Banking Update: report and review on recent cases

Consumer or business contract?

A borrower who takes out a loan secured on a property that is partly residential and partly commercial is a consumer for the purposes of the Unfair Terms in Consumer Contracts Regulations 1999.

This was the finding of the Court of Appeal in Evans v Cherry Tree Finance Ltd & Anor where the application form was entitled "Secured credit agreement for a commercial loan". The borrower's property was partly residential and partly commercial and each part had a separate address. The borrower's address on the form was given as his residential address and the property to be secured was given as the commercial address. The phone number given for each address was the same. The purpose of the loan was said to be the repayment of an existing mortgage and to satisfy a divorce settlement. The borrower subsequently defaulted on the loan and his property was sold. The lender realised the sum due under the loan which included an early redemption charge calculated under the rule of 78. The borrower claimed he was not bound by the terms imposing the charge because they were unfair.

The judge at first instance held that the loan was not a business one but one taken out to settle the divorce settlement and enable the borrower to have a roof over his head as well as a place to work. As a result, the borrower was a consumer under the Regulations which therefore applied to the loan contract and the condition imposing the charge was unfair.

The Court of Appeal agreed. Looked at objectively, the loan was to enable the borrower to continue his livelihood but that was not its only purpose. The lender could have deduced from the information supplied that the borrower had been both living and working at the property and that he had taken out the loan for non-business purposes.

Things to consider

The courts will look behind what is written on the application form to determine whether a loan is truly for commercial as opposed to consumer purposes where clauses which are capable of being construed as unfair are being imposed.

Adverse possession affects mortgagees

Where a borrower fails to make any mortgage payments for a period exceeding 12 years and a lender fails to enforce its right to possession of the property, the mortgage will be extinguished under the Limitation Act.

In National Westminster Bank Plc v Ashe (trustee in bankruptcy of Djabar Babai), the Bank secured a mortgage over the borrower's property. The Bank made some formal demands for payment both before and after the borrower became bankrupt and thereafter said it would accept monthly installments over a ten year period failing which it would await a sale of the property for the liabilities to be repaid. No payments were received and no legal proceedings were issued by the Bank. The trustee in bankruptcy did commence proceedings though, seeking a declaration that as no payment had been made to the Bank for over 12 years, its legal charge on the property had been extinguished. The Bank contended that the borrower's possession of the property had been with its express or implied consent so that possession could not be treated as adverse.

The Court of Appeal disagreed. Again, applying JA Pye (Oxford) Ltd v Graham, the court held that adverse possession referred to the capacity of the person in possession, not to the nature of that person's possession. Possession has to be given its ordinary meaning. The borrower here was in exclusive possession. The Bank had a right to possession on default of payment but had chosen not to take any steps to enforce its right. The borrower was never given express permission by the Bank to remain in possession. Although the Bank had not enforced its right to possession, it did not follow that as a result, it had impliedly given permission to remain in possession so as to prevent the borrower from being in adverse possession. The borrower had been in adverse possession as against the Bank for a period in excess of 12 years and the Bank's charge was extinguished.

Things to consider

This is the latest in a number of Court of Appeal decisions on adverse possession in recent months where the court has held that inactivity on behalf of the owner or lender is fatal to its claim. Lenders should review their books to ascertain whether there are any loans where payment has not been made for a substantial number of years and steps have not yet been taken to protect their position either through rigorously pursuing possession proceedings or by some other express means. Doing nothing, or simply awaiting a sale of the property at some undefined time in the future without anything more, is not an option.

Floating charge holder not an unsecured creditor

Floating charge holders cannot participate as unsecured creditors in a claim for the prescribed part of a company's property made available for the satisfaction of unsecured debts.

In the matter of (1) Airbase (UK) Ltd (2) Airbase International Services Ltd sub nom (1) Thornley and (2) Forsey v (1) Revenue & Customs (2) Harris NA, Harris had the benefit of a fixed and floating charge over the companies in administration. There were insufficient assets to satisfy the charge in full. Harris sought to recover the unsatisfied part of the charge from the prescribed part of the companies' net property that had been calculated for the purpose of satisfying its unsecured debts pursuant to s176A(2)(a) of the Insolvency Act. It argued that the shortfall on both its fixed and floating charges was an unsecured debt and that all that this section did was prevent the realisations represented by the prescribed part from going to floating charge holders in so far as they were secured.

The court disagreed. The wording of s176A(2)(a) and (b) meant that "unsecured debts" could not include the unsecured debts of any type of secured creditor. S176(2)(b) provided that where the prescribed part of a company's net property exceeded the amount required to discharge the unsecured debts in full and therefore left a surplus, the embargo on distributing the prescribed part to floating charge holders was removed and the surplus was then available to satisfy those claims. This provision would be inoperable if Harris' construction of "unsecured debts" was correct as they would already have been discharged. That could not be correct.

Things to consider

Only in the relatively rare situation where a surplus remains after payment of unsecured debts from the prescribed part of a company's net assets will floating charge holders be able to recoup their losses should there be insufficient assets available to meet their charge otherwise.

Proposed mortgage arrears pre-action protocol

The Civil Justice Council has issued a consultation paper on a proposed mortgage arrears pre-action protocol for residential possession claims which will seek to regulate pre-litigation conduct. The draft adopts many of the provisions of and reflects guidance on good practice by lenders in dealing with borrowers in arrears as set out in the Mortgage Conduct of Business Rules within the FSA Handbook. Wragge & Co LLP is one of the named consultees.

The aim of the protocol is to provide a clear structure to be followed in residential mortgage arrears claims. It encourages pre-action contact between the parties; seeks to use court time effectively; aims to ensure lenders deal fairly with borrowers in arrears, which will include having in place a written policy (agreed by its governing body) and procedures for complying with the requirement to deal with borrowers fairly; and will enable the court to take into account whether the protocol has been followed and if not, whether any sanctions should be levied against lenders for such failures.

The protocol seeks responses to a number of questions that arise from the proposal including whether lenders think it would be useful or not; how will it impact in terms of benefit or costs; what sector of the lending market will be affected; do lenders agree with the scheme of the protocol and what should be the sanctions for non-compliance?

Things to consider

The consultation period will end on 23 May 2008.A full copy of the consultation paper can be obtained from the Civil Justice Council website on http://www.civiljusticecouncil.gov.uk/. Given that there are already nine other pre-action protocols, including a protocol to deal with rent arrears, and upon which this proposed protocol is based, a mortgage arrears protocol, in some shape or form, is highly likely to come into existence. That being the case, this is a good opportunity for lenders to have input into what that protocol should look like, not least as many steps are already being take by lenders internally. Also increased procedures may result in additional default costs being charged to borrowers' accounts.