Not so safe as houses
The judgment in Southern Pacific v Scott marks the end of the line for many tenants caught up in similar sale-and-rent-back mortgage litigation, explains Paul Heeley
The Supreme Court decision in Southern Pacific Limited v Scott, which will affect hundreds of civil cases on hold pending the judgment, also presents a huge relief to those lenders whose security for the money they lent – the value of the property – was potentially at risk. Had the decision gone in favour of Scott,
the risks involved in making future mortgage advances would have increased, which would almost certainly have had a significant impact on their willingness to lend.
Sale-and-rent-back schemes are familiar to most. A homeowner sells their property at a reduced price to a buyer who grants them a tenancy, allowing them to continue living in the property. These schemes were popular until the government caught wind of the potential for exploitation, introducing regulation in 2010 that all but outlawed them.
This case was one of ten test cases, often referred to collectively as the ‘North East Property Buyers Litigation’, relating to a group of opportunists who sought to cash in on the soaring buy-to-let market of the noughties by arranging sale-and-rent-back deals on an almost industrial scale.
Each case varies in terms of the specific deal offered to the homeowner. In this case, what attracted Scott was a lifetime tenancy at low rent and also a future cashback payment from her buyer. Southern Pacific was not aware of this
when it agreed to lend to Scott’s buyer.
The test cases all hinged on the same central legal issue, which was whether the buyer’s promise of a tenancy, made prior to the property changing hands, could create for the seller a new type of property interest binding on the new lender.
There was an interesting mix of trite law and novel legal argument in the litigation. At first instance in June 2010, the judge decided that
any interest the test case tenants acquired prior
to completion could not have priority over the lenders’ charges. Applying the principle in Abbey National v Cann [1991] that there can be no moment in time – or scintilla temporis – between the completion of the purchase and the creation of the mortgage funding it during which third-party rights could be created (trumping the lender’s charge), the court held that the lenders had priority.
Alternatively, the tenants could not have interests that arose on exchange of contracts because of the decision in Nationwide Anglia Building Society v Ahmed [1995] that the contract, conveyance and charge formed one indivisible transaction. Furthermore, the tenants’ interests could only be personal rights against their buyers rather than proprietary rights against the world
at large, and in any event these rights would have passed to the buyers under the terms of the contract.
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‘Lenders must consider the hardship’ Andy Creer is a barrister practising from Hardwicke Chambers Scott is an interesting decision, but, perhaps, an unsurprising one. In many cases of property fraud, the court is left to untangle the rights of two or more innocent victims, thus refereeing the tug-of-war between fairness and certainty in property law. As Lady Hale noted at paragraph 104 of the judgment, the promises of the nominee purchaser upon which Scott relied “bore all the hallmarks of a proprietary estoppel”. But, crucially, Scott only had the expectation of an interest in land from a party not yet legally entitled to grant it. It is only the acquisition of the legal estate that feeds the estoppel. If Scott’s claims to an equitable proprietary interest arising at the moment of exchange of contracts had been binding on the mortgagee, then where would this have left the lending market? Yes, lenders have had to moderate their practices based on seminal decisions like Williams and Glyn’s Bank v Boland [1981] AC 487 and Royal Bank of Scotland v Etridge (No.2) [2002] 2 AC 773, but those cases concerned the competing rights of the mortgagors (or their family members) and mortgagees. Here there was no contractual nexus between the lender and the vendor. Practically, how could the bank be expected to discover the alleged equity? The Supreme Court took some seven-and-a-half months to give judgment, which suggests the decision was an uneasy one. The reality is that, as a result of the regulation of sale-and-rent-back transactions in 2009, the occurrence of such transactions is now rare. To amend the law to ameliorate the real and undoubted hardship facing a defined body of defrauded vendors would be to shut the stable door after the horse has bolted. Many lawyers will doubtless wish to echo Lord Collins’ hope, expressed at paragraph 94, that the lenders in such cases will consider this hardship before enforcing their strict legal rights. |
In 2012, the Court of Appeal agreed no interest with priority over the lenders’ mortgages had been created, but for different reasons. The court held that on any objective view there were two distinct agreements as between the sellers and the buyers: first, the contract for the sale of the property and, second, the subsequent granting of the tenancies.
Given the first transaction’s dependence on the lender’s money in order to complete, there could be no possibility of a new superior seller’s interest. Any new interest could only derive from the second transaction, there being no mention in the documentation that the sales were expressly subject to new tenancies being created.
Additionally, there were two basic propositions. First, the tenant’s interest created by the buyer at exchange of contracts could not be proprietary because that would be superior to the buyer’s own interest existing at the same time. Second, the buyer therefore had an equitable interest from which a legal interest binding on the lender could not be carved. The tenants were also unsuccessful in their attempt to distinguish Cann.
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Clive Stevens is executive chairman of accountancy firm Reeves In giving his judgment on, Lord Collins said: “It was impossible not to feel great sympathy with Mrs Scott and the former home owners in her position, who may have been not only the victims of a fraud which tricked them out of their homes, but also of unprofessional and dishonest behaviour by the solicitors appointed to act for them. Professional ethics are a moving target. Thirty years ago tax planning was standard practice for accountants, now it is often called ‘tax avoidance’ and measurable to a moral, rather than strictly legal standard. The distressing case of Scott losing her home raises a similar issue for solicitors, which they should not be slow to recognise. Even strictly legal activities can be morally, plainly wrong. This is a complex case involving a chain of different parties. It is for others to assess the particulars and decide negligence and culpability. But there is a straightforward principle that should have been guiding behaviour and apparently was not: the law exists not just for the person applying it, but as a protection for the vulnerable. It is very easy to view the legal profession through the blinkers of client benefits and fail to accept responsibility for the ethics of one’s behaviour. This is no longer an acceptable position. Ethics are not contractual. They exist and overarch all activities. That is their point. They cannot be flexible in a post-recession age with a public mood intolerant of professional misconduct and sceptical about standards across the board. We must all, particularly as protectors of assets, pay strong regard to what might be described as the public good, to ensure how we behave does not impact on people detrimentally. What is particularly unsettling about this case, and the other test cases, is that none of the solicitors, perhaps otherwise decent and professional people/lawyers, seemed to assume responsibility for standing back and thinking of whether the sales were in the best interests of the sellers, even as they drafted conveyancing documents. Ethical behaviour should be a standard, not an aspiration. If we fail to make it so, then we should expect politicians to step in and add layers of further regulations or competition. They will be deserved. |
‘Ethical When the case reached the Supreme Court in March 2014, only Scott’s case remained. The others had been settled or had otherwise fallen away. The appeal was fought on a number of fronts, including the general assertion that the housing market and various public policy considerations had changed significantly since Cann and so required new law. The main issue, however, was still whether Scott had at any point in time acquired an interest that was binding upon Southern Pacific because of her occupation of the property. Essentially, did she have an overriding interest under the Land Registration Act 2002?
The court was urged to distinguish Cann and overrule Ahmed. Scott’s lawyers also sought to throw into the mix their criticism of Southern Pacific’s lending practices, seemingly in an attempt to demonstrate that a radically different lending landscape needed better protection. They did not succeed.>
The Supreme Court’s judgment confirms the existing application and interpretation of the law. Although there was some disagreement over whether the contract, the acquisition of the property and the grant of the charge were one indivisible transaction, there was full agreement that only personal rights could have been created in Scott’s favour, rights that were only enforceable by Scott against her purchaser and not her lender.
Had Scott succeeded in her appeal, 300 years of conveyancing law and practice would have been turned on its head, leaving lenders with the challenge of funding transactions with greater risk from unknown third-party interests.
Lord Collins referred in his judgment to the fact that one of the objectives of the 2002 Act had been a simplified and electronically based conveyancing system that enabled title to be investigated almost entirely online with few additional inquiries being required. Overriding interests, being interests that are not apparent simply from looking at the Land Register, had presented a major difficulty in achieving that objective, but nevertheless the
Act retained them.
The Scott decision therefore serves to keep in place the workable checks and safeguards that have developed around these interests to protect purchasers and lenders alike.
The opportunity that Scott saw to extend the scope for unregistered interests in property would have had a significant impact on residential lending in the UK, with a knock-on effect on the wider economy that relies to a great extent on a buoyant property market. Thankfully, the legal position is now certain. SJ
Paul Heeley is a partner at TLT