Mortgages of Residential Long Leases and Liabilities

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Lenders often end up writing a cheque to landlords where their borrower has defaulted on the payment of sums due under their long-lease.  That sum is then usually added to the principal debt and repaid over the remainder of the term of the mortgage.  However, mortgagees frequently complain that they are being forced into paying landlords’ unreasonable demands in order to protect their security from forfeiture.  Often the demand will come from the landlord’s solicitor inviting the lender to pay before proceedings are issued but it is becoming increasingly common for lenders to refuse to pay until the landlords have issued proceedings.  As we will see, this is not always the most cost-effective approach because a well-advised landlord will make it clear from the outset that he intends to serve a notice under section 146 of the Law of Property Act 1925 (“LPA 1925”), thereby triggering the liability for costs under any contractual indemnity. 

So what can a mortgagee do to reduce or challenge the bills presented by landlords? 

Steps to Saving Money

A mortgagee usually discovers its borrower’s arrears either when the landlord’s solicitor writes inviting payment, or when it is served with a copy of the proceedings for possession pursuant to CPR PD55, paragraph 2.4, as a person entitled to apply for relief from forfeiture.

The following is a checklist of considerations and steps the mortgagee can take to ensure the sums demanded are due and reasonable.

Check the Lease

It may seem obvious but the lease is a contractual document and the landlord must demand sums due under it in accordance with its provisions.  The contractual obligation to pay is not triggered unless the landlord has properly demanded those sums.

Check compliance with sections 47 and 48 of the Landlord and Tenant Act 1987

Section 47 requires the landlord to give his name and address in demands for rent or other sums payable under the lease.  Giving his agent’s address is not sufficient to discharge this obligation (see Beitov Properties Ltd v Martin [2012] UKUT 133).  Section 48 states that the landlord should provide the tenant with his address in England & Wales for service of notices.  Failure to comply with either of these sections means any sums due under a demand are not payable until the landlord complies.

Has the landlord served a summary of rights and obligations?

A lessee (and therefore his mortgagee) is not required to pay the service or administration charges unless the summary has been served with the demand in accordance with section 21B LTA 1985 in the form prescribed by the Service Charges (Summary of Rights and Obligations, and Transitional Provision) (England) Regulations 2007.

Challenge the sums due

The method by which the lender does so depends on the stage at which it discovers the arrears.  If the sums demanded are service charges, there are no proceedings and the borrower has not admitted that the sums are due, the lender may issue or join in proceedings in the court or FTT under section 27A LTA 1985 for a determination that the service charges are reasonably incurred and the works are to a reasonable standard. 

It is extremely rare in practice for a mortgagee to join in or commence such proceedings but it may be economically sensible where the service charge is sufficiently large and the equity in the property sufficiently low to warrant such an approach.  An assessment of the service charges and the merits of pursuing an application should be made at an early stage.

Check the contractual costs demanded

Often leases will provide that the lessee shall pay all the costs charges and expenses incurred by the lessor in contemplation of, or incidental to, the preparation and service of a notice under section 146 or 147 of the LPA 1925, notwithstanding the fact that forfeiture may be avoided.  It is under this provision that landlords will seek to recover their costs of seeking a determination in the court or the FTT. 

There are two important considerations to which lenders should have regard when being faced with paying their borrower’s arrears for these costs.  First, this clause will only be engaged where forfeiture has truly been avoided.  If the tenant was not in breach or the landlord has waived his right to forfeit for the breach, it will not have been possible to have forfeited the lease (see Barrett v Robinson [2015] L&TR 1 at 49).  Secondly, costs will only be incurred in contemplation of a section 146 notice if, at the time the expenditure is incurred, the landlord has in mind that he will serve a section 146 notice (see Barrett at 52).

The latter consideration may seem obvious but unless the landlord can prove he contemplated service of a notice when he started incurring costs in, for instance, seeking a determination that the sums are due, he cannot recover them under the contractual indemnity.  If there is no letter or email at an early stage stating the landlord’s intention to serve a section 146-notice mortgagees should challenge the right to recover the costs.

Furthermore, this type of claim for costs is a variable administration charge (see Christoforou v Standard Apartments Ltd [2014] L&TR 12 at §32), which are only recoverable to the extent that the amount of the charge is reasonable (paragraph 2 of schedule 11 of CLRA 2002).

Pay up early

Often borrowers do not pay their service charge because they cannot afford it.  Where lenders are likely to pay on their behalf but the tenant or the lender intends to challenge the charges it is sensible to make the payment in full at the earliest possible stage so the landlord cannot rely on the indemnity costs provision.  If the sum has been paid the landlord cannot be contemplating a section 146 notice and the costs incurred by him in the FTT will merely be in relation to a challenge to the reasonableness of the charges under section 19 LTA 1985.  Any sums found not to be due can be recovered from the landlord or credited against future service charge years.

When a mortgagee is considering making payment it should ensure it is entitled to do so.  Most lenders will have standard terms which permit them to make payments on the borrowers behalf where the security is at risk.  However, it is important to check the terms applicable to the mortgage entitle the mortgagee to do this if it is to protect against a claim against it by their borrower.

Well-advised lenders will act early and swiftly when they discover their borrowers are in arrears of charges under their lease.  Such action may prevent increasing liabilities for costs or the forfeiture of the security and the associated costs of seeking relief.