Changes to the Real Property Act which effect Lenders

On 14 May 2009 the Real Property and Conveyancing Legislation Amendment Act 2009 (NSW) was passed. This amending legislation makes several key changes to the Real Property Act (RPA) and Conveyancing Act, both of which will significantly impact lenders.

New obligations on mortgagees and witnesses will commence 1 November 2011. Land and Property Information NSW has issued Circular 2011/05 to provide information on the new obligations.

1 August 2009

Borrower identification requirement

Reasonable steps

Lenders are now required to take ‘reasonable steps’ to ensure the person who signs the mortgage is the mortgagor. The legislation envisages that regulations will be published that will guide lenders on what is sufficient. The fact that no regulations have as yet been proclaimed does not relieve lenders of their obligations in the meantime. According to a recent speech of the Attorney General the identification procedures will likely follow the 100 points ID scheme.

Record keeping

The lender must keep records of the steps taken to verify the mortgagor’s identity and copies of the identification documents must be sited for 7 years from the date of registration.

Identification requisitions

The Registrar-General (RG) has been empowered to make requisitions of the lender to determine whether or not the identification requirements have been complied with. These requisitions can be made before or after registration.

Refusal of registration

If a lender fails to answer requisitions the RG may ‘refuse to register, or reject, the mortgage.’ One anomaly of the drafting is that the power to refuse to register a mortgage does not arise if no identification check was made, but rather only if you do not tell the RG about it when asked. Nevertheless, as will be seen, this can be rectified immediately after registration if the mortgage was indeed forged.

Cancellation of a registered mortgage

The biggest innovation introduced by the amending Act is the power of the RG to cancel the registration of a mortgage. Up until now once a mortgage was registered the lender was safe. Nothing but actual fraud by the lender could dislodge the mortgage or impede its enforceability. If the fraud was discovered after registration there was nothing the RG, or anyone else could do about it. Now, under the changes, the RG can under two circumstances cancel the registration of a forged mortgage.

Cancellation for failure to take reasonable steps to identify

The first ground upon which a mortgage can be cancelled is if the lender has failed to comply with the identification requirements. This significantly dilutes indefeasibility so far as it applies to imposter fraud.

Cancellation where there is ‘constructive notice’ of fraud

The second basis upon which the registration of a forged mortgage can be cancelled is where the lender had ‘constructive notice’ of the forgery. Constructive notice is where the RG can point to the lender and say, “He ought to have known about the fraud based on the material he had before him”. It is a de facto negligence standard but without the safeguard of the lender being able to claim its oversight was no more than that of an ordinary reasonable person would make (which is the test in negligence). It is a very loose concept in practice because, with the wisdom of hindsight, virtually every fraud could have been detected. For example if a fraudulent letter on the application file had an ABN number with less than eleven digits then arguably that put the lender on constructive notice of the fraud.

This is a radical departure from the safeguards contained in the Torrens title system. All the case law for the last hundred years has rejected the suggestion that constructive notice was sufficient to impugn a mortgage. It was no good to say the lender ‘ought’ to have known, you had to show the lender actually did know of the fraud.

Another difference introduced by the amendments is that the determination is being made, in the first instance, by the RG – not the court. As the RG is the nominal defendant which defrauded owners sue there seems to be an inherent conflict of interest in the powers granted. The RG has an incentive to strike down mortgages i.e. stretch the definition of ‘constructive notice’ as far as it needs to do the job. Moreover the amendments do not address what happens if the RG oversteps the mark and cancels a mortgage improperly – can a court order it to be re-instated, certainly no express power has been included in the changes.

Transferee tainted

One of the key elements of indefeasibility was the protection it gave to a funder that took a transfer of a mortgage without actual notice of a fraud by the transferor. Under the changes this is has been done away with and a transferee suffers any consequences, which would attend the original lender. This means that any lender proposing to take a transfer of a mortgage will have to be absolutely certain of the identity of the borrower or else hold title insurance.

Summary

In summary it will now be necessary for lenders to take out title insurance. These changes effectively dilute the state guarantee of title under the Torrens Systems to almost nothing. Although the extent of the dilution will remain unclear until the case law beds down the changes what is immediately clear is that lenders cannot be certain of ever being able to rely on title in the event of fraud. Bransgroves urges lenders to consider the impact of these changes now and implement title insurance rather than wait until they experience losses.

Limits on amount recoverable from the Torrens Assurance Fund

The new section 129B is headed Limits on amount recoverable in respect of mortgage obtained by fraud. It might be thought that this section has the potential to impact on the rights of lenders. However, assuming a forged mortgage is not cancelled under the new provisions, it is not the lender who makes an application for compensation. The party which suffers a loss is the registered proprietor. It is therefore the registered proprietor that is entitled to make a claim.

Accordingly as drafted the only occasion on which the new section 129B will come into play is when a fraudulent discharge of mortgage has been registered. In those circumstances the amount of compensation that the lender could recover will be influenced by the section.

Aside from some superfluous provisions the only significant element in the new section 129B is that the maximum interest that can be recovered by the lender is the official cash rate plus 2%.

Duty of care when exercising power of sale

The amending act inserts a new section 111(A)(1) into the Conveyancing Act which reads:

A mortgagee in exercising a power of sale in respect of mortgaged land, must take reasonable care to ensure that the land is sold for:

  • if the land has an ascertainable market value when it is sold – not less than its market value, or
  • in any other case – the best price that may reasonably be obtained in the circumstances.

This brings the law in relation to the sale of land owned by an individual into line with the law in relation to the sale of land owned by a corporation. This is governed by section 420A (1) of the Corporations Act, which reads:

In exercising a power of sale in respect of property of a corporation, a controller must take all reasonable care to sell the property for:
  • if, when it is sold, it has a market value—not less than that market value; or
  • otherwise—the best price that is reasonably obtainable, having regard to the circumstances existing when the property is sold.

The previous common law duty was a duty to act in good faith. This meant that so long as the lender was not fraudulently selling the property to a friend for a knock down price, or behaving with reckless indifference, then the fact that the property was sold at less than market value was irrelevant. Under the new individual regime, presumably the jurisprudence that has applied under the corporation regime will apply. In that regard Whelan J in Irani v St George Bank Ltd (No 2) [2005] VSC 403 at [142] set out at [142] set out the following principles:

It first is necessary for the court to determine whether the property in question has a “market value”. If it does, (a) applies. If it does not, (b) applies.

The question of whether a property has a “market value” depends upon the degree of certainty with which value is ascertainable by reference to events in a market. A property does not have a “market value” where market experience does not yield a value with sufficient certainty to be used as an integer.

Both limbs of s 420A are concerned with the process of exercise of the power of sale. On the one hand, breach of the duty provided for is not established merely because market value or the best price reasonably obtainable is not achieved. On the other hand, breach may be found to have occurred even where it is established that market value or the best price reasonably obtainable was achieved.

The final paragraph is at odds with the literal wording of the legislation. As worded it imports a strict liability on the lender to get the market value or the best price available. Whelen J’s formulation seems to suggest that what is important is the steps that were taken.

This in turn amounts to an analysis of the lender’s bona fides and that is a reversion to the common law good faith test. Thus Whelen J is shying away from the strict liability of the legislation. Do the judges follow him? In a June 2009 case where Bransgroves acted for the lender  Winters v H G & R Nominees [2009] NSWSC 467 Bryson J noted:

It is essential to the borrowers’ case to establish that there was a serious discrepancy between the market value of the property at the time it was sold and the sale price. Unless there was a serious discrepancy, criticisms of the lender’s conduct cannot affect the outcome.

This seems to show a deference for the literal construction of strict liability (although adding the qualified of serious where none exists in the legislation). However, later His Honour seemed to back away from this. Although it might be that he only meant to address the subsisting common law duty of good faith:

This document shows careful consideration and review of factors relevant to a decision to sell and to the price, going through the information and advice available and supporting the decision to recommend it with careful reasoning. This rebuts any view that the defendant acted with any extraneous or improper motive, or with indifference or lack of appropriate attention to the business in hand and its importance.

The distinction is probably irrelevant to lenders. The main lesson applies either way, more professionalism is required in order to cover the lender’s position. It is not good enough to sell in a casual manner. There must be a paper trail which demonstrates the steps taken, for example valuations before setting reserve prices etc. Care should be taken to address any anomalous valuations or claims as to value at the time rather than later in court. Write every letter, email and memo as though it will one day be read by a judge because it will be discoverable.

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