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Bofinger v Kingsway - High Court upholds subrogation right
Practical Law UK Legal Update 9-501-8552 (Approx. 3 pages)
Bofinger v Kingsway - High Court upholds subrogation right
by Richard Mann and Keith Rovers, Minter Ellison
| Published on 26 Mar 2010 • Australia |
This article is part of the PLC Global Finance March 2010 e-mail update for Australia.
Speedread
The recent Australian High Court decision in Bofinger v. Kingsway Group and Others [2009] HCA 44 concerning a guarantor's right of subrogation in a transaction involving three layers of secured creditors has prompted financiers and their advisers to review and tighten terms in guarantees, security documents and inter-creditor deeds that relate to an obligor's right of subrogation. As a result of the decision, unless the relevant subrogation provisions are drafted widely enough, a subsequent mortgagee could become unsecured and be denied proceeds of first mortgagee realisations through no action or fault of its own.
The recent Australian High Court decision in Bofinger v. Kingsway Group and Others [2009] HCA 44 concerning a guarantor's right of subrogation in a transaction involving three layers of secured creditors has prompted financiers and their advisers to review and tighten terms in guarantees, security documents and inter-creditor deeds that relate to an obligor's right of subrogation. As a result of the decision, unless the relevant subrogation provisions are drafted widely enough, a subsequent mortgagee could become unsecured and be denied proceeds of first mortgagee realisations through no action or fault of its own.
Case background
A development company, B&B Holdings, borrowed money from the first, second and third mortgagees and gave mortgages over various properties in support of its loans. A director of B&B Holdings and his wife guaranteed repayment of each of the loans.
B&B Holdings then defaulted under the first mortgagee's loans. The guarantors sold properties they owned and applied the proceeds in reduction of the first mortgagee's debt. The first mortgagee then exercised its power of sale to recover the balance owed by B&B Holdings. After satisfying the balance of the indebtedness owed, the first mortgagee paid the surplus to the second mortgagee and delivered to the second mortgagee certificates of title and discharges of the first mortgages over two unsold properties.
The guarantors contended that the first mortgagee should have paid the surplus proceeds to them so that they could recoup, under their right of subrogation, what they had paid to reduce the indebtedness of B&B Holdings.
Decision
In a unanimous decision, the High Court overturned a decision of the New South Wales Court of Appeal and found in favour of the guarantors.
The court found that the guarantors, having paid down some of the first mortgagee's debt, had the right to the surplus proceeds and the first mortgagee should have accounted to them. Having paid the second mortgagee, the first mortgagee was still liable to the guarantors. This was based on the principle of subrogation which allows a guarantor, having paid off the guaranteed debt, to stand in the shoes of the lender and have all the rights of the lender against the borrower.
Prior to this case, mortgagees would have taken comfort from section 58(3) of the Real Property Act 1900 (NSW) which requires the proceeds from the sale of land by a mortgagee to be applied first in payment of the first mortgage and second in payment of the second mortgage and so on. However, the court found that "upon that first mortgagee equity may place requirements as to the disposition of the surplus purchase money".
The court found that the guarantors could have excluded their right of subrogation by agreement or conduct but the terms of the documentation in this case did not operate in that way.
The effect of the decision is that whilst the guarantors were still liable under their guarantees to the subsequent mortgagees, their liability should have been treated as unsecured.
Action points
First mortgagees. These will need to take legal advice before they distribute any surplus enforcement proceeds or property following repayment of their debt, if there are subsequent registered mortgagees and a guarantor has made a payment to the first mortgagee.
Second and later ranking mortgagees. Any second or later mortgagee will need to carefully examine the documentation they use when the first mortgagee's debt has been guaranteed. Such mortgagees would want their guarantee and inter-creditor/priority agreements to both:
- Prohibit the exercise of subrogation (or similar) rights prior to the satisfaction of all secured moneys (that is, the drafting should clearly specify that the relevant secured money is both that owing to the first mortgagee and that owing to each subsequent mortgagee).
- Ensure that moneys received by obligors in breach of the prohibition be held on trust for them.