This is an order of the Court which terminates the equitable right of redemption,
thereby vesting the full legal and equitable estate in the mortgagee. Where the value
of the property is significantly greater than the outstanding mortgage, the Court is
more likely to order a sale. After the property is sold, the mortgagee is only entitled to
the outstanding sums owed on the mortgage.

The Power of Sale

Where the value of the house far exceeds the outstanding balance on the mortgage, the
Court is more likely to order a sale than a foreclosure. The mortgagee may also
choose this option in any event. Before the mortgagee sells, he should ensure that the
power of sale has arisen and that it has become exercisable.

The Power Arising

The power of sale arises only after the legal date for redemption has passed (or where
an instalment is in arrears). If this power has not arisen, the mortgagee does not have a
statutory power of sale.

The Power Being Exercisable

The power does not become exercisable until one of three conditions has been
satisfied:
1. Notice requiring payment has been served on the mortgagor and default has been
made for three months thereafter
2. Some interest under the mortgage is two months in arrears
3. There has been a breach of some other (non-payment) provision contained in the
Act or in the mortgage deed.

Protection of the Purchaser

The mortgagee has no statutory right to sell the property until the power has arisen[1].
Once it has arisen, he is able to give good title to the purchaser free from the equity of
redemption. If, at the time, the power was not exercisable, or if it was exercised
improperly, the mortgagor can sue the mortgagee, but he cannot recover the property.

The purchaser does not have to enquire whether the power of sale was
actually exercisable, though, at the same time, he cannot close his eyes to suspicious
circumstances. If he has notice that the power was not exercisable, his title may be
impeachable (i.e., the mortgagor may still be able to recover the property).

Mode of Sale
The mortgagor does not require a Court order in order to sell the property. This is a
major advantage over the foreclosure proceedings which require a Court order.

Before selling, the mortgagee should ensure that it has vacant possession by serving
eviction notices on any tenants or occupants.

The mortgagee is under a general duty to act in good faith, but it is not a trustee for
the mortgagor. In other words, it is not obliged to get the best price possible, or to
delay the sale until he can get a good price. This is why persons usually prefer to try
to sell the house themselves instead of waiting for the bank to sell it. (Although I have
seen some matrimonial cases where the parties take the opposite approach, usually to
spite their former spouse...)

The mortgagee must sell the property in an arm’s length transaction. Although the sale
may be by private auction, it cannot sell to itself or to its employee. The mortgagee
must take reasonable care to obtain ‘the true market value’, the ‘proper price’ or ‘the
best price reasonably obtainable at the time’.

Examples of breaches of this duty include:

1. Advertising the property without mentioning that the land had valuable planning
permission:Cuckmere Brick v Mutual Finance [1971] Ch 949
2. Selling lighting and sound equipment without taking specialist advice or advertising
in specialist journals: American Express International Banking v Hurley [1985] 3 All
ER 564
3. Selling at a “crash sale valuation” to obtain an immediate sale rather than putting
the property on the open market: Predeth v Castle Phillips Finance [1986] 2 EGLR
144.

Proceeds of Sale
The proceeds of the sale must be applied in the following order:
1. In discharge of any prior encumbrances (i.e., where the property has two mortgages
and the second mortgagee sells, he must pay off the first mortgage first)
2. In discharge of the expenses of the sale
3. In discharge of its own mortgage
4. To the subsequent encumbrances or to the mortgagor (The mortgagee will be held
liable if it has notice of subsequent mortgages and fails to pay over the surplus. Where
there is any uncertainty, the money may be paid into Court.)

Taking Possession
Instead of selling or foreclosing, the mortgagee may go into possession. It may do this
in order to enforce its security, e.g., by renting the premises or by demanding the
proceeds of the rent from any existing tenants. The mortgagee may also seek to
protect its security by going into possession to carry out repairs or to prevent waste or
vandalism.

Taking possession does not require a Court order. The right arises since the mortgage
gives the mortgagee a legal estate. In the case of the charge, the chargee has a
corresponding statutory right. The right arises “before the ink is dry on the mortgage”
(Four-Maids v Dudley Marshall [1957] Ch 317).

However, if the mortgagee serves an eviction notice on the mortgagor who then
refuses to leave, the mortgagee may start eviction proceedings in the Court. The
mortgagor is given a chance for relief, which involves paying the amount due. If there
is no reasonable prospect of this, the relief will be refused.

Note that the right is only for the protection or security of the mortgage. It cannot be
used for any other purpose. In Quennell v Maltby [1979] 1 WLR 318, the mortgagor,
attempting to get rid of a rent protected client, tried to persuade the mortgagee to
claim possession. When it declined, he arranged for his wife to pay off the mortgage
and step in as the new mortgagee. The Court refused to allow her to take possession.
Although she had the power to do so, it was held that she was exercising this power
for improper purposes.

Duty to Account Strictly

Where the mortgagee has taken possession, it is strictly liable to account, not just for
all moneys received, but also for all moneys which he ought to have received if he had
managed the property with due diligence. In other words, it must maximise the return
from the property (e.g., by getting the highest rent possible).

Appointing a Receiver
Appointing a receiver allows the mortgagee to avoid the responsibilities of taking
possession, but achieve the same result. The typical mortgage deed gives the
mortgagee the power to appoint a receiver on behalf of the mortgagor. Hence the
receiver is the mortgagor’s agent and not the mortgagee’s agent. The mortgagee is
therefore not held strictly liable for maximising the monies received.

The money received by the receiver must be applied in the following order:
1. in discharge of rents, rates and taxes
2. in paying instalments on prior encumbrances
3. in payment of his own commission (5% of the gross received unless his contract
otherwise directs), and in payment of the insurance premiums. Also in payment of any
repairs where the mortgagee so directs in writing
4. in payment of the interest under the mortgage
5. if the mortgagee directs in writing, towards the discharge of the mortgage principle.
6. towards the mortgagor or any other person entitled to receive the money.

Note
The mortgagee may exercise any and all of the remedies. Where it forecloses, it can
no longer claim payment. However, for all other remedies, including sale, the
mortgagee can still sue the mortgagor for any outstanding sums.

Tutorial Question

Juan, a successful entrepreneur and property mogul, obtained a mortgage in respect of

a freehold commercial property from International Owners Unity Bank (IOU Bank).
Juan wished to construct a trendy 2-storey jazz bar. IOU Bank was a financial arm of
a multinational organisation, Greatness Incorporated, which included several
manufacturing companies. Three years after the mortgage was executed, Juan's jazz
bar was making large profits and Juan sought to settle the outstanding balance of the
mortgage. IOU Bank refused to accept the repayment and sought to enforce the
following clauses contained in the mortgage deed:

(a) The mortgage was to run for 25 years, the mortgagor's agreeing not to redeem
before the end of the 25 year mortgage period;
(b) The mortgagor was obligated to use glassware provided only by ClearWare Ltd, a
subsidiary of Greatness Incorporated, for the duration of the 25 year period;

(c) IOU Bank was to be given an option to purchase the property, exercisable within
30 years of the date of execution of the mortgage.

Advise Juan on the legality of the mortgage clauses upon which IOU Bank seek to
rely

This question deals with the topic: Clogging the Equity of Redemption
In answering, define the term “equity of redemption” and explain the concept of
clogging the equity in a manner similar to the notes above (supplemented by any
points highlighted in the textbook). Then turn to the analysis of the present situation.

a) redemption postponed to 25 years

Is the present case more similar to Fairclough or toKnightsbridge? Unlike Fairclough,
where the asset (a fixed-term lease) depreciated with time, this asset (commercial real
estate) is expected to appreciate with time. On the other hand, the commercial lifespan
of a jazz-club is uncertain, and it makes sense for Juan to want to pay the money while
the going is good. Like Knightsbridge, the mortgage is between two experienced
entities and Juan is scarcely in the position of an impecunious landowner in the hands
of a crafty moneylender. However, on the other hand, Juan is an individual and not a
corporation. His success largely depends on his personal input and he does not have
an infinite lifespan. Nor is there any indication that IOU Bank created special terms in
the mortgage which would place it at a disadvantage (as happened in Knightsbridge).
Although the mortgage is not, on its face, oppressive, nevertheless, it is likely that
Court will find the 25-year date is a clog in the equity of redemption, and permit Juan
to redeem early.

b) Necessity of using the glassware for the duration of the 25 year period
Is this case more like Biggs or more like Kreglinger?

The Court will first determine if the advantage is unconscionable. This will happen
where there was inequality of bargaining power, or undue influence. Where the
transaction is between businessmen with their eyes open, the term will not be set
aside.

In this case, there is no hint that the advantage was imposed in a morally reprehensible
manner. Both parties are experienced business entities with their eyes open, and there
is no inequality of bargaining power.
The next question is whether the requirement will continue if early redemption is
permitted in (a) above. Unlike Kreglinger where the time frame was quite short (a
mere five years), the 25-year period is extremely long. Nor is there any indication that
this term formed part of the consideration for the mortgage as happened in Kreglinger.
Although part of a larger entity, at the end of the day, IOU is a bank and its business is
lending money. The requirement to use the glassware does not, therefore, bring a
direct benefit to the bank itself. It is likely that the Court will sever this requirement,
and hold that the requirement to use the glassware ends with the redemption of the
mortgage.

(c) IOU Bank was to be given an option to purchase the property, exercisable within
30 years of the date of execution of the mortgage.

As in Jones v Morgan and Samuel v Jarrah Timber, the Court will find that this term
is repugnant to the equity of redemption. As mentioned in Samuel, this rule is
followed very strictly, even if the Court might wish otherwise.

[1] The mortgagee can always sell the mortgage itself. A mortgage is a receivable. If
the mortgagee wants to liquidate it, he can sell to another entity, such as another bank.
The purchaser would pay cash and take over the mortgage. The mortgagor would then
make future payments to that new bank.