The Court of Appeal have recently considered what rights the lender of money secured by a property mortgage has against a guarantor of the loan where the lender has exercised his right to sell the property as mortgagee. Jonathan Bridge of Farleys explores the implications of Skipton Building Society -v- Bratley and Stott .

As an Insolvency lawyer I am frequently asked to advise directors facing personal financial difficulties as a result of the failure of their company. The director will often have guaranteed a loan in addition to granting a property mortgage to the lender of money. Not only is the unfortunate client having to come to terms with the loss of his business but he is also receiving requests from the lender for proposals to repay monies due under the guarantee, accompanied by the possible sale of property by such lender.

The client already has his grievances against those whom he blames for the failure of the company - it is rarely his own fault - and the culprits are often seen to be the money lenders who have "pulled the plug" and failed to support the ailing company with further loans. Insult is therefore added to already deep injury when the same lender then sells property to reduce monies due under the guarantee.

Against this background it is not surprising that clients frequently allege that the property has been sold too cheaply. Often, even after deduction of the proceeds of sale, the amount still due to the lender under the guarantee is so great that this argument becomes little more than a bargaining tool on behalf of the client. In the matter of Skipton Building Society -v- Bratley and Stott, however, I was instructed by a director who alleged that property had been sold so cheaply it had created a shortfall on the guarantee when in fact there should have been a surplus.

The facts of the case.

John Robert Stott was a director of D K Precision Engineering Co. Ltd. ("the Company"). In May of 1991 the Company acquired a leasehold interest in commercial premises and charged this in favour of the Skipton Building Society. Mr Stott and his co-director Kenneth Bratley each signed a Deed of Guarantee in relation to the Company's loan which was for approximately £130,000.

The Company experienced financial difficulties and on 22 November 1994 receivers were appointed by the Skipton. They attempted to sell the business as a going concern and continued to operate from the premises for 28 days. Selling agents were used. The occupiers of an adjacent plot approached the receivers and expressed an interest in purchasing the premises as they needed more space themselves. They made an offer to the Receiver on 9 December 1994 to purchase the Company's interest in the sum of £120,000. The receiver obtained a valuation and refused the offer. This was then increased on 12 January 1995 to £122,500 and made to the Building Society direct. It was accepted on 24 January 1995 following a valuation from an independent chartered surveyor.

Completion of the sale took place on 12 April 1995. After deduction of expenses a net balance of £118,001.49 was realised. The sum due under the mortgage was £135,432.07. On the 24 January 1996 the Building Society issued proceedings to recover the shortfall of £17,430.58 from the directors under the terms of the Deeds of Guarantee.

Mr. Stott filed a defence and counterclaim on the basis that the Building Society had failed to take reasonable steps to ensure that the sale price of the premises was the best price reasonably obtainable in the circumstances.

First instance

The case eventually came before Mr. Recorder Duggan sitting in Burnley County Court on 4th December 1998.

It is an interesting initial aside to note that criticism was raised at both first instance and appeal level as to the listing of the trial. Mr Recorder Duggan began his judgement by admitting his lack of knowledge in this subject and thanking counsel for "leading him by the hand through unfamiliar pastures". Lord Justice Evans suggested that the County Court listing authorities may be subject to criticism for allowing this case to come before a judge with so little knowledge of this area but he did not wish to level such criticism without the full facts.

The message to take from the comments of Evans LJ is that greater consideration should be given by County Court listing departments when allocating judges to matters of some complexity. There is no reason why Claimant and Defendant solicitors can not take the initiative and advise the court where a matter is inappropriate for transfer to a specialist court but would still benefit from listing before a judge with some degree of knowledge about the area of law in issue. This must surely be in all parties interests.

The judge considered whether the Building Society had breached its statutory duty as set out in schedule 4 paragraph 1(1)(a) of the Building Societies Act 1986 to take reasonable care to ensure that the price at which the property had been sold was the best price reasonably obtainable.

As a finding of fact it was held that the Building Society were negligent in two ways:-

  • 1. They failed to seek further interest by marketing the property
  • 2. They failed to take account of the "special interest" of the purchaser
In defining a special interest purchaser it was suggested that the purchasers in this case had a special interest in purchasing the property as next door neighbours and as such may be expected to pay more than an outsider would pay.

It was implicit in the findings that the Society could have sought further offers with or without the help of agents at least until April 1995 when completion took place.

The Recorder concluded that the failings of the Building Society had caused a "loss of chance" of obtaining a better price for the premises. Evidence had been heard from expert witnesses for both parties and the Recorder went on to value the loss of chance at £2,500.00.

The amount outstanding under the guarantee was therefore reduced by £2,500.00 and judgement was entered for the Building Society in the sum of £14,930.58.

The issues

The Court of Appeal were asked to consider the matter and Evans LJ delivered a judgement which has implications for borrowers and lenders alike. There were two distinct areas where clarification of existing case law was given.

The court initially considered the appellants submission that the breach by the creditor of its duty to obtain the current market value of the secured property discharges the guarantor entirely. The Building society contended that the breach should result in a pro tanto reduction.

I was surprised at the lack of case law on this specific point. The court were asked to consider authorities dating back to 1860. In support of the submission the appellant referred to Watts -v-Shuttleworth which came before the Court of Exchequer in 1860. This case involved a guarantee of a contract to fit out a warehouse which provided for the contractor to insure the fittings. The contractor failed to insure the fittings which were destroyed by fire. The creditor's claim against the guarantor failed because as stated in the headnote-

"In equity, upon a contract of suretyship, if the person guaranteed does any act injurious to the surety, or inconsistant with his rights, or if he omits to do any act which his duty enjoins him to do, and this omission proves injurious to the surety, the surety will be discharged." The more recent case of China and South Sea Bank -v- Tan, and in particular the judgement therein of Lord Templeman, was also considered at length.

In the case of Tan the issue was whether a creditor secured by guarantee and property mortgage is under a duty to sell the property in order to obtain the best price possible thus reducing the level of debt of the guarantor. The key phrase from Lord Templeman's judgement which was considered by the Court of Appeal in the Stott case is at p.545 where he states-

"If the creditor chose to exercise his power of sale over the mortgaged security he must sell for the current market value but the creditor must decide in his own interest if and when he should sell."

What the Tan case did not say was what the consequences would be if the creditor chose to sell and did not achieve the current market value and specifically whether this would constitute a breach which would allow the guarantor to treat the guarantee as discharged.

The appellant also referred to The Mutual Loan Fund Association -v- Sudlow where a creditors claim against a surety failed because the goods held as security were sold at an undervalue. This was argued to be a comparable case to that of Mr Stott where property was sold at less than its true worth. This would allow for discharge from the guarantee rather than a pro tanto reduction in the amount outstanding.

In Wulff -v- Jay a surety was again discharged from the principal debt as a result of an omission by the plaintifffs both to register a deed and to seize property assigned to them.

Lord Justice Evans pointed out in his judgement that both of these cases should be considered on their own facts. The Mutual Loan Fund case could even be argued to support the "pro tanto" argument where at p.450 it states

"but for the misconduct of the persons employed by the plaintiffs to sell them, the goods would have produced enough to satisfy the entire balance due under the promissory note"

The court preferred the summary of earlier authorities found within the Privy Council decision given by Lord Watson in Taylor -v- Bank of New South Wales. This case confirmed the earlier rule put forward in Pearl -v- Deacon. The creditors own actions had rendered unavailable part of the security to which the surety was entitled. The surety was held to be discharged only pro tanto.

Lord Justice Evans concluded that the appellant was not to be treated as discharged from the guarantee by the respondents failure to obtain the proper value for the security. The correct approach was to apply a pro tanto reduction to the amount for which the guarantor was liable.

Despite my own position as solicitor to the appellant I can see the logic in this decision. One need only consider a situation where the indebtedness under the guarantee is £100,000 and the value achieved for the property falls only £2,500 short of the current market value to see the injustice in allowing the guarantor to escape all liability.

The Court of Appeal went on to consider the methods employed at first instance to reach a current market value for the property.

The appellant argued that Recorder Duggan was wrong in his conclusion that the loss to the guarantor could be valued at £2,500 and that this was inconsistant with his findings of fact. Evans LJ gives useful guidance in his judgement as to how the assessment of current market value should be approached.

The Society argued that only forced sale values should be taken into account. At first instance Mr. Recorder Duggan described the concept of a force sale valuation as incorporating "an additional element of discount below the open market value because if a purchaser is able to discover that property has to be sold that in itself has the consequence of depressing the offer which he is prepared to make. "

The surveyors agreed in this case that a forced sale valuation represented 85% of an open market value.

The "loss of chance" approach adopted at first instance was described by the Court of Appeal as misguided and wrong in law.

Lord Justice Evans ruled that it was wrong in principle to take only the "forced sale" valuation and that the creditor should give credit for the current market value. This would necessitate taking into account special interest purchaser and the failure by the Building Society to expose the property to the market.

Mr. Recorder Duggan had found that not allowing for the special interest purchaser the open market valuation of the premises was £142,000 or £144,000. The current market value was therefore significantly higher than the amount due under the guarantee and the Building Society had to give credit for this amount. On this basis the appeal was allowed.

The only area of disagreement in what was a unanimous judgement came in relation to burden of proof. In his leading judgement Evans LJ indicated that the creditor should show that he has obtained the current market value but the guarantor has the burden of proving that the creditor was in breach of his obligation to obtain it. Potter LJ felt that the burden of proof was largely academic and that deciding where it lay should be reserved to a case in which it would be a decisive factor.

Conclusions

1. The case has clarified the legal position where a guarantor has been prejudiced by the actions of a mortgagee in selling property covered by the guarantee too cheaply. His entitlement is to a pro tanto reduction in the amount due under the guarantee and not to treat the guarantee as discharged.

2. When exercising the right to sell property under a guarantee the lender must take great care to ensure that the current market value is obtained. In the Stott case it was not enough to simply obtain an independent valuation when an offer was received. Consideration should be given to exposing the property to the market. In addition, where a "special interest purchaser" such as a neighbour exists the position should be exploited to try and increase the purchase price.

3. Had the Skipton Building Society recognised the "special interest" of the purchasers and approached them to try and negotiate a higher price in this case they would have discharged their duty to the guarantor. This is probably true even if such negotiations had been unsuccessful - at least the attempt would have been made.

4. Likewise the significant gap between the price being agreed and completion taking place left the Building Society open to criticism for failing to advertise the property. It was suggested that an advertisement could have been drawn up to simply advise of the offer received and invite higher offers over a stipulated period of say 28 days failing which the property would be sold to the current bidder. Again had the Building Society done this they would probably have discharged their duty to the guarantor.

Cases cited
  • Watts -v- Shuttleworth (1860) 5 H and N 235
  • China and South Sea Bank -v- Tan [1990] 1 A.C. 536
  • The Mutual Loan Fund Association -v- Sudlow (1858) 5 C.B. (N.S.) 449
  • Wulff -v- Jay (1872) Q.B. 756
  • Taylor -v- Bank of New South Wales (1886) 11 App. Cas. 596
  • Pearl -v- Deacon 24 Beav. 186, 1 De G and J 461

Mr Jonathan Bridge
Civil Litigation Department
Commercial Law Department