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Focus: Who gets what's left?

25 March 2011

In brief: A recent case in the NSW Court of Appeal gives some important clarification on aspects of a mortgagee's obligation following the exercise of a power of sale. Partner John Gallimore (view CV) and Lawyer Jacinta Dyer report on how the court dealt with the issue of contested surplus funds.

How does it affect you?

  • The case clarifies the operation of various statutes in relation to the distribution of sale proceeds to subsequent unregistered mortgagees.
  • It also confirms that these statutes are supplemented by equitable principles.

Background

In this case – Residential Housing Corporation v Esber & Ors [2011] NSWCA 25 – the respondents (the Esbers) were involved in a real estate development. To fund this venture, a first and second mortgage were placed over two home units they owned. A third unregistered mortgage was later also applied to their property. Following default under the mortgages, the first registered mortgagee of the property exercised its power of sale and applied the sale proceeds to repay the amount owed to it by the mortgagors. It paid the surplus proceeds to the second registered mortgagee. After the second registered mortgagee repaid the secured amount owed to it, it paid the remaining proceeds to the party that claimed to be a third unregistered mortgagee. That party subsequently became insolvent and it was later found that the alleged third unregistered mortgage did not in fact secure any debt.

The mortgagors claimed the money that had been paid to the purported third mortgagee. In the first instance proceedings, the Esbers won the right to the surplus funds.

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The court's decision

The NSW Court of Appeal made the following rulings:

  • section 58(3) of the Real Property Act 1990 (NSW) (the RPA) (requiring mortgagees receiving sale proceeds to account to subsequent mortgagees) applied to both the first and second mortgagees (even though the second mortgagee in this case did not exercise its power of sale, but simply received proceeds from the first mortgagee);
  • the section only applied to registered mortgages (ie it did not require any excess to be paid to an unregistered mortgagee);
  • corresponding provisions in most other jurisdictions1 also only apply to registered mortgages;
  • by contrast, s77 of the Property Law Act 1974 (Qld), the Queensland equivalent of s58(3) of the RPA, does apply to land under both Torrens title and non-Torrens title, and to registered and unregistered mortgages;2
  • section 58(3) requires a mortgagee whose own debt has been paid out, to pay the surplus to the registered mortgagee next in line. If a prior-ranking mortgagee is in real doubt about how much to pay to whom, and it is not possible for an agreement to be reached between the mortgagor and all mortgagees, then the surplus should be paid into the court;
  • section 58(3) interacts with equitable principles – such that equity can intervene in the operation of the section, to prevent the statute from being used in an inequitable way. In this instance, there was no need for equity to intervene in the operation of s58(3);
  • the second mortgagee owed a fiduciary duty to both the respondent and the third mortgagee, to inform and pay each of them the amounts to which they were respectively entitled. Because the third mortgagee was owed nothing under its equitable mortgage, the appellant breached its duty to the mortgagor when it paid the remaining proceeds to the third mortgagee; and
  • the mortgagors were entitled to equitable compensation for this breach.

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Conclusion

The decision is a useful reminder of mortgagees' obligations in respect of any excess proceeds following the exercise of a power of sale.

Despite there being no statutory obligation (except in Queensland) to pay surplus sale proceeds to subsequent unregistered mortgagees, prior-ranking mortgagees still owe an equitable duty to all subsequent interest holders to inform them of and pay them the amounts to which they are entitled.

If a mortgagee has doubt about how much, or to whom they should be making payment, the safest course of action is to pay this money into court.

Footnotes
  1. Section 135, Real Property Act 1886 (SA); s77(3), Transfer of Land Act 1958 (Vic); s109, Transfer of Land Act 1893 (WA).
  2. Section 140(2)(e) of the Personal Property Securities Act 2009 (Cth) will also require a security holder to account to subsequent security holders in order of priority for any excess it holds, whether or not the subsequent security holders have a registered/perfected security interest.

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