Is a Mortgagee’s 60% default interest rate just a collateral advantage? Or is it unfair and unconscionable?

Mortgagees should not only consider the content of a mortgage term, but the effect of its operation. If the effect of the mortgage terms could be seen to operate unfairly or unconscionably to a mortgagor, as discussed in the recent decision of the New South Wales Supreme Court in First Mortgage Capital Pty Ltd v Westpac Banking Corporation Ltd,[1] the Court will intervene if that term also provides a mortgagee with a collateral advantage that is a clog or impediment to the equity of redemption.

Relevantly:

1. The Plaintiff, First Mortgage Capital Pty Ltd (First Mortgage), sought to transfer to it, two registered mortgages over two NSW properties held by Westpac Banking Corporation (Westpac), the First Defendant.
2. The properties were owned by the Second Defendant Ms Juri and the Third Defendant Mr Husain.
3. Ms Juri and Mr Husain filed a cross-claim, seeking to restrain First Mortgage from redeeming any mortgage over property they owned alleging that First Mortgage’s:

• conduct in entering into the relevant loan agreement and associated mortgages was unconscionable due to the higher rates of interest; and
• exercise of clause 18.3(h) of the mortgage memorandum to pay-out other mortgagees was done in an improper manner, which amounted to unconscionable conduct and that its exercise amounted to a collateral advantage beyond payment of principal, interest and costs.

Background

In May 2018, First Mortgage, advanced $289,915.00 to Glocal Villager International Pty Ltd (Glocal). Ms Juri was the sole director.

The term of the loan was around six months and Ms Juri and Mr Husain executed mortgages over two Victorian properties in exchange for the advance. Those mortgages were registered second in time behind Westpac.

Relevantly, the terms of the mortgage documents:

• gave First Mortgage a mortgage over all of the mortgagors’ property;
• defined ‘debtor’ to mean the borrower and/or mortgagor;
• specified a lower interest rate of 30% p.a. and higher default rate of 60% p.a.; and
• gave First Mortgage the right to pay-out another mortgagee upon default by the mortgagor, with that amount forming part of the ‘Secured Money’ owed.

Ms Juri and Mr Husain signed a declaration to the effect that they understood the guarantee and mortgage provided in favour of First Mortgage, having also received legal advice explaining the nature and effects of the guarantee and mortgage.

The loan wasn’t repaid by the due date and in 2019, First Mortgage commenced enforcement proceedings.

Following this, First Mortgage exercised its rights to pay out the first-ranking mortgages over other properties owned by Ms Juri and Mr Husain. The first mortgage, held by CBA over two other Victorian properties, was paid out in January 2020. Then in May 2020, First Mortgage paid out a mortgage held by Westpac over a property in NSW. First Mortgage later sold these three properties, recovering about $850,000.

However, prior to the properties being sold, a total of $487,297.96 was added to the ‘Secured Money’ – almost 1.7 times the amount of the original loan – attracting interest of 60%.

In May 2020, First Mortgage commenced efforts to have transferred to itself the two first-ranking mortgages held by Westpac over the two Victorian properties owned by Ms Juri and Mr Husain which First Mortgage held second-ranking mortgages over.

Court’s findings

Were the interest rates unconscionable?

The Court found it wasn’t unconscionable for First Mortgage to enter into the loan and mortgage with the interest rate provisions. Whilst high, the rates weren’t exorbitant for short-term commercial loans. Ms Juri and Mr Husain entered into the transaction with knowledge of the interest rates, without undue influence, pressure, exploitation or victimisation and after receiving legal advice.

Collateral advantage which was an impediment to redemption?

The mortgages paid out were subject to much lower interest rates and until the secured properties were sold, the mortgagors were subject to an additional interest burden, even though the debt secured hadn’t increased. First Mortgage essentially assumed the position of first mortgagee, yet charged interest at a higher, default rate under a different loan agreement which was secured by a lower ranking mortgage. This was collateral to First Mortgage’s interest to recover the principal, plus interest.

Was clause 18.3(h) unfair and unconscionable?

In the Court’s opinion, clause 18.3(h) of the mortgage could be regarded as a collateral advantage and a clog or impediment to the exercise by Ms Juri and Mr Husain of the equity of redemption. However, even if this was so, it would be upheld unless found to be unfair and unconscionable.

The Court found clause 18.3(h) operated unfairly to the mortgagors because large amounts of debt, initially subject to standard interest rates by banks lending on first mortgage security, were effectively converted into high-interest loans. The unfairness lay in charging the higher default rate of 60% on the amount paid out, not in paying out the mortgages and adding that sum to the secured money. Whilst the mortgagors were in default pursuant to the mortgages originally given in favour of First Mortgage, they were treated as being in default of a much larger sum. In addition, the security available in respect of the total indebtedness had not diminished.

In the Court’s opinion, reliance by First Mortgage on clause 18.3(h) to charge 60% interest on amounts paid to either redeem or acquire first mortgages fell below community standards, could be described as morally deficient and involved an element of exploitation of the mortgagors’ default.

Exercising clause 18.3(h) in this way allowed First Mortgage to obtain an unconscionable collateral advantage that impeded the mortgagors’ ability to discharge and was not enforceable.

The Court’s decision

Ultimately First Mortgage was restrained from enforcing clause 18.3(h) and confined to charging interest rates provided for by the CBA and Westpac mortgages on the amounts it had paid out, or in the absence of such, court rates.

Key takeaway

In the event a mortgage term operates to provide a mortgagee a collateral advantage and a clog or impediment to the equity of redemption, a court will not intervene, unless the term is found to be unfair and unconscionable.

If you found this insight article useful and you would like to subscribe to Gadens’ updates, click here.

Authored by:

Susan Forrest, Partner
Jessica Lawrence, Graduate

[1] [2021] NSWSC 1143.