Residue Case Note: The Iniquity of Equity: Scott v Southern Pacific Mortgages Ltd

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1 Residue Case Note: The Iniquity of Equity: Scott v Southern Pacific Mortgages Ltd Stephanie Lee * Solicitor, Travers Smith LLP Equity release schemes; Leaseback; Mortgages; Occupation; Overriding interests; Proprietary rights In October 2014 the Supreme Court handed down judgment in the North East Property Buyers case, Scott v Southern Pacific Mortgages Ltd, 1 bringing to an end a long-running piece of litigation. Although now disposed of, no doubt the matter will continue to sit uneasily in the minds of many, including one of the Supreme Court s own Justices, Lady Hale, who described the result as harsh (despite agreeing, in the main, with the legal principles which led to the decision, as well as with the ultimate decision itself). The rationale of the Court s decision to confirm the priority of secured lenders mortgages over other rights granted by the purchaser of a property at the time of acquisition is difficult to fault (particularly since it is grounded in the principles laid down by the House of Lords in the well-known decision of Abbey National Building Society v Cann). 2 However, its effect to render homeless those very individuals who had innocently sought to take steps to ensure that they could remain in their homes for life seems to run contrary to the principles of fairness and justice, which equity seeks to achieve. Factual background The Supreme Court proceedings arose from a group of ten test cases, which related to an equity release scheme in the North East of England involving sale and rent back transactions. The concept was a simple one: owner-occupiers would sell their homes to nominees of North East Property Buyers (NEPB), typically at an undervalue, on the assurance that they would be able to remain in occupation of their homes, indefinitely and at a reduced rent. As Lord Collins explained at the outset of his judgment, tens of thousands of individuals took up deals akin to that offered by NEPB in a bid to be able to remain in their homes whilst alleviating their financial difficulties. However, far from offering the individuals the form of security they were seeking, the scheme operated by NEPB resulted in quite the opposite effect. The NEPB nominee purchasers would take out buy to let mortgages to fund the purchase of the properties. Those mortgages neither contemplated, nor permitted, the rights of occupation that had been promised to the vendor/occupiers (indeed, in each case, neither the vendor/occupier nor the lender knew of each other). Furthermore, each loan was granted on the basis that the purchase was made at full value and with vacant possession, contrary to the terms agreed with the vendor/occupiers. Following exchange of contracts, execution of the mortgage, and completion of the transfer (which all took place on the same day), NEPB would grant an assured shorthold tenancy to the vendor/occupier, typically for a year or two, * Stephanie Lee is an associate at Travers Smith LLP specialising in dispute resolution. 1 Scott v Southern Pacific Mortgages Ltd [2014] UKSC 52; [2014] 3 W.L.R Abbey National Building Society v Cann [1991] 1 A.C

2 78 Private Client Business following which the tenancy would become a monthly periodic tenancy, terminable on not less than two months notice in writing. When, a few years later, NEPB defaulted on the mortgages, the mortgagee banks brought possession proceedings and the vendor/occupiers faced eviction. The issues The vendor/occupiers would appear, prima facie, to have claims against NEPB and/or the purchasers of the property who induced them to enter into the sale and rent back arrangements on the basis of false representations (albeit that the merit of bringing any such claims would turn on NEPB and/or the purchasers having the funds to meet judgments made against them). At issue in the test cases, however, was something a little closer to home: whether the vendor/occupiers had any rights as against the lenders which would entitle them to remain in occupation; in particular whether a bank which lent money to fund the purchase of a property, not knowing the arrangements reached as between NEPB and the vendor/occupier before the purchase, would be bound by interests arising from those arrangements. At first instance, the High Court held that the mortgagee banks were not bound by any interests in the properties which may have arisen from the purchasers promises. The vendor/occupiers in four of the test cases appealed to the Court of Appeal, which also found in favour of the mortgagee banks. The Supreme Court granted the vendor/occupiers permission to appeal. By the time of the appeal hearing there were around 90 or so cases in the Newcastle area involving NEPB (and many more in other parts of the country involving similar schemes), but only one remained live before the Court, that of Mrs Rosemary Scott. The hearing before the Supreme Court was, in effect, to determine which of the innocent parties caught up in NEPB s scheme, Mrs Scott as vendor/occupier, or Southern Pacific Mortgages Limited as lender, would bear the consequences of NEPB s default. Abbey National Building Society v Cann revisited The seminal case of Abbey National Building Society v Cann posed real difficulties for Mrs Scott and her bid to establish that the mortgagee s interest did not take priority over her own. In that case, the House of Lords had held that where a property is purchased with the aid of a mortgage, the acquisition of the legal estate and the grant of the mortgage charge complete simultaneously and, as such, are indivisible. Accordingly, the purchaser only ever obtains an equity of redemption in the property, meaning that he/she cannot create rights binding on a lender (save, of course, to the extent they are permitted by the mortgage). Whilst Mrs Cann had argued that there was a very short period of time a scintilla temporis in which the buyer had owned the property free of any charge and was able to grant her what was, in essence, a lifetime tenancy, the House of Lords rejected that argument, stating that where a buyer relies upon a bank or building society loan to complete a purchase, the buyer will, on completion, acquire the legal estate with the mortgage charge, in effect, already attached to it. The Cann decision gave secured lenders great comfort: it was viewed as establishing the priority of a lender s interest over that of an occupier. With that position established, was Mrs Scott not destined to fall at the first hurdle? The case put forward on Mrs Scott s behalf sought to distinguish Cann on a point of timing. It was argued that Mrs Scott had obtained, at the moment that contracts for sale were exchanged (as opposed to at the moment of transfer of the legal estate as in Cann), an interest in the property. That interest was said to have arisen, by way of proprietary estoppel, out of the promises already made to her by the purchaser as to indefinite occupation. She contended that at the moment of exchange of contracts, and prior to completion, the purchaser had an interest in the property out of which her own proprietary interest could be carved. Accordingly, it was said, Mrs Scott s interest arose before completion of the mortgage that funded the purchase, and so took priority over the mortgage.

3 Residue 79 The distinction was stated to arise from Mrs Scott s position not just as occupier but also as vendor; she had sold her property reliant on the promise from the purchaser of a tenancy for life. In contrast, Mrs Cann had no legal interest in the relevant property at the time assurances as to occupation were given. Moreover, unlike Mrs Cann, Mrs Scott was living in the property prior to and at the moment of sale which, she claimed, rendered her interest overriding by virtue of s.29(2)(a)(ii) of, and para.2 of Sch.3 to the Land Registration Act On this argument, the mortgagee would take its charge subject to Mrs Scott s property rights. Two key questions therefore arose before the Supreme Court: (i) whether the nominee purchaser had been in a position at exchange of contracts to confer equitable proprietary rights on Mrs Scott (i.e. an interest affecting the estate as opposed to personal rights only); and (ii) even if proprietary rights had been conferred on exchange of contracts, whether, by an extension of the Cann principle (that the transfer and grant of the mortgage are simultaneous and indivisible), the contract for sale should also be viewed as simultaneous to and indivisible from the transfer and grant of the mortgage, so that Mrs Scott would not be able to assert against the lender a binding equitable interest. The decision Was the nominee purchaser in a position, on exchange of contracts, to confer equitable proprietary rights on Mrs Scott? It was unanimously accepted by the Justices that the promises made to Mrs Scott by the nominee purchaser did not give rise to an interest binding upon the mortgagee. There were two elements to this decision, as summarised by Lord Collins in the leading judgment. The first turned upon the construction of the Land Registration Act 2002; the second on the case law concerning proprietary and overriding interests. In reaching their conclusions, the Supreme Court conducted a thorough review of both the Land Registration Act 2002 and the relevant case law, including a re-examination of the issues in Cann. First, it was held that for an unregistered interest to override a registered disposition pursuant to s.29(2) of the Land Registration Act 2002, it must be proprietary in nature. The basis for this determination lies in the Land Registration Act 2002 itself and the reference in s.29(1) to an overriding interest as one affecting the estate. Secondly, a purchaser could not grant those equitable rights of a proprietary nature, required to bind the mortgagee, until acquisition of the legal interest on completion of the purchase. Although the decision in Cann had not dealt directly with this point, Lord Collins thought it implicit in the obiter comments of two of the Law Lords in that case that such a position was supported. Lord Collins himself saw support from the old doctrine of feeding the estoppel. Whilst a party without an estate in land, such as the nominee purchaser, can promise a tenancy to another party, such as Mrs Scott, those rights are personal in nature for so long as the purchaser continues without the estate itself. When the legal estate subsequently is acquired on completion, the estoppel can be fed, and the previously personal interest will become proprietary in nature. By this stage, however, it will be too late for the proprietary interest to bind the lender, since, as per Cann, there is no scintilla temporis; no moment in time when the nominee purchaser owned the property free from the charge. Lady Hale, in her judgment (confirming Lord Collins decision on this issue), considered Lord Collins conclusion in the context of the Land Registration Act 2002, and noted that the legislation itself supports the same conclusion, namely that a purchaser is not in a position to grant to a third party a proprietary interest until completion. Section 29 of the Land Registration Act 2002, addressing priority, refers to interests affecting the estate, whilst the interpretation provision, s.132(3)(b) makes it clear that references to an interest affecting an estate are to an adverse right affecting the title to the estate. It is therefore

4 80 Private Client Business necessary for there to be an estate before there can be an interest which affects that estate. Since a purchaser does not hold the legal estate (defined as per s.1(1) of the Law of Property Act 1925 as an estate in fee simple absolute in possession or a term of years absolute ) until completion, he/she cannot grant an interest capable of being a protected interest for the purpose of s.29 of the Land Registration Act 2002 Act until that time. The Supreme Court s decision on this first question disposed of the appeal: Mrs Scott had obtained no interest capable of binding the mortgagee. Nevertheless, since the second issue was the main question canvassed in the Courts below, the Justices went on to consider it. Does the Cann principle extend to the contract for sale, so that all elements of a property transaction exchange of contracts, conveyance, and mortgage are indivisible? On this second question, the Justices were divided, the majority in favour of Mrs Scott. Whilst Lord Collins (with whom Lord Sumption agreed) was of the view that the contract, transfer and mortgage would generally be linked to each other in such a way as to be indivisible, Lady Hale (with whom Lord Wilson and Lord Reed agreed) thought that there were circumstances in which a contract for sale could sit separately from the transfer and mortgage. On this analysis, a proprietary interest arising at the time of exchange of contracts may, depending on the circumstances, bind a lender. Such a conclusion, though, is surely moot in light of the Supreme Court s determination of the first issue in the case, namely that a proprietary interest cannot arise at the exchange of contract stage? In any event, support from the majority on the second question would likely not have helped Mrs Scott, even if she had succeeded on the first. Lady Hale made clear that whether the contract could be separated from the other elements of a property transaction depended on the facts in each case; since, for Mrs Scott, the contract, transfer, and charge had all been executed on the same day, it seems likely that an extension to the indivisibility principle set out in Cann would have been viewed as applicable in the circumstances. Comment The Supreme Court s thorough reasoning and application of the law has led to an outcome which is entirely logical but which nevertheless leaves the feeling that justice has not been done. There is common sense in the conclusion that a person who does not yet own the legal title to a property cannot grant rights in that property to a third party: you cannot give what you yourself do not have. Yet the impact of this conclusion on innocent parties Mrs Scott, and others in her position is devastating. It is right that the lenders, who will no doubt be breathing a huge sigh of relief at the Supreme Court s conclusions, were also innocent parties. But, as Lady Hale herself commented, innocence is a comparative concept, and there should at least be some middle way, so that the individuals, who are those with the most to lose, do not lose everything. It is at least of some consolation that sale and rent back schemes of the sort addressed in this case are now a rarity as a result of action taken by the (then) Office of Fair Trading and FSA to make such schemes a regulated activity pursuant to s.19 of the Financial Services and Markets Act 2000, and that criminal charges are pending in the context of the NEPB scheme. Furthermore, the sort of middle way envisaged by Lady Hale may be developed following the Law Commission s wide-ranging review, in its Twelfth Programme of Law Reform, of the Land Registration Act 2002, which it is understood will include consideration of the impact of fraud on the Act. As to the more general impact of the case, one cannot help but recognise the adverse effect that success on the part of Mrs Scott would have had on the secured lending market (notwithstanding Lord Collins comments that the Court s duty was to apply the law irrespective of that effect) and, consequently, the UK s housing market. Confirmation of the priority of lenders interests has ensured that the risks faced

5 Residue 81 by lenders when making a decision as to whether or not to approve a mortgage are not increased and, in turn, that residential mortgages do not become more difficult, and more costly, to obtain. Whilst Mrs Scott has suffered, many others will have an easier path as a result.