A mildly important little decision came out recently that at first blush might appear important only to bankers and the solicitors who write their precedents, but it does have some general application.
ASB Bank Limited v South Canterbury Finance, case CA553/2010 involves some landowners that got into financial trouble….not exactly an unusual sight over the last four years.
Their land was mortgaged to both ASB and South Canterbury, who had, as first and subsequent mortgagees usually do, signed up a Deed of Priority, which governed what each would get in the event of a mortgagee sale.
The Deed of Priority was in the commonly used NZ Bankers Association forms. Not every bank uses them – some have their own form – but plenty do.
Problem was, the land wasn’t mortgagee sold. The owners sold it before the banks could – usually a desirable thing as addition of the words “mortgagee sale” tends to immediately depress the obtainable price.
So, all good, right? Well no. South Canterbury refused to release their mortgage unless they got a bigger chunk of the pie. Turns out that the NZBA form only covers what happens when there is a forced sale….not a voluntary sale. With a “normal” sale by the landowner, any mortgagee can refuse to release their mortgage unless they get repaid in full.
Now, this type of mexican standoff by a mortgagee demanding all its money when there quite obviously isn’t much left over for them can be quite counterproductive…the time delay can result in additional costs and interest of the first mortgagee swallowing up what the second mortgagee might have been able to obtain if it had allowed the sale to proceed, so the second mortgagee loses out entirely.
However, if the second mortgagee was going to get nothing anyway, or so little that it feels it has nothing much to lose, then the tactic of refusing consent can result in a bit of a windfall. The usual response by the first mortgagee is to turn the sale from a private one into a mortgagee sale by the bank. However this generally takes some time, and in that time purchasers can get frustrated and cancel. Alternately, the double whammy of penalty interest against the vendor for failing to settle (because this usually all comes to a head just before settlement) PLUS the first mortgagee’s legal costs and penalty interest, can really start to eat into the proceeds of sale and mean the first mortgagee is starting to take a real loss as opposed to actually getting all it is owed.
The easiest path can then be to give the second mortgagee something.
Personally, I would argue that a first mortgagee should act instantly to convert the mortgagor sale to a mortgagee sale and cut the second mortgagee out of the equation, but there are some risks in doing so given that you have an aggressive second mortgagee who might challenge any sale that hasn’t properly “tested” the market (which is why so many mortgagee sales are (in my opinion quite unnecessarily) by auction). It’s not that they actually want to challenge, they just threaten to do so to let the first mortgagee know that actually concluding a sale will be long and drawn out while all the time the first mortgagee is losing money in terms of fees and interest. So is the second mortgagee…but they weren’t going to get anything anyway, so they’re not losing any more sleep over it than they were already.
Such is the Machiavellian world of negotiation when you’re a marginalised second mortgagee. So why would this matter to the layperson? Well, unless you’re expecting to enjoy the wonders of bankruptcy no matter what, this fight is going to add significantly to the amount you end up owing the second mortgagee, and maybe the first. If you can ultimately pay it back, the banks are merely fighting about who gets paid first and how much, and it’s all, one hundred percent, coming straight out of your pocket.
I would imagine there is a bit of redrafting going on now so as to ensure the NZBA deed of priority covers any form of sale of a property to which a deed of priority applies. Clients using two lenders would be well advised to ensure the form the lenders use does cover both situations so as to avoid becoming the meat in the middle of the bankers’ dispute sandwich.