Real Property Secured Loans — Strategising For Priority

Hairani Saban looks at prioritisation in secured lending where real property is offered as security.

Framework for Discussion

This article briefly reviews the laws, common practices and current strategies regulating and influencing the patterns and schemes of secured lending where real property is offered as security. Loss of priority of some of these secured loans have been attributable in some instances to non-compliance issues, lack of adequate investigations of title and encumbrances or even to unanticipated or unforeseeable intervening events as well as poor strategising. There are certainly well-trodden paths taken by experienced lenders and their solicitors. There are also new tracks to be explored. The hypothesis here is that these strategies would provide enhanced protection for lenders if the prevailing ethics of the lending/borrowing community are also supportive — these should commit all the players, the lenders, the mortgagors and the solicitors, to some fiduciary duties. The caveat emptor philosophy is hence questioned in its jurisprudential aspects and application to these loan dealings and a more transparent regime involving borrower’s disclosure statement advocated as a macro strategy and pre-emptive measure to check if not minimise priority upsets.

Whilst the focus of this article will be on the legal devices for preserving priority of security obtained over real property, these strategies are examined in the context of the underlying reality that priority, in its substantive aspects, is also a proxy for the validation of security claims.

Perfecting the Loan Security — An Overview of the Validation Process

The validation process for securing loans by the three-step implementation of documentation, registration and preservation of the security is unquestionably a dynamic process. This overview of the legal devices is intended to signpost the possibilities for optimisation of the protection available to lenders in secured loan transactions. Maximum protection may not always be possible nor desirable. On this note, the writer examines some relevant aspects and application problems of the prevailing laws and practices supporting such lending schemes.

Basic documentation

Generally, legal as well as equitable interests in real property are acceptable securities to lenders. Equitable interests may be registrable or non-registrable as the case may be; until registration, they remain unsecured against the real property to which they are intended to attach.

Equitable interests acquired over real property as security are essentially dealt with by Deeds of Assignment, Mortgages in Escrow and other such contractual documents.

Priority may in some cases be conferred by statutes but are sometimes re-arranged or settled by Deeds of Arrangement, Deeds of Postponement and Subordination Agreements.

The Land Register and the Caveat Index

Registration at the Singapore Land Registry not only validates but also establishes priority of security interests over real property (see section 48 of the Land Titles Act (Cap 157) and sections 115–117 of the Registration of Deeds Act).

Non-registrable security interests are protected by way of caveat entries.1 However, it was clarified in a recent case that a caveat lodgment is not a mechanism for the creation of a charge over real property (Asiatic Enterprises (Pte) Ltd v United Overseas Bank Ltd CA 76/99). It serves as an injunctive entry and preserves priority of claims over real property.

The importance of caveat lodgment to establish and preserve priority of equitable interests cannot be over-emphasised.2 Statutory provisions facilitating extensions of caveats have alleviated the problems encountered in the past when this facility was unavailable and there was no continuity in the protection initially accorded to these interests on the expiry of the 5-year lifetime of the caveat.3

Registration procedures under section 131 of the Companies Act (Cap 50) — Practice dilemma

The Companies Act provides for registration of charges by incorporated companies, non-registration of which would render any security claimed to be void as against the liquidator and any creditor of the company (section 131(1)).

In particular, the prevailing practice concerning registration of equitable mortgages of real property under section 131 of the Companies Act has been the cause of continuing concern among solicitors. One query which solicitors have been asking is this: at the stage when an equitable mortgage is perfected as a legal mortgage, is there a requirement for another set of Forms 33 and 34 (prescribed under the Companies Regulations (Cap 50 Rg 1, 1990 Ed)) to be submitted at the Registry of Companies? In this regard, banks are calling for maximum protection by requiring solicitors to notify the Registry of Companies of the legal mortgage once it is perfected by registration at the Land Registry. The banks have taken the view that their security may be at risk. It is submitted that there is perhaps undue anxiety here as the validity of the security has been established by the registration of the equitable mortgage, which in time will be rendered legal by the subsequent registration of the instrument of mortgage (earlier executed in escrow) at the Land Registry. Notification of the loan and all relevant security documents remain on the register of the Registry of Companies until notice of the loan redemption is filed. A double entry over the same loan security may cause confusion unless the subsequent notification is properly and clearly identified to refer to the same loan earlier endorsed and is so stated in the public records. Until the Registry of Company intervenes with some solution, solicitors will, in the mean time, have to cope with the dilemma.

Loss of Priority — The Minefields

Even when all legal compliance requirements for a secured loan have been observed and performed, risks faced by lenders are still not over. Loss of priority to the property secured is a real problem and can come about in any one of these exigencies:

In such a legal minefield, just how effective is the deployment of pre-loan and post-loan covenants and conditions contained in the package of loan documentation at minimising the risk of loss of priority for lenders relying on real property as security? What are the limitations and problems attendant on the legal strategies adopted by these lenders? Some available options and their relative efficacies are discussed below.

Tacking within the Statutory Protection

The rights and remedies of the mortgagee are generally dealt with under the relevant provisions of the Conveyancing and Law of Property Act (Cap 61) (see Part IV) and the Land Titles Act (section 69). Tacking is specifically addressed in section 80 of the Land Titles Act and the corresponding provisions of section 15 of the Registration of Deeds Act (Cap 26). Section 80 of the Land Titles Act states:

  1. if the prior mortgage expressly authorizes the making of further advance, or the giving of credit in instalments or on a current, revolving or continuing account or other accommodation ; or
  2. where the prior mortgage does not expressly authorize the making of such further advances, or the giving of credit in instalments or on a current, revolving or continuing account or other accommodation, if the subsequent mortgagee agrees to such further advances being made or credit or other accommodation being given.

In these times when flexible loan arrangements are preferred by lenders and borrowers, the deployment of the open mortgage5 is commonplace. Subsequent disbursements of loans by lenders can be prioritised provided the statutory requirements are properly observed. To this extent the problems pertaining to loss of priority which were previously encountered by lenders under common law tacking (refer to Hopkinson v Rolt (1861) 9 HLC 514) are now addressed by statute. Essentially, parties should take such steps to contractually provide for tacking of subsequent advances.

The mortgage document will typically provide for tacking as follows:

This Mortgage expressly authorises the Bank to make further advances or give credit in instalments or on a current, revolving or continuing account or otherwise or any other credit or banking facilities or accommodation whatsoever from time to time to the Mortgagor whether solely or jointly with any other person or persons in partnership or otherwise or the Third Party and all moneys and liabilities owing to the Bank from time to time in connection therewith shall be secured by this Mortgage in addition to the moneys and liabilities already outstanding or incurred as at the date hereof.

With the streamlining of the provisions on tacking under the Conveyancing and Law of Property Act and the Land Titles Act, tacking of further advances by banks should not pose any risk of loss of priority once the statutory preconditions for the disbursement of the subsequent loans are observed and steps are taken in the loan documentation to implement these requirements. However, subsequent actions by the bank or the borrower may affect the priority of loans quite apart from problems related to tacking. For this reason, protective reinforcements are usually achieved by the imposition of restrictions, covenants and conditions. The usual consideration here is not to hinder mortgagors from dealing with the property under mortgage but essentially to preserve property and the lender’s priority. Some of the more familiar devices adopted by the banks and financial institutions are highlighted below.

Negative Pledges and Restrictions as Contractual Options 6

Negative pledges

Negative pledges adopted in mortgage documents securing real property are usually in the nature of covenants or undertakings by the mortgagor not to create any or subsequent charges over the mortgaged property. These may be absolute or partial in tenor, the latter allowing for the creation of subsequent charges if written consent is obtained.

Traditionally, negative pledges were deployed to maintain equality or pari passu status of the security given, so that the security taker is not placed at a disadvantage should the security giver subsequently decide to deal with the security.

Typically, such covenants or undertaking which are deployed in mortgages of real property have somewhat been modified from the prototype negative pledges and may take this form:

That the Mortgagor shall not without the written consent of the Bank assign mortgage or otherwise dispose of any estate right title or interest in the Mortgaged Property or agree or purport to do the same or raise money on the security of the Mortgagor’s rights in the Mortgaged Property or deal with the same in any manner whatsoever.

Whilst such a negative pledge does not impose absolute prohibition on the mortgagor it does, however, at least place the mortgagee on alert to review the adequacy of the security given and perhaps to take such action as may be necessary to protect its interest as a secured lender.

Restrictions

The more usual way of preserving priority in secured lending is illustrated in the case of Keppel Tat Lee Bank Ltd v Teck Koon Investment Pte Ltd & Ors (supra). In that case, the loan was secured by a deed of assignment and a mortgage which was duly registered. The deed of assignment forming part of the security documentation contained, inter alia, the following covenants which were intended to give the bank added protection. These covenants given by the mortgagor were significant to the decision made by Lai Siu Chiu J:

  1. that it would not sell any unit to be built at less than such price as the plaintiffs may fix at any time at its absolute discretion;7
  2. to notify the plaintiffs immediately upon signing an agreement with any purchaser and give the plaintiffs a copy of the signed agreement and all such other information relating to the unit sold as the plaintiffs shall require;
  3. that so long as any money remained outstanding under the mortgage and assignment, Teck Koon (the first defendant) would direct the purchasers to pay all moneys due to the plaintiffs for Teck Koon’s account or Teck Koon’s Project Account (if applicable).

In the grounds of decision, Lai Siu Chiu J also relied on the provisions of section 48 of the Land Titles Act which clearly states:

  1. Except as provided in section 27(6), interest appearing in the land-register shall have priority according to the order of their registration or notification, irrespective of the dates of the instruments by which these interests were created or are cvidenced except that where an instrument was materially amended for compliance with the requirements of the Registrar, the priority of that instrument shall be determined by reference to the date of its rectification and acceptance as being in order for registration in the Land Titles Registry.
  2. Subject to section 11, interests notified on the folio may include mortgages, charges (including statutory charges) and leases registered in the Registry of Deeds.

In Keppel Tat Lee, it was held that the mortgagee bank had at the time of the claim a duly registered legal mortgage over the property which entitled them to priority over any equity or equitable interests which the second and third defendants as equitable purchasers may have in the mortgaged property. The court went further to state that the second and third defendants, claiming from the owner as the equitable purchasers of the property in question, had neither equity nor equitable interest that bind the owner. The second and third defendants’ arguments based on proprietary estoppel and estoppel by acquiescence over receipts by the bank of the purchase money from the said two defendants were dismissed. The fact that both the said defendants had not come to the court with clean hands weighed heavily against them. They were the principals for the nominal purchasers. Further, the second defendant as a solicitor was also involved in representing the sellers, purchasers, mortgagors in the transactions.

Judgement was given to the plaintiffs for delivery of vacant possession of plot 1 (the mortgaged property). The second and third defendants’ counterclaimed that they be allowed to redeem the mortgaged property by settling the balance of the purchase money into the outstanding account of the seller-mortgagor failed. The said defendants have appealed to the Court of Appeal vide CA 38/2000.

Covenants and restrictions aside, lenders would sometimes have to consider arrangements which would leave the borrowers’ assets free from undue shackles, so as to allow them to carry on with the daily task of managing their businesses. Hence, charges over real property are sometimes created. In the case examined below, floating charges are created over real property. In these circumstances, problems of crystallisation and attachment are dicey and lenders are essentially unsecured until subsequent attachment of the property is effected.

Floating Charge over Real Property?

In Asiatic Enterprises (Pte) Ltd v United Overseas Bank Ltd (supra), the relevant clause in the standard terms of the agreement governing the credit facilities extended by the bank to the company provided for the crystallisation of the floating charge over real property on the contingency of a default in the loan payment. The relevant clause provided as follows:

  1. The Bank shall cease to be under any further commitment to you and all outstandings under the entire credit line (“the Outstandings”) shall become due and payable immediately;
  2. the Bank shall, in addition to the rights set out herein, be entitled (as equitable chargee) to attach the Outstandings to any property of yours (whether real or personal) and to lodge a caveat against any real property that may now or hereafter be registered in your name whether singly or jointly …

These issues were, inter alia, raised: whether the credit facilities granted were secured and, if so, at what stage of the transaction?

In brief, the Court of Appeal was of the view that the charge attacheded to the property on the default of the mortgagor and on the intimation by the mortgagee to attach the property. It was observed that the mode of attachment was not specified. The court was of the opinion that the mechanism of the caveat lodgment did not of itself create the charge.

The adoption of this type of clause is not, however, without problems and should be considered8 perhaps with some hindsight wisdom as to the efficacy of such a clause securing its objective. To summarise: a floating charge over real property is, therefore, at best a quasi-security and, at worst, no security until crystallisation and attachment. The mode of establishing a valid charge is also brought into issue in the absence of any express provision dealing with the same.

Such legal problems of crystallisation and attachment may be avoided where a charge of real property is taken by deposit of title deeds. The Registration of Deeds Act (section 6) and the Land Titles Act both require notification of such a charge by which notification priority of the charge is established. However, the rights and remedies accorded to these chargees will have to be carefully weighed by the lender should this course be taken in preference over a legal mortgage. The chargee’s interest in the property remain equitable.9 This option, however, does provide a compromise situation where the lender has to factor in business or commercial concerns or expediency or when flexible financing arrangements are preferred by the borrower.

Of necessity, legal strategising will be tailored to the requirements of each lender in a given situation. It is no uncommon wisdom to state that those strategies which accord the maximum protection may not necessarily be the strategy of choice for the reason that such strategy may unduly handicap the borrower in carrying out his business in the real world.

Similarly, expectations of conveyancing solicitors and legal consultants should also be realistic; commercial decisions do not come within the scope of their work. However, certain investigative work of the type which are linked to the conveyancing solicitors’ duties of attending to title investigations, transfer and registration should be dealt with in more intelligent ways. This brings the writer to the final section of this article which deals with the borrower’s disclosure statements and the need to institutionalise this practice as part of the macro plan to preserve lender’s priority in claims involving real property.

Disclosure Statements

Conveyancing solicitors are not private investigators 

This statement that conveyancing solicitors are not private investigators was emphasised at the trial by the expert witness for the respondent in the case of Foo Maun Yee v Yoong Weng Ho Robert [1997] 2 SLR 297. It was made in the context of the solicitor’s duty to verify the authorisation given by resolution by a foreign company to represent the company in a conveyancing matter. The solicitors were held accountable for not investigating what was claimed by the solicitors to be a prima facie normal appointment for their services. The statement of the expert witness for the respondent did not go down well with the Court of Appeal, which was of the view that the duty of care owed by solicitors was a matter of law and not merely referable to the practice of solicitors.

Requisitions on Title

What then are the pro-active initiatives solicitors can take or introduce to ensure standards of professionalism in the practice? The idea of having the borrower-mortgagor commit to paper (albeit through their solicitors) information relevant to the lender has been around for some time. It is the practice today for solicitors to issue Requisitions on Title to the solicitors of the borrower-mortgagor. Unfortunately, this practice has been rendered futile in eliciting information required. Replies provided by solicitors to such requisitions have been dismally marginalised to this standard sentence: ‘Please make your own searches.’ The spirit behind this well-intentioned practice has long been lost amongst conveyancers. The situation might be different if the disclosure is made legally obligatory and full answers are to be supplied as a fiduciary duty. Perhaps only then will the practice of serving Requisitions on Title meet the objectives for which they were originally intended. Alternatively, or in addition to the investigations carried out under the Requisitions on Title, solicitors for the borrower-mortgagor could obtain a mortgagor disclosure statement.

Mortgagor’s statement

This disclosure requirement should call for compulsory participation by the mortgagor to declare and provide a statement on specific information on his title, encumbrances, statutory and other obligations pertaining to the property to be mortgaged. As an institutionalised regime, this practice will minimise the investigation burden currently placed on solicitors. Matters which will be declared by the borrower-mortgagors in a simple proforma may be formulated to solicit information on matters such as these:10

  1. latent defects of the property known to the mortgagor-borrower;
  2. outstanding outgoings;
  3. outstanding taxes/estate duties;
  4. trusts;
  5. outstanding statutory liabilities and obligations;
  6. notices received from the local authorities;
  7. prior equity and other unregistered charges affecting the property;
  8. unauthorised structures;
  9. known encroachments;
  10. charges amd other equities created before or intended to be created after the mortgage;
  11. tenancies/licences affecting the property; and
  12. involuntary conveyance made over the past five years.

To be effective, such information should constitute a contractual commitment on the part of the borrower-mortgagor.

This commitment will be a positive factor in minimising and even pre-empting third party claims and claims based on latent defects, statutory and other liens which may otherwise be hidden to those responsible for arranging the loans and documentation for the security transactions.

In concept, this disclosure requirement in conveyancing is neither new nor ground-breaking. In Australia, a Vendor Statement is a statutory requirement for sellers of property. For instance, in the State of Victoria, the Sale of Land Act 1962 (section 32) renders it a statutory obligation that sellers of property disclose in writing to the prospective purchaser restrictions, planning and road access, outgoings, statutory charges, building approvals, notices and title encumbrances.

As the cutting edge sciences of digital communication and ‘webonomics’11 impact on society, it is relevant that the concept of caveat emptor and such legal doctrines be re-assessed and re-evaluated within the new disciplines. Although transactions and dealings in property are not uberimae fide contracts, there are nonetheless rules against concealment of deeds and defects of a latent nature. There are also compelling reasons for relationships between lenders and borrowers to be viewed and treated as one of utmost good faith. The disclosure regime will therefore underscore the need in these present times to enhance the situation of transparency in such dealings and hence to shift to more positive and open practices. It is not inconceivable that a disclosure regime will of necessity and for all practical purposes be de rigueur and a basis for a legal commitment as exchanges of information grow beyond global proportions and accessibility to shared information and databases are managed within the ethics of the new economy — demanding accurate and responsible accountability. Many problems involving loss of priority of secured loans are then not likely to turn up as bad surprises when pre-emptive measures can be better planned and factored in and there are less wild cards for solicitors to uncover.  

Hairani Saban  
Hairani Saban Hardjoe  

Endnotes

1 The Singapore Land Registry maintains a Caveat Index for this purpose: section 116(a) of the Land Titles Act (Cap 157). Refer also to the definition of prior mortgagee in section 80 (3) (a) of the Land Titles Act which specifically includes, inter alia, claims made under a caveat.

2 For claims based on caveat lodgments refer to: Tan Soo Leng David v Saktu & Kumar Pte Ltd & Anor [1993] 3 SLR 569; Cathay Theatres Pte Ltd v LKM 9 Investment Holdings Pte Ltd [1989] 1 SLR 917; Mooka Pillai Ragagopal & Ors v Kushvinder Singh Chopra [1998] 1 SLR 186.

3 See United Overseas Finance Ltd v Mutu Jeras [1989] 3 MLJ 20. For extension of caveats, refer to section 122 of the Land Titles Act.

4 Lennar Northeast Partners v Buice Revocable Living Trust 49 Cal App 4th 1576. See also Avoid Loss of Priority On Real Property Secured Loans, James E Anderson 1997 (1996–1999 Gray Cary Ware & Freidenrich, LLP). Loss of priority may be total or partial. One criterion is that any modification of the loan which materially increases the risk of default of junior lienees will to that extent place at risk the senior lender’s priority.

5 This is a market term for a mortgage arrangement whereby the lender may at the mortgagor’s request extend the amount of loan from time to time and where all further advances and outstandings are secured by the mortgage initially executed by the mortgagor.

6 Other contractual options for preserving priority are, for example, those adopted by the Central Provident Fund Board (CPF Board), in their use of the Instruments of Postponement and Deed of Arrangement, where the priorities of secured loans disbursed by commercial banks are prioritised according to the CPF Board’s prevailing policies. These steps are taken notwithstanding the fact that the CPF Board is entitled by statute to a first charge of the property for which a member’s funds are utilised in the financing or re-financing of the property. Refer to section 19 of the Central Provident Fund Act (Cap 36, 1997 Ed) on the priority of claims established vis-ΰ-vis the CPF Board’s first statutory charge.

7 This is a common restriction imposed by financiers granting building construction loans. Solicitors for the purchasers of such property would do well to scrutinise the terms of the mortgage loans contained in the mortgage instrument as well as all other supplemental agreements and assignments of equitable interests, since a breach by the borrower-seller of the property would place the purchaser at risk of the seller’s mortgagee claim when there is a short payment in the redemption money in the scenario where the sale proceeds are insufficient to cover the borrower-sellers’ loan repayment.

8 Refer to the casenote in ‘No Security For the Unsecured Creditor — The Asiatic Enterprises (Pte) Ltd v United Overseas Bank Ltd’ by Victor CS Yeo, Singapore Academy of Law Journal Volume 12 March 2000 at p 218.

9 As to the rights and remedies of an equitable mortgagee, refer to the case-note by Hairani Saban on the Rimmon Watch Pte Ltd v Great Pacific Fnance [1989] 1 MLJ 265.

10 This list is merely illustrative and does set out the full disclosure requirements which are expected of the borrower-mortgagor.

11 This term is used by Evan L Schwartz in his book of the same title (Broadway Books, 1997). It means the study of the production, distribution and consumption of goods, services and ideas over the World Wide Web.