Will our mortgage lending culture ever cross the channel?
SGH partner David Bailey takes us on a whistle stop tour of the quirks and characteristics of other European residential lending markets
Cross border mortgage lending is certainly not common practice, unlike other aspects of lending. These are now on the rise for the first time since the collapse of Lehman Brothers, which, for many, marked the beginning of the global economic crisis. We have recently discussed the proposed European Directive on mortgage regulations, widely considered an aberration, or at the very least a wasted effort, since it is unlikely that consumers would suddenly start shopping across the channel for their mortgage products.
But mortgage lenders may still have an interest in keeping an eye on the global market when more and more Britons buy property abroad, mostly in Continental Europe and the Balkans. So far, the financing of those purchases has essentially relied on cash or the local credit market, but many buyers are put off by the legal and linguistic complexity, not to mention other topical difficulties such as the sharply rising French interest rates or the 70 per cent LTV caps in several countries.
Could it make legal sense for British mortgage lenders to explore markets outside of the UK? It is not our intention or indeed our remit to carry out unsolicited market research in that respect. This is no more than a jaunt around some of the legal aspects relevant to lenders in countries where British based customers may acquire residential and investment property, yet it may well reveal opportunities or at the very least, some entertaining peculiarities. A healthy dose of legal curiosity would surely lead anyone to wonder why the French never refer to a real estate loan as a “mortgage”? Or how reliable the Land Registry is in Slovakia? Or even, what you actually get when you purchase a “derecho de superficie” in Spain?
The polymorphous nature of ownership
In England and Wales, we are all relatively familiar with the distinction between freehold and leasehold and can just about cope with the added complexity of contractual concepts such as easements, call options and contractual rights of pre-emption. And yet even specialists in the field struggle to define the legal concept of ownership.
Now, imagine a world where permanent ownership distinguishes between pleine propriété (full ownership) and nue propriété (bare – or naked, according to some dictionaries - ownership), the latter being commonly held by the heirs while the surviving owner merely benefits from an usufruit, i.e. a right of use and the entitlement to any income generated by the property. This is a common scenario in France, particularly for older “period” property, that Britons are more likely to be keen to acquire. They may proceed to “exchange” with what appears to be the owner and may later find that the apparent owner only holds the usufruit, the nue propriete having passed to the heirs from the predeceased spouse. This is a set up that almost systematically occurs in French families and can appear daunting to the purchaser. In practice, it is usually rectified by the time of completion but has to be borne in mind throughout the process as it allows both sides to change their minds even though exchange appears to have occurred.
Armed with that knowledge, one would think buying property in Spain or Portugal cannot be that different. One would be wrong. Iberic legal systems such as Spain, Portugal or Angola (the latter being worth mentioning since its property market is currently considered the fastest growing in the world!) do have a concept of “usufructo” but there are several other distinctions that tend to dominate the system, including the rather confounding surface right or Derecho de superficie. This grants its holder the right to build on the land in question and, figuratively, a right to the surface of that land (and the air above it). This raises obvious issues of permanency as well as questions over buried infrastructures and, indeed, potential natural resources. Interestingly, however, it is usually possible under local law to “pledge” the assets built pursuant to a surface right and this method has been used in project finance schemes. It may be complex and deserves careful observation of the extinction clauses but may well provide food for thought in a residential context?
The Balkans present another interesting set of issues, partly due to their communist past. In Romania, for example, property is essentially categorised between private and public property. Private property rights are split between the usual ownership rights, right of use (e.g. lease or usufruct) and easements, but the regime is heavily regulated and many private property rights are still subject to public property rights.
This goes further still in Poland, where full ownership is rare and often limited to the buildings, whilst land rights are held pursuant to a “perpetual usufruct”. This is a specifically Polish legal concept, whereby property is owned by central or local authorities who grant a right of use of the land to a beneficiary who then owns any structure built on that land in accordance with its purpose, as specified by the authority in question. Polish law also provides for co-operative members’ ownership rights, left over from the communist era, adding a further dimension into the complexity.
It must be reassuring to anyone who has found themselves struggling to explain the concept of title to land in this country, that, clearly, you are not alone.
The universal panacea of land registration
In the UK, since the Land Registration Act 2002, all land must be registered. This has somewhat changed the property landscape and has, arguably, rendered possession rights largely obsolete. Even though titles in registered land can range from possessory title (usually where title documents have been lost or destroyed), down to qualified titles (that carry a defect, excluded from the land registry guarantee) or even simple “good leasehold titles”(first registration without evidence of the title ), the vast majority of titles to land in the UK are now “absolute titles”.
In France, all land has been registered in the cadastre and the conservation des hypothèques for two and three centuries respectively. The doctrine of possession is now essentially limited to easements, such as rights of way, that do not require registration. This is a common problem, worth flagging up, as it is often encountered by purchasers, especially in rural areas, where one’s dream property may no longer appear so idyllic once it becomes apparent that the local farmers have a historical right to drive through with their tractors!
Interestingly, there is no state guarantee of accuracy of the registration. The assumption is that once the notaire (a cross between conveyancer and notary public) has ascertained the validity of the vendor’s title based on the records of the conservateur des hypothèques (registrar), there should indeed be no scope for error other than punctual human error, arguably covered by the notaire or the registrar’s professional liability.
Presumably for the same reason, there is no hierarchy between registered titles (i.e all registered titles are deemed absolute) other than chronological.
Land registration in Spain is voluntary and a large proportion of rural property is still unregistered. However, registration guarantees the validity of title if the property is acquired in good faith for adequate consideration. This means that the purchaser’s rights will be protected even if the vendor’s title is proven invalid in court. This also applies to rights that are newly acquired over unregistered property and registered as such for the first time. This appears a rather encouraging and protective scenario for foreign investors who buy unregistered property in Spain, as is likely to be the case in rural areas. Mortgages and surface rights must however be registered to be valid.
Spain, Portugal and the UK are among the lucky few to benefit from a compensation scheme in the event of a mistake committed by the Registry. But it is difficult to operate and not as accessible as one might hope.
The Romanian real estate register is said to have been incepted mainly for tax purposes. All ownership rights should be registered but this is yet to be completed, although mortgages and “perpetual usufruct” can however only exist if validly registered. For purchasers and third parties, it originally appeared to have a remarkably informative flavour, rather than the power to create enforceable rights. Notaries must now register any rights arising out of a deed they have authenticated. It is therefore likely that the system is, indeed, gradually moving towards more comprehensive and compulsory registration, even though it is still unusual to register inherited titles and those acquired pursuant to a forced sale and/or a court order. Furthermore, rights acquired through possession are obviously common and their ranking against registered titles is far from clear: there are currently three co-existing registers, a new centralised one as well as two pre-existing for different parts of the country. Unsurprisingly, the state only guarantees the accuracy of registration where it is itself a party to the registered transfer of title.
The situation in Slovakia is also slightly disconcerting in that all land must be registered and entries to the land registry are reputed binding to third parties, who are deemed to have had constructive notice of those, but it is also commonly accepted that many entries were arbitrarily made during the communist era and are entirely fictional. As if to make matters more ironic, failing to register one’s title accurately is an offence that can lead to a fine of several hundred Euros.
It is probably an understatement to say that a certain lack of fluidity would have to be expected, should one decide, for example, to launch a cross-border mortgage product. Legal discrepancies can possibly be ironed out but the patchiness of electronic access to transfer and registration is somewhat illustrative of cultural differences that may well prove to be THE major obstacle. To name a few examples, French notaries have been entitled to complete transactions electronically for over five years but are determined to carry on delivering hand annotated hard copies. In the UK, it is currently possible to carry out some formalities electronically but the process is still incomplete. Spain and Portugal enjoy full electronic access to their Land Registry, whilst there is none in Romania and most of the Balkans.
Mortgages, hipotecas and other privilèges immobiliers
There is clearly no need, in these pages, to go over the concept of mortgage and its application to the guarantee of residential lending in the UK. It may however be worth pointing out that the anglo-saxon culture of “the mortgage” is totally unique. Nowhere in Europe do “mortgages” get as much press coverage, never mind entire publications and professional organisations exclusively dedicated to their regulation, their health and their political implications.
In many other countries, mortgages are merely one of the ways (although, admittedly, often the most commonly used) to guarantee a loan.
Entities that can lend money in France are defined by law and must either be licensed as an “Institution Financiere” or be licensed in the European Union under the "European passport" scheme pursuant to EU Directive 2000/12. This may indeed limit opportunities for British mortgage lenders, especially those that do not belong to a large banking group, to operate in France. But would it perhaps be conceivable to grant a personal loan to a British citizen and take out a separate security on his assets?
The French do not, in common parlance, refer to their real estate loan as a mortgage (hypotheque). The Land Registry is historically named the “conservation des hypotheques” and, in practice, real estate lenders generally aim to secure their loans with a first rank mortgage (hypothèque conventionnelle de premier rang). But French law benefits from an arsenal of securities that provide many interesting alternatives. There are a number of privilèges immobiliers spéciaux including the privilège du vendeur (vendor's lien) or privilège de prêteur de deniers (lender's lien) which exist by law and even though they must be registered, rank back to the date of sale completion. Mortgages are also consented (or “taken out”) by law in other situations than real estate loans. As a result, if a mortgage is taken out by the lender, it is a separate legal operation from the loan agreement. This dissociation between the two concepts is not just semantic or psychological: in France, repossessions pursuant to a mortgage are 25 times less frequent than in the UK.
One can also use a transfer of the property to a trust (fiducie sûreté) or secure the loan over other assets of the borrower, a quintessentially French “cession Dailly”, a very traditional method of assignment of receivables that has recently got a new lease of life in project finance, which may conceivably be applied to the rental income of an investment property, or even a pledge over the debtor's bank accounts. This is worth considering, bearing in mind, however, that most of those securities require registration.
The Spanish system also allows for relatively creative guarantees such as the assignment of rental income, or personal guarantees restricting the right to sell or otherwise dispose of the property, but they are purely contractual rather than legally defined and mortgages remain central to real estate lending. The mortgage must be registered and its ranking will depend purely on the registration date.
In Portugal, however, it is common to include in the loan agreement clauses that prohibit the buyer to provide security to another party, or borrow money from another party, as well as termination clauses with penalties in case of breach of the loan agreement.
But as in France, specific creditors, such as tax and social services, legal costs and sometimes employees have absolute priority over the assets.
In Romania, the concept of mortgage finance is relatively recent, and most of its regulatory dispositions date back to the 90’s. First rank mortgages are now the most usual method of real estate loan guarantee, they must cover the total amount of the loan and be registered in order to be valid against all third parties. Mortgages are sometimes taken over other property than that being financed. Pledges over other assets and personal third party guarantees are also not uncommon. The borrower is often required to take out insurance over the property, which is immediately assigned to the lender.
Beyond the mildly facetious tone of these reflexions, should one genuinely consider foreign mortgage markets as a compelling prospect, there are many serious aspects that would require careful attention, starting with the regulations that apply to building societies and the mortgage market in this country. This, in fact, stems from the same concerns as those raised regarding the need (or lack thereof) for European regulation of mortgages. Borrowing copy from CML’s last annual report, the “significant differences between national markets” mean that “consumers are not best served by an attempt to harmonise detailed rules” and therefore any “European proposals that work in a UK context [must] not impose inappropriate or excessive requirements on UK firms and consumers and do not conflict with proposed FSA rule changes”. It is essential that the specificity of each national market remains and any uniformisation of mortgage and residential lending would be counter-productive, but a closer, open minded look at the way others do it can only enhance creativity and innovation.
David Bailey is partner and head of services to lenders group at SGH.
Note from the author: although legally oriented by nature, the aim of this article is purely journalistic and its purpose is merely to provoke thought and even, possibly (and rather ambitiously!) entertain. I am not, by any means or pretence, an expert in any of the foreign legal systems mentioned in this article. It is based on informal conversations with colleagues and personal experience. Should any specialist practitioner wish to rectify any aspect of the above, I will happily receive their comments.
