Mortgagees: Show me the Money

Mortgagees: Show me the Money!

By Alysha Tuziak | May 2011 Area of Expertise | Commercial Disputes & Insolvency

Summary Where there are multiple mortgages registered on title and the property is sold by a mortgagee (whether the first mortgagee or not), if there are surplus funds following the sale and the mortgagee in possession of these funds is aware of a dispute between the mortgagor and the mortgagee next in line, serious consideration should be given to paying the money into court. A failure to take this precaution may result in considerable loss to the selling mortgagee.

The same process as above should be followed even where the mortgagee is in receipt or surplus funds other than through a sale as mortgagee in possession. This authority comes from the unreported judgment of the NSW Court of Appeal in Residential Housing Corporation v Esber [2011] NSWCA 25.

Who Does This Impact?

Financiers and property lawyers

What Action Should Be Taken?

Care should be taken by a mortgagee who finds itself with surplus funds. Assuming, without reference to a mortgager that the surplus must be paid to the mortgagee next in line is risky. Ignoring the mortgager when paying the surplus is to invite significant risk.

FACTS The mortgagors were the registered proprietors of two units. There was a first registered mortgage over each unit in favour of Permanent Trustee Australia Limited (‘PT’) and a second registered mortgage in favour of Residential Housing Corporation (‘Resi’).

The mortgagors were involved in a company, Knox Street Apartments Pty Ltd (‘Knox’), that was undertaking a real estate development.

When the development was partially complete Knox entered into a joint venture agreement with Kimberley Securities Limited (‘Kimberley’) to facilitate the funding of the completion of the development. This agreement included an obligation on Knox to pay Kimberley a $2M fee and to reimburse Kimberley for certain project costs.

Pursuant to the joint venture agreement, the mortgagors provided a guarantee to Kimberley which was to be secured by a third mortgage over the two units in favour of Kimberley. Resi provided written consent to the registration of the third mortgages, however Kimberley did not register the mortgages.

The mortgagors defaulted under the mortgages to PT and PT exercised its power of sale. After payment of its debt, PT paid the remaining proceeds to Resi. After Resi took the amount owed to it under its mortgages, surplus proceeds of $416,780.81 remained.

A dispute then arose between the mortgagors and Kimberley about the debt claimed to be owed to Kimberley and which party was entitled to the surplus proceeds.

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Mortgagees: Show Me the Money!

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Despite being aware of the dispute, on 28 February 2002 Resi paid the surplus proceeds to Kimberley. It distributed the proceeds to Kimberley to satisfy its debt. In return Kimberley provided an indemnity to Resi for any loss it might suffer by paying the surplus proceeds to it.

In 2006 the mortgagors instituted proceedings against both Resi and Kimberley in relation to the payment of the surplus proceeds to Kimberley. In two separate proceedings McDougall J held that the third unregistered mortgage to Kimberley did not secure payment of the $2M fee, and that as at 28 February 2002 (when Resi distributed the surplus funds to Kimberley) the mortgagors did not owe any monies to Kimberley under the third mortgage.

However, the mortgagors were unable to recover from Kimberley because in the intervening period Kimberley went into liquidation.

Accordingly, the mortgagors sought to recover from Resi on the grounds that Resi did not act in accordance with section 58(3) of the Real Property Act 1900 (NSW) (‘RPA’). Importantly from Resi’s perspective, the indemnity it received from Kimberley was worthless because of Kimberley’s insolvency.

Section 58(3) of the RPA requires that proceeds from a sale by a mortgagee be applied first, in payment of the expenses occasioned by such sale; second, in payment of the moneys which may then be due or owing to the mortgagee; third, in payment of subsequent mortgages (if any) in the order of their priority; and the surplus (if any) shall then be paid to the mortgagor. (The equivalent provision in Victoria is found in section 77(3) of the Transfer of Land Act 1958 (Vic) (‘TLA’).)

In a judgment given in December 2009, Hammerschlag J decided that Resi owed fiduciary obligations concerning the surplus proceeds, and that it did not act in accordance with either section 58(3) of the RPA or its equitable obligations. It followed that Resi was obliged to compensate the mortgagors.

Hammerschlag J gave judgment for the mortgagors for the surplus funds plus interest from 28 February 2002 plus an amount to be determined as representing the costs properly and reasonably incurred by the mortgagors in their unsuccessful pursuit of Kimberley.

On 21 February 2011 the NSW Court of Appeal upheld the decision of Hammerschlag J. Important points to note from the Court of Appeal’s decision are:

• Section 58(3) applies equally to non-selling mortgagees. This is because section 58(3) provides that money ‘shall be applied’ but does not say by whom it shall be so applied. Therefore, whenever proceeds arising from the exercise of a power of sale comes into the hands of a party, that party is obliged to dispose of the surplus proceeds in accordance with section 58(3).

• Section 58(3) does not apply to unregistered mortgages, however equitable principles would operate to prevent the section being used to produce inequitable results.

(It should be noted that in Victoria the position is presently different. In the 2009 Victorian case of Re S & D International Pty Ltd in liquidation) (Receiver and Manager Appointed) Robson J concluded that ‘the reference to subsequent mortgages and charges in s 77(3)(c) of the TLA includes unregistered mortgages and charges’. This authority may be overturned in the future in light of the criticism of it by the NSW Court of Appeal.)

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• Section 58(3) does not require a mortgagee to pay the whole surplus proceeds to the next mortgagee in order of priority. If a mortgagee holding a surplus is in doubt about how much to pay and to whom, and it is not possible to reach an agreement between the mortgagor and all the subsequent mortgagees about how to distribute the monies, the Court of Appeal suggests the solution is to pay the money into the court.

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Mortgagees: Show me the Money!

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For more information, please contact: Alysha Tuziak Lawyer T: 03 8600 5035 alysha.tuziak@turkslegal.com.au

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