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A red light for short-term lenders

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20th June 2023

The decision of Mr Richard Farnhill sitting as a Deputy Judge of the High Court on the trial of Houssein v London Credit Ltd [2023] EWHC 1428 (Ch) will serve as a dire warning to the short-term lending industry. It fully justifies the interim injunction that Chris Maynard obtained at the commencement of the claim to restrain sale of the mortgaged properties by LPA receivers: [2021] EWHC 1417 (Ch).

Dishonesty on the part of mortgage lenders and their representatives is not infrequently alleged, but it is rarely substantiated. It is generally an unpromising start for an advocate. Yet that was what happened in this case in which a mortgage intermediary, acting in concert with the lender’s business development manager (BDM), was found to have concocted a false narrative by means of photographs which purported to show a house was unoccupied when, in fact, it was occupied the directors of the borrower company as their home. In the Judge’s judgment, the intermediary either lied to the Court or was recklessly indifferent to the facts and the BDM gave dishonest evidence.

A 12-month bridging loan was secured over a group of 5 buy-to-let properties and the house as well. It was a term of the facility that neither the borrower nor any related persons should reside in the security property. Less than a month after the draw-down, the lender alleged default on the basis that the directors of the borrower company were living in the house. The case for the company and its directors (one of whom had died before the commencement of proceedings) was that they did not know there was a non-residence condition in respect of the house. The court accepted the evidence of the surviving director that she had not been told in her meetings with the intermediary that she would have to move out of her home. The intermediary’s evidence to the contrary was disbelieved.

Not long before the drawdown, the intermediary and the BDM had visited the house. They had taken a series of photographs, some of which were forwarded to the underwriters to secure approval of the loan. However, the directors’ case was that it was obvious they were in residence at that time, and they had no plans to leave. A careful and detailed examination of the photographs showed images which were so inconsistent with the false narrative that it could not be true. The BDM must have known the directors were living there. That knowledge was imputed to the lender who, by continuing with the transaction with that knowledge, had waived the non-residence condition in relation to the house.

In the circumstances, there was no breach of covenant on the part of the borrower. Accordingly, there was no contractual entitlement to default interest and the subsequent appointment of receivers over the mortgaged properties was unlawful.

Thus far the case may be regarded as quite unique and fact specific. But the Judge went on to consider whether the default interest claimed by the lender was enforceable in any event. He held it was not.

The expert evidence for both sides was that the default rate, which quadrupled the standard rate, was higher than normal. But the analysis did not need to get that far. In a passage which may cause an industry-wide review of standard terms, he considered whether the default rate actually protected a legitimate interest of the lender.

The lender was unregulated, and the purpose of the non-residency provision had been to ensure that it was not a regulated mortgage contract. But the non-residency requirement was not an interest that required further protection because using a corporate borrower meant the loan was not in breach of FSMA in any event.

It was not an issue that charging a higher rate on default could be commercially justified on the basis of the enhanced credit risk of the borrower. However, Upon analysis, that was not the interest the lender was seeking legitimately to protect.

First, a level of credit risk had already been priced into the interest rate of 1% per month under the loan. On the evidence, that was some 0.3% higher than the starting point of the lender’s range for this type of loan, which reflected the lender’s assessment of the enhanced credit risk for this transaction. There was no evidence that justified an increase of a further 3% when 0.3% was sufficient to cover the historic credit risk factors.

Secondly, the default rate was the same regardless of the breach and was set without reference to the borrower or the particular loan. The loan was well secured. The LTV was around 54% in circumstances where the lender’s guidelines permitted much higher ratios. If the legitimate interest were credit risk, one would expect some account to be taken of the security, but none was.

Thirdly, the same default rate applied to all breaches. That would mean that the lender required identical protection for each of the following: late payment; residence at a security address (whether or not the loan was to a corporate borrower); final judgments against the borrower in excess of £20,000; and litigation or arbitration threatened or commenced against the borrower. That could not be right. To take an obvious example, a final and unappealable judgment for £20,000 is a very different thing to a letter of claim for the same amount, yet under this facility, they were subject to the same default rate.

Finally, the experts agreed that a more typical default rate was 3% in total per month. In circumstances where there was nothing specific to the borrower (or its directors) or the security for this loan and where there was nothing specific about the breach, it is hard to see what took this outside the norm to justify an additional 1% per month.

Accordingly, the default rate did not protect any legitimate interest of the lender; it was a penalty. The Court could not substitute any alternative default rate. Therefore, the contractual interest payable to the end of the term remained the same.

This decision will cause short-term lenders across the industry to review their standard terms to ensure that their default provisions are proportionate, and they genuinely address the protection of the lender’s legitimate interests. Lenders who insert unnecessary conditions into their facility letters may find them difficult to enforce and a uniform rate of default interest in respect of all breaches, be they grave or minimal, may not be justifiable.

At trial, Chris Maynard led Edward Blakeney of Falcon Chambers. They were instructed by Hugh Cartwright and Amin, solicitors.

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