Holding back to defend attack: Withholding security for anticipated litigation costs – Charges, Mortgages, Indemnities

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In this week’s TGIF we examine the question: when
can a mortgagee claim a right to retain reasonable security for
costs of anticipated litigation with a mortgagor?

In
A1 Catering Services Pty Ltd v Manassen Holdings Pty
Ltd [2024] NSWSC 178, Richmond J held that a
mortgagee could retain surplus funds from the sale of secured
assets as security for a contingent liability, namely reasonable
costs to be incurred by the mortgagee in the event of an
anticipated dispute with the mortgagor, provided the terms of the
mortgage define potential enforcement costs as a secured
liability.

The decision turned on the finance documents and general law.
While ‘Secured Moneys’ within the mortgage was not defined
with precision, it did cover the borrowers’ contingent
liability to indemnify the Defendant (Manassen) for costs incurred
defending reasonably anticipated claims by the borrowers.

Therefore, on the basis that $300,000 represented a reasonable
estimate of its likely legal costs, Manassen was entitled to retain
this as security for the anticipated claims by the borrowers.

Key Takeaways

Where an alternative proposed liquidator is nominated by
another creditor or interested party, the Court will, all things
being equal, generally appoint the nominee of the party applying
for the winding up. To depart from this approach, there must be
some reason, such as the liquidator’s independence, fitness,
qualifications, or costs. It is for the defendant to establish
grounds to depart from the usual course.

A Court should not be forced to accede to a party’s
nomination on the basis that a creditor is prepared to fund that
liquidator only, as this would encourage parties to be selective in
the funding of liquidators for irrelevant reasons.

In this case, the Court’s decision to appoint the
plaintiff’s nominee was made solely on the basis that their
hourly rates were lower, despite the fact that there were likely no
funds available in the liquidation and the interested party had
filed an undertaking to fund the proposed alternative
liquidator.

Relevant Law

Richmond J, in determining the matter, considered authorities on
the discharge of mortgage where a contingent liability is owing to
the mortgagee, including authorities supporting the principle that
where a mortgagor seeks a discharge of a mortgage when a contingent
liability is owing and secured by the mortgage, the mortgagee is
entitled to require payment of an amount which is a reasonable
estimate of that contingent liability.

His Honour further considered the finance documents themselves,
which relevantly provided that:

each borrower was required to pay to the mortgagor on demand
all expenses incurred by the mortgagor in connection with the
enforcement of the mortgage;

‘Secured Moneys’ was defined as being all moneys which
the mortgagor presently owes or may contingently owe the mortgagee,
including costs incurred by the mortgagee in enforcing the
mortgage;

the mortgagor was required to indemnify the mortgagor
“against all actions, claims, demands, losses, damages,
liabilities, costs, charges, fees and expenses suffered or incurred
by the Mortgagee as a result of or in connection
with“ the mortgagee exercising its rights under
the mortgage; and

the discharge of the mortgage was subject to the mortgagee
reasonably considering whether “part of the Secured Moneys
will or may become actually, contingently or prospectively
owing” to the mortgagee as a result of any claim the mortgagee
has against the mortgagor.

Main issues and determinations

The main issues heard were:

Whether Manassen was entitled to retain the sum as
security for costs of an anticipated dispute with the
borrowers.

Richmond J was satisfied that the clauses in the loan agreement,
the mortgages and the general security deed would catch expenses
incurred by Manassen in the event of a dispute with the
borrowers.

Whether it was reasonable for Manassen to anticipate
that it was likely that there would be litigation with the
borrowers.

His Honour was satisfied that Manassen’s affidavit evidence
established the borrowers had threatened to bring a number of
claims disputing their obligations under the finance documents.

Whether the amount retained by Manassen was a reasonable
estimate of the likely costs it would incur in the event any of the
anticipated disputes arose.

His Honour was satisfied that the calculation of $300,000 for
likely fees and expenses in the event of a dispute set out in
Manassen’s affidavit evidence was a rational and coherent
explanation of its claim that this amount was a reasonable
estimate.

Final thoughts

Whist A1 Catering is directly relevant to
the treatment of mortgages, it has broader relevance to any secured
loan arrangement in which the Lender may desire to have the right
to withhold surplus funds as security for costs of reasonably
anticipated litigation by the Borrower.

The likelihood of the circumstances arising will increase in a
rising property market (where surplus proceeds are available) and
the non-financier stakeholders are dissatisfied with the conduct of
the financier (e.g. challenging the sale process).

This judgment further serves as a reminder to lenders to
consider the terms of enforcement provisions within their documents
and whether they achieve suitable protection and risk
mitigation.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.