Appeal Court amplifies marshalling rights

Marshalling is an equitable doctrine which permits a second mortgagee to, in appropriate circumstances, access the proceeds of sale of a property over which it held no mortgage in priority to other creditors.

The circumstances which attract the operation of the doctrine (or, more accurately, the circumstances which will disentitle a secured creditor to marshal securities) were examined by the Victorian Court of Appeal in Burness v Hill[1] (Burness). The court’s reasons confirm that a secured creditors’ right to a marshalling of securities will not easily be dislodged.

Background

Thomas Love owned three properties in Epping, Victoria. Antony Hill was his solicitor.

Mr Love borrowed approximately $12 million from a bank, secured by a first mortgage over each of his three properties. Mr Love was soon in default of the mortgages. He also owed moneys to Mr Hill for legal fees.

He granted a second mortgage to Mr Hill over one of the properties for unpaid legal fees and disbursements. The mortgage included an “all moneys” term.

Mr Hill later sought further security from Mr Love, then purported to create a charge by sending an email referring to Mr Love’s acceptance of the request for further security. Following the email, Mr Hill lodged a caveat over the other two properties claiming an interest pursuant to the charge (being the email Mr Hill had sent to Mr Love).

The first mortgagee sold the property encumbered by both its mortgage and Mr Hill’s. The proceeds of sale were insufficient to discharge the debt secured by the first mortgage, and Mr Hill’s second mortgage was removed from title upon registration of the transfer.

Some months later, following the issue of a notice by Mr Love, the caveats lodged by Mr Hill lapsed. At this stage, Mr Hill had no registered security for his unpaid legal fees or disbursements.

Mr Hill then commenced proceedings for his unpaid legal fees and disbursements of approximately $4.15 million. In the proceedings, Mr Hill admitted he did not have a caveatable interest in the two properties. The proceedings were resolved in accordance with terms of settlement that provided that Mr Love would consent to judgment in favour of Mr Hill in the amount of $2.2 million.

The first mortgagee subsequently sold the second of the three properties and again the net proceeds were insufficient to discharge Mr Love’s debt to the first mortgagee.

There remained one property in Mr Love’s name. Mr Hill lodged a caveat over that property on the ground that, under the doctrine of marshalling, he had a right to be subrogated to the first mortgagee’s position.

Mr Hill commenced proceedings to establish that right, claiming that his second mortgage over the property sold first gave him the right to stand in the shoes of the first mortgagee of the remaining property and be paid the amount secured by his second mortgage, now the judgment debt, plus interest and costs. The first mortgagee subsequently sold that property and paid the $5.9 million surplus into court.

The issues at trial (and on appeal) were:

• Was Mr Hill entitled to the benefit of marshalling where his judgment debt did not (in that form) exist at the time the first property was sold?
• Did the non-binding arrangement between the first mortgagee and Mr Love as to the order of sale of the properties disentitle Mr Hill to the benefit of marshalling?
• Did Mr Hill release his marshalling rights, by the terms of settlement of the proceeding against Mr Love?
• Did an Anshun estoppel[2] operate by reason of Mr Hill’s failure to claim the marshalling right in those proceedings?

Relevant principles

The principles applied by the Victorian Court of Appeal in Burness (as articulated in Szepietowski v National Crime Agency[3] (Szepietowski)) were:

Marshalling [is] allowed to a creditor, in a case where: (i) his debt is secured by a second mortgage over property (the common property); (ii) the first mortgagee of the common property is also a creditor of the debtor; (iii) the first mortgagee also has security for his debt in the form of another property (the other property); (iv) the first mortgagee has been repaid from the proceeds of sale of the common property; (v) the second mortgagee’s debt remains unpaid; and (vi) the proceeds of sale of the other property are not needed (at least in full) to repay the first mortgagee’s debt. In such a case, the second mortgagee can look to the other property to satisfy the debt owed to him.[4]

The court applied these principles as follows.

Was the debt secured?

It was contended that the judgment in the earlier proceeding had the effect that Mr Love’s debt to Mr Hill ceased to have an independent existence, the merger of the debt into the judgment creating a new charter of rights. It followed, so went the argument, that there was no debt secured by the second mortgage at the time the first property was sold.

This was rejected in reliance on the doctrine of res judicata. The court found that a merger of rights following judgment on a cause of action does not eliminate the initial obligation and replace it, thereby retrospectively extinguishing the earlier rights.

As Mr Hill held an all moneys mortgage, his marshalling right was not limited to the exact amount and legal character of the secured debt at the time. Moreover, the court found that it would be an absurd result if a second mortgagee lost the right to marshal securities by obtaining judgment. It would also lead to a first mortgagee being in a position to “auction” the choice between the second mortgagee (who would be prepared to pay to enforce against the other property) and the unsecured creditors of the mortgagor (who may also be prepared to pay to enforce against the common property).

Agreement as to the order of the sale of property

In Szepietowski it was accepted that if the first mortgagee was contractually bound to look first to property subject to two or more mortgages, it must do so, as the “basis of the right to marshal is the arbitrariness of allowing the first mortgagee’s decision as to which asset to enforce against to affect the second mortgagee’s rights.”[5]

This principle was relied upon to support the argument that an agreement between Mr Love and the first mortgagee to sell the first property (also subject to Mr Hill’s mortgage) meant that it was not “arbitrary or capricious” to sell it first. However, the court found that no binding agreement existed between the first mortgagee and Mr Love as to the order of sale. The (so-called) agreement was simply an accommodation by the first mortgagee of Mr Love’s desire to sell that particular property first.

Did Mr Hill release his marshalling rights?

The deed of settlement signed in the proceedings between Mr Hill and Mr Love included a release in general terms of a kind usually found in such agreements.

It was accepted that, at the time the terms of settlement were signed, neither Mr Hill nor Mr Love knew that Mr Hill had a marshalling claim.

Applying the principles of contractual interpretation that require consideration of matters including the commercial purpose of the relevant terms, the court rejected the contention that the commercial purpose was to put an end to all conceivable further dispute between the parties in respect of the earlier proceedings and the retainer of Mr Hill. Critically, there was no marshalling claim in dispute on the pleadings, and no evidence that Mr Hill’s retainer included provision for the giving of security for unpaid fees.

The court applied the principles articulated in Grant v John Grant & Sons Pty Ltd,[6] to the effect that the words of a release are restrained by a particular recital and that the general words of a release should be restricted or read down by reference to the disputes existing between the parties at the time the release is given.

Was there an Anshun estoppel?

It was argued against Mr Hill that it was unreasonable for him not to have raised his marshalling claim in the proceedings, in answer to Mr Love’s counterclaim for damages in respect of the wrongfully lodged caveat. It was said further that Mr Hill, at that stage, ought to have considered whether he had a caveatable interest on some other basis and been alerted to the existence of the marshalling claim.

The court disposed of this argument on the basis that even if Mr Hill knew about the marshalling claim (and it was accepted that he did not) he would have been justified in refraining from litigating that claim in the earlier proceeding because:

• the marshalling claim was irrelevant to the debt recovery claim
• including a marshalling claim would have serious consequences for all parties, as it would have been necessary to join other parties including the first mortgagee, thus increasing complexity and cost (and making the proceeding more difficult to compromise)
• if the earlier proceedings had been determined, there was no risk that judgment would conflict with Mr Hill’s marshalling rights as the earlier proceedings would have resulted in a monetary judgment, while the marshalling claim concerns Mr Hill’s security
• at the time of the earlier proceedings, it was reasonable for Mr Hill to consider that the two remaining properties owned by Mr Love were sufficient to meet his debt claim

Conclusion

The decision in Burness confirms that marshalling rights will not easily be extinguished. The policy reasons which underpin the robustness of the doctrine include that it improves the position of the second mortgagee as against unsecured creditors, not the debtor themselves. The rationale identified by the court included the observations in Szepietowski, to the effect that it would be an unattractive and adventitious benefit to the first mortgagee if marshalling was not available to the second mortgagee, where the first mortgagee could choose the property against which it enforced a sale, and effectively auction that right between the second mortgagee and unsecured creditors.