Security Impairment

General

There are various grounds on which a mortgage or charge may be invalidated or impaired. In some cases, the risk may arise as a result of certain matters which are covered by the legal due diligence or under the borrower’s solicitor’s certificate of title. In this case, there may be a right of compensation for professional negligence or breach of the certificate of title.

In other cases, the bank may have taken the risk concerned at the underwriting stage or the risk may have been unforeseeable and uncovered by due diligence or a certificate of title.


Limits on the Borrower’s Title

A mortgagee cannot obtain greater rights to the secured property than those held by the borrower.  Borrowers may hold their property under a long lease or be subject to easements, restrictions, and conditions in favour of other third parties. A lender’s mortgage will be subject to these title conditions unless the holders of these rights have released them.


Forgery, Fraud and Mistake

A mortgage or charge which is not signed by the borrower is void and of no effect.  A forged mortgage is absolutely void and will be set aside. A forged mortgage is a particular risk in the case of estranged spouses.

Generally, it is difficult to avoid a mortgage by reason of mistake. Once a legal document has been signed it is usually very difficult to have it set aside. It is not enough that the person did not understand the document. A freely signed document can only be set aside on the basis that the person did not understand they were signing a legal document at all or that have been entirely misled as to the nature of what they signed.


Insolvency set aside

Mortgages and charges can be set aside in certain circumstances under insolvency law, if an individual borrower later becomes bankrupt or if a corporate borrower later goes into liquidation.

A transaction, including a mortgage, at “undervalue” can be set aside, if the person or company making it becomes insolvent within a certain period. The period is generally two years and in some cases five, before the commencement of the insolvency proceedings. A transaction is at undervalue if it is for significantly less value than that provided in return.

Under insolvency law, a “preference,” which may include a mortgage or guarantee, given within six months prior to the commencement of insolvency proceedings, can be set aside if it was entered with the intention of giving a preference to the lender relative to other creditors in a later insolvency. A mortgage given just before insolvency may be vulnerable to being set aside, under these provisions.

A floating charge given in the twelve months before insolvency, other than for full value, will be set aside in certain circumstances. The company must have been insolvent at the time the charge was given, or have become insolvent, as a result of the charge. Therefore, a floating charge given in the twelve-month period prior to the commencement of insolvency proceedings for a pre-existing debt or for no or inadequate new funds is vulnerable to challenge.


Family Rights of Spouse and Beneficial Owners

A spouse, partner or other person whose name is not on the registered title to the property, may have beneficial ownership rights to the mortgaged property, by virtue of having made contributions to the purchase price of the property or to mortgage repayments. He or she may also obtain beneficial rights by making contributions to a family fund, which finances mortgage repayments. Even where a spouse has no ownership rights, certain statutory rights apply under Family legislation.


Duress

Duress involves anything which overrides the free will of a person who enters an agreement.  A contract will be rendered void, only if the duress is illegitimate. Economic pressure or threats of litigation will not usually affect the validity of contracts.

There would have to be an illegitimate threat, such as a threat of violence or illegal action before a contract could be rendered void.  The fact that a borrower has to make a choice between unwelcome alternatives is not enough to invalidate a loan agreement on the grounds of duress


Undue Influence / Pressure

A transaction entered by reason of so-called “undue influence” may be set aside.

There are two types of undue influence. With the first type, it is necessary for the person alleging undue influence to show that he or she entered the transaction concerned as a result of his or her free will being overborne, usually by the beneficiary of the transaction.

In the second category of cases, the relationship between the parties is such that undue influence is presumed where the weaker party enters a transaction for the benefit of the other. This can happen in the case of certain relationships, where it is presumed one person is in a dominant position. Examples include child and parent, solicitor and client, and doctor and patient. The presumption does not automatically apply to a husband and wife.

The bank will be affected by undue influence where it has notice of circumstances, giving rise to a risk of undue influence, and does not seek to mitigate this risk. The classic situation is where one spouse agrees to guarantee or to join in a mortgage of a jointly owned property as security for the other spouse’s sole debts. If the bank is aware that the spouse has no economic interest in the transaction and if there is, in fact, undue influence, the guarantee may be avoided. It will generally be sufficient to protect that bank in such cases, that the guarantor has had independent legal advice.


Unconscionable Transaction I

The courts will not invalidate an agreement or guarantee merely because it was ill-advised, rash, foolish or unbalanced. Generally, a legal agreement once signed and entered, can only be set aside in limited circumstances.

Exceptionally, a very one-sided contract may be set aside as an “unconscionable” bargain. This is separate to the principle of undue influence.  This may occur where very vulnerable persons (e.g. very old) transfer assets with no obvious benefit and/or on terms that are so disadvantageous that it amounts to a taking of advantage of the person’s vulnerability.

The mere fact of unequal bargaining power is not a ground to set aside a transaction. Generally, where a lender requires additional security in return for not enforcing a default, this would not amount to an unconscionable bargain, because there is a real exchange.


Unconscionable Transaction II

Examples of unconscionable transactions have included cases where a reluctant spouse or parent mortgages his or her home by way of collateral security, because of overbearing family or emotional pressures.  Pressure itself is not enough to set aside the transaction. It must be shown that the person concerned was left with no free will

Generally, where there is a risk of undue influence or an unconscionable transaction, independent legal advice should be obtained for the benefit of the person making the transfer. An independent solicitor should advise on the legal and practical implications of the transaction.

The seriousness of the risks should be communicated. The independent solicitor should explain that there is a choice and that the choice might call for a discussion of the full financial position. The person giving the advice should be content that the person is acting of his or her own free will.


Unfair Contract Terms

The Unfair Contract Terms Regulations apply to contracts between a consumer and business which have not been individually negotiated. It can apply to a loan agreement, mortgage deed or guarantee. An agreement is deemed not to be individually negotiated when it is drafted in advance, and the consumer has not been able to influence its substance.

The fact that some individual terms may have been negotiated does not mean that on an overall assessment, the contract will be deemed to be individually negotiated. For example, the fact that there are some negotiated special conditions and commercial terms in a loan agreement does not prevent a court finding that the general conditions, or small print are standard. The regulations only apply to a person acting outside its business.  This does not include companies.

An unfair contract term is not binding on the consumer, if contrary to the requirements of good faith, it causes a significant imbalance in the rights and obligations of the parties. Account is taken of the entire circumstances in determining whether the term is unfair. The followings factors are considered including;

  • the relative strength of bargaining positions;
  • whether the consumer was induced to enter the agreement;
  • the extent of negotiation; and
  • whether the customer has been dealt with fairly and equitably

It may well be that some terms of standard guarantees, mortgages, and loan agreements are vulnerable to challenge under the Regulations. A term is presumed valid until a court or other body determines the clause to be unfair. A consumer cannot simply decide that a term is unfair and not binding.

 


Companies Law Compliance Issues

Companies, as legal persons can borrow, enter contracts, hold property and grant security in much the same way as an individual can do. However, there are particular Companies Acts considerations which may invalidate or affect a security. Generally, the lender’s legal advisers should have put in place procedures so that the requisite formalities have been complied with.

Historically, all companies were required to have “objects” or purposes in their founding documents. The effect of this requirement was reduced over time. A mortgage by a company might be invalid because it was outside the powers of the company. Guarantees for the benefit of other companies were particularly prone to invalidity. Because the bank’s agents usually had seen the company rules, the protections that applied to third parties dealing with the company, were not available. Therefore, it was generally necessary to ensure that the loan and mortgage and its purpose are within the company’s powers.

The Companies Act 2014 removed all limitations on the capacity of private limited companies (LTDs). All existing private companies became LTDs at the end of the transitional period on 1st December 2016, unless they had elected to become a Designated Activity Company in the meantime. Public limited companies, designated activity companies and most other types of company retain objects.

Under company law, loans, guarantees and mortgages given for the benefit of directors and certain persons connected with directors are presumptively invalid. There are limited circumstances in which it is possible to follow particular procedures, so as to validate the loan, guarantee or security. The legislation is complex, and the circumstances need to be carefully considered in each case.

There is a very broad prohibition under Irish company law on companies assisting in the purchase of their own shares. There are also certain procedures by which such a transaction may be validated, provided certain conditions apply. The procedures for validation of “director’s loans” and financial assistance for share purchase, are intricate and must be implemented carefully.


Insolvency Set Aside

A pre-insolvency transaction may be set aside if the dominant intention is to prefer one creditor over another. The normal period in which a preference given by an insolvent company may be set aside is six months. Where a preference is given to a connected person, the relevant period is two years from the commencement of insolvency. In such circumstances, it is presumed until the contrary is shown, that the company intended to prefer the connected person over creditors.

A connected person includes directors, persons controlling the company and certain trustees and guarantors of the company’s debts. A preference commonly occurs where there is a guarantee by a director in favour of a particular creditor. The director may be tempted to cause the company to prefer the creditor so that the creditor is paid off and the guarantee is released or reduced. The court may unwind the preference and determine the respective obligations of the parties to the transaction.

A floating charge given within twelve months of winding up will be invalid if the company was insolvent at that time or became insolvent as a result of the charge. “Solvent” means the ability to pay debts as they fall due. The period is two years if the person to whom the charge is given is connected to the company.


Company charges/Floating Charges

A company is not subject to the restrictions which apply to individuals granting mortgages over moveable items. A company can create a charge over any or all of its assets, including present and future goods and moveable goods.  This facilitates the creation of a fixed and “floating” charge over all of the company’s assets. A “debenture” is the name commonly given to a deed incorporating a fixed and floating charge given by a company.

A floating charge is a charge over the circulating assets of the company. The key feature is that it does not attach to particular assets, but leaves the company at liberty to deal with the asset in the normal course of business.   A floating charge is “crystallised” (i.e. attaches and becomes fixed) on being enforced. The result is that the entire business and undertaking of a company can be mortgaged, “lock stock and barrel.”  The receiver can step in and commence to trade either for the purpose of making loan payments or for the purpose of effecting a sale of all or parts of the business assets.

Upon “crystallisation” such as on cessation of business, the appointment of a receiver or winding up, the charge becomes fixed to all the assets. This gives the debenture holder priority over the general unsecured creditors.

Certain preferential creditors such as the Revenue and employee’s rights arising within a certain period prior to formal insolvency, rank ahead of the rights of the lender in relation to the proceeds of the sale of the floating charge assets.


Registration

Most charges by a company must be registered in the Companies Registration Office within twenty-one days.  Failure to register means that the security will be invalid as against a liquidator or a creditor. The rules apply to a very wide range of mortgages and securities granted by companies.

Failure to register will cause serious prejudice to a mortgagee. When the security is most needed, on insolvency, the liquidator is in a position to treat the mortgage as void and accordingly take the assets for the benefit of the creditors generally.

Where registration does not take place within twenty-one days, it is possible to apply to the court for an extension of time.  It must be shown that there is no prejudice to other creditors. The court may grant the extension on such terms, as it sees fit. Once a company charge is registered, the registrar issues a certificate of registration.


Foreign Companies

Irish law recognises companies formed in other jurisdictions. Companies are regulated by the legislation of the country in which they are formed. Generally, foreign jurisdictions rules determine the mechanics of how a company can grant a mortgage or enter a legal transaction.

In some cases, where a company is formed in one country and has a place of business in another country, it is necessary to register documents in both countries’ companies registration offices. There are also certain Irish company law restrictions and rules which apply to all companies within the jurisdiction, even those formed abroad.  A foreign company may have an obligation to register charges in the Companies register in the country where it is formed. It may also have to register in the Irish CRO if it has a branch or place of business in Ireland.

In the case of a foreign company entering a transaction in Ireland, foreign company law rules may apply to the taking of the security. Some Irish company law rules may also apply. It is desirable to obtain a so-called “foreign lawyer’s opinion” from a lawyer in the foreign country in which the company is formed, in relation to be the validity of the security by the foreign company from the perspective of that country’s law.


References and Sources

Irish Texts

Breslin Banking law + Supplement     3rd Ed  2013

Mortgages Law & Practice     Maddox 2nd Ed            2017

NAMA Act 2009: A Reference Guide Raghallaigh, Kennedy, Whelan

Money Laundering & Anti-Terrorist Financing Act 2010

Financial & Emergency Provision Legislation Annotated      2011

Shelley & McGrath     National Asset Management Agency Act Annotated 2011

Dodd & Carroll            Law Relating to NAMA 2012  0

Ashe & Reid    Anti-Money Laundering: Risks, Governance & Compliance             2013

Johnston & Ors           Arthur Cox Banking Law Handbook               2007

Dr Mary Donnelly  The Law of Credit and Security, 2nd Ed, 2015

UK Texts

A Hudson The Law of Finance 2nd Ed (Sweet and Maxwell 2013)

Veil (Ed) European capital markets law (Hart Publishing 2013)

IG MacNeil An Introduction to the Law on Financial Investment 2nd Ed ( Hart Publishing 2012)

E Ferran Principles of Corporate Finance 2nd Ed ( OUP 2014)

Gullifer (ed) Goode and Gullifer on legal problems of credit and security (6th edn Sweet and Maxwell London 2017).

MA Clarke et al (eds) Commercial Law: Text, Cases and Materials (5th edn OUP Oxford 2017)

McKendrick (ed) Goode on commercial law (5th edn Penguin London 2017)

G McCormack Secured credit under English and American law (CUP Cambridge 2004)

L Gullifer and J Payne Corporate Finance (2nd edn Hart Oxford 2015)

D Sheehan The Principles of Personal Property Law (2nd edn Hart Oxford 2017)

Ross Cranston, Emilios Avgouleas, Kristin van Zwieten, Christopher Hare, and Theodor van Sante Principles of Banking Law 3rd Ed 2018

E.P. Ellinger, E. Lomnicka, and C. Hare Ellinger’s Modern Banking Law 5th Ed 2011

Andrew Haynes The Law Relating to International Banking  Bloomsbury Professional 2009

Charles Proctor Mann on the Legal Aspect of Money 7th Ed 2012

Charles Proctor The Law and Practice of International Banking 2nd Ed  2015

Sheelagh McCracken The Banker’s Remedy of Set-Off   2010 Bloomsbury Professional

Louise Gullifer, Jennifer Payne Banking & Financial Law 2018

Hubert Picarda QC The Law Relating to Receivers, Managers and Administrators 4th Ed  2006 5th Ed 2019

Lightman & Moss on the Law of Administrators and Receivers of Companies 6th Ed  Sweet & Maxwell 2017

Timothy N Parsons  Lingard’s Bank Security Documents 6th Ed 2015