When is a lender required to release its security?

In the recent case of Re Industrial North West LLP (in administration) [2020] EWHC 3052 (Ch), the High Court had to consider the circumstances in which a secured lender could be required to release its security following repayment in full of its debt in circumstances where contingent liabilities may still arise as a result of the borrower’s obligation to pay the lender’s costs in respect of potential claims against the lender as a result of it taking enforcement action.

This Article considers the court's finding that a lender retaining security for a contingent liability in those circumstances is not repugnant to the borrower’s equitable right to redeem the security and its implications for both borrowers and lenders. 

The Equity of Redemption

It is a fundamental principle of English property law that a mortgagor has the right to recover its assets free of any charge granted by it upon it discharging the relevant secured debt in full. Any provision of a charge which serves to fetter this right, for example by preventing the realistic prospect of the mortgagor ever getting back the property over which it granted the security, or which unconscionably seeks to regulate or control the right to redeem will be void and unlawful.

This has generally given borrowers comfort that, in the event of any issues with their lenders, they will ultimately be able to repay their debt and require a release of security from their lender, enabling them to deal with the property again, including granting security to their new lender.

Re Industrial North West LLP (in administration)

Industrial North West LLP had borrowed £61.25m to fund the acquisition and development of some land. This loan was secured by a security agreement over its business and assets. As is usual market practice, the security document secured all present and future obligations and liabilities (whether actual or contingent) under the finance documents, with there being an obligation to release the security following the date on which all the secured liabilities had been unconditionally and irrevocably paid and discharged in full.

The facility agreement for the loan contained a costs and expenses clause in the form contained in the Loan Market Association’s precedent form. Specifically, it provided that :

"The Borrower shall, within three Business Days of demand, pay to each Secured Party the amount of all costs and expenses (including legal fees) incurred by that Secured Party in connection with the enforcement of, or the preservation of any rights under, any Finance Document or the Transaction Security and with any proceedings instituted by or against that Secured Party as a consequence of it entering into a Finance Document, taking or holding the Transaction Security, or enforcing those rights". 

Following the alleged occurrence of an event of default by the borrower, the lender had cancelled the relevant facility, demanded repayment and enforced its security. This resulted in the borrower being put into administration. The borrower's owner, who stood to lose £25m as a result of the development not being completed, subsequently threatened legal proceedings against the lender for wrongfully terminating the facility on the basis that no event of default had in fact occurred.

The administrators were able to repay the loan in full with the proceeds of sale of certain assets of the borrower. Following this, they sought direction as to whether or not the lender should still be treated as a secured creditor. The two key issues were: 

• whether the borrower had a contingent liability for the lender's costs of defending the threatened litigation; and 
• whether the security document continued to provide security for that liability.

The court found that:

• as a matter of contractual interpretation the lender's costs of defending the threatened litigation fell within the costs and expenses clause and, on the evidence, there was a real prospect that the borrower would become liable to the lender under that clause. The court rejected the argument that the clause should be limited to those claims which had been begun at the point of repayment; 
• the potential liability was a contingent liability within the definition of "Secured Liabilities" in the security document. The court rejected the argument that such a contingent liability for legal costs would be perpetual and that the borrower would, therefore, never be able to redeem. This was because the borrower’s owner could choose whether to litigate and, if he did, the litigation would be heard and resolved so crystallising the liability. Likewise, the owner could also choose to waive his claim, against the lender; 
• as a matter of construction, the lender did not have to release the security when the principal amount of the loan (plus interest) was repaid if there were other outstanding secured liabilities. This was not repugnant to the borrower's equitable right to redeem. There was no authority suggesting that it was oppressive for a lender to retain security if no provision for contingent liabilities was made. A contingent liability remaining secured for an indefinite period was not contrary to any equitable principle. It should be noted that detailed particulars of the claim had been requested so as to enable the lender to reach an informed view as to how much security it needed to retain but this had not been provided;
• there was nothing unfair or unconscionable in the terms of the finance documents.

What this means for Borrowers and Lenders

This case provides additional clarity for lenders as to their rights to retain security in circumstances where there remains a prospect of claims against them as a result of their actions in preserving and enforcing their rights under finance and security documents. 

It should however be noted that this related to a situation where a claim against the lender was likely and did not specifically consider a situation where claims against the lender were not contemplated (but remained theoretically possible). A wider interpretation whereby outgoing lenders insist on retaining their security until the relevant statutory limitation period have expired (which could be up to six years following redemption for claims from third parties), would likely to restrict a borrower’s ability to refinance its borrowings (and for a new lender to fund a borrower). As such, even if such action were permitted, we do not expect to see lenders deviating from the usual market practice of granting releases upon repayment of a loan in circumstances where a contingent liability is not currently contemplated as a result of this case.

Borrowers (and their stakeholders) should also be aware that the borrower will potentially be on the hook for the lender’s costs in the event that a shareholder or other third party sought to challenge enforcement action by a lender and that any such liability would be a secured liability, reducing the amounts available for other creditors.