Unregistered Second Mortgages in NSW – To be avoided?
Non-bank lenders sometimes secure their loans via an unregistered second mortgage over real property, supported by caveat. In the event of a default, these mortgages are more difficult to enforce via a court action, as compared to a registered mortgage. Our view is that an unregistered mortgage should rarely be accepted by a lender as principal form of security.
The problem of prior registered mortgages
Incoming second mortgagees seeking registration of a mortgage must deal with any prior registered mortgagee. This is because the prior mortgage almost always has a condition requiring the first mortgagee’s consent to latter mortgages. Also, the security property’s certificate of title needs to be produced for registration. An existing first mortgagee would therefore ideally be approached by a proposed second mortgagee to seek that first mortgagee’s consent. A condition of that consent will normally include a requirement for a Deed of Priority to be entered into. This usually causes additional costs to be incurred by the mortgagor for both mortgagee’s fees and expenses in negotiating and entering into that deed and for their own legal expenses. That process can also delay the loan finalisation. It follows that there is some disincentive to registering a second mortgage.
If a second mortgage is entered into without the consent of the first mortgagee however, the entry into the second mortgage will usually be a breach of the first mortgage’s terms. That breach may trigger the charging of higher interest rates under the first mortgage and create a risk of it being enforced. Whilst those outcomes may not affect the validity of the second mortgage, they could erode its value to that lender.
The enforcement of an unregistered mortgage can be complex and costly.
Unregistered NSW mortgages are enforced by seeking orders in the NSW Supreme Court Equity division for:
- Judicial sale and possession of the property (the latter being by way of seeking specific performance of an express contractual right, which hopefully is set out in the mortgage); or,
- The appointment of a receiver.
A useful thorough judicial review of the enforcement process is found in King Investment Solutions v Hussain, a 2005 NSW Supreme Court case.
This process differs quite markedly from how registered mortgages are enforced. They are normally enforced via a claim brought in the Possession List in the Common Law division of the Supreme Court of NSW. This is a well-trodden path and can be quite expeditious if the mortgagor does not oppose the process.
Important points to note when enforcing an unregistered mortgage seeking possession and a judicial sale are
- You must join all parties affected by the application as defendants, including any first mortgagee
- Comprehensive drafting of the various orders required will need to be sought – see the King case above for guidance;
- Section 57(2)(b) Real Property Act or section 111 Conveyancing Act notices are not required, as no statutory power of sale is being exercised;
- Evidence must be lead of a recent valuation of the mortgaged property;
- Evidence must be lead as to the amount of any first mortgagee’s secured debt. This evidence and the valuation will inform the Court as to the likely equity remaining in the property;
- The occupiers of the land/property must be ascertained and probably should be given a notice under UCPR Pt 8 rule 6.8;
- Any first mortgagee’s costs in taking legal advice on its position and appearing as a defendant, will probably be ordered to be paid by the second mortgagee;
- Consideration will be given by the court as to whether the costs of the proceeding and of any first mortgagee’s costs can be added to the second mortgage debt on an indemnity basis, or be reduced to party/party costs;
- The registered mortgagor may be given conduct of the sale if there is substantial equity left in the property;
- The mortgagor may be given time to redeem the mortgage;
- The court may fix a reserve price for the sale;
- Any first registered mortgagee may appear and oppose the orders on the basis that it will take possession under its statutory right. Early negotiation about that issue should therefore occur to try to prevent such a dispute. Sometimes the commencement of proceedings by the unregistered second mortgagee will trigger enforcement action by a first registered mortgagee.
Some lenders in a rising property market may be prepared to take a punt on the value of the property continuing to secure their loan(s) and short term lenders may want to avoid the additional cost and inconvenience of obtaining registration of their mortgage. The consequences of failing to register a second mortgage can be significant. Lenders should err on the side of caution.
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