Home Law Implementing the Cape Town Convention and the Domestic Laws on Secured Transactions
Enforcement of Interests
One of the main reasons behind the popularity of English law is its commercial pragmatism in enforcing both security and “quasi-security” interests over aircraft. As a general comment, English law provides for few formalities, supports “selfhelp” remedies and in principle respects the contractual arrangements of the parties.
With respect to security interests proper, English law provides for four main methods of enforcement, namely (re)possession of the asset, sale of the asset, foreclosure and appointment of a receiver. Due to space constraints, our focus will be on the enforcement of mortgages by repossession, sale and foreclosure.
Unlike Art. 3 of the Cape Town Convention, English law does not impose on the mortgagee an overarching duty “to exercise its remedies in a commercially reasonable manner or, indeed, to exercise them at all”. In an often quoted extract Sir Donald Nicholls VC provided a succinct analysis of what is expected from a mortgagee:
a mortgagee can sit back and do nothing. He is not obliged to take steps to realise his security. But if he does take steps to exercise his rights over his security, common law and equity alike have set bounds to the extent to which he can look after himself and ignore the mortgagor’s interests. In the exercise of his rights over his security the mortgagee must act fairly towards the mortgagor. His interest in the property has priority over the interest of the mortgagor, and he is entitled to proceed on that footing. He can protect his own interest, but he is not entitled to conduct himself in a way which unfairly prejudices the mortgagor.
Strictly speaking, a legal mortgagee, being the owner of the legal estate, has the right “to possession at any time, irrespective of default on the mortgagor’s part, unless the parties have agreed otherwise”. Parties will invariably contract out, expressly or by implication, of this broad right and provide in their agreement for the right of the mortgagee to (re)possess the asset upon the default of the mortgagor. This broad right does not extend to equitable mortgages where an express provision is required for the equitable mortgagee to repossess the aircraft upon the mortgagor’s default without a court’s order or without appointing a receiver. Judicial opinion supporting the right of the equitable mortgagee to (re)possess the asset in the absence of an express contractual provision exists, but it is submitted that it is a minority. In its absence (re)possession can take place by appointing a receiver. Under a legal mortgage (with or without an express provision) or an equitable mortgage (with an express provision) (re)possession can take place without a court’s order, provided that the aircraft “can be seized without entry on to the premises of the debtor”. Otherwise, the consent of the debtor or a court’s order is required. If the cooperation of the debtor is not forthcoming, resort to the courts is also necessary.
Upon (re)possessing the asset what are the duties of the mortgagee? Lightman J applied the principles advanced by Sir Donald Nicholls VC and gave a concise response: “If the mortgagee takes possession, he becomes the manager of the charged property.. .He thereby assumes a duty to take reasonable care of the property secured...; and this requires him to be active in protecting and exploiting the security, maximising the return, but without taking undue risks.”.
Taking reasonable care of the asset is the beginning of the story with the inevitable question then arising: how do English courts interpret the duty of the mortgagee in possession to “protect and exploit the security, maximise the return”? Professor Beale et al reviewed numerous authorities and provided an accurate description of the current state of the law:
a duty to use any income arising from the possession of the assets to reduce the amount due from the mortgagor, and any profit made must be strictly accounted for, although the mortgagee can set off against the income from the assets any expenses in taking and keeping possession...[it] is also under a duty to preserve and take reasonable care of the property [and] it will be liable for failure to obtain a reasonable income if this is due to wilful default, but.it is not liable to account for profits made by reason of possession of the mortgaged assets if the profits are not income generated by the assets themselves.[notes omitted]
As long as the mortgagee comes into possession of the asset in question, common law gives her/him the power to sell the asset in question upon the mortgagor’s default without obtaining a court order. The prevailing view is that an equitable mortgagee does not have the power to sell the asset without the court’s intervention.
It is submitted that s. 101(1) of the Law of Property Act 1935, which is applicable to mortgages made by deed, gives both a legal and an equitable mortgagee the power “to sell.. .the mortgaged property.. .by public auction or by private contract” without the court’s intervention. S. 103 of the Law of Property Act 1935 curtails this broad power by providing that it should be exercised (i) 3 months upon serving a notice requiring payment of the outstanding money on the mortgagor(s); or (ii) when interest under the mortgage has not been paid for over 2 months; or (iii) when the mortgagor has breached a condition of the mortgage deed that is not related to the payment of the mortgage money or interest. It is common practice for the parties to exclude the application of s. 103 in their agreement, as per the contractual freedom granted by s. 101(4) of the Law of Property Act 1935.
In any case, the parties are free to include express provisions in their agreement on the power of the mortgagee to sell the asset that will modify the common law, as well as the statutory powers.
Like the right to (re)possess, the mortgagee’s right of sale is subject to the general principles pronounced by Sir Donald Nicholls VC in Palk v Mortgage Services Funding plc. Lightman J applied these principles in the context of the right of sale:
In default of provision to the contrary in the mortgage, the power is conferred upon the mortgagee by way of bargain by the mortgagor for his own benefit and he has an unfettered discretion to sell when he likes to achieve repayment of the debt which he is owed... A mortgagee is at all times free to consult his own interests alone whether and when to exercise his power of sale.The mortgagee’s decision is not constrained by reason of the fact that the exercise or non-exercise of the power will occasion loss or damage to the mort- gagor.It does not matter that the time may be unpropitious and that by waiting a higher price could be obtained: he is not bound to postpone in the hope of obtaining a better price..
Assuming the mortgagee decides to go ahead with the sale of the asset, she/he has the duty to take reasonable care to achieve a proper price; proper price is equated with the “the true market value of the mortgaged property” at the day the decision was made. English courts are in general reluctant to set overarching rules on the “informed judgment” of the mortgagee preferring a case by case approach. Having said that, courts have set a few principles over the years with the burden of proof resting on the mortgagor to prove a breach, which in practice is a not such an easy task:
[t]he duty includes drawing the sale to the attention of available buyers, and drawing the attention of potential buyers to all the features of the asset that affected its value.. .However, the duty will depend on the facts of the case, and a mortgagee will not be liable unless he is plainly ‘on the wrong side of the line’. The mere fact that a higher price might have been obtained does not mean that there is a breach, if the price is a ‘proper price’. There is also no duty to improve, as oppose to preserve, the assets prior to marketing them. [notes omitted]
Inevitably, English law would treat any sale of the asset to the mortgagee himself as void on policy grounds. Yet, sale of the asset by the mortgagee to a connected party, i.e. a party in which the mortgagee has an interest, such as shares, is permitted, but is subject to stricter rules. The burden of proof is reversed and it is for the mortgagee to show that “he acted fairly to the borrower and used his best endeavours to obtain the best price reasonably obtainable for the mortgaged property”. English courts look carefully into any conflicts of interests that is resolved in favour of the connected party. Caesar’s wife must be above suspicion: “the facts must show that the desire to obtain the best price was given absolute preference over any desire than an associate should obtain a good bargain.. .The inevitable conflict of interest which arises on a sale to a close associate may be not only consciously but also unconsciously resolved in favour of the associate.”. It is submitted that seeking the court’s approval prior to undertaking such sale is the best way forward.
What is the effect of selling the asset on priorities?
Sale by a first mortgagee extinguishes the debtor’s equity of redemption and overrides the second mortgage, which then attaches to any surplus proceeds of sale remaining after the first mortgage has taken what is due to him. Sale by a second mortgagee takes effect subject to the first mortgagee unless that is discharged from the proceeds of sale.. .If the proceeds of sale of the mortgaged property produce a surplus remaining after the first mortgage has taken what is due to him, the mortgagee is accountable for it to next ranking incumbrances, if there is one, or, if not, then to the debtor. Where the sale leaves a deficiency this remains governed by the express covenant for payment, which the mortgagee is entitled to enforce.
Foreclosure is essentially the “termination of the...right to redeem by court order.The mortgagee may then treat the property as absolutely his, and is therefore entitled to keep all the proceeds of any sale, even where there is a surplus over and above the amount of the debt and the costs of disposal”. Courts regard this remedy with caution considering its drastic impact on the mortgagor; as such they will initially issue an interim order giving the mortgagor time to pay the outstanding amount and redeem the asset. Failing that, they will issue a final order foreclosing the asset in question. At any time before the order turning final the court has the power to order the sale of the asset. Foreclosure is rarely used any more since (i) the court controls the process which inevitably causes delays; and (ii) the mortgagee loses the right to go after the mortgagor for recovering any deficit between the value of the foreclosed asset and the secured liability. In that respect, Art. 9 of the Cape Town Convention provides for a less draconian and more balanced procedure to be followed.
Overall, Art. 8(1) and (2) of the Cape Town Convention will not come as a surprise to an English lawyer, since the “self-help” remedies in Art. 8(1), as well as the court’s assistance envisaged in Art. 8(2) are all options available to a mortgagee in this jurisdiction. At the same time, English courts have produced an elaborate and evolving line of case law over the years exploring the practicalities of enforcing the mortgagee’s remedies following a default of the mortgagor. How to distribute the proceeds of sale and any surplus remaining has also been analysed extensively by English courts which in principle echo Arts 8(5) and (6) of the Cape Town Convention (with the exception of foreclosure in Art. 9). What constitutes “a commercially reasonable manner” under the Cape Town Convention will almost certainly be tested before English courts. It is submitted that this new requirement is not a cause of concern: one commentator has already argued that the duties of the mortgagee vis-a-vis the exercise of the remedies under English law “appear... to be similar to the one intended under the Convention”.
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