Fresh advances and subsequent mortgages – lenders beware

It has long been an established principle that a first mortgagee, having received notice of a subsequent mortgage, cannot gain priority for further voluntary advances over other advances secured by the subsequent mortgage.  The rule is often referred to as the rule in Hopkinson v Rolt[1] (Rule) and was considered by the Supreme Court of Victoria in the decision of Salta Constructions Pty Ltd v St George Bank [2013] VSC 685.  The decision provides some useful guidance to lenders as it clarifies the operation and application of the Rule.

The facts

First State Developments (WA) Pty Ltd (FSDWA) is a member of a group of companies known as the First State Group (Group).  FSDWA was provided with financial accommodation by St.George Bank, now a division of Westpac Banking Corporation (St.George).  In 2003 FSDWA granted a first registered mortgage to St.George over the relevant property as security for its liabilities. 

In 2008 Salta Constructions Pty Ltd (Salta) entered into a building contract with another entity within the Group.  A number of events transpired which resulted in the obligations of that entity being secured by two mortgages granted by FSDWA to Salta over the property in May 2009 and September 2009 respectively.

Upon the expiration of FSDWA’s facilities in July 2009, St.George rolled over the facility and granted a new overdraft account in October 2009. 

In 2012 St.George appointed receivers and managers over the assets of FSDWA and the whole of the proceeds of the sale of the property was applied by St.George to reduce the amounts owing under its mortgage.  Subsequently, Salta brought proceedings against St.George challenging the right of St.George to take any priority over the proceeds of the sale of the property.

The issues

Salta alleged that St.George received actual notice of the first Salta mortgage prior to the expiry of FSDWA’s bill facility in July 2009 and that the roll-over of the bill facility and the establishment of an overdraft account in October 2009, constituted a grant of a further advance by St.George.

In determining whether the Rule had been breached, the Court had to consider whether:

  • the subsequent mortgage was disclosed to St.George; and
  • the roll-over of bills and the creation of an overdraft constituted a further advance.

The decision

The requirement of notice and a future advance

The Court found that St.George did not breach the Rule.

The Court clarified that a future advance for the purposes of the Rule must be voluntary and in effect must increase the liability of the mortgagor and diminish the value of the mortgagor’s unencumbered equity in the charged property.

Although St.George continued to roll-over bills after the bill facility came to an end, and eventually converted the liability into an overdraft because FSDWA failed to repay the facility, the Court found that the roll-overs and establishment of a new overdraft account did not amount to a further advance. 

Further, the Court found that FSDWA deliberately withheld information from St.George and as a result St.George did not have actual knowledge of the existence of the Salta mortgage.

The Rule in practice

In reaching the decision, Judd J provided some useful guidance with respect to the application of the Rule:

  • The Rule only operates when the first mortgagee has made a further advance.
  • The Rule does not operate to defeat the security or any part of it.  Instead, the Rule merely fixes the amount of which the security has priority over subsequent securities at the date upon which the mortgagee has notice of those subsequent securities.
  • The Rule has no application where the first mortgagee is bound to make and the mortgagor bound to accept advances made after the date of the second mortgage.

Lavan Legal comment

Lenders should be aware that definitions of “advance” used in facility agreements and mortgage documents may provide little assistance in circumstances where a lender provides a borrower with new financial accommodation where there is a subsequent mortgage.

The decision is unclear as to whether actual or constructive notice is required or whether or not lenders are required to make their own enquiries when providing further advances for the purposes of the Rule.  However lenders should of course be diligent in the process in any event.

An appeal has since been commenced against this decision. Lavan Legal will continue to monitor Salta Construction Pty Ltd v St.George and its impact on lenders’ rights.

[1] Hopkinson v Rolt (1861) 9 HL Cas 514.

Disclaimer – the information contained in this publication does not constitute legal advice and should not be relied upon as such. You should seek legal advice in relation to any particular matter you may have before relying or acting on this information. The Lavan team are here to assist.