Dealing with surplus proceeds

The recent NSW Court of Appeal decision in Residential Housing Corporation v Esber & Ors [2011] NSWCA 25 considered the obligations of mortgagee (enforcing its power of sale) when dealing with surplus funds under section 58(3) of the Real Property Act 1900 (NSW) (which is analogous to section 109 of the Transfer of Land Act 1983 (WA)).

Summary of facts

The mortgagors were involved in Knox Street Apartments Pty Ltd (Knox), a company that embarked on a real estate development. The mortgagors owned two strata units in the development. They granted a first registered mortgage to Permanent Trustees Australia Limited (First Mortgagee), and a second registered mortgage to Residential Housing Corporation (Second Mortgagee) over both units.

When the development was partly complete, Knox entered into a joint venture arrangement with Kimberley Securities Limited (Third Mortgagee). The mortgagors guaranteed Knox’s obligations under the joint venture agreement. As security for their obligations under the guarantee they granted the Third Mortgagee a mortgage over the two units. The Third Mortgagee did not register its mortgage over the two units.

Following a default under the mortgage, the First Mortgagee entered in possession of and subsequently sold the two units. The First Mortgagee applied the proceeds of sale to satisfy in full the amounts it was owed, and paid the surplus proceeds to the Second Mortgagee. The Second Mortgagee then applied the proceeds of sale to satisfy in full the amounts it was owed.

Surplus sale proceeds of $416,780.81 remained after both the First and Second Mortgagees were paid in full (the Surplus). By this time, a dispute had arisen between the mortgagors and the Third Mortgagee as to who was entitled to the Surplus.

Both the mortgagors and the Third Mortgagee wrote to the Second Mortgagee and requested that it pay the Surplus to them. The Second Mortgagee advised the mortgagors and the Third Mortgagee that it was not in a position to release the Surplus until the dispute was resolved.

The Third Mortgagee then offered to indemnify the Second Mortgagee if it paid the funds to it. The Second Mortgagee, after receiving the indemnity, transferred the Surplus to the Third Mortgagee.

The mortgagors then commenced proceedings against the Third Mortgagee and obtained judgment against the Third Mortgagee that no money secured by the mortgage was due and payable to the Third Mortgagee. Before the mortgagors could enforce their judgment against the Third Mortgagee, the Third Mortgagee was wound up in insolvency.

The mortgagors then looked to the Second Mortgagee to account for the Surplus, which the mortgagors contended ought not have been transferred to the Third Mortgagee.

Decision

Section 58 of the Real Property Act and section 109 of the Transfer of Land Act require a mortgagee who exercises its power of sale to pay all surplus proceeds to a person who holds a ‘subsequent mortgage’.

The NSW Court of Appeal (per Campbell JA, Macfarlan JA and Sackville JA agreeing) held that the unregistered mortgage granted to the Third Mortgagee was not a ‘subsequent mortgage’ for the purposes of section 58 of the Real Property Act because it was not a registered mortgage.

Accordingly, the Second Mortgagee was not obligated to pay the Surplus to the Third Mortgagee, and was liable to account to the mortgagors for the amounts paid.

Lavan Legal comment

The circumstances of this case are applicable to both mortgagees and receivers and managers appointed by mortgagees who generate sale proceeds sufficient to satisfy the amounts owed to them (or their appointers).

While the Transfer of Land Act and general common law principles (see for examples Re Thomson’s Mortgage Trusts [1920] 1 Ch 508) set out a regime for mortgagees and receivers and managers to deal with surplus sale proceeds, both mortgagees and receivers and managers should be aware that it is not their role (and often not in their best interests) to settle disputes between subsequent ranking creditors, whether secured or unsecured.

Mortgagees and receivers and managers who retain a surplus after paying their (or their appointer’s) debt in full should take care to ensure that any surplus funds are not incorrectly distributed. In the event that a mortgagee or receivers and manager receives notice of a dispute between subsequent creditors, the mortgagee or receiver ought (either) pay the surplus into a jointly named interest bearing trust account, or into court and allow the disputing parties to resolve the dispute.

It may also be prudent for mortgagees and receivers and managers who are aware of subsequent creditor’s interests to contact those creditors to confirm that no dispute exists in order to ensure that they do not deal with the funds in a manner inconsistent with those creditors’ interests.

If you have any queries in relation to this matter or any other matters, please do not hesitate to contact Alison Robertson, Partner on (08) 9288 6872 / alison.robertson@lavan.com.au or Joseph Abberton, Senior Associate on (08) 9288 6765 / joseph.abberton@lavan.com.au.