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Broken promises? Sale and rent back is no answer to a mortgage

This article was first published in New Law Journal (http://www.newlawjournal.co.uk), “Broken promises?”, NLJ 27 April 2012, p 563.

Owner occupiers unable to afford their mortgages have sometimes entered into sale and rent back arrangements (“SRBs”). Under a SRB, the house is sold, often at a discount, but the vendor remains in occupation under a lease granted by the purchaser. According to a 2008 OFT study, even though SRBs were a relatively new phenomenon there had been about 50,000 of them. At that time the SRB market was unregulated. The FSA began to regulate it in 2009. According to a recent FSA press release, “the entire SRB market is temporarily shut”. Nevertheless, it is apparent that many tens of thousands of SRBs must have taken place by now.

It appears that in some, perhaps many, SRB transactions the vendors have been given the impression that they will be able to remain in their homes indefinitely but are only granted short term assured shorthold tenancies. Often where the SRB purchase is mortgage-funded the bank is not told that the vendor is to remain in occupation.

You may be able to see where this leads. Further down the line, the purchaser defaults on the mortgage and the bank seeks possession believing that the property is occupied by someone who moved in after the purchase under a short AST permitted under the mortgage. The bank is met, however, with an occupier, previously the owner, who claims to have entered into a SRB having been promised that they could stay in the property for life. The occupier claims an interest under a proprietary estoppel or constructive trust arising out of the promise he alleges and asserts it as an overriding interest against the bank.

In such circumstances, who has priority, the occupier or the bank? Can the bank assert the primacy of its charge and obtain possession? Or can the occupier rely on the fact that he was in occupation when the mortgage was granted to fix the bank with any interest that may arise from promises made to him by the purchaser. That is the main question that the Court of Appeal addressed in four test cases known as Cook v The Mortgage Business plc and other cases [2012] EWCA Civ 17.

The cases started out in county courts around the north east where a firm named North East Property Buyers (“NEPB”) had been active in the SRB market. Mortgages ceased being paid by NEPB or its nominees leading to possession proceedings which were defended, not by the mortgagors but by occupiers raising defences along the lines described above. Some 90 odd NEPB cases were case managed together and 9 selected as test cases. The rest were stayed.

The test cases were transferred to the High Court and preliminary issues in them heard by His Honour Judge Behrens in autumn 2010. HHJ Behrens decided in favour of the lenders; his decision is cited as [2010] EWHC 2991 (Ch). He also held that his conclusions on the preliminary issues meant that the occupiers had no rights that they could assert against the banks, which were entitled to possession orders.

The occupiers in the test cases all appealed to the Court of Appeal. It is thought that hundreds of similar cases up and down the country have been stayed awaiting the outcome of the appeal. The appeal was heard shortly before Christmas by a Court comprising Lord Neuberger MR, Etherton and Rix LJJ. By then five of the test cases had been settled or stayed. While expressing sympathy for the occupiers, the Court of Appeal dismissed the appeals, affirmed HHJ Behrens’ answers to the preliminary issues before him and held that he was right to make possession orders. In the course of the judgment a point of more general application to residential and commercial conveyancing was also dealt with.

Overriding interests?

There were three preliminary issues before HHJ Behrens but his conclusions on only two of them were appealed. In essence, the issues were:

  • whether any of the equitable interests claimed by the occupiers were capable of overriding the banks’ registered charges under s. 29 of and Sch. 3 to the Land Registration Act 2002;
  • where the occupiers had been granted leases which were too short to be substantially registrable (i.e. for less than 7 years) but were longer than was permitted under the purchasers’ mortgages, whether those leases obtained priority over the charges under s. 29(4) of the 2002 Act; if so whether it made a difference if the lenders had taken out priority searches.

On the first issue, the banks argued that it followed from the House of Lords decision in Abbey National BS v Cann [1991] 1 AC 56 that any equitable interests that the occupiers might have could not override the banks’ charges. It may be recalled that in Cann the mother of someone purchasing a property with the aid of a mortgage claimed to have an interest in it by proprietary estoppel or trust that overrode the mortgage because she was (she claimed) in occupation of the property by the time of completion. The House of Lords rejected that argument. It was held that where a property was purchased with the aid of a mortgage there was no moment in time in which the purchaser held the property free of the mortgage and was able to grant an interest which had priority to that of the lender. In effect, the purchaser only ever acquired an equity of redemption in the property.

A SRB case in Birmingham County Court, Redstone Mortgages plc v Welch [2009] 3 EGLR 71, attracted notice because the Judge held that by a novel application of the Cann case, the occupiers could get priority – he held that the lender could only charge a freehold that was already subject to the occupiers’ estoppel or equitable interest. HHJ Behrens declined to follow that decision and the Court of Appeal held that he was right to do so. Abbey National v Cann could not be distinguished and led to the conclusion that the lenders were unaffected by any proprietary estoppel or trust interest that might arise against the SRB purchasers. The SRB occupiers were in no worse position than the mother in Cann. The contracts of sale in the test cases made no mention of the promises claimed to give rise to estoppels or equities. Since they did not, it would not be appropriate to expect lenders to have made enquiries of the vendors to discover if they planned to retain any interest in the properties after their sale.

An alternative argument had been advanced by the occupiers that their equitable interests arose on exchange of contracts and so preceded the mortgagee’s interest arising on completion of its charge. This was rejected. Etherton LJ, giving the main judgment, thought that the SRBs consisted of two separate transactions – a sale and a leaseback on completion. Absent any reference in the contracts of sale to the rights claimed, no relevant interests in favour of the vendors could have arisen prior to completion. In any event, the Court concluded, Nationwide v Ahmed [1995] 70 P & CR 381 was binding authority against the occupiers on this point where, as in all the test cases, exchange of contracts and completion took place on the same day. Where the contract is made and completed at broadly the same time as the mortgage is executed, it is too technical to separate out the contract from the transfer and mortgage as distinct transactions.

So, unless the case goes higher (which it may yet do), the position ought now to be clear in most lender’s possession claims being resisted on the grounds of promises made during an SRB. Promises or representations made by a purchaser may give the former vendor, now occupier, rights as against the purchaser, but those rights do not bind the bank whose mortgage funded the purchase.

Short leases and the registration gap

Section 29(4) of the LRA 2002 provides, in effect, that where a lease is granted which is not a registrable disposition (i.e. is for less than 7 years), it is treated for priorities purposes as if the lease were registrable and was registered on the date of grant. So it has priority to any interests that would be postponed to it on registration were it for 7 years or longer but is subject to any interests that would have priority over it if it were a registered 7 year plus lease.

The mortgage terms in these cases permitted letting but only by ASTs for terms of up to a year. In some of the test cases tenancies for two years or more were granted to the former owners, during the registration gap between completion of the purchases/ mortgages and their registration. It was argued that the effect of s. 29(4) was to make the tenancies binding on the banks because they were deemed registered before the bank’s charges were registered. This submission failed before the Court of Appeal, as it had in the High Court. It was held that s. 29(4) only applies to legal leases. Any leases granted to the occupiers during the registration gap could only take effect in equity until registration of the purchase: only on registration does the legal estate pass to the purchaser so that a lease he grants can take effect as a legal lease.  By the time that the tenancies became legal leases and were deemed as if registered by s. 29(4), the mortgages, which were registered with the purchases, were also registered.

Short leases and priority searches

The Court of Appeal also considered the effects of priority searches taken out by the lenders, which were still in force when the leases in question were granted. It was held that the priority searches would have prevented the leases obtaining priority over the mortgages if they otherwise could have. This, so far as the writer knows, is the first occasion on which the Court of Appeal has considered the operation of priority searches on short leases. It is now clear that if a vendor grants a short lease to a third party after completing a sale but before the new owner is registered, a purchaser or lender with the benefit of a priority search obtains priority over the lease under s. 72 of the LRA 2002, just as it would over a registrable lease entered into during that period.  Short leases granted before the execution of a charge or transfer override it despite any priority search (Land Registration Act 2002, s. 29 and Sch. 3).  But short leases granted during the registration gap come too late to be overriding interests; their priority is postponed by s. 72 to the interest protected by the priority search.

Author: Daniel Gatty