Challenge to a Mortgage by the Beneficial Owner of the Property

Mortgagees will recall that overriding interests, including the rights of anyone in actual occupation (and prior to 13 October 2003, anyone in receipt of rents or profits) of the land, may take priority over a mortgage, notwithstanding that such interests are by their nature not registrable. Mortgagees may also be aware that it is usual to deal with two registered owners of the legal title to land in cases of split legal and beneficial interest, so that the payment of the mortgage advance made to both the legal title owners would overreach any beneficial interests that others might have in the property.

In the recent case of Credit & Mercantile plc v Kaymuu Ltd and others [2014] All ER (D) 49 (Jun), the legal owner of the property had borrowed money and granted a mortgage over the property to the lender. Unbeknown to the lender, the legal owner was not the beneficial owner of the property and the loan had been obtained without the knowledge of the beneficial owner, who was in occupation of the property. Following default on the loan, the lender repossessed and sold the property.

Could the Beneficial Owner assert his rights in priority to the Lender’s Mortgage?

This case is unusual in that the beneficial owner’s interests were defeated by application of the principles of agency. Generally, acts of an agent are binding if the agent had actual or ostensible authority.

As the beneficial owner had not had any involvement in the mechanics of the purchase of the property, the court held that he had given the legal owner the means of representing himself as the beneficial owner of the property, with full authority to deal with third parties as owner. Any limit which the beneficial owner might or might not have imposed on his agent's dealing could not be enforced against an innocent purchaser or mortgagee from the agent, who had no notice of the limitation. The court took the view that the beneficial owner should have brought his interest to the attention of the lender, if he had wished to establish the priority of his beneficial interest to the lender’s subsequent mortgage.

Prior to lending, and nearly a month prior to execution of the mortgage deed, the lender had the property valued but it was noted by the court that the report was ‘not meticulous’; its purpose had been to confirm that the property was sufficient security, the loan amount being for half of the recent purchase price. The inspection occurred only days after the purchase of the property was completed and the beneficial owner had just started the process of moving in. The surveyor reported the property was vacant and the lender also received answers to enquiries confirming this (based on misleading instructions from the legal owner to its solicitor). If the lender had been made aware of the occupancy at this stage then further enquiries could have been made by the lender as to any rights of those in occupation of the property prior to advancing the loan.

The court noted that the beneficial owner’s occupation of the property would have been obvious on a reasonably careful inspection of the property on the date the mortgage deed was executed and therefore, if it were not for the court’s findings on the unusual agency point, the beneficial owner’s equitable interest might have overridden the mortgage despite the registration of the mortgage.

As such, this case serves as a useful reminder that inspections should include an appropriate challenge to any signs of occupancy. Where unanticipated signs of occupancy are revealed, lenders should ensure that a waiver is obtained from any occupant and/or consider the appointment of a second trustee to hold the legal title to seek to protect their position as mortgagee.

It is also interesting to note how the principles of agency can be applied in certain situations where a lender is not aware that the legal owner is not the beneficial owner at the time a mortgage is granted.