Court rulings can save the day for lenders
In the two recent decisions of Menelaou v Bank of Cyprus UK Limited  EWCA Civ 1960, and Bank of Scotland PLC v Joseph and others  EWCA Civ 28 the Court of Appeal has recognised the lenders rights of subrogation in strikingly unusual circumstances.
Subrogation in the legal process by which one party assumes the legal rights that belong (or used to belong) to another, effectively it allows a lender to step into the shoes of a third party and exercise the rights of that party.
Rosling King Partner Rebecca Sharpe explains: “When taking steps to repossess and sell their security, lenders often face an allegation by the borrower and owner of the security property that their signature on the mortgage deed has been forged. A genuine forgery can mean that the security is void and the lender is left with an unsecured debt.
“However, in cases where there has been a fraud, there may still be light at the end of the tunnel for the lender through the principle of subrogation. In addition to general subrogation, there are other rights besides a charge that a lender can be subrogated to and this was highlighted in the Menelaou decision.
“The seller of a house retains a right to remain in possession of the house until the buyer has paid over the purchase price; this is called the ‘unpaid vendor’s lien’. Where a third party pays the purchase price to the seller, thereby satisfying the buyer’s contractual duties, the third party can be subrogated to the unpaid vendor’s right to remain in possession of the property until payment of the purchase price; that is, the third party is subrogated to the unpaid vendor’s lien.
“Subrogation to a vendor’s lien can therefore be a useful tool for a lender who will often advance funds to a borrower which are then used to purchase a property; the intention being that the loan will be secured over the property. But in circumstances where the borrower subsequently fails to execute a charge over that property, the lender will have an unsecured debt. In this case, the lender may be able to make use of the unpaid vendor’s lien to effectively exercise a proprietary right over the security.
“In the normal case of subrogation to the unpaid vendor’s lien, the lender has advanced the monies which are then used to purchase the property but fails to receive the security promised. However, in the case of Menelaou v Bank of Cyprus, the Court of Appeal upheld the lender’s right to be subrogated to the unpaid vendor’s lien even though it had advanced no money at all.”
Menelaou v Bank of Cyprus
Mr and Mrs Menelaou sold their family home, Rush Green Hall, in 2008 which had been mortgaged to the Bank of Cyprus to the tune of £2.2m.
Mr and Mrs Menelaou came to an arrangement with the Bank whereby it would agree to release its charge over Rush Green Hall and in return, they would repay £750,000 to the Bank and execute a charge over their new home, Great Oak Court, for the remaining debt. The intention was that Great Oak Court would be purchased in the name of Melissa, the Menelaous second oldest child, and so the new charge in favour of the Bank over Great Oak Court was to be executed by her as the legal owner. Consequently, the Bank released its charges over Rush Green Hall as it believed that a new charge had been executed by Melissa over Great Oak Court.
In 2010, the Menelaous began to experience financial difficulties and decided to sell Great Oak Court. They were reminded by the conveyancers of the charge that Melissa had executed over the Property securing their debt to the Bank.
Melissa (who believed Great Oak Court was bought as a gift for her) brought proceedings seeking to remove the Bank’s charge from the register, claiming she had never signed the charge and her signature had been forged. This account was supported by the evidence of her brother, who it seemed had signed it on her behalf. The Court accepted that Melissa had not, in fact, signed the charge deed and therefore the charge in favour of the Bank was held to be void.
The Bank was left with an unsecured debt. However, it then argued that because Melissa had been unfairly enriched, it should be subrogated to the unpaid vendor’s lien in respect of Great Oak Court, which would give them a proprietary right against which it could enforce the debt owing.
In order to be subrogated to the unpaid vendor’s lien, a lender must have provided the funds used to purchase the property. Although the Bank did not provide funds per se, it had agreed to release its charge over Rush Green Hall which allowed Mr and Mrs Menelaou to use the proceeds of sale from that property to purchase Great Oak Court. It was the Bank’s agreement to this course of action which meant that the Menelaous had the funds to purchase Great Oak Court in the first place.
The Court of Appeal held that it was the Bank’s decision to release the original charge over Rush Green Hall which made it financially possible for the purchase of Great Oak Court to proceed. The Bank was therefore entitled to be subrogated to the unpaid vendor’s lien even though it had never provided the purchase price by advancing funds in the traditional sense.
Bank of Scotland PLC v Joseph and others
In this case, a developer (the ‘Developer’) had granted a lease of a flat (the ‘Flat’) to a Mr Samad. On the same day, Mr Samad assigned the lease to Ms Joseph. Ms Joseph took a loan from the Bank of Scotland (‘BoS’) in order to purchase the lease from Mr Samad. There were delays in registering Ms Joseph as the proprietor and therefore delays in registering the BoS charge over the Flat. BoS registered a Unilateral Notice over the Flat in the meantime to afford it some protection. However, Mr Samad had been registered as the proprietor of the Flat in the interim and had placed a legal charge in favour of another lender, W, on the Flat before Ms Joseph could be registered as proprietor and therefore before BoS could register its charge. Subsequently, Ms Joseph was able to be registered as proprietor and BoS’ charge was duly placed on the Flat but it was now ranked behind W’s charge in priority.
Sometime later, W obtained possession of the Flat and sold it to Mr Lyons (a director of W) without BoS’ charge being removed from the title. There was evidence in the case that the charge in favour of BoS was invalid on account of forgery and W therefore argued that it had repossessed the Flat free of BoS’ charge, which was invalid.
Faced with an unsecured debt, BoS sought to be subrogated to the Developer’s unpaid vendor’s lien since it had effectively provided the monies used to purchase the Flat from the Developer. W accepted the application of this principle but argued that BoS’ subrogated rights must rank behind W’s legal charge.
The Court of Appeal confirmed that the Unilateral Notice was effective to preserve BoS’ rights in priority to W’s charge and that it was irrelevant that the Unilateral Notice did not specifically refer to the subrogated unpaid vendor’s lien as the right relied on.
The decisions in Menelaou v Bank of Cyprus and Bank of Scotland v Joseph and others are great news for lenders facing unsecured debts in circumstances where a charge is held void for fraud. Menelaou demonstrates that with some inventiveness on the part of a Bank’s legal advisors, subrogation can often provide an effective remedy when at first glance it appears all is lost for the Bank. The Court of Appeal has reaffirmed the importance of the economic reality in deciding the lender’s rights and an equitable claim will not be defeated simply because the lender has provided value by releasing a security rather than paying actual funds across.
Bank of Scotland confirms that a lender’s claim to the unpaid vendor’s lien will not rank behind another lender’s legal charge if it has registered a Unilateral Notice to protect its position. A lender may place a Unilateral Notice on the title when faced with delays registering its charge. Even though the lender may have no reason to suspect at that time that the charge it will eventually place could later be void for fraud, the Unilateral Notice will still protect its subrogation rights even though these may not be specified in the Notice itself.
Of course the aim of a lender should always be to perfect its security at the outset in order to avoid sometimes costly litigation, however where this has not been possible, lenders can take comfort in the possibility that they may be able to seek the equitable remedy of subrogation in order to establish some proprietary interest in the seemingly lost security.