Mortgages and Charges
What Security Interests Exist in Land?
Lending money to a person is risky. They fail to pay, or may become insolvent with insufficient assets to repay all the loans they owe. Lenders can minimise this risk by acquiring security. This is where, in exchange for lending money, the lender gains a right over the borrower’s land or assets.
Types of Security Interest
There are four kinds of security, which can take effect in law or equity:
Mortgage: the lender gains ownership or a leasehold of the legal title and right to possession: Swiss Bank Group v Lloyds Bank [1982] AC 584. The borrower can discharge or ‘redeem’ this legal ownership by repaying the loan. The borrower’s equitable right to redeem the property prevents the lender from disposing of the property unless extinguished by the foreclosure process.
Charge: the lender gains a special property interest in the property charged. This allows them to apply to the court for a sale order and take the proceeds if the loan is not repaid. Unlike a mortgage, the lender gains no estate: Re Cosslett Contractors [1998] Ch 495. Charges are fixed (attached to a specific piece of property) or floating (attached to a defined but changing fund of property).
Pledge: the borrower delivers possession of the asset pledged to the lender. The borrower retains ownership. The lender gains a special right to sell and keep the proceeds if the loan defaults. Giving items to a pawnbroker is a common example of a pledge.
Lien: the borrower delivers possession of the asset pledged to the lender. The lender can keep the asset until the borrower pays the loan. A lien is often implied into repair contracts. For example, a mechanic gains a lien over cars delivered to them for repair to the extent that the customer does not pay in advance.
For land, there is also a unique ‘legal charge by way of mortgage’: Law of Property Act 1925, s.87(1). The lender gets security without the need for the borrower to transfer their estate in the land. Most security arrangements involving land take this form.
Creating a Legal Mortgage
The Law of Property Act 1925 recognises two ways of creating a legal mortgage (s.85(1)):
A mortgage by sub-demise grants the lender a 3000-year legal leasehold estate. These are very uncommon in the modern era. Registered land owners can only create charges by way of mortgage: Land Registration Act 2002, s.23. Meanwhile, mortgaging unregistered land triggers first registration. Registration then converts the mortgage into a legal charge by way of mortgage: s.51. Only sub-demise mortgages created before 2002 continue to exist, therefore.
A charge by way of mortgage grants the lender a charge. However, this charge grants them the same remedies and protections which a 3000-year lease would: Law of Property Act 1925, s.87(1).
A legal charge or mortgage can only be created by deed. It is also void if not registered.
Creating an Equitable Mortgage or Charge
There are three ways to create an equitable mortgage or charge:
If a borrower attempts to create a legal mortgage, but fails to use a deed, or the lender fails to register, the lender acquires an equitable charge so long as the borrower is under a duty to grant the mortgage: Bank of Scotland v Waugh [2014] EWHC 2117. The lender can use this right to demand the creation of a legal mortgage and acquire all the associated rights.
This only applies if the borrower owns the legal estate in the land and where the agreement fulfils the formality requirements of the Law of Property (Miscellaneous Provisions) Act 1989, s.2. It is an application of the maxim that equity sees as done that which ought to be done.
A borrower who owns the legal or equitable estate can create an equitable charge by agreeing in writing to make property available to discharge a debt.
This agreement or intention can be inferred from a failed attempt to make a legal charge. For example, a co-owner of the legal and equitable estate might forge the other co-owner’s signature on a mortgage agreement. A legal charge is not possible here. Instead, an equitable charge of the forger’s equitable estate arises: Ahmed v Kendrick [1985] QB 210.
The lender’s rights are more limited under this form of charge. They cannot demand the creation of a legal charge. Their only right is to apply to the court for a sale order or receivership. It is sometimes called a ‘purely equitable charge’ as a result.
If the borrower only owns an equitable estate in land, they cannot create a legal mortgage or charge.
They can, however, create a traditional equitable mortgage by transferring their equitable interest to the lender, subject to the lender’s agreement to transfer the property back on repayment of the loan.
Charging Orders
Finally, the court can create a charge by granting a charging order under the Charging Orders Act 1979, s.1(1). This may happen if the court orders an individual to pay another a sum of money, if it sees fit to secure the payment.
When deciding whether to grant a charging order, the court must consider all the circumstances, such as the debtor’s personal circumstances and whether the order might unduly prejudice any other creditors: s.1(5). If a partner or spouse jointly owns the home, the court will also consider their interests and those of any children: Harman v Glencross [1986] Fam 81; Kremen v Agrest [2013] EWCA Civ 41.
The charging order creates a right equivalent to a purely equitable charge: s.3(4). It therefore allows the other party to apply to the court for a sale order or receivership.
Lenders’ Rights: Charges and Mortgages
Certain rights and remedies arise out of the nature of the security interest in a charge or mortgage. Most of these rights are codified and implied into agreements in the Law of Property Act 1925. While the parties can expressly exclude or modify them in the mortgage agreement, this is rare.
The Right to Possession
A lender who has a mortgage by sub-demise or a legal charge by way of mortgage has an immediate right to possess the property: Four-Maids v Dudley Marshall (Properties) Ltd [1957] Ch 317. This if because they have either a 3000-year lease or rights equivalent to it, respectively.
Generally, however, there will be a term preventing the lender from exercising that right unless the borrower is in default. Lenders usually seek a court order anyway, to avoid running afoul of the various criminal offences which an improper eviction can give rise to (for example under s.6 of the Criminal Law Act 1977).
Where a lender validly seeks possession of the property, equity will not provide any relief: Birmingham Citizens Permanent Building Society v Caunt [1962] Ch 883. However, under s.36 of the Administration of Justice Act 1970, s.36, if the property is a dwelling-house the borrower can apply for discretionary relief. They must show that they are likely to be able to repay any arrears or remedy any default within a reasonable period. Relief is only possible if the lender applies for a court order, however; not if they rely on their inherent right to take possession: Ropaigealach v Barclays Bank [2000] QB 263.
A lender who has taken possession of the property has a duty account for any profits and receipts, take reasonable care of the property and maximise their returns: Palk v Mortgage Service Funding [1993] Ch 330. They must also account for any receipts they would have had but for their failure to maximise their return: White v City of London Brewery (1889) 42 Ch D 237. This means that they cannot simply leave the property empty for a long time.
The Power to Sell the Property
A legal mortgagee (by sub-demise or legal charge) has the power to sell the property if the borrower fails to pay: Law of Property Act 1925, s.101(1). A lender who has an non-purely equitable charge created by deed also has this power. They are not required to apply to the court for a sale order, unless the borrower has a special right to protection (discussed below).
However, unless the specific mortgage terms say otherwise, they cannot exercise the power unless one of the following conditions is met: Law of Property Act 1925, s.103.
- Notice requiring full repayment has been served on the borrower (or one of the borrowers if there are multiple) and the mortgage is in default for three months afterwards; or
- Interest is in arrears and unpaid for two months after becoming due; or
- The borrower has breached some provision of the mortgage other than a payment provision.
Certain security interests do not allow the lender to sell out of court. Rather, they must apply for a sale order from the court under s.14 of the Trusts of Land and Appointment of Trustees Act 1996. These include the purely equitable charge and the interest granted under a charging order.
A lender is under an equitable duty to act fairly towards the borrower when selling the property: Palk v Mortgage Service Funding [1993] Ch 330. This comes with various sub-duties:
The property must be sold in good faith and with reasonable care at its proper market value: Palk v Mortgage Service Funding [1993] Ch 330. The lender cannot sell at an undervalue just to more quickly recover what is owed. Nor can they sell to themselves or their agents.
They owe this equitable duty to the borrower, but not to any third-parties the sale might affect: Alpstream v PK Airfinance [2015] EWCA Civ 1318.
Even though the lender owes duties to the borrower, the lender’s interests have primacy. They can choose when to sell and are not obliged to improve the property to get a better price: Silven Properties v Royal Bank of Scotland [2003] EWCA Civ 1409.
If the borrower suspects the lender has sold in breach of their duties, they can apply for an order setting aside the sale or an account to compensate them for any shortfall resulting from the breach. A sale will not be voided unless the purchaser had notice of the impropriety or the land was unregistered and the lender had no power to sell: Law of Property Act 1925, s.104.
If the land is sold, property passes to the buyer by operation of s.88(1) of the Law of Property Act 1925. The lender’s rights, and any subsequent charges or mortgages, are extinguished. The lender holds the proceeds of the sale on trust. The proceeds are first applied to discharge the debt and any cost involved in the sale. If anything is left after this, it is repaid to the borrower: Law of Property Act 1925, s.105.
The Power to Appoint a Receiver
A legal mortgagee, or a person who has an equitable charge conferred by deed, has the power to appoint a receiver if the power to sell has arisen: Law of Property Act 1925, s.101(1). They do not require the permission of the court; they need only give written notice: s.109.
A receiver has the right to take possession of the property, manage and sell it. However, they act as the borrower’s agent, not the lender’s agent: Silven Properties v Royal Bank of Scotland [2003] EWCA Civ 1409. This makes them a useful tool for lenders who want to avoid liability for breach of any of the duties involved in possessing or selling property. However, it is common for lenders to indemnify receivers against personal liability.
A receiver owes the borrower the same duties as the lender when it comes to possession and sale of the property. When managing the property, they must do so reasonably, in good faith, and with due diligence: Medforth v Blake [2000] Ch 86. Their primary duty in this regard is to try to ensure that the interest/debt can be repaid. This can include ensuring that any business on the premises is carried out profitably, depending on the circumstances.
Foreclosure
Foreclosure extinguishes the borrower’s equity of redemption and vests absolute ownership of the property in the lender (subject to registration). It is only available to lenders with a legal mortgage or an equitable charge resulting from an enforceable agreement to grant a legal mortgage over a legal estate.
The lender must seek a court order for foreclosure. The court has a discretion to order foreclosure when the buyer’s liabilities are repayable but in default. The borrower may ask the court to order a sale instead, or to delay the foreclosure order to allow them to pay arrears or sell the property themselves.
If the court grants the order, the debt is extinguished. So, if the property is worth less than the outstanding debt, the lender cannot pursue the borrower for the difference. Similarly, if the property is worth more than the outstanding debt, the borrower cannot claim the difference. Foreclosure is relatively rare: the court will usually grant a sale order instead.
Protecting Borrowers: Charges and Mortgages
Borrowers can rely on the usual contractual defences to establish that their agreement to the mortgage is invalid, particularly duress, undue influence, mistake and misrepresentation. They can also rely on the Consumer Rights Act 2015 to the extent that the terms of the mortgage are unfair.
The Equity of Redemption
The buyer’s crucial right under a mortgage or legal charge by way of mortgage is the equity of redemption. This is the right to redeem the loan, recover the legal or equitable estate (if it has been transferred) and extinguish the lender’s rights. It is a property right which attaches to the estate mortgaged. It is therefore capable of binding third-parties.
Historically, equity would strike down any attempt to limit the borrower’s equity of redemption. This was known as the ‘clogs and fetters’ doctrine. Today, the doctrine is far more restrictive. However, certain terms will still be void:
A term which excludes the borrower’s ability to redeem completely is void: Jones v Morgan [2001] EWCA Civ 995. A term which postpones the right is valid unless it is oppressive and unconscionable or renders the redemption right illusory: Fairclough v Swan Brewery Ltd [1912] AC 565.
This is a high threshold. It is not enough that the clause seems unreasonable: Knightsbridge Estates Ltd v Byrne [1939] Ch 441.
A ‘collateral advantage’ is a benefit which goes beyond repayment of the loan. For example, a supplier might lend to a petrol station on condition that they buy their petrol from the supplier for the duration of the loan.
A collateral advantage term is void if it forms part of the substance of the mortgage and is unconscionable: Kreglinger v New Patagonia Meat & Cold Storage Co Ltd [1913] UKHL 1.
This is likely if the advantage continues after repayment of the loan: Biggs v Hoddinott [1898] 2 Ch 307.
Where a lender is empowered to unilaterally alter the interest rates, the courts imply two further terms: Paragon Finance v Nash [2001] EWCA Civ 1466.
1. a duty not to improperly, capriciously or arbitrarily change the rate.
2. A duty not to change the interest rate in a manner no reasonable lender would.
Equity also has a limited power to strike down excessive interest rates, but only if oppressive and unconscionable: Multiservice Bookbinding v Marden [1979] Ch 84.
Equity will strike out any option to purchase forming part of the mortgage transaction: Jones v Morgan [2001] EWCA Civ 995. This is true even if the option seems fair.
The courts look to the substance rather than the form of the agreement – examining whether the option was enacted at the same time and for the same purpose as the mortgage transaction: Lewis v Frank Love Ltd [1961] All ER 446; Warnborough Ltd v Garmite Ltd [2003] EWCA Civ 1544.
The courts are reluctant to interfere with terms agreed between two parties of equal bargaining power and financial expertise: Cityland Holdings Ltd v Dabrah [1968] Ch 166.
Regulated Mortgage Contracts
The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 establishes the category of ‘regulated mortgage contracts’. These are mortgages:
- With an individual or trustees for land;
- Within the European Economic Area; and
- Where at least 40% of the land is intended to be used as a dwelling by that individual, or by the trust’s beneficiaries or a related person.
Most domestic mortgages are therefore regulated contracts. A loan for business purposes may also be a regulated contract if it secured against a person’s dwelling.
Only licensed mortgage providers can enter regulated mortgage contracts. It is a criminal offence to try to grant such mortgages without a licence (the mortgage will also usually be unenforceable). A licensed provider who acts in breach of the duties associated with the licence can also be liable for damages.
A licensed provider is subject to the Financial Conduct Authority’s codes of conduct and rules. Failure to obey may result in fines or withdrawal of the licence. The FCA’s general principles include:
- Paying due regard to the borrower’s interests and treating them fairly;
- Communicating information clearly, fairly, and without misleading borrowers;
- Lending responsibly, including by complying with affordability assessments.
