In a recent decision, the NSW Supreme Court (at the request of a mortgagor) ordered second and third ranking mortgagees to discharge their mortgages without receiving payment of their outstanding debt.
The case is a first for New South Wales (in that it was the mortgagor and not the mortgagee seeking the orders) and raises a further risk that needs to be considered by mezzanine financiers when determining whether to participate in lending transactions. The case appears to also cut across the underlying principle behind the generally accepted rule that mortgagees have a discretion as to when to effect a mortgagee sale.
- A developer was the owner of land at Darling Point in New South Wales.
- The land was subject to first, second and third registered mortgages.
- The amounts owing under the various mortgages exceeded the value of the land.
- The mortgagor had run out of money and could not develop the land or pay interest due under the various mortgages.
- The mortgagor entered into a contract for sale of the land without prior agreement of the mortgagees and in default of its obligations under the mortgages. The purchase price was sufficient to discharge the first mortgage but insufficient to pay any amount to the second or third mortgagees.
- The mortgagor asked for the agreement of the second and third mortgagees to the sale on the basis that the purchase price reflected the value of the land and that on a mortgagee sale it was anticipated a lesser price would be obtained for the land.
- The second mortgagees had concerns about the degree of marketing which had been done by the mortgagor in relation to sale and did not consent to the sale.
- The mortgagor made application to the Court seeking an order for judicial sale of the land and to enable it to complete the contract for sale it had executed. The effect of such an order would be to require the second and third mortgagees to discharge their mortgages without receiving payment of the debts secured by the mortgages.
- The mortgagor had obtained a number of valuations and appraisals for the land and the purchase price under the contract was within the valuation ranges. There was also evidence that on a forced sale basis, the value of the land would likely reduce by at least 20%.
- The second mortgagees opposed the order being made as they were not satisfied that a proper marketing campaign had been undertaken and that the purchase price represented the best available price.
- The order for judicial sale related only to sale of the land. Guarantees and other securities that the mortgagor or other parties provided in relation to the mortgage debt were unaffected.
- Justice White of the Supreme Court made the order for sale. In prior cases in New South Wales and in a case decided by the English Court of Appeal of Palk v Mortgage Services Funding, the Courts have identified an inherent equitable jurisdiction to order a judicial sale of land whether on the application of the mortgagor or mortgagee.
- The Court held that the exercise of the inherent jurisdiction was reserved for special circumstances and was subject to the discretion of the Court based on an assessment of the competing interests of the mortgagor and mortgagees.
- After weighing the interests of the mortgagor and second mortgagees (particularly the accruing of substantial interest under the mortgage debts, that no income was being generated from the land and the valuation evidence), his Honour found that the prospect of gain by the second mortgagees which could have resulted from further marketing was disproportionate to the potential for loss to the mortgagor and guarantor of the mortgagor’s debts should the sale of the land be rescinded.
Practical implications of the case?
- When special circumstances exist to warrant the intervention of the Court, a mortgagee can be required to discharge its mortgage without receiving payment of the debt secured by the mortgage.
- The decision may be open to abuse by mortgagors’ seeking to minimise their liabilities for failed projects.
- In practice, cases of this type would operate to the detriment of second and subsequent mortgagees, particularly if a similar decision were to apply in circumstances where the mortgagor is a special purpose vehicle with no other assets and/or where the transaction is limited recourse.
- The outcome of the case was clearly detrimental to the investors in the mezzanine lender involved.
- Cases of this type will emerge where asset values are falling or remain static and mortgage debts are increasing, and should be of particular interest and concern to mezzanine financiers.
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