Innovative advice for lendersPrint publication
Walker Morris’ Banking Litigation Team increasingly advises on the ever-present threat to lenders of forfeiture/loss of leasehold security. The Team also increasingly handles cases involving breaches of mortgage conditions other than mortgage arrears, as a ground for recovering possession. These two seemingly quite separate trends have, together, resulted in some exciting new options for lenders.
Diversity in Low Cost Home Ownership (or, Immediate Market) options , coupled with economic pressures facing borrowers of all ages and across all socio-economic groups today, is resulting in mortgages increasingly being offered on leasehold flats, retirement housing, shared-ownership arrangements and so on.
In addition, while leasehold has traditionally been the appropriate form of land ownership for properties within communal buildings and estates, a recent trend has emerged over for housebuilders to sell new-build houses as leasehold properties.
Earlier this year the BBC announced that: “Almost half of all newly built properties in the UK are sold as leasehold rather than freehold properties. Some homeowners have found they are then tied into paying a ground rent that increases every year.” The reason for this is commercially motivated. Housebuilders sell the leasehold title to the house owner and then make a further financial return by selling the freehold title to a third party – often a profit-making entity owning a number of such properties. One MP has described this practice as the “PPI of the property sector”.
All of this means that lenders are increasingly finding themselves having to grapple with issues affecting their leasehold securities. These difficulties apply to both shared ownership and conventional long leasehold properties. Where a tenant defaults on paying monies due under the lease (such as service charges and ground rent), the first a lender hears about this is often when the landlord takes steps to forfeit the lease.
Faced with a threat of forfeiture lenders can be on the ‘back foot’ and are frequently left in the position of paying such charges (including substantial legal fees to the landlord’s lawyers), so as to ensure that the lease, and therefore the lender’s security, is not lost. This can be before proceedings are issued, or as a condition of applying for relief against forfeiture. The lender then generally debits such payments to the mortgage account in accordance with its Mortgage Terms and Conditions.
However, this approach creates multiple risks for the lender:
- Customers may decide to rely upon the lender to repeatedly pay the landlord on their behalf, instead of making those payments themselves;
- Equity can be eroded; and
- Lenders can ‘sleep walk’ into a negative equity situation, as a result of multiple debits to the mortgage account.
- A landlord of a shared ownership lease (most likely a Housing Association) may refuse to accept continued payments from a lender and may bring its own possession proceedings to recover possession (for fear of erosion of equity and of being out-of-pocket if the lender takes possession and relies on the Mortgagee Protection Clause in the lease allowing it to staircase up to 100%). A vitally important point to note here is that such action by a Housing Association will ultimately result in loss of the security. This is because these possession proceedings are for statutory termination of an assured tenancy under the Housing Act 1988 and a lender does not therefore have a right to apply for relief from forfeiture.
- Ongoing payment by the lender of customer’s lease sums can also mask wider affordability issues. It will often result in the mortgage debt increasing and the customer’s financial situation worsening overall. This raises the question whether the lender is acting responsibly and treating the customer fairly.
Financial Ombudsman Service (FOS) complaints
Another key issue for lenders is that payment of customers’ outstanding lease sums can (albeit somewhat paradoxically) lead to serious customer relationship issues. Through our own research we have discovered that, in the last three years, numerous customer complaints have been upheld by the Financial Ombudsman Service following the payment by lenders of ground rent and service charges on behalf of their customers. For example:
- In several cases lenders have made payments prematurely, often where the landlord has made demands but has not obtained a debt judgment or tribunal determination regarding the lease arrears. In such cases, the situation had not reached the stage in the forfeiture process where the security was at any material risk of forfeiture and so, according to FOS, the lender should not have made payment to the landlord.
- In several cases the security has been at risk and the lender has legitimately made payment in respect of some arrears, but the lender has not checked properly and has paid additional sums, which it was not obliged to do. (That can lead to additional charges to the mortgage account and/or it can prejudice the customer’s position in any outstanding disputes with the landlord regarding sums allegedly owing.)
- In other cases the lender has legitimately made a payment to protect its security, but has then continued paying subsequent demands without fully investigating their validity.
- In at least one case the lender’s involvement in the payment of lease sums resulted in an administrative error (the lender’s incorrect recording of the customer’s change of address) which meant that the customer did not receive payment demands. The customer’s arrears situation therefore worsened significantly as a result of the lender’s involvement.
- In another case an administrative error meant that a lender made payment of a customer’s lease arrears in reliance on a court order which, in actual fact, the lender knew had been set aside.
- The FOS has also upheld complaints arising from customers’ prolonged difficulties in actually dealing and corresponding with the lender, due to communication errors and poor complaints handling.
- In many other cases lenders have avoided complaints being upheld by the FOS by pre-emptively offering compensation to customers whose positions have been prejudiced as a result of the lenders’ payments to landlords.
In any event, whenever a complaint is made – and whatever the outcome – significant management time and costs are wasted, and customer relationships and lenders’ reputations are adversely affected.
Draft Pre-Action Protocol
Currently, in many cases a lender’s options when faced with a potential lease forfeiture will depend on the approach taken by the particular landlord.
- Some landlords (and their legal advisors) are aware of a lender’s need to contact its customer (to verify whether the customer is aware of the situation; whether the customer contests the lease sums claimed; and whether the customer consents to the lender intervening to make any payment to preserve security in the immediate term); and to take legal advice on the options open to it. Such landlords/legal advisors may take into account the timescales involved in the lender doing this; others do not and instead use this delay to increase the level of legal costs claimed to resolve matters.
- Some law firms acting for landlords are fully aware of the propensity for lenders to pay up to protect their security and they use this as a viable business model. They operate by incurring unnecessary and unreasonable legal costs and make payment of those costs a condition of agreeing settlement to avoid forfeiture. It is not uncommon for legal costs of several £thousand to be claimed in recovery of a few hundred pounds. In one well publicised (but extreme) case the 74 year old owner of a flat worth £800,000 in Chelsea Harbour was threatened with forfeiture for landlord’s legal costs of £76,000 incurred in relation to a service charge demand of just £7,500.
- Some landlords/legal advisors also do not contact lenders until after proceedings have been issued (it is only at this stage that landlords have to make contact, due to the requirements of the CPR).
In the interests of seeking to resolve matters to the benefit of all parties without the need to progress to litigation, and in accordance with the spirit of the Civil Procedure Rules’ Practice Direction on Pre-Action Conduct generally, Walker Morris has (working in conjunction with one of our key clients and the CML) drafted a proposed new Pre-Action Protocol – the draft Pre-Action Protocol for Claims based on Forfeiture of Long Residential Leases – which seeks to address this issue.
We are currently seeking comments from the CML Legal Advisory Panel prior to referring the draft to the Ministry of Justice and the Civil Procedure Rules Committee. It aims to prevent landlords from issuing lease forfeiture claims before lenders have received appropriate notification and have had sufficient time to contact and consult with their customer and respond with any proposals to resolve matters.
It is to be hoped that, if and when the draft Protocol is finalised and incorporated into the Civil Procedure Rules, the number of cases in which lenders’ leasehold security are lost can be reduced, along with the amount of costs added to mortgage accounts to resolve these cases.
However, there will also be an alternative option for lenders, which might preclude action by landlords in any event. This involves lenders pursuing possession themselves, but on the basis of breach of mortgage conditions, as opposed to on the basis of mortgage arrears.
The usual course…
We have seen that, in the majority of cases, the mortgage lender receives a payment demand from the landlord and the lender then makes payment so that its security is not left vulnerable to forfeiture or possession. The lender then adds any such payments to the mortgage debt.
In due course the mortgage account might fall into arrears as the customer’s repeated failure to pay sums due under the lease masks wider affordability issues. The lender will then pursue possession proceedings on the basis of mortgage arrears.
A suspended order is very often likely to be made because reliance on mortgage arrears engages the court’s discretion under section 36 of the Administration of Justice Act 1970 to adjourn proceedings; stay or suspend execution; or postpone the date for possession, where the court considers that the customer is likely to be able within a reasonable period of time to pay any sums due under the mortgage.
…an alternative approach: Ousting the court’s discretion?
However, in many cases where a lender has been asked to make payments under a lease where forfeiture is threatened (or where a shared ownership Housing Association is threatening to commence possession proceedings), lenders may be better served by following an alternative course. This involves lenders seeking possession on the basis of breach of mortgage condition (the breach being the customer’s failure to comply with the terms of its lease), rather than/or in conjunction with, action on the basis of mortgage arrears.
It is likely that, on the facts of many of these cases, a lender should be able to prove that its security is at risk and that it should thereby be entitled to an outright possession order. In addition, if a borrower cannot put forward reasonable proposals to remedy the breach of mortgage condition, then the section 36 discretion to suspend a possession order will be excluded in any event.
Intervention in practice: Sharing our success
Walker Morris’ Banking Litigation team already acts for a number of retail lenders who have adopted an enforcement policy which involves seeking possession of leasehold properties on the basis of repeated breach of mortgage conditions where the customer fails to meet their leasehold obligations.
These lenders have taken this ‘alternative approach’ in over 150 cases in which the security was at risk due to lease non-compliance. In 48% of those cases lease arrears were cleared by the customer. That not only resolved the immediate security risk, but also ensured that the customer fully understood, and took responsibility for, their liability to make lease sum payments going forwards.
The remaining cases were resolved through via the threat and/or issue of mortgage possession proceedings and the vast majority of those – some 89.4% – resulted in an outright possession order for the lender. (In the 10.6% of cases which resulted in a suspended possession order, the lender had actually paid the lease arrears and added those sums to the mortgage debt, such that the security was no longer at risk.)
As well as the high rate of outright possession orders, this approach by lenders has been a “wake up call” for customers resulting in them properly addressing lease and mortgage compliance, and affordability issues generally, where they may previously have been unwilling to do so. As well as resolving the security risk for the lenders, this has enabled customers to continue living in their homes.
If you would like to find out more about Walker Morris’ draft pre-action protocol and/or alternative approach to resolving lease forfeiture/loss of security issues, please do not hesitate to contact a member of the team who will be very happy to help.