The Co-Operative Bank Plc v Phillips [2014] EWHC 2862 (Ch) (21 August 2014)

This important case raises a number of key issues as to a lenders right to seek possession and the costs a lender can recover under a charge. This case is an excellent resume of the law and will be of great interest to those acting for lenders and borrowers.

In simple terms, the Bank lent money to Mr Phillips and as security, took a second charge over two residential properties owned by Mr Phillips. The charges ranked lower than earlier charges in favour of Barclays Bank plc.

In April 2013, the Bank brought procession proceedings. However in June 2014, the Bank served notice of discontinuance of both its claims.  Under the court rules the Bank accepted that it was liable to pay to Mr Phillips his costs of the proceedings. 

In April 2007, the Bank agreed to lend a sum in excess of £2.1 million to a company of which Mr Phillips was then a director. One of the terms of the loan agreement was that Mr Phillips would grant to the Bank a second legal charge over two properties. Both properties were subject to a first charge in favour of Barclays.

By the terms of the charges all monies due by the company were secured. As is standard such monies were deemed due for the purposes of section 101 of the Law of Property Act 1925 on demand. 

By clause 9 of the charge, all costs, charges and expenses incurred by the Bank and all other monies paid by the Bank in connection with the charge or the charged property were recoverable from Mr Phillips and/or the company as a debt and were to be charged on the charged property. Again as is standard such costs were expressed to include all costs incurred by or charged to the Bank (on a full indemnity basis) in taking, perfecting, enforcing or exercising (or attempting to perfect, enforce or exercise) any power under the charge. 

The company and Mr Phillips failed to make payment and in July 2008, the Bank made demands. 

In December 2009, Mr Phillips made a proposal for an individual voluntary arrangement. The proposal was on terms that the properties were to be excluded from the IVA. The proposal did not affect the rights of any secured creditor to enforce its security. Under the terms of the IVA it was noted that there was negative equity in both properties.

The Bank brought possession proceedings on the basis that the Bank wished to exercise its power of sale of the charged properties. The Particulars of Claim pleaded that the Bank’s power to sell the charged properties had arisen.  Mr Phillips served an amended Defence which alleged the proceedings were an abuse of process.  That was on the basis that the Bank would obtain no legitimate commercial advantage from enforcing the second legal charges.

The reader is referred to the judgement for the full background. Suffice to say the Bank at a later stage in the proceedings served a notice of discontinuance on Mr Phillips in respect of both claims.

Before Mr Justice Morgan the following issues were raised:

Given that under the court rules the Bank were liable to pay Mr Phillips costs in respect of the discontinuance of the proceedings, an issue arose as to whether the Bank should pay such costs on the indemnity basis. To determine that issue the court had to consider whether the Bank brought the proceedings for a collateral purpose which was beyond its powers as a lender (“the Lenders Powers”).

Under the terms of the Bank’s charge was the Bank able to add the costs incurred by it in the proceedings (including the sums it is liable to pay to Mr Phillips in relation to Mr Phillips’ costs) to the sums secured by the charges  so that they were  a debt owed by Mr Phillips to the Bank? (“the Costs Issues”)

Was the Bank entitled to set off its liability to pay Mr Phillips’ costs against sums otherwise due from Mr Phillips to the Bank?

Mr Justice Morgan noted the following principles as to the power of a lender:

A mortgage confers on a lender various powers such as a right to sell the security, a right to appoint a receiver and a right to take possession of the security. There are important equitable constraints as to when and how a mortgagee can exercise these powers (see Downsview Ltd v First City Corporation Ltd [1993] AC 29).

Lord Templeman held  in Downsview Ltd v First City Corporation Ltd [1993] AC 295 at 312 that 

“Several centuries ago equity evolved principles for the enforcement of mortgages and the protection of borrowers. The most basic principles were, first, that a mortgage is security for the repayment of a debt and, secondly, that a security for repayment of a debt is only a mortgage. From these principles flowed two rules, first, that powers conferred on a mortgagee must be exercised in good faith for the purpose of obtaining repayment and secondly that, subject to the first rule, powers conferred on a mortgagee may be exercised although the consequences may be disadvantageous to the borrower. These principles and rules apply also to a receiver and manager appointed by the mortgagee”.

Historically the courts have held that a lender has a right to go into possession "as soon as the ink is dry on the mortgage". The lender’s right to possession may be exercised out of court provided that the taking of possession does not involve a contravention of the criminal law under section 6 of the Criminal Law Act 1977 see Ropaigealach v Barclays Bank plc [2000] QB 263.

In  Quennell v Maltby [1979] 1 WLR 318, Templeman LJ said at 324: 

“The estate, rights and powers of a mortgagee, however, are only vested in a mortgagee to protect his position as a mortgagee and to enable him to obtain repayment. Subject to this, the property belongs in equity to the mortgagor."

Issues can arise where the lender has a number of reasons for seeking to exercise his powers or where the lender hopes to achieve more than one purpose by doing so. In  Meretz Investments NV v ACP Ltd [2007] Ch 197,  Lewison J held that  

“…a power of sale is improperly exercised if it is no part of the mortgagee’s purpose to recover the debt secured by the mortgage. Where, however, a mortgagee has mixed motives (or purposes) one of which is a genuine purpose of recovering, in whole or in part, the amount secured by the mortgage, then in my judgment his exercise of the power of sale will not be invalidated on that ground. In addition I consider that it is legitimate for a mortgagee to exercise his powers for the purpose of protecting his security."

As regards the position of a lender holding a second charge they are entitled to possession of the property, subject to the rights of a prior lender. The court can make an order for possession in favour of the second lender, subject to the rights of a prior lender: see Berkshire Capital Funding Ltd v Street (1999) 78 P&CR 321.

As to whether the Bank sought possession for a collateral purpose Mr Justice Morgan noted:

The Bank had the ability to give the court direct evidence as to its purpose but chose not to do so. . When the Bank discontinued the proceedings it had already failed to comply with an order that it give disclosure in relation to this issue.

On the evidence, at all material times, the values of both properties were significantly less than the sums owed to Barclays. The court was asked to draw an inference that the Bank believed that this was not the position. There was no evidence on which the court   could draw that inference. If the Bank did have that belief, it could have given evidence to that effect but it has not done so. The fact that it expressed scepticism about negative equity in letters to Mr Phillips did not establish that it believed that there was equity secured by the second charges to the Bank.

Accordingly the court could not find that the Bank believed that if it recovered possession of the properties it would be able to sell them and receive monies to reduce the sum owed to the Bank. Therefore the court could not find that the Bank’s purpose in bringing the proceedings was to sell the properties. 

There was no evidence that the Bank contemplated letting the properties and so I the court could not find that the Bank’s purpose in claiming possession was to derive an income from letting them.

The court considered the possibility that the Bank might have brought these proceedings to put pressure on Mr Phillips. Although the Bank had not called any evidence as to its purpose, on the incomplete evidence the court was unable to decide that the Bank wanted to sell or let the properties. The court was not persuaded that the Bank was acting irrationally and without any purpose at all. 

On the balance of probabilities, the Bank brought the proceedings to put pressure on Mr Phillips which the Bank considered, or hoped, would produce some payment. The Bank’s view was in the event borne out to the extent of the offer of £50,000 made by Mr Phillips’ daughter.

Therefore the court held that the bringing of these possession proceedings for the purpose of putting pressure on Mr Phillips was for the purpose of obtaining repayment of the sums secured by the charges and was therefore a permissible purpose.

The Bank had incurred two sets of costs. Its own legal costs. In addition   it was liable to pay Mr Phillips’ costs, pursuant to a previous order and following discontinuance.

The Bank relies upon clause 9 of the charges, and argued that both sets of costs were incurred by it in attempting to enforce or exercise any power under the charges. The Bank therefore claimed it was entitled to recover both sets of costs from Mr Phillips as a debt on a full indemnity basis.

 Mr Phillips argued that as a matter of construction pursuant to clause 9 of the charges, the Bank was not entitled to recover from him any costs which had been unreasonably incurred or which were unreasonable in amount. He relied on Gomba Holdings Ltd v Minories Finance [1993] Ch 171. In that case a similar provision in a charge referred to all costs incurred by the lender and stated that they could be recovered from the borrower on a full indemnity basis. The Court of Appeal held that, as a matter of construction the lender was not entitled to recover any costs which were of an unreasonable amount or which had been unreasonably incurred. He held that the burden of showing that the costs were unreasonable in either respect was on the borrower so that any doubts on those matters were to be resolved in favour of the lender.

Mr Justice Morgan held:

As to the Bank’s own costs, the Bank was entitled to claim possession of the two properties. The Bank did not act outside the equitable constraints on its power to take possession and its proceedings were not an abuse of the process of the court. However, the question whether its costs of the proceedings were reasonably incurred was not necessarily answered by these findings. 

The Bank got absolutely nothing out of the proceedings, which have been a waste of time and expense from its point of view. The Bank itself appeared to have recognised that by discontinuing the proceedings. The Bank did not give evidence as to its reason for discontinuing the proceedings. It submitted that the court should infer that its reason was connected with various developments in relation to Mr Phillips’ IVA but in the absence of evidence from the Bank and in view of the lack of clarity as to what is happening in relation to the IVA, the court was not able to draw that inference.

 In these circumstances,   Mr Phillips has shown that the Bank’s own costs of these proceedings were not reasonably incurred. They are, therefore, not recoverable under clause 9 of the charges.

The position was even clearer in relation to the second set of costs incurred by the Bank, namely, its liability to pay Mr Phillips’ costs. Just as the Bank’s own costs were unreasonably incurred for the purposes of clause 9, so too were the costs that the Bank has made itself liable to pay to Mr Phillips as a result of starting and then discontinuing proceedings. 

Given that Mr Phillips was entitled to be paid by the Bank the costs which he incurred in the proceedings, Mr Phillips required the Bank to agree that the Bank had no relevant right of set off of those costs against the liabilities which Mr Phillips had to the Bank subject to the terms of Mr Phillips’ IVA. 

There no right to a common law or equitable set off in this case. Clauses 7(1) and 7(2) of the Standard Conditions for IVAs, which apply to the IVA, allow mutual credit and set off where before the commencement of the IVA there have been mutual credits, mutual debts or other mutual dealings between the Bank and Mr Phillips. Clause 7(4) provides that set off is not available in respect of any debt, other than in accordance with the provisions of clause 7. "Debt" is defined in the Standard Conditions by reference to section 382 of the Insolvency Act 1986, subject to necessary modifications to refer to a voluntary arrangement. 

However the Bank could not invoke clause 7 of the Standard Conditions in this case. The Bank’s liability to pay Mr Phillips’ costs was not a debt, or the result of a dealing, before the commencement of the IVA. 

This case provides an excellent resume of a lenders exercise of its powers.  Such powers are of course well known to those practising in this area. However it is the exercise of such powers where the lender has a number of reasons which is of real interest.  It is worth repeating Lewison J in Meretz Investments NV v ACP Ltd [2007] Ch 197, 

“The cases do support the proposition that a power of sale is improperly exercised if it is no part of the mortgagee’s purpose to recover the debt secured by the mortgage. Where, however, a mortgagee has mixed motives (or purposes) one of which is a genuine purpose of recovering, in whole or in part, the amount secured by the mortgage, then in my judgment his exercise of the power of sale will not be invalidated on that ground. In addition I consider that it is legitimate for a mortgagee to exercise his powers for the purpose of protecting his security."

The court found in this case that the Bank brought proceedings for the purpose of obtaining repayment of the sums secured by the charges and was therefore a permissible purpose.  However the Bank in this case did not put forward evidence why it brought proceedings and why it believed there was equity.

The Cost Issues reflect the common law position but crucially for lenders, despite what are standard provisions in most charges, a lender is not simply entitled to add its costs to its security.  As most litigators will be aware the court rules make specific provision for a presumption that costs payable under a contract have been reasonably incurred (see CPR 44.5 (1). However such presumption is rebuttable. 

Whilst this case does not depart from existing principles it is an important reminder to lenders and indeed borrower’s solicitors as to key issues and getting a claim in order.