A recent case has considered a claim that a lender breached an equitable duty to act in good faith by taking a substantial shareholding in a borrowing company. The shares were transferred as part of a debt restructuring following a breach of one of the borrower’s financial covenants.
The shareholders claimed that the lender, and the appointed chairperson of the company, unlawfully sought to maximise its shareholding and the borrower claimed, amongst other things, that the lender acted in breach of certain equitable duties arising from the fact that it held security over real property.
The lender applied to strike out the claim on the basis that the particulars of claim showed no reasonable grounds for bringing it.
The borrowers’ claim
The claim was based on a previous case, Medforth v Blake, and the principle that receivers and mortgagees owe equitable duties (including the duty to act in good faith) to mortgagors when selling a mortgaged property.
The case provided that “duties imposed on a mortgagee in possession, and on a mortgagee exercising his powers whether or not in possession, were introduced in order to ensure that a mortgagee dealt fairly and equitably with the mortgagor”.
It specifically related to the actions of a receiver managing a mortgagor’s business. It concluded that a receiver owes similar duties when managing a mortgagor’s business as when selling a mortgaged property.
It was argued by the shareholders of the borrower in Standish that a lender with the benefit of security over land has a general implied duty to act in good faith even when not exercising the powers conferred on it by the security.
Did the Court agree?
This argument was comprehensively rejected by the Court. It was “impossible to extrapolate from the very specific facts in Medforth… a wide-ranging proposition that will apply to a lender, if it happens to have security by way of a mortgage of land but has not exercised, or threatened to exercise, that security”.
Fundamentally, the security provided by the borrower was incidental to the facility terms and the complaints about the transfer of shares were completely unrelated to the security.
Good news for lenders
The decision in Standish should be welcomed by lenders as it avoids what would have been an artificial extension of a mortgagee’s duties to something far more extensive than exists at present.
A negative decision for the lender could have opened up a series of challenges to other secured lenders arising from matters such as: pricing changes; additional covenants; lender protections; or (as in Standish) a transfer of equity, negotiated in the context of a variation or restructure of facilities.
There is no guarantee that other borrowers may not try similar arguments. (In Standish the borrowers also argued an overarching ‘customer agreement’, separate from the security and the numerous facility agreements, into which a similar duty was alleged to be implied). However, this decision has sent a clear message that these imaginative attempts to extend the duties of a lender should be given short shrift.
This blog post was written by Ashley Neville. For further information, please contact:
Ashley Neville, solicitor, Banking & Finance
T: 0113 261 6785