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Subrogation

WHAT IS SUBROGATION?

If you have remortgaged your property - getting a mortgage from lender 2 to pay off lender 1 - it allows lender 2 in certain circumstances to stand in the shoes of lender 1 and enforce its loan as if it had the benefit of lender 1's mortgage.

Lawyers call it an equitable restitutionary remedy - it enables a later lender to trace its mortgage advance into the hands of an earlier lender.

For the basic principles, see Banque Financiere de la Cite v Parc (Battersea) Ltd [1999] 1 AC 221
For its application, see Cheltenham & Gloucester Plc v Appleyard [2004] EWCA Civ 291

WHY SHOULD MY LENDER NEED TO RESORT TO SUBROGATION AND HOW DOES IT WORK IN PRACTICE?

Here's an example:

Mr & Mrs Smith are the joint legal and beneficial owners of a house

In year 1 they obtain a mortgage of £50,000 from Lender 1
In year 2 they obtain a remortgage of £100,000 from Lender 2 of which £50,000 is used to repay Lender 1
In year 3 they obtain a remortgage of £150,000 from Lender 3 of which £100,000 is used to repay Lender 2

In year 4 they default in repayment of their mortgage to Lender 3. Lender 3 brings standard mortgage possession proceedings against them, claiming possession of the property and judgment for the balance outstanding.

When served with the proceedings, Mrs Smith realises that her husband forged her signature on the mortgage to Lender 3, so she claims the mortgage deed is void and she is not liable.

Lender 3 should be entitled to be subrogated to the rights of Lender 2 to the extent of £100,000 - the amount of Lender 3's advance which was used to repay Lender 2. In addition, since the effect of the forgery usually means that Lender 3's mortgage will not not take effect as a valid legal mortgage, it will take effect as an equitable charge on Mr Smith's beneficial half share in the house which Lender 3 would be entitled to realise on sale.

The net effect is that Lender 3 can enforce Lender 2's charge and obtain possession against Mr & Mrs Smith and recover £100,000, and then recoup the balance outstanding from the half share in the net proceeds due to Mr Smith. Depending on the amounts involved and the value of the property, it is quite possible that Lender 3 can make a full recovery, notwithstanding the serious effect of the forgery.

For an example, see Eagle Star Insurance Co Ltd v Karasiewicz [2002] EWCA Civ 940

BUT ISN'T THIS UNFAIR. LENDER 3 AND/OR ITS SOLICITORS HAVE OBVIOUSLY BEEN CARELESS IN THE WAY THEY OBTAINED MRS

SMITH'S SIGNATURE TO THE MORTGAGE. SURELY THEY CANNOT PROFIT FROM THEIR OWN NEGLIGENCE?

Fault is irrelevant. What matters is that Mr & Mrs Smith have been enriched at Lender 3's expense. If it were otherwise, it would mean that Mrs Smith had the benefit of having her £100,000 mortgage to Lender 2 paid off using Lender 3's money without any corresponding liability on her part.

BUT LENDER 2'S MORTGAGE WILL HAVE BEEN DISCHARGED AND REMOVED FROM THE CHARGES REGISTER OF THE REGISTERED

TITLE OF THE PROPERTY AT HM LAND REGISTRY. HOW CAN SUBROGATION WORK?

Subrogation is an equitable remedy. Although Lender 2's mortgage will have been discharged, it enables Lender 3 to "stand in the shoes" of Lender 2 as if it had the benefit of Lender 2's mortgage ie. as if Lender 2's mortgage had been kept alive and the benefit of it assigned to Lender 3

SO HOW MUCH CAN LENDER 3 ACTUALLY CLAIM?

This is where it gets tricky.

In simple terms, Lender 3 has to re-run Lender 2's account, as if Lender 2's mortgage had continued rather than being discharged by Lender 3's mortgage, but giving credit for any payments made to Lender 3. This is called the subrogation account, and it will invariably need to be verified with the assistance of Lender 2.

In addition, Lender 3 is entitled to claim interest, but so that it is not seen to profit out of subrogation, the rate will usually be capped at the lower of the rate charged from time to time by Lender 3 and Lender 2. See the Eagle Star case referred to above.

WHAT IF MRS SMITH SAYS SHE IS NOT LIABLE FOR LENDER 2'S MORTGAGE EITHER, FOR EG. IT MAY HAVE BEEN PROCURED BY

UNDUE INFLUENCE BY MR SMITH?

Lender 3 may be able to resort to sub-subrogation - enabling it to trace its advance to Lender 2 and in turn back to Lender 1 to the extent of £50,000. See UCB Group Ltd v Hedworth [2003] EWCA Civ 1717 

DOES IT ONLY APPLY WHERE LENDER 3'S MORTGAGE HAS BEEN USED TO PAY OFF A PREVIOUS MORTGAGE?

No. You can have subrogation to unsecured liabilities. For example, if out of the £150,000 advance made by Lender 3 say £20,000 had been used to pay off an unsecured joint loan taken out by Mr & Mrs Smith with Bank X, Lender 3 would be entitled to be subrogated to Bank X. Lender 3 will not acquire proprietary rights ie. the right to enforce a security against the property, but it will be entitled to a personal remedy and recover the monies due from Mr & Mrs X. See Filby v Mortgage Express (No 2) Ltd [2004] EWCA Civ 759 

SUBROGATION LOOKS TO BE A REMARKABLY FLEXIBLE REMEDY