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Secured debts and shortfall issues

» Introduction

» Commercial decisions and legal rights

» How have the courts dealt with it?

» Conclusion

 

Introduction

In recent times, our Financial Difficulty Team has frequently confronted circumstances in which customers have rationalised their financial position, or wish to do so, by selling assets which are held as security by their FSP. However, the proceeds of the sale have, or would be, insufficient to meet the customer’s outstanding debt, and the FSP has refused to release its security without payment of the debt in full.

 

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Commercial decisions and legal rights

An FSP’s decision to release its security is generally a commercial decision and one which we generally do not have the power to review.

It should however be remembered that, pursuant to clause 5.1(c)(ii) of the our current Terms of Reference, we are able to review an FSP’s decision regarding the credit risk of a customer relating to a request for a variation of a contract regulated by the UCCC or to be regulated under the NCC.

Further, we can review disputes claiming maladministration in 

 

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lending, loan management or security matters.

In investigating a dispute, we will consider what is fair in all the circumstances, having regard to our dispute resolution criteria set out in the Terms of Reference, including reference to legal principles. Therefore, in considering whether the FSP is entitled to refuse to discharge its security, we will consider whether it would be fair in all the circumstances for a customer’s sale to proceed, even if their liability to the FSP is not satisfied. In doing so, we will, among other criteria, have regard to applicable legal principles. 

 
How have the courts dealt with it?

In considering an FSP’s legal entitlement to prevent a sale at a shortfall, we will take into account the circumstances in which a court may exercise its inherent jurisdiction to order a sale of secured property.

Legislation pertaining to property law in each state and territory, such as section 103 of the Real Property Act 1900 (NSW), gives the court inherent power to order a sale of secured property in circumstances where the interests of a mortgagee may be affected. The court’s power has recently been considered by White J of the New South Wales Supreme Court in New Beach Apartments Pty Ltd v Epic Hotels Pty Ltd and 12 Ors [2007] NSWSC 47 and Spendright v Classfoot [2009] NSWSC 317.

White J acknowledged that there would need to be special or exceptional circumstances warranting the court’s exercise of its inherent power of sale. However, from the circumstances of the cases before His Honour and those he referred to in his judgments, it appears that a court would exercise its power to order a sale at the request of a mortgagor, and in the face of objection by the mortgagee, where the mortgagee’s refusal:

(a) is not founded on any reasonable benefit or preservation of rights accruing to it, the mortgagor or other parties interested in the property; or

(b) is based on speculation about better sales results obtainable in the future without regard to the mortgagor’s liabilities in the interim.

Therefore, in considering a dispute about an FSP’s refusal to consent to a sale of secured property at a shortfall, we will

 

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consider the reasons given by the FSP for its refusal and whether any alternative course of action could result in a better outcome for them without undue detriment to the customer. Having regard to our decision making criteria including the law and fairness in all the circumstances, we may conclude that a bona fide, arms length sale by the customer should be allowed to proceed even though it may result in a shortfall arising from the receipt of sale proceeds without any commensurate security.

Should a sale result in a shortfall in repayment of a customer's debt, we would expect the FSP to work with the customer to reach an arrangement for repayment of any unsecured residual. In the event that there is a residual security, but the FSP believes it is, or would be, inadequate to secure the residual debt, having regard to their policy regarding required loan to value ratios, we might consider it appropriate for the FSP to discharge its security over the sold property subject to reasonable conditions regarding the residual security. For example, the FSP may require any remaining secured property to be placed on the market and sold within a reasonable sales period, or may require alternative security to be provided within a reasonable time frame. In the event of the customer failing to meet reasonable condition/s, it might be appropriate for any remaining property to be surrendered to the FSP.

Our comments below about lenders’ mortgage insurance (LMI) may also be pertinent to our consideration of whether an FSP has adequately tried to assist their customer in financial difficulty when a sale of a security may lead, or has resulted in, insufficient monies being available to satisfy the customer’s liability or inadequate security remaining to secure any residual debt.

 
Conclusion

Where an FSP’s refusal to consent to the disposal of a security does not reasonably protect its interest as mortgagee and has no realistic prospect of benefitting the customer, we may, with reference to the applicable legal principles, consider it fair in all the circumstances that the customer be entitled to complete their sale provided the net proceeds are paid to the FSP in full. This result may occur even if an FSP would be left with an unsecured shortfall or a residual loan to value ratio on the remaining debt and security exceeding its usually accepted exposure.

 

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