In 16th century England, such clauses were standard practice and routinely upheld. However, contemporary Australian case law is clear – you cannot do it. Why? Because it ‘clogs’ the equitable right of redemption.
upon an event of default, the mortgagor must transfer the mortgaged property to the mortgagee as full satisfaction of the mortgage debt.That is, upon an event of default, the lender will receive full possession of the mortgaged property. If the lender’s predictions are correct, they would receive a $3 million property, which if they could realise at that price, may result in them earning a $2 million profit on their original $1 million loan.
Unfortunately, in 2018, such a transaction structure would be unenforceable, even if the mortgagor agreed to it.
However, if an option to purchase (or transfer) is included as part of the mortgage transaction (as is the case in the above example), then the option will be void for extinguishing – or ‘clogging’ – the mortgagor’s equity of redemption. This position is consistent with the doctrine that ‘once a mortgage, always a mortgage’.
In this scenario, the $2 million gain by the mortgagee – which represents a disproportionate gain compared to the loaned amount – is likely to significantly exceed any damage suffered by the mortgagee because of the default.
The courts have held that a mortgagee exercising a power of sale cannot sell to themselves as it is deemed a ‘logical impossibility’. Nor can a mortgagee sell to an officer, solicitor or agent acting for the mortgagee.
There is an exception to this though. If the purchaser of the security is a person or entity that is only merely associated with the mortgagee, then the sale may be valid. However, the sale must be a truly independent bargain. It cannot be a sale where the purchaser is effectively under the mortgagee’s control.
For instance, in the case of Sewell v The Agricultural Bank of Western Australia (1930) 44 CLR 104, the High Court upheld a sale by a bank to its own employee – a district inspector – in circumstances where the bank was found to have first exhausted all reasonable efforts to sell land through public advertising over 18 months. The sale was valid because the employee was not involved in the process of sale and the bank had taken steps to ensure that the best price for the land was obtained.
However, the mere separation of the transaction or document may not be sufficient to deny the existence of a clog on the equity of redemption. It is the transaction itself which must be independent, and a Court will look to the chronology of the transactions and the substance of the whole transaction to determine whether the purchase is independent of the mortgage.
The law leans towards protecting vulnerable mortgagors and therefore, once a mortgage, always a mortgage.
If you require assistance on loan agreements, related security documents or other finance related matters, please contact Trent le Breton or Danton Stoloff from McCabe Curwood’s Corporate group who have extensive experience in this area.