[PRIVY COUNCIL]

AND

[APPEAL FROM THE COURT OF APPEAL OF NEW ZEALAND]

Mortgage - Sale by mortgagee - Prior charge - Successive mortgagees of same property varying priority of mortgages without mortgagor's consent - Whether mortgagor entitled to require satisfaction of debts in original order

By the first mortgage the defendant mortgagor covenanted to pay certain sums to a company and as security therefor charged shares by way of a first fixed charge. By the second mortgage he covenanted to pay further sums to another company, charging the same shares as security by way of a second fixed charge. Both mortgages became vested in the first plaintiff, which obtained judgment against him for a debt secured by the first mortgage. The plaintiff exercised its power to sell the shares, conferred by the second mortgage, but applied the proceeds of sale towards discharging the debts secured by that mortgage, not in satisfaction of the judgment debt. On application by the defendant to the High Court pursuant to rule 544 of the High Court Rules¹ for satisfaction of the judgment to be entered, the judge found that the judgment had been fully satisfied, holding that the proceeds of sale should have been applied in the order specified in the mortgages. The Court of Appeal reversed that decision, holding that as holder of both mortgages the plaintiff could unilaterally decide whether to apply the proceeds of sale in satisfaction of the debts due under the first or the second mortgage.

On the defendant's appeal to the Judicial Committee:-

Held, dismissing the appeal, that ordinarily where there were two mortgages of the same property the mortgagees could vary the order of priority of their mortgages without the mortgagor's consent; that although a mortgagor who wished to have the secured debts satisfied in a particular order could require a specific term to be inserted in the mortgage preventing the priorities of the mortgages from being altered, the reference in the first mortgage to the charge being a first charge merely described the nature of the security and conferred no contractual right on the defendant to have that debt satisfied first; that since the defendant could only recover the shares on payment of the debts secured by both mortgages, his right to recover the mortgaged property had not been adversely affected by the

1 High Court Rules, r. 544: "Satisfaction of judgment - (1) As soon as any judgment has been satisfied by payment . . . or in any other manner, the party against whom the judgment has been given shall be entitled to have satisfaction of the judgment entered up . . . (3) . . . the court may order satisfaction to be entered upon proof that the judgment has been satisfied."

variation in priorities; and that, accordingly, the plaintiff was under no obligation to apply the proceeds of the sale of the shares towards the discharge of the debt secured by the first mortgage and the defendant was not entitled to an order that the judgment in respect thereof had been fully satisfied (post, p. 477A-D).

Decision of the Court of Appeal of New Zealand affirmed.

The following cases are referred to in the judgment of their Lordships:

Ellis & Co.'s Trustee v. Dixon-Johnson [1925] A.C. 489, H.L.(E.)

Palmer v. Hendrie (1859) 27 Beav. 349

Putnam v. Broten (1930) 232 N.W. 749

No additional cases were cited in argument.

APPEAL (No. 14 of 1991) with leave of the Court of Appeal of New Zealand by the defendant, Cheah Theam Swee, from the judgment of the Court of Appeal of New Zealand (Richardson, Somers and Hardie-Boys JJ.) given on 31 October 1990 allowing an appeal by the plaintiffs, Equiticorp Finance Group Ltd. and Equiticorp Nominees Ltd., from the judgment of Wylie J. delivered on 2 July 1990 in the High Court of New Zealand ordering that satisfaction of the judgment dated 17 December 1987 be entered.

The facts are stated in the judgment of their Lordships.

D. F. Dugdale (of the New Zealand Bar) for the defendant. The question, on which there is no direct Commonwealth authority, is whether, and to what extent, a mortgagor is bound by variations in the order of priorities made by successive mortgagees without his consent.

The ranking of a mortgage is part of the totality of the bargain between the mortgagor and the mortgagee. On general principles that ranking cannot be varied so as to bind the mortgagor without his consent, although inter se the mortgagees can vary their priorities.

The order of priority of mortgagees does not usually concern the mortgagor unless he is insolvent. Whether the defendant is bound by the variation in the priorities is important to him because he has been prejudiced by the application of the proceeds of the sale towards the discharge of a debt which is contested instead of the judgment debt, and because he has the right to recover the mortgaged property from the mortgagee on payment of the secured sum.

Although a secured creditor has a number of remedies and is entitled to choose any of them, he is doing more than pursuing his remedies if he agrees to another mortgage having priority over his own mortgage. The right to sue on the mortgagor's personal covenant is not unqualified, and the mortgagee cannot exercise that right unless he has the ability to return the security intact: see Palmer v. Hendrie (1859) 27 Beav. 349 and Ellis & Co.'s Trustee v. Dixon-Johnson [1925] A.C. 489. A first mortgagee is unable to return the security to the mortgagor if that mortgagee has relinquished his security to another mortgagee. The second mortgagee's rights in relation to the security do not cast any light

on whether or not mortgagees can affect the mortgagor by altering the priority of their mortgages without his consent.

R. J. Craddock Q.C. and M. E. Parker (both of the New Zealand Bar) for the plaintiffs. The Court of Appeal's decision and reasoning were correct. A first mortgagee is entitled to waive his priority under the first mortgage for four reasons. (1) In principle there can be no objection to him doing so. (2) It is recognised by commercial practice. (3) American authorities support that proposition. (4) There is no Commonwealth authority which precludes it.

With regard to the first reason a creditor has no obligation to a debtor to enforce his security, only an entitlement to do so. A secured creditor may choose to waive, abandon or release his security rights for a number of reasons. For example, he may have other rights which he considers to be adequate, or he may be content to rely on the debtor's personal covenant. Although his choice of remedy may have the result of altering the priority of a subsequent secured creditor, the debtor's consent to that choice is not required. The promise to pay a debt and the security for that obligation are quite distinct. A change in priority between first and second mortgagees does not adversely affect the mortgagor because the mortgagor is obliged to pay each debt. If there is only one mortgage, the mortgagee can abandon his security without the mortgagor's consent. The mortgagee's entitlement to do that cannot be changed to an obligation to enforce his security merely by the mortgagor giving a subsequent charge.

With regard to the second reason agreements or waivers between security holders affecting their priorities are well recognised and commonplace, and there has been no suggestion that the debtor's consent to them is required: see Jones on Mortgages, 6th ed. (1904), vol. 1, p. 580, para. 608. If such consent were required many commercial dealings would be stultified. In the United States charge holders have the right to alter their priority without the debtor's consent: see Putnam v. Broten (1930) 232 N.W. 749.

The defendant's argument, if correct, would mean that a first mortgagee would be compelled to enforce his security rather than seek to recover the debt by other means. There may be circumstances in which a first mortgagee may wish to permit the enforcement of the security by a subsequent mortgagee. A debtor has no right to insist on a particular order of priority, and without his consent creditors have a right to agree that debts should rank in a different order of priority.

Dugdale in reply. The ranking of a mortgage is a term of the contract between the mortgagee and the mortgagor intended to be for the benefit of the mortgagor.

13 November. The judgment of their Lordships was delivered by LORD BROWNE-WILKINSON.

This appeal from the Court of Appeal of New Zealand raises a short question of principle: where there are two mortgages of the same

property, can the mortgagees effectively agree to alter the priorities of the mortgages without the consent of the debtor?

The factual background is complicated, but for the present purposes the salient facts can be shortly stated. By a mortgage deed ("mortgage I") the defendant covenanted to pay certain sums of money to a company, Equiticorp Securities Ltd., and as security for such payment charged 14 million shares in London Pacific Ltd. "by way of first fixed charge." By a further mortgage deed ("mortgage II") the defendant covenanted to pay certain further sums to Capitalcorp Investments U.K. and as security for such payment charged, inter alia, the same 14 million shares in London Pacific Ltd. "by way of second fixed charge." By a series of transactions both the mortgages became vested in the first plaintiff, Equiticorp Finance Group Ltd. In December 1987 the plaintiff obtained judgment against the defendant for the sum of $7,556,442.47, being moneys the payment of which was secured by mortgage I.

The plaintiff then exercised its power of sale under mortgage II over, inter alia, the 14 million shares in London Pacific Ltd. Apparently it was overlooked that those shares were subject to a first charge under mortgage I. The shares were not sold subject to mortgage I. The proceeds of sale of the shares were applied by the plaintiff, not in satisfying the moneys due under mortgage I (being the judgment debt), but in or towards discharging the debts secured by mortgage II. The Court of Appeal treated the plaintiff as having waived its priority under mortgage I and this was not challenged before their Lordships' Board.

The defendant took the view that he was entitled to insist that the proceeds of sale should have been applied in the order laid down by the original mortgages, in which case the judgment against him would have been fully satisfied. He therefore applied to the High Court under rule 544 of the High Court Rules for an order that the judgment had been fully satisfied.

The case came before Wylie J. who decided in the defendant's favour. The Court of Appeal reversed that decision and held that the plaintiff, as the holder of both mortgages, could unilaterally decide whether to apply the proceeds of sale of the London Pacific Ltd. shares in satisfaction of mortgage I or mortgage II. It is from that decision that this appeal is brought.

The following extract from the judgment of Wylie J. shows the grounds on which he held in the defendant's favour:

"Every mortgage is a contract, albeit one with special characteristics by reason of the charge it creates. In the case of successive mortgages each of them the first mortgagee and the second mortgagee has a contractual relationship with the mortgagor. Each has, by lending on the security of, and accepting the mortgage, created and accepted rights and duties between the mortgagor and the mortgagee. But there is no contract between the two mortgagees, and no arrangement between them can by unilateral act by each as against the mortgagor alter the terms of his contract with the mortgagor. By giving a first mortgage to the one and a second to the other the mortgagor has defined the rights of each in relationship to himself. While either mortgagee may deal with his mortgage -

e.g., sell it, or sub-mortgage it, he cannot unilaterally alter his contract with the mortgagor and the mortgagor cannot be affected by any such dealing. If two successive mortgagees agree amongst themselves to deal with the proceeds of sale on a mortgagee's sale that may be a valid and enforceable transaction as between themselves but they cannot do so to the prejudice of the mortgagor."

In contrast, the Court of Appeal emphasised the right of a mortgagee to pursue his various remedies alternatively and cumulatively: if a mortgagee chooses to enforce a personal covenant for repayment, he is entitled to do so and is not bound first to realise his security. Moreover, by choosing to waive his priority a first mortgagee is not varying or prejudicing the mortgagor's right to redeem. In no circumstances can the mortgagor recover the mortgaged property until all the debts secured on it have been satisfied. Therefore there is no need for a mortgagor to consent to any variation in the priorities.

Their Lordships would have been content to adopt the reasoning of the Court of Appeal. But in deference to the arguments of counsel and because there is no Commonwealth decision on a point which is of practical importance in relation to the subordination of debts, the Board think it desirable to state shortly their own reasons.

The question must be approached on the basis that mortgage I and mortgage II had remained vested in two separate mortgagees. The plaintiff, as holder of both mortgages, cannot be in a better position than the original mortgagees. The question therefore is whether two mortgagees can, without the consent of the mortgagor, agree to vary the priority of their mortgages. In the ordinary case, the mortgagor is not affected by the order in which his debts are satisfied. The mortgagor is bound to satisfy all his secured debts before he can recover the mortgaged property. In the ordinary case priority of mortgages affects only the rights of the mortgagees inter se, in particular where the security is inadequate to pay all the secured debts in full.

Moreover, the mortgagor has no right to insist on the mortgagee pursuing one of his remedies rather than another. It is for the mortgagee to decide whether to rely on the personal covenant for payment, or to sell the security or to take possession of the mortgaged property. So, in the present case, mortgagee I was fully entitled to sue the debtor on his personal covenant and rely on that alone. Mortgagee I could, if he chose, abandon or waive his security to the benefit of both mortgagee II and the debtor: the debtor had no right to insist that mortgagee I enforce his debt against the security.

The one matter that the mortgagor can insist upon is that, on redemption by payment, he gets back his security. That is the explanation of the principle in Palmer v. Hendrie (1859) 27 Beav. 349 that a mortgagee cannot sue on the mortgagor's personal covenant of payment if the mortgagee has put it out of his power to restore the mortgaged property on repayment of the debt: see also Ellis & Co.'s Trustee v. Dixon-Johnson [1925] A.C. 489, 491.

Mr. Dugdale, for the defendant, sought to rely on that principle in the present case. He submitted that, by reason of mortgagee I agreeing

to waive or postpone its priority, the defendant was precluded from recovering the mortgaged property on paying the sum secured by mortgage I: mortgagee I, by permitting mortgagee II to apply the proceeds of sale in satisfaction of the debt secured by mortgage II, had prevented mortgagee I from returning the security to the defendant. Their Lordships do not accept this argument. Even if there had been no alteration in the priorities and the defendant had paid the sums secured by mortgage I, the defendant would not have been entitled to recover the mortgaged property until the debt secured by mortgage II had been paid. The alteration in priorities did not adversely affect the defendant's rights to recover his security.

For these reasons, in the ordinary case a mortgagor has no right to insist on the order in which successive mortgaged debts are satisfied. This is the answer to the otherwise compelling reasoning of Wylie J. The provisions in mortgage I describing the charge as a "first . . . charge" are merely a description of the nature of the security which the defendant was giving: it did not confer on the defendant a contractual right to insist on the satisfaction of his debts in any particular order. There may be cases (for example where the successive mortgages carry differing rates of interest) where the mortgagor has a genuine interest in ensuring that the debts are satisfied in particular order. In such a case it will be for the mortgagor to insist upon a specific contractual provision precluding the alteration of the priorities of the mortgages.

Their Lordships' conclusions accord both with what they understand to be the generally accepted view of the law affecting subordination of debts and the law of the United States: see 59 Corpus Juris Secundum, para. 218; Putnam v. Broten (1930) 232 N.W. 749. It is manifestly desirable that the law on this subject should be the same in all common law jurisdictions.

Their Lordships will accordingly humbly advise Her Majesty that the appeal ought to be dismissed. The defendant must pay the plaintiffs' costs before their Lordships' Board.

Solicitors: D. J. Freeman & Co.; Alan Taylor & Co.

S. S.