What is the doctrine of marshalling?

In my post dated 12 April 2013 (see: https://melbournepropertylaw.blogspot.com/2013/04/are-there-any-recent-decisions-about_12.html), I discussed the doctrine of marshalling and its potential impact in modern lending law. 

Another example of the relevance of the doctrine of marshalling arose in the May 2019 Court of Appeal decision in Burness (in their capacity as trustees of the bankrupt estate of Love) v Hill [2019] VSCA 94. 

A lawyer, Hill, was engaged by Mr Love to conduct extensive litigation against VicRoads relating to the compulsory acquisition of land owned by Love in Epping, Victoria.

The litigation conducted by Hill on Love’s behalf was lengthy, costly and complex. Although Love was land-rich, it appears that he needed to borrow in order to fund the litigation. Accordingly, Love borrowed about $12 million from the Commonwealth Bank of Australia (‘CBA’) and gave a first mortgage over each of the Epping properties to CBA to secure the loans.

Hill held a second mortgage over Property A, belonging to his client, Love, in respect of unpaid legal fees. Love had become bankrupt, and as a result was not in a position to pay Hill's fees.  

The CBA held a first mortgage over Property A. It also held mortgages over other properties owned by Love, over which Hill did not hold a mortgage. 

The CBA sold Property A, and no proceeds were left to satisfy Hill’s debt. As a result, Hill's second mortgage was discharged automatically at the settlement of the sale (see section 77(4) of the Transfer of Land Act, 1958).

Hill had previously sued Love in the County Court, and obtained judgment for $2.2 million in fees. 

CBA sold Property B. Following payment of all secured indebtedness due to CBA, there were surplus sale proceeds which were paid into Court by CBA. 

Hill then brought proceedings in the Supreme Court to marshal the CBA’s securities to discharge his judgment debt.  

Justice Sifris in the Supreme Court of Victoria confirmed that Hill was entitled to be subrogated to the CBA’s first mortgage over Property B, to the extent of the debt previously secured by Hill’s second mortgage over property A (see (2018) 53 VR 459). The Trial Judge ordered that Hill's claim (and his costs on an indemnity basis in accordance with the terms of Hill's mortgage) be paid from the surplus sale proceeds.

Love’s trustees in bankruptcy appealed against the orders made by Sifris J. 

The Court of Appeal dismissed the trustees' appeal. Justices of Appeal Kaye, McLeish and Hargrave quoted (at paragraph 33 of their judgment) from Lord Neuberger’s speech in National Crime Agency v Szepietowski [2014] AC 338: 

Marshalling [is] allowed to a creditor, in a case where (i) his debt is secured by a second mortgage over property (‘the common property’), (ii) the first mortgagee of the common property is also a creditor of the debtor, (iii) the first mortgagee also has security for his debt in the form of another property (‘the other property’) (iv) the first mortgagee has been repaid from the proceeds of sale of the common property, (v) the second mortgagee’s debt remains unpaid, and (vi) the proceeds of sale of the other property are not needed (at least in full) to repay the first mortgagee’s debt. In such a case, the second mortgagee can look to the other property to satisfy the debt owed to him.

The Court of Appeal also noted that when dealing with the reason for the doctrine later in Szepietowski, Lord Neuberger quoted from a broad statement by Joseph Story in his text, Commentaries on Equity Jurisprudence:

The reason is obvious… [By] compelling [the first creditor with the two securities] to take satisfaction out of one of the funds no injustice is done to him … But it is the only way by which [the second creditor with one security] can receive payment. And natural justice requires, that one man should not be permitted from wantonness, caprice, or rashness, to do injury to another.

At paragraph 49 of their judgment, the Court of Appeal further quoted Lord Neuberger in National Crime Agency v Szepietowski [2014] AC 338, where he stated:    

... The right to marshal is based on a simple principle, and there is no reason to dilute it in the way contended for ... After all, the right to marshal is not based on the proposition that the first mortgagee is under an obligation to sell the other property first ... Further, if [the] contention were accepted, one can readily imagine all sorts of arguments as to whether one property is more difficult to sell than another, and whether the extent or nature of the difficulty is such as qualifies for the purposes of the contention.

At paragraph [54], the Court of Appeal noted that the only bases to avoid the marshalling doctrine is a contractually enforceable arrangement, binding estoppel, or a legislative obligation.  

While the Trial Judge and the Court of Appeal dealt with a unique set of facts, the Court of Appeal’s reasons contain a number of relevant principles that will apply generally.

First, the requirements to invoke the doctrine of marshalling are those quoted above in Szepietowski.  The Court of Appeal specifically found that there is no independent requirement that the first mortgagee’s conduct be arbitrary or capricious.  

Secondly, securities can be marshalled to discharge the whole of a fluctuating debt even if the debt increases after the sale of the principal security property.

Thirdly, the County Court consent judgment [relating to the quantum of Mr Hill's legal fees] in this case did not extinguish the secured debt.  A debt merges in a judgment and continues its existence in that merged form – it is not retrospectively extinguished. The debt remained secured, and able to support a marshalling claim.

Solicitors acting for subordinate security holders should keep marshalling in mind. If it is available, it can significantly improve a second (or even later) mortgagee’s prospects of recovery. 

The doctrine is particularly attractive where a debtor is insolvent (as with Mr Love here) as it should give a second mortgagee priority over unsecured creditors. 

WG Stark 
Hayden Starke Chambers