Nature
Where a mortgagee obtains possession of a property by surrender, peaceable possession (where possible) or a court order, it will become a mortgagee in possession. This carries certain duties and rights.
In the case of a mortgage or debenture by a company, the bank as mortgagee in possession or a receiver may be able to carry on the company’s business if the mortgage included a fixed and a floating charge over all or enough of the business assets A mortgage by an individual will, for certain legal reasons, only cover land, buildings and fixtures. Therefore, it is not generally possible for a mortgage by an individual to allow the mortgagee in possession to conduct a business.
Powers
A mortgagee in possession may sell the property. Provided (as would be usual), that there is a power of sale in the mortgage or the statutory power of sale in the Law of Property Act applies, the property can be sold without a court order. Alternatively, the property may be let or continue to be let, in order to generate an income.
The mortgagee can exercise the powers itself or it may be entitled to appoint a receiver to exercise the powers on its behalf. See our separate note of Receivers. Receivers carry certain advantages.
Where there is a lease or tenancy in existence which binds the bank (because, for example, the bank consented to it or it predated the mortgage), possession is taken by taking possession of the rents. This is done by giving notice to the tenant requesting payment of the rent directly to the mortgagee.
After the bank as mortgagee has taken possession, the borrower / mortgagor has no right to collect rent from the tenant. If the tenant pays the rent in error to the borrower after notice has been given, the mortgagee may still recover it from the tenant.
Tenancies
Most residential investment property loans allow the borrower to grant tenancies or leases. Sometimes the loan offer will state this specifically. Sometimes it may be implied. There may a consent clause in the loan offer which has not been operated in practice. In these situations, the bank may be bound by the lease or tenancy by waiving its right to consent.
See our separate chapters in relation to residential and commercial property management. These are the most common type of short term tenancy of residential property. There may be a fixed term lease, in which case, the bank is bound to wait until after it expires before it can obtain vacant possession. There may be a rolling tenancy from period to period. It is generally possible to terminate a rolling tenancy in order to sell the property. At least two months’ notice is usually required.
The bank may choose to sell a property under its power of sale with the tenant in place. This may be the most appropriate means of realising the security. The bank has some general obligations in relation to how it exercises its power of sale. Unless there was some good reason to the contrary, a sale with a tenant in place will be permissible.
If the tenancy does not bind the bank (because for example, it was made without consent) the bank is not entitled to demand rent as such. However, the bank may create a new tenancy by requesting and accepting rent. Alternatively, the bank may take action for possession of the property. Obtaining peaceable possession, other than by the tenant’s voluntary surrender, is not usually possible. A court order is usually required. There is a special short summary court procedure for obtaining possession in these circumstances.
A mortgagee in possession of land may accept surrenders of leases and grant new leases under certain conditions set out in the Law of Property Act. The powers may be delegated to a receiver in the mortgage deed.
Furniture and Movables
When a tenancy or lease of furnished property is in being, the mortgagee under a mortgage by an individual will have no claim to the movables and furniture. Strictly speaking, it is necessary to apportion the rent between the buildings, land and fixtures on the one hand and movable items / contents on the other hand. Contents and movables will be included in the letting, even though they belong to the borrower.
If furniture or other effects are left in the property, a mortgagee in possession may obtain an order for their removal. Potentially, the borrower could be in breach of court order and be liable for contempt of court if he fails to remove them. Alternatively, if a judgment for the debt is executed, the sheriff may enforce against the goods.
Movables on a premises may be an impediment. A mortgagee in possession is generally entitled to remove an impediment. It may be entitled to the cost of removal. The mortgagee is generally allowed to store movables and to add the storage costs and expenses to the debt provided they are justifiable. Alternatively, the mortgage itself may specify what is to happen.
Application of Proceeds
A mortgage or is obliged to apply the receipts from the property, such as rents and profits as follows
- paying outgoings,
- paying interest on prior mortgages,
- paying costs and expenses;
- paying interest on the mortgage,
- and paying any surplus in discharge of the principal.
A mortgagee who takes possession is not allowed to take any advantage beyond securing payment of the mortgage. It must use reasonable diligence to use the property in order to realise the money due, having regard to the fact that the property may ultimately be restored to the mortgagor, if there is a surplus.
A mortgagee must “account” for rent and profit actually received and also rents and profits which would have been received, but for its willful default. The mortgagee must therefore take reasonable care to maximise the return from the property. This duty is often reduced by the terms of the mortgage.
The person to whom the mortgagee most account for any surplus (if any) depends on who is interested in the property after the mortgagee. There may be a second mortgage. If there is none, the person to whom account is made, is the borrower / owner.
A mortgagee in possession cannot charge a commission, but can recover for necessary outlay and expenses. A mortgagee in possession is generally entitled to claim the cost of rent collection and agents’ expenses. If the mortgagee in possession manages the property through an agent or employees, it may generally charge for their salaries. The mortgagee is not generally allowed anything for the its own internal costs in collecting rents although the mortgage may provide that a commission is payable.
Duties of Mortgagee
If the mortgagee itself takes possession and uses the property, it would be obliged to pay rent for occupation. This is not the case if the occupation is for the purpose of a sale within a reasonable time.
If a property is vacant and it is appropriate, the mortgagee should attempt to let it at a proper rent. However, there is no duty to do so, if this would impede the sale or if the tenant might obtain statutory rights.
A mortgagee will only be liable in respect of rent he would have received, if the failure to receive it is due to his serious default, mismanagement or fraud. This could arise by removal of a satisfactory tenant, by letting at undervalue or by making improper use of the property.
A mortgagee in possession must take reasonable care not to damage or neglect the property. It must take reasonable steps to protect the property such as securing it against vandals. The mortgagee should insure the property. The mortgagee is entitled to add the reasonable and proper expenses incurred in preserving the property from damage. The principle of salvage gives priority in respect of certain necessary expenditure, even where that priority would not otherwise be available.
Where the mortgagee takes possession of a leasehold property, it becomes liable on the covenants in the lease. The mortgagor will be allowed expenditure in preserving the security such as, for example, arrears of rent and expenditure to prevent forfeiture of a leasehold property.
The mortgagee may be allowed compensation paid to an outgoing tenant to obtain vacant possession. The mortgagee should inform the borrower and lower ranking mortgagees of the necessity to incur extraordinary expenses. This may be most relevant where buildings are incomplete or have become unsafe.
Other Liabilities of Mortgagee in Possession
There is potentially onerous legislation in the UK in relation to liability to clean up contaminated land. See our development and construction guide on our website. A mortgagee in possession may fall within the category of persons who may be made liable for clean up obligations, under certain circumstances. Even where a receiver is appointed, this may not be enough to avoid the legislation.
In some circumstances a mortgagee in possession may be in rateable occupation of the property and the liable for business rates.
A mortgagee in possession usually has control of the property and is therefore liable for accidents that occur. A mortgagee should therefore obtain appropriate liability and buildings insurance.
Repair
A mortgagee in possession must take reasonable care of the property. It may carry out reasonable repairs, but generally need not do so. It is not judged by the standards which an owner would be judged by. It need not increase its debt by laying out large sums beyond the immediate requirements. It need not rebuild ruinous premises.
The cost of reasonable repairs will be allowed in the accounts as to entitlement. It will not be held responsible for deterioration of the property by ordinary lapse of time, unless it is proper for such deterioration to be remedied. However, it need not increase the debt substantially by undertaking significant improvement. It need not rebuild a ruinous building law
Generally, there will be powers in the mortgage which will be assistance to the mortgagee. There will generally be a power to undertake repairs, if the mortgagor does not do so and recover the cost for the mortgagor.
Improvements
A mortgagee in possession may make reasonable improvements to the property. The improvements should not be of a value, nature and extent which makes it impossible or difficult for the borrower to redeem the mortgage debt. This is part of the equitable principle that a mortgagor who redeems must pay all that is equitably due. The mortgagee may also carry out works as are necessary to prevent a forfeiture of the title. The works must be reasonable having regard to the nature of the security.
A mortgagee will not lose his right to claim for improvements by not notifying the mortgagor or lower ranking mortgagees, provided the works are reasonable and beneficial. Where the mortgagor consents, it does not follow that the mortgagee will recover the cost of unreasonable expenditure.
The mortgagee will have a stronger claim to repayment, if it can be shown that the improvement added to the sale price to the extent of expenditure or more. In appropriate circumstances where there are buildings which are incomplete, the mortgagee may complete them or even pull them down and rebuild them. The rebuild or improvement must add to the substantially to the value.
The Law of Property Act sets out the mandatory order of entitlement to payment of the proceeds of sale when the statutory power is exercised. Included are payments of all costs, charges and expenses properly incurred by him as incident to the sale or attempted sale or otherwise. Some improvement expenditure may be capable of qualifying under this heading, depending on the circumstances.
A mortgagee in possession needs to take great care in undertaking improvement works. Issues may arise as to whether the expenditure will be allowed under the default rules as against the lower ranking mortgagees and the mortgagor. Particular problems arise in applying the rules where there are known later charges, which limit the priority of the earlier mortgagee in respect of extent of its secured debt. The better course is to agree the improvement works with lower ranking mortgagees and / or the mortgagor who rank lower in entitlement to the proceeds of sale.
Salvage
There is a separate principle of salvage. Salvage is an exception to the normal rules as to priority. Salvage involves action taken by one interested party for the benefit of all other interested parties. An example would be where a mortgagee pays rent arrears in order to avoid forfeiture of the lease under which the property is held. The payment is likely to have priority, even when paid by a lower ranking mortgagee. This is because it is made to save and secure the position of all mortgagees. This is an exception to the normal rules.
Generally, the principle is only applicable to removing legal risks. There must be an absolute necessity. It is possible the courts may apply the same broad equitable principles to necessary physical works.
