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High risk lending alert6 February, 2019
The current economic climate is increasing the risks for lenders and their lawyers
We have seen a significant increase in mortgage claims involving inadequate security in the 2017/18 policy year. Many of these claims have in common private lenders providing urgent, short term, high interest rate loans, or risky joint venture arrangements. The prevalence of these loans and arrangements reflects a tightening in the market for funding which looks like it will continue.
Acting for lenders in urgent short-term loans
If you are asked to act for lenders in urgent short-term loans our claims experience shows that you need to do the following:
- Take the time to check accuracy of your documents once you have produced them — no matter how urgent the matter is.
- Do a title search of the security property to understand how the property is held, or what encumbrances are registered against it. Don’t just rely on what the lender or broker tells you.
- Give the client clear advice face to face and importantly, confirm it in writing.
- The advice should cover the
risks of the transaction and what should be done including:
- the money should not be handed over until all documents are properly signed and witnessed and returned to the lender, no matter how well the lender knows the borrower, or how urgent or short term the loan is
- obtain an independent valuation of the security property and read it
carefully looking for any signs that the valuation may be flawed. Mistakes
- inaccurate description of the property – does it value the correct parcel of land
- a valuation that assumes the completion of a project that has not commenced rather than the value as it is currently
- failure to consider lease terms and conditions
- failure to address any relevant planning restrictions affecting the property’s use or development and their impact on the valuation
- material differences between the valuation and the sale price for any recent contract of sale
- obtain written confirmation from any first mortgagees as to the amount secured against the security property and obtain their consent to registration of a subsequent mortgage. If the client refuses to do this because there is no time, explain the risks of all moneys mortgages and cross collateralisation and that no equity may be available. Consider drawing a diagram to help the client understand this risk.
- the disadvantages of only having a caveat or an unregistered mortgage as security and recommend that the mortgage be registered and preferably as a first mortgage. This should be done even if the client looks like a successful and sophisticated business person. Caveat-lending is inherently risky and if such a loan goes into default lender clients are usually quick to assert that their lawyer failed to warn them of the risks of not registering mortgage security.
- Where the security is provided by a third party, insist on the security provider obtaining independent legal advice and require them to provide a solicitor’s certificate to confirm they have received such advice and understood it.
- Give the client the time they need to absorb the information and insist they take the letter of advice away to read and think about at least overnight.
These precautions will enable you to defend a claim, but there is no guarantee that the client will not try to sue you later if their money is not paid back. You need to consider at the start of the transaction if it is worth the risk.
Acting for land owners in a joint venture property development
Our recent claims experience suggests there has been an increase in joint ventures between land owners and property developers. The land owner finances the development by transferring the property to the developer who borrows against it to finance the development. They share the units or apartments that are built on the land in the end.
The problem with these arrangements is it is difficult, if not impossible, to properly protect the land owner from a developer who goes broke during the development. In the claims we have seen, even caveats on the property limiting the borrowings does not prevent the developer using the borrowed funds in other developments. We also see that the original land owner is often prevailed upon to remove the caveat when more funding is required to finish the development.
If approached to document a deal like this you should give the client clear, robust advice not to do it and detail all of the risks, both orally and in writing, and consider not acting if the client won’t take your advice.
- Regularly review your precedent loan and mortgage documents
- Always do a title search of the security property
- Advise lenders to obtain independent valuations and scrutinise them carefully
- Give clear face to face advice about the risks and confirm the advice in writing
- Insist on a solicitor’s certificate if there is third party security
- Give the client time to absorb your advice
- Advise land owner clients wanting to enter a property joint venture it is too risky