Law regarding clogs on a mortgagor’s equity of redemption reconsidered in Supreme Court of NSW

Bonanno v Finamore [2021] NSWSC 1558; Bonanno v Finamore [2022] NSWCA 276

On 25 February 2011, Mr Finamore and Ms Zhou (borrowers) – a de facto couple – entered into a deed with Mr Bonanno (lender) for the purpose of assisting the borrowers with their mortgage debt owed to the National Australia Bank (NAB).

On its face, the deed contained provisions:

1. for the lender to advance $130,000 to the borrowers;
2. giving the lender a right to require from the borrowers the transfer (to the lender) a one-third interest in the mortgaged property owned jointly by the borrowers (property); and
3. for the lender to receive $130,000 plus one-third of the remaining proceeds of sale (after the NAB mortgage was paid out), in the event of the property’s sale.

Upon executing the deed, the lender advanced $130,000, but the borrowers declined to transfer the one third interest in the property to him. The lender sought declaratory relief for the one-third interest in the property to be held by the borrowers on trust. The borrowers filed a cross-claim seeking, among other orders, the setting aside of the deed for unconscionability, and they otherwise argued that the lender had terminated the deed.

Much of Justice Robb’s decision is concerned with the characterisation of the provisions listed above. Justice Robb noted that the deed was not drafted to conform with conventional property law principles and that it was silent on numerous practical matters, such as how particular rights were triggered. The deed’s omissions appeared to be the result of inexpert drafting. The only lawyer involved was apparently not engaged to draft or provide advice regarding the deed.

Invalidity of transfer provisions in the deed

The lender contended for the deed to be interpreted as a loan arrangement with an option exercisable by the lender at his discretion to request the transfer of the one-third interest in the property. The lender also contended that the deed did not create a secured arrangement.

Justice Robb disagreed, and found that the deed created a mortgage over the property in respect of the repayment of $130,000, substantially on the basis that the lender’s ability to realise his interest in the property was contingent upon its sale (the proceeds from which he had a right to be repaid $130,000).

As the deed was silent as to any obligation upon the lender to provide any consideration for his receipt of the one-third interest in the property, Justice Robb construed the borrowers’ obligation to transfer the one-third interest in the property (and the net proceeds of sale of the property after repayment of the advance) as a collateral advantage to the lender.

The borrowers were taken to submit that clause (2) above was a collateral advantage clogging on the borrower’s equity of redemption (or was otherwise unconscionable). Heavily summarised, the ancient equitable principle prohibiting clogs on a mortgagor’s equity of redemption developed in response to attempts by lenders to charge high interest rates.

 Justice Robb used the occasion to wade into what his Honour described as a “recent judicial controversy”, noting that until recently, Lord Parker of Waddington’s statement in Kreglinger (G & C) v New Patagonia Meat and Cold Storage Company Ltd [1914] AC 25 — itself a relaxation of the aforementioned equitable principle was regarded as good law:

“There is now no rule in equity which precludes a mortgagee, whether the mortgage be made upon the occasion of a loan or otherwise, from stipulating for any collateral advantage, provided such collateral advantage is not either

(1) unfair and unconscionable, or

(2) in the nature of a penalty clogging the equity of redemption, or

(3) inconsistent with or repugnant to the contractual and equitable right to redeem.” (Proposition 3)

(Lord Parker’s Principle).

In 1992, Justice Young, in Westfield Holdings Ltd v Australian Capital Television Pty Ltd (1992) 32 NSWLR 194 queried whether Lord Parker’s Principle ought to be adjusted so that the collateral advantage should be disallowed only where it is unconscionable, there being no reason in modern practice to deny every collateral advantage to the mortgagor, who may seek to purchase a mortgaged property. This would remove the latter two propositions from Lord Parker’s Principle.

 After reviewing several authorities, Justice Robb noted that unconscionability “has been recognised elsewhere in the common law world as the essential basis of equity’s willingness to strike down clogs on the equity of redemption”. Justice Robb then accepted the proposition that legal and commercial changes in mortgage law and practice have occurred that call for a change to Proposition 3, in essence, to permit the parties to include in the one transaction both a mortgage and option to purchase, where the option gives the mortgagee a right to require the mortgagor to enter a contract to sell the property to the mortgagee for a price appropriately referable to its value. His Honour was careful to hold that Proposition 3 should otherwise be maintained. His Honour held that, on that view of the continuing operation of Lord Parker’s Proposition (3), the transfer provisions are invalid, because they constitute a collateral advantage created by a mortgage whereby the mortgagor is obliged to transfer the title to part of the mortgaged property without any consideration additional to the making of the loan.

The defendants submitted that Mr Bonanno was not entitled to any relief under the deed, as he had not complied with any formal requirements imposed on mortgagees. Justice Robb did not consider that a lack of compliance with formal requirements provided any significant impediment to the access of relief in favour of Mr Bonanno.

Accordingly, Justice Robb found that the deed had the effect of creating charging the property so that Mr Bonanno would be able to secure the repayment of the $130,000, and any additional money owed to him under the deed. It remains unclear whether there was any outstanding debt owing to NAB; and whether the property would need to be sold to repay Mr Bonanno the amount owed to him.

Final Comment:

It seems that hard cases occasionally make good law. Justice Robb’s findings were not overturned on appeal. The status of Lord Parker’s Principle is perhaps more likely to be revisited in the ‘private loans’ sphere as opposed to mortgages drawn by professional lenders. The case is noteworthy for the (in modern times) relatively rare finding of a mortgage despite the documentation not making reference to same, and in particular for Justice Robb’s text-book worthy analysis of the modern status of the doctrine prohibiting clogs on a mortgagor’s equity of redemption – essentially governing the circumstances in which a mortgagee may have a collateral advantage.