Limitation on mortgagee claims following a shortfall on sale of secured property; Simon Hill and Georgia Bedworth explain how to advise on mortgage shortfalls

The crash in the property market in the late 1980s and early 1990s saw many home owners fall in to negative equity. Great confidence in the market had led some borrowers to leave themselves vulnerable to interest rate increases. When the market turned sour, many borrowers were unable to keep up repayments. Over the period 1990 to 1994, there were 295,720 mortgage repossessions (source: Council of Mortgage Lenders). With many of those who lost their homes having been in negative equity, the result was that, following sale, many borrowers still owed a significant amount to the banks as mortgage shortfall.

A number of these debts have been left dormant, either because the borrowers had no money or they had simply disappeared.

Recently, banks have been asserting their rights to recover these mortgage shortfalls, most likely because: (1) some of these borrowers have got a foot back onto the property ladder and with the well documented increase in property values over the past few years, now appear to be good targets for banks keen to claw back some of the outstanding debt; (2) banks are conscious that if they don’t issue soon, they may find themselves time-barred.

Many borrowers are surprised to find themselves faced with claims for many thousands of pounds after all this time, when they had considered that they had put their financial difficulties behind them. The best, often only, defence open to the borrowers faced with this situation is a defence that the claim is time-barred.

Limitation - relevant period

The relevant limitation period in mortgage shortfall cases has been placed beyond doubt by the House of Lords in West Bromwich Building Society v Wilkinson [2005] 1 WLR 2303, affirming the decision in Bristol & West plc v Bartlett [2003] 1 WLR 284 that s 20 of the Limitation Act 1980 (sums secured by mortgage) applies. In respect of the principal sum, the lender has 12 years from the date upon which the right to receive the money accrued. In relation to interest, the bank must have issued within six years of the date upon which the interest became due. Section 20 applies despite the fact that, as the property has been sold, the debt is no longer secured.

When does time start to run?

There is usually a long delay between default by the borrower and the bank obtaining possession, selling the property and quantifying the shortfall. The House of Lords in Wilkinson held that time begins to run from date of default, not, as the banks had sought to argue, from the date when the shortfall was ascertained. This gives the borrower a head start when considering a limitation defence.

The first step is to analyse the history of the account. When was the last payment under the mortgage made? Add 12 years to that date, check the date of issue and you may find that the bank has issued outside of the limitation period. It is important to remember that neither the realisation of the property nor of any secondary security, such as an endowment policy, amounts to a payment under the mortgage for these purposes.

Extension of limitation period

Unfortunately the matter does not end here. Although there may be more than 12 years between issue of proceedings and the last payment under the mortgage, time may have begun to run afresh by an intervening acknowledgement or part payment.

The relevant part of LA 1980, s 29(5) provides as follows:

“Subject to subsection (6) below, where any right of action has accrued to recover –

and the person liable or accountable for the claim acknowledges the claim or makes any payment in respect of it the right shall be treated as having accrued on and not before the date of the acknowledgement or payment.”

Acknowledgment

In considering the question of acknowledgment, the adviser needs to review all documents that have passed between the parties since the last payment under the mortgage until the issue of proceedings, as one of those letters may amount to an acknowledgment of the indebtedness. It is for this reason that a borrower’s representative must be especially careful in responding to a letter before action if time has not yet expired. It is unnecessary to consider documents served after issue, such as a defence, because, if the claim was time-barred before issue, the debt cannot be revived by any subsequent acknowledgement of it: s 29(7) LA 1980.

The basic requirements of an acknowledgment are that it must be in writing and signed by the debtor or his agent: s 30(1), LA 1980. In this context ‘signed’ means in manuscript and not typed (see Firstpost Homes Limited v Johnson [1995] 1 WLR 1567) and naturally, the admission of liability needs to have been communicated to the creditor or his agent.

Where there are joint debtors, the adviser should consider not only correspondence written by his own client, but also any communications between the co-debtor and the bank. Although one joint debtor is not automatically bound by an acknowledgment of the other, in the case of married borrowers, one spouse may be treated as acting as the agent of the other.

The vital characteristic of an acknowledgement is that it must amount to an unequivocal admission that the debt remains due: Surrendra Overseas Ltd v Government of Sri Lanka [1977] 1 WLR 565. The court must construe the alleged acknowledgment as a whole – the bank will not be allowed to pick and choose those parts of a document which suits it, while ignoring others: Surrendra. It is further arguable that not only must an individual letter be construed as a whole, but that it must be looked at in the context of the whole of the correspondence passing between the parties. A consequence of the importance of context is that words that have previously been found to amount to an acknowledgment are of only limited guidance.

An acknowledgment need not quantify the debt due, it is sufficient that the amount owed may be ascertained by extrinsic evidence: Dungate v Dungate [1965] 1 WLR 1477. However, a document which admits all the facts necessary to give rise to liability, but in which the debtor denies that he is in fact liable, will not amount to an effective acknowledgement: Re Flynn [1969] 2 Ch 403. To be effective, the denial must amount to a denial of liability for all times and all purposes: Bank of Baroda v Mahomed [1999] Lloyds Rep Bank 14. A statement by the debtor that he is unable to pay the debt “at the moment” will constitute an acknowledgement because it amounts to an admission that the liability exists: Dungate.

Where the borrower has asserted a set-off or cross-claim against the lender, e.g., a failure to obtain the “best price reasonably obtainable” on sale of the mortgaged property, the proportion of the debt taken to have been acknowledged will be reduced, or extinguished entirely, by the amount of that set-off or cross-claim. The debtor is treated as acknowledging only the balance of the debt. This is the case no matter how unmeritorious the set-off or cross-claim is. However, note, the Court of Appeal in Bank of Baroda left open the question whether or not all cross-claims have this effect.

‘Without prejudice’ correspondence

[Author's Update: see Bradford & Bingley Plc v Rashid [2006] 1 W.L.R. 2066]

The next step is to consider the nature of the correspondence relied on by the bank. Even where the borrower has acknowledged the debt, the document may have been written ‘without prejudice’ and so be inadmissible in court. The recent case of Bradford & Bingley plc v Rashid [2005] EWCA Civ 1080 vividly demonstrates how this can assist a borrower.

Mr Rashid fell into arrears on his mortgage and, following the sale, his property in 1991, there remained a shortfall of £15,583. The bank issued more than 12 years after the last payment, but sought to rely on correspondence during the 12-year period as restarting the limitation. In 2001, Mr Rashid had consulted an advice centre that sent two letters to the bank on his behalf. These letters offered to pay £500 “towards the indebtedness”. Neither letter was marked without prejudice. However, it was held that these letters were written without prejudice and could not be relied on in evidence by the bank. The bank’s claim was time-barred.

The decision in Rashid is based on three well known principles:
(1) The bank must prove the acknowledgment;
(2) Without prejudice correspondence may not be given in evidence without the consent of both parties; and
(3) Correspondence need not be headed without prejudice to attract without prejudice privilege.

Any letter or document will attract without prejudice privilege if it contains a genuine attempt to settle the matter without resort to litigation: Rush & Tompkins v Greater London Council [1989] AC 1280. If there is a significant amount of correspondence, the chances are that the judge will hold that this amounted to negotiation with a view to settlement. As demonstrated by the low amount offered in Rashid, it is immaterial that the offer of settlement was unrealistic or unlikely to be accepted, so long as it was genuine.

Banks frequently ask borrowers to fill in an income and expenditure form that often contains a space for the borrowers to offer an amount that they can pay each week towards their indebtedness. In the past, banks have relied on such forms as acknowledgments. However, following Rashid, it may be arguable that offers to pay small sums towards the debt do not amount to admissible acknowledgments at all, since they are offers to settle without resort to litigation, and so protected by without prejudice privilege.

Part-payment

Alternatively, the limitation period may have been extended by a part-payment made “in respect of” the debt. A part-payment is a species of acknowledgment. A part-payment will only have the effect of restarting the clock if it amounts to an admission that the balance of the debt remains due: Surrendra.

The act and intention of the debtor are vitally important in considering whether the limitation period has been extended by a part-payment: Re Footman, Brewer & Co Ltd [1961] Ch 443. Indeed, if it appears from the circumstances that the debtor making the payment did not intend to admit that the whole or a particular part of the debt was due, it is arguable that this does not extend the limitation period in relation to the whole of the debt. The debtor must be actively involved in the part-payment. This is why time does not begin again on the sale of the property and payment of proceeds of sale to the bank.

The debtor must intend to acknowledge that claim and no other when making the payment in order for it to be effective under s 29(5): Kleinwort Benson v South Tyneside Council [1994] 4 ALL ER 972. It is the belief and intention of the parties, not the actual legal analysis of the situation, which is relevant.

Appropriation

With most claims now being brought more than six years after the cause of action accrued, whatever part of the original shortfall was interest, will be time-barred. At first blush, it would appear that borrowers could attempt to exploit the different limitation periods applicable to interest and principal sum (six years compared to 12) by means of the doctrine of appropriation, by arguing that the proceeds of sale should be attributed to capital in the first instance, so that the majority of the shortfall consists of accrued interest, and so would be time-barred. In most cases, this question will be dealt with in the mortgage deed. In those cases where it is not, the decision of Neuberger J in West Bromwich Building Society v Crammer [2002] EWHC 2618 (Ch) has put paid to this argument in the majority of cases. Such an argument will only be possible in the unlikely event that the borrower made an express appropriation at the date of sale or where appropriation to principal can be implied from the terms of the mortgage deed, most likely only where there is a repayment mortgage. Advisors should read the mortgage deed and Crammer carefully.

Interest

Banks often claim interest on the shortfall debt from the date that the shortfall arose to the date of judgment. This claim is usually made under s 69 County Courts Act 1984, to which no limitation period applies. However, it may be argued that the court should exercise its discretion against awarding interest for the whole of the period on the ground that the bank ought to have brought its claim sooner or alternatively by analogy with s 20(5) LA 1980, which limits recovery to six years. Further, it may be argued that the court should take account of the fact that banks are able to borrow money at a rate close to the Bank of England base rate when setting the rate of interest under s 69.

Conclusion

Limitation problems frequently arise in mortgage shortfall cases, confronting those acting for banks and borrowers alike. Banks should be careful to look at the question of acknowledgment and part-payment and ensure that it is pleaded specifically. The borrower’s adviser should similarly check the file thoroughly to see whether or not the claim could be defeated on limitation grounds. Rashid has thrown into sharp focus the effect of without prejudice privilege in preventing banks from proving an acknowledgment, with the result that this area is likely to remain a fertile ground for litigation.

SIMON HILL AND GEORGIA BEDWORTH © 2006

BARRISTERS

33 BEDFORD ROW AND 10 OLD SQUARE

Simon Hill and Georgia Bedworth are barristers practising from 33 Bedford Row and 10 Old Square respectively 

NOTICE: This article is provided free of charge for information purposes only; it does not constitute legal advice and should not be relied on as such. No responsibility for the accuracy and/or correctness of the information and commentary set out in the article, or for any consequences of relying on it, is assumed or accepted by any member of Chambers or by Chambers as a whole.