Who will win in a priority dispute between a secured creditor and a judgment creditor?

The Supreme Court of Queensland recently had to decide a priority dispute between a secured creditor and a judgment creditor (see Brava Trading Pte Ltd v Leybourne Nominees Pty Ltd & Anor [2012] QSC 328, a decision by Philippides J).

The plaintiff, (“Brava Trading”) held a registered mortgage debenture provided by the second defendant, (“Brava Marine”), now in liquidation. The first defendant, ("Leybourne") obtained default judgment against Brava Marine for outstanding rent in the sum of $66,366.69. 

Leybourne issued an enforcement warrant directed to the National Australia Bank (NAB). On 20 July 2009, the NAB debited the sum of $67,321.53 from the trading account of Brava Marine, and drew a cheque in favour of Leybourne.

Subsequently, Brava Marine applied to set aside the default judgment obtained by Leybourne. It was given leave to defend and the sum of $67,321.53 from the NAB was ordered to be retained in Leybourne's solicitors' trust account. 

Subsequently again a receiver was appointed over the assets of Brava Marine pursuant to the Charge, and then Brava Marine was wound up and liquidators appointed.

Leybourne was granted leave to proceed against Brava Marine in the District Court proceeding and it obtained another judgment against Brava Marine.

Issues

The issues for determination were:

1. Whether, by reason of the crystallisation of the registered charge, Brava Treading was entitled to the moneys deposited into the trust account in priority to Leybourne? That raised the issue of whether there was an event of default and, if so, what effect the crystallised security interest had? 

2. Did the enforcement warrant create a security interest, which gave Leybourne priority to the fund?  

3. Were any rights Brava Trading had as chargee over Brava Marine lost upon the completion of the process of execution against the NAB? 

The court concluded that:

1. The issue of a winding up application on 20 July 2009 was an event of default crystallising the Charge (based upon the terms of the Charge document); and more importantly, 

2. Leybourne did not acquire any interest in or entitlement to the trust moneys prior to crystallisation of the Charge on 20 July 2009.

Relying on old authorities, the court concluded: If prior to the crystallizing of the floating charge a judgment creditor receives judgment from the garnishee, then the mere existence of the floating charge is not sufficient to give the mortgagee a right to the debt. The debt must be an actual security under the charge by its crystallization before payment to the judgment creditor. 

The court concluded that when the Charge crystallised, Brava Marine became a trustee of the moneys for Brava Trading. The subsequent payment of the moneys into the solicitors’ trust account to give effect to the order did not derogate from Brava Trading’s then existing entitlement pursuant to the crystallised Charge. After the making of the order, the funds paid into the solicitors’ trust account remained subject to any pre-existing beneficial interest of Brava Trading arising from the crystallisation of its Charge which rendered Brava Marine a trustee of the debt. The payment of the moneys into the solicitors’ trust account, albeit that it was made pursuant to a court order, did not alter the entitlement that Brava Trading already had to the moneys.

Conclusion

A judgment does not give a creditor any security in priority to a secured creditor, provided that secured creditor's security has crystallized. 

It is therefore important to ensure that any charge relied on as a security includes very broad 'events of default'. That way the charge will crystallize before judgment is obtained by an unsecured creditor. As a result, a secured creditor will be able to collect any proceeds of execution obtained by the judgment creditor. 

W G Stark 
Hayden Starke Chambers

Who will win in a priority dispute between 2 defrauded lenders?

Associate Justice Macready of the Supreme Court of New South Wales was recently called upon to determine a priority dispute between two lenders.

Background facts 
In Australian Financial Services and Leasing Pty Limited v All Up Finance Pty Limited [2012] NSWSC 1004 the circumstances were: 

Australian Financial Services and Leasing Pty Limited, the Plaintiff ("AFS") carried on a finance business, providing customers with finance to purchase commercial or industrial equipment for use in the customer's business. Typically this involved AFS purchasing equipment from a supplier, upon the presentation of an invoice from a supplier, and then entering into a rental agreement with a customer. Under the rental agreement the customer paid an agreed monthly rental payment but the equipment remained the property of AFS. 

All Up Finance Pty Ltd, the first defendant ("All Up"), carried on a short-term finance business. It provided customers with brokerage and other financial services by arranging loans from lenders to its customers. Its customers typically had bad credit ratings, and due to the high-risk nature of the lending, All Up was able to charge high rates of interest. Its customers usually required these services for the purpose of home loans, debt consolidation, bridging loans, and commercial finance requirements. 

In late 2009, two companies controlled by Richard Skarzynski, the husband of the Third Defendant, (Total Concept Projects (Australia) Pty Ltd and Total Concept Productions (Australia) Pty Ltd) perpetrated a fraud on AFS. AFS entered into a number of rental agreements with these 2 companies under which AFS would own certain equipment to be used by these companies and those companies would rent that equipment from AFS. It was a term of the rental agreements that these companies would make rental payments to AFS for the equipment purchased by AFS. In fact, AFS financed business equipment based on forged receipts provided by Skarzynski.

After the equipment finance fraud was committed, All Up purported to loan the third defendant wife $300,000, also secured with a charge protected by a caveat over her property. However the wife denied borrowing the $300,000 or signing the caveat. All Up did not have a registered mortgage over the property.

After AFS discovered the fraud, the wife agreed to charge her property to secure the debt and a caveat was lodged. AFS also did not have a registered mortgage over the property.

The wife's property was sold for $5million, and the net proceeds of the sale available for distribution to the competing claims by AFS and All Up were $500,000 (after paying in excess of $4million to the first registered mortgagee, St George Bank). The sum of $500,000 was paid into court, pending the outcome of the litigation. AFS and All Up both claimed that sum. 

The normal rules of priority in a dispute between equitable interest holders are that the first in time prevails, provided there is no disentitling conduct. If those rules applied, All Up would win.

However, before considering those normal rules of priority to see whose equitable interest took priority, the court had to decide whether the All Up mortgage was forged (if it was forged it was void, meaning that All Up had no interest at all in the property, and hence no interest in the fund).

Although the wife was originally a party to the proceeding, by the time of the trial the only parties left were AFS and All Up. 

AFS called the wife as a witness. In her evidence, she denied signing the All Up caveat and a mortgage dated the same day (among other documents). Expert evidence was also called by AFS to show that the All Up documents were forged.


The NSW Supreme Court concluded the All Up documents were forgeries because:

1. the wife had no knowledge of her husband’s dealings with All Up;
2. the wife’s actual signature appeared to be vastly different to the putative signature on All Up’s documentation;
3. the expert evidence concluded that the wife’s putative signature on All Up’s documentation was questionable; and 
4. All Up failed to call the witness who allegedly saw the wife sign the All Up documentation, creating an inference that the witness’s evidence would have harmed All Up's case.     

The case also provides a useful analysis of the Briginshaw standard as it applies to allegations of fraud in civil cases (see Briginshaw v Briginshaw [1938] HCA 34; (1938) 60 CLR 336). The conclusion noted (at paragraph 60) is: 

The "Briginshaw standard" is often spoken of quite loosely and as if it is a third standard of proof sitting somewhere between the balance of probabilities and beyond reasonable doubt. This is wrong. As Dixon J points out the civil standard of proof is proof on the balance of probabilities requiring the relevant party to prove the elements of its case to that standard.

Conclusion 
The case raises a number of issues for lenders to consider in reviewing their lending practices in order to avoid losing to fraudsters. 
First, always obtain registrable mortgages, not just an equitable charge;
Secondly, always register the mortgage, do not just lodge a caveat (in this case, the All Up mortgage was not registered because St George Bank required the execution of a deed of priority, which the wife refused) - once a mortgage is registered on title, it is indefeasible; and
Finally, ensure that the witness to any mortgage documents is known to the lender (it is obviously best practice to have the borrower sign the security documents in front of an employee of the lender, or an independent solicitor, who certifies that he or she has explained the documents to the borrower and that the borrower understood what they were signing). 

WG Stark 
Hayden Starke Chambers

What happens if a lender misleads a borrower or a guarantor?

In Dowdle v Pay Now for Business Pty Ltd & Anor [2012] QSC 272 the guarantor sued the lender alleging misleading and deceptive conduct.

Background 
On 19 February 2003, Pay Now For Business Pty Ltd (Pay Now For Business) offered to lend Mrs Dowdle $50,000 to help fund her spouse’s ongoing litigation (Initial Offer). As a term of the Initial Offer, Pay Now For Business required a guarantee from Mr Dowdle and a supporting mortgage over the family home. 

Unfortunately, 2 days later, Pay Now changed the terms of the Initial Offer, without telling Mrs Dowdle about the changes (which were that Mr Dowdle would be the borrower and Mrs Dowdle would sign the guarantee and mortgage, which would be unlimited).

On 24 February 2003, Mrs Dowdle signed both the guarantee and mortgage. 

Some time later, Mrs Dowdle brought proceedings against Pay Now For Business, on the basis that she signed the guarantee and mortgage believing that  her liability was limited to $50,000 (as per the Initial Offer).

The Court decided that Pay Now For Business had engaged in misleading and deceptive conduct by failing to inform Mrs Dowdle of the change to the structure of the transaction and, in particular, failing to withdraw the Initial Offer. This was particularly relevant in circumstances where Mrs Dowdle did not know of Mr Dowdle’s significant personal indebtedness to Pay Now For Business at the time she signed the guarantee and mortgage.

The Court also considered that, while Mrs Dowdle obtained independent legal advice in relation to the transaction, this was undermined by the failure of Pay Now to notify Mrs Dowdle of the changes to the structure of the transaction.
The Court accordingly limited Mrs Dowdle's guarantee to the amount that she had anticipated would apply when she signed the guarantee ($50,000).

Conclusion 
If it was not already clear, this case confirms that lenders should make any changes in the structure of a proposed financing transaction clear to all potential borrowers and/or guarantors, well before the money actually changes hands. Any acknowledgements provided by the borrowers and guarantors should specifically refer to the alterations made to the initial proposal.

W G Stark
Hayden Starke Chambers

Are there any recent decisions about the priorities between mortgagees in 2012?

Late in 2012, the Full Federal Court was called upon to look at the issue of priorities between first and second ranking mortgagees. 


Background
Naxatu Pty Limited v Perpetual Trustee Company Limited [2012] FCAFC 163 was a dispute between Naxatu, the second mortgagee and Perpetual (the first mortgage holder), in respect of units owned by Sterling Estates Development Corporation Pty Ltd (Sterling). 

Perpetual also held a number of mortgages over other units owned by Sterling and some of those units had second mortgages in favour of Bridgecorp Financial Ltd (Bridgecorp).  

Perpetual and Bridgecorp had a priority agreement which limited Perpetual’s priority under its first mortgage to $9.4 million, and provided that Bridgecorp would receive its money after that amount was paid to Perpetual (the Bridgecorp Agreement).


Perpetual sold some of the secured properties and paid a portion of the proceeds to Bridgecorp under the Bridgecorp Priority Agreement.

Naxatu claimed that the payments to Bridgecorp diminished the value of Naxatu’s mortgages, in breach of Perpetual’s duty to Naxatu.  Naxatu relied on the rule in Hopkinson v Rolt* in asserting that its second ranking mortgages should have priority over Perpetual’s mortgages.  The rule provides that the priority of a first mortgagee whose mortgage secures all moneys owing by the mortgagor, is relegated to third priority for any further advances made after the first mortgagee became aware of the existence of a second mortgagee. The argument requires the Court to accept that the payments by Perpetual to Bridgecorp were further advances under Perpetual's first mortgage.

Foster J dismissed Naxatu’s claim under Hopkinson v Rolt because the Perpetual did not have notice of Naxatu's mortgage at the time it made further advances. 

Before equity will regard it as fraudulent for a first mortgagee to insist on its priority for subsequent advances, it is necessary that it have had actual notice of the subsequent mortgage.

The Full Court decided that the rule in Hopkinson v Rolt applies when the first mortgagee has notice of the second mortgagee and either party makes any further advances.  In other words, the rule is not limited to further advances made by the second mortgagee and it is not dependent on when the mortgagees become aware of further advances made by either mortgagee.  The Full Court also decided that the rule can be limited by an agreement between the mortgagees, such as a priority agreement.

Marshalling
Naxatu also relied on the doctrine of marshalling in correspondence before the commencement of the proceeding, although not at trial. 

Dowsett J (at paragraph 61) concluded that this doctrine was the only possible basis for Naxatu's claim against the Bridgecorp properties.

The doctrine was stated by Lord Eldon as (quoted in Miles v Official Receiver in Bankruptcy [1963] HCA 24; (1963) 109 CLR 501, by the High Court (Dixon CJ, Menzies and Windeyer JJ) :

If a party has two funds ... a person having an interest in one only has a right to resort to the other, if that is necessary for the satisfaction of both . ... So that it shall not depend upon the will of one creditor to disappoint another.

Thus, if the first mortgage lender has a first mortgage over property A and B and the second mortgage lender only has a second mortgage over property B and the first sells property B and takes all the money (leaving the second mortgage lender with nothing), the second mortgage lender is allowed to sell property A (even though he has no mortgage). This is because he stands in the shoes of the first mortgage lender. 

The Full Court concluded that Naxatu lost in this case because the doctrine of marshalling imposes no obligations on the first mortgage lender.

Conclusion
Naxatu shows that a number of these old rules relating to lending still apply in the modern context.  

The case is a reminder that where a mortgagee has notice of another mortgage over the same property, the mortgagee should ensure that it does not make further advances to the borrower without negotiating a deed of priority with the other mortgagee. 


W G Stark
Hayden Starke Chambers  

*[1861] Eng R 641