Mortgage lenders’ duty to sell a repossessed property at the best price available is owed not only to the borrower but also to the guarantor
|
Key points |
|
● In principle, a lender that sells mortgaged property owes a duty to a guarantor as well as to the borrower ● However, the wording of the guarantee may alter this position |
When a mortgage borrower defaults on the repayment of the loan, the lender can recoup some or all of what is outstanding in a number of ways. The most valuable of these is the right to repossess and sell the mortgaged property. In that event, the lender is entitled to as much of the proceeds of sale as cover the debt, following which the balance is returned to the borrower. However, if the proceeds are not sufficient to cover the entire debt, the borrower remains liable for the balance.
It follows that when the lender sells the mortgaged property, it is in the borrower’s interest that the sale achieves the best possible price. This interest is recognised and protected by law, in that a lender that sells is under a legal obligation to the borrower to obtain a proper price for the property.
This duty, however, has its limits, which are long-established and well known: the lender is free to choose whether to sell at all (it may choose, for example, to rely instead upon some other remedy) and when to sell (it is not obliged to wait for favourable market conditions). All that is required is that, when it sells, it must, together with its professional advisers (such as agents, auctioneers, valuers or surveyors), take reasonable care to obtain the best price available at that time. Failure to do so will render the lender liable to the borrower for the shortfall.
Position of guarantors
A party that has entered into an agreement with the lender, under which it guarantees the borrower’s liabilities, would appear to be in a very similar position to the borrower if and when the lender exercises a power of sale. This is for two reasons. First, if the guarantor pays the amount owing, it will become entitled to the security by being subrogated to the lender’s rights. Second, if the lender sells the property, the guarantor’s ultimate liability will be affected by the amount realised. None the less, and despite this similarity, it was held in Barclays Bank Ltd v Thienel (1978) 247 EG 385 that the lender’s duty is owed to the borrower alone, and cannot extend to the guarantor. In later cases, however, the Court of Appeal has expressed its disapproval of that decision, although thus far without overruling it.
The position of a guarantor was recently questioned in the High Court in Barclays Bank plc v Kingston [2006] EWHC 533 (QB); [2006] 1 All ER (Comm) 519. That case concerned a loan of some £627,000 by the claimant bank to Kingstonian Football Club. The loan was secured on the club’s ground and was also guaranteed by the defendants, who were directors of the club, up to £100,000.
Football ground
In 2001, the club, which was in serious financial difficulties, went into administration and, in 2002, the administrators sold the ground. The bank received the proceeds in partial satisfaction of the amount owing and sued the directors for £100,000 on their guarantee. The directors contended that the bank had caused or permitted the ground to be sold at an undervalue and that, had this not occurred, the bank would not have had to call on the guarantee.
The bank’s response to this defence was that, even if it were correct, the terms of the guarantee agreement meant that the defendants were liable in any event. This argument came before Burnton J as a preliminary issue, in which it was to be assumed (without any evidence to that effect) that the bank was responsible for the sale at an undervalue and that a proper price would have covered the full amount guaranteed.
Having ruled that, in principle, the bank would owe a duty of care to the defendants when exercising its power of sale, the judge considered whether the terms of the guarantee operated to exclude or restrict this duty. The crucial provision was clause 5.3, which stated that from time to time the bank might do any or all of a wide range of things. These included: providing the borrower with further credit; cancelling or refusing credit; allowing the borrower further time for repayment; making other arrangements with the borrower; taking or dealing with other securities for the loan; and releasing, enforcing or not enforcing rights under any such security agreement. The clause concluded:
If we carry out any of the above acts, or do or fail to do anything else, this will not affect our rights under the guarantee, even if it would have done so if this condition did not exist.
The bank argued that this clause entitled it to enforce its guarantee in full, regardless of whether it had caused the property to be sold at an undervalue. The judge, however, disagreed, taking the view that even if the bank could be said to have engaged in “acts” that fell within clause 5.3, this was not the point:
The defendants complain, not that the bank caused the property to be sold, but that it caused it to be sold at an undervalue.
The concluding words of this clause were therefore insufficient to permit the bank to enforce the guarantee.
Lingering questions
The question that remains is whether a differently worded clause might have that effect. It would seem that, were a lender to insert a term in a guarantee stating explicitly “You will be liable in full on this guarantee, even if we are responsible for causing or permitting the mortgaged property to be sold for less than its true value”, the guarantor would probably have no defence to a claim on the guarantee and would have to pay.
As to whether lenders would be this brazen, however, or whether guarantors would be prepared to sign up to such an arrangement, only time will tell.
John Murdoch, professor of law, Reading University
