Mortgage Clauses
Cases
Director General of Fair Trading v. First National Bank
[2001] UKHL 52 [2002] ECC 22, [2002] AC 481, [2001] 2 All ER (Comm) 1000, [2002] 1 AC 481, [2001] 3 WLR 1297, [2002] 1 All ER 97, [2001] UKHL 52, [2002] 1 Lloyd’s Rep 489, [2002] 1 LLR 489
LORD BINGHAM OF CORNHILL
My Lords,
1. First National Bank plc (“the bank”) is licensed to carry on consumer credit business. It is a major lender in the market and has lent large sums to borrowers under credit agreements regulated under the Consumer Credit Act 1974. Such agreements are made on its printed form which contains a number of standard terms. The Director General of FairTrading (“the Director”), in exercising powers conferred on him by regulation 8 of the Unfair Terms in Consumer Contracts Regulations 1994 (SI 1994/3159) (“the regulations”), sought an injunction to restrain use of or reliance on one such standard term on the ground that it was unfair. The bank resisted the Director’s application on two grounds. The first, rejected by Evans-Lombe J at first instance ([2000] 1 WLR 98) and the Court of Appeal (Peter Gibson, Waller and Buxton L JJ) ([2000] QB 672), was that the fairness provisions of the regulations did not apply to the term in question. The second, accepted by the judge but partially rejected by the Court of Appeal, was that the term in question was not unfair. In this appeal to the House the bank again relies on both these arguments. The Director seeks to uphold the decision of the Court of Appeal but contends that the term was more fundamentally unfair than the Court of Appeal held it to be. Thus there are two broad questions before the House:
(1) Do the fairness provisions of the regulations apply to the term in question?
(2) If so, is the term unfair and, if it is, on what ground?
2. By its standard form of regulated credit agreement the bank agrees to make a sum of money available to the borrower for a specified period in consideration of the borrower’s agreement to repay that sum by specified instalments on specified dates with interest at a specified rate. Condition 4 of the bank’s standard form provided that:
“The rate of interest will be charged on a day to day basis on the outstanding balance and will be debited to the Customer’s account monthly in arrears . . .”
and provided that the rate of interest might be varied. Condition 8 of the agreement was in these terms:
“Time is of the essence for making all repayments to FNB as they fall due. If any repayment instalment is unpaid for more than 7 days after it became due, FNB may serve a notice on the Customer requiring payment before a specified date not less than 7 days later. If the repayment instalment is not paid in full by that date, FNB will be entitled to demand payment of the balance on the Customer’s account and interest then outstanding together with all reasonable legal and other costs charges and expenses claimed or incurred by FNB in trying to obtain the repayment of the unpaid instalment of such balance and interest. Interest on the amount which becomes payable shall be charged in accordance with Condition 4, at the rate stated in paragraph D overleaf (subject to variation) until payment after as well as before any judgement (such obligation to be independent of and not to merge with the judgement).”
Emphasis has been added to the last sentence of this condition, since it is to that sentence alone that the Director’s objection relates. I shall refer to this sentence as “the term”.
3. The bank’s stipulation that interest shall be charged until payment after as well as before any judgment, such obligation to be independent of and not to merge with the judgment, is readily explicable. At any rate since In re Sneyd; Ex p Fewings (1883) 25 Ch D 338, not challenged but accepted without demur by the House of Lords in Economic Life Assurance Society v Usborne [1902] AC 147, the understanding of lawyers in England has been as accurately summarised by the Court of Appeal at p 682 of the judgment under appeal:
“It is trite law in England that once a judgment is obtained under a loan agreement for a principal sum and judgment is entered, the contract merges in the judgment and the principal becomes owed under the judgment and not under the contract. If under the contract interest on any principal sum is due, absent special provisions the contract is considered ancillary to the covenant to pay the principal, with the result that if judgment is obtained for the principal, the covenant to pay interest merges in the judgment. Parties to a contract may agree that a covenant to pay interest will not merge in any judgment for the principal sum due, and in that event interest may be charged under the contract on the principal sum due even after judgment for that sum.”
4. To ensure that they were able to recover not only the full sum of principal outstanding but also any interest accruing on that sum after judgment as well as before, it became the practice for lenders to include in their credit agreements a term to the effect of the term here in issue. If such a provision had not been included, a lender seeking to enforce a loan agreement against a borrower in the High Court would suffer prejudice only to the extent that the statutory rate of interest on judgment debts at the material time is lower than the contractual interest rate, because the High Court has, since 1838, had power to award statutory interest on a judgment debt until payment.
5. But a lender seeking to enforce a regulated credit agreement is in a different position. He is obliged by section 141 of the 1974 Act to sue in the county court. Until the Lord Chancellor, exercising his power under section 74 of the County Courts Act 1984, made the County Courts (Interest on Judgment Debts) Order 1991 (SI 1991/1184), the county court lacked power to award statutory interest on any judgment debt and, when such a general power was conferred by the order, judgments given in proceedings to recover money due under agreements regulated by the 1974 Act were expressly excluded from its scope. It was further provided in the order:
“3 Where under the terms of the relevant judgment payment of a judgment debt –
(a) is not required to be made until a specified date, or
(b) is to be made by instalments,
interest shall not accrue under this Order –
(i) until that date, or
(ii) on the amount of any instalment, until it falls due,
as the case may be.”
6. Thus a lender under a regulated credit agreement who obtains judgment against a defaulting borrower in the county court will be entitled to recover the principal outstanding at the date of judgment and interest accrued up to that date but will not be entitled to an order for statutory interest after that date, and even if the court had power to award statutory post-judgment interest it could not do so, in any case where an instalment order had been made, unless there had been a default in the due payment of any instalment. The lender may recover post-judgment interest only if he has the benefit of an independent covenant by the borrower entitling him to recover such interest. There is nothing to preclude inclusion of such a covenant in a regulated credit agreement, unless it falls foul of the fairness requirement in the regulations.
7. Section 71 of the County Courts Act 1984 conferred a general power on the county court, where any judgment was given or order made for payment of a money sum, to order that the money might be paid “by such instalments payable at such times as the court may fix”. The 1974 Act also conferred on the county court three powers relevant for present purposes. First, the court was empowered to make a time order. Sections 129 and 130 of the Act, so far as relevant, provided:
“129. (1) If it appears to the court just to do so –
. . .
(c) in an action brought by a creditor or owner to enforce a regulated agreement or any security, or recover possession of any goods or land to which a regulated agreement relates,
the court may make an order under this section (a ‘time order’).
(2) A time order shall provide for one or both of the following, as the court considers just –
(a) the payment by the debtor or hirer or any surety of any sum owed under a regulated agreement or a security by such instalments, payable at such times, as the court, having regard to the means of the debtor or hirer and any surety, considers reasonable;
. . .
“130. (1) Where in accordance with rules of court an offer to pay any sum by instalments is made by the debtor or hirer and accepted by the creditor or owner, the court may in accordance with rules of court make a time order under section 129(2) (a) giving effect to the offer without hearing evidence of means. . . .”
Secondly, section 136 provided:
“136. The court may in an order made by it under this Act include such provision as it considers just for amending any agreement or security in consequence of a term of the order.”
Thirdly, by sections 137, 138 and 139 of the Act the county court was given power to reopen credit agreements “so as to do justice between the parties” if it found a credit bargain to be “extortionate”. A credit bargain was defined as extortionate if it
“(a) requires the debtor or a relative of his to make payments (whether unconditionally, or on certain contingencies) which are grossly exorbitant, or
(b) otherwise grossly contravenes ordinary principles of fair dealing.”
In determining whether a credit bargain was extortionate regard was to be had to such evidence as might be adduced concerning interest rates prevailing at the time the bargain was made, a number of factors relating to the debtor and the circumstances of the transaction and “any other relevant considerations”.
8. The provisions of the regulations directly at issue in these proceedings must be considered in more detail below. It should however be noted that the regulations were made to give effect in the United Kingdom to Council Directive 93/13/EEC (OJ 1993, L95, p 29) on unfair terms in consumer contracts (“the directive”). (They were superseded by further regulations in 1999, but these are to very much the same effect, do not govern this case and need not be further considered). It is common ground that the regulations should be construed so as to give effect to the directive, to which resort may properly be made for purposes of construction. Regulation 5, giving effect to article 6 of the directive, provides:
“(1) An unfair term in a contract concluded with a consumer by a seller or supplier shall not be binding on the consumer.
(2) The contract shall continue to bind the parties if it is capable of continuing in existence without the unfair term.”
Thus the Director’s challenge, although addressed only to the bank’s use of and reliance on the term, if upheld, may well invalidate any similar term in any other regulated agreement made by any other lender with any borrower. The questions at issue are accordingly of general public importance.
(1) The applicability of the regulations
9. Regulation 3(2) of the regulations provides:
“In so far as it is in plain, intelligible language, no assessment shall be made of the fairness of any term which –
(a) defines the main subject matter of the contract, or
(b) concerns the adequacy of the price or remuneration, as against the goods or services sold or supplied.”
This gives effect, almost word for word, to article 4(2) of the directive, although some light may be shed on its meaning by the 19th recital to the directive:
“Whereas, for the purposes of this Directive, assessment of unfair character shall not be made of terms which describe the main subject matter of the contract nor the quality/price ratio of the goods or services supplied; whereas the main subject matter of the contract and the price/quality ratio may nevertheless be taken into account in assessing the fairnessof other terms; whereas it follows, inter alia, that in insurance contracts, the terms which clearly define or circumscribe the insured risk and the insurer’s liability shall not be subject to such assessment since these restrictions are taken into account in calculating the premium paid by the consumer;”.
10. In reliance on regulation 3(2)(b) Lord Goodhart QC, on behalf of the bank, submitted that no assessment might be made of the fairness of the term because it concerns the adequacy of the bank’s remuneration as against the services supplied, namely the loan of money. A bank’s remuneration under a credit agreement is the receipt of interest. The term, by entitling the bank to post-judgment interest, concerns the quantum and thus the adequacy of that remuneration. This was the more obviously true if, as Lord Goodhart submitted, the merger rule as commonly understood is unsound. Where judgment is given for outstanding principal payable under a loan agreement and interest accrued up to the date of judgment, those claims (he accepted) are merged in the judgment. That is a conventional application of the principle of res judicata. But no claim for future interest has been the subject of adjudication by the court and such a claim cannot be barred as res judicata. The borrower’s covenant to pay interest on any part of the principal loan outstanding thus survives such a judgment, and In re Sneyd, above, was wrong to lay down any contrary principle. Lord Goodhart adopted the observation of Templeman LJ in Ealing London Borough Council v El Isaac [1980] 1 WLR 932 at 937:
“I do not for myself understand how a debt payable with interest until actual repayment can be merged in a judgment without interest or with a different rate of interest payable thereafter.”
11. To this submission Mr Crowe, representing the Director, gave two short answers. First, condition 8, of which the term forms part, is a default provision. Its purpose, and its only purpose, is to prescribe the consequences of a default by the borrower. It does not lay down the rate of interest which the bank is entitled to receive and the borrower bound to pay. It is an ancillary term, well outside the bounds of regulation 3(2)(b). Secondly, there is no merger “rule” but only a rule of construction. It is a question of construction of any given agreement whether the borrower’s covenant to pay interest is or is not to be understood as intended to continue after judgment. But whatever the correct approach to merger, it is an irrelevance. Even if a bank’s borrower’s covenant to pay interest is ordinarily to be taken, as in Scotland (see Bank of Scotland v Davis 1982 SLT 20), to continue until the full sum of principal is repaid, after as before judgment, the term remains part of a default provision and not one falling within the provisions of regulation 3(2)(b).
12. In agreement with the judge and the Court of Appeal, I do not accept the bank’s submission on this issue. The regulations, as Professor Sir Guenter Treitel QC has aptly observed (The Law of Contract, 10th ed, 1999, p 248) “are not intended to operate as a mechanism of quality or price control” and regulation 3(2) is of “crucial importance in recognising the parties’ freedom of contract with respect to the essential features of their bargain” (ibid, at p 249). But there is an important “distinction between the term or terms which express the substance of the bargain and ‘incidental’ (if important) terms which surround them” (Chitty on Contracts, 28th ed, 1999, “Unfair Terms in Consumer Contracts”, p 747, para 15-025). The object of the regulations and the directive is to protect consumers against the inclusion of unfair and prejudicial terms in standard-form contracts into which they enter, and that object would plainly be frustrated if regulation 3(2)(b) were so broadly interpreted as to cover any terms other than those falling squarely within it. In my opinion the term, as part of a provision prescribing the consequences of default, plainly does not fall within it. It does not concern the adequacy of the interest earned by the bank as its remuneration but is designed to ensure that the bank’s entitlement to interest does not come to an end on the entry of judgment. I do not think the bank’s argument on merger advances its case. It appears that some judges in the past have been readier than I would be to infer that a borrower’s covenant to pay interest was not intended to extend beyond the entry of judgment. But even if a borrower’s obligation were ordinarily understood to extend beyond judgment even in the absence of an independent covenant, it would not alter my view of the term as an ancillary provision and not one concerned with the adequacy of the bank’s remuneration as against the services supplied. It is therefore necessary to address the second question.
(2) Unfairness
13. Regulation 4 of the regulations is entitled “Unfair terms” and provides:
“(1) In these Regulations, subject to paragraphs (2) and (3) below, ‘unfair term’ means any term which contrary to the requirement of good faith causes a significant imbalance in the parties’ rights and obligations under the contract to the detriment of the consumer.
(2) An assessment of the unfair nature of a term shall be made taking into account the nature of the goods or services for which the contract was concluded and referring, as at the time of the conclusion of the contract, to all circumstances attending the conclusion of the contract and to all the other terms of the contract or of another contract on which it is dependent.
(3) In determining whether a term satisfies the requirement of good faith, regard shall be had in particular to the matters specified in Schedule 2 to these Regulations.
(4) Schedule 3 to these Regulations contains an indicative and non-exhaustive list of the terms which may be regarded as unfair.”
Schedule 2 to the regulations provides:
“In making an assessment of good faith, regard shall be had in particular to:
(a) the strength of the bargaining positions of the parties;
(b) whether the consumer had an inducement to agree to the term;
(c) whether the goods or services were sold or supplied to the special order of the consumer, and
(d) the extent to which the seller or supplier has dealt fairly and equitably with the consumer.”
Each of (a), (b) and (c) also appear in Schedule 2 to the Unfair Contract Terms Act 1977 among the guidelines for application of the reasonableness test laid down by that statute, suggesting that some similarity of approach in applying the two tests may be appropriate. In a case such as the present, where the fairness of a term is challenged in the absence of any individual consumer, little attention need be paid to (b) and (c). It may however be assumed that any borrower is in a much weaker bargaining position than a large bank contracting on its own standard form. (d) applies a general test of fair and equitable dealing between supplier and consumer. Schedule 3 contains a list of indicative and illustrative terms which may because of their object or effect be regarded as unfair. Examples are terms which have the object or effect of “(e) requiring any consumer who fails to fulfil his obligation to pay a disproportionately high sum in compensation;”, “(i) irrevocably binding the consumer to terms with which he had no real opportunity of becoming acquainted before the conclusion of the contract;”, or “(k) enabling the seller or supplier to alter unilaterally without a valid reason any characteristics of the product or service to be provided”. It is not suggested that the term falls within any specific entry in the list. It is common ground that fairness must be judged as at the date the contract is made, although account may properly be taken of the likely effect of any term which is then agreed and said to be unfair.
14. The 15th and 16th recitals to the directive are relevant. They provide:
“Whereas it is necessary to fix in a general way the criteria for assessing the unfair character of contract terms;
Whereas the assessment, according to the general criteria chosen, of the unfair character of terms, in particular in sale or supply activities of a public nature providing collective services which take account of solidarity among users, must be supplemented by a means of making an overall evaluation of the different interests involved; whereas this constitutes the requirement of good faith; whereas, in making an assessment of good faith, particular regard shall be had to the strength of the bargaining positions of the parties, whether the consumer had an inducement to agree to the term and whether the goods or services were sold or supplied to the special order of the consumer; whereas the requirement of good faith may be satisfied by the seller or supplier where he deals fairly and equitably with the other party whose legitimate interests he has to take into account;”.
Article 3(1) of the directive is the counterpart of regulation 4(1), and is in terms which are for present purposes indistinguishable. The directive has no annex to the effect of Schedule 2 to the regulations, but has an annex in terms identical to those of Schedule 3.
15. The trial judge first asked himself whether the term was inherently unfair and concluded that it was not because a borrower, to whom the effect of the term had been fully explained, would not have regarded it as unfair that he would be obliged, in the event of his default, to pay interest on the full sum owed to the lender until complete repayment, even if the court permitted him to pay by instalments extending over a substantial period ([2000] 1 WLR 98 at 108C-H). The judge then considered whether the term was unfair because a defaulting borrower would not expect to bear an interest charge over and above any instalments ordered by the court, and whether the term deprived the consumer of a benefit or advantage which he might reasonably expect to receive. The judge resolved these issues in favour of the bank (pp 108-111), observing (at p 111H) that
“if the provisions of sections 129 and 136 of the Act of 1974 are correctly used by the courts the inclusion of the provisions of clause 8 need not operate to impose on a borrower post judgment interest where it would not be appropriate and just to do so.”
16. The Court of Appeal differed from the judge on the question of unfairness. In the judgment of the court it was said ([2000] QB 672 at 688):
“In our judgment the relevant term is unfair within the meaning of the Regulations of 1994 to the extent that it enables the bank to obtain judgment against a debtor under a regulated agreement and an instalment order under section 71 of the Act of 1984 without the court considering whether to make a time order, or, if it does and makes a time order, whether also to make an order under section 136 to reduce the contractual interest rate. The bank, with its strong bargaining position as against the relatively weak position of the consumer, has not adequately considered the consumer’s interests in this respect. In our view the relevant term in that respect does create unfair surprise and so does not satisfy the test of good faith; it does cause a significant imbalance in the rights and obligations of the parties by allowing the bank to obtain interest after judgment in circumstances when it would not obtain interest under the Act of 1984 and the Order of 1991, and no specific benefit to compensate the borrower is provided; and it operates to the detriment of that consumer who has to pay the interest.”
The Court of Appeal did not grant an injunction but instead accepted undertakings offered by the bank (subject to appeal) which would bring to the borrower’s attention the powers of the court under sections 129 and 136 of the 1974 Act and ensure that a claim to post judgment contractual interest would not be enforced by the bank after the court had made an instalment order unless the court’s attention had previously been drawn to its powers under sections 129 and 136 and it had considered whether to exercise those powers.
17. The test laid down by regulation 4(1), deriving as it does from article 3(1) of the directive, has understandably attracted much discussion in academic and professional circles and helpful submissions were made to the House on it. It is plain from the recitals to the directive that one of its objectives was partially to harmonise the law in this important field among all member states of the European Union. The member states have no common concept of fairness or good faith, and the directive does not purport to state the law of any single member state. It lays down a test to be applied, whatever their pre-existing law, by all member states. If the meaning of the test were doubtful, or vulnerable to the possibility of differing interpretations in differing member states, it might be desirable or necessary to seek a ruling from the European Court of Justice on its interpretation. But the language used in expressing the test, so far as applicable in this case, is in my opinion clear and not reasonably capable of differing interpretations. A term falling within the scope of the regulations is unfair if it causes a significant imbalance in the parties’ rights and obligations under the contract to the detriment of the consumer in a manner or to an extent which is contrary to the requirement of good faith. The requirement of significant imbalance is met if a term is so weighted in favour of the supplier as to tilt the parties’ rights and obligations under the contract significantly in his favour. This may be by the granting to the supplier of a beneficial option or discretion or power, or by the imposing on the consumer of a disadvantageous burden or risk or duty. The illustrative terms set out in Schedule 3 to the regulations provide very good examples of terms which may be regarded as unfair; whether a given term is or is not to be so regarded depends on whether it causes a significant imbalance in the parties’ rights and obligations under the contract. This involves looking at the contract as a whole. But the imbalance must be to the detriment of the consumer; a significant imbalance to the detriment of the supplier, assumed to be the stronger party, is not a mischief which the regulations seek to address. The requirement of good faith in this context is one of fair and open dealing. Openness requires that the terms should be expressed fully, clearly and legibly, containing no concealed pitfalls or traps. Appropriate prominence should be given to terms which might operate disadvantageously to the customer. Fair dealing requires that a supplier should not, whether deliberately or unconsciously, take advantage of the consumer’s necessity, indigence, lack of experience, unfamiliarity with the subject matter of the contract, weak bargaining position or any other factor listed in or analogous to those listed in Schedule 2 of the regulations. Good faith in this context is not an artificial or technical concept; nor, since Lord Mansfield was its champion, is it a concept wholly unfamiliar to British lawyers. It looks to good standards of commercial morality and practice. Regulation 4(1) lays down a composite test, covering both the making and the substance of the contract, and must be applied bearing clearly in mind the objective which the regulations are designed to promote.
18. In support of his contention that the term is unfair the Director adduced evidence of complaints made to him by a number of borrowers. Some of these disclose a very highly unsatisfactory state of affairs. In one case a husband and wife borrowed £3,000 plus £443.70 for insurance to finance improvements to their home. The principal was repayable over a five-year term by instalments of £84.89 plus £8.98 insurance. The borrowers fell into arrear and judgment was given for £3,953.11. The court ordered this sum to be paid by monthly instalments of £4.18, at which rate (it was calculated) the judgment debt would take 78 years to clear. Meanwhile, under the contract, interest would continue to accrue even if the instalments were fully and punctually paid. The bank’s deponent described these borrowers as “a good example of customers who demonstrated an ability easily to pay the instalments for home improvements when the credit was granted but thereafter appeared to have undertaken many other financial commitments which seriously prejudiced their ability to pay” the bank. A financial statement prepared on these borrowers some months before the county court judgment is consistent with that assertion.
19. For the Director, reliance was placed on the provisions in the 1991 order which denied the court power to order payment of statutory interest on money judgments given under regulated agreements and precluded entitlement to interest in any case where payment by instalments had been ordered and the instalments had been fully and punctually paid. It was argued that the term was unfair because it denied the borrower the protection which those provisions afforded. It was argued, in the alternative, that the term was unfair for the more limited reason upheld by the Court of Appeal.
20. In judging the fairness of the term it is necessary to consider the position of typical parties when the contract is made. The borrower wants to borrow a sum of money, often quite a modest sum, often for purposes of improving his home. He discloses an income sufficient to finance repayment by instalments over the contract term. If he cannot do that, the bank will be unwilling to lend. The essential bargain is that the bank will make funds available to the borrower which the borrower will repay, over a period, with interest. Neither party could suppose that the bank would willingly forgo any part of its principal or interest. If the bank thought that outcome at all likely, it would not lend. If there were any room for doubt about the borrower’s obligation to repay the principal in full with interest, that obligation is very clearly and unambiguously expressed in the conditions of contract. There is nothing unbalanced or detrimental to the consumer in that obligation; the absence of such a term would unbalance the contract to the detriment of the lender.
21. It seems clear, as the judge pointed out ([2000] 1 WLR 98 at 111) that a secured lender who does not obtain a money judgment but instead proceeds for possession and sale under the mortgage may obtain interest at the contract rate provided for in the mortgage down to the date when he is actually repaid, and in my opinion there is nothing unbalanced or detrimental to the consumer in that result either.
22. Should it then be said that the provisions of the 1991 order render the term unfair, providing as it does for a continuing obligation to pay interest after judgment notwithstanding the payment of instalments by the borrower in accordance with a court order? It is, I think, pertinent that the 1974 Act, which laid down a number of stipulations with which regulated agreements must comply, did not prohibit terms providing for post-judgment interest even though it required claims to enforce regulated agreements to be brought in the county court which could not at the time award statutory interest in any circumstances. The 1974 Act was passed to protect consumers and such a prohibition would no doubt have been enacted had it been recognised as a necessary or desirable form of protection. The Crowther Committee, on whose report (Cmnd. 4596, March 1971) the Act was based, did not recommend such a prohibition; indeed, it contemplated the recovery of contractual interest: see paragraphs 5.4.3, 6.6.33, 6.6.44(iv) and 6.7.16). It is also pertinent that judgments based on regulated agreements appear to have been excluded from the scope of the county court’s power to award statutory interest in response to observations of Lord Donaldson of Lymington MR in Forward Trust Ltd v Whymark [1990] 2 QB 670 at 681: but that was a case based on a flat rate agreement, in which the judgment in default would include a sum for future interest not yet accrued, in contrast with a simple rate agreement of the present kind (see [2000] 1 WLR 98 at 110-111; [2000] QB 672 at 679); the logic underpinning exclusion of statutory interest in the one case would not apply, at any rate with the same force, in the other. It is understandable that when a court is exercising a statutory power to order payment by instalments it should not also be empowered to order payment of statutory interest if the instalments are duly paid, but the term is directed to the recovery of contractual and not statutory interest. I do not think that the term can be stigmatised as unfair on the ground that it violates or undermines a statutory regime enacted for the protection of consumers.
23. It is of course foreseeable that a borrower, no matter how honourable and realistic his intentions when entering into a credit agreement, may fall on hard times and find himself unable to honour his obligations. The bank’s standard conditions recognise that possibility by providing for the contingency of default. The 1974 Act even more fully recognises that possibility, by providing for time orders to be made and providing that when a time order is made the terms of the underlying agreement may also be amended. These provisions are clearly framed for the relief not of the borrower who, having the means to meet his contractual obligations, chooses not to do so, but for the relief of those who cannot pay or cannot pay without more time. Properly applied, these provisions enable the undeserving borrower to be distinguished from the deserving and for the contractual obligations of the deserving to be re-drawn in terms which reasonably reflect such ability, if any, as he may then have to repay within a reasonable period. Where problems arise in practice, it appears to be because borrowers do not know of the effect of sections 129 and 136; neither the procedure for giving notice of default to the borrower nor the prescribed county court forms draw attention to them; and judgments will routinely be entered in the county court without the court considering whether to exercise its power under the sections.
24. I have no hesitation in accepting the proposition, inherent in the Director’s submissions, that this situation is unacceptable. I have much greater difficulty in deciding whether the difficulties derive, as the Court of Appeal concluded, from the unfairness of the term or from the absence of procedural safeguards for the consumer at the stage of default. When the contract is made, default is a foreseeable contingency, not an expected outcome. It is not customary, even in consumer contracts, for notice to be given to the consumer of statutory reliefs open to him if he defaults. The 1974 Act does not require that notice of the effect of sections 129 and 136 be given. The evidence contains examples of clauses used by over 30 other lenders providing for the payment of interest after judgment, and none alerts the borrower to these potential grounds of relief. Regulation 4 is directed to the unfairness of a contract term, not the use which a supplier may make of a term which is in itself fair. It is readily understandable that a borrower may be disagreeably surprised if he finds that his contractual interest obligation continues to mount despite his duly paying the instalments ordered by the court, but it appears that the bank seeks to prevent that surprise by sending what is described in the evidence as a standard form of letter:
“You need only pay the amount ordered by the Court under the terms of the judgment but you should be aware that under the terms of the agreement interest continues to accrue on your account.
It is therefore in your interest to increase the instalment paid as soon as possible otherwise a much greater balance than the judgment debt may quickly build up.”
On balance, I do not consider that the term can properly be said to cause a significant imbalance in the parties’ rights and obligations under the contract to the detriment of the consumer in a manner or to an extent which is contrary to the requirement of good faith.
25. I do not think that the issues raised in this appeal raise any question on which the House requires a ruling from the European Court of Justice to enable it to give judgment and I would not accordingly order a reference to be made.
26. For the reasons I have given, and those given by each of my noble and learned friends, I would allow the bank’s appeal with costs in the House and the Court of Appeal and restore the order of the judge.
27. In conclusion, I would add a footnote on sections 129 and 136 of the 1974 Act. In the course of argument the House was referred to the decision of the Court of Appeal in Southern and District Finance plc v Barnes and Barnes and two related appeals reported at [1995] CCLR 62. The effect and interaction of sections 129 and 136 were there considered.
28. Of section 129 the court said (at p 68):
“When a time order is made, it should normally be made for a stipulated period on account of temporary financial difficulty. If, despite the giving of time, the debtor is unlikely to be able to resume repayment of the total indebtedness by at least the amount of the contractual instalments, no time order should be made. In such circumstances it will be more equitable to allow the regulated agreement to be enforced.”
I would in general agree that time orders extending over very long periods of time are usually better avoided. But I note that the court dismissed an appeal against a judge who had rescheduled payments over a period of 15 years (“Though the judge’s methods were robust and his reasoning economical, his instincts were sound and his order just”: p 71), and the broad language of section 129 should be so construed as to permit the county court to make such order as seems to it just in all the circumstances.
29. Of section 136 the court said (at p 68):
“The court may include in a time order any amendment of the agreement, which it considers just to both parties, and which is a consequence of a term of the order . . .”
In the case already referred to the judge had ordered that no additional interest should be payable beyond that which had already accrued, and the Court of Appeal upheld his decision. It was right to do so: provided the amendment is a consequence of a term of the time order, the court should be ready to include in a time order any provision amending the agreement which it considers just to both parties.
LORD STEYN
My Lords,
30. This is the first occasion on which the House has had the opportunity to examine an important branch of consumer law. It is therefore appropriate to consider the framework in which the questions before the House must be considered.
31. As between the directive and the domestic implementing regulations, the former is the dominant text. Fortunately, the 1994 Regulations, and even more so the 1999 Regulations, appear to have implemented the directive in domestic law in a manner which ought not to cause serious difficulty. The purpose of the directive is twofold, viz the promotion of fairstandard contract forms to improve the functioning of the European market place and the protection of consumers throughout the European Community. The directive is aimed at contracts of adhesion, viz “take it or leave it” contracts. It treats consumers as presumptively weaker parties and therefore fit for protection from abuses by stronger contracting parties. This is an objective which must throughout guide the interpretation of the directive as well as the implementing regulations. If contracting parties were able to avoid the application of the directive and regulations by exclusionary stipulations the regulatory scheme would be ineffective. The conclusion that the directive and regulations are mandatory is inescapable.
32. The directive is not an altogether harmonious text. It reflects the pragmatic compromises which were necessary to arrive at practical solutions between member states with divergent legal systems. But, despite some inelegance and untidiness in the text, the general principle that the construction must be adopted which promotes the effectiveness and practical value of the system ought to overcome difficulties. And the concepts of the directive must be given autonomous meanings so that there will be uniform application of the directive so far as is possible.
33. The directive made provision for a dual system of ex casu challenges and pre-emptive or collective challenges by appropriate bodies: see article 7. This system was domestically enacted in the 1994 Regulations, with the Director General of Fair Trading as the administering official to investigate and take action on complaints: see regulation 8. The 1999 Regulations extended the system of enforcement by including other bodies as qualified to undertake pre-emptive challenges. The system of pre-emptive challenges is a more effective way of preventing the continuing use of unfair terms and changing contracting practice than ex casu actions: see Susan Bright, “Winning the battle against unfair contract terms”, (2000) 20 Legal Studies 331, 333-338. It is, however, to be noted that in a pre-emptive challenge there is not a direct lis between the consumer and the other contracting party. The directive and the Regulations do not always distinguish between the two situations. This point is illustrated by the emphasis in article 4.1 of the directive and regulation 4(2) on the relevance of particular circumstances affecting a contractual relationship. The directive and the regulations must be made to work sensibly and effectively and this can only be done by taking into account the effects of contemplated or typical relationships between the contracting parties. Inevitably, the primary focus of such a pre-emptive challenge is on issues of substantive unfairness.
34. Under the Regulations, a term in a standard form contract that is unfair is not binding on the consumer. But certain provisions, sometimes called core terms, have been excepted from the regulatory regime. Regulation 3(2) so provides:
“In so far as it is in plain, intelligible language, no assessment shall be made of the fairness of any term which – (a) defines the main subject matter of the contract, or (b) concerns the adequacy of the price or remuneration, as against the goods or services sold or supplied.”
Clause 8 of the contract, the only provision in dispute, is a default provision. It prescribes remedies which only become available to the lender upon the default of the consumer. For this reason the escape route of regulation 3(2) is not available to the bank. So far as the description of terms covered by regulation 3(2) as core terms is helpful at all, I would say that clause 8 of the contract is a subsidiary term. In any event, article 3(2) must be given a restrictive interpretation. Unless that is done article 3(2)(a) will enable the main purpose of the scheme to be frustrated by endless formalistic arguments as to whether a provision is a definitional or an exclusionary provision. Similarly, article 3(2)(b) dealing with “the adequacy of the price of remuneration” must be given a restrictive interpretation. After all, in a broad sense all terms of the contract are in some way related to the price or remuneration. That is not what is intended. Even price escalation clauses have been treated by the Director as subject to the fairness provision: see Susan Bright, loc. cit., at pp 345 and 349. It would be a gaping hole in the system if such clauses were not subject to the fairness requirement. For these further reasons I would reject the argument of the bank that regulation 3(2), and in particular 3(2)(b), take clause 8 outside the scope of the regulations.
35. Given these conclusions the attack on the merger principle mounted by the bank was misplaced. In any event, I am not willing to uphold criticism by the bank of the well tried and tested principle of merger. I would therefore reject the bank’s submissions under this heading.
36. It is now necessary to refer to the provisions which prescribe how it should be determined whether a term is unfair. Implementing article 3(1) of the directive regulation 4(1) provides:
“‘unfair term’ means any term which contrary to the requirement of good faith causes a significant imbalance in the parties’ rights and obligations under the contract to the detriment of the consumer.”
There are three independent requirements. But the element of detriment to the consumer may not add much. But it serves to make clear that the directive is aimed at significant imbalance against the consumer, rather than the seller or supplier. The twin requirements of good faith and significant imbalance will in practice be determinative. Schedule 2 to the Regulations, which explains the concept of good faith, provides that regard must be had, amongst other things, to the extent to which the seller or supplier has dealt fairly and equitably with the consumer. It is an objective criterion. Good faith imports, as Lord Bingham has observed in his opinion, the notion of open and fair dealing: see also Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433. And helpfully the commentary to the 2000 edition of Principles of European Contract Law, prepared by the Commission of European Contract Law, explains that the purpose of the provision of good faith and fair dealing is “to enforce community standards of fairness and reasonableness in commercial transactions”: at 113; A fortiori that is true of consumer transactions. Schedule 3 to the Regulations (which corresponds to the Annex to the directive) is best regarded as a check list of terms which must be regarded as potentially vulnerable. The examples given in Schedule 3 convincingly demonstrate that the argument of the bank that good faith is predominantly concerned with procedural defects in negotiating procedures cannot be sustained. Any purely procedural or even predominantly procedural interpretation of the requirement of good faith must be rejected.
37. That brings me to the element of significant imbalance. It has been pointed out by Hugh Collins that the test “of a significant imbalance of the obligations obviously directs attention to the substantive unfairness of the contract”: “Good Faith in European Contract Law,” (1994), 14 Oxford Journal of Legal Studies 229, 249. It is however, also right to say that there is a large area of overlap between the concepts of good faith and significant imbalance.
38. It is now necessary to turn to the application of these requirements to the facts of the present case. The point is a relatively narrow one. I agree that the starting point is that a lender ought to be able to recover interest at the contractual rate until the date of payment, and this applies both before and after judgment. On the other hand, counsel for the Director advanced a contrary argument. Adopting the test of asking what the position of a consumer is in the contract under consideration with or without clause 8, he said that the consumer is in a significantly worse position than he would have been if there had been no such provision. Certainly, the consumer is worse off. The difficulty facing counsel, however, is that this disadvantage to the consumer appears to be the consequence not of clause 8 but of the County Courts (Interest on Judgment Debts) Order 1991. Under this Order no statutory interest is payable on a county court judgment given in proceedings to recover money due under a regulated agreement: see regulation 2. Counsel said that for policy reasons it was decided that in such a case no interest may be recovered after judgment. He said that it is not open to the House to criticise directly or indirectly this legal context. In these circumstances he submitted that it is not legitimate for a court to conclude that fairness requires that a lender must be able to insist on a stipulation designed to avoid the statutory regime under the 1991 Order. Initially I was inclined to uphold this policy argument. On reflection, however, I have been persuaded that this argument cannot prevail in circumstances where the legislature has neither expressly nor by necessary implication barred a stipulation that interest may continue to accrue after judgment until payment in full.
39. For these reasons as well as the reasons given by Lord Bingham I agree that clause 8 is not unfair and I would also make the order which Lord Bingham proposes.
LORD HOPE OF CRAIGHEAD
My Lords,
40. I have had the advantage of reading in draft the speech of my noble and learned friend Lord Bingham of Cornhill. I agree with it, and for reasons which he has given I too would allow the appeal. I also agree with my noble and learned friend Lord Millett that the real source of the problem revealed by this case remains to be tackled. It is with that point particularly in mind that I wish to add these observations.
41. The term to which the Director has taken objection is to be found in the last sentence of condition 8 of the bank’s standard form. It seeks to do three things. Firstly, it provides that interest on the amount which becomes payable under that condition is to be payable in accordance with condition 4. Second, it provides that interest is to be payable on that amount until payment after as well as before any judgment. Third, it makes it clear that the obligation to pay interest is to be independent of and not to merge with the judgment. The amount on which the interest is to be charged is described in the preceding sentence. It consists of (a) the balance on the customer’s account, (b) interest outstanding at the specified date and (c) other costs, charges and expenses incurred in trying to obtain the repayment of the unpaid instalment of such balance and interest. Mr Crowe for the Director made it clear that no objection was taken to the provision in the first part of the sentence that interest was to be payable on that amount. He accepted that this part of the sentence cannot be regarded as unfair. The contractual term which he says is unfair is to be found in the other parts of the sentence, which provide that interest on the amount referred to in the first part of it is to be payable after as well as before any judgment and that the obligation to do so is to be independent of and not to merge with the judgment.
42. Regulation 3(2)(b) of the Unfair Terms in Consumer Contracts Regulations 1994 provides that no assessment is to be made of the fairness of any term which concerns the adequacy of the price or remuneration as against the goods or services supplied. This is the provision on which Lord Goodhart QC relied when he said that the fairness provisions did not apply in this case. But it seems to me to be plain that the last sentence of condition 8 is not concerned with the adequacy of the remuneration which the bank is to receive for making its money available to the borrower.
43. As the nineteenth recital to the Council Directive 93/13/EEC indicates, regulation 3(2) applies only to terms which describe the main subject matter of the contract or are directly related to the adequacy of the price charged for the goods or services. The last sentence of condition 8 is concerned with neither of these two things. The obligation to pay interest on the outstanding balance is set out in condition 4. It is there that the provisions are to be found that concern the adequacy of the price charged for the loan. Condition 8 is a default provision. The last sentence of it is designed to enable interest to be recovered on the whole of the amount due on default. That amount includes legal and other costs, charges and expenses, so it is not confined to the outstanding balance due by the borrower. I do not think that it can be said to be directly related to the price charged for the loan or to its adequacy. It is concerned instead with the consequences of the borrower’s breach of contract. It sets out what is to happen if he fails to make the repayments to the bank as they fall due. I agree that regulation 3(2)(b) does not apply to it, and that its fairness as defined in regulation 4(1) of the 1994 Regulations must be assessed.
44. The primary reason which the Director has given for maintaining that the term is unfair is the uncertainty, confusion and hardship which has been shown to result from the bank’s practice of claiming contractual interest from its borrowers after judgment has been given for the principal. Particular unfairness is said to arise where an order is made to pay the debt by instalments, whether under section 71 of the County Courts Act 1984 or a time order under section 129 of the 1974 Act, and where no consideration has been given to making an order under section 136 of the 1974 Act to amend the agreement so as to prevent the accrual of contractual interest on instalments which are paid when they fall due. The fact that it is commonplace for no consideration to be given to the use of section 136 when payment by instalments is being ordered is not in dispute. So it is not surprising that borrowers, on finding that they are liable for further amounts in addition to the instalments provided for in judgments obtained against them by the bank, have complained to the Director.
45. I am not persuaded that, despite these consequences, the term is unfair. The meaning to be given to the word “unfair” in this context is laid down in regulation 4(1) of the 1994 Regulations. Guidance as to how the words used in that paragraph are to be understood is to be found in the sixteenth recital to the directive. The recital explains what “constitutes the requirement of good faith”. It states that an assessment of the unfair character of unfair terms must be supplemented by an overall evaluation of the different interests involved. Regulation 4(2) indicates the wide range of circumstances to be taken into account in the assessment. It provides that the assessment is to be done as at the time of the conclusion of the contract. But an appreciation of how the term will affect each party when the contract is put into effect must clearly form part of the exercise. It has been pointed out that there are considerable differences between the legal systems of the member states as to how extensive and how powerful the penetration has been of the principle of good faith and fair dealing: Lando and Beale, Principles of European Contract Law, Parts I and II (Combined and Revised, 2000), p 116. But in the present context there is no need to explore this topic in any depth. The directive provides all the guidance that it needed as to its application.
46. Following this approach it does not seem to me that there is a significant imbalance to the detriment of the borrower in the stipulation that the interest which is payable in terms of the first part of the last sentence is to be charged after as well as before any judgment and that this obligation is not to merge in the judgment. The primary obligation in condition 4 is to pay interest on the outstanding balance due to the bank. The plain fact is that, in the event of a default by the borrower, the bank will not have recovered all of its money until the entire balance on the borrower’s account has been paid. The main purpose of the last sentence is to ensure that the borrower does not enjoy the benefit of the outstanding balance after judgment without fulfilling the corresponding obligation which he has undertaken to pay interest on it as provided for in the contract. While the working out of that purpose may give rise to uncertainty in practice, the term itself does not seem to me to be unfair.
47. There is however an underlying problem, and it is not difficult to identify. It is not possible for a lender who seeks to enforce a regulated agreement in England and Wales to obtain from the court an order for interest to be paid on the judgment debt. Section 141 of the 1974 Act provides that the county court is to have jurisdiction to hear and determine such actions and that they shall not be brought in any other court. The County Courts (Interest on Judgment Debts) Order 1991 (SI 1991/1184) enables the county court to award statutory interest, but it excludes regulated agreements from that power. It also provides that where payment of a judgment debt is to be made by instalments interest is not to accrue under that Order on the amount of any instalment until it falls due. Where there is an independent covenant to pay interest which does not merge in the judgment, contractual interest will continue nevertheless to accrue and remain payable. It is not unreasonable to think that the problem would be greatly reduced, and perhaps removed entirely, if it were possible for the lender to obtain an order from the county court which included post-judgment contractual interest when judgment was being given for the principal. If that were possible, separate proceedings to recover post-judgment contractual interest would be unnecessary. It would also enable the court to take account of the borrower’s liability for post-judgment contractual interest when it is considering whether to make an order for the amount due to be paid by instalments.
48. This is an English appeal, so the practice of the Scottish courts as regards the making of orders for the payment of contractual interest is not directly relevant. But the 1974 Act extends to the whole of the United Kingdom, and the bank uses the same standard form when it is entering into transactions with Scottish borrowers. In Scotland, actions to enforce regulated agreements must be brought in the sheriff court: section 141(3) of the 1974 Act. It appears never to have been doubted that post-judgment interest may be awarded on a money claim in the sheriff court, although a sheriff does not have power to order the payment of interest on the sum awarded in any decree unless it has been asked for expressly in the sum sued for: Dobie, Sheriff Court Practice (1952), p 104; Macphail, Sheriff Court Practice (2nd ed, 1998), para 9.93. The rate at which interest may be recovered on a judgment in that court is regulated by section 9 of the Sheriff Courts (Scotland) Extracts Act 1892 (55 & 56 Vict (c17)) as amended from time to time by various Acts of Sederunt. It provides that where interest is included in a decree or extract it shall be deemed to be at the prescribed rate (currently 8 per cent) “unless otherwise stated.”
49. The question whether it was competent for post-judgment interest to be ordered at the contractual rate was the subject of competing decisions in the sheriff court. But doubts on this point were removed by the decision of the Inner House in Bank of Scotland v Davis 1982 SLT 20. It was held in that case that there was no good reason why the court should refuse to grant a decree for payment of interest in terms of the parties’ contract. The Lord Justice-Clerk (Wheatley) referred with approval to observations by Sheriff Sir Allan G Walker QC in Bank of Scotland v Forsyth 1969 SLT (Sh Ct) 15. I think that it is worth quoting the following passage from the sheriff’s note in that case:
“When an obligation to pay is created for the first time by a decree of court, as in an action of damages for negligence, it is clearly desirable that interest from the date of the decree until payment should be at the customary rate which at present is 5 per cent. No doubt this customary rate is susceptible of change, but until it is deliberately changed by the courts, it will be allowed automatically on all such decrees. I can see no reason, however, why this customary rate should be applied when the parties themselves have, by their own contract, fixed the rate of interest which is to be paid….It seems clearly inequitable that the bank should be denied the right to obtain the agreed interest on the money lent because, from the date of the decree onwards, the court absolves the defender from paying interest in excess of 5 per cent. The view has been expressed that when pursuers obtain the advantages and sanctions of the law by constituting their debt by action, they must be content with interest at the rate of 5 per cent. I cannot myself understand, however, why it should be regarded as just that a contracting party must be denied the aid of the court in enforcing a contract, unless he is prepared, as the price of obtaining that aid, to surrender his right to receive the rate of interest which the other party contracted to pay.”
50. As the sheriff’s use of the phrase “constituting their debt by action” indicates, a similar rule is followed in Scotland to that which applies in England under the merger rule. When the court pronounces decree for a principal sum due under a contract, the obligation to pay that sum is then owed under the court’s decree and not under the contract. This principle has been recognised by the Prescription and Limitation (Scotland) Act 1973, which provides that the five year prescription which applies to any obligation to pay a sum of money does not apply to an obligation to obtemper a decree of court: Schedule 1, para 2 (a). The sheriff’s discussion of the application of the principle appears also to assume – consistent with the merger rule – that, if the court is unable to award post-judgment interest on the principal sum at the rate provided for in the contract, the right to recover interest thereafter at the contractual rate would be lost.
51. The question whether the court will enforce a term that interest at the contractual rate may be charged on the principal sum due after as well as before any judgment does not seem to have been tested in Scotland. But it has been rendered academic by the decision in Bank of Scotland v Davis that post-judgment interest at the contractual rate may be awarded in the sheriff court. In contrast to the position which applies in England under the County Courts (Interest on Judgment Debts) Order 1991, section 1(7) of the Debtors (Scotland) Act 1987 provides that interest may be recovered on a time to pay order pronounced in the sheriff court if the creditor has given notice to the debtor of his intention to claim interest: see also the Act of Sederunt (Summary Applications, Statutory Applications and Appeals etc Rules) 1999 (SI 1999/929) which prescribes the form of notice which is to be used. There is no provision which excludes regulated agreements from this power.
52. As Lord Millett has observed, the Scottish practice of awarding post- judgment interest at the contractual rate in the sheriff court avoids the uncertainty, confusion and hardship which would otherwise arise if the borrower were to be exposed to further proceedings to satisfy the bank’s claim for interest at the contractual rate. Like him, I do not think that it would be right to express a view in this case as to whether the Scottish practice could be followed under existing law and practice in England in the county court. But I suggest that consideration should now be given to the question whether the present constraints on the awarding of interest in the county court should be relaxed to enable this to be done. Any such relaxation could be combined with the making of rules, similar to those in the 1999 Act of Sederunt, designed to ensure that a borrower against whom proceedings were brought is made fully aware at the outset of the powers which the county court has under the relevant statutes to prevent hardship.
LORD MILLETT
My Lords,
53. I have had the advantage of reading in draft the speech of my noble and learned friend Lord Bingham of Cornhill. I agree with it, and for the reasons he gives I too would allow the appeal. Because of the importance of the case, and because the real source of the problem remains to be tackled, I propose to add a few brief observations of my own.
54. A contractual term in a consumer contract is unfair if “contrary to the requirement of good faith [it] causes a significant imbalance in the parties’ rights and obligations under the contract to the detriment of the consumer”. There can be no one single test of this. It is obviously useful to assess the impact of an impugned term on the parties’ rights and obligations by comparing the effect of the contract with the term and the effect it would have without it. But the inquiry cannot stop there. It may also be necessary to consider the effect of the inclusion of the term on the substance or core of the transaction; whether if it were drawn to his attention the consumer would be likely to be surprised by it; whether the term is a standard term, not merely in similar non-negotiable consumer contracts, but in commercial contracts freely negotiated between parties acting on level terms and at arms’ length; and whether, in such cases, the party adversely affected by the inclusion of the term or his lawyer might reasonably be expected to object to its inclusion and press for its deletion. The list is not necessarily exhaustive; other approaches may sometimes be more appropriate.
55. The substance of the transaction in the present case is self-evident. It is a loan repayable by instalments with interest on the balance from time to time outstanding until the whole of the principal is repaid. The borrower would have no difficulty in understanding this. Nor would he think it unfair. If his attention were drawn to the impugned term, ie that interest should continue to be paid on the outstanding balance after as well as before judgment, he might well be surprised at the need to spell this out, but he would surely not be at all surprised by the fact. It is what he would expect. The term does not affect the substance of the transaction, which is that the borrower should continue to pay interest on the principal from time to time outstanding, nor does it impose any further or unexpected liability upon him not inherent in the basic transaction. It is included only to protect the lender from the (to modern eyes artificial) meaning placed on a covenant to pay interest by the Court of Appeal in In re Sneyd, Ex p Fewings (1883) 25 Ch D 338, where a covenant to pay interest on the balance of the principal sum from time to time remaining unpaid was construed as meaning remaining due under the covenant, so that it fell when the covenant was subsumed in the judgment.
56. The term is not only a standard term in non-negotiable loans to consumers, but in commercial loans freely negotiated between parties on equal terms and acting with professional advice. I venture to think that no lawyer advising a commercial borrower would dream of objecting to the inclusion of such a term, which merely reinforces and carries into effect what the parties themselves would regard as the essence of the transaction.
57. I am satisfied, therefore, that the term is not unfair. It does not cause an imbalance in the parties’ rights and obligations; and the lender did not act in bad faith by taking advantage of the borrower’s weakness of bargaining power or lack of professional advice to insist upon a term which would otherwise have been omitted.
58. This is not to say that the many complaints which the Director General has received from borrowers are without substance. These are borrowers who have failed to keep up the instalments and suffered a judgment in consequence. Asked to suggest terms on which they can satisfy the judgment, they offer to pay it off by instalments. They are advised to offer as much as they can afford. They do so; their offer is accepted; and they duly pay all the instalments required of them. Despite having done so, they find that they have not discharged their contractual obligations but are still liable in respect of interest which has accrued since judgment and which was not covered by the instalment agreement. Where the agreed instalments are insufficient to keep interest down, the amount still outstanding when all the instalments have been paid is greater than the amount for which judgment was given.
59. Despite the fact that lenders draw attention to these consequences when inviting borrowers to agree terms of repayment, they must still come as a nasty shock to many of them. I think that they have a legitimate grievance. A man who breaks his contract, suffers a judgment, makes an offer which is accepted to satisfy the judgment by instalments, and duly pays all the instalments required of him, would expect to be discharged from all further liability. The reason that this is not the case is that the amount for which judgment is given is not co-extensive with the amount for which the borrower is contractually liable. The practice in England and Wales is for the court to give judgment for the amount of principal and interest outstanding at the date of judgment, without reference to the borrower’s continuing liability to pay interest on the outstanding balance of the principal sum after judgment. This has the unfortunate (though not I think the inevitable) consequence that the parties subsequently agree terms of repayment of the judgment debt rather than of the borrower’s greater contractual liability.
60. This does not happen in Scotland, where I understand the courts give judgment for the arrears of principal and interest at the date of judgment together with interest at the contractual rate on the arrears of principal until payment. If the judgment were in that form, then the borrower’s compliance with a repayment schedule designed to satisfy the judgment debt would automatically discharge his contractual obligations. This would avoid the unfairness that occurs where a borrower who could not afford the instalments necessary to discharge his contractual obligations is induced to offer the smaller or fewer instalments sufficient to satisfy the judgment, and (because he can afford them) refrains from applying for relief while leaving himself exposed to further proceedings.
61. But this unfairness does not arise from any inherent unfairness of the term. It is due to the limited nature of the judgment and the fact that it does not cover the whole of the borrower’s indebtedness to the lender. I am not myself convinced that an English court could not make an order in the same form as the Scottish courts do; and there is old authority that it could do so: Arnott v Redfern (1826), 3 Bing 353. Counsel were unable to identify any persuasive reason why it cannot. But we have heard no argument on the question, and it would be wrong to express any concluded view on so important a matter without full argument. In the meantime I would hope either (i) that lenders would invite borrowers to agree instalment terms to discharge the contractual indebtedness and not merely the judgment debt or (ii) that administrative arrangements could be made so that instalment agreements which left an outstanding contractual liability were automatically referred to the district judge for consideration.
LORD RODGER OF EARLSFERRY
My Lords,
62. I have had the opportunity of reading the speech of my noble and learned friend Lord Bingham in draft and, for the reasons which he gives, I too would allow the appeal. I add two short observations.
63. On behalf of the appellants Lord Goodhart submitted that the last sentence in condition 8 fell within regulation 3(2)(b) of the Unfair Terms in Consumer Contracts Regulations 1994 which provides:
“In so far as it is in plain, intelligible language, no assessment shall be made of the fairness of any term which –
…
(b) concerns the adequacy of the price or remuneration, as against the goods or services sold or supplied.”
This is a transposition of part of article 4(2) of Directive 93/13/EEC:
“Assessment of the unfair nature of the terms shall relate neither to the definition of the main subject matter of the contract nor to the adequacy of the price and remuneration, on the one hand, as against the services or goods supplied in exchange, on the other, in so far as these terms are in plain intelligible language.”
It is common ground, of course, that the domestic regulation requires to be read in conformity with the meaning of the directive.
64. At first sight the language of both the regulation and the directive is somewhat strange since it might seem to suggest that the court is not to consider the fairness of a term which concerns “the adequacy”, in its usual sense of “the sufficiency”, of the price or remuneration as against the goods or services sold or supplied. But it is obvious from the context that this cannot be what is intended. In his opinion Evans-Lombe J accepted a submission to the effect that “adequacy” must be read “as meaning the equivalent of ‘the extent of … the remuneration’ “: Director General of Fair Trading v First National Bank PLC [2000] 1 WLR 98, at p. 107 B – C. That interpretation seems to me to risk watering down what the directive may have intended. While the point was not explored before us and I therefore express no concluded view on it, I note that the French text of the directive uses the word “adéquation” and the German text the word “Angemessenheit”. Both may suggest that what is in issue is the “appropriateness” of the price or remuneration as compared with the services or goods – in other words whether there is an equivalence between the services or goods and the consideration for them. This would seem to be consistent with the reference to “the price/quality ratio” in the nineteenth recital. It may therefore be that “adequacy” in both the directive and the regulations should be interpreted in that spirit. Which is indeed how I understand your Lordships to have approached the matter.
65. The appeal reveals that, under the system that prevails in England and Wales, a borrower may punctually pay all the instalments required of him under a time order and still find, to his dismay, that he owes money to the bank because post-judgment interest has been accruing and has not been factored into the instalments. I share the general view that this is a highly unsatisfactory state of affairs. Basing himself on this unsatisfactory position, in one part of his argument the Director General suggested that the final sentence of condition 8, which ensures that post-judgment interest is recoverable, is unfair because the bank do not draw attention to the borrower’s rights under section 129 of the Consumer Credit Act 1974 to apply for a time order and, more particularly perhaps, under section 136 to ask the court making a time order to amend the loan agreement. The suggestion was that, if the borrower were made aware of the powers and drew attention to it, the county court judge might use section 136 to adjust the rate of post-judgment interest so as to ensure that the borrower who duly paid the required instalments thereby discharged the whole of his liability to the bank.
66. I agree with your Lordships that condition 8 cannot be regarded as unfair simply because the bank do not draw the borrower’s attention to the remedies that may be available under the 1974 Act. The Act itself does not require that the borrower should be alerted to the effect of sections 129 and 136. But if the Director General thinks that the borrower’s attention should be drawn to this matter at the time when the agreement is made, then he has powers under the Act to deal with the situation. The form and content of documents embodying regulated agreements, such as the agreement in this case, are prescribed by regulations made by the Secretary of State under section 60(1) of the 1974 Act. In terms of paragraph (c) of that subsection the Secretary of State may make such provisions as appear to him appropriate with a view to ensuring that the debtor is made aware of the protection and remedies available to him under the Act. It would therefore be open to the Secretary of State to amend the relevant regulations so as to require the prescribed form of agreement to include a reference to the borrower’s remedies under sections 129 and 136. This is a matter as to the working of the regulations on which the Director General could advise the Secretary of State, in the exercise of his general duty under section 1(2)(b) of the Act.
Kreglinger v. New Patagonia Meat And Cold Storage Co., Ltd
[1913] UKHL 843 [1913] UKHL 843, 51 SLR 843
Bight in Security — Mortgage — Validity of a Condition Limiting the Right of Redemption — Stipulation for a Collateral Advantage — Floating Charge.
Facts:
The appellants sought to enforce an option granted them under an agreement by the respondents in consideration for a loan on the security of a mortgage. The loan having been repaid prior to the expiry of the option, the respondents declined to further implement the agreement, on the ground that the option granted to the appellants was of the nature of a collateral advantage limiting the debtor’s right of redemption.
Held that the stipulation in the agreement did not limit the right of redemption, and was therefore valid.
Observed per Lord Parker—There is now no rule in equity which precludes a mortgagee from stipulating for any collateral advantage, provided it is not either (1) unfair and unconscionable, or (2) in the nature of a penalty clogging the equity of redemption, or (3) inconsistent with the contractual and equitable right to redeem.
Observed per Lord Chancellor—The same general principles apply to a floating charge (vide De Beers, Limited v. British South Africa Company, 1912 A.C. 52, where there are dicta to the contrary).
Observations per Lord Chancellor on “the true limits of the use of authority.”
Noakes v. Rice, 1902 AC 24; Bradley v. Carritt, 1903 AC 253; Samuel v. Jarrah Timber, &c., Corporation, 1904 AC 323, distinguished.
Headnote:
The judgment of the Lord Chancellor contains the following statement of the facts and the arguments of the parties:—“The appellants are a firm of merchants and wool brokers. The respondents carry on the business of preserving and canning meat, and of boiling down the carcases of sheep and other animals. In the course of this business they have at their disposal a large number of skeepskins. It appears that in the summer of 1910 the respondents were desirous of borrowing £10,000, and requested the appellants to advance that sum. The appellants, who were desirous of obtaining an option to purchase for a term of five years all the sheepskins at the respondents’ disposal, agreed to lend the money in consideration of being given such an option. The negotiations which followed resulted in an agreement dated the 24th August 1910. Under this agreement the appellants were to lend the respondents the sum of £10,000, repayable on demand, with interest at 6 per cent. If, however, among other conditions to be observed, the interest was duly paid, the appellants were not to demand repayment till the 30th September 1915, but the respondents were to be at liberty to pay off the loan earlier. To secure the loan the respondents by the agreement charged their undertaking and all their property, both present and future, with the payment of the principal sum and interest, to the intent that the charge should be a floating security on the undertaking and property, but so that the respondents should not create any mortgage or charge in priority without the appellants’ consent, or without such consent sell their farms or lands. The principal sum was to become payable in certain prescribed events. By clause 8 of the agreement the respondents were not for five years from the date of the agreement, i.e., till the 24th August 1915, to sell sheepskins to anyone excepting the appellants so long as the latter were willing to buy at a price equal to the best price (c.i.f. London) offered by anyone else, and the respondents were to pay to the appellants a commission of 1 per cent. on the sale price of all sheepskins sold by the respondents to anyone else.
“The respondents have now, as they were entitled to do under the agreement, paid off the loan. They claim that such payment has put an end to the option of the appellants to buy the respondents’ sheepskins. Under the terms of the agreement this option, as I have already stated, will, if it is
valid, continue operative until the 24th August 1915. What the respondents say is that the stipulation is one that restricts their freedom in conducting the undertaking or business which is the subject of the floating charge, that it was consequently of the nature of a clog of their right to redeem and invalid, and that whether it clogged the right to redeem or was in the nature of a collateral advantage, it was not intended and could not be made to endure after redemption. The appellants, on the other hand, say that the stipulation in question was one of a kind usual in business, and that it was in the nature, not of a clog, but of a collateral bargain outside the actual loan which they only agreed to make in order to obtain the option itself. They further say that even if the option could be regarded as within the doctrine of equity which forbids the clogging of the right to redeem, that doctrine does not in a case such as this extend to a floating charge.
“The controversy which has thus arisen was brought before Swinfen Eady, J., on a motion for an interlocutory injunction to restrain the respondents from selling sheepskins to anyone else than the appellants. The learned Judge refused this motion on the ground that the point had been settled adversely to the appellants by decisions of your Lordships’ House. The case was brought formally before the Court of Appeal, but was disposed of there without argument with a view to taking the point as speedily as possible before your Lordships for review.”
The respondents founded on Noakes v. Rice, Bradley v. Carritt, and Samuel v. Jarrah Timber, &c., Corporation (vide supra) to show that a collateral stipulation relating to a mortgage formed part of and ended with the mortgage itself.
Their Lordships took time to consider their judgment.
Judgment:
Lord Chancellor—[ After stating the facts set out above, continued]—Before I refer to the decisions of this House which the Courts below have considered to cover the case, I will state what I conceive to be the broad principles which must govern it.
The reason for which a court of equity will set aside the legal title of a mortgagee and compel him to reconvey the land on being paid principal, interest, and costs is a very old one. It appears to owe its origin to the influence of the Church in the courts of the early Chancellors. As early as the Council of Lateran in 1178 we find, according to Matthew Paris—Historia Major, at pp. 114–5—that famous assembly of ecclesiastics condemning usurers, and laying down that when a creditor had been paid his debt he should restore his pledge. It was therefore not surprising that the Court of Chancery should at an early date have begun to exercise jurisdiction in personam over mortgagees. This jurisdiction was merely a special application of a more general power to relieve against penalties and to mould them into mere securities. The case of the common law mortgagee of land was indeed a gross one. The land was conveyed to the creditor upon the condition that if the money he had advanced to the feoffor was repaid on a date and at a place named the fee-simple should revest in the latter, but that if the condition was not strictly and literally fulfilled he should lose the land for ever. What made the hardship on the debtor a glaring one was that the debt still remained unpaid and could be recovered from the feoffor, notwithstanding that he had actually forfeited the land to his mortgagee. Equity, therefore, at an early date began to relieve against what was virtually a penalty by compelling the creditor to use his legal title as a mere security.
This was the origin of the jurisdiction which we are now considering, and it is important to bear that origin in mind, for the end to accomplish which the jurisdiction has been evolved ought to govern and limit its exercise by equity judges. That end has always been to ascertain, by parole evidence if need be, the real nature and substance of the transaction, and if it turned out to be in truth one of mortgage simply to place it on that footing. It was in ordinary cases only where there was conduct which the Court of Chancery regarded as unconscientious that it interfered with freedom of contract. The lending of money on mortgage or otherwise was looked on with suspicion, and the Court was on the alert to discover want of conscience in the terms imposed by lenders. But whatever else may have been the intention of those judges who laid the foundations of the modern doctrines with which we are concerned in this appeal, they certainly do not appear to have contemplated that their principle should develop consequences which would go far beyond the necessities of the case with which they were dealing, and interfere with transactions which were not really of the nature of a mortgage and which were free from objection on moral grounds. Moreover, the principle on which the Court of Chancery interfered with contracts of the class under consideration was not a rigid one. The equity judges looked not at what was technically the form, but at what was really the substance of transactions, and confined the application of their rules to cases in which they thought that in its substance the transaction was oppressive. Thus in Howards v. Harris, 1 Vern.32, Lord Keeper North in 1683 set aside an agreement that a mortgage should be irredeemable after the death of the mortgagor and failure of the heirs of his body, on the ground that such a restriction on the right to redeem was void in equity. But he went on to intimate that if the money had been borrowed by the mortgagor from his brother, and the former had agreed that if he had no issue the land should become irredeemable, equity would not have interfered with what would really have been a family arrangement. The exception thus made to the rule, in cases where the transaction includes a family arrangement as well as a mortgage, has been recognised in later authorities.
The principle was thus in early days limited in its application to the accomplishment of the end which was held to justify
interference of equity with freedom of contract. It did not go further. As established it was expressed in three ways.
The most general of these was that if the transaction was once found to be a mortgage, it must be treated as always remaining a mortgage and nothing but a mortgage. That the substance of the transaction must be looked to in applying this doctrine, and that it did not apply to cases which were only apparently or technically within it, but were in reality something more than cases of mortgage— Howard v. Harris and other authorities show this. It was only a different application of the paramount doctrine to lay it down in the form of a second rule that a mortgagee should not stipulate for a collateral advantage which would make his remuneration for the loan exceed a proper rate of interest. The Legislature during a long period placed restrictions on the rate of interest which could legally be exacted. But equity went beyond the limits of the statutes which limited the interest, and was ready to interfere with any usurious stipulation in a mortgage. In so doing it was influenced by the public policy of the time. That policy has now changed, and the Acts which limited the rate of interest have been repealed. The result is that a collateral advantage may now be stipulated for by the mortgagee, provided that he has not acted unfairly or oppressively, and provided that the bargain does not conflict with the third form of the principle. This is that a mortgage (subject to the apparent exception in the case of family arrangements to which I have already alluded) cannot be made irredeemable, and that any stipulation which restricts or clogs the equity of redemption is void. It is obvious that the reason for the doctrine in this form is the same as that which gave rise to the other forms.—It was simply an assertion in a different way of the principle that once a mortgage always a mortgage and nothing else.
The rules I have stated have now been applied by courts of equity for nearly three centuries, and the books are full of illustrations of their application. But what I have pointed out shows that it is inconsistent with the objects for which they were established that these rules should crystallize into technical language so rigid that the letter could defeat the underlying spirit and purpose. Their application must correspond with the practical necessities of the time.
The rule as to collateral advantages, for example, has been much modified by the repeal of the usury law and by the recognition of modern varieties of commercial bargaining. In Biggs v. Hoddinot (1898, 2 Ch. 307) it was held that a brewer might stipulate in a mortgage made to him of an hotel that during the five years for which the loan was to continue the mortgagor would deal with him exclusively for malt liquor. In the seventeenth and eighteenth centuries a court of equity could hardly have so decided, and the judgment illustrates the elastic character of equity jurisdiction and the power of equity judges to mould the rules which they apply in accordance with the exigencies of the time. The decision proceeded on the ground that a mortgagee may stipulate for a collateral advantage at the time and as a term of the advance, provided, first, that no unfairness is shown, and secondly, that the right to redeem is not thereby clogged. It is no longer true that, as was said in Jennings v. Ward (2 Vern. 520), “a man shall not have interest for his money and a collateral advantage besides for the loan of it.” Unless such a bargain is unconscionable it is now good. But none the less the other and wider principle remains unshaken that it is the essence of a mortgage that in the eye of a court of equity it should be a mere security for money, and that no bargain can be validly made which will prevent the mortgagor from redeeming on payment of what is due, including principal, interest, and costs. He may stipulate that he will not pay off his debt and so redeem his mortgage for a fixed period. But whenever a right to redeem arises out of the doctrine of equity he is precluded from fettering it. This principle as become an integral part of our system of jurisprudence and must be faithfully adhered to.
The question in the present case is whether the right to redeem has been interfered with. And this must, for the reasons to which I have adverted in considering the history of the doctrine of equity, depend on the answer to a question which is primarily one of fact. What was the true character of the transaction? Did the appellants make a bargain such that the right to redeem was cut down, or did they simply stipulate for a collateral undertaking, outside and clear of the mortgage, which would give them an exclusive option of purchase of the sheepskins of the respondents? The question is, in my opinion, not whether the two contracts were made at the same moment and evidenced by the same instrument, but whether they were in substance a single and undivided contract or two distinct contracts. Putting aside for the moment considerations turning on the character of the floating charge, such an option no doubt affects the freedom of the respondents in carrying on their business even after the mortgage has been paid off. But so might other arrangements which would be plainly collateral—an agreement, for example, to take permanently into the firm a new partner as a condition of obtaining fresh capital in the form of a loan. The question is one, not of form but of substance, and it can be answered in each case only by looking at all the circumstances and not by mere reliance on some abstract principle, or upon the dicta which have fallen obiter from judges in other and different cases. Some at least of the authorities on the subject disclose an embarrassment which has, in my opinion, arisen from neglect to bear this in mind. In applying a principle, the ambit and validity of which depend on confining it steadily to the end for which it was established, the analogies of previous instances where it has been applied are apt to be misleading. For each case forms a real precedent only in so far as it affirms a principle,
the relevancy of which in other cases turns on the true character of the particular transaction, and to that extent on circumstances.
If in the case before the House your Lordships arrive at the conclusion that the agreement for an option to purchase the respondents’ sheepskins was not in substance a fetter on the exercise of their right to redeem, but was in the nature of a collateral bargain the entering into which was a preliminary and separable condition of the loan, the decided cases cease to present any difficulty. In questions of this kind the binding force of previous decisions, unless the facts are indistinguishable, depends on whether they establish a principle. To follow previous authorities, so far as they lay down principles, is essential if the law is to be preserved from becoming unsettled and vague. In this respect the previous decisions of a court of co-ordinate jurisdiction are more binding in a system of jurisprudence such as ours is than in systems where the paramount authority is that of a code. But when a previous case has not laid down any new principle, but has merely decided that a particular set of facts illustrates an existing rule, there are few more fertile sources of fallacy than to search in it for what is simply resemblance in circumstances, and to erect a previous decision into a governing precedent merely on this account. To look for anything except the principle established or recognised by previous decisions is really to weaken and not to strengthen the importance of precedent. The consideration of cases which turn on particular facts may often be used for edification, but it can rarely yield authoritative guidance. I desire to associate myself with what was said on this subject by Sir George Jessel in the case of re Hallett’s Estate (13 Ch. Div. 696), and I will add that the view of the true limits of the use of authority, which I agree with him in holding is of especial importance where, as here, the principle to be applied arises in the elastic jurisdiction of a court of equity, and has been established simply as an instrument to give effect to well—defined and governing purpose.
It is not, in my opinion, necessary for your Lordships to form an opinion as to whether you would have given the same decisions as were recently given by this House in certain cases which were cited to us. These cases, which related to circumstances differing widely from those before us, have been disposed of finally, and we are not concerned with them excepting in so far as they may have thrown fresh light on questions of principle. What is vital in the appeal now under consideration is to classify accurately the transaction between the parties. What we have to do is to ascertain from scrutiny of the circumstances whether there has really been an attempt to effect a mortgage with a provision preventing redemption of what was pledged merely as security for payment of the amount of the debt and any charges besides that may legitimately be added. It is not, in my opinion, conclusive in favour of the appellants that the security assumed the form of a floating charge. A floating charge is not the less a pledge because of its floating character, and a contract which fetters the right to redeem, on which equity insists as regards all contracts of loan and security, ought on principle to be set aside as readily in the case of a floating security as in any other case. But it is material that such a floating charge, in the absence of bargain to the contrary effect, permits the assets to be dealt with freely by the mortgagor until the charge becomes enforceable. If it be said that the undertaking of the respondents which was charged included their entire business, including the right to dispose of the skins of which they might from time to time become possessed, the comment is that at least they were to be free, so long as the security remained a floating one, to make contracts in the ordinary course of business in regard to these skins. If there had been no mortgage such a contract as the one in question would have been an ordinary incident in such a business. We are considering the simple question of what is the effect on the right to redeem of having inserted into the formal instrument signed when the money was borrowed an ordinary commercial contract for the sale of skins extending over a period. It appears that it was the intention of the parties that the grant of the security should not affect the power to enter into such a contract either with strangers or with the appellants, and if so I am unable to see how the equity of redemption is affected. No doubt it is the fact that on redemption the respondents will not get back their business as free from obligation as it was before the date of the security. But that may well be, because outside the security and consistently with its terms there was a contemporaneous but collateral contract, contained in the same document as constituted the security but in substance independent of it. If it was the intention of the parties, as I think it was, to enter into this contract as a condition of the respondents getting their advance, I know no reason either in morals or in equity which ought to prevent this intention from being left to have its effect. What was to be capable of redemption was an undertaking which was deliberately left to be freely changed in its details by ordinary business transactions with which the mortgage was not to interfere. Had the charge not been a floating one, it might have been more difficult to give effect to this intention.
In Noakes v. Rice (1902 AC 24) this difficulty is illustrated, for the House held that what had been inserted in the shape of a covenant by the mortgagor to buy the beer of the mortgagee after redemption of the public-house mortgaged was really a term of the mortgage and was inoperative as being, not merely a collateral agreement, but in truth a restriction on the right to get back the security free from the terms of the mortgage. That was the case of a mortgage of a specific property. The decision that the transaction was what it was held to be is, at all events, readily intelligible. In Bradley v. Carritt (1903 AC 253)
it was decided that the mortgagor of shares in a tea company who had covenanted that he would use his best endeavours to secure that always thereafter the mortgagee should have the sale of the company’s tea had permanently fettered himself in the free disposition and enjoyment of the shares. It was held that though the covenant did not operate in rem of the shares it amounted to a device or contrivance designed to impede redemption. The decision was a striking one. It was not unanimous, for Lord Lindley dissented from the conclusions of Lord Macnaghten and Lord Davey. It is binding on your Lordships in any case in which the transaction is really of the same kind, although it does not follow that all the dicta in the judgments of those of your Lordships’ House, who were in a majority, must be taken as of binding authority. And it certainly cannot, in my opinion, be taken as authoritatively laying down that the mere circumstance that after redemption the property redeemed may not, as the result of some bargain made at the time of the mortgage, be in the same condition as it was before that time is conclusive against the validity of that bargain. To render it invalid, the bargain must when its substance is examined turn out to have formed part of the terms of the mortgage and to have really cut down a true right of redemption.
I think that the tendency of recent decisions has been to lay undue stress on the letter of the principle which limits the jurisdiction of equity in setting aside contracts. The origin and reason of the principle ought, as I have already said, to be kept steadily in view in applying it to fresh cases. There appears to me to have grown up a tendency to look to the letter rather than to the spirit of the doctrine. The true view is, I think, that judges ought in this kind of jurisdiction to proceed cautiously, and to bear in mind the real reasons which have led courts of equity to insist on the free right to redeem and the limits within which the purpose of the rule ought to confine its scope. I cannot but think that the validity of the bargain in such cases as Bradley v. Carritt and Santley v. Wilde (1899, 2 Ch. 474) might have been made free from serious question if the parties had chosen to seek what would have been substantially the same result in a different form. For form may be very important when the question is one of the construction of ambiguous words in which people have expressed their intentions. I will add that if I am right in the view which I take of the authorities, there is no reason for thinking that they establish another rule suggested by the learned counsel for the respondents that even a mere collateral advantage stipulated for in the same instrument as constitutes the mortgage cannot endure after redemption. The dicta on which he relied are really illustrations of the other principles to which I have referred.
There is a further remark which I wish to make about Bradley v. Carritt. It is impossible to read the report without seeing that there was a marked divergence of opinion among those members of your Lordships’ House who took part in the decision as to the test by which the validity of contracts collateral to a mortgage is to be determined. Lord Davey observes that he cannot understand how, consistently with the doctrine of equity, a mortgagee can insist on retaining the benefit of a covenant in the mortgage contract materially affecting the enjoyment of the mortgaged property after redemption. Lord Lindley, on the other hand, doubts whether the covenant in question, a covenant that the mortgagor would use his influence as a shareholder to secure for the mortgagee in permanence the brokerage business of the company, ought to be looked on as really forming part of the terms of the security. He points out that when the usury laws were in force, and when every device for evading them had to be defeated by equity, the proposition that everything that was part of the mortgage transaction must cease with it, if it was not to infringe the doctrine that once a mortgage always a mortgage, was a convenient statement, and as free from objection as most concise statements are, but that when the usury laws were abolished the language was too wide to be accurate.
The views expressed by Lord Davey and Lord Lindley are not, so far as the mere words go, contradictory. But I cannot shut my eyes to the fact that they represent divergent tendencies. Lord Davey seems to suggest that the doctrine about which, when expressed in general terms, there is little controversy, had become finally crystallised in the particular expressions used in certain of the earlier authorities, and that, having become thus rigid, it is to-day fatal to the freedom of mortgagor and mortgagee to make their own bargains even in cases where the reason for applying the doctrine has ceased to exist. The tendency of Lord Lindley’s language is, on the other hand, to treat the application of such a rule as a question in which the courts must not lose sight of the the dominating principle underlying the reasons which originally influenced the terms of the rule—reasons which have in certain cases become modified as public policy has changed. Speaking for myself, and notwithstanding the high authority of Lord Davey, I think that the tendency of Lord Lindley’s conclusion is the one which is most consonant with principle, and I see no valid reason why this House should not act in accordance with it in the case now under consideration.
The decision of this House in De Beers Consolidated Mines, Limited v. British South Africa Company (1912, A.C. 52) does not assist us much, because it really turned on the facts. It was held that the stipulation for the licence in question was not part of the mortgage transaction, and this disposed of the appeal. The question was, however, raised, whether the general principles of equity in regard to the right to redeem apply in their integrity to mortgages by way of floating charge. I have
already expressed all that it seems to me necessary to say on the point.
The Earl Of Halsbury said he had read the judgments of the Lord Chancellor and Lord Parker and concurred in them and did not desire to add anything.
Lord Atkinson said he had also read these judgments and concurred.
Lord Mersey—I agree, and I desire to add only a few words. The transaction out of which this dispute arises is sufficiently described in the judgment of the Lord Chancellor. Though embodied in one document it is an agreement made up of two parts. The first part consists of a promise by the appellants, who are merchants, to lend to the respondents, who are a trading company, money at interest on the security of a floating charge over the company’s undertaking; the second part consists of an agreement by the company to give to the lenders the option of purchasing for a time their periodical production of sheepskins. The whole transaction is of a most ordinary commercial kind.
If is contended that the contract is a mortgage to which the equitable doctrine prohibiting the imposition of a clog on the mortgagor’s right to redeem applies, and that therefore on payment off of the loan the borrowers are entitled to have back their undertaking freed from any further obligation to sell or deliver sheepskins. Now whether a transaction is or is not such a mortgage is a question of intention, and it seems that it has always been the practice of the Court of Chancery to admit oral evidence to assist in solving the question. No such evidence is forthcoming in this case, so that your Lordships are left (I think rightly) to determine the intention merely from the words which the parties have used in drawing up their agreement, These words are, in my opinion, too plain and simple to leave any doubt as to their meaning. The obligation to sell sheepskins created by clause 8 of the agreement was to endure in any event until August 1915. That was the plain intention of both parties to the agreement, and the only effect of applying to the contract the equitable doctrine against clogging the right to redeem would be to defeat that intention and to enable one of the parties to inflict an injustice on the other.
I have nothing to say about the doctrine itself. It seems to me to be like an unruly dog, which if not securely chained to its own kennel is prone to wander into places where it ought not to be. Its introduction into the present case would give effect to no equity and would defeat justice.
Lord Parker—The defendants in this case are appealing to the equitable jurisdiction of the Court for relief from a contract which they admit to be fair and reasonable, and of which they have already enjoyed the full advantage. Their title to relief is based on some equity which they say is inherent in all transactions in the nature of a mortgage. They can state no intelligible principle underlying the) alleged equity, but contend that your Lordships are bound by authority. That the Court should be asked in the exercise of its equitable jurisdiction to assist in so inequitable a proceeding, or the repudiation of a fair and reasonable bargain, is somewhat startling, and makes it necessary to examine the point of view from which courts of equity have always regarded mortgage transactions. For this purpose I have referred to most, if not all, of the reported cases on the subject, and propose to state shortly the conclusions at which I have arrived.
A legal mortgage has generally taken the form of a conveyance, with a proviso for reconveyance on the payment of money by a specified date. But a conveyance in this form is by no means necessarily a mortgage. In order to determine whether it is or is not a mortgage, equity has always looked to the real intentions of the parties, to be gathered not only from the terms of the particular instrument but from all the circumstances of the transaction, and has always admitted parole evidence in cases where the real intention is in doubt. Only if according to the real intention of the parties the property was to be held as a pledge or security for the payment of the money, and as such to be restored to the mortgagor when the money was paid, was the conveyance considered to be a mortgage. Further, the mortgage might be given to secure not only a single money payment but a series of money payments extending over many years, and again, the money secured might or might not, according to the circumstances, constitute a debt due from mortgagor to mortgagee. There might also be mortgages by way of security for something other than a money payment or series of money payments—for example, mortgages by way of indemnity— but these may be disregarded for the purposes of this case.
Taking the simple case of a mortgage by way of conveyance, with a proviso for reconveyance on payment of a sum of money upon a specified date, two events might happen. The mortgagor might pay the money on the specified date, in which case equity would specifically perform the contract for reconveyance. On the other hand, the mortgagor might fail to pay the money on the date specified for that purpose. In this case the property conveyed became at law an absolute interest in the mortgagee. Equity, however, did not treat time as of the essence of the transaction, and hence on failure to exercise what may be called the contractual right to redeem there arose an equity to redeem notwithstanding the specified date had passed. Till this date had passed there was no equity to redeem, and a bill either to redeem or foreclose would have been demurrable. The equity to redeem, which arises on failure to exercise the contractual right of redemption, must be carefully distinguished from the equitable estate, which from the
first remains in the mortgagor, and is sometimes referred to as an equity of redemption.
Now if, as was not infrequently the case, such a legal mortgage as above described contained a further stipulation that if default were made in payment of the money secured on the date specified, the mortgagor should not exercise his equitable right to redeem, or should only exercise it as to part of the mortgaged property, or on payment of some additional sum, or performance of some additional condition, such stipulation was always regarded in equity as a penal clause against which relief would be given. This is the principle underlying the rule against fetters or clogs on the equity of redemption. The rule may be stated thus—The equity which arises on failure to exercise the contractual right cannot be fettered or clogged by any stipulation contained in the mortgage or entered into as part of the mortgage transaction. This rule is equally applicable to all transactions of mortgage, whether the mortgagor is or is not under personal liability to pay the money secured, and whether or not the mortgage is given to secure a loan made at the time of the mortgage or some existing debt of the mortgagee. For example, it would be applicable to a mortgage with a proviso for reconveyance on the payment to the mortgagee by the mortgagor or a third party of moneys owing by such third party to the mortgagee.
By way of illustration of this rule I will ask your Lordships’ attention to the case of Salt v. Marquis of Northampton (1892, A.C. 1), which came to your Lordships’ House. In that case an insurance society had advanced £10,000 to Lord Compton on the security of a reversionary interest to which he was entitled if he survived his father. Pursuant to the agreement made upon the occasion of the advance, the society insured Lord Compton’s life against the life of his father, and paid the premiums on this policy up to the father’s death. This agreement contained a provision that if Lord Compton during his father’s life repaid to the society this £10,000 and the amount of the premiums with interest, the policy should belong to Lord Compton, but if Lord Compton died in his father’s lifetime without having repaid the £10,000 and the premiums with interest the policy should belong to the society. It was this latter event which happened, and the question arose whether the policy belonged to the society or whether it was redeemable on payment of what was due in respect of the moneys advanced and the premiums and interest. If the policy when taken out pursuant to the agreement was in equity the property of the mortgagor, it was part of the property which he had mortgaged to secure the advance, and there being a contractual right to redeem during his father’s life, and an equitable right to redeem arising if the contractual right were not exercised, the clause providing that if the contractual right were not exercised the policy should belong to the society was in the nature of a penalty against which equity would relieve. It was a clog on the equity in the proper sense of that expression. It having been held that the policy did in equity from the first belong to the mortgagor, it followed that the provision in question was void as a clog on the equity.
There is another point which has some importance—namely, the terms upon which equity allowed redemption after the estate had become absolute at law. Except in the case of mortgages to secure moneys advanced by way of loan, to which I shall presently refer, equity only allowed redemption on the mortgagor giving effect so far as he could to the terms on which by the bargain between the parties he had a contractual right to redeem the property. Equity might, and most frequently did, confer further terms, e.g., payment of interest up to the date of redemption and proper mortgagees’ costs. But except in the case of mortgages to secure moneys advanced by way of loan, I can find no trace in the authorities of any equitable right to redeem without giving effect as far as possible to the terms of the bargain. This is consistent with the principle underlying the rule as to clogging the equity. In relieving from penalties or forfeitures equity has always endeavoured to put the parties as far as possible into the position in which they would have been if no penalty or forfeiture had occurred. It is only in the case of mortgages to secure moneys advanced by way of loan that there was ever any equity to redeem on terms not involving performance of the bargain between the parties. The reason for this exception will appear presently.
There is another point of view from which a clog or fetter on the equitable right to redeem may be properly regarded. The nature of the equitable right is so well known that upon a mortgage in the usual form to secure a money payment on a certain day it must be taken to be a term of the real bargain between the parties that the property should remain redeemable in equity after failure to exercise the contractual right. Any fetter or clog imposed by the instrument of mortgage on this equitable right may be properly regarded as a repugnant condition and as such invalid. There are, however, repugnant conditions which cannot be regarded as mere penalties intended to deter in the exercise of the equitable right which arises when the time for the exercise of the contractual right has gone by, but which are repugnant to the contractual right itself. A condition to the effect that if the contractual right is not exercised by the time specified the mortgagee shall have an option of purchasing the mortgaged property may properly be regarded as a penal clause. It is repugnant only to the equity and not to the contractual right. But a condition that the mortgagee is to have such an option for a period which begins before the time for the exercise of the statutory right has arrived, or which reserves to the mortgagee any interest in the property after the exercise of the
contractual right, is inconsistent not only with the equity but with the contractual right itself, and might, I think, be held invalid for repugnancy even in a court of law.
This consideration affords a possible and reasonable explanation of the rule referred to in some of the authorities to the effect that a mortgagee cannot as a term of the mortgage enter into a contract to purchase or stipulate for an option to purchase any part of or interest in the mortgaged premises. Suppose the following simple case, namely, a conveyance by way of mortgage with a proviso for reconveyance if the mortgagor pay to the mortgagee £500 and interest at the end of six months, and then a further stipulation that the mortgagee should have an option of purchasing the property for another six months. If the mortgagor pays the moneys secured by the specified date the mortgagee comes under a contractual liability to reconvey, and if he does reconvey he reconveys his whole interest in the mortgaged property, thus destroying his option. The option, therefore, is inconsistent with and repugnant to the proviso for reconveyance which embodies the terms of the contractual right to redeem. It may therefore be rejected. It is also inconsistent with and repugnant to the equity of redemption which arises on failure to exercise the contractual right to redeem. It is, therefore, though not strictly a penalty, sometimes referred to as a clog on this equity. The fact that the inconsistency is most apparent in mortgages with an express proviso for redemption may account for Lord Hardwicke’s inclination to confine the rule to such mortgages— Mellor v. Lees, 2 Atk. 494. In Newcomb v. Bonham, 1 Vern. 7, the objection based on the rule is thus formulated— “Here is a power” (meaning the express proviso) “to redeem, and it shall never be extinct by any covenant at the same time, and the Court hold that this was the usual rule.” In the case of mortgages without such an express proviso there might, it is true, be a like inconsistency or repugnancy, but only if the real intention of the parties was that the property should be held as security for the moneys charged thereon and restored intact to the mortgagor as soon as these moneys were paid, but, as in the last-mentioned case, it is always possible that this was not the true intention, and unless it be the true intention the transaction is not really a mortgage under the rule but something more complex. It should be noticed that Lord Henley’s explanation of the rule in Vernon v. Bethell (2 Eden 110) is based on considerations applicable only to mortgages to secure loans, though the rule itself is not confined to such last—mentioned mortgages. Indeed, in the case of mortgages to secure loans, the mortgagee could not in Lord Henley’s time have contracted for an interest in or option over the mortgaged property for quite another reason.
All that I have said hitherto as to the equitable considerations affecting legal mortgages in the usual form applies equally to conveyances of equitable interests where there is an express proviso for redemption. The only difference in this case is that there is no legal estate to become absolute on failure to exercise the contractual right though there is a contract for reconveyance for breach of which an action might lie at law. It applies also, but with some important qualifications, to mere equitable charges. In the case of a mortgagor merely charging a property with payment to the mortgagee of a sum of money, not only does the mortgagee take no interest at law in the property charged, but there is no contract for reconveyance at all. The right to redeem is from the very outset a right in equity only, and it is merely the right to have the property freed from the charge on payment of the moneys charged thereon. If the charge is for payment of a specified sum on a specified day, payment on that day will set the property free, and if the day passes without payment there will still be an equity to have the property so freed notwithstanding any provision in the nature of a penalty, such final provision being a clog on the equity. The difference between transactions by way of equitable charge and transactions by way of conveyance with a proviso for reconveyance is chiefly important when, for the purpose of determining whether a particular stipulation ought or ought not to be rejected for inconsistency or repugnancy, the nature of the transaction between the parties has to be investigated.
I have pointed out that in mortgages in common form an option to purchase is inconsistent with and repugnant to the proviso for reconveyance on payment of the money secured. But is there any such repugnancy or inconsistency in the following case? A agrees to give B an option for one year to purchase a property for £10,000. In consideration of such option B agrees to lend, and does lend, A £1000 to be charged on the property without interest and be repayable at the expiration or earlier exercise of the option. I cannot myself see that there is any inconsistency or repugnancy between the provisions of this perfectly simple and straightforward transaction. It would have been very different if A had conveyed the property to B with a proviso that on payment of the £1000 there should be a reconveyance, and the deed had then provided for the year’s option. Here the option would be inconsistent with, and would in fact have been destroyed by, the reconveyance.
I desire in connection with what I have just said to add a few words on the maxims in which attempts have been made to sum up the equitable principles applicable to mortgage transactions. I refer to the maxims, “Once a mortgage, always a mortgage,” or “Amortgage cannot be made irredeemable.” Such maxims, however convenient, afford little assistance where the Court has to deal with a new or doubtful case. They obviously beg the question, always of great importance, whether the particular transaction which the Court has to consider is in fact a mortgage or not, and if they be acted on without a careful consideration of the equitable
considerations on which they are based, can only, like Bacon’s idols of the market place, lead to misconception and error.
We will suppose that money is advanced to a company repayable at the expiration of fifteen years, not an unusual period, and that the company by way of security subdemises (as is often the case) to trustees for the lenders a number of leaseholds, some of which are held for terms less than fifteen years. It would, in my opinion, be a serious error to argue that this was an attempt to make an irredeemable mortgage. There would be the same error in objecting on the like ground to a mortgage of leaseholds to secure an annuity for a period exceeding the term of the lease. If the mortgage is irredeemable at all, this arises from the nature of the property mortgaged, and not from any penal or repugnant stipulation on the part of the mortgagee, and the maxim properly understood is in no way infringed. We will suppose, again, that a firm of manufacturers desires to take in a new partner, proposing to charge a premium of £3000. A wants to buy a partnership, but before entering this firm desires some further acquaintance with the extent and methods of its business. It is thereupon arranged that A shall be taken on as clerk for a year and have a year’s option of entering the firm as a partner at a premium of £3000, and in the meantime shall advance the firm £3000, charged on some partnership property, to be set off against the premium if the option be exercised, but otherwise refunded at the end of the year. To suggest that such an arrangement was bad because it infringed the maxim of “Once a mortgage, always a mortgage,” would, in my opinion, be absolutely erroneous.
I now come to the particular class of mortgages to which I have already referred—that is to say, mortgages to secure borrowed money. For the whole period during which the Court of Chancery was formulating and laying down its equitable doctrines in relation to mortgages there existed statutes strictly limiting the rate of interest which could be legally charged for borrowed money. If a mortgagee stipulated for some advantage beyond repayment of his principal with interest, equity considered that he was acting contrary to the spirit of these statutes, and held the stipulation bad on this ground. There thus arose the rule, so often referred to in the reported decisions, that in a mortgage to secure borrowed money the mortgagee could not contract for any such advantage. There was said to be an equity to redeem on payment of principal, interest, and costs, whatever might have been the bargain between the parties, and any stipulation by the mortgagee for a further, or as it was sometimes called a collateral advantage, came to be spoken of as a clog or fetter on this equity. It is of the greatest importance to observe that this equity is not the equity to redeem with which I have hitherto been dealing. It is an equity which arises ab initio, and not only on failure to exercise the contractual right to redeem. It can be asserted before as well as after such failure. It has nothing to do with time, not being of the essence of a contract, or with relief from penalties, or with repugnant conditions. It is not a right to redeem on the contractual terms, but a right to redeem notwithstanding the contractual terms—a right which depended on the existence of the statutes against usury and the public policy thought to be involved in those statutes. Unfortunately in some of the authorities this right is spoken of as a right incidental to mortgages generally, and not confined to mortgages to secure borrowed money. This is quite explicable when it is remembered that a loan is perhaps the most frequent occasion for a mortgage. But it is, I think, none the less erroneous. I can find no instance of the rule which precludes a mortgagee from stipulating for a collateral advantage having been applied to a mortgage other than a mortgage to secure borrowed money, and there is the authority of Lord Eldon in Chambers v. Goldwin ( 9 Ves. 254) for saying that this rule was based on the usury laws. The right (notwithstanding the terms of the bargain) to redeem on payment of principal, interest, and costs is a mere corollary to this rule, and falls with it. It is to be observed that stipulations for a collateral advantage may be classified under two heads. First, those the performance of which is made a term of the contractual right to redeem, and, secondly, those the performance of which is not made a term of such contractual right. In the former case, in settling the terms on which redemption was allowed the Court of Chancery entirely ignored such stipulation. In the latter case, so far as redemption was concerned, the stipulations were immaterial, but it is said that in both cases the Court of Chancery would have restrained an action at law for damages for their breach. This is possible, though I can find no instance of its having been done, but clearly on a bill for an injunction to restrain an action at law the plaintiff would have to show some equity entitling him to be relieved from his contract, and such equity could, I think, have been based only on the usury laws or the public policy which gave rise to them.
The last of the usury laws was repealed in 1854, and thenceforward there was, in my opinion, no intelligible reason why mortgages to secure loans should be on any different footing from other mortgages. In particular, there was no reason why the old rule against a mortgagee being able to stipulate for a collateral advantage should be maintained in any form or with any modification. Borrowers of money were fully protected from oppression by the pains always taken by the Court of Chancery to see that the bargain between borrower and lender was not unconscionable. Unfortunately at the time when the last of the usury laws was repealed the origin of the rule appears to have been more or less forgotten, and the cases decided since such repeal exhibit an extraordinary diversity of judicial opinion on the subject. It is little wonder that with the existence in
the authorities of so many contradictory theories, persons desiring to repudiate a fair and reasonable bargain have attempted to obtain the assistance of the Court in that behalf. To one who, like myself, has always admired the way in which the Court of Chancery succeeded in supplementing our common law system in accordance with the exigencies of a growing civilisation, it is satisfactory to find, as I have found on analysing the cases in question, that no such attempt has yet been successful. In every case in which a stipulation by a mortgagee for a collateral advantage has since the repeal of the usury laws been held invalid, the stipulation has been open to objection, either (1) because it was unconscionable, or (2) because it was in the nature of a penal clause clogging the equity arising on failure to exercise a contractual right to redeem, or (3) because it was in the nature of a condition repugnant as well to the contractual as to the equitable right. It is true that in the case of Santley v. Wilde (1899, 2 Ch. 474) the attempt that was made to induce the Court in the exercise of its equitable jurisdiction to assist in the repudiation of a fair and reasonable bargain ought, according to the opinion of other Judges, to have been successful, but it is one thing to criticise a decision and quite another to take the responsibility of deciding it.
The defendants in the present case rely chiefly on three cases which came up to your Lordships’ House, and to which I must shortly refer. In the first of those cases— Noakes v. Bice, 1902 AC 24—the collateral advantage in question was a covenant tying the mortgaged premises, which consisted of a leasehold public-house, to the mortgagee’s brewery. There was a proviso for reconveyance of the public-house to the mortgagor upon payment on demand or without demand of all moneys thereby covenanted to be paid. There was therefore a contractual right to a reconveyance whenever the mortgagor thought fit to pay, The tie, however, was for the whole term of the lease, and was clearly inconsistent with and repugnant to this right. It was therefore bad. There is, I think, nothing at variance with anything I have suggested to your Lordships either in the decision itself or in the speeches of any of the noble Lords who advised the House, with the exception of the speech of Lord Davey.
It is with the greatest diffidence that I venture to criticise any opinion expressed by so great an authority, but I cannot wholly accept what Lord Davey lays down as to the equitable principle in relation to mortgages. It appears to me that he omits to notice that the doctrine as to clogs upon the equity of redemption is applicable to all mortgages, and not confined to mortgages to secure borrowed money, and founding himself upon considerations which apply, if they apply at all, only to the latter class of mortgage, defines the equity to redeem in such a way that in many cases it could never fit the facts at all. I can best illustrate this by supposing that in the case he was considering the mortgage had been given by way of security for the debt of a third party, the mortgagee agreeing not to enforce the debt for a specified period. The tie would still have constituted a clog, being inconsistent with the proviso for redemption, and consequently inconsistent with any equitable right to redeem, but a considerable part of Lord Davey’s judgment would have been entirely inappropriate. Thus, after approving Lord Lindley’s statement in Santley v. Wilde to the effect that a clog is something inconsistent with the security and in the nature of a repugnant condition, he proceeds as follows—“But I ask ‘security’ for what? I think it must be security for the principal, interest, and costs, and, I will add, for any advantage in the nature of increased interest or remuneration for the loan which the mortgagee has validly stipulated for during the continuance of the mortgage. There are two elements in the conception of a mortgage—first, security for money advanced; and secondly, remuneration for the use of money. When the mortgage is paid off the security is at an end, and as the mortgagee is no longer kept out of his money the remuneration to him for the use of his money is also at an end.” Then, after criticising Santley v. Wilde, he continues—“In my opinion every yearly or other recurring payment stipulated for by the mortgagee should be held to be in the nature of interest, and no more payable after the principal is paid off than interest could be. I apprehend that a man could not stipulate for the continuance of payment of interest after the principal is paid, and I do not think he can stipulate for any other recurring payment such as a share of profits. Any stipulation to that effect would in my opinion be void, as a clog or fetter on the equity of redemption.” It is evident that no part of the above can possibly apply to mortgages other than those entered into upon the occasion of a transaction of loan.
It appears to me that the noble Lord is reasserting in a modified form the doctrine which prevailed prior to the repeal of the usury laws, and was based on those laws. As long as it was impossible because of the usury laws for a mortgagee before making a loan to-stipulate for any collateral advantage, the equity was an equity to redeem on payment of the principal of the loan with interest and costs, and any stipulation to the contrary might be considered a clog; a mortgagee may now stipulate for a collateral advantage, but Lord Davey assumes that the equity remains the same; only, if this be so, it follows that every collateral stipulation which cannot be considered in the nature of interest is still bad. In my opinion the equity cannot remain the same when the only reason for its existence is gone. Nor can I accept the proposition that upon the occasion of a loan the mortgagee cannot stipulate for any payment falling due after the principal is paid. Such a rule would seriously interfere with business transactions and would be a hardship on mortgagees and mortgagors alike. Take, for instance, a case like Potter v. Edwards, 26 L.J. 468, Ch., where in consideration of
£700 a mortgagee agrees to pay £1000 with interest on a fixed date, and the proviso for redemption is framed accordingly. This is good, but according to the proposition in question if the mortgagee had desired further time for the payment of the £300 bonus and the proviso for reconveyance had been upon payment of the £700 and interest on the fixed date and the £300 by instalments payable later, there would have been an illegal clog. I can see no objection to a bargain by which money is advanced for three years and the borrower pays by way of remuneration or interest for the use of money a further sum payable by instalments extending over five years. Why should there be any principle of law or equity precluding free contract in this respect?
I come now to the second of the three cases to which I have referred, the case of Bradley v. Carritt (1903 AC 253). Here there was a mortgage of shares in a company expressed to be by way of security for borrowed money payable on or before a fixed date with interest in the meantime. This involved an obligation to retransfer the shares if the money and interest were paid as agreed. On default there would be an equity to a reconveyance on payment of principal, interest, and costs. There was a clause enabling the mortgagee on default to take over the shares in satisfaction of the debt. This was inconsistent with and a clog on the equity to redeem, and therefore bad. There was also a provision that the mortgagee should always thereafter as shareholder use his best endeavours to secure that the mortgagee or his firm should have the sale of the company’s teas, and in the event of such teas being sold otherwise than to the mortgagee or his firm the mortgagor was to pay the mortgagee a commission. It was as to this latter clause that the difficulty arose. Was it or was it not operative after redemption? The real question, in my opinion, was whether it was inconsistent with or repugnant to the contractual right of the mortgagee to have his property restored unfettered if he paid the money secured with interest as provided in the agreement, and the consequent equitable right to have the property so restored if he paid this money with interest and costs at any time. On this point there was room for difference of opinion, and accordingly we find Bigham, J., A. L. Smith, M.R., Stirling and Vaughan Williams, L.JJ., Lord Lindley, and Lord Shand taking the one view, and Lords Macnaghten, Davey, and Robertson taking another. There is really no difficulty in the decision itself. It is merely to the effect that the case was within the principles of Noakes v. Rice. Lords Macnaghten, Shand, and Davey all thought that if the stipulations in question were binding after redemption the mortgagor could not upon redemption get back his property intact. In other words, that the stipulation was repugnant both to the contractual right and the equity. But both Lord Macnaghten and Lord Davey also expressed opinions to the effect that all stipulations for collateral advantages, and not only those which were repugnant to the contractual or equitable right, must come to an end upon redemption. These expressions of opinion were not, I think, necessary to the decision, and, though of course of the greatest weight, are not, I think, binding on your Lordships. I have already given my reasons for not being able to accept them. It appears to me that if they be accepted it will be found that equity has involved itself in a Gordian knot which can only be cut by an Act of Parliament, and that unless and until the Legislature finds time to intervene your Lordships will be obliged in the name of equity to connive at, and indeed assist in, the violation of fair and reasonable bargains. There is, I think, nothing in the former decisions of this House which compels your Lordships to submit to this indignity.
The last case to which it is necessary to refer is Samuel v. Jarrah Timber and Wood Paving Corporation, Limited ( 1904 A.C.323). The facts of this case were simple. There was a loan, and certain debenture stock was by the express terms of the agreement to be transferred, and was in fact transferred, to the mortgagee “as security” for the loan. This meant that on repayment of the loan with interest the stock was to be retransferred. The loan was repayable upon thirty days’ notice on either side, and the mortgagee was to have an option to purchase the stock for twelve months. This option being inconsistent with both the contractual and equitable right of redemption was clearly invalid. To use Lord Macnaghten’s language—“It is an established rule that a mortgagee can never provide at the time of making the loan for any event or condition on which the equity of redemption shall be discharged and the conveyance absolute.” As I have already said, I think the rule depends on the inconsistency or repugnancy involved in any such provision. If once you come to the conclusion that the parties intended that the property should be reconveyed on payment off of the moneys secured, any provision which would prevent this must be rejected as inconsistent with and repugnant to the true intention. But, on the other hand, if you once come to the conclusion that this was not the real intention of the parties, then the transaction is not one of mortgage at all.
After the most careful consideration of the authorities I think it is open to this House to hold, and I invite your Lordships to hold, that there is now no rule in equity which precludes a mortgagee, whether the mortgage be made upon the occasion of a loan or otherwise, from stipulating for any collateral advantage, provided such collateral advantage is not either (1) unfair and unconscionable, or (2) in the nature of a penalty clogging the equity of redemption, or (3) inconsistent with or repugnant to the contractual and equitable right to redeem.
In the present case it is clear from the evidence, if not from the agreement of the 24th August 1910 itself, that the nature of the transaction was as follows:—The defendant company wanted to borrow £10,000, and the plaintiffs desired to obtain an option
Page: 854?
of purchase over any sheepskins the defendants might have for sale during a period of five years. The plaintiffs agreed to lend the money in consideration of obtaining this option, and the defendant company agreed to give the option in consideration of obtaining the loan. The loan was to carry interest at 6 per cent. per annum, and was not to be called in by the plaintiffs for a specified period. The defendant company, however, might pay it off at any time. It was to be secured by a floating charge over the defendant company’s undertaking. The option was to continue for five years whether the loan was paid off or otherwise, and if the plaintiffs did not exercise their option as to any of the defendant company’s skins a commission on the sale of such skins was in certain events payable to the plaintiffs.
I doubt whether, even before the repeal of the usury laws, this perfectly fair and businesslike transaction would have been considered a mortgage within any equitable rule or maxim relating to mortgages. It never was intended by the parties that if the defendant company exercised their right to pay off the loan they should get rid of the option. The option was not in the nature of a penalty, nor was it nor could it ever become inconsistent with or repugnant to any other part of the real bargain between the parties. The same is true of the commission payable on the sale of skins as to which the option was not exercised. Under these circumstances it seems to me that the bargain must stand, and that the plaintiffs are entitled to the relief they claim.
Their Lordships sustained the appeal.
Nash & Ors v Paragon Finance Plc
[2001] EWCA Civ 1466 [2002] 1 P & CR DG13, [2002] 2 P & CR 20, [2001] 2 All ER (Comm) 1025, [2002] WLR 685, [2002] 1 WLR 685, [2001] EWCA Civ 1466, [2002] 2 All ER 248
On 21 December 1990, Mr and Mrs Staunton entered into a Loan Agreement on the terms of the Offer of Loan from the Claimant, including the Stabilised Rate Facility. The loan was secured by a legal charge on the property. The Loan Agreement incorporated a set of printed General conditions and the Claimant’s Mortgage Conditions (1990 edition). In September 1996, they repaid some capital, and thereafter the repayments included both interest and capital. Mr and Mrs Staunton discharged all their interest liabilities under the Loan Agreement until August 1998, when, the monthly instalments due increased from £548.13 to £928.75. The Recorder said that there was no evidence as to the reason for this sudden jump, but he inferred that it was due, at least in part, to the fact that the maximum deferred interest had been exceeded, so that the Stabilised Rate Period had come to an end. Mr and Mrs Staunton fell into arrears. The Claimant started proceedings on 15 June 1999 asserting that by now the arrears amounted to approximately £6700.
The Claimant’s standard Conditions
“General Conditions (1986) edition
“6. INTEREST
Interest will be charged from the date on which the loan is completed. The rate current at the date of this Offer of Loan is as specified in the Offer of Loan. If the rate of interest should change before the Loan is completed, the Company may give the Applicant notice of the change by any method permitted under the Company’s Mortgage Conditions for the giving of notice of such change to existing Borrowers…”
7. MONTHLY PAYMENTS
The Monthly Payment specified in the Offer of Loan is calculated on the applicable rate of interest current at the date of this offer… However, the rate of interest may change before (as well as after) the loan is completed and other factors such as insurance premiums or tax rates may affect the amount of the Monthly Payment.”
Mortgage Conditions (1986 edition)
“1. DEFINITIONS
1.5 “Interest” means interest at the rate applicable to the Mortgage from time to time.
1.12 “Payment” means the monthly payment notified to the Borrower as constituting the Payment for the time being by notice given by the Company whether by any offer of loan or revision thereof prior to or at the time of the Mortgage or under these Conditions thereafter.
2. PAYMENTS
2.1 The Borrower covenants that he will pay to the Company
2.1.2 The Payment …
2.2 The Payment may be calculated so as to include all or any part of capital, interest and such costs, expenses, liabilities and moneys recoverable or payable and premiums, sums expended and costs and expenses incurred as aforesaid and may be varied to take account from time to time of any increase or decrease in any of the same or any change in the rate or incidence of any tax.
3. INTEREST
3.3 Interest shall be charged at such rate as the Company shall from time to time apply to the category of business to which the Company shall consider the Mortgage belongs and may accordingly be increased or decreased by the Company at any time and with effect from such date or dates as the Company shall determine provided that the Company will take such steps as it considers to be reasonable and appropriate to bring any such increase or decrease to the attention of the Borrower and further provided that without prejudice to the generality of the foregoing either written notice given in accordance with the provisions in that behalf hereinafter contained or publication of such notice in at least two national daily newspapers shall constitute reasonable and appropriate notice for the purposes of this clause.
7. COMPANY’S REMEDIES
7.3 If the Borrower
7.3.1 is in default of the payment of any two Payments in whole or in part or for two Months in the payment of any sums …
then in any such case all moneys secured by the Mortgage including Interest shall become immediately due and payable and all mortgagees’ powers by statute as hereby applied shall immediately become exercisable by the Company and the Company may at any time thereafter and without previous notice to the Borrower and without the Borrower’s agreement exercise all or any of such powers.”
General Conditions (1990 edition)
“8. INTEREST AND MONTHLY PAYMENTS
8.1 The rate of interest applicable to the Loan and the monthly payment will be as specified in the Offer of Loan as varied from time to time in accordance with the applicable Mortgage Condition indicated in the Offer of Loan.”
The Consumer Credit Act 1974
The principal conditions with which these appeals are concerned are contained in sections 137-139, which provide:
“Extortionate credit bargains
137.- (1) If the court finds a credit bargain extortionate it may re-open the credit agreement so as to do justice between the parties.
(2) In this section and sections 138-140, –
(a) “credit agreement” means any agreement between an individual (“the debtor”) and any other person (“the creditor”) by which the creditor provides the debtor with credit of any amount, and
(b) “credit bargain” –
(i) where no transaction other than the credit agreement is to be taken into account in computing the total charge for credit, means the credit agreement, or
(ii) where one or more other transactions are to be so taken into account, means the credit agreement and those other transactions, taken together.
When bargains are extortionate
138.- (1) A credit bargain is extortionate if it –
(a) requires the debtor or a relative of his to make payments (whether unconditionally, or on certain contingencies) which are grossly exorbitant,
or
(b) otherwise grossly contravenes ordinary principles of fair trading.
(2) In determining whether a credit bargain is extortionate, regard shall be had to such evidence as is adduced concerning –
(a) interest rates prevailing at the time it was made,
(b) the factors mentioned in subsections (3) to (5), and
(c) any other relevant considerations.
(3) Factors applicable under subsection (2) in relation to the debtor include –
(a) his age, experience, business capacity and state of health; and
(b) the degree to which, at the time of making the credit bargain, he was under financial pressure, and the nature of that pressure.
(4) Factors applicable under subsection (2) in relation to the creditor include –
a) the degree of risk accepted by him, having regard to the value of any security provided;
(b) his relationship to the debtor;
(c) whether or not a colourable cash price was quoted for any goods or services included in the credit bargain.
…
Reopening of extortionate agreements
139.- (1) A credit agreement may, if the court thinks just, be reopened on the ground that the credit bargain is extortionate –
(a) on an application for the purpose made by the debtor or any surety to the High Court, county court or sheriff court; or
(b) at the instance of the debtor or a surety in any proceedings to which the debtor and creditor are parties, being proceedings to enforce the credit agreement, any security relating to it, or any linked transaction; or
(c) at the instance of the debtor or a surety in other proceedings in any court where the amount paid or payable under the credit agreement is relevant.
(2) In reopening the agreement, the court may, for the purpose of relieving the debtor or a surety from payment of any sum in excess of that fairly due and reasonable, by order –
(a) direct accounts to be taken … between any persons;
(b) set aside the whole or part of any obligation imposed on the debtor or a surety by the credit bargain or any related agreement,
(c) require the creditor to repay the whole or part of any sum paid under the credit bargain or any related agreement by the debtor or a surety, whether paid to the creditor or any other person.
(d) direct the return to the surety of any property provided for the purposes of the security, or
(e) alter the terms of the credit agreement or any security instrument….”
The issues
Mr and Mrs Nash
(i) Was there a breach of the express term contained in clause 3.3 of the General Conditions (1986 edition)?
Mr and Mrs Nash and Mr and Mrs Staunton
(ii) Was there an implied term that, in exercising its discretion to vary interest rates, the Claimant was bound to make its judgment fairly, honestly and in good faith, and not arbitrarily, capriciously or unreasonably?
(iii) If there was such an implied term, was the Claimant in breach of it?
(iv) Was the loan agreement an extortionate credit bargain within the meaning of section 138 of the 1974 Act?
(v) Is the counterclaim for relief under section 139 of the 1974 Act time-barred by the Limitation Act 1980?
(vi) Is the claimant’s reliance on discretion to vary interest rates contrary to section 3(2)(b)(i) of the Unfair Contracts Terms Act 1977?
Mr and Mrs Staunton
(vii) Did the credit bargain grossly contravene ordinary principles of fair dealing (and was the credit bargain therefore extortionate within the meaning of section 138(1)(b) of the 1974 Act) on the grounds that the Claimant did not sufficiently explain the effect of the Stabilised Rate Facility?
Both appeals concern applications to strike out under CPR Rule 3.4 and under the inherent jurisdiction of the court. The grounds relied on by the Claimant are that the amended defences and counterclaims disclose no reasonable grounds of defence or are an abuse of the process of the court. The Recorder adopted the test of asking in each case whether the defence and counterclaim had any real prospect of success. It is common ground that the Recorder adopted the correct test.
Breach of the express term in clause 3.3 of the General Conditions (1986 edition) applicable to the Nash mortgage
This is a new point not taken in the court below. The proposed substitute amended defence and counterclaim alleges that there was a breach of clause 3.3 in that:
“the Claimants applied different rates of interest to the Defendants’ loan from those which were applied to later borrowers falling within the same category of business as did the Defendants, without having any or any sufficient grounds for discriminating in this way against the Defendants”.
The particulars relied on are contained in two schedules to the draft pleading. The first is a schedule of interest rates from 1 March 1986 to 1 April 1998: it compares the Claimant’s “standard” mortgage interest rates on house purchase and remortgage (payable by mortgagors such as Mr and Mrs Nash) with its “Blue Chip” remortgage interest rates. This shows that from 1986 until early 1997, the “standard” rates were about 2-3% higher than the Blue Chip rates. In 1997 and 1998, the differential rose to about 4%. The second schedule is Table 3 in the expert’s report of Mr R Rosenberg dated 14 April 2000. Mr Rosenberg was the expert instructed on behalf of Mr and Mrs Nash in these proceedings. This table compares the rates of interest payable between April 1997 and May 1999 (a) by borrowers (such as the appellants) who took out mortgages with the Claimant in the late 1980s and early 1990s with (b) later borrowers who obtained mortgages from Paragon from the mid-1990s and who have benefited from the highly competitive rates then being offered by Paragon. This table shows a differential of a little above 4%. Mr Bannister QC submits that the relevant “category of business” within the meaning of clause 3.3 is “first legal charges over residential property”.
In answer to this new case, Mr Ali Malek QC makes the following points. First, the pleading does not attempt to define the “category of business” to which Mr and Mrs Nash belong. Secondly, the first schedule does not show a breach. It compares two different products marketed by the Claimant, namely its standard loans and its “Blue Chip Home Loans”. The Claimant’s Blue Chip loans differed from its standard loans in that they were subject to different terms, and set a rate of interest based on LIBOR. Thirdly, as regards the table in Mr Rosenberg’s report, the position is that the business written by Paragon differed from that written by the Claimant: it was lower risk, and therefore not the same category of business with that of Mr and Mrs Nash.
I am in no doubt that there was no breach of clause 3.3 of the Nash loan agreement. The phrase “category of business” is not a term of art and it is not defined. The clause referred to the “category of business to which the Company shall consider the Mortgage belongs” (my emphasis). It is clear that the Claimant considered that its standard borrowers did not belong to the same category of business as its Blue Chip borrowers, or the subsequent Paragon borrowers. It is true that the evidence is somewhat exiguous. This may be because the allegation of breach of clause 3.3 was not made in the court below. It is also true that the evidence as to the circumstances in which the Claimant withdrew from the lending market in 1991, and re-emerged in 1994 are not explained in the witness statements before the court. But there is material in the documents that are before the court from which it is possible to say with some confidence what happened. By 1991, the Claimant was in financial trouble. One result of this was that the money markets were charging higher rates for lending to the Claimant because it was perceived as a greater risk than other mortgage lenders. Not surprisingly, these higher charges were passed on to borrowers (who were about 70,000 in number). The Claimant, therefore, decided to withdraw from the lending market. In 1994, it decided to re-enter the market through a different entity, Paragon. According to the Claimant’s chief executive, the plan was to “undertake relatively low risk business which will be suitable for securitisation”.
I cannot accept that clause 3.3 obliged the Claimant to charge the same rate of interest to all mortgagors who had borrowed money to secure first legal charges on residential property. And yet that is the effect of Mr Bannister’s submission. It is a submission which ignores the fact that the clause defines the category of business by reference to the opinion of the Claimant. But it also involves the proposition that the Claimant would have agreed to charge the same rate of interest to all borrowers who had granted first charges on residential property regardless of the other terms of the loan, the credit-rating of the borrower and matters of that kind. That is a most unlikely commercial arrangement which I would not impute to the Claimant without clear express words. For these reasons, I consider that the allegation of breach of clause 3.3 has no real prospect of success, and should not be permitted by way of amendment.
Implied term
The amended defences and counterclaims that were before the Recorder both pleaded that the discretion given to the lender to vary the interest rate was subject to an implied term. Two alternative formulations were put forward in the pleadings, viz (a) the Claimant would determine the rate “in line with interest rates being charged from time to time by mortgage lenders within England and Wales to status borrowers”; or (b) “the interest rate would only vary in accordance with the changes in the interest rate of the Bank of England from time to time”. The Recorder rejected each of these formulations, saying that they stood no real prospect of success (paragraph 127). There is no appeal from that part of his judgment.
It was also pleaded that upon the true construction of the variation of rate clause, the Claimant was bound to exercise its discretion to vary the interest rate “fairly as between both parties to the contract, and not arbitrarily, capriciously or unreasonably”. The Recorder rejected this construction of the contract, but said (paragraph 121) that his decision would be different if the defendants had sought to achieve the same result by way of an implied term. Encouraged by this remark, the defendants in both proceedings applied to the Recorder for permission to amend their defences and counterclaims. The implied term was formulated in accordance with the Recorder’s suggestion. Permission was, however, refused on the grounds that the pleadings gave insufficient particulars of breach.
All the appellants appeal against the Recorder’s refusal to grant permission to amend their defences to plead breach of an implied term. The implied term that it is sought to plead in the substitute amended pleadings is at paragraph 6 of the amended defences, and is in these terms:
“It was an (or a further) implied term of the contract, to be implied into the clause conferring the discretion to vary interest rates referred to at paragraph 3 above being an obvious qualification or to give business efficacy to or to give effect to the reasonable expectation of the parties that that discretion was a discretion which the Claimants were bound to exercise fairly honestly and in good faith as between both parties to the contract, and not arbitrarily, capriciously or unreasonably; and that in making a decision or decisions under the said power the Claimants would give proper consideration to the matter, taking into account all relevant matters and ignoring irrelevant matters.”
The breaches are alleged at paragraph 7 of the proposed pleadings. It alleges that the Claimant has exercised its discretion in a manner which is unfair and/or arbitrary and/or unreasonable by increasing the appellants’ loan repayment interest rates and/or failing to decrease them (a) without reference to prevailing market rates, and/or (b) taking into account an irrelevant matter, namely its own financial difficulties. Particulars are then given comparing the Claimant’s rates with the standard rates from time to time of the Halifax Building Society, these being taken as representative of the prevailing market.
Mr Malek submits that the appellants would have no real prospect of establishing the implied term at a trial, and in any event the Recorder exercised his discretion correctly in refusing permission to amend the pleadings on the grounds that the alleged breaches were not sufficiently particularised. Mr Bannister QC and Mr Falkowski submit that (a) the term for which they contend is to be implied, or at least that it has not been shown that there would be no real prospect of establishing such an implied term at a trial, and (b) the Recorder should have granted permission to amend to plead the implied term and the allegations of breach of it.
Was there an implied term in the terms pleaded?
The decision of this court in Lombard Tricity Finance v Paton [1989] 1 AER 918 has loomed large in the debate on this issue. In that case, the defendant borrower entered into a credit agreement with the plaintiff credit company to finance the purchase of a computer. The agreement provided that interest would be “subject to variations by the creditor from time to time on notification as required by law”. The borrower fell into arrears with his monthly payments. The lender started proceedings claiming the amount due. The judge dismissed the claim on the grounds that the agreement did not comply with the statutory requirements as to notification of variations in the rate of interest. The lender’s appeal was allowed by this court. Staughton LJ gave the judgment of the court. It was common ground that the lender could vary the interest rate in its absolute discretion. If the exercise of the discretion had been subject to some fetter, that would potentially have had a bearing on the issues raised on the appeal. No doubt aware of the wider significance of the concession, the court went to some trouble to explain why in its opinion the concession had been rightly made. At page 923A, the court said:
“On two potential issues there has been no dispute before us. The first is whether the contract does, as a matter of construction, provide that Lombard may vary the interest rate in their absolute discretion, subject only to due notice. The second, whether such a contract, if made, is lawful. Counsel for Mr Paton concedes that the answer is Yes to both questions. But as the case is of some general importance, and as his concessions mean that he is, to some extent at any rate, unable to support the reasoning of Judge Heald in the county court, we think it right to explain why in our view they were rightly made.
In general it is no doubt unusual for a contract to provide that its terms may be varied unilaterally by one party, in his absolute discretion, to the detriment of the other; in general one would require clear words to achieve that result. But in this particular case it is, we think, part of the background, matrix or surrounding circumstances that market rates of interest are known to vary from time to time and that some variation was very likely to occur during the lifetime of the agreement. There is also provision that the borrower may bring it to an end at any time by repaying the amount outstanding. In theory he could thus avoid the effect of an increase in the interest rate, if he found it unattractive. But we recognise that in practice this remedy is unlikely to be available, since he is unlikely to have the money, or to be able to borrow it from some other lender at less than the prevailing market rate.
Counsel for Lombard observed that the provision of credit is a competitive industry, and that the effect of competition is likely to restrain Lombard from a capricious increase in their interest rate. That is no doubt true if they increase rates by the same amount and at the same time for both new and old borrowers, as he tells us they do. Indeed if a provider of credit capriciously treated old borrowers unfavourably, one would hope that the Director General of Fair Trading would consider whether he should still have a licence under the 1974 Act. It was also suggested that the provisions of the Act relating to extortionate credit bargains might provide protection for the borrower. But counsel for Mr Paton suggested that ss137 and 138 may apply only to the original credit agreement, and not to how it is subsequently operated. It is unnecessary to express any view on that point.
Bearing all these considerations in mind, we consider that on a fair reading of the agreement it does provide, as counsel for Mr Paton accepts, that Lombard may increase the interest rate at their absolute discretion subject only to notice. A power to vary the rate is conferred in plain terms, there is no other express restriction on it and we can see no sufficient basis for any implied restriction.”
The Recorder relied on Lombard in arriving at his decision that the implied terms alleged in the amended defences that were before him when he delivered his judgment on the main issues had no real prospect of success. At paragraph 126 of his judgment, he said:
“126. These points were well made by Mr Falkowski: but I do not consider that they are sufficient to justify placing the Lombard decision on one side. The fact is that most of the matters to which the Court of Appeal had regard as being “factual matrix” in Lombard apply equally here. The residential mortgage market is highly competitive. Not only do rates vary up and down during the currency of a mortgage loan but the competition between lenders and the variety of risk means that rates may not all vary at the same time or by the same amount. I recognise that it is not easy for a borrower with negative equity in his property to switch mortgage lender and re-mortgage elsewhere: but if negative equity is not a problem it is quite possible for a borrower to move from one lender to another. There is mobility in the residential mortgage market, and has been for the best part of the last decade. On the evidence I have seen, I am unable to find that either Mr and Mrs Nash or Mr and Mrs Staunton were at any time “locked in” to their Loan Agreements with the Claimant by reason of negative equity. Certainly they have no problem of negative equity now and are most unlikely to have done in the past 5 years. Furthermore, as I have already noted, neither Loan Agreement appears to have contained any early redemption penalty after the first two years. It therefore seems to me that the only factor which could have seriously inhibited the Defendants’ ability to re-mortgage elsewhere was their personal creditworthiness. The problem is that this factor is precisely the factor which may justify an enhanced rate of interest being charged by the lender, when compared with market rates generally.”
At paragraphs 127-130, he explained why he thought that an implied term such as that for which the defendants sought permission to amend at the hearing on 4 September 2000 had a real prospect of success. He relied in particular on Abu Dhabi National Tanker Co v Product Star Shipping Ltd (The Product Star) (No 2) [1993] 1 Lloyd’s Rep 397. That case concerned a charter party under which the Master and the Owners had a discretion in determining whether any port to which the vessel was ordered was dangerous. In the express terms of the charter, the discretion was unqualified. The question was whether any restriction on the exercise of the discretion was to be implied. In giving the leading judgment of the court, Leggatt LJ said (at page 404):
“…..Where A and B contract with each other to confer a discretion on A, that does not render B subject to A’s uninhibited whim. In my judgment, the authorities show that not only must the discretion be exercised honestly and in good faith, but, having regard to the provisions of the contract by which it is conferred, it must not be exercised arbitrarily, capriciously or unreasonably”.
It will be seen at once that the formulation of the implied term for which the appellants now contend is closely based on this passage in the judgment of Leggatt LJ. The authorities to which Leggatt LJ was referring were charterparty cases. The Recorder said that in his view there was nothing special about charter contracts which sets them apart from other kinds of contract such as contracts of loan. As he put it: “a contract where one party truly found himself subject to the whim of the other would be a commercial and practical absurdity”.
Mr Bannister submits that Lombard is not authority against the implication of the term for which he contends. It was concerned with a question of construction. No argument had been addressed to the court on the question whether any term should be implied, and it is misconceived to treat the passage at page 923F as holding that as a matter of law a variation clause could not be subject to an implied term. In short, he submits that this passage is both obiter and wrong.
Mr Malek submits that in a case such as this, a term will only be implied if the strict test of necessity has been satisfied: see, for example, per Lord Steyn in Equitable Life Assurance Society v Hyman [2000] 3 WLR 529, 539. He submits that this test is not satisfied in this case for a number of reasons. First, commercial considerations require a lender to behave sensibly when fixing interest rates. Market forces dictate that the interest rate must be competitive and comparable with other available interest rates, since if it is not, the borrowers will simply go elsewhere. Secondly, the regulatory framework is relevant. The Director General of Fair Trading has considerable regulatory powers, including the power to grant or withold licences under section 25 of the 1974 Act. Thirdly, neither the Nash nor the Staunton agreements prevented the borrowers from redeeming their mortgages and re-mortgaging elsewhere, although they did contain certain penalty provisions in the event of early redemption.
Fourthly, Mr Malek submits that it is inherently unlikely that at the date of the making of a variable interest loan agreement, a lender would agree to restrict the rates to “reasonable” rates. There are problems of determining the yardstick by reference to which reasonableness is to be judged. There are different types of loans and mortgages suitable for different kinds of borrowers. Moreover, there are different types of lending institution ranging from high street banks and building societies to so-called “tertiary” or “non-status” lenders. The latter carry out the most limited checks of the proposed borrower’s financial circumstances, and they often deal with borrowers who have a poor credit rating. Mr Malek also makes the point that if the lender were precluded from demanding “unreasonable” interest rates, there would be endless disputes as to what was payable, and it is most unlikely that the lender would have agreed to a term which had that consequence.
I cannot accept the submission of Mr Malek that the power given to the Claimant by these loan agreements to set the interest rates from time to time is completely unfettered. If that were so, it would mean that the Claimant would be completely free, in theory at least, to specify interest rates at the most exorbitant level. It is true that in the case of the Nash agreement, clause 3.3 provides that the rate charged is that which applies to the category of business to which the Claimant considers the mortgage belongs. That prevents the Claimant from treating the Nashes differently from other borrowers in the same category. But it does not protect borrowers in that category from being treated in a capricious manner, or, for example, being subjected to very high rates of interest in order to force them into arrears with a view to obtaining possession of their properties.
The Stauntons do not even have the limited protection that is afforded by clause 3.3 of the Nash agreement. In the absence of an implied term, there would be nothing to prevent the Claimant from raising the rate demanded of the Stauntons to exorbitant levels, or raising the rate to a level higher than that required of other similar borrowers for some improper purpose or capricious reason. An example of an improper purpose would be where the lender decided that the borrower was a nuisance (but had not been in breach of the terms of the agreement) and, wishing to get rid of him, raised the rate of interest to a level that it knew he could not afford to pay. An example of a capricious reason would be where the lender decided to raise the rate of interest because its manager did not like the colour of the borrower’s hair.
It seems to me that the commercial considerations relied on by Mr Malek are not sufficient to exclude an implied term that the discretion to vary interest rates should not be exercised dishonestly, for an improper purpose, capriciously or arbitrarily. I shall come shortly to the question whether the discretion should also not be exercised unreasonably. But before doing so, I should explain in a little more detail why I would reject Mr Malek’s submission that there is no need for an implied term at all.
Of course I accept as a general proposition that a lender must have an eye to the market when it sets its rates of interest. To do otherwise is bound ultimately to lead to commercial disaster. But commercial considerations of that kind will not necessarily deter a lender from acting improperly in all situations. They may not deter a lender from unfair discrimination against an individual borrower. They may not even avail a class of borrowers. Take the present cases. The appellants borrowed from the Claimant which withdrew from the lending business in 1991. The rates of interest offered by Paragon are highly competitive. But the history of the interest rates demanded by the Claimant in the late 1990s demonstrates how limited the deterrent argument is. The proof of the pudding is in the eating. Between 1989 and 1992, the difference between the Claimant’s standard rate and the rate demanded by the Halifax Building Society was approximately 2 percentage points. By 1997, the gap was in excess of 4 points. In March 1999 it rose to 5.14, when the Claimant’s rate was 12.09% and the Halifax rate was 6.95%.
The argument based on the existence of the regulatory powers of the Director General of Fair Trading is in my view not sufficient to deny the implied term. I note that in Lombard, the court said that if a lender capriciously treated old borrowers unfavourably “one would hope that the Director General of Fair Trading would consider whether he should still have a licence under the 1974 Act” (my emphasis). One would indeed have such a hope, but that does not seem to me to be a secure basis on which to decide that there is no need for an implied term that a lender will not exercise the discretion to set rates of interest capriciously. There are two strands to the argument that found favour with the court in Lombard: (a) it is implicitly accepted that the lender should not act capriciously; but (b) there is no need to impose an obligation on the lender not to act capriciously, because there is no realistic possibility that he will do so. I can see that there may be no need to impose such an obligation on a lender where it would be impossible for him to act in breach of it. But it is inter alia for the very reason that lenders can act unfairly and improperly that the Director General has the power to withdraw licences from those who provide credit to consumers. In my judgment, the existence of the Director General and the fact that he has certain regulatory powers is not a good reason for holding that the power to set rates of interest is absolutely unfettered.
Finally, I must consider whether the fact that the borrowers can redeem their mortgages and seek loans from another source if the rates are set capriciously etc is a sufficient reason for acceding to Mr Malek’s argument. In my view, it is not. As with the last point, this is not so much an argument against the need to imply a term as an argument that it is unlikely to be broken because the lender will be aware that it is open to the borrower to go elsewhere. But it seems to me to be obvious that there may be circumstances in which the lender will act capriciously towards an individual borrower knowing that it might compel the borrower to redeem the mortgage and go elsewhere. Indeed, the lender may have decided to increase the rate of interest for that very reason. But why should the lender be able capriciously to compel the borrower to find another lender with impunity? The borrower may find it difficult to find another lender, especially if he has fallen into arrears with the first lender as a result of that lender’s interest rate policy. His employment status may have changed adversely since he entered into the first loan agreement. The process of re-mortgaging is costly. The new lender will probably require a survey. There will be lawyers’ fees. And there may be a penalty for early redemption.
It follows that I do not agree with the obiter dicta expressed by this court in Lombard in the passage that I have cited. I would hold that there were terms to be implied in both agreements that the rates of interest would not be set dishonestly, for an improper purpose, capriciously or arbitrarily. I have no doubt that such an implied term is necessary in order to give effect to the reasonable expectations of the parties. I am equally in no doubt that such an implied term is one of which it could be said that “it goes without saying”. If asked at the time of the making of the agreements whether it accepted that the discretion to fix rates of interest could be exercised dishonestly, for an improper purpose, capriciously or arbitrarily, I have no doubt that the Claimant would have said “of course not”.
I come, therefore, to the question whether the implied term should also extend to “unreasonably”. The first difficulty is to define what one means by “unreasonably”. Mr Bannister was at pains to emphasise that he was not saying that the rates of interest had to be reasonable rates in the sense of closely and consistently tracking LIBOR or the rates charged by the Halifax Building Society. He said that what he meant by the unreasonable exercise of the discretionary power to set the rate of interest was something very close to the capricious or arbitrary exercise of that power.
As we have seen, in The Product Star, Leggatt LJ said that where A and B contract with each other to confer a discretion on A, the discretion must be exercised honestly and in good faith, and not “arbitrarily, capriciously or unreasonably”. In that case, the judge held the owner acted unreasonably in the sense that there was no material on which a reasonable owner could reasonably have exercised the discretion in the way that he did. Leggatt LJ (with whom the other two members of the court agreed) found that various factors called into question the owners’ good faith and strongly suggested that their decision was arbitrary. He also upheld the judge’s approach to the question of reasonableness. Thus the word “unreasonably” in the passage at page 404 must be understood in a sense analogous to unreasonably in the Wednesbury sense: Associated Provincial Picture Houses Ltd v Wednesbury Corporation [1948] 1 KB 223.
This question whether an apparently unfettered discretion is subject to an implied limitation that it must be exercised reasonably has been considered in other contexts. They were helpfully reviewed by Mance LJ in Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd [2001] All ER (D) 33. That case concerned a reinsurance contract which contained a clause which provided that no settlement or compromise of a claim could be made or liability admitted by the insured without the prior approval of the reinsurers. One of the questions that arose was whether the right to withold approval was subject to any (and if so what) restriction. The judge held that the reinsurers could not withold approval unless there were reasonable grounds for doing so. Mance LJ (with whom Latham LJ agreed) decided that the right to withold consent was less restricted. Having reviewed a number of previous authorities, Mance LJ said (paragraph 64) that what was proscribed in all of them was “unreasonableness in the sense of conduct or a decision to which no reasonable person having the relevant discretion could have subscribed”. At paragraph 67, he said:
“I would therefore accept as a general qualification that any witholding of approval by reinsurers should take place in good faith after consideration of and on the basis of the facts giving rise to the particular claim and not with reference to considerations wholly extraneous to the subject-matter of the particular reinsurance.”
After a detailed consideration of what considerations could properly be take into account, he said at paragraph 73:
“If there is any further implication, it is along the lines that the reinsurer will not withold approval arbitrarily, or (to use what I see as no more than an expanded expression of the same concept) will not do so in circumstances so extreme that no reasonable company in its position could possibly withold approval. This will not ordinarily add materially to the requirement that the reinsurer should form a genuine view as to the appropriateness of settlement or compromise without taking into account considerations extraneous to the subject-matter of the reinsurance.”
So here too, we find a somewhat reluctant extension of the implied term to include unreasonableness that is analogous to Wednesbury unreasonableness. I entirely accept that the scope of an implied term will depend on the circumstances of the particular contract. But I find the analogy of Gan Insurance and the cases considered in the judgment of Mance LJ helpful. It is one thing to imply a term that a lender will not exercise his discretion in a way that no reasonable lender, acting reasonably, would do. It is unlikely that a lender who was acting in that way would not also be acting either dishonestly, for an improper purpose, capriciously or arbitrarily. It is quite another matter to imply a term that the lender would not impose unreasonable rates. It could be said that as soon as the difference between the Claimant’s standard rates and the Halifax rates started to exceed about two percentage points, the Claimant was charging unreasonable rates. From the appellants’ point of view, that was undoubtedly true. But from the Claimant’s point of view, it charged these rates because it was commercially necessary, and therefore reasonable, for it to do so.
I conclude therefore that there was an implied term of both agreements that the Claimant would not set rates of interest unreasonably in the limited sense that I have described. Such an implied term is necessary in order to give effect to the reasonable expectations of the parties.
Should the Recorder have granted permission to amend?
The issue here is whether on the basis of the draft pleadings in their present form, the appellants have a real prospect of successfully establishing breaches of the implied term. Mr Bannister relies on paragraph 106 of the Recorder’s judgment. In that paragraph, the Recorder held “not without considerable hesitation” that there was a real prospect of success for the argument that the Claimant had contravened the “ordinary principles of fair dealing” in fixing its interest rates. At paragraph 131, he said “not without misgivings” that for much the same reasons as he had concluded at paragraph 106 that there was an arguable case that the credit bargains were extortionate that “if the correct implied term were to be pleaded, the allegation of breach is not so improbable that it stands no real prospect of success and it ought to be struck out”. The “correct implied term” was that to which I have referred at paragraphs 36 and 42 above.
What were the factors that led the Recorder to conclude at paragraph 106 that the allegation of breach of the “correct” implied term had a real prospect of success? They were:
“(i) whether the Claimants’ witness and the Defendants’ witnesses are comparing like with like when they are comparing rates of interest, and what the correct comparisons should be, (ii) the suggestion, implicit in the Defendants’ criticism of the Claimants’ failure to reduce rates in line with the market, that the reason why the Claimant’s rates were kept high had nothing to do with the lending risk and everything to do with NHL’s financial difficulties, and (iii) the statement made by Mr Rosenberg that the rate of interest charged by Paragon to new lenders is lower than that charged to customers of NHL, such as Mr and Mrs Nash and Mr and Mrs Staunton. If the difference is not explicable in terms of risk, there is at least room for an argument (I say no more) that the Claimant is not treating all of its customers fairly (see Staughton LJ in the Lombard case, quoted in paragraph 61 above.)”
But at paragraph 7 of the draft pleading that is now relied on by the appellants, the breaches alleged are that the Claimant fixed the rates of interest (a) without reference to prevailing market rates, and/or (b) taking into account an irrelevant consideration, namely its own financial difficulties. The particulars of breach that are given are based on a comparison of the Claimant’s rates of interest and those of the Halifax, especially between 1995 and 2000, and a comparison of the Claimant’s rates and those of Paragon after April 1997. The rates charged by the Halifax are taken as the paradigm of “prevailing market rates”.
In my judgment, the mere fact that the rates charged were made “without reference to the prevailing rates” is not evidence from which it can be inferred that, in fixing them, the Claimant acted in breach of the implied term. It is not said by Mr Bannister that the rates set by the Claimant had to match those of the Halifax. As Mr Rosenberg points out in his report (paragraph 4.3.7), the Claimant was not regarded as a sub-prime lender; it was a centralised lender with no branch network; and relied on self-certification by borrowers. It was not in the same category of lenders as the Halifax. The real complaint is that the gap between the Claimant’s rates and those charged by the Halifax widened from 1995 onwards. It widened from about 2 percentage points to 4-5 points. One of the reasons for this according to counsel for the Claimant (if not the only reason) was that the Claimant was in serious financialdifficulties because many of its borrowers had defaulted, the money markets charged higher rates for lending to the Claimant because it was perceived to be a greater risk than other mortgage lenders, and these higher costs had been passed on to borrowers. It is the fact that the Claimant took this into account in deciding at what level to fix its rates that forms the basis of the second way in which the case of breach of the implied term is put. In my view, if it was the case that the rates were increased because the Claimant was in financialdifficulties for reasons of that kind, that would not be a breach of the implied term. If a lender is in financial difficulty, for example, because it is obliged to pay higher rates on interest to the money market, then it is likely to have to pass those increased costs on to its borrowers. If in such circumstances the rate of interest charged to a borrower is increased, it is impossible to say that the discretion to set the rate of interest is being exercised for an improper purpose, capriciously, arbitrarily or in a way in which no reasonable lender would reasonably do.
On the material placed before this court, there is no evidence to suggest that the decision to widen the gap between the rates of interest charged by the Claimant to the appellants and the standard rates charged by the Halifax Building Society to its borrowers was motivated by other than purely commercial considerations. The Claimant is not a charitable institution. Its aim is to make a profit by lending money. It follows that if it encounters financial difficulties, it may feel obliged to raise the interest rates paid by its borrowers. In deciding whether to raise interest rates, it will have to make fine commercial judgments. But if it decides to take that course in order to overcome financial difficulties, it is not acting dishonestly, capriciously or in an arbitrary manner. It is not taking into account an irrelevant consideration. Nor is it acting in a way which is so unreasonable that it can be said of it that no reasonable lender would take that course if placed in that situation.
It follows that in my view, there is no real prospect that the appellants would be able to prove at trial that the Claimant acted in breach of the implied term in relation to either of these appellants. Accordingly, I would uphold the decision of the Recorder to refuse permission to amend.
Extortionate credit bargain?
Can variations in rates of interest be taken into account at all?
In summary, the Recorder held as follows. The notice of interest rate increases or decreases could not fairly be described as “transactions” so as to form part of a “credit bargain” within the meaning of section 137(2) of the 1974 Act (paragraphs 38-39 of the judgment); nor were they relevant considerations within the meaning of section 138(2)(c) in assessing whether the credit bargain was one which, after its inception, became extortionate (paragraphs 40-64); so that the appellants’ causes of action (if any) accrued when they entered into the loan agreements (paragraph 64).
Mr Bannister accepts that the notices of changes in interest rates are not “transactions” so as to form part of a “credit bargain” within the meaning of section 137(2). But he submits that the question whether subsequent transactions are to be taken into account in determining whether a credit bargain is extortionate is a “red herring”. The only inquiry required by the 1974 Act is whether a credit bargain requires the borrower to make payments which are grossly exorbitant (section 138(1)(a)) or otherwise grossly contravenes ordinary principles of fair dealing (section 138(1)(b)).
As regards section 138(1)(a), the appellants are plainly required by the terms of the loan agreements and mortgages (ie the credit bargains) to pay interest at the rates that have been demanded. The agreements, therefore, fall within section 138(1)(a) unless the Claimant discharges the burden on it of showing that the payments so required to be made were not “grossly exorbitant”: see section 171(7) of the 1974 Act.
Mr Bannister submits that, quite apart from the burden of proof, there was ample evidence to support the view that the rates demanded of borrowers since the early to mid-1990s were grossly exorbitant. At paragraphs 106-107, the Recorder examined the evidence and concluded “not without considerable hesitation” that, if (contrary to his view) post-contract events were relevant, then he would not have struck out the appellants’ argument that the credit bargains were extortionate.
Mr Malek submits that a variation in interest rates after a credit bargain is entered into does not come within sections 137-139 of the 1974 Act. The relevant inquiry should be limited to facts existing at the time of entering into the bargain. In support of this submission, Mr Malek makes the following points. First, if subsequent events were relevant to the question whether the credit bargain is extortionate, the issue would become unacceptably uncertain. Secondly, the language of sections 137-139 is all directed to the circumstances that exist at the date of the making of the credit bargain. The present tense is used in sections 137(1), 138(1) and 139(1). The time at which the factors listed in sections 138(2)-(5) are to be applied in determining whether a credit bargain is extortionate is the time of the making of the agreement.
Thirdly, section 189(1) of the 1974 Act provides that “total charge for credit” is defined as meaning a sum calculated in accordance with regulations under section 20(1). The relevant regulations are the Consumer Credit (Total Charge for Credit) Regulations 1980 SI 1980/51. Regulation 2 provides that:
“(1) Any calculation under these Regulations shall be made on the
following assumptions:
….
(d) in the case of a transaction which provides for variation of the rate or amount of any item included in the total charge for credit in consequence of the occurrence after the relevant date of any event, the assumption that the event will not occur; and, in this sub-paragraph, ‘event’ means an act or omission of the debtor or of the creditor or any other event (including where the transaction makes provision for variation upon the continuation of any circumstance, the continuation of that circumstance) but does not include an event which is certain to occur and of which the date of occurrence, or the earliest date of occurrence, can be ascertained at the date of the making of the agreement.”
Regulation 3 provides:
“3. Total charge for credit. For the purposes of the Act, the total charge for the credit which may be provided under an actual or prospective agreement shall be the total of the amounts determined as at the date of the making of the agreement of such of the charges specified in regulation 4 below as apply in relation to the agreement but excluding the amount of the charges specified in regulation 5 below.”
Regulation 4(1) provides:
“4. Items included in total charge for credit. (1) Except as provided in regulation 5 below, the amounts of the following charges are included in the total charge for credit in relation to an agreement:
(a) the total of the interest on the credit which may be provided under the agreement; ..”
It follows that, as the Recorder said at paragraphs 38 and 63 of his judgment, variations in the rate of interest charged in consequence of unpredictable future occurrences are to be excluded from the calculation of the total charge for credit and are excluded from being part of the credit bargain under the definition contained in section 137(2)(b).
The question whether a subsequent interest rate change may be relevant in determining whether a credit bargain is extortionate has been considered on a number of occasions in the county court, but never at any higher level. It is clearly a matter of very considerable importance, since credit bargains commonly provide that the rate of interest shall be at the discretion of the lender. In every case but one, the county court judge held that subsequent changes in interest rates are irrelevant to the question whether the credit bargain is extortionate. The exception is J&J Securities Ltd v Khan and Khan (18 August 1999), a decision of His Honour Judge Altman at Bradford County Court.
The point has been the subject of academic comment. Goode: Consumer Credit Law and Practice Volume 1 paragraph 47.27 says:
“The time as at which the bargain is to be tested. The question is whether the credit bargain is extortionate, not whether it has become unprofitable through a drop in the level of interest rates, nor whether the creditor has acted unconscionably in enforcing it. The Court has adequate powers to grant relief to the debtor from the consequences of unconscionable enforcement. Whether the credit bargain is extortionate has to be determined as at the date of the credit agreement, not in the light of subsequent events.”
Professor Goode cites two cases in support of this last sentence: Harris v Clarson [1910] 27 TLR 30 and Harrison v Gremlin Holdings Property Ltd [1962] NSWR 112. The first is a decision under the Moneylenders Act 1900, and the second a decision under the Moneylenders and Infants Loan Act 1941 of New South Wales. With respect to Professor Goode, like the Recorder, I do not derive any support from these decisions, based as they are on a consideration of different statutes which contain language that is significantly different from that of the 1974 Act.
But in his commentary on section 138 of the 1974 Act in Volume 2, paragraph 5.268, Professor Goode says:
“Is extortionate. The time at which the factors listed in the section are to be applied is the time of the agreement. This is explicit in sub-ss (2)(a) and (3)(b), and it would be neither sensible nor a natural reading of the language of the section to construe the remaining provisions otherwise”.
In this passage, Professor Goode does not cite the two earlier authorities and bases his view on the language of section 138 alone.
The Encyclopaedia of Consumer Credit Law (Guest and Lloyd), Volume 1, paragraph 2-139 states that “it is possible that under subs (2)(c) [of section 138] factors arising during the agreement may be relevant”. But a little later in the same paragraph the authors record that in Lombard the court of appeal left open the question whether ss 137 and 138 might apply to the unfair operation of a clause which empowered the creditor to vary the rate of interest unilaterally at his discretion, and state: “but it is submitted that, in principle, these sections apply only to the original credit bargain”.
In my judgment, the Recorder was right to hold that the subsequent changes in rates of interest were irrelevant to the question whether the credit bargains were extortionate. The submission advanced by Mr Bannister is seductively simple. It is that the interest payments that the appellants were required to make were payments required to be made by the credit agreements. Accordingly, they were payments to which section 138(1) applies, and if they were grossly exorbitant, that would be sufficient to render the credit bargains extortionate. It is to be noted that Mr Bannister does not submit that changes in interest rates are capable of being “other relevant considerations” within the meaning of section 138(2)(c).
But I cannot accept his argument. My principal reason is that variations in rates of interest are excluded from the calculation of the “total charge for credit” and therefore excluded from being part of the credit bargain. Section 137(1) provides that a credit agreement may be reopened if the credit bargain is extortionate. Section 137(2)(b) defines “credit bargain” by reference to the transaction or transactions that are to be taken into account in computing the “total charge for credit”. It is not in dispute that the effect of section 20 of the 1974 Act and the Credit (Total Charge for Credit) Regulations 1980 is that (with exceptions that are immaterial for present purposes) subsequent variations of the rate of interest are not taken into account in determining the total charge for credit. This is the clear effect of Regulations 2(1)(d), 3 and 4 of the 1980 Regulations and section 20(1) of the 1974 Act which provides:
“(1) The Secretary of State shall make regulations containing such provisions as appear to him appropriate for determining the true cost to the debtor of the credit provided or to be provided under an actual or prospective consumer credit agreement (the “total charge for credit”), and regulations so made shall prescribe –
(a) what items are to be treated as entering into the total charge for credit, and how their amount is to be ascertained;
(b) the method of calculating the rate of the total charge for credit.”
Thus the purpose of the 1980 Regulations is to determine the “true cost to the debtor of the credit provided”, and it does this by defining the total charge for credit. The definition of “credit bargain” in section 137(2)(b) is based on the transaction or transactions which are taken into account in determining the total charge for credit. The total charge for credit is central to a consideration of whether a credit bargain is extortionate. It would be extraordinary if the rules for computing the total charge for credit were to be ignored in deciding whether a credit bargain is extortionate, and yet that is the effect of Mr Bannister’s submission. He submits that section 137(2)(b) serves no other purpose than that of defining the credit bargain, and ensuring that all transactions that are taken into account in computing the total charge for credit, and not merely the credit agreement, are taken into account. I agree that section 137(2)(b) does serve that purpose. But it does not follow that the rules for computing the total charge for credit can be ignored when deciding whether a credit bargain is extortionate. An important purpose of the Regulations which define the total charge for credit is to provide a measure by reference to which it can be determined whether a credit bargain is extortionate. Regulation 2 contains detailed provisions as to the assumptions that should be made in carrying out the calculation.
Quite apart from the argument based on the 1980 Regulations, I derive support from the language of section 138 itself. The factors that are relevant to the question whether a credit bargain is extortionate are not only the credit agreement and other transactions that are to be taken into account in computing the “total charge for credit”, but also other factors present at the time when the credit bargain was made. Thus it is expressly provided in section 138(2)(a) (interest rates prevailing) and section 138(3)(b) (financial pressure) that the relevant time for considering these matters is the time of the making of the credit bargain. It is also the natural reading of section 138(3)(a) (age, experience, business capacity and state of health), section 138(4)(a) (degree of risk), section 138(4)(b) (relationship to the debtor), section 138(4)(c) (quote of a colourable cash price for goods or services included in the credit bargain) that all of these matters are to be considered as at the date when the credit bargain is made, and at no other time.
It might be said that, if variations in rates of interest are not to be taken into account in deciding whether a credit bargain is extortionate, then there is a glaring lacuna in the protection provided by the 1974 Act. Mr Malek was unable to suggest any policy reason why the protection should be limited in this way. But if I am right in holding that the discretion to set variable interest rates is subject to an implied restriction that it will be exercised in the way that I have described, then the lacuna is less considerable than it might appear. Moreover, the measure of the protection that is undoubtedly afforded by the 1974 Act should not be overstated. At paragraph 47.26 of Consumer Credit Law and Practice, Professor Goode says:
“Nevertheless, it seems clear that the concepts of extortion and unconscionability are very similar. ‘Extortionate’, like ‘harsh and unconscionable’, signifies not merely that the terms of the bargain are stiff, or even unreasonable, but that they are so unfair as to be oppressive. This carries with it the notion of morally reprehensible conduct on the part of the creditor in taking grossly unfair advantage of the debtor’s circumstances. This element of moral culpability, in the form of abuse of power or bargaining position, is well brought out in the judgment of Sir John Donaldson MR in Wills v Wood [1984] CCLR 7:
‘It is, of course, clear that the Consumer credit Act 1974 gives and is intended to give the widest possible control over credit bargains which, for a variety of reasons, might be considered “extortionate”. But the word is “extortionate”, not “unwise”. The jurisdiction seems to me to contemplate at least a substantial imbalance in bargaining power of which one party has taken advantage’.”.
In practice, there are unlikely to be many situations in which an allegation of breach of the term that I have held should be implied would fail where the same allegation, expressed as a complaint that the rate of interest is “grossly exorbitant” so as to render the transaction “extortionate”, would succeed.
Were the rates of interest grossly exorbitant?
In view of my conclusion that the subsequent rates of interest are irrelevant to the question whether a credit bargain is extortionate, I shall deal with this issue very shortly. The particulars relied on by the appellants are precisely the same as those relied on as particulars of breach of the implied term for which they contend. For substantially the same reasons as I have rejected their case on breach of the implied term, I would hold that the allegation that the rates of interest were grossly exorbitant has no real prospect of success. The rates are not merely required to be exorbitant. The appellants must show that they are grossly exorbitant. In my judgment, if one looks at the rates alone, the disparity between the rates that the Claimant was charging the appellants from about 1995 onwards and those charged during this period either by the Halifax or by Paragon was not such as to make the Claimant’s rates grossly exorbitant. It may be said that they were high, even unreasonably high, but that is insufficient. Thus, even if the subsequent rates could be taken into account in deciding whether the credit bargains were extortionate, I am not persuaded that the appellants would have real prospects of success on this issue at trial.
The Limitation Issues
A number of arguments were addressed to us as to when the cause of action under section 139 of the 1974 Act first arose, and indeed as to whether the Limitation Act 1980 applies at all to such a cause of action. I mention in passing that in Rahman v Sterling Credit Limited [2001] 1 WLR 496, it was held by this court that a claim to reopen an agreement under section 139 is “an action upon a specialty” for which the relevant limitation period under section 8 of the Limitation Act 1980 is 12 years. Mr Bannister submits that this decision proceeded on the basis of a concession by counsel for the borrower that a claim to relief under section 139 is an action upon a specialty, and that it is wrong. Since I have reached the clear conclusion that the appellants have no real prospect of succeeding in their claim under section 139, it is unnecessary for me to decide the limitation point, and I do not propose to do so.
Section 3(2)(b)(i) of the Unfair Contract Terms Act 1977
Section 3 of the Act provides so far as material:
“(1) This section applies as between contracting parties where one of them deals as consumer or on the other’s written standard terms of business.
(2) As against that party, the other cannot by reference to any contract term—
…
(b) claim to be entitled—
(i) to render a contractual performance substantially different from that which was reasonably expected of him, or
(ii) in respect of the whole or any part of his contractual obligation, to render no performance at all,
except in so far as (in any of the cases mentioned above in this subsection) the contract term satisfies the requirement of reasonableness”
It is submitted on behalf of the appellants that they were reasonably entitled to expect that, in performing their side of the bargain, the Claimant would not apply rates which were substantially out of line with rates applied by comparable lenders to borrowers in comparable situations to the appellants. It is contended that the setting of interest rates is “contractual performance” within the meaning of section 3(2)(b) of the 1977 Act, and that the Claimant set interest rates that defeated that expectation.
The first question is whether the fixing of rates of interest under a discretion given by the contract was “contractual performance” within the meaning of section 3(2)(b). Mr Broatch submits that it is. He relies on two authorities. The first is Timeload Ltd v British Telecommunications PLC [1995] EMLR 459. In that case, the plaintiff set up a free telephone inquiry service, and entered into a contract with BT whereby BT provided the plaintiff with the use of a certain telephone number. There was a clause in the contract which authorised BT to terminate apparently without reason. BT gave one month’s notice of termination, and the plaintiff sought an injunction to restrain BT from terminating. It was held by the court of appeal that it was at least arguable that a clause purporting to authorise BT to terminate without reason purported to permit partial or different performance from that which the plaintiff was entitled to expect, and that section 3(2) of the 1977 Act applied. But the licence agreement imposed clear performance obligations on BT. Thus, clause 1.1 obliged BT to provide the various services there set out. In these circumstances, it is not difficult to see why the court thought that it was at least arguable that a clause authorising termination of the obligation to provide those services for no good reason purported to permit a contractual performance different from that which the customer might reasonably expect.
The second authority is The Zockoll Group Ltd v Mercury Communications Ltd [1999] EMLR 385. This was another telecommunications case. The plaintiff planned to set up a network of franchisees to provide goods and services to the public in response to telephone inquiries. It entered into a contract with Mercury under which it obtained a number of telephone numbers. Mercury wished to withdraw one number from the plaintiff and asserted that it was entitled to do so at its sole discretion. The plaintiff brought proceedings and relied on section 3(2)(b)(i) of the 1977 Act. The court held that the withdrawal of the disputed number did not render the contractual performance substantially different from what was expected. Mr Broatch points out that it is implicit in the decision of the court that it was accepted that the withdrawal of the disputed number was capable of being contractual performance substantially different from that which it was reasonable to expect.
In my judgment, neither of these authorities assists Mr Broatch’s submission. In both cases, the defendant telecommunications provider was contractually bound to provide a service. The question was whether the withdrawal of the service in the particular circumstances of the case was such as to render the contract performance (ie the provision of that service) substantially different from that which it was reasonable for the other contracting party to expect. The present cases are quite different. Here, there is no relevant obligation on the Claimant, and therefore nothing that can qualify as “contractual performance” for the purposes of section 3(2)(b)(i). Even if that is wrong, by fixing the rate of interest at a particular level the Claimant is not altering the performance of any obligation assumed by it under the contract. Rather, it is altering the performance required of the appellants.
There appears to be no authority in which the application of section 3(2)(b)(i) to a situation similar to that which exists in this case has been considered. The editors of Chitty on Contracts (28th edition) offer this view at paragraph 14-071:
“Nevertheless it seems unlikely that a contract term entitling one party to terminate the contract in the event of a material breach by the other (e.g. failure to pay by the due date) would fall within paragraph (b), or, if it did so, would be adjudged not to satisfy the requirement of reasonableness. Nor, it is submitted, would that provision extend to a contract term which entitled one party, not to alter the performance expected of himself, but to alter the performance required of the other party (e.g. a term by which a seller of goods is entitled to increase the price payable by the buyer to the price ruling at the date of delivery, or a term by which a person advancing a loan is entitled to vary the interest payable by the borrower on the loan).”
In my judgment, this passage accurately states the law. The contract term must be one which has an effect (indeed a substantial effect) on the contractual performance reasonably expected of the party who relies on the term. The key word is “performance”. A good example of what would come within the scope of the statute is given at paragraph 14-070 of Chitty. The editors postulate a person dealing as a consumer with a holiday tour operator who agrees to provide a holiday at a certain hotel at a certain resort, but who claims to be entitled, by reference to a term of the contract to that effect, to be able to accommodate the consumer at a different hotel, or to change the resort, or to cancel the holiday in whole or in part. In that example, the operator has an obligation to provide a holiday. The provision of the holiday is the “contractual performance”. But that does not apply here.
Mr and Mrs Staunton: the Stabilised Rate Facility
As I explained at paragraph 5 of this judgment, the Stabilised Rate Facility enabled Mr and Mrs Staunton to cap the amount of interest payable each month and defer payment of the excess by granting a “monthly credit” and converting the credit (up to a maximum of £10500) into part of the capital amount of the loan. The Offer of Loan incorporated certain Special Conditions in respect of the Stabilised Rate Facility. Condition 2 provided that:
“The Company’s obligation to credit any Monthly Credit shall cease if the amount of the next Monthly Credit when aggregated with Monthly Credits previously paid and amounts of Interest capitalised or accrued in accordance with Condition 5 would equal or be greater than the Maximum Deferred Interest shown on the Offer of Loan.”
In other words, once the maximum deferred interest of £10500 was reached, Mr and Mrs Staunton ceased to be entitled to the benefit of the cap. If that occurred, they would inevitably face a jump in interest rates.
Mr Falkowski submits that they were not warned of the jump in interest rates that would occur once the Stabilised Rate Period came to an end. What was required was an explanation in plain and intelligible language of the way in which the Facility would operate. The failure of the contract documents to do this rendered the credit bargain extortionate, since it grossly contravened ordinary principles of fair dealing: see section 138(1)(b) of the 1974 Act.
In my view, there is nothing misleading or underhand about the contract documentation. It may not be especially easy for a lay person to understand. But it does clearly describe the way in which the Stabilised Rate Facility works. It does not even contravene ordinary principles of fair dealing, let alone contravene them grossly. I would reject Mr Falkowski’s argument.
Conclusion
In my judgment, therefore, these appeals must be dismissed. This may seem a harsh result, since it is clear that the appellants have suffered serious hardship as a result of the increases in interest rates. But the 1974 Act provides borrowers with only limited protection from the working of the free market. Parliament has empowered the court to intervene only where a bargain is grossly unfair to the borrower, either because the payments required to be made are grossly exorbitant, or because it otherwise grossly contravenes ordinary principles of fair dealing. Nothing less will do. For the reasons that I have explained, money lending agreements which contain provisions for variable rates of interest are also subject to an implied term of limited scope, but that cannot avail the appellants in this case. If greater protection is to be accorded to borrowers, that is a matter for Parliament.
Mr Justice Astill:
I agree.
Lord Justice Thorpe:
I also agree.
Order: appeals dismissed; order made in terms of draft minute of order produced by Mr Malek QC; permission to appeal to the House of Lords refused; stay of order granted pending petition to House of Lords for leave and, in the event of petition succeeding, pending the determination of the subsequent appeal; detailed public funded costs assessment for Mrs Nash.
(Order not part of approved judgment.)
BRIGHTON AND HOVE CITY COUNCIL V AUDUS:
[2009] EWHC 340 (Ch), [2009] 9 EG 192, [2010] 1 All ER (Comm) 343, [2009] NPC 31
Morgan J
The claimant was the proprietor of a fourth legal charge on a title. It sought a declaration that a second charge in favour of the defendant was void as a clog on the proprietor’s equity of redemption. An advance secured by a first charge, also in favour of the defendant had been used to purchase the lease. The second charge was intended to secure that the proprietor could continue to live in the property without further payment for their lives, but that it would then revert to the defendant, their nephew. It did so by charging any future increase in value of the property.
‘It was in substance a transaction whereby Mr Audus would buy the flat and have ownership of the flat but his rights were to be postponed to the rights of Mr and Mrs Bull to live in the flat for their lives.’
‘It is inherent in the concept of a mortgage or security interest that the borrower of money should be able to discharge the security interest, that is, to redeem the mortgage by paying the money and in that way performing the obligation performance of which is secured. At common law it was possible to include in a mortgage a contractual term which had the effect that the mortgagor would lose the right to redeem if he failed to repay the monies due by a specified date. Equity regarded such a term as liable to work injustice and hardship and equity granted relief against the operation of such a contractual term by recognising an equitable right to redeem, notwithstanding non-compliance with the contractual term . . The relevant rules are threefold. The first is that a condition which is repugnant to the contractual right to redeem and the equitable right to redeem is void. The second rule is that a condition which imposes a penalty in respect of the exercise of the equitable right to redeem, following a failure to exercise a contractual right to redeem, is void in equity. The third rule is that a provision which regulates or controls the right to redeem is invalid, if it is unconscionable.’
Quennell v Maltby & Anor
[1978] EWCA Civ 1 [1979] WLR 318, [1979] 1 WLR 318, [1978] EWCA Civ 1, 249 EG 1169, [1979] 1 All ER 568
Giving judgment, LORD DENNING MR said: If the judgment of the judge below is right, it will open a gap in the protection which is offered to tenants by the Rent Act. I will first give the facts.
Mr Quennell is a gentleman who lives in Cheyne Row in London. But he is the owner of a large house in Lewes. It is 6 Wallands Crescent, Lewes, with about nine bedrooms. He has an agent in Lewes who looks after it for him. The house is very suitable for students. In 1973 the agent let it to some students of the University of Sussex. Two of them became the tenants. They were Mr Maltby and Mr Jack. They were let into possession for a term of one year at a rent of £ 90 a month, expiring on December 31 1974. They had other students there with them, about nine students in the house. While Mr Maltby and Mr Jack were tenants Mr Quennell borrowed money from Barclays Bank and mortgaged this house to secure the loan. It was only for the sum of £ 2,500. He executed a legal charge on August 13 1974 in favour of Barclays Bank to cover any moneys which might from time to time be owing to the bank. In that legal charge there was this clause 4, which is in common form:
During the continuance of this security no statutory or other power of granting or agreeing to grant or of accepting or agreeing to accept surrenders of leases or tenancies of the Mortgaged Property or any part thereof shall be capable of being exercised by the Mortgagor without the previous consent in writing of the Bank.
That meant thereafter from August 13 1974 so long as this legal charge subsisted to the bank, Mr Quennell could not let the premises or accept surrenders without the consent in writing of the bank.
The tenancy of Mr Maltby and Mr Jack came to an end at the end of December 1974. The house was then relet to two other students, a Mr Quilter and a Mr Lyeth, again for a year. It was not relet to Mr Maltby because it was thought that he was going to the United States. As it happened Mr Maltby did not go to the United States. In fact he stayed on living in the house. So did several other students. At all events, the important thing to note is that the bank did not give its consent to this letting to Mr Quilter and Mr Lyeth. No one asked the bank for its consent. No one realised it was necessary. No one interfered and nothing happened. The year 1975 passed. Then at the end of that year there was a fresh letting. This was between Mr Quennell as landlord and Mr Maltby and a Mr Lupton as tenants. That tenancy lasted until December 1976. Again no one asked the bank for consent. No one realised it was necessary. And from January 1977 onwards the tenants remained as statutory tenants, paying the rent to the agents.
The position then arose that Mr Quennell wanted to get possession of the house. If he could get vacant possession, he could sell it at a high price. It might be worth £ 30,000 to £ 40,000 with vacant possession. Mr Quennell started proceedings for nuisance and annoyance, but he dropped them. Then he went to lawyers for advice. After consulting them, in October 1977 Mr Quennell went to the bank and told them about the tenants in the house. The bank had not heard before about the various changes in the tenancies. Even when they were told the bank made it clear that they had no intention of taking any proceedings to enter the property or to turn the tenants out or anything of that kind. The bank were not concerned to get possession.
Then Mr Quennell’s lawyers in London advised him that there was a good way in which possession could be achieved. This is what it was: Mr Quennell’s wife, Mrs Quennell,paid off the bank. She paid the £ 2,500 which was owing to the bank and took a transfer of the charge. The bank transferred it to her by a transfer dated January 17 1978. Then Mrs Quennell brought proceedings against the tenants, Mr Maltby and Mr Lupton, seeking possession. She said that she stood in the shoes of the bank, and, seeing that the tenancy was granted without the consent of the bank, it was void. So she could recover possession.
The judge accepted this submission. He held that the wife, Mrs Quennell, was entitled to possession of the premises and could turn Mr Maltby and all the other students out of the house. Now it has been held that, when the bank holds a charge and there is a clause in it whereby there are to be no tenancies granted or surrendered except with the consent of the bank in writing, then in those circumstances, if the mortgagor does thereafter grant tenancies without the consent of the bank, those tenancies are not binding on the bank, and the tenants are not entitled to the protection of the Rent Acts. That was decided in Dudley & District Benefit Building Society v Emerson [1949] Ch 707. Mrs Quennell relies on that case. She says that, as transferee of the legal charge, she stands in the shoes of the bank and can obtain possession.
The judge accepted that submission. His decision, if right, opens the way to widespread evasion of the Rent Acts. If the owner of a house wishes to obtain vacant possession, all he has to do is charge it to the bank for a small sum. Then grant a new tenancy without telling the bank. Then get his wife to pay off the bank and take a transfer. Then get the wife to sue for possession.
That indeed was what happened here. In October 1977, when Mr Quennell went to the bank, he told them about the tenancies. They said that they did not intend to take proceedings. So he got Mrs Quennell to do it. In evidence, she said: ‘I paid £ 2,500. This was for my husband. I took the charge to make the debt to his bank less onerous. I was aware he wanted to obtain possession of the house to sell it. I merely paid off the charge. These proceedings have been brought to get possession to sell.’ So the objective is plain. It was not to enforce the security or to obtain repayment or anything of that kind. It was in order to get possession of the house and to overcome the protection of the Rent Acts.
Is that permissible? It seems to me that this is one of those cases where equity steps in to mitigate the rigour of the law. Long years ago it did the same when it invented the equity of redemption. As is said in Snell’s Equity, 27th ed (1973) on p 376:
The Courts left the legal effect of the transaction unaltered, but declared it to be unreasonable and against conscience that the mortgagee should retain as owner for his own benefit what was intended as a mere security.
So here in modern times equity can step in so as to prevent a mortgagee, or a transferee from him, from getting possession of a house contrary to the justice of the case. A mortgagee will be restrained from getting possession except when it is sought bona fide and reasonably for the purpose of enforcing the security and then only subject to such conditions as the court thinks fit to impose. When the bank itself or a building society lends the money, then it may well be right to allow the mortgagee to obtain possession when the borrower is in default. But so long as the interest is paid and there is nothing outstanding, equity has ample power to restrain any unjust use of the right to possession.
It is plain that in this transaction Mr and Mrs Quennell had an ulterior motive. It was not done to enforce the security or due payment of the principal or interest. It was done for the purpose of getting possession of the house in order to resell it at a profit. It was done so as to avoid the protection which the Rent Acts afford to tenants in their occupation. If Mr Quennell himself had sought to evict the tenants, he would not be allowed to do so. He could not say the tenancies were void. He would be estopped from saying so. They certainly would be protected against him. Are they protected against his wife now that she is the transferee of the charge? In my opinion they are protected. For this simple reason, she is not seeking possession for the purpose of enforcing the loan or the interest or anything of that kind. She is doing it simply for an ulterior purpose of getting possession of the house, contrary to the intention of Parliament as expressed in the Rent Acts.
On that simple ground it seems to me that this action fails and it should be dismissed. The legal right to possession is not to be enforced when it is sought for an ulterior motive. I would on this account allow the appeal and dismiss the action for possession.
Agreeing BRIDGE LJ said: The situation arising in this case is one, it seems to me, in which the court is not only entitled but bound to look behind the formal legal relationship between the parties to see what is the true substance of the matter. Once one does that, on the facts of this case it is as plain as a pikestaff that the purpose of the bringing of these proceedings via Mrs Quennell is not for her own benefit to protect or enforce the security which she holds as the transferee of the legal charge but for the benefit of her husband as mortgagor to enable him to sell the property with the benefit of vacant possession. In substance she is suing as his agent. That being so, it seems to me inevitably to follow that she can be in no better position in these proceedings than her husband would be if they had been brought in his name. If they had been brought in his name, it is clear that the defendants would have had an unanswerable defence under the Rent Acts.
I agree that the appeal should be allowed.
Also agreeing, TEMPLEMAN LJ said: I agree that the appeal should be allowed. The landlord Mr Quennell, finding that he was encumbered by a statutory tenant and not able to reap the benefit of a sale with vacant possession, devised under advice a scheme whereby he might obtain vacant possession. It so happened that the landlord had mortgaged the property to his bank to secure his overdraft and other borrowings, and the mortgage contained a common form prohibition on any lettings without the consent of the mortgagee bank.
The lease to the statutory tenant was made by the landlord after the date of the mortgage without the consent of the bank and was therefore in breach of the landlord’s covenant contained in the mortgage. That lease was binding on the land-
lord but void against the bank. On expiry of the lease the tenant became a statutory tenant as against the landlord but not as against the bank.
The landlord being unable to get possession from his own statutory tenant approached the bank and asked the bank to bring an action against the tenant for possession. This would then enable the landlord to sell the property with vacant possession. The bank very properly declined to take any such action which was not required to protect their position as mortgagee. The amount of the debt owed by the landlord to the bank was £ 2,500, the rent payable by the tenants exceeded £ 1,000 a year, and the property was worth in the region of £ 30,000 to £ 40,000. The bank in these circumstances rightly refused to do for the landlord that which the landlord could not do for himself.
The landlord, again under advice and undaunted, conceived an alternative method of obtaining vacant possession. His wife paid off the debt of £ 2,500 owed to the bank by her husband-landlord; and the bank, as it was bound to do accepted that payment and transferred the mortgage to the wife. The landlord’s wife (then the mortgagee) was owed £ 2,500 by her husband; and she, at the request of her husband, brings an action against the tenant for possession claiming that the lease made by her husband is not binding on her as mortgagee and that she can therefore obtain possession and then sell to the benefit of herself and her husband.
As I say, the authorities establish that as a matter of law a lease made in breach of covenant by a mortgagor is void against the mortgagee and, I assume for present purposes, against the transferee unless the lease is adopted by the mortgagee. Neither the bank nor the wife adopted the tenancy. The estate, rights and powers of a mortgagee, however, are only vested in a mortgagee to protect his position as a mortgagee and to enable him to obtain repayment. Subject to this, the property belongs in equity to the mortgagor. In the present case it is clear from the facts and the evidence that the mortgagee Mrs Quennell is not bona fide exercising her rights and powers for her own purposes as mortgagee but for the purpose of enabling the landlord mortgagor (her own husband) to repudiate his contractual obligations and defeat the statutory tenancy of the tenant which is binding on the landlord. Mrs Quennell does not even pretend to be acting in her own interests as mortgagee. She brings this action to oblige her husband. In my judgment the court must therefore treat this action, although in form brought by a mortgagee, as an action brought for and on behalf of the landlord mortgagor. The court should deal with it as though the mortgagor landlord were the plaintiff, and on that basis possession will not be ordered.
The appeal was allowed with costs in the Court of Appeal and below. Legal aid taxation ordered for the successful appellants (defendants below).
The electronic text of this judgment was provided by Estates Gazette, whose assistance is gratefully acknowledged.
Fennell & Anor -v- N17 Electrics Ltd
[2012] IEHC 228
Judgment by: Dunne J.
Submissions and Discussion
12. The applicants in this case make the point that the terms of the charges expressly reflect such a contrary intention and, accordingly, the statutory power of leasing contained in the 1881 Act has been excluded and replaced by a conditional power to grant a lease subject to the prior written consent of the bank being obtained, which has not been satisfied in this case. Very simply put, the bank’s case is that as there was no prior written consent in accordance with the terms of the charges, the 2005 business lease agreement is not binding on the bank.
13. In the course of submissions, I was referred to some of the leading textbooks on this topic. Wiley, in ‘Law of Landlord and Tenant’ (2nd Ed.), stated at para. 6.10 as follows:
“Though both the mortgagor and mortgagee have power to lease the land at common law, such leases were of limited effect since, while binding between the lesser and lessee, they could not prejudice the rights of the other party to the mortgage i.e. in the case of a lease by the mortgagor, the mortgagee’s paramount rights to take possession or otherwise realise his security … these difficulties were removed by s. 18 of the Conveyancing Act 1881, which conferred a statutory power of leasing upon both mortgagor and mortgagee, exercisable while either is in possession of the mortgaged land. A lease granted by the mortgagor under his statutory power binds every mortgagee … provided in each case the statutory powers are complied with … it is also important to note that most mortgage deeds restrict the mortgagor’s power of leasing, by requiring the consent of the mortgagee, if the power is not excluded altogether. The point is that the existence of a tenant on the land may hinder the exercise by the mortgagee of his powers to realise his security, e.g. to take possession or to sell the land. If a tenancy is binding on the mortgagee, it may also affect the value of his security, especially if the tenant acquires renewal rights. In ICC Bank v. Verling, the mortgage of an off-licence premises contained a clause that, during the continuance of the security, ‘the statutory and other power of leasing, letting, entering into agreements for leases and letting …’ were not exercisable by the borrower. Lynch J. held that this clause was a sufficient indication of a ‘contrary intention’ so as to exclude the statutory powers of leasing conferred by s. 18 of the Conveyancing Act 1881. Furthermore, following a concession by counsel, he held that a purported lease granted by the mortgagor was null and void when first granted.”
14. Reference was made in that passage to the decision in the case of ICC Bank plc. v. Verling in which Lynch J., having referred to the provisions of s. 18(13) of the 1881 Act, went on to say:
“Clause 15 of the mortgage deed of 31st May 1991, which I have quoted above, is, of course, such a contrary intention as is referred to in s. 18(13) of the Conveyancing Act 1881, and it is clear therefore and indeed counsel for the second and third defendants conceded that the lease of 23rd March 1993 was null and void when it was first granted by the first defendant to the second and third defendants …”
On the basis of those authorities, it was contended that the charges in this case evinced a contrary intention such as that referred to in s. 13 and, thus, it was argued that the statutory power contained therein was excluded expressly and the power to grant a lease could only be exercised in accordance with the terms of the charge which required the prior written consent of the mortgagee.
15. It was also submitted that although it is the contention that the statutory power had been excluded, that even if that were not the case, then, notwithstanding that, the statutory conditions which permit the grant of a lease had not been complied with. That being so, it was argued that the business lease agreement still could not bind the bank, one of the obligations of the lessor created by s. 18 of the 1881 Act being to obtain the best rent that can reasonably be obtained. Reliance was placed on English authority in that regard and I was referred to a passage from Megarry and Wade, ‘Law of Real Property’, 7th Ed., at para. 25-080, a passage which referred to leases granted outside the statutory power, wherein it was stated as follows:
“If the power is excluded and the mortgagor nevertheless grants an unauthorised lease, the lease is void against the mortgagee and his successors in title (unless they are estopped from asserting this), but valid as between the parties to it. The statutory powers of leasing do not deprive the parties of their common law rights to create leases not binding upon each other. For example, if the mortgage contains a covenant by the mortgagor not to exercise a statutory power of leasing without the mortgagor’s written consent, the mortgagor may, nevertheless, grant a yearly tenancy which binds the mortgagor under the principle of estoppel but which does not bind the mortgagee.”
16. It was submitted on behalf of the bank that that is precisely what has occurred in the circumstances of this case.
17. Further reliance was placed on a passage from Fisher and Lightwood’s ‘Law of Mortgage’ at para. 29.18, in which it is stated:
“The mortgagor is unable to confer upon another a greater right than he himself possesses. Thus, in the absence of a statutory or express power of leasing, where, after the mortgage, the mortgagor purports to grant a lease without the privity of the mortgagee, the tenancy will subsist by estoppel between the mortgagor and tenant but will be void against the mortgagee. Such a tenant is liable, like his lessor, to be ejected without notice. His only remedy is against the mortgagor …”
18. A further passage was referred to in support of the bank’s arguments from Woodfall ‘Landlord and Tenant Act’ para 2.169, in which the following passage appears:
“If the mortgage was made before January 15 1882, or if the statutory powers of leasing are excluded or modified, a lease granted by a mortgagor confers on the tenant a precarious title. Although it is good by estoppel as between the tenant and the mortgagor and the world in general, it is liable to be defeated by the mortgagee asserting his paramount title. This principle is not affected by the fact that the tenant is, against the mortgagor, a protected or a statutory tenant under the Rent Act. Where a lease made after the mortgage operates as a precarious tenancy, the mortgagee may treat the tenants of the mortgagor as trespassers; they are not his tenants and he cannot distrain or sue for rent unless a new tenancy has been created as between him and the tenant in possession by an attornment or otherwise. A tenancy was not created:
…
(e) Where the mortgagee received rent under an express authority from the mortgagor.”
19. Thus, it was argued that in circumstances where the mortgagor had provided for the mortgagee to receive the rent under an express authority or by means of an assignment, that still did not create a tenancy binding on the mortgagee under the provisions of the 1881 Act. On that basis, it was submitted that there was no question that the bank was bound by the business lease agreement herein.
20. It was pointed out on behalf of the bank and the receiver that the explanation for the legal position contended for was quite simple, namely, if the position were not so, a mortgagee would simply not be able to enforce its security by obtaining its right to possession, and thus, the value of the security would be rendered pointless or nonexistent.
21. I now want to look at a number of authorities that were opened in the course of the submissions on behalf of the applicants. The first of those is the decision in the case of Iron Trades Employers Assurance Association Ltd. v. Union Land and House Investors Ltd. [1937] Ch. 313. In that case, there was a legal mortgage and the defendants had covenanted with the plaintiffs that they would not, except with the previous written consent of the plaintiffs, exercise the power of leasing. By a tenancy agreement, the defendants granted a lease of part of premises included in the legal charge upon a yearly tenancy. The plaintiffs were not asked for and did not give their consent to the execution of the tenancy agreement. In those circumstances, it was held that the defendants, in granting the lease, were not exercising their statutory power and, consequently, they did not commit any breach of the covenant contained in the legal charge. Judgment in that case was opened extensively and I want to refer to a number of short passages from it. It was pointed out in the judgment that the purpose of the proceedings was to have the question determined by the Court as to the respective rights of the parties as to whether the granting of a lease was not a breach of the covenant contained in the charge. Farwell J. stated at p. 317 of his judgment as follows:
“In order to determine this question it is necessary to consider quite briefly the position between mortgagors and mortgagees before the passing of either the Act of 1925 or the Conveyancing Act, 1881. Under the law as it was before the Act of 1881 the position was this, that in the case of a legal mortgage the mortgagor, although in possession, had no power at all to grant a lease which was binding on the mortgagee. Any lease granted by him to some third party would be in no way binding on the mortgagee and as between the lessee and the mortgagee would create no estate or interest other than that which I will mention in a moment. So far as the mortgagor, who had granted the lease, was concerned, it was binding upon him as against the lessee, and he was estopped from disputing it and as against the mortgagor or against any one other than a person having a title paramount to the mortgagor, e.g., the mortgagee, such a lease was good and the lessee was entitled to the benefit conferred thereby, but so far as the mortgagee was concerned the lessee had no estate or interest as against him, except that he had a right to redeem in the event of the mortgagee taking steps to evict him from possession of the property which had been leased to him by the mortgagor, but beyond that right to redeem he had no rights as against the mortgagee nor had he any estate or interest as against the mortgagee in the land at all …”
Farwell J. continued:
“That position was altered by the Conveyancing Act, 1881, because by that Act express power was given to the mortgagor in possession to grant leases on certain terms and subject to certain conditions which were good as against the mortgagee. The effect of that statutory power was to enable the mortgagor for the first time to do something which hitherto it had not been possible for him to do-namely, to grant a lease during the continuance of the charge which would be binding on the mortgagee. The fact that that power was given to the mortgagor did not, and as the law now stands does not, in my judgment, deprive the mortgagor of the power of doing that which he could have done apart from the Act – namely, grant a lease to a third party, which without the consent of the mortgagee is not binding on him, but is binding as between the lessor and the lessee. I cannot find that the power which the mortgagor had in that regard was taken away by the Act, which merely gave the mortgagor a wider power of granting leases on certain conditions which were binding on the mortgagee. The position, apart from the Act, in my judgment, remained the same. The mortgagee as soon as he ascertained that the mortgagor had granted a lease to a third party was entitled to take steps immediately to evict the tenant, to treat him as a trespasser, and, subject to the tenant’s right to redeem, the mortgagee could evict him and recover possession of the property.”
So far as those passages are concerned, it was submitted that they are a useful exposition of the law before the enactment of the 1881 Act, and following its enactment and I see no reason to disagree with that submission. There was a further passage from that judgment which it was stated by Mr. McDonald on behalf of the applicants did not represent the law, and in that passage, Farwell J. commented:
“On the other hand, he might, if he desired, confirm what had been done, but if, knowing the facts, he stayed his hand and did nothing, he might find himself in danger of being held to have acquiesced in and thereby confirmed the lease and, therefore, not entitled to oust the tenant.”
There are some further passages which I think it would be useful to refer to from the judgment of Farwell J. in that case. He continued at p. 322 as follows:
“There is nothing to prevent the mortgagor and mortgagee agreeing that the statutory powers shall not be exercised or shall be exercised in a wider or less restricted manner than that provided by the Statute. In my judgment, the effect of inserting in the mortgage a covenant by the defendants that they will not, except with the consent in writing of the mortgagee, exercise the power of leasing given by the Statute is to impose a further and additional term on the obligations which are contained in the Act itself, and that the exercise or purported exercise of a power for which no previous consent has been obtained is not an exercise of the statutory power at all, because, as the result of the agreement made between the parties, the only power of leasing given by the Statute is the power of leasing with the consent of the mortgagee. If I read into the section an overriding obligation on the mortgagor to obtain the written consent of the plaintiffs, the effect must be that if there is no such written consent, then the power which otherwise would have been exercisable by the mortgagor has not been validly exercised.”
22. That paragraph seems to me to set out the position that applies as a general rule.
23. Farwell J. continued at p. 323 to state:
“They had deprived themselves of the power of granting statutory leases without the written consent of the plaintiffs, and consequently when they granted this lease they were not exercising and could not have been exercising the power under the Statute and were only doing that which they could do apart from the Statute – namely, grant a lease which was not binding on the mortgagees.”
That decision, it was submitted, is a clear illustration that one can have a situation where a mortgagor grants a lease but the lease will not be binding on the mortgagee by virtue of the terms of the charge between the mortgagor and the mortgagee.
24. The next case to which I want to refer is the case of In Re O’Rourke’s Estate [1889] 23 LR Ir. 497. As appears from the head note in that case, where, subsequently to a mortgage, the mortgagor creates new tenancies, and submits rental to mortgagee, who raises no objection, such tacit acquiescence does not suffice to create a new tenancy as against the mortgagee. The act of the solicitor having carriage, in approving the rental which sets out such tenancies, will not create a new tenancy. The act of the receiver, in accepting rent from such tenants, and paying interest there out to the mortgagee, will not create a new tenancy. At p. 500 of the judgment, Monroe J. stated:
“I take it that the law on this subject is free from all manner of doubt. A lease made by a mortgagor, subsequent to the mortgage and not coming within the provisions of the Conveyancing and Law of Property Act, 1881
…
is absolutely void as against the mortgagee. He can treat the tenant as a trespasser, and evict him without notice. It is open, however, to the mortgagee and the tenant by agreement, express or implied, to create a new tenancy; and the question which always arises is the mere question of fact, whether such an agreement has been made in the particular case. If the mortgagee enters into the receipt of the rents and continues to take them from the tenants, this is almost conclusive evidence of an agreement between the mortgagee and the tenant for a new tenancy from year to year on the terms of the old tenancy; or, if the mortgagee served notice on the tenant, requiring him to pay his rents direct to the mortgagee, and the tenants do not dissent, these are facts from which a jury may, and probably ought, to infer the existence of such a contract of tenancy :… I have therefore to enquire in this case whether there are facts proved from which I ought to infer the existence of such an agreement. Three matters were relied upon not to set up the leases, but to create a tenancy from year to year on the terms of those leases, respectively:-
(i) The actions of Judge Lefroy [a party to the proceedings] who was all through representing the mortgagee;
(ii) the action of the solicitor having carriage who filed the petition for the mortgagee, and approved of the rental furnished by the agent; and
(iii) the action of the receiver in receiving the rents and paying the interest thereto to the mortgagee.
As regards the action of Judge Lefroy, which applies to M’Breen’s case alone, what is said is this:- He was furnished with the rentals; he knew that at the date of sale to the O’Rourkes, the lands were in the owner’s hands; he saw the name of M’Breen included in the list of tenants; he saw that rent was being paid by him; he knew that out of that rent his interest was being paid; and as he took no steps to object to such a tenancy, he must now be presumed to have adopted it. I certainly cannot infer the creation of a new tenancy between the tenant and the mortgagee merely because the mortgagee takes no active steps to disavow a tenancy created by the mortgagor. The mortgagor, while in possession, and bound to keep down the interest on his mortgage, is at liberty to manage the lands as he pleases. It is not for the mortgagee to interfere with that management unless he chooses to go into possession. He treats the tenancy as one binding on the mortgagor, but in no way binding upon himself if he find it afterwards for his interest to repudiate it.”
25. The final decision referred to in the course of these submissions on behalf of the applicants was the case of Taylor v. Ellis [1960] 1 Ch. 368. That was a case which concerned a mortgage dated 27th October, 1924, which excluded the mortgagor’s statutory power of leasing unless the mortgagee should consent in writing to the lease. Subsequently, the surviving mortgagor purported to grant a monthly tenancy to W.H. The surviving mortgagor, who granted the tenancy, died on 11th July, 1943, and the original mortgagee died on 21st July, 1957. There was no evidence that the mortgagee did give written consent to the grant of the tenancy, but there was no positive evidence that he did not and it was possible that he had: it was admitted that the mortgagee knew of the tenancy. No mortgage interest was paid after October 1950, and on 5th August, 1959, the mortgagee’s personal representative issued an originating summons claiming possession of the property subject to the mortgage. It was held in that case:
(i) That the onus was on the tenant to prove that the mortgagee gave written consent to the grant of the tenancy, and, therefore, in the absence of any evidence of such consent, the tenancy was not, to begin with, binding on the mortgagee.
(ii) that the tenancy had not become binding on the mortgagee by reason of the events subsequent to the grant of the tenancy, for it would be wrong to infer merely from the facts that the mortgagee, having knowledge of the tenancy, allowed the tenant to remain in possession, and that no interest had been paid for nine years, that the mortgagee had consented to take the tenant as his tenant. The plaintiff, accordingly, was entitled to possession against the tenant.
26. It appears from the head note that the decision in In Re O’Rourkes Estate was applied.
27. In the course of his judgment in that case, Cross J. commented on the evidence in relation to the issue of consent and stated as follows:
“… there is no positive evidence that he did not give his consent and it remains possible that he may have done so.
On those facts, the point that has been argued is on whom does the onus lie that the establish that the mortgagee either gave or did not give his consent in writing.
I think the matter can best be decided how the point would be pleaded in an action of ejectment. It seems to me that the mortgagee, in his statement of claim against anybody in possession of the land, would have to do no more than set out the mortgage, which showed that he had the immediate legal estate, and claimed possession. It would not be necessary for him to allege that the defendant claimed to be in possession as a tenant, but that the tenancy was not binding on him: it would be sufficient for him to say that he had the legal estate as mortgagee, and that he claimed possession.”
28. Cross J. went on to say:
“I think that it must be taken that to begin with, this tenancy was not binding on the plaintiff. Then the question arises: did the mortgagee become bound by the tenancy by reason of subsequent events? It is, of course, quite common for a mortgagee who was not previously bound by a tenancy to consent to take the mortgagor’s tenant, whom he could have treated as a trespasser, as his own tenant. The commonest way in which that happens is when a mortgagor fails to pay the mortgage interest and the mortgagee serves a notice on the tenant to pay the rent to him. Then, a new tenancy is created between the mortgagee and the mortgagor’s tenant. But all that happened in this case was that for a great many years, the tenant was allowed to remain in occupation of the property, and then there is the very curious circumstance that from October 5th 1950 onwards, no mortgage interest was paid.
Apart from the second point, it does not seem to me that the fact that the tenant of the mortgagor, who could have been treated by the mortgagee as a trespasser, was allowed to remain in possession for a long period could itself in any way preclude the mortgagee from treating him as a trespasser if and when he desired to do so. After all, as long as the mortgage interest is being paid, the mortgagee may perfectly well be content to allow the tenant to remain in possession. The only way in which he can turn him out of possession is by going into possession himself, which is a thing a mortgagee is very unwilling to do. I think that it would be quite wrong to infer, merely from the fact that the mortgagee allowed the tenant to remain in possession, having knowledge of the tenancy – there is no doubt in this case, and it is accepted, that Thomas Taylor knew of the tenancy – that the mortgagee consented to take the tenant as his tenant.”
29. Cross J. then went on to quote from one of the passages in the decision in In Re O’Rourke’s Estate to the effect that one cannot infer the creation of a new tenancy between the tenant and the mortgagee because the mortgagee takes no active steps to disavow the tenancy created by the mortgagor.
30. A number of useful observations can be made from the authorities referred to above. I think, first of all, that it is clear that a mortgagor and mortgagee can expressly agree to exclude the power conferred by s. 18 of the 1881 Act. If the power is excluded, it may be done in a way that permits the mortgagor to grant a lease subject to the prior consent of the mortgagee. If such prior written consent is not obtained by the mortgagor and the mortgagor proceeds to enter into a lease with a tenant, the lease will be binding on the mortgagor as lessor, but as against the mortgagee, the lease will not be binding. It is also clear that in certain circumstances, the lease may be binding on the mortgagee in circumstances such as those described in the authorities referred, where, for example, the mortgagee “serves a notice on the tenant to pay the rent to him”. It is also clear from the authorities referred to above, that the mere fact that the mortgagee is aware of the existence of a tenancy and that a tenant is paying rent to the mortgagor which is being used to pay the obligations of the mortgagor to the mortgagee, is not, of itself, sufficient to create a relationship between the mortgagor’s tenant and the mortgagee.
31. I think it is clear from the affidavits sworn herein, and in particular, from the affidavit of Michael McEvoy, the official liquidator of the respondent herein, and from the affidavit of Tom Naughton, the borrower, that no prior written consent of the bank had been obtained to the creation of the business lease agreement. The most that is asserted by Mr. Naughton, the borrower, is that he believed that he had delivered a copy of the agreement to the bank himself. Equally, I think it is fair to say that the bank was at all times aware of the fact that the respondent was in occupation of the premises, although there is a dispute as to whether or not the bank was aware of the existence of the business lease agreement.
32. The approach of the respondent as set out in the Points of Defence has been to assert that the building lease agreement constitutes a valid and binding tenancy agreement between the parties, presumably, that is the company and Mr. Naughton, the borrower. It is further pleaded that the company is a stranger to the allegation that the borrower did not seek the prior written consent of the bank to the business lease agreement, and insofar as that is alleged, it is asserted that it was not incumbent upon the company to seek any such written consent from the bank. It was also denied that the borrower had no power to grant the business lease agreement and that the negative covenants contained in the charges did not have the effect contended for by the bank. It was also pleaded in the points of claim as follows:
“Insofar as the bank is not a party to the business lease agreement, it is admitted that the bank is not bound by same but it is denied that the bank is entitled to ignore the contractual reality as pertains between the respondent and the borrower.”
The points of claim go on to state that the bank is “by virtue of the conduct referred to in the affidavits sworn on behalf of the respondent herein, and in the manner described in the respondent’s outline legal submissions of 6th March, 2012, estopped from denying the validity of the company’s tenancy pursuant to the agreement”. It is also specifically pleaded that the bank waived any requirement for prior written consent articulated in the mortgages relied upon.
33. I now want to look at the submissions of the respondent in support of those pleas.
34. Mr. Redmond S.C. on behalf of the respondent referred to a number of factual matters. First of all, he pointed out that N17 Electrics Limited was in occupation of some of the premises prior to the first mortgage. Therefore, in those circumstances, he submitted it would not have been possible for the mortgagor to get prior written consent given that the tenancy was already in existence. It was further noted that the aim of the bank in dealing with Mr. Naughton was at all times to ensure that the rentals being paid by N17 Electrics Limited was sufficient to defray the payments required by the bank from Mr. Naughton. There was also a submission made on behalf of the respondent to the effect that the bank knowingly facilitated the non payment of tax by Mr. Naughton. This assertion was made on the basis that the business lease agreement provided for rent in the amount of €30,000 per annum in circumstances were the bank was aware that the rent actually being paid was a multiple of this figure. The point was made that the bank facilitated or acquiesced in this arrangement because the less tax paid to the Revenue, the more money would have been available to the bank to repay the amount due to the bank. This allegation was hotly contested on behalf of the applicant herein and I note that there is nothing in the affidavit sworn by Mr. Naughton on behalf of the respondent herein to support such a contention.
35. The main point made by Mr. Redmond on behalf of the respondent was that at all times, the bank was aware of the occupation by N17 Electrics Limited of the relevant units at Terryland and Milltown and that the rent payable by N17 Electrics was used by Mr. Naughton to make the repayments due by him to the bank on foot of the various charges. It was further submitted that the bank was aware of the arrangements between the company and Mr. Naughton and expressed no dissatisfaction and is therefore estopped from relying on the negative pledge clauses contained in the various charges. To put it simply, it was submitted that the bank had taken the benefit of the arrangements between the company and Mr. Naughton and therefore the bank had to take the “flip side” of the arrangement.
36. There was also an issue raised as to the apparently inconsistent approach of the receiver in seeking to serve notice pursuant to s.290 of the Companies Act 1963. While this was done, I do not think that this fact in any way assists me to determine the issue in controversy between the parties which relates to the question as to the status of the 2005 Business Lease Agreement.
Decision
37. I now want to look more closely at the factual background to this matter. The first charge herein was made on 29th June 2001 and related to Unit A3 at Terryland; the second charge was made on 12h September 2002 and was in respect of Unit 2 at Terryland; the third charge was made on 30th May 2003 and was in respect of Unit A1 at Terryland and the final charge was made on 19th November 2004 in respect of the retail premises at Milltown, Tuam, County Galway.
38. Mr. Gavigan in an affidavit sworn herein on the 26th January 2012 on behalf of the bank accepted that a copy of the business lease agreement was found in the bank files but pointed out that there was no prior request for the bank’s consent to that agreement and he stated that the bank had not furnished its consent to it.
39. I have also looked at the various letters of sanction relating to the provision of further facilities to Mr. Naughton. The various letters of sanction speak of the bank’s requirement that leases be put in place with “rental payments sufficient to meet repayments” or “in an amount not less than the monthly repayment”. The letters of sanction further required that “no lettings or renewal… are to be made without the bank’s prior consent in writing”.
40. I have read carefully the affidavit of Mr. McEvoy, the official liquidator and that of Mr. Naughton in regard to the issue of consent. I note that an issue is raised as to a 2002 tenancy agreement executed by Mr. Naughton and the company which Mr. Gavigan states was never on the bank’s file but which was on the bank’s solicitors file. I also note the criticism of the bank’s dealings with Mr. Naughton contained in Mr. McEvoy’s affidavit. It does appear that the bank was somewhat lax in its approach to the question as to whether appropriate formal leasing arrangements were in place as between the borrower, Mr Naughton, and the company, given the requirements contained in the various letters of sanction. Having said that I am satisfied on the evidence before me that no prior consent, written or otherwise, was furnished by the bank to the 2005 business lease agreement. The fact that the company was in occupation of the premises did not mean that that a formal lease could not be put in place on terms which would have met the bank’s requirements and therefore, presumably, would have received it’s consent.
41. That leaves the question as to how it can be asserted the bank is estopped from denying the validity of the 2005 business lease agreement. The high point of the arguments made on the respondent’s behalf in this regard is to be found in para 30 and 31 of the affidavit of Mr. Naughton. Mr. Naughton averred that he was at “at loss to understand the bank’s contention… that it was not aware or did not consent to the creation of the business lease agreement of the 1st April 2005”. Mr. Naughton went on to say:-
“I executed the said agreement to formulise the relationship of landlord and tenant which existed between the company and I at the bank’s request and I believe that I delivered a copy of the agreement to the bank myself. I say and believe that in that circumstances where my dealings with the bank, both personally and as a director of the company, were always closely related to the company’s trade from the Milltown and Terryland units, I am surprised that the bank is now contending that it was unaware of or had not consented to this occupation.”
42. At para 31 of his affidavit he continued:-
“I say and believe that the company’s occupation of the said units has been well known to the bank for over ten years and that each of the three mortgages which I executed over the units was agreed against the backdrop of this use and occupation. Had the bank for a moment suggested that some formal written consent was need (sic) to regularise the company’s use of the premises, I say and believe that I would have sought same. However, in circumstances were the bank was content to advance monies to me on more than one occasion over the ten years on the strength of security which they knew to occupied by the company by agreement, I say and believe that I at all times understood that this occupation was with the agreement and consent of the bank.”
43. There are a number of observations to make in respect of those averments. There is no doubt whatsoever that the bank was aware of the company’s occupation of the units. There is also no doubt that the bank was anxious that a formal leasing agreement be put in place between the company and Mr. Naughton and it is also the case that this requirement was referred to in various letters of sanction and it is also clear from those letters of sanction that what was necessary was the prior consent of the bank to any lease. However it is at this point, it seems to me, the arguments of the respondent fall down.
44. I have already indicated that I am satisfied that there was never any prior consent to the 2005 business lease agreement. When one considers its terms, it is not difficult to see the reason why the bank would not agree to be bound by a lease without its prior consent. The 2005 business lease agreement provided for a rent payable of €30,000. The terms of that agreement are somewhat unclear as to whether that was intended to be a payment of €30,000 per month or per annum but by and large it appears to be accepted by all parties that what was to be understood by the phrase in the business lease agreement was that the sum was payable per annum. The other unsatisfactory aspect of the business lease agreement relied on by the respondent herein is the reference in that business lease agreement to the fact that “each of the parties further agree and accept the terms and conditions on their respective parts to be observed and performed and which are set out in the schedule and general conditions attached to this agreement”. It is a matter of significance that no term and conditions were attached to the agreement. It is accepted the rent payable by the company to the borrower was in multiples of the figure set out in the business lease agreement. It seems to be me to be inconceivable that the bank would ever have agreed to a lease of the various premises in those terms. In addition, it is extremely unusual to have one lease of separate properties at different locations. It would have I been entirely contrary to the bank’s interests. There is nothing in the papers before me to indicate that any representatives of the bank conveyed to Mr. Naughton or the company in any way that it accepted the validity of the lease or that it was in any way binding on the bank.
45. I was referred also by the respondent to the decision in First Energy (UK.) v. Hungarian International Bank Limited, [1993] B 3 LV1409, a decision of the Court of Appeal in the United Kingdom, which concerned the issue of ostensible and actual authority and whether or not an official of a bank had ostensible or actual authority to sanction a credit facility and had authority to communicate the offer of credit facility and in that regard it was held in construing a letter of the 2nd August 1990, enclosing draft hire purchase agreements in respect of a number of contracts that “the Court would take into account the surrounding circumstances which reasonable persons in the position of the parties would have in mind. On the facts, a reasonable business man placed in the same objective setting as C would have read the letter as communicating an unconditional and firm offer. That offer was capable upon acceptance of being converted into a binding contract.” The Court went on to indicate that on the facts, J.’s position as senior manager clothed him with ostensible authority to communicate that head office approval had been given for the facility offered in the letter of the 2nd August 1990. That decision was relied on to argue that while the bank’s employees may not have had an authority to commit the bank they were in a position to communicate a decision made by the bank in relation to sanction of loans and to that extent it was argued that they had ostensible authority to bind the bank. That may be so but it does not seem to me that the fact that loans having been sanctioned on certain terms and then advanced to the borrower without those terms being fully implemented assists the respondent in this case.
46. I have already set out a number of authorities relied on by the applicant in support of the case made by the them to the effect that whilst a lease entered into between the borrower and its tenant, in this case the company, may be binding as between them, it is not binding on the mortgagee. The facts and circumstances described in the various authorities referred to above clearly establish that to be the case. I cannot see any basis for suggesting that the bank is, in any shape or form, estopped from denying the validity of the business lease agreement. It seems to me that the respondent has simply failed to engage with the principles to be found in the authorities.
47. There might be an argument to be made that modem commercial realities are somewhat different to the facts and circumstances outlined in those authorities which are of some vintage. However, the answer to that argument may be simply that those principles have stood the test of time because the logic of the principles is unassailable; the one thing I am sure of is that on the facts of this case no commercial reality would justify departing from those well established authorities. It is essential from a lender’s point of view that the secured property is available as security in the event of default by the borrower. It is therefore important to ensure from the lender’s point of view that any impediment to the realisation of it’s security by reason of a lease binding on the mortgagee should be one in respect of which the mortgagee had furnished it’s consent. That is the importance and the function of the negative pledge clause contained in the various mortgages/charges. From the bank’s point of view in this case, there was no commercial reality apparent in the business lease agreement. It is inconceivable that the bank would ever have consented to a lease in the terms of the business lease agreement had it been asked to do so. It’s conduct in granting loans from time to time without appropriate leases having been put in place does not alter the position.
48. In the circumstances I am satisfied that the applicants herein are entitled to the declaration sought herein.
Maulbawn Ltd (in receivership) -v- Haulbowline Industry Ltd
[2011] IEHC 394 Laffoy J
I will consider each of those issues in turn.
5. Prima facie defence?
5.1 It was submitted on behalf of the defendant that the Licence Variation Agreement was a continuation or extension of the 2006 Licence Agreement and that it was a logical consequence of it in the context where the deferred consideration payable by the Investors to the Hills had not been discharged. It was submitted that the Investors, as directors, had authority to enter into the Licence Variation Agreement. Further, it was submitted that they were not precluded from doing so by reason of the existence of the mortgage in favour of Anglo. At the time when it was executed, that is to say, on 19th June, 2009, no enforcement event had arisen under the Anglo mortgage, it was contended. Further, it was submitted that Anglo had constructive notice of the creation of the Licence Variation Agreement and that it is estopped from contending that it is not valid.
5.2 None of those propositions, in my view, stands up to scrutiny. It is worth reiterating the basic facts. The plaintiff owns the land at Passage West. The vast majority of the shares in the plaintiff are owned by Holdings, which in turn is owned by the Investors. The shares were purchased by the Investors, through the medium of Holdings, from the Hills and the Hills have received €24,540,000 of the consideration. All but €5m thereof was funded by Anglo and is secured by the mortgage in favour of Anglo. As regards the outstanding €3m due to the Hills, while Holdings was primarily liable for that sum, the Hills have procured the Consent dated 19th June, 2009 arising from the secondary liability of the Investors as guarantors. In essence, the intended effect of the Licence Variation Agreement was to gratuitously dispose of the use of the land at Passage West for an indefinite period until the Investors discharge the amount due by them to the Hills on foot of the Consent, because a peppercorn rent has no value. The intended effect, if legally permissible, would have benefited each of the Investors in his personal capacity. It would not have benefited the plaintiff, the owner of the lands, in any way. Having regard to the fundamental principles of company law, in my view, that intended effect is not legally permissible. It is only necessary to mention two of the basic principles of company law. First, the company, in this case, the plaintiff, has a separate and distinct legal personality from its members (Salomon v. Salomon & Co. Ltd. [1897] AC 22). Secondly, it has been settled law for over a century that a company, in this case the plaintiff, cannot spend money or dispose of property except for purposes which are reasonably incidental to the carrying on of the business of the company (Re Greendale Developments Ltd. [1998] 1 I.R. 8). I find it unnecessary to consider those basic principles of company law in any greater depth, nor do I consider it necessary to consider whether either s. 60 of the Act of 1963 or, indeed, s. 99 of that Act, which were the subject of submissions, are of relevance to the creation of the Licence Variation Agreement.
5.3 On the facts, Mr. Coughlan, on behalf of the Investors, purported to create the Licence Variation Agreement on behalf of Holdings. As I have stated, Holdings does not have title to the lands at Passage West. Further, even if they purported to do so in the name of the plaintiff, the Investors, whom I assume are the directors and shareholders of the plaintiff, would have no authority to bind the plaintiff to the terms of the Licence Variation Agreement, which would be ultra vires the powers of the plaintiff.
5.4 Even if the rights in favour of the defendant over the lands at Passage West secured by the mortgage given by the plaintiff were intra vires and validly created, given the terms of the mortgage by the plaintiff in favour of Anglo, they could not have been created without the prior consent of Anglo. It is expressly provided in the mortgage (clause 6) that the plaintiff is not entitled, without the prior consent of Anglo, which may be granted or withheld at Anglo’s absolute discretion, to create or permit to subsist “any Encumbrance” on or affecting the land at Passage West the subject of Anglo’s security. “Encumbrance” is broadly defined in the mortgage as including any “agreement . . .or other instrument creating or evidencing any rights over the relevant Mortgaged Properties in favour of any other party”. There is no evidence before the Court that Anglo gave prior consent to the Licence Variation Agreement. There is evidence that over two months after the Licence Variation Agreement was executed, the consent of Anglo to it was sought. The response of Anglo, was that no consent would be given unless the defendant “is paying rent on a proper lease”. There is no evidence before the Court of conduct on the part of Anglo which would estop it from contending that the purported Licence Variation Agreement was in breach of the terms of the mortgage. However, that is very much a subsidiary point because, in my view, the purported Licence Variation Agreement has no validity.
5.5 For the reasons set out above, in my view, the defendant has not established that it has a prima facie defence to the plaintiff’s claim. I have come to that conclusion acutely conscious of the fact that a Court should be very cautious about reaching such a conclusion on an interlocutory application.
6. Delay/other special circumstance