The balance of power

In this article, I consider the situation where you are acting for a buyer, the seller has defaulted on its obligations to its mortgage lender and the lender considers it appropriate to realise its security by direct use of its power of sale, rather than by appointing a receiver or administrator.

What is a power of sale and when does it arise?

The legislation around a lender’s statutory power of sale is found in the Law of Property Act 1925 (LPA 1925). All references are to this act.

The power arises under section 101(1)(i) once monies have become due and payable by the borrower. Many lenders also include within the underlying security document an explicit right to dispose of a secured property, but in this article, I focus on the operation of the statutory right.

Section 103(i) requires a lender to serve at least three months’ notice on the borrower when demanding payment of outstanding liabilities (which should include the specific figure, as opposed to “all monies” or similar). In practice, lenders will often have drafted security documents in a manner so as to modify or disapply section 103(i), in order to remove this three-month time limit.

Section 104(1) provides that a lender exercising its power of sale may dispose of the secured property by way of a deed. This will usually consist of a form TR2 (see below on “agreeing the form of transfer”). In the case of property with registered title, these powers apply to the proprietor of a registered charge by virtue of sections 51 and 52 of the Land Registration Act 2002.

A lender owes a number of common law duties where it is disposing of a property pursuant to its power of sale. Bear these duties in mind so enquiries can be raised with the lender’s solicitors if there is any doubt as to the lender’s compliance. These duties have arisen through case law, and include obligations to

• act in good faith,
• take reasonable steps to obtain a proper price for the property,
• obtain the best price reasonably obtainable,
• act with reasonable care and skill, and
• act fairly towards the borrower.

Where a lender disposes of a property, it is entitled to retain such sums from the purchase price as necessary to discharge its security (together with any reasonable expenses). The lender must then pass any surplus sale proceeds to any lower-ranking lender or, if there is none, to the borrower.

When will the power be used in practice?

The circumstances of each transaction will vary, but typical scenarios which may give rise to exercise of the power of sale include the following.

• Where a borrower has not made its scheduled repayments and falls into arrears: in most cases, institutional lenders would not immediately proceed to dispose of the property, but instead serve the requisite notice and allow a borrower time to make payment. Generally, lenders will only consider exercising a power of sale where there is a high level of certainty that the borrower will be unable to make the required payments.
• Where a borrower has entered into a contract for the disposal of a property while solvent, but an intervening event of insolvency has occurred between the date of the contract and the completion date, requiring the lender to step in and complete the disposal.
• Where a borrower, lender and, potentially, the buyer have engineered an arrangement pursuant to which the borrower will secure the sale on the basis that the property will be disposed of by the lender pursuant to its power of sale. This may be used in order to overreach any interests over which the lender’s security has priority or to ensure that the completion monies are paid to the lender in an attempt to keep the borrower solvent.

The issues to consider in each  scenario are the same, although it will clearly be an easier process if the borrower is willing to assist with the lender’s disposal.

The buyer will almost certainly be cautious and in need of practical and definitive advice to ensure that the transfer is correctly completed and not subject to any potential challenge.

Dealing with a lender

There is a common misunderstanding on the part of some lenders and most borrowers that in order to exercise a power of sale, a lender must first obtain a possession order from the court or otherwise take possession of the secured property. This is not the case: most lenders which exercise the power of sale do not obtain a possession order or go into possession, although it may be necessary if the borrower refuses to vacate. Normally, however, lenders will look to serve notice and complete the disposal as quickly as possible (subject to compliance with section 103(i)) to reduce their risk of exposure to any potential perceived liabilities. While this is standard practice, it does raise some issues which need to be considered from a buyer’s perspective. I explore these below.

Satisfaction that the lender is entitled to dispose of the property

Section 104(2) makes it clear that any buyer buying a property from a lender pursuant to its statutory power of sale is entitled to assume that the power has arisen and become exercisable. This assumption will only be rebutted if the borrower is aware of a “contrary intention” (section 104(3)). Any dispute arising between the lender and borrower following the transfer will not therefore affect the validity of the transfer or the buyer’s title.

However, it is best practice to check the lender’s power of sale has properly arisen, so you should review the underlying security document to ensure that the power, and therefore its right to dispose of the property, has become exercisable.

Where a demand has previously been served, you should request a copy of the demand and satisfy yourself that it has been properly served and that the outstanding liabilities to which it relates have not been discharged.

Agreeing the form of transfer

Where a lender is disposing of a property pursuant to its power of sale, the transfer should be documented using HM Land Registry (HMLR) form TR2 (transfer of whole of registered title(s) under power of sale). This should be executed by the lender and the buyer, and include a provision that the property is to be disposed of pursuant to the lender’s power of sale conferred by its legal charge. Details of the legal charge must be included in form TR2.

Given that the lender will usually have no actual knowledge of the property, any transfer is likely to be given with no title guarantee, and a lender’s solicitor will often look to further limit any liabilities or obligations on the part of the lender so as to ensure that the purchaser has no right to recourse. It is generally accepted in the marketplace that a lender selling will not give answers to the Commercial Property Standard Enquiries or any other standard enquiries, nor will it give any warranties relating to the property. While any additional risk for the buyer should be reflected in the agreed purchase price, you should carefully consider any aspects of the title to the property for which it is not entirely clear whether indemnity insurance should be arranged.

The buyer will be subject to any rights, covenants and other encumbrances affecting the property as at the date of the transfer and, given that the lender will have no information about any subsisting rights beyond what is on the title, the future use of the property should also be considered, especially if the buyer is looking to develop or redevelop the property following its purchase.

Agreeing the completion mechanics

For a buyer the mechanics of completion are much the same as for a standard transaction. The lender and the buyer will need to execute form TR2 and the usual requisitions on title, and pre-completion searches should be raised.

Where circumstances dictate that a notice is to be served by the lender on the borrower shortly before completion of the transfer, I would recommend that you request specific undertakings from a lender’s solicitor to confirm that it is holding the necessary letter of demand and that that letter will be served upon the borrower at an agreed time prior to completion.

Ensuring the buyer’s registration requirements can be met

The lender’s solicitors should provide you with the lender’s executed part of form TR2, together with copies of any necessary powers of attorney or other documents required to confirm that the stated signatories are authorised to execute form TR2. I would also recommend that you obtain an undertaking from the lender’s solicitors requiring them to provide assistance with any requisitions raised by HMLR in relation to the registration of the transfer.

By entering into a form TR2, the lender is also discharging its security over the property, and no separate discharge (such as form DS1) will be required. No further documents are required by HMLR in relation to the lender’s authority to execute a form TR2, provided the transfer is made at least one month after the date of the security. HMLR’s practice guide 75, ‘Transfer under a chargee’s power of sale’, provides that it will “presume that the power of sale has arisen where the transfer by the chargee is made at least one month after the date of the charge”.

If the property is subject to other security, the buyer will take ownership free from any interests over which the selling lender’s charge has priority, but will be subject to any interests which have priority over the security document. If the TR2 is not being entered into by the first-ranking chargeholder, a DS1 will be required from the prior chargeholder, and you will need to ensure that the completion mechanics cover the necessary payment to the prior chargeholder to deal with the discharge of its security.

Accepting a transfer from a lender pursuant to its power of sale does provide some additional considerations, and clients should be properly briefed on the complexities. However, the conveyancing mechanisms involved are quite straightforward and, provided the necessary due diligence is undertaken, our legal system together with HMLR should provide for a smooth transaction.