McKinty and Wright Solicitors - Northern Ireland Based Solicitors, Lawyers Belfast.

The importance of a bank or other lender obtaining priority for monies it advances cannot be over-emphasised. If not properly obtained, the consequences for the lender can be extremely serious. Colm Johnston takes a look at a recent case which underlines this point.

When a bank lends money to a customer it must always consider its position under the worst-case scenario: if the borrower defaults on repayment will the bank be able to recover the sum it leant? When the bank takes collateral, such as securing its lending against the borrower's house, the bank will carry out a valuation of the property to ensure that, if the borrower does default, the bank can take steps to sell the collateral with a view to having its advance repaid out of the sale proceeds. But this arrangement can be a lot less straightforward if additional lenders are involved.

The England & Wales Court of Appeal recently handed down its judgment in Scottish & Newcastle plc -v- Lancashire Mortgage Corporation Ltd which involved the competing claims of two parties who were owed sums by the owner of a club and fish bar. The club was subject to a charge in favour of Scottish & Newcastle (S&N) to secure sums owed to it for supplying drinks to the club. The club owner later obtained a mortgage from Lancashire Mortgage Corporation (LMC), part of which was to be used to pay S&N the money owed for the drinks. Part of the conditions of LMC's mortgage offer was that it would have a first legal charge over both the club and the owner's house. However, in the absence of LMC having the protection of a priority search, S&N registered its charge one month before LMC registered its charge. The club's owner subsequently fell into arrears with repayments and LMC sold the secured properties. There was a shortfall on the sale of the club and the proceeds from the sale of the house were insufficient to satisfy the sums owed to both S&N and LMC. S&N claimed its charge over the house had priority; it was registered first so it should be paid first out of the proceeds of sale of the house.

At first glance, it would seem that S&N had an open and shut case. It had, after all, registered its charge first. Ordinarily this would have entitled S&N to have its debt satisfied out of the sale proceeds of the house, with the remaining amount of the proceeds (if any) being used to pay off the monies advanced by LMC. However, LMC felt this was not an ordinary case, and advanced an argument based on estoppel to claim its charge should have priority. Essentially LMC asserted that S&N had acquiesced in LMC's actions whilst knowing that LMC believed its charge would have priority over S&N's charge. It would therefore be unconscionable for S&N to claim its charge had priority. S&N knew that the money advanced by LMC would be used to discharge part of S&N's indebtedness, and, in return for this, LMC would be entitled to a first legal charge over the house. The High Court accepted this argument and declared that LMC's charge ranked in priority over S&N's charge. S&N appealed.

The Court of Appeal found in favour of LMC. There was evidence of correspondence between the various solicitors involved in the transaction which confirmed S&N would have a second charge over the club and house. The Court felt it should dismiss S&N's appeal on the basis that S&N stood by and let LMC advance monies on its expectation that it would have priority. S&N benefited from the advance, but subsequently claimed it had priority over the proceeds of sale of the house.

The time and expense invested in this case could so easily have been avoided if the parties had entered into a deed of priorities, spelling out exactly the manner in which both parties would be paid out of the sale proceeds. LMC was somewhat fortunate in that it was able to rely on an estoppel argument to establish its priority; but it took the consideration of both the High Court and the Court of Appeal to dispose of this issue. The parties' respective positions could have been firmly established much earlier (and much less expensively) had they had the foresight to enter into a deed of priorities.