A borrower agreed to sell her property, to a purchaser. The total amount owed under the mortgage exceeded the purchase price. The lender agreed to release its mortgage in return for the full sale proceeds (presumably because the lender agreed the price being paid was top dollar).
However between the time the contract was signed and settlement, the ATO served garnishee notice on the purchaser requiring it to pay part of the purchase price owed to the borrower to it for a tax debt the borrower owed.
The lender agreed to provide a discharge and for the disputed money to paid into court pending judicial determination as to who was entitled to it.
The judge at first instance found that the purchase monies were not owing to the taxpayer, but owing to the mortgagees and hence there were no monies to which the tax office demand or notice could attach. The judge compared the mortgages with a floating charge that had crystallised and noted that the mortgagor/charger had no beneficial interest in monies paid to it because the monies were not owed to it but to the mortgagee/chargee.
The tax office appealed and argued that the mortgage only operated over the property to secure repayment of the mortgage debt and not over the proceeds of sale. They argued that at settlement, the mortgagees lost their security interest in the property upon release of their respective mortgages and obtained no security interest over the proceeds of sale. The mortgagees went from being secured creditors to being unsecured creditors by their own acts. The vendor obtained beneficial interest in all the purchase monies and the tax debt attached to those proceeds in priority to the debts due to the mortgagees as unsecured creditors.
The Federal Court of Appeal by a majority agreed and found that that the purchase monies were received by the vendor/taxpayer and the tax office demand attached to them. The court noted that the mortgagee could have exercised its power of sale but chose instead to release its mortgage and that was critical because in the latter case, the purchaser never owed any money to the mortgagees, only the vendor. The release of mortgage compromised the mortgagee’s position.
The court rejected the argument that the decision turns secured creditors into unsecured because if the mortgagee had exercised its power of sale, its security would have remained intact and would not then be affected by a tax office notice. The court held that a mortgagee only has a registered security over land and not a beneficial interest in all money that becomes owing to the mortgagor. And while the court accepted that a defrauded mortgagee would have an equitable charge over the proceeds if the sale had not been authorised by the mortgagees, that was not a ground upon which the Federal Court decision had been made and not covered by the notice of contention. But in any case the court found that the situation would not arise where the tax office had made a demand because the monies would be paid to the tax office instead of the vendor and so not capable of being subject to any charge. The Federal Court also found the floating charge analogy incorrect because a mortgage relates to land and not monies owed even by a purchaser of that land.
The court set aside the declaration and held the tax office entitled to the money paid into court and ordered that it be paid to the tax office.
The lesson for lenders is if there is a garnishee order never release your mortgage – sell the property under power of sale.