CPF One Limited & another v Ortus Secured Finance Limited [2023] EWHC 2102 Ch

In-depth analysis

Introduction

This case considered the exercise of powers by a security trustee and senior participant in a loan to settle debt owed by a mortgagor and to release associated securities, where the exercise of that power resulted in the junior participant in the underlying syndicated loan agreement receiving nothing.

The claimants argued that two duties applied here, which were considered by the court and ultimately rejected, having considered the facts and relevant documentation. The first duty was the equitable duty owed by a mortgagee to a second mortgagee when exercising a power of sale and the second were the duties owed by a trustee under the Trustee Act 2000, specifically the duty of care applicable when exercising powers to settle any debt, account, claim or thing related to the trust. Interesting arguments were raised as to the application of these duties, and a helpful analysis provided of the legal basis on which they would or would not apply.

Power of sale: what duty does a first mortgagee owe to a subsequent mortgagee?

The actions of first mortgagees can materially affect the position of subsequent mortgagees and as a result the courts have traditionally recognised that first mortgagees owe certain duties to subsequent mortgagees. Following the exercise of the power of sale; after the first mortgagee's secured debt has been paid, any surplus proceeds will be held on trust for the subsequent mortgagee in accordance with priorities – the second mortgagee as a consequence of this has an interest in ensuring a good price is obtained for the property to boost its own recoveries.

The problem with such duties has been to establish the precise extent of them and on this the courts have not always been consistent, with notably a difference in approach between common law judges and equity judges. The duty is based in equity and derives from equitable principles – it is owed to people who own the equity of redemption (ie the debtor) or to those who have a proprietary interest in the equity of redemption (which would include subsequent mortgagees but not persons entitled to a beneficial interest under a trust of the mortgaged property) and is based on the equitable concept of good faith ie that the first mortgagee is required to act in good faith once it has embarked on the process of sale. The prima facie measure of damages is the reduction in value of the equity of redemption.

In Farrar v Farrars (1888) LR 40 Ch D 395 clear statements on the application of this duty were provided both at first instance and in the Court of Appeal, which have been complicated by subsequent case law. The court was clear that the creditor is not a trustee of the power, when exercising the power of sale. It is part of its security and the creditor can exercise it in his own interests. The creditor is not exercising it on behalf of the debtor. The duty is based on equitable concepts ie concepts of good faith: the creditor can sell the property when he elects to do so but when he comes to sell he must act fairly and in good faith and must take reasonable steps to obtain a proper price.

Subsequent case law has muddied the waters a little in terms of where this duty derives from with the obligation also having been expressed as a duty rooted in negligence concepts importing the obligation to take reasonable care to obtain a proper price, for example - Re Cuckmere Brick Company v Mutual Finance [1971] Ch 949.

Some elements of the exercise of this duty have been considered by case law and the following appear to be clear:

The primary creditor can, subject to the duty of good faith, choose whether or not to sell the asset and if it decides to sell it can decide when to do so. However, if it does decide to sell (via receiver or otherwise) it must take proper care whether by fairly and properly exposing the property to the market or otherwise to obtain the best price reasonably obtainable at the date of sale – Silven Properties v RBS [2003] EWCA Civ 1409.
The duty is not breached by a mortgagee's assessment of the market value of the mortgaged property which falls within an acceptable margin of error – Michael v Miller [2004] EWCA Civ 282.
Unless laid down in the documentation agreed between the parties, there is no prescribed procedure that must be followed by a mortgagee in determining how charged assets should be sold – Saltri III v MD Mezzanine [2013] 1 All ER (Comm) 661.

Relevant Facts of CPF v Ortus

CPF made a loan available to Laner Limited (Laner), secured over a property in Dagenham (the Property) and supported by a cross guarantee and a personal guarantee. CPF approached two entities referred to in the judgment as OSF and FFF with a view to structuring the loan as a syndicated loan. The structure that was eventually agreed was that OSF would be the senior participant in the arrangement, providing over £2.4 million, and FFF would be the junior participant, providing funding of approximately £335,000. As part of this arrangement, CPF assigned its beneficial interest in the debt payable under the facility it agreed with Laner Limited to OSF and FFF in proportion to their respective contributions. CPF was appointed security trustee, then replaced by Ortus in this role on 26 October 2020 (the Security Trustee).

By clause 8 of the Security Trust Deed, all amounts received or recovered by the Security Trustee in connection with the realisation or enforcement of all or part of the security were to be applied towards payment in full of the proportion of the debt assigned to OFS as Senior Participant before payment of the proportion of the Debt assigned to FFF as Junior Participant.

In August 2021, Ortus, acting on the instructions of OSF, accepted a settlement proposal by Laner in relation to the debt. Settlement was in the sum of payment to Ortus of £3.5 million and the terms were agreed in a settlement agreement between Ortus and Laner in which Ortus agreed to discharge Laner from its obligations under the facility letter and security documents in consideration of such payment.

OSF was owed £3.54 million, and in accordance with the terms of the Security Deed, was entitled to be paid in priority to FFF. FFF therefore received nothing despite CPF and FFF making representations that the Property was worth at least £5.7 million and that enforcement by appointment of receiver was necessary to protect the interests of both participants.

The Claimants' arguments followed two lines of attack (which were both rejected for the reasons outlined):

OSF and Ortus acted in breach of their duties as trustees under the Trustee Act 2000, specifically under section 15 of the Trustee Act 1925 (Section 15) which contains a general power on a trustee to "compound, abandon……. or otherwise settle any debt, account, claim or thing whatever related to the trust", and paragraph 4 of Schedule 1 of the Trustee Act 2000 which imposes a duty of care when exercising the powers under Section 15. This argument also failed on several fronts including that:
(i) OSF was not a trustee and did not hold title to any asset over which it could have owed trustees duties to either CPF or FFF, and neither Defendant owed CPF any trustees duties because CPF was not the beneficiary of any trust.
(ii) Ortus did not owe FFF any duty of care in relation to the acceptance of Laner's offer to redeem because on the correct construction of the Security Trust Deed, Ortus was entitled and obliged to comply with OSF's instructions. Any powers exercisable in this regard under the Security Trust Deed were subject to an overriding obligation to act in accordance with the instructions of OSF. Saltri III Limited MD Mezzanine SA Sicare [2012] EWHC 3025 was relied upon, noting that it has a similar fact pattern. The court was of the view that in both cases the plain intention of all of the parties was to ensure that the Security Trustee had no independent discretion and that in this case it would act in accordance with the instructions of OSF as Senior Participant.
OSF and Ortus owed to CPF and FFF the same fiduciary and/or equitable duties owed between successive mortgagors when exercising a power of sale. In accepting an offer that was £2 million below the best price that was reasonably obtainable for the Property, they failed in the exercise of those duties. This argument failed on several fronts, each of which is examined below.
(i) The relationship between the claimants and the defendants was held not to be that of successive mortgagees – there was only one charge, and for the duty to apply there would need to be separate charges with separate priority such that enforcement by the first ranking charge holder would have an impact on the extent of the other party's security. FFF and OSF each only had a beneficial interest as participant.
(ii) There was no exercise of a power of sale. The power of sale was vested in the Security Trustee (ie CPF then Ortus and not OSF). Ortus desisted from exercising a power of sale by entering into the settlement agreement. The judgment includes the following remark: "[the] Claimants' case essentially seeks to extend the incidence and scope of the equitable duty owed by a mortgagee when exercising a power of sale so as to fashion a duty owed by a Security Trustee to a junior participant in a syndicated loan agreement when deciding to settle the debt owed by the mortgagor and to release the securities".
(iii) The mortgagee's equitable duty was in any event analysed and the court noted that it is subject to well-established limitations as to the circumstances of exercise and range of parties to whom it is owed. Evershed MR's statement in Re B Johnson & Co (Builders) Lrd [1955] Ch 634 was quoted, as follows: "it is elementary that a mortgagee seeking to realise his security has no duty of care to see that there is as much as possible left over for those who are interested in what is called the equity". It is only if and when a decision to sell is made that equity intervenes to impose a limited duty to obtain the best price reasonably obtainable in the circumstances.
(iv) It was held not to be sufficient for the Claimants simply to assert that a duty akin to that owed by a mortgagee when exercising a power of sale was owed by OSF and Ortus when accepting Laner's offer to redeem the securities. In the absence of any provision in the Security Trust Deed imposing such a duty, the fact that FFF as Junior Participant might suffer a loss as a result of the acceptance by the Security Trustee of a low settlement offer was not in itself enough to warrant the imposition of that duty.

Key takeaways

In this case, the commercially agreed position between the parties was upheld and, it was clear that outside duties that are expressly provided for in the documentation, it will be hard to impose any additional duties on senior creditors and their agents. The parties can, if they wish, at drafting stage, include more detail in relation to distressed disposals on how the duties will be exercised and to allocate responsibility. An example of this is in the Loan Market Association's Leveraged Senior/Mezzanine Intercreditor Agreement where the drafting in relation to distressed disposals provides for the need to obtain a fair market price, having regard to prevailing market conditions but acknowledging that the Security Agent shall have no obligation to postpone any sale in order to achieve a higher price. Safe harbours are also included as optional drafting which include a sale pursuant to a process or proceedings approved or supervised by a court, a sale subject to a competitive marketing procedure or where the sale is at the direction of an insolvency office holder. Junior lenders may seek to tighten these provisions up to require for example a properly conducted competitive marketing procedure, and the need to obtain an independent opinion as to fairness.
This case highlights the precarious position of junior creditors, which is often the accepted position in tiered lending structures. Paget's law of Banking was referred to in the judgment, noting that in the context of tiered lending, the law does not generally intervene to protect junior creditors since the risk of being unpaid or outvoted is inherent in the junior or minority position of the junior participant and is part of the commercial risk that that particular creditor has assumed.
While not being directly applicable on the facts of this case, the narrow circumstances, scope and application of the mortgagee's duty in relation to the exercise of its power of sale was confirmed.
If the parties wish to limit any independent discretion on the part of the Security Trustee, and to ensure the Security Trustee will act in accordance with the instructions of the Senior Creditor, clear wording to this effect should be included in the instrument in which the trust is established. The following wording was used in the declaration of trust in CPF v Ortus:
(i)"The Security Trustee shall hold the Trust Property pursuant to the terms of this Deed for the Participants from time to time and the obligations, rights and benefits vested or to be vested in the Security Trustee in its capacity as lender and chargee by the Finance Documents shall (as well before as after enforcement) be performed and (as the case may be) exercised in accordance with the provisions of this Deed. Unless otherwise expressly provided or otherwise agreed by all the Participants, the Security Trustee shall perform such obligations and exercise such rights in accordance with the instructions of the Senior Participant".
(ii) "The Security Trustee shall seek instructions from the Senior Participant as to the manner in which it should endeavour to carry out any course of action which it is obliged to carry out pursuant to this Deed or the Finance Documents" and "The Security Trustee shall not be obliged or required to act in accordance with the directions of the Participants given otherwise than through the Senior Participant."
One interesting point to note is that better protection may be offered where the mortgage is a regulated mortgage contract under FSMA – a firm administering the contract after the property has been repossessed owes a statutory duty under the Mortgage Conduct of Business to ensure that steps are taken to market the property for sale asap and to obtain the best price that might reasonably be paid, taking into account factors such as market conditions as well as the continuing increase in the amount owed by the borrower under the contract. A person suffering loss would be entitled under s 138D(2) of FSMA to pursue a claim against the firm for damages for breach of statutory duty.