The High Court of Australia has clarified the question of
priority between a guarantor of a first mortgage and later
registered mortgagees in relation to the distribution of sale
proceeds in the case of Bofinger v Kingsway Group Limited.
The case makes it clear that guarantors will rank ahead of
subsequent mortgagees and may rely on their right in equity to
claim compensation from the first mortgagee.
The case is particularly important for second or subsequent
mortgagees, who may find themselves suddenly unsecured under these
principles if specific steps to protect their interests are not
taken when consenting to guarantor dealings with security
properties.
Facts
The Bofingers were directors of B&B Holdings, which had
borrowed money from three lenders. The loans were separate and
secured by first, second and third mortgages over land owned by
B&B Holdings (B&B Holdings property). The
Bofingers were also guarantors of the loans and provided their own
land (Bofinger property) as security to the first,
second and third mortgagees for the debts of B&B Holdings.
In order to discharge their liability under the guarantees to
the first mortgagee, the Bofingers sold the Bofinger property with
the consent of all three mortgagees and made payment to the first
mortgagee. The first mortgagee then sold the B&B Holdings
property to satisfy the balance of its debt. The first mortgagee
paid the surplus of the proceeds to the second mortgagee.
Question of priority
Having made payment to the first mortgagee to satisfy part of
the guaranteed debt, the Bofingers contended that they were
entitled to the surplus of the sale proceeds to the extent of that
payment through the principle of subrogation, which allows a
guarantor to stand in the shoes of a lender and have all the rights
of the lender against the borrower, and imposes an obligation on
the lender to account to the guarantor for any recovery in excess
of the full amount of its debt.
The second mortgagee objected on various grounds, including that
the guarantee given by the Bofingers to it waived the guarantor's
rights 'which may be inconsistent with the provisions of this deed
or in any way restrict… the rights, remedies or recourse' of the
second mortgagee.
Decision
The court found in favour of the Bofingers, deciding that the
Bofingers should have received the surplus money because they were
entitled to be subrogated to the rights of the first mortgagee, in
priority to the second mortgagee. It was reasoned that a second
mortgagee, when advancing money, knows perfectly well that there is
a prior charge on the property and his security will be limited so
that it is a matter of indifference whether the first mortgagee or
the guarantor make a prior claim for that amount.
Of importance was the fact that the second and third mortgagees
had consented to the sale of the Bofinger property without
requiring that the Bofingers relinquish their right to subrogation
in relation to sale of the B&B property.
Accordingly, any surplus in the hands of the first mortgagee was
held by it as a constructive trustee for the Bofingers. The first
mortgagee was obliged to account the surplus to the Bofingers as
such and was liable to pay equitable compensation to them.
While the Bofingers were still liable to the second and third
mortgagee under guarantees to the second and third mortgages, the
second and third mortgagees had now become unsecured.
The court commented that the Bofingers could have excluded their
right to subrogation by agreement or inequitable conduct. However,
in this case, the guarantees did not provide for a waiver of this
nature. In deciding on the application of the terms of the
guarantee, the court noted that where there is ambiguity, terms are
to be interpreted in favour of the surety. The court held that the
waiver only applied to the guarantor's rights to the second
mortgagor, and not in relation to the guarantee given to the first
mortgagor.
Implications
Consenting to transfers
Second and subsequent mortgagees should take care when
consenting to transfers of security properties, to ensure that all
parties to the transaction agree that the guarantor(s) waive their
right to subrogation so that they do not take priority to the
second mortgagee's interests.
Drafting guarantees
Guarantee documents should be reviewed to cover the
circumstances of this case, expanding waiver provisions to any
rights of subrogation in respect of prior mortgages, charges and
other interests.
Surplus proceeds
In exercising a power of sale where a guarantor has made a
contribution and there are subsequent registered mortgagees, first
mortgagees should take care in distributing the surplus. Because
surplus funds are considered by the courts as being held by the
first mortgagee in trust, the first mortgagee may be called to
account for the funds personally if they are distributed
incorrectly.
(Authored by Tanya Nguyen, Cornwall Stodart)