Legal aspects of Assisted Voluntary Sales


More lenders are looking at the option of Assisted Voluntary Sales as they seek alternative ways to deal with arrears and repossessions. David Bailey of SGH explains what lenders should look out for if they are considering going down this route

The handling of accounts in arrears has always been a critical issue for lenders, even in the by-gone era when repossessions were a simple legal and arithmetic exercise. It always had a high cost and was never as straight forward as the situation may have appeared at first glance.

Over the last few years, forbearance practices have been increasingly encouraged by the Financial Services Authority, followed by the industry and demanded by the economic circumstances.

Getting borrowers to the end of that tunnel has been, laudably, everyone’s priority. But many have reached the end to find that there is no light: forbearance measures are exhausted, arrears are stacking up and there are no prospects for borrowers or for lenders to reduce the debt.

At that stage, repossession is almost guaranteed to generate a large shortfall. The borrower is also unlikely to be willing to leave his house after so many months trying to salvage the situation. Walking away from it is no longer an option – and yet may seem to be the only one available.

Enter the AVS, or Assisted Voluntary Sale. There is no legal definition of the scheme but it is certainly taking shape, rising out of economic need, market practice and possibly, transatlantic emulation.

AVS has the obvious advantage of placing the borrower back in control, which is not only consistent with the overall stance of the regulatory dispositions on arrears handling and fair treatment of customers, but is also likely to minimise legal costs, as any negotiated solution would. It may, however, be advisable to keep a close eye on that particular trend.

USA

In North America, where those schemes have been implemented for a while and have become much more structured and, as a result, engrained in the economic and social culture, the level of control exercised by the borrower is in danger of turning the situation on its head. We mentioned in these pages some TV programmes that have run entire shows around the idea of “walking away” from one’s mortgage.

There are now countless services available online and through specialist “realtors” that promote “strategic default”. What started as a commendable notion - that of allowing borrowers who could foresee their financial difficulties to put their affairs in order while they could still afford their mortgage - appears to have degenerated into a pseudo-political campaign of “living off your bank for eight months” and “how to stay in your house without paying a penny”.

Admittedly, the underlying principle may be worthwhile and some banks themselves have been contributing to those schemes, such as Chase in the US, who recently made the headlines for offering up to $30,000 cashback to borrowers who proceeded to a “short sale” before they went into arrears.

But the industry that has developed on the back of these creditable intentions is another matter altogether. The “advisors” and other “short sale specialists” that are now involved have turned the market into a parody of social justice.

UK courts

Should those schemes ever have to be examined by British courts, will they look upon lenders’ conduct and involvement in a favourable light? Will lenders who find themselves with shortfalls after the borrower has taken full advantage of the scheme on offer receive much sympathy?

The 1993 case of Palk v Mortgage Services Funding Plc ([1993] ch330) springs to mind: in a situation where the borrowers wanted to sell their house but the lender was of the view that selling was not economically sensible, the Court of Appeal eventually found that the lender did not have a choice over whether it wished to pursue its security and “law and equity alike had set bounds to the extent to which it could look after itself and ignore the mortgagor's interests”. In that case the lender had “embarked on a course of realisation which was likely to be highly prejudicial to Mrs Palk's financial position as borrower”.

The analogy may appear tenuous, but there is no doubt that this decision could conceivably have paved the way for an enhanced responsibility of the lender in circumstances where borrower and lender are trying to find a negotiated way forward and disagree on the best course of action

Strategic defaults

At the risk of sounding even more alarmist, this highlights some of the risks that could result from allowing borrowers to take full control of the situation, which is the case in “strategic defaults”. Typically the borrower is still solvent and able to repay the mortgage but for reasons of its own, whether an impending redundancy or simply the wish to move on to pastures new, no longer feels that its mortgage suits its lifestyle.

One US specialist website offers step by step advice on “How To Strategically Default On Your Mortgage And Make Life Miserable For Your Bank” and how to walk away from your mortgage without owing your lender a penny (www.businessinsider.com).

It is somewhat reassuring to know that even when "strategic default" makes economic sense, many homeowners shy away from it, out of fear and guilt, according to Brent White, a University of Arizona real estate expert, who goes on to deplore: "We have a double standard... individuals are told they have a moral obligation to pay their mortgages and corporations understand that contracts are to be breached when it's not economically efficient.”

Breach of contract is obviously at the core of the whole issue. As reminded by Munby LJ in the recent case of Bank of Scotland plc v Zinda [2011] EWCA Civ 706, there is indeed a contract amidst the confusion even though “a mortgage (is) neither the loan nor the contract, it (is) that element of the overall transaction constituting the charge on property which gave the lender his security.”

It is somewhat reassuring to know that even when "strategic default" makes economic sense, many homeowners shy away from it, out of fear and guilt, according to Brent White, a University of Arizona real estate expert, who goes on to deplore: "We have a double standard... individuals are told they have a moral obligation to pay their mortgages and corporations understand that contracts are to be breached when it's not economically efficient.”

Breach of contract is obviously at the core of the whole issue. As reminded by Munby LJ in the recent case of Bank of Scotland plc v Zinda [2011] EWCA Civ 706, there is indeed a contract amidst the confusion even though “a mortgage (is) neither the loan nor the contract, it (is) that element of the overall transaction constituting the charge on property which gave the lender his security.”

Formalisation of AVS

Thankfully, there appears to be, in the UK, many efforts made towards the greater formalisation of assisted sales. The underlying idea is that arrears handling should be consistent with the FSA regulations and recommendations, but should also be economically viable for lenders.

The National Homelessness Advice Service and Shelter have just published a report by the University of York entitled “Exiting Unsustainable Homeownership”, which analyses the practice as well as the strengths and weaknesses of Assisted Voluntary Sales. Lenders will decide for themselves (and many already have) whether AVS and related schemes are commercially viable in the long run.

But the report usefully draws lenders’ attention to the need for a clearer understanding of the regulatory implications of AVS as well as those that may affect their reputation.

Paul Smee, director general of the Council of Mortgage Lenders, highlighted in a recent communication (MFG October 2011) that “there may also be reputational and business benefits for the industry, with AVS offering the potential for a lower number of cases of possession and reduced losses through negative equity (with houses sold by the occupier likely to realise a better price than empty homes that have been taken into possession)”.

There is no doubt that Assisted Voluntary Sales have a potential to fulfill, but the pitfalls underlined in the University of York Report raise legal concerns that deserve bearing in mind.

Lender misconduct

“Lender misconduct” is a concept that has arisen over the last two decades and at the risk of sounding cynical, has developed in situations where there is increased personal contact between lender and borrower.

And it is precisely in a context of cooperation, in order to achieve a jointly acceptable solution, such as that of an assisted sale, that those contacts can easily result in promises made by the lenders or understood as such by the borrower.

The case of Siegner v Interstate Production Credit Association of Spokane (Oregon 1991) is often quoted as pivotal authority on the matter, where the court considered verbal commitments made by the bank to the borrower in the course of their discussions as a “separate verbal agreement” that somewhat detracted from the written loan agreement. Admittedly this is an American case, but such trends have been known to cross the Atlantic.

Fiduciary duty

Another potential hazard to watch is that of the fiduciary duty of the lender. It is clear from the practice of assisted sales in the UK, albeit embryonic, that the lender will have to assume many advisory roles in the process.

Maintaining the “arm’s length” characteristic of a non-fiduciary relationship may be difficult when the lender is required to assess the ability of borrowers to repay and examine the sustainability of their ownership and thus whether they qualify for the lender’s scheme. This is a potentially critical decision, in which the lender will inevitably play a fundamental part.

Drawing a parallel with the FSA’s expectations as to the lender’s role when assessing the borrower’s ability to afford the mortgage in the first place, this can generate quite a hefty liability: would lenders, for instance, be expected to analyse the personal ability of the borrower to regenerate themselves financially?

This is further compounded when the consequences of that advice, as highlighted by the above mentioned report, can be rather dire: some local authorities have been known to refuse re-housing to people whose “homelessness” was effectively voluntary.

Asset manager

There is also the issue of the “asset manager” that is customarily appointed by lenders to manage the AVS procedure. As they become more institutionalised, is it foreseeable that a specific liability of the lender who has appointed the asset manager may develop along the same vein as the lender’s liability for the actions of their receivers in buy-to-let situations?

There is established case law in situations where the receiver, who should be the agent of the borrower, seems to be taking instructions from the lenders and acting in their interests. In Standard Chartered Bank Ltd v Walker and another ([1982] 3 All ER 938), the bank had “interfered, by giving instructions to the receiver, in the conduct of the receivership”, thereby “making the receiver its agent”.

In American Express International Banking Corp v Hurley ([1985] 3 All ER 564) there was constant communication between the bank and the receiver and the latter sought the former’s approval to such actions as he proposed to take, therefore the receiver had become the agent of the bank, who was responsible for his actions.

Advisers

The conclusion of most analysis and discussions on AVS, including that of the University of York Report, revolves around the need for advice throughout the process and in its successive phases. Both borrowers and lenders will indeed benefit from the support of a solid team of advisers.

But the choice of advisers and the way they are instructed will be crucial for lenders. Even those that are legally independent by becoming too closely involved with the lender, commercially or strategically, could conceivably generate a liability for the lender.

Informal or ad-hoc responses to requests for support from borrowers may be adequate depending on the circumstances. But of course, the more formal the arrangement the better the protection. Lenders may want to consider ways in which they can offer detailed and structured schemes including terms and conditions. The terms of any agreement will depend upon the scheme but should clearly set out such matters as:

  • the roles and responsibilities of the parties (including agents) regarding the sale including how the marketing price of the property will be agreed
  • who will pay the costs associated with the sale
  • whether the borrower needs to continue paying the mortgage instalments in full or part whilst the property is on the market
  • how the shortfall (if any) after sale will be dealt with
  • circumstances in which either party may withdraw from the scheme
  • mechanisms for resolving dis-agreements about the way the process is being handled or progressed.

Lenders being sued for liability by a borrower would have been an aberration 30 years ago, but the scope for exposure has increased to the point of becoming a separate body of law. It is not yet as developed in the UK as it in the US and Australasia, but as mortgage lenders’ roles shift and evolve within the lending relationship, so may the opportunities for borrowers to seek compensation.


Date: November 1, 2011
Author: Rebekah Commane