by Marcus Barclay
When a mortgagor defaults a mortgagee wanting to realise its security has to take a decision: should it go into possession as mortgagee or appoint a receiver under the Law of Property Act 1925? While their powers may be similar the difference between them, as regards a mortgagee’s potential liabilities, is enormous.
LAP receivers cost money. Their receivership fees are often calculated as a percentage of the total value of the security realised. Alternatively, they may charge an hourly rate for managing the property plus a percentage fee for any sales. For mortgagees already facing deficits on the realisation of their security the prospect of paying a large receivership fee is understandably unattractive.
Prima facie nothing prevents mortgagees from avoiding such fees by going into possession themselves. Few are fully aware, however, of what they would be taking on. Answers to a number of specific questions are needed: (1) What constitutes “taking possession” by a mortgagee where “actual” possession is impossible? (2) What rights/powers will a mortgagee in possession acquire? (3) What liabilities and responsibilities will it take on? (4) Is it practical?
Take the example of a mortgagee with a first legal charge over the headlease of a large development such as a shopping centre where underleases have been granted binding on the mortgagee. The mortgagor is in substantial default and, reluctantly, the mortgagee decides to realise its security. What is involved if it wishes to do so as mortgagee in possession?
What is possession?
In our example “actual” possession is clearly impossible. Perhaps the clearest statement of what is necessary for a mortgagee to be deemed in possession where “actual” possession cannot be taken was given by Bowen LJ in Noyes v Pollack (1886) 32 ChD 53. What is required is for the mortgagee to displace
. . . for the purpose of realising the security, the mortgagor from the control and dominion of the reversion of the estate which is demised.
The prospect of displacing a mortgagor from the “control and dominion” of the reversion of his estate may conjour up images of a titanic struggle, but it is easy to achieve in practice. In our example the mortgagee must simply give the mortgagor’s tenants notice to pay their rents to the mortgagee. That will be sufficient evidence of the mortgagee substituting itself for the mortgagor in the control and management of the estate. It is essential that any such notice actually reaches the tenants. In the case cited above it did not and the mortgagee was held not to have taken possession. Normal precautions such as service by recorded delivery or registered post should suffice. Similarly, as a matter of common sense, the letter should state that the mortgagee is taking possession as mortgagee under the powers conferred by the mortgage deed.
Rights/powers
Having obtained the rental income the mortgagee in our example now wishes to sell the property and, in the meantime, conduct the mortgagor’s business. This includes, in particular, the management of the underleases, for example, lease renewals, rent reviews etc. Can it do so?
Surprisingly, perhaps, the extent to which any period for which a mortgagee can carry on the business of its mortgagor is difficult to state with precision. The accepted wisdom is that where the mortgagee of a business enters into possession it becomes the owner of the business and stands exactly, as regards its powers, in the place of the mortgagor: see Chaplin v Young (No 1) (1864) 33 Bear 330. It appears that it can do so for a “reasonable time so as to sell it [the business] as a going concern”: see Cooke v Thomas (1876) 24 WR 427. What constitutes a “reasonable time”, however, is not defined. Presumably it means such period as is reasonable for the mortgagee to find a purchaser willing to pay the true market value for the premises/business.
So far as the underleases are concerned the mortgagee in possession steps into the mortgagor’s shoes. Where, as in our example, underleases are binding on the mortgagee it becomes entitled to the benefits of those leases as if it had been a party to them: see Municipal Permanent Investment Building Society v Smith (1888) 22 QBD 70, CA. Our mortgagee, therefore, will be in a position to enforce covenants given to the mortgagor by its undertenants including covenants as to rent, repairs and rent reviews. Further, a mortgagee in possession is the proper respondent to any application made by the undertenants for new tenancies under the Landlord and Tenant Act 1954 Part II, and will have all the necessary powers under that Act to conduct the lease renewal proceedings: section 67, Landlord and Tenant 1954, Part II. Finally, a mortgagee has the statutory powers of leasing, set out in section 99 of the LPA 1925.
Liabilities/responsibilities
The extent of potential liabilities being adopted is crucial to any mortgagee contemplating going into possession. Fortunately this is one area where the law is clear and precise. Unfortunately for mortgagees, it is also particularly onerous.
Two points must be borne in mind: first, by taking possession a mortgagee becomes manager of property in which the beneficial interest is retained by the mortgagor; second, a mortgagee is not entitled to anything from the mortgaged property except payment of the debt secured by its security. For these reasons a mortgagee in possession is liable to account to the mortgagor on the basis of “wilful default”. That means it must account to the mortgagor not only for all the rents and profits which it actually receives while in possession but also for rents and profits which, but for its wilful default, it would have received. In practice this strict liability to account puts a mortgagee in possession in “. . . a dangerous and difficult position . . .”: Cooke v Thomas (1876) 24 WR 427.
In our example the mortgagee would be at risk on several fronts. If it failed to obtain the best rent possible from the underleases it would be liable for the difference between the rent actually obtained and the best rent possible: see Shepherd v Spanheath Ltd [8] EGCS 35. Similarly, if it failed to apply for an interim rent in the course of lease renewal proceedings it could be liable for the difference between the actual rental income received and that which could have been obtained. Being in possession of the headlease the mortgagee would be bound to act as a “provident owner” and take whatever steps were necessary to prevent the forfeiture of that lease by the freeholder including, if necessary, complying with repairing covenants: see Perry v Walker (1855) 3 EQ Rep 721. Further, if it failed to obtain the “true market value of the mortgaged property” on sale the mortgagee would be liable for the difference between that and the price actually obtained. Finally, a recent unwelcome addition to the potential liability of mortgagees in possession is contained in the Environmental Protection Act 1990 (“EPA”). Liability under that Act attaches to “owners”, “occupiers” or “persons with operation or control or responsibility” While arguable, it appears likely that mortgagees in possession will be considered both “owners” and “occupiers” under the EPA. That is something which all lenders must now bear in mind.
Practicalities
In practical terms, it would be impossible for a mortgagee to manage any large development itself. Agents would have to be appointed and they would require payment. Whether they would agree to act as agents for a mortgagee in possession for a lesser fee than they would demand as LPA receivers is doubtful. What seems certain is that the potential saving in costs (if any) could not be justified by the additional risks adopted.
Why are receivers different?
The essential difference between mortgagees in possession and LPA receivers is that while the mortgagee acts on its own behalf the LPA receiver, although appointed by the mortgagee, acts as agent for the mortgagor: section 109, Law of Property Act 1925. Appointing an LPA receiver, therefore, has the advantage for a mortgagee of removing the property from the mortgagor’s control without adopting the liabilities discussed above. One exception to this is where the mortgagor goes into liquidation in which case the LPA receiver can no longer act as its agent and will need to be appointed agent of the mortgagee.
Powers of the LPA receiver
An LPA receiver’s powers are conferred by section 109(3) of the Law of Property Act 1925. Those powers are to demand and recover all the income, whether by action, distraint or otherwise, of the mortgagor’s estate or interest. In practice, LPA receivers will be given additional powers by the mortgage deed. In particular they will normally be given the power to manage the mortgagor’s business, grant leases and to sell the mortgaged property. It is essential that the instrument of appointment makes it clear that the LPA receiver is being granted not only the powers under the Act but also the additional powers specified in the mortgage deed. The LPA receiver will then have full power to deal with the mortgaged property in any way necessary
Indemnifying the receiver
Mortgagees might legitimately ask whether the indemnity which an LPA receiver will require does not mean they are still taking on the liabilities discussed above albeit by the back door.
What LPA receivers require is an indemnity against any personal liability. Such liability will normally be limited to that incurred as a result of some defect in the mortgage deed or in the appointment of the receiver or to liabilities for acts carried out by the receiver outside the authority granted to him by the mortgage deed or appointment.
Further, such indemnities are normally limited by excluding any liability incurred by the receiver owing to any failure on his part to act with due care and diligence. LPA receivers will not incur personal liability for acts carried out during the normal day-to-day mangement of the mortgaged property.
Mortgagees should not equate the indemnity which they will be required to give an LPA receiver with the liabilities which they will take on if they go into possession as mortgagees.
Conclusion
Mortgagees are obviously concerned to obtain the maximum income from their securities. The possibility of avoiding payment of a large receivership fee might tempt them to take the plunge and go into possession as mortgagees. Any mortgagees considering that option should appreciate, however, that they may be getting into very hot water indeed!