Australia: Priority Arrangements In Mortgage Enforcement Actions

Ronald John Bofinger & Anor v Kingsway Group Limited Formerly Willis & Bowring Mortgage Investments Limited & Ors

This recent unanimous decision of the High Court of Australia highlights the need for mortgagees to carefully consider the terms contained in their guarantees, as certain provisions can displace priority arrangements between mortgagees in any enforcement action, through rights of subrogation.

Facts

Mr Bofinger was the director of B&B Holdings Pty Ltd (B&B), which was a real estate development company operating in New South Wales. B&B obtained three separate loans from three different financiers and provided security to each financier in the form of a first, second and third ranking mortgage over property owned by B&B (B&B Property). A guarantee was also provided to each financier by Mr and Mrs Bofinger which was supported by a mortgage over property which Mr and Mrs Bofinger owned together (Bofinger Property).

B&B defaulted on the repayment of its loans. To reduce the debt owed to the first mortgagee, the Bofinger Property was sold with the consent of the second and third mortgagees. The first mortgagee then took enforcement action against some of the B&B Property to recover the remainder of the outstanding debt in full.

The surplus amounts from the sale of part of the B&B Property were then given to the second mortgagee, to be applied in reduction of amounts owed by B&B to the second mortgagee.

Decision

Mr and Mrs Bofinger, as guarantors, brought proceedings to the New South Wales Supreme Court claiming that the first mortgagee should have provided the surplus money from the sale of part of the B&B Property to them so they could recoup what they had paid off the debt owed by B&B to the first mortgagee through the sale of the Bofinger Property.

The claim put to the court was that the first mortgagee had acted in breach of a constructive trust arising in equity in favour of Mr and Mrs Bofinger as guarantors and that as a result of this failure to account to them as beneficiaries, the first mortgagee had acted in breach of trust.

The New South Wales Supreme Court dismissed this claim as did the Court of Appeal.

Mr and Mrs Bofinger then appealed to the High Court of Australia.

Appeal

The High Court of Australia found in favour of Mr and Mrs Bofinger noting the surplus money should have be given to them because they were entitled to be subrogated to the rights of the first mortgagee, in priority to the second mortgagee.

As a result of this decision, a mortgagee may have to account to a guarantor for amounts exceeding the full amount of the debt where the guarantor has made a contribution in reduction of amounts owing to the mortgagee.

Mr and Mrs Bofinger were still liable to the second mortgagee and the third mortgagee however, their obligations to the second and third mortgagee were now unsecured as both the second and third mortgagee had released their mortgages over the Bofinger Property to effect the sale of these properties in reduction of debt owed by B&B to the first mortgagee.

It would be difficult for the second or third mortgagee to complain in these circumstances, as each took their subsequent interest with notice.

Moving forward

As a result of this decision, mortgagees need to consider:

1. the rights of any guarantors in any enforcement or recovery action, particularly where a guarantor has contributed to the repayment of a mortgagee's debt
2. whether the terms of a guarantee are broad enough to exclude or limit subrogation through mechanisms such as a 'no competition' clause
3. whether mortgagees need to draw up further agreements in any work out arrangement or enforcement action in order to better protect their position and exclude or limit rights of subrogation to avoid the risk of displacing priority arrangements
4. carefully, the disbursement of surplus proceeds - obtain consent or ensure there are no competing interests.

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