Introduction
Debt forms a very important part of commercial life. While, some may say that borrowing is not a prudent practice, it is often the only way for an individual or company to stay afloat in business or to pay for expenses incurred that threaten to bring business to a halt. In the legal context, a debt is basically an amount owed by an individual to another person, whether natural or artificial, for money borrowed which is payable at a future date. The debt can take the form of a loan, mortgage, bond or credit as long as they is an agreement for repayment and where applicable, charging of interest. Generally, what denotes a debt is the agreement and intent to repay at an agreed period in the future.
Since a debt requires the lender to part with a substantial amount of money, there is a risk that the debtor might default and thus cause untold financial losses to the lender. It is thus important that a debtor provide the lender with a form of security normally known as collateral so as to guarantee that he or she is committed to repaying the debt (Wood 65). In most cases, a lender will not disburse borrowed funds until sufficient security has been provided. Security for debts takes various forms as shall be discussed hereunder and it is up to the lender to decide what type of security they require in order to advance debt.
Securing debt
Generally, there are two types of debt; secured and unsecured. A secured debt is one that has good security places against it usually in the form of an asset. Unsecured debts are not guaranteed by assets and they are issued upon good faith that the debtor will honour his or her obligation to pay. However, banks and other lending institutions usually charge a higher interest on unsecured debts. Nevertheless, most bank loans are secured since the banks do not usually allow themselves to run such a high-level amount of risk. To acquire rights over the secured assets, the lender must have security interest.
Under common law, there are eight forms of security interest which include; legal mortgages, statutory mortgages, equitable mortgages, fixed charges, floating charges, legal lien, pledges (pawns), trust receipts or hypothecations and finally, equitable lien. However, I shall focus on mortgages and charges since they are the most common forms of security interest. These forms of security are created by agreement between parties, operation of law e.g. for liens and statute e.g. where debt is unpaid taxes.
‘True’ legal mortgage
This kind of mortgage arises where assets are conveyed to the lender as security subject to the right that the borrower will have the assets back once he/she has completed paying the loaned amount. This is generally referred to as the debtor’s equity of redemption which is legally protected. The behaviour of courts has been to ignore any clause in a lending contract that purports to ‘impede’ or prevent the right of redemption (Tyree 208).
The reason these kinds of mortgages are known as ‘true’ mortgages is that they are created through the traditional common law practices that usually involved transfer of title documents to the lender. In actual practice, legal mortgages are quite rare and they have even been abolished in most common law countries.
Before completing this type of mortgage contract, the title of the asset being used as security is passed to the lender making him the true owner of the property. Due to the complete transfer of title, one cannot take a subsequent mortgage on the same property or enter into a mortgage contract based on future property. In practice, the possession of the asset remains with the debtor or mortgagor. In case there is a default in payment, the mortgagee/lender has the option to foreclose on the asset (s), sell it or appoint a receiver over the asset. Other options include the institution of a suit for monies owed or breach of contract and another host of land-related remedies that are mostly curtailed in statute. The mortgagee is allowed to pursue more than one remedy whether consecutively or concurrently.
Statutory mortgage
This is the most common type of mortgage and it differs distinctly from the legal or ‘true’ mortgage due to the fact that it attempts to offer more protection for the borrower or debtor. Generally, the lender is considered to be at risk and thus in need of protection but according to the law and in reality, lenders are usually big financial institutions such as banks and there is need to protect the borrower especially in mortgage contracts due to the huge power imbalance between the two. In Australia, all mortgage contracts that relate to registered aircraft, ships and land have to be statutory. One of the most significant differences between the statutory mortgage and the true mortgage is the transfer of title. In the landmark case of Clarkson v. Mutual Life Association of Australasia [1879], Lilley J clearly stated that the mortgagee was not the true owner of the mortgaged property and could not prevent the mortgagor from taking a second mortgage (Tyree & Weaver 204). Additionally, the honourable judge averred that the transfer of documents of title was for the purposes of encumbrance and not possession. The judge relied on the provisions of the then Real Property Act which provided for statutory mortgages (Duncan & Dixon 67).
In addition, there are several remedies that are curtailed under statutory mortgages which could have been available to the lender. A good example of this is the mortgagee right of possession. In true mortgages, the mortgagee could gain entry of the land that is the subject of the mortgage wilfully to inspect it. In a statutory mortgage, the mortgagee is only entitled to enter possession upon default. The statutory mortgage allows more for the power of sale than that of foreclosure. Before foreclosing, the mortgagee must obtain permission to do so from the Registrar of Titles (except in Queensland where a judicial order is required) since all statutory mortgages have to be registered Other requirements include notice of default to the mortgagor, default must be for a period not less than six months and an attempted auction must have failed to cover the defaulted amount. In summary, statutory mortgages are both procedurally and substantively controlled by legislation.
Equitable mortgage
An equitable mortgage can be created by the express agreement by the lender and borrower to make such an arrangement or it can arise where a legal mortgage is incomplete due the borrower’s failure to convey the assets and their titles to the mortgagee after receiving the loaned amount. The use of equitable mortgages in commerce has generally diminished due to the risk borne by the lender. In most cases, a mere deposit of documents of title creates an equitable mortgage since there is no actual transfer of the property to the lender as is the case in a legal mortgage. In many jurisdictions, equitable mortgages are only allowed for chattels and not immoveable property.
The reason this type of mortgage is referred to as ‘equitable’ is because it largely relies on the law of equity to prevent the borrower from denying liability for the debt. In legal diction, the borrower is ‘estopped’ from escaping the debt. Being ‘equitable’, the mortgagee cannot have a better right to the mortgaged property than a purchaser for value without notice of the mortgage. Since the mortgagee does not have legal ownership or possession of the property, there is need for further action to be taken for it/him/her to exercise its/his/her remedies.
Fixed equitable charge
This is the most common form of security interest in the world of modern commerce. A fixed charge usually gives the lender a particular asset that they can appropriate in case of the debtor’s default. A charge is normally enforced by appointment of a receiver or power of sale. The most distinct feature between a charge and a mortgage is the fact that the borrower does not convey the title in the property to the lender. Instead, the lender places an encumbrance on the asset so as to affect the borrower’s right to handle the property. Since the lender has no proprietary interest in the asset, he or she has to use judicial intervention to recover the money owed. It is very much similar to an equitable mortgage due to its non-possessory nature.
Floating equitable charge
Just like fixed charges, floating charges are non-possessory in nature and they do not involve any transfer of property. However, the two differ in the essence that in a fixed charge, the particular property charged is known and an encumbrance is placed on it. On the other hand, floating charges are imposed on a cluster of assets belonging to the borrower. A floating charge was described by Lord Macnaghten in Illingworth v Houldsworth as being “…ambulatory and shifting in nature, hovering over and so to speak floating with the property which it is intended to affect until some event occurs or some act is done which causes it to settle and fasten on the subject of the charge within its reach and grasp” (358). The charge ‘floats’ around since it does not impose any restriction on the part of the borrower from dealing with that cluster of property. The charge normally crystallizes when the chargor is insolvent or bankrupt and is paid out just like any other debt during liquidation. Floating charges are very popular due to their ‘business-friendly’ nature that allows the borrower to deal with his or her property normally without the inconveniences of encumbrances.
Legal provisions
While the law has been keen to ensure that the mortgagee is not interrupted in his/her attempts to recover the amounts owed to him/her, the law has also been very careful in ensuring that the available remedies are not used for another ulterior purpose other than that stipulated in the mortgage or charge. Since charges and mortgages are contracts, their validity is also dependent on the observance of the requirements for valid contracts such as consensus, capacity, legality and intention to create legal relations. However, mortgages are special types of contracts since they involve the transfer of the borrower’s rights to the lender (Everett & McCracken 109).
Since mortgages and charges adequately provide for the lender’s security, it/he/she must act in a manner that cannot be termed as unconscionable conduct when it comes to exercising available remedies such as the power of sale and foreclosure. Additionally, since most mortgages are in standard form set by the banks and lending institutions, the lender should not include clause that seem to undermine the mortgagor’s equity of redemption. According to Lord Lindley in Samuel v Jarrah Timber Corp, “no contract between a mortgagor and a mortgagee as part of the mortgage transaction… as one of the terms of the loan… can be valid if it prevents the mortgagor from getting back his property on paying off what is due on his security” (323).
In deciding whether a mortgage is valid, courts usually try to balance between the inequality in power between parties and the commercial viability of mortgages. In the case of Knightsbridge Estates Trust v Byrne, the Court of Appeal of England overturned a High Court decision that had found a mortgage to be invalid due to the fact that it had purported to postpone equity of redemption for a period of 34 years yet the mortgagor was willing to pay off the entire debt. The court based its decision on the commercial viability of the contract stating that “… courts could not introduce notions of reasonableness to the agreements of commercial people and that intervention could be permitted only if the terms of the mortgage were ‘oppressive’ or ‘unconscionable’”(741). This rule was later applied in Cityland and Property Ltd v Dabrah where a punitive premium clause for early redemption was allowed to stand by the courts (166). As a rule, statutory provisions need to be followed to the letter if charges and mortgages are to have validity. Without validity, the lender cannot have adequate security for loaned monies
Works Cited
Cityland and Property Ltd v Dabrah [1968] Ch 166. Clarkson v. Mutual Life Association of Australasia (1879) 5 SCR 165
Duncan, William & Dixon, William. The Law of Real Property Mortgages. Sydney: The Federation Press, 2007. Print
Everett, D. & McCracken, Sheelagh. Banking and financial institutions law. Sydney: Law Book Company, 2009. Print
Illingworth v Houldsworth [1904] AC 355.
Knightsbridge Estates Trust v Byrne [1938] Ch 741.
Samuel v Jarrah Timber Corp [1904] AC 323.
Tyree, Alan & Weaver, Prudence. Weerasooria’s banking law and the financial system in Australia. Sydney: LexisNexis Butterworths, 2006. Print
Tyree, Alan. Banking law in Australia. Sydney: LexisNexis Butterworths, 2008. Print
Wood, Phillip. Comparative law of security interests and title finance. London: Sweet & Maxwell, 2007. Print