Holding back to defend attack: Withholding security for anticipated litigation costs - Charges, Mortgages, Indemnities

In this week's TGIF we examine the question: when can a mortgagee claim a right to retain reasonable security for costs of anticipated litigation with a mortgagor?

In A1 Catering Services Pty Ltd v Manassen Holdings Pty Ltd [2024] NSWSC 178, Richmond J held that a mortgagee could retain surplus funds from the sale of secured assets as security for a contingent liability, namely reasonable costs to be incurred by the mortgagee in the event of an anticipated dispute with the mortgagor, provided the terms of the mortgage define potential enforcement costs as a secured liability.

The decision turned on the finance documents and general law. While 'Secured Moneys' within the mortgage was not defined with precision, it did cover the borrowers' contingent liability to indemnify the Defendant (Manassen) for costs incurred defending reasonably anticipated claims by the borrowers.

Therefore, on the basis that $300,000 represented a reasonable estimate of its likely legal costs, Manassen was entitled to retain this as security for the anticipated claims by the borrowers.

Key Takeaways

Where an alternative proposed liquidator is nominated by another creditor or interested party, the Court will, all things being equal, generally appoint the nominee of the party applying for the winding up. To depart from this approach, there must be some reason, such as the liquidator's independence, fitness, qualifications, or costs. It is for the defendant to establish grounds to depart from the usual course.
A Court should not be forced to accede to a party's nomination on the basis that a creditor is prepared to fund that liquidator only, as this would encourage parties to be selective in the funding of liquidators for irrelevant reasons.
In this case, the Court's decision to appoint the plaintiff's nominee was made solely on the basis that their hourly rates were lower, despite the fact that there were likely no funds available in the liquidation and the interested party had filed an undertaking to fund the proposed alternative liquidator.

Relevant Law

Richmond J, in determining the matter, considered authorities on the discharge of mortgage where a contingent liability is owing to the mortgagee, including authorities supporting the principle that where a mortgagor seeks a discharge of a mortgage when a contingent liability is owing and secured by the mortgage, the mortgagee is entitled to require payment of an amount which is a reasonable estimate of that contingent liability.

His Honour further considered the finance documents themselves, which relevantly provided that:

each borrower was required to pay to the mortgagor on demand all expenses incurred by the mortgagor in connection with the enforcement of the mortgage;
'Secured Moneys' was defined as being all moneys which the mortgagor presently owes or may contingently owe the mortgagee, including costs incurred by the mortgagee in enforcing the mortgage;
the mortgagor was required to indemnify the mortgagor "against all actions, claims, demands, losses, damages, liabilities, costs, charges, fees and expenses suffered or incurred by the Mortgagee as a result of or in connection with" the mortgagee exercising its rights under the mortgage; and
the discharge of the mortgage was subject to the mortgagee reasonably considering whether "part of the Secured Moneys will or may become actually, contingently or prospectively owing" to the mortgagee as a result of any claim the mortgagee has against the mortgagor.

Main issues and determinations

The main issues heard were:

Whether Manassen was entitled to retain the sum as security for costs of an anticipated dispute with the borrowers.

Richmond J was satisfied that the clauses in the loan agreement, the mortgages and the general security deed would catch expenses incurred by Manassen in the event of a dispute with the borrowers.

Whether it was reasonable for Manassen to anticipate that it was likely that there would be litigation with the borrowers.

His Honour was satisfied that Manassen's affidavit evidence established the borrowers had threatened to bring a number of claims disputing their obligations under the finance documents.

Whether the amount retained by Manassen was a reasonable estimate of the likely costs it would incur in the event any of the anticipated disputes arose.

His Honour was satisfied that the calculation of $300,000 for likely fees and expenses in the event of a dispute set out in Manassen's affidavit evidence was a rational and coherent explanation of its claim that this amount was a reasonable estimate.

Final thoughts

Whist A1 Catering is directly relevant to the treatment of mortgages, it has broader relevance to any secured loan arrangement in which the Lender may desire to have the right to withhold surplus funds as security for costs of reasonably anticipated litigation by the Borrower.

The likelihood of the circumstances arising will increase in a rising property market (where surplus proceeds are available) and the non-financier stakeholders are dissatisfied with the conduct of the financier (e.g. challenging the sale process).

This judgment further serves as a reminder to lenders to consider the terms of enforcement provisions within their documents and whether they achieve suitable protection and risk mitigation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.