Banking update

Benefit of mortgage indemnity guarantee

A mortgagee is not obliged to account to the mortgagor for any sums paid out under a mortgage indemnity guarantee. The guarantee is for the benefit of the mortgagee, not the mortgagor.

This principle was reaffirmed by the Court of Appeal in Banfield v Leeds Building Society. In this case the borrowers alleged that the lender was obliged to account to them in respect of such a guarantee and had also failed to surrender a life policy correctly when the endowment mortage was converted to a capital and interest repayment mortgage. The argument was that had these two events occurred, there would have been no arrears on the mortgage at the time possession proceedings were commenced and so the lender was not entitled to possession.

The court held that the benefit of a mortgage indemnity guarantee policy is for the lender and a debt is not reduced for the benefit of the borrower by the payment under the mortgage insurance guarantee. This is so even if, had a claim been made under the guarantee, the amount received would have been sufficient to eliminate any arrears.

As to the alllegation that the lender failed to surrender the life policy correctly, the lender's evidence clearly showed that even had it done so there would still have been sufficient arrears to enable it to implement possession proceedings in accordance with the terms of the mortgage. The failure to surrender the policy earlier did not therefore prejudice the borrowers.

Things to consider

It is settled law that the above principle in relation to mortgage indemnity guarantees applies equally where professionals have been found guilty of professional negligence in overvaluing properties or failing to comply with a lender's instructions. The lender is not obliged to give credit for any sums received. Additionally, had the arrears been reduced to nil by the correct surrender of the life policy, the court would have had to address the question of whether the borrowers might have had a claim against the lender.

Fraudulent valuations

Although a trial and an exploration of the available evidence will often be required, if the evidence of fraud is clear and obvious, summary judgment is an appropriate, quick and ultimately less expensive way to obtain judgment.

In Cheshire Building Society v Dunlop Haywards (DHL) Ltd (T/A Dunlop Heywood Lorenz) and others, the claimant sought summary judgment against the defendant valuers who in turn sought an indemnity against its director M. M valued premises at £16 million with the benefit of three new business leases, and at £10.5 million with vacant possession. In reliance, the claimant advanced £11.5 million in all to the purchaser company against the security of the property. The proposed new leases subsequently turned out to be bogus and the true valuation of the property was only £1.5 million. The purchaser defaulted and the claimant sought summary judgment against the valuer for the substantial losses it suffered.

The claimant had to establish that the defendant had no realistic prospect of successfully defending the claim in deceit. The court found that the fact that the claimant was the object of a mortgage fraud by those controlling the purchaser was obvious. But was M dishonest in the valuations or simply a negligent tool of the fraudsters? It was clear from the evidence that M had been dishonest:

• There was no record of payment to the company for the valuation which suggested that either no payment had been made or it had been made direct to M personally;
• M was aware of the purchase price of £1.4 million;
• The terms of the leases were so onerous no tenant would have accepted them;
• No substantive defence was advanced by the defendant company despite extensive investigations that it had carried out; and
• Mortgage fraud had been proved against both the defendant company and M in other proceedings in similar circumstances. This demonstrated that M had a propensity to commit fraud in the manner contended for by the claimant.

The claimant was entitled to summary judgment, as was the defendant company against M.

Things to consider

With mortgage fraud and overvaluations once again appearing in the market, this case is a timely reminder that the courts will take a robust stance, and that summary judgment can be entirely appropriate in this class of case.

Adverse possession

In adverse possession claims it is necessary only to show that a person who claims to have acquired property by adverse possession is in possession without the consent of the owner and intends to possess.

So held the Court of Appeal in Ofulue v Bossert, applying JA Pye (Oxford) Ltd v United Kingdom and refusing to distinguish the cases on the facts. In Pye, the owners did not assert title until the limitation period had expired. Here, the defendant took up occupation of the property in 1981. The owners requested the defendant to leave in 1983 and 1987, commenced possession proceedings in 1989, served notices to quit in 2000 and 2003 and then issued further possession proceedings. Despite this, the court held that the claimants title had been extinguished.

Although the claimants had objected to the defendant's possession of the property, they had slept on their rights in not pursuing the possession proceedings to a conclusion. It was only necessary for the defendant to show possession without the consent of the paper owner and intention to possess. It was not necessary to show an intention to exclude the paper owner or acquire title. The fact that the defendant mistakenly thought she was a tenant (albeit she never paid rent) was irrelevant. The inception of the possession proceedings stopped time only for the purposes of those proceedings and only for so long as they remained live, but not thereafter.

Things to consider

It is imperative, once there is knowledge of adverse possession of a property, that all necessary steps are taken to either remove the occupiers or have the terms of their occupation legitimised. Commencement of possession proceedings alone will not be sufficient to stop time running: they must be brought to a conclusion.

Valid demand for repayment

Although a loan agreement may contain a penalty clause and so be unenforceable and the amount demanded under the agreement therefore excessive, this does not stop the lender being entitled to repayment of the sum properly owing where the borrower has not offered to repay any sum.

In County Leasing Ltd and another v East, the court found a term in a business loan agreement that obliged the borrower to pay, on termination, the principal amount of the loan unpaid plus interest for the entire outstanding period of the loan to be a penalty clause and so unenforceable. It also found the agreement to be an extortionate credit bargain. However, that did not mean that there had been no valid demand for payment even though the demand had been made for the 'extortionate' amount.

Whether a demand is valid or not will depend on the proper construction of the document by which the demand is made. It must either be necessary for a demand to state accurately the amount due, or not. If it is not necessary for the sum due to be stated accurately, then the authorities show that a statement of the correct sum due is not necessary for the demand to be valid. Further, the court found that a demand for an amount in excess of that actually due is not rendered ineffective if the person making the demand declines to accept the sum properly due when that sum is tendered. Whether a demand is valid falls to be determined at the time it is made, not later. There had been a valid demand here albeit that the lender was only entitled to a reduced amount.

Things to consider

This is also a timely reminder of a point of principle which lenders may increasingly need to argue with the introduction of the 'unfair relationship test' in April 2008 which replaces the extortionate credit bargain provisions. While there are no guidelines as to how this test will be applied, it is clear, given the factors the court is entitled to take into account, that the court has a much wider discretion. This could result in account balances being reduced.