Investigating potential beneficial interests in property

What should secured lenders do to ensure there is no overriding beneficial interest in a property? Neil Mendoza, barrister at Selborne Chambers, considers the decision in Credit & Mercantile in which he acted for the second defendant (Wishart).

Original news

Credit & Mercantile plc v Kaymuu Ltd and others [2014] EWHC 1746 (Ch) (£)

The claimant held a charge over a property, which had been occupied by the second defendant. It sought to retain a sum of money from the net proceeds of the sale of the property. The second defendant contended that he was entitled to that sum as the beneficial owner of the property. The Chancery Division held that, while the second defendant had been the beneficial owner of the property, on the facts, he could not assert his beneficial ownership of the property in priority to the claimant’s charge. The claimant was entitled to retain the amount it held from the proceeds of sale of the property. The second defendant was entitled to the surplus paid into court in respect of the balance of the proceeds of sale.

What was the background to this case?

Sami, his brother and Wishart (W) were involved in property transactions on a very informal joint basis. As far as this case is concerned, the project related to the buying and developing of a cemetery. They intended to sell off their interest in the LLP that was holding the cemetery.

The loose plan was that W would receive over £1m in order for him to buy a house, mortgage free. W left Sami to deal with the solicitors on all aspects of the conveyancing transaction. W was persuaded by Sami that the property ought to be purchased in the name of a Jersey trust. However, when it came to completion, Sami caused the contract to be altered, so that he was named as the contractual purchaser, but with a provision in the contract that the property could be purchased in the name of a company—which is in fact what ultimately happened, but using a company owned and controlled by Sami and with a name very similar to that of the Jersey trust.

On completion, W moved into his family house. Shortly afterwards, Sami, the sole director and shareholder of the company that purchased the house, raised money from Credit & Mercantile (C) by way of a mortgage. This was without W’s knowledge or consent. W therefore found his house charged to C for £500,000. Sami then defaulted on the mortgage, and C obtained possession and sold the property. Quite unusually, the sale after the mortgage repossession produced a surplus. C therefore took the money owed to pay off the mortgage and paid the balance into court. There were therefore two funds—the surplus, which C had paid into court and the money that C had taken from the sale proceeds to redeem its charge. With Sami having been declared bankrupt, his trustee also sought to claim the surplus held in court.

W contended the surplus is his and that the property should never have been mortgaged in the first place. He also argued that since the property had been mortgaged by the fraudulent Sami, the entire proceeds of sale belonged to W and C was not entitled to retain any part of the sale proceeds.

At trial, the judge agreed with W on every single factual issue. However, the difficulty that W faced was that since W had allowed Sami to deal with the solicitors on the conveyancing, he was effectively bound by the actions of Sami since he had put him into the position where Sami had been able to act as he did. Therefore, although W would have had an overriding interest in the property, that interest did not have priority over C’s mortgage. W is appealing this decision.

There is a line of authorities that demonstrate that where you have allowed someone to mortgage your property but they exceed their authority and borrow too much, the property owner is bound by the full extent of the mortgage (see eg Abbey National v Cann [1990] 1 All ER 1085).

It is contended that this line of authority is distinguishable on the facts. W did not give Sami any authority to deal with the property at all—all he was authorised to do was liaise with the solicitors to get the property purchased for W. Sami went considerably beyond what he was authorised to do. This is a very different type of case—one should look at the basis of the authorities giving rise to the principle relied upon below that resulted in W being bound by Sami’s actions. Here, the position is more akin to those cases where wives have been held to be not bound by mortgages of homes entered into solely by their husbands on the basis that the wives have overriding interests taking priority over the mortgages (eg Williams & Glyn’s Bank v Boland [1980] 2 All ER 408).

What factors will the court take into account in establishing a party’s beneficial interest in a property?

See the five features of a Pallant v Morgan type trust (Pallant v Morgan [1952] 2 All ER 951) referred to by Chadwick LJ in Banner Homes Group plc v Luff Developments Ltd and another [2000] Ch 372, [2000] 2 All ER 117 at paras [397–399]:

  1. There must be a pre-acquisition arrangement or understanding between the acquiring party and the non-acquiring party about the manner in which interests will be held in the property to be subsequently acquired. In the present case, the judge was satisfied that there was such an arrangement or understanding.
  2. It is not necessary that the arrangement or understanding should be contractually enforceable. If it is, then specific performance would provide the obvious remedy. In the present case there was no contract and nothing that was contractually enforceable—there was an informal understanding reached over a cup of coffee at a Costa Coffee shop in Sevenoaks.
  3. The pre-acquisition arrangement or understanding should contemplate that one party, the acquiring party, will take steps to acquire the relevant property, and that, if he does so, the non-acquiring party will obtain some interest in the property. That requirement was met here. Since it was always contemplated that W would have an interest, if not the sole beneficial interest, in the house that was to be acquired.
  4. It is necessary that the non-acquiring party, in reliance on the arrangement or understanding, should do or (omit to do) something that confers an advantage on the acquiring party or is detrimental to the non-acquiring party. Frequently, the detriment is seen by reference to the ability of the non-acquiring party to bid for, or acquire, the property on equal terms. That test was also met here.
  5. It is not necessary, as Chadwick LJ pointed out in Banner Homes at para [399B], that there must be both an advantage to the acquiring party and a disadvantage or detriment to the non-acquiring party—either one will do.

Note that in the dissenting judgment of Etherton LJ’s judgment in Crossco No 4 Unlimited and others v Jolan Ltd and others [2011] EWCA civ 1619, [2012] 2 All ER 754, the Pallant v Morgan type of cases were analysed as being explainable by reference to the existence of a fiduciary duty that had been broken. This would provide a different basis for the type of constructive trust that was found to exist and may limit that application of the principles.

What should beneficial owners do to ensure that their interest is brought to the attention of a mortgagee?

A very interesting point, because in this case W didn’t know there was a mortgage in the first place. Accordingly, what could W have done to bring his beneficial interest to the attention of potential mortgagees that he was unaware of? W had moved into the property and so a careful inspection should have revealed that he was in occupation so as to demonstrate his potential overriding interest.

What steps can secured lenders take to investigate any potential beneficial interest in a property either at time of lending or enforcement?

The key issue here is the steps to be taken prior to the grant of the loan. The lender should carry out a careful inspection of the property looking for any signs of occupation. If there are signs of occupation, very careful questions are required to ascertain the reasons for those signs. If the lenders send a professional valuer to inspect the property and they report back that it’s unoccupied, when it clearly isn’t, the lender should be able to sue the valuer and get any losses, perhaps through the valuer’s insurers. It is therefore important for the lender to contract with professional surveyors for such an inspection.

What should lawyers consider when drafting clauses in the mortgage deed dealing with recovery of costs by the mortgagee following the decision?

I can’t answer this question—this aspect is subject to a cross-appeal by the mortgagee.

PSL practical point: In the case, the court decided that the mortgagee was unable to recover the costs of defending against W’s claims (as opposed to the costs of the possession proceedings) as the court decided that this was not covered in the drafting of the cost clause in the mortgage deed nor fell within Norse LJ’s second proposition in Parker-Tweedale v Dunbar Bank plc (No.2) [1990] 2 All ER 588.

Further reading

If you are a LexisPSL Subscriber, click the link below for further information on enforcing security over land:

Enforcement—security over land (Subscriber access only)

Understanding official copy entries from an enforcement point of view (Subscriber access only)

Not a subscriber? Find out more about how LexisPSL can help you.

Interviewed by Duncan Wood.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor. 

Relevant Articles
Area of Interest