Victorian Court of Appeal considers doctrine of marshalling

A solicitor, Hill, held a second mortgage over Property A, belonging to his client, Love, to secure payment of legal fees.  The CBA held a first mortgage over Property A and other properties owned by Love. The CBA sold Property A, and no proceeds were left to satisfy Hill’s debt.

Hill sued Love in the County Court, and obtained a consent judgment for $2.2 million. Hill then brought proceedings in the Supreme Court to marshal the CBA’s securities to discharge his debt.  At first instance Sifris J upheld the claim: (2018) 53 VR 459.  Hill was entitled to be subrogated to the CBA’s first mortgage over another of Love’s properties which had been sold by the CBA, to the extent of the debt previously secured by Hill’s second mortgage.

The trustees of Love’s bankrupt estate brought an unsuccessful appeal.  In granting leave in part but dismissing the appeal, the Court summarised the elements of the doctrine by quoting from Lord Neuberger’s speech in National Crime Agency v Szepietowski [2014] AC 338:

‘Marshalling [is] allowed to a creditor, in a case where (i) his debt is secured by a second mortgage over property (‘the common property’), (ii) the first mortgagee of the common property is also a creditor of the debtor, (iii) the first mortgagee also has security for his debt in the form of another property (‘the other property’), (iv) the first mortgagee has been repaid from the proceeds of sale of the common property, (v) the second mortgagee’s debt remains unpaid, and (vi) the proceeds of sale of the other property are not needed (at least in full) to repay the first mortgagee’s debt. In such a case, the second mortgagee can look to the other property to satisfy the debt owed to him.’

The policy behind the doctrine is to prevent a second mortgagee’s debt being left unpaid by the arbitrary or capricious realization of securities by a first mortgagee.

The Court of Appeal’s reasons contain three matters of general application.

First, the requirements to invoke the doctrine of marshalling are those quoted above in Szepietowski.  There is no independent requirement that the first mortgagee’s conduct be arbitrary or capricious.  That may be the policy justification for the rule, but it is not required for equity’s intervention.

Secondly, securities can be marshalled to discharge the whole of a fluctuating debt even if the debt increases after the sale of the principal security property.

Thirdly, the County Court consent judgment did not extinguish the secured debt.  A debt merges in a judgment and continues its existence in that merged form – it is not retrospectively extinguished.  The debt remained secured, and able to support a marshalling claim.

Solicitors acting for subordinate security holders should keep marshalling in mind.  If it is available, it can significantly improve a subordinate mortgagee’s prospects of recovery.  It is particularly attractive where a debtor is insolvent as it may give a second mortgagee priority over unsecured creditors.