McDonagh v Bank of Scotland & Others  EWHC 3262 (Ch) concerned a dispute between a borrower, Mr McDonagh (“the Claimant”) and a lender, Bank of Scotland (“the Bank”) in respect of the borrower’s default on a loan facility which had been used to refinance commercial property in an out of town business park near Liverpool. There was a consequential and related dispute between the Claimant and the fixed charge receivers appointed by the Bank, in which the Claimant alleged that the receivers had failed to achieve the ‘best price reasonably obtainable’ when selling the premises, and had failed to expose the property to the market because it had only been marketed for sale as part of a mixed borrower portfolio.
McDonagh not only gave rise to questions of contractual construction regarding the Claimant’s loan facility with the Bank, but also concerned allegations of duress, intimidation and, in the action against the receivers, resulted in an interesting consideration of the duties owed by fixed charge receivers when selling a property as part of a larger portfolio. Morgan J’s conclusions will be of interest to those practising in the area.
In 2007 the Claimant obtained a loan of £7.5m (“the First Loan Agreement”) from the Bank for the purposes of purchasing commercial premises in Liverpool known as Sony House (“the Property”). In addition to the Bank’s standard terms and conditions, the material provisions of the First Loan Agreement were:
“Seven Million Five Hundred (sic) (£7,500,000) to be drawn down in Euros (the “term loan”).”
“You may only use the term loan to assist with the purchase of [the Property].
The term loan will be drawn down into your Euro account with us (to be opened) which will operate as the servicing account for the term loan.”
“You will pay interest on the term loan at the annual rate equal to one point two per cent (1.2%) over the cost of funds incurred by us for making the term loan available, such interest payable quarterly in arrear …
The relevant cost of funds will be set by us on or before the date of drawdown of the term loan and will be based on the Euro fixing rates provided by the British Bankers Association on the relevant date which shall be the date of drawdown or such earlier agreed date.
Interest will be debited to your servicing account quarterly in arrears unless that day is not a Business Day, in which case it will be applied on the next Business Day
All sums payable under this letter, with the exception of the arrangement fee and the interest rate contract fee, shall be paid in Euros. If you fail to pay any amount due under the term loan when due, we may at any time purchase an equivalent amount of Euros as we consider necessary or desirable to cover the amount due and payable under the term loan at its prevailing spot rate of exchange and you shall indemnify us against the full cost to us (including all costs, charges and expenses) incurred by us in purchasing the said Euros.
Whenever the “Sterling equivalent” of the term loan requires to be calculated, it shall be calculated at our spot rate of exchange for Euros on the applicable date at such time as we may select.
The Default Rate of interest which will apply to the term loan is the annual rate of two point four per cent (2.4%) over the rate at which interest is paid on the term loan under this letter.
“The term loan will be repaid in one lump sum of Seven Million Five Hundred (sic) (£7,500,000) on the date being thirty six months from the date of drawdown or (if earlier) upon receipt of the proceeds of the Property. If for any reason the proceeds are less than the outstanding amount of the term loan a balancing payment will be debited to your servicing account on the date of the disposal of the Property or an Event of Default whichever is the earlier … For the avoidance of doubt, you will apply the net sale proceeds of any disposal of all or any part of any real or heritable property owned by you and secured to us in permanent reduction of the term loan.”
The Claimant purchased the Property using the First Loan Agreement monies and granted the Bank a first legal charge over the two leasehold titles that comprised the Property. The terms of the charge permitted the Bank to appoint receivers in the event of default; reserved the Bank’s right to do so pursuant to the Law of Property Act 1925 (“the LPA 1925”) and granted the receivers full power to sell the Property.
On 11 February 2010 the Claimant and the Bank entered into a second loan agreement (“the Second Loan Agreement”), the purpose of which was to refinance the First Loan Agreement. The material provisions were:
“The Borrower may only use the Facility to refinance existing facilities made available by [the Bank] to the Borrower.”
“When drawn, the Term Loan may only be applied in repayment of the Borrower’s existing term loan facility with [the Bank] and the Borrower authorises [the Bank] to apply the Term Loan for that purpose.”
“The Term Loan shall (subject to the other provisions of this letter) be repaid in full by a single bullet repayment on 13 July 2010.”
“The Borrower will, as security for the Term Loan, deliver or procure delivery of the Security Documents detailed in Schedule 1.”
Schedule 1 of the Second Loan required a first legal charge to be secured over a number of properties, including the Property, Balcora House and Flat 6, Sackville Place, Manchester (“the Security Properties”).
Schedule 5 of the Second Loan Agreement contained financial covenant. Paragraph 1 of Schedule 5 provided for a loan to value ratio and ratio for interest cover. The loan to value ratio was expressed as 0.8:1. This was the same ratio as expressed in the first loan agreement, save that it was there expressed as the reciprocal value to the loan ratio of 1.25:1. Paragraph 2 of Schedule 5 provided: “It is acknowledged that, at the date of this letter, the financial covenants set out in paragraph 1 above are not being met. Accordingly [the Bank] agrees that the testing of the financial covenants will be suspended until the Final Repayment Date.”
Unfortunately, the value of the Property fell, although the extent of that depreciation was in issue between the parties. The Bank sought repayment of the First and Second Loans, but the Claimant failed to make those repayments. The Bank accordingly exercised its rights under the LPA 1925 and the terms of the First and Second Loan Agreements to appoint receivers. The receivers initially appointed were replaced by the LPA Receivers in March 2011.
The LPA Receivers sold the Property in October 2011 as part of a portfolio of 35 properties (“the Portfolio”). The Portfolio sold for £41m and the sum of £3,780,215 was credited to the Claimant in respect of the Property. The sum credited reflected the ‘pro rata’ amount of the total portfolio sum determined by reference to an independent valuation by CBRE conducted shortly before the Portfolio was launched to the market. However the Claimant claimed that the Property should not have formed part of the Portfolio and that, had it been sold separately, it would have achieved more than £3,780,215 on the open market. The Claimant also alleged that the pro rata sum credited did not accurately reflect the Property’s share of the Portfolio sum.
The Claimant issued claims against the Bank for breach of contract and tort and against the LPA Receivers for selling the Property at an undervalue. The Bank counterclaimed for the sums due to it pursuant to the First and Second Loans. The two claims were tried together.
The parties’ positions at trial
There were a significant number of issues in dispute between the Claimant and the Bank and the Claimant and the LPA Receivers, which are set out in full in the judgment. However, they can be shortly summarised as follows.
- As against the Bank, with regards the First Loan Agreement:
- The Claimant alleged that on a proper construction of the First Loan Agreement the sum of £7.5m was repayable (irrespective of the euro exchange rate), whilst the Bank claimed that under the First Loan Agreement was made in euros and the Claimant was required to repay all monies outstanding under the facility to redeem it, not a fixed sum of £7.5m.
- In the alternative, the Bank argued that if the Claimant’s interpretation of the First Loan Agreement was correct then the Claimant was either estopped from relying upon that interpretation or the First Loan Agreement should be rectified for common mistake.
- If the Claimant’s interpretation of the First Loan Agreement was correct, he claimed that the Bank had acted in breach of the First Loan Agreement by demanding repay of the First Loan in euros.
- As against the Bank and with regards to the Second Loan Agreement:
- The Claimant denied that the Bank had provided any consideration for the Second Loan Agreement, but the Bank claimed to have suspended the testing of the loan to value covenant in Schedule 5 of the Second Loan Agreement, thereby giving consideration.
- The Claimant also claimed to have entered the Second Loan Agreement as a result of duress and/or intimidation from the Bank and sought damages in respect of the same, which the Bank denied.
- The Bank counterclaimed for the money outstanding under the First and Second Loan Agreements.
- Finally, the Claimant brought a claim against the LPA Receivers alleging that they had acted in breach of their duty by including the Property as part of the Portfolio, thereby selling it for less than it would have achieved on the open market had it been sold separately. In essence it was alleged that the Property was the “jewel in the crown” of the Portfolio, or “bait” to entice potential buyers to purchase the other, less desirable, properties in the Portfolio. The LPA Receivers denied acting in breach of duty and claimed that the decision to the sell the Property as part of the Portfolio was made to maximise the Property’s value. The fact that the sum achieved was less than the CBRE valuation reflected the poor state of the market for secondary property liked the Property at the relevant time.
Morgan J handed down a careful and detailed judgment that rejected the Claimant’s claims against both the Bank and the LPA Receivers. Morgan J’s conclusions and reasoning are considered below.
The interpretation (or rectification) of the First Loan Agreement and the Bank’s alleged breaches thereof
At  – , Morgan J considered the meaning and effect of the First Loan Agreement. After applying the principles of construction set out by the Supreme Court in Arnold v Britton  A.C. 1619 and Wood v Capita Insurance Services Ltd  A.C. 1173 to the terms of the First Loan Agreement and the permissible factual matrix (applying the test laid down in Chartbrook v Persimmon Homes Ltd  1 A.C. 1101), Morgan J concluded that:
- On a proper construction of the First Loan Agreement it was made in euros and not sterling. With the exception of clause 1.5, the First Loan Agreement referred to the repayment of a sum expressed in sterling. However, clauses 1.5 and 1.3 (set out above) had to be read together, and clause 1.3 required the sums payable pursuant to clause 1.5 to be paid in euros. Accordingly, applying an exchange rate of 1.47 euros to the pound, the Claimant had borrowed €11,071,500.
- Contrary to the Claimant’s proposed interpretation of the First Loan Agreement, he had to repay €11,071,500 to redeem the First Loan in full, not £7.5m sterling’s equivalent in euros at the date of repayment (an amount significantly less than €11,071,500) Morgan J considered the First Loan Agreement against the permissible factual background and found that the effect of the Claimant’s interpretation of the agreement was unusual, was not expressly provided for by the First Loan Agreement and was contrary to commercial sense.
- The Bank’s alternative construction, which required the reference to £7.5m being removed from clause 1.5 and the First Loan to be interpreted in its absence, should be rejected in favour of the construction set out in (b) above. Whilst East v Pantiles (Plant Hire) Ltd (1981) 263 E.G. 61, KPMG LLP v Network Rail Infrastructure Ltd  Bus LR 1336 and Chartbrook permitted the Court to adopt the Bank’s alternative approach to correct a clear and obvious mistake, to do so would have been a “radical”
In the further alternative, the Bank argued that the Claimant was either estopped by convention from pursuing his construction of the First Loan Agreement or that the First Loan Agreement should be rectified on the grounds of common mistake. Although Morgan J’s construction of the First Loan Agreement meant that he did not need to consider the Bank’s alternative arguments, he concluded that if the Bank had failed on its case as to construction it would have had a “clear” case for rectification:
- The applicable principles were those set stated by Lord Hoffmann in Chartbrook at , namely: (i) the parties had a common continuing intention, whether or not amounting to an agreement, in respect of a particular matter in the instrument to be rectified; (ii) there was an outward expression of accord; (iii) the intention continued at the time of the execution of the instrument sought to be rectified; (iv) the instrument mistakenly failed to reflect the parties’ common intention.
- It was apparent from the contemporaneous documents and witness evidence that the Claimant had wanted a euro loan so that he could benefit from the lower rate of interest and the Bank had agreed to make a euro loan. If the Claimant’s construction of the First Loan Agreement was correct, it would not have reflected the parties’ shared intention at the date the First Loan Agreement was executed.
As a result of Morgan J’s construction of the First Loan Agreement, he concluded at  –  that the Bank had not acted in breach of contract by calling on the Claimant to repay the full amount of the First Loan Agreement in euros, or when relying upon the Claimant’s failure to do so as a reason for appointing receivers.
The Second Loan Agreement
With regards the Second Loan Agreement, the Claimant alleged that the Bank had failed to provide consideration and that he had been forced to enter into it under duress. Morgan J rejected both of the Claimant’s arguments:
- As explained at , at the date of the Second Loan Agreement the Claimant was in breach of loan to value covenant of the First Loan Agreement. Schedule 5 of the Second Loan Agreement suspended the testing of the covenant and the Bank therefore did not treat the Claimant as being in default. He had, therefore, received something of value.
- As the Claimant’s case on duress was premised on his construction of the First Loan Agreement (i.e. he was only required to repay £7.5m under the First Loan Agreement, but had been intimidated into entering the Second Loan Agreement pursuant to which he was obliged to repay €11,071,500) it fell away following Morgan J’s conclusions about the proper construction of the First Loan Agreement.
- Nevertheless, Morgan J considered the Claimant’s allegations of duress and intimidation in full. It was agreed that the legal principles were as stated by Dyson J in DSND Subsea Ltd v Petroleum Geo-Services  BLR 530 and Leggatt J in Nehayan v Kent  EWHC 333 (Comm). However, Morgan J found that the Claimant was unable to satisfy the relevant test for the reasons summarised at . They included, amongst others, that: (i) the Claimant was in default; (ii) the Bank was therefore entitled to take action; and (iii) the Bank did not immediately exercise its legal rights, but gave the Claimant the opportunity to provide extra security (which was not provided) and restructure on the terms of the Second Loan Agreement.
The Bank’s counterclaim for payment of the sums owed under the First and Second Loan Agreements
As a result of Morgan J’s findings in respect of the First and Second Loan Agreements, the Bank succeeded on its counterclaim for the sums due to the Bank pursuant to the same. The only remaining dispute concerned the credit that should be given by the Bank for the Property following its sale, which was the subject of the claim against the LPA Receivers and is considered below.
The Claimant’s claim against the LPA Receivers
A significant number of shifting allegations were made against the LPA Receivers, but by the end of the trial the thrust of the Claimant’s case was that the LPA Receivers’ decision to sell the Property as part of the Portfolio resulted in the Claimant’s loan account with the Bank being credited with less than the market value for the Property. The Claimant did not seek an account and did not seek permission to amend his case to pursue one.
Morgan J considered Silven Properties v Royal Bank of Scotland  1 W.L.R. 997, in which the Court of Appeal discussed the duties owed by a fixed charge receiver when exercising a power of sale, and concluded at  that: “When considering whether a mortgagee or a receiver has committed a breach of the equitable duty to take care to obtain the best price reasonably obtainable, the court must recognise that the mortgagee or receiver is involved in an exercise of informed judgment and if he goes about the exercise of his judgment in a reasonable way, he will not be held to be in breach of duty. An error of judgment, without more, is not negligence or a breach of the relevant duty in equity.”
He then proceed to consider Bell v Long  2 B.C.L.C 706, in which the receivers had been criticised for selling four properties as part of a portfolio rather than selling them individually and adopted Patten J’s conclusion that: “Whatever the weight of the arguments for and against recommending acceptance of the portfolio bid from [the buyer] I am satisfied that [the selling agent advising the receiver] made the decision for himself based on his own re-assessment of the market and that the advice contained in his Second Report represented his genuine views of the most prudent course for the receivers to take. For an allegation that this advice was negligent to succeed it is not enough to produce evidence which shows with the benefit of hindsight that an alternative strategy could or would have produced a higher return. What has to be demonstrated is that no competent valuer standing in [the selling agent advising the receiver’s] shoes at the time when the information which he had could reasonably have given the advice contained in his Second Report.”
Having set out the general principles, at  –  Morgan J discussed whether any special principles applied to a “portfolio” sale, concluding that:
- The inclusion of a property within a portfolio for the purposes of exercising the receiver’s power of sale is not a breach of duty if the receiver is satisfied, acting reasonably, that its inclusion is likely to obtain the best price reasonably obtainable in the market (i.e. thereby satisfying the test restated by the Court of Appeal in Silven at ).
- The decision to include a property in a portfolio sale involves an exercise of judgment. An error of judgment is not, without more, a breach of the receiver’s duty. However, “the receiver is not able to include a mortgaged property in a portfolio sale unless the receiver asks himself whether that course is likely to be in the best interests of the mortgagor of that property. It is not good enough for the receiver to want to include that property in the portfolio in order to help the mortgagee or even the owners of other properties where he has been appointed receiver. Further, the receiver must actually ask himself the relevant question. If he does not do so, then his decision not to conduct a conventional separate sale of the property where he has not formed the view that including the property in a portfolio is likely to be in the best interests of the mortgagor of that property will be a breach of duty.” As a result of the foregoing, some evidence of the receiver’s reasoning should be on the receiver’s file.
- Once the property has been sold the receiver is under a duty to ensure that the correct portion of the total sale proceeds raised by the sale of the portfolio is attributed to the property in question. In the event of a dispute as to the correct apportionment, that dispute would have to be resolved by the Court.
- Even if a receiver wrongly sells a property as part of a portfolio it does not mean that the mortgagor has suffered loss. The mortgagor will have to establish, by reference to valuation evidence, that the sum attributed to the property by the receiver is less than the achievable price of the property had it been sold separately.
- A receiver that sells a property as part of a portfolio of properties does not have the benefit of the Michael v Miller  2 E.G.L.R 151 defence that the market was tested for the individual property.
Following consideration of the contemporaneous documents, the witness evidence and the “receivership experts”, Morgan J concluded that the LPA Receivers had given adequate consideration to the Claimant’s interests and had sold the Property as part of the Portfolio to achieve the best possible price for the Property. Contrary to the Claimant’s allegations, the LPA Receivers had not used the Property as “bait” to entice investors to purchase the less desirable properties in the Portfolio. Morgan J accordingly rejected the Claimant’s claim against the LPA Receivers.
Although Morgan J’s findings about the receiver’s methodology meant that there was no need to consider the valuation evidence, and the judge made no findings in respect of the same, he did pass comment on the quality of the expert valuation evidence at  – . Of particular note was the criticism levelled at the Claimant’s valuer for failing to consider any comparable properties, adopting an inappropriate yield and valuing the rental income on the unrealistic premise that the Property would continue to provide the same income in perpetuity (notwithstanding that the sitting tenant’s lease was coming to an end).
The conclusions reached by Morgan J in McDonagh not only determined the specific issues between the parties. The case is worthy of note by commercial, banking and professional liability lawyers for several reasons.
Firstly, Morgan J’s analysis of the duties owed by fixed charge receivers when conducting a portfolio sale will be of particular note to receivers and lawyers alike. As the judge acknowledged, the conflict between the interests of the mortgagor and the mortgagee when a property is sold by receivers is resolved in favour of the mortgagee. A receiver is therefore entitled to decide the time and manner in which the property should be sold (an assessment in respect of which mortgagees and receivers are extended significant latitude: see Bell) in favour of the mortgagee.
However, once the time and method of sale have been determined, the receiver is under a duty to obtain the best price reasonably available. The law has, therefore, always protected the mortgagor’s interests when either a mortgagee or fixed charge receiver decides to include a property in a portfolio sale.
As Morgan J explained at [146 – 148], where a property is included as part of a portfolio the question for the receiver is whether the sale is likely to achieve the best price possible for the relevant property; the receiver should not simply include a property in a portfolio sale at the behest of the mortgagee without first assessing what price is likely to be achieved by (or apportioned to) the relevant property (although a receiver acting as agent of the mortgagor should exercise independent judgment in respect of any sale). When determining if the receiver’s judgment was exercised reasonably, the Court will consider the receiver’s own deliberations about how to obtain a proper price for the property.
Morgan J’s judgment therefore clarifies the position in respect of portfolios comprised of properties in diverse ownership. Whilst the fixed charge receiver’s primary duty remains to the mortgagee, when a portfolio of properties is sold the receiver is also under a duty to each mortgagor to obtain the best possible price for each property and he is therefore required to consider in each instance if a portfolio sale is likely to achieve the best price reasonably available for each component part. McDonagh therefore underlines the need for detailed record keeping and reasoned justification by receivers for the inclusion of a property in a portfolio sale.
Secondly, McDonagh restates the need for a mortgagor to claim an account when contesting the apportionment of the total portfolio sale proceeds to an individual property. As Morgan J explained at , in the absence of such a claim he was not required to investigate what sum might have been appropriate to credit to the Property and the Claimant was accordingly bound by the decision of the LPA Receivers to credit the sum of £3,780,215 to the Claimant’s loan account.
Finally, the judgment in McDonagh is a further example of the modern approach taken by the Court when tasked with interpreting commercial contracts. Whilst the Court is prepared to adopt a commercial approach to the construction of loan agreements, it is reluctant to take “radical” steps such as removing the words expressly used by the draftsman if it is unnecessary to do so. As was the case in McDonagh, a claim for rectification may face greater chances of success than a contractual interpretation that requires violence to be done to the language of the draftsman.
Disclaimer: this article is not to be relied upon as legal advice. The circumstances of each case differ and legal advice specific to the individual case should always be sought.
Siân Mirchandani: Since joining in 1998 following pupillage in Chambers and an earlier career as a veterinary surgeon, Siân Mirchandani has established a thriving and wide ranging practice in five areas: professional liability claims, construction/engineering, disciplinary, property damage and insurance.
Siân has wide and considerable experience of professional liability claims, including claims against lawyers (solicitors and barristers), architects, engineers, insurance brokers and agents, surveyors and valuers, accountants, financial services professionals, receivers, land management agents, farm management agents, estate agents, clinicians and veterinary surgeons. Siân is also a TECBAR accredited adjudicator.
Siân’s particular interest in disputes involving technical and scientific elements has led to a strong construction/engineering practice, a busy property damage practice and experience in regulatory and experimental product testing claims. As part of her insurance brokers’ negligence practice Siân is often instructed in claims where the insurer is the co-defendant, following avoidance of a policy. Siân has extensive experience of advising and acting for both insurer and insured on claims concerning policy construction and coverage issues.
Nicholas Broomfield joined Chambers following completion of his pupillage in 2011. He has developed a busy commercial chancery practice with particular emphasis on commercial, banking and mortgage related disputes, insurance litigation, claims involving issues of real property and land law, professional negligence claims and the law of trusts and restitution.
Nick is described by the directories as “exceptionally bright, tactically astute, very easy to work with and great with clients”. His banking, finance and mortgage cases of note include Scott v Southern Pacific Mortgages Limited in the Supreme Court, Mortgage Express v Lambert and Pathania v Adedeji in the Court of Appeal and Landmark Mortgages v Bamrah on appeal to the High Court. Nick is also a contributor to Cousins, The Law of Mortgages (4th ed).