Mortgagee Sale: the Lender's Duty on Price

A mortgage gives the lender a power to sell the property if the borrower defaults, set out in the mortgage document and in each market's property law. The sequence is similar everywhere: a default, a notice, the notice period expiring, possession of the property where the sale needs it, the sale, the application of the proceeds to costs and debt, and an account to the borrower of what was received and paid.

The notice rules differ. In New Zealand, a lender selling mortgaged land must first serve a notice under the Property Law Act giving at least 20 working days to remedy the default. In Australia the notice is set by each state's land law. For small business loans covered by the industry's Banking Code of Practice, the bank must also give at least 30 days' notice of a missed payment before demanding full repayment or enforcing, and at least 30 days to remedy most other defaults that can be remedied, unless one of the Code's exceptions applies. In England and Wales the statutory power of sale is commonly varied by the terms of a commercial mortgage, and many commercial lenders appoint a receiver to sell instead of selling themselves.

In New Zealand the Property Law Act requires a mortgagee selling under its power to take reasonable care to obtain the best price reasonably obtainable as at the time of sale. The duty is owed to the mortgagor and, among others, to any guarantor and any later mortgagee, and the courts add an equitable duty to act in good faith and for a proper purpose. In England and Wales the Court of Appeal held in 1971 that a mortgagee who decides to sell must take reasonable precautions to obtain the true market value at the time it chooses to sell. In Australia the duty varies by state: the general law asks a mortgagee for good faith, and some states' land law adds a duty of reasonable care over the price. Where the mortgagor is a company, the Corporations Act also requires a controller, a term that includes a mortgagee in possession or control of the property to enforce its security, to take all reasonable care to sell for not less than market value.

In all three the duty concerns the process, not the outcome. A price below a valuation does not by itself prove a breach. What a court looks at is what the lender did: whether it obtained an independent valuation, marketed the property for a period and through channels suited to it, chose a sensible method of sale and set any reserve by reference to the valuation. The timing is the lender's. It may sell into a soft market rather than wait, because the duty is to get the best price at the time it sells, not to pick the best time.

A panel-beating business, constructed for this page like every figure in it, owns its workshop and has stopped trading. Its bank is owed US$1.85m on a loan secured by a first mortgage over the workshop, and the owner has guaranteed the debt. The notice period expires unremedied. The bank's independent valuation, taken for the sale, gives a market value of US$2.05m and a forced-sale value of US$1.75m. The workshop goes to auction after a five-week campaign, is passed in at US$1.80m, and sells two weeks later by negotiation for US$1.92m. Figures are in US$m and belong to the example.

The owner, now facing a US$130,000 claim under the guarantee, says the workshop was worth US$2.05m and the bank sold US$130,000 short of it. The bank's answer is its file: the valuation, the campaign, the auction, the post-auction offers and the reason it accepted US$1.92m rather than relisting. The price sits between the forced-sale and market figures, which is where a vacant, as-is sale on a lender's timetable is likely to land. Whether that was the best price reasonably obtainable at the time is a question about the process, and the file is what answers it.

The nearest neighbour is a sale by a receiver the lender appoints. A mortgagee sells as principal, in its own right. A receiver usually acts as the borrower's agent and can do more than sell: collect rent, finish works, run a business. Commercial lenders often prefer a receiver for property that needs managing before it is sold, and in England and Wales a receiver appointed under the mortgage is a common route for commercial property. The duty on price follows the seller: a receivership brings its own statutory duty in New Zealand and Australia, and in England and Wales the courts apply a mortgagee's duty on price to a receiver who sells.

It also differs from the values a lender works with before default. A forced-sale or liquidation value is an estimate of what a sale like this might fetch. The mortgagee sale is the event itself, and its price is tested against what the lender did, not against the estimate.

DEFINED IN ONE PARAGRAPH → · WHAT YOUR BANK HOLDS AS SECURITY → · SHORTFALL DEBT →

The mortgagee sale is the event every property-secured loan is priced against. At approval, the lender's lending value and loan-to-security ratio assume that one day the property may be sold this way, vacant and on the lender's timetable, which is why they use more cautious figures than the owner's view of the property.

At default, the decision is timing. Every month of waiting adds interest, rates and insurance to the debt, while a falling market can take more off the price. Many lenders first give the owner a period to sell the property themselves, because a sale with the owner's cooperation usually costs less and fetches more. At the end, the account and any shortfall go to the borrower and guarantors, and a well-kept sale file is what settles the argument that follows.