Law Report: Home to be sold despite mortgage shortfall: Palk v Mortgage Services Funding plc. Court of Appeal (Sir Donald Nicholls, Vice-Chancellor, Lord Justice Butler-Sloss and Sir Michael Kerr), 31 July 1992

The court had an unfettered discretion to order the sale of mortgaged property, notwithstanding that the lender had refused to consent to the sale and that the sale would raise too little money to discharge the borrower's outstanding mortgage debt.

The Court of Appeal allowed an appeal by Margaret Palk, one of the two borrowers, from the decision of Judge Lovegrove, sitting at Eastbourne County Court on 12 November 1991, who dismissed an application by her and her husband, Anthony Palk, under section 91(2) of the Law of Property Act 1925 for an order for sale of property mortgaged by them to the lender, Mortgage Services Funding plc.

Anthony Rimmer (Meredith Smith & Pratt, Tonbridge) for Mrs Palk; Gavin Lightman QC and Michael Kay (Lewis Silkin) for the lender.

SIR DONALD NICHOLLS V-C said Anthony Palk was a victim of the recession whose business had gone into liquidation, and who was unable to meet the repayments on an advance of pounds 300,000, obtained from the lender in January 1990, and secured by a mortgage on his and his wife's home.

In March 1991, he negotiated a sale of the house for pounds 283,000, and although he needed pounds 358,587 to redeem the mortgage, he decided to proceed with the sale, despite the shortfall, because it would at least stop interest accruing on the debt.

But the lender declined to agree to the sale and in the meantime obtained an order for possession. Instead of selling the property, the lender proposed to let it on short-term lease and sell when the market improved.

This course of action did not recommend itself to the borrowers.

For a postponement of sale to be worthwhile, housing prices would have to rise faster than the rate of interest payable under the mortgage after deducting the rent obtained from the proposed letting.

The sum due under the mortgage was increasing by about pounds 43,000 a year. Lettings were unlikely to yield more than pounds 14,000 a year. So the overall debt would continue to grow by almost pounds 30,000 a year. Moreover, the likely rental would not even match the interest the borrowers would save if the house were sold and they were credited with the net proceeds of sale.

The possession order was suspended pending the borrowers' application for an order of sale. The judge dismissed the application on the ground that an order for sale could only be made against the wishes of the mortgagee or lender if the property could be sold for an amount which would discharge the mortgage or if security was provided for that amount.

Mr Palk was now bankrupt while the amount due under the mortgage had risen to pounds 409,000. His wife appealed.

The thrust of the lender's argument was that, in exchange for the loan, it acquired a security and several remedies. It could choose which remedy it wished to pursue and when, so long as it acted in good faith. If it decided to sell, it must take reasonable care to obtain the proper market value, but it was under no duty to exercise its power of sale, and if it decided to postpone a sale indefinitely there was no occasion for the court to intervene. If the mortgagor asked the court to intervene and direct a sale against the mortgagee's wishes, the sale should be on terms that provided for repayment of the whole indebtedness.

His Lordship emphasised, however, that a mortgagee did owe some duties to a mortgagor. Although it was not obliged to take steps to realise its security, if it did take steps to exercise its rights over its security, common law and equity alike had set bounds to the extent to which it could look after itself and ignore the mortgagor's interests. The mortgagee had to act fairly towards the mortgagor. In the present case, the lender had embarked on a course of realisation which was likely to be highly prejudicial to Mrs Palk's financial position as borrower.

But the question of whether the lender was in breach of any duty to Mrs Palk was not crucial, since the court's exercise of its statutory power to direct a sale did not depend on there having first been a breach by the mortgagor.

Section 91(2) of the 1925 Act gave the court an unfettered discretion, which could be exercised at any time. In exercising that power, the court would have due regard to the interests of all concerned.

In his Lordship's view, it would be just and equitable to order a sale in this case, even though there would be a deficiency, because otherwise unfairness and injustice would follow. Four factors combined to produce this result.

(1) There was a substantial income shortfall.

(2) The only prospect of recoupment of the shortfall lay in the hope there would be a substantial rise in house prices generally. This was not a case where sale was being postponed for a reason specific to this property, such as a pending planning application.

(3) On the scanty evidence before the court, the likelihood of Mrs Palk suffering increased loss if the lender's plan proceeded was so high as to make the plan oppressive to her. Her liability was open-ended and would increase indefinitely. This risk far outweighed the prospect of any gain to the lender.

(4) Directing a sale would not deny the mortgagee the opportunity to wait and see what happened to house prices. A mortgagee could not buy from itself, but it could buy the property if a sale was directed by the court, since it was not then a sale by a mortgagee in exercise of its own power of sale.

Lord Justice Butler-Sloss agreed and Sir Michael Kerr gave a concurring judgment.