From the High Court in Northern Ireland comes a significant joined case of a mortgage lender behaving badly. Bank of Scotland, and indeed possibly the whole Lloyds group seem to have acted in this way, for which they have received an extremely severe judicial take down. The principles in this case may well have application outside Northern Ireland, and the practices identified well worth looking out for.

Bank of Scotland plc v Rea, McGeady, Laverty [2014] NIMaster 11

The borrowers’ cases were brought by NI Housing Rights Service, here is their account of the matter. These were effectively test cases to address a widespread practice.

These were variously a claim for possession by BoS, an application for stay of enforcement of a possession order, and BoS application to enforce a suspended order. In each case, there had been a sudden and unexplained increase in the monthly payments demanded by the lender, but in at least two of the cases, there had been ‘significant and regular’ monthly payments by the borrowers.

The primary issue in the hearing was:

[2]     All three cases raise a point of some importance, namely whether the lender may both (a) consolidate (or, as it is often called,capitalise) arrears of monthly instalments with the mortgage balance upon which the instalments are calculated with the effect of increasing the contractual monthly instalments to spread those arrears over the residue of the mortgage term and also (b) rely on the arrears so consolidated as outstanding arrears for the purpose of possession proceedings.
[3]     Broadly, the plaintiff insists that it can do exactly that.  It argues that the consolidated arrears were not extinguished qua arrears (which is normally what happens when arrears are consolidated) because the plaintiff took the step of consolidation unilaterally, ie without the consent of the borrower specific to that step save insomuch as consent had been given to such a step in the mortgage contract.  Indeed the plaintiff does not accept that the relevant restructuring of the mortgage accounts that I have just described is either capitalisation or consolidation, and avoids the use of either word when referring to it.   However for the purpose of this judgment (and without doing so by way of prejudgment) I will refer mostly to the practice of the plaintiff which I have just described as “unilateral consolidation”.

Meanwhile

The defendants (save Mrs Laverty who has not engaged in these proceedings) contend that, for reasons I shall explain, the practice is an unconscionable one because it prevents them from putting a proposal to repay the arrears to the court and prevents the court from exercising, or exercising properly, its discretion to defer possession. That discretion arises under the Administration of Justice Act 1970 (“the 1970 Act”) section 36 and the Administration of Justice Act 1973 (“the 1973 Act”) section 8 and, if exercised, allows the court to make either an order adjourning the proceedings or a suspended order for possession on terms which would allow the defendants to pay the arrears within a defined or ascertained time which the court regards as reasonable. The defendants also argue that the plaintiff’s practice compromises the affordability of payments towards arrears under pre-existing and future suspended orders for possession.

It is fair to say that Bank of Scotland did not come out of this well. They had indeed added arrears to the capital sum of the mortgage, in at least one case on four separate occasions from 2009. Monthly payments had risen (on a largely unchanged interest rate) by amounts between about £150 to some £500 per month

However, there had been affidavits in the proceedings from the bank’s solicitors stating that ‘at no time had capitalisation taken place’. These were apparently made because the bank continued to treat the entire arrears as being immediately due and this was what showed on the computer records. Still, the bank’s solicitors had not put the actual position to the court.

Yet, despite conceding that there had indeed been ‘informal’ or ‘automatic’ capitalisations, the bank continued to argue that it could rely on the pre- capitalisation arrears in proceedings, as if for practical purposes, payment of the arrears had not been spread over the remaining lifetime of the mortgage. The bank argued that ‘capitalisation’, or ‘consolidation’ was “restricted to that category of forbearance in which the borrower and lender agree (normally after a period of six successive payments of the contractual monthly instalments) that the outstanding arrears should be merged in future monthly instalments”.

This did not go down well.

“Consolidation is an objective fact: the arrears are either consolidated by being absorbed into increased contractual monthly instalments or they are not.”

regardless of whether this was with the agreement of the borrower or not. It was not for the bank to subjectively prescribe what constituted ‘consolidation’.

The bank relied on a provision in the mortgage conditions to allow a unilateral consolidation.

The position of the defendants is that they do not understand how these provisions could have allowed the plaintiff on the one hand to revise their monthly instalments to include contributions towards outstanding arrears and on the other hand to claim in proceedings for possession that those arrears remain overdue, given that the plaintiff itself has arranged for them to be repaid by way of monthly instalments over the remainder of the mortgage term.  The defendants also claim that these provisions permitting unilateral steps to be taken by the plaintiff constitute or include unfair terms under the Unfair Terms in Consumer Contracts Regulations 1999.

The court found that, assuming the right to unilateral consolidation could be found in the mortgage contract, that right had to be exercised reasonably.

In Unfair Contract Terms: improving standards in consumer contracts (January 2012) the FCA is generally critical of “unilateral variation” clauses. However, I consider there are sufficiently “valid” reasons for a mortgage lender to consolidate some items such as administrative fees, expenses and legal costs by spreading them over the residue of the mortgage term (rather than demanding their immediate payment or postponing any payment until redemption) to justify a provision such as that relied on by the plaintiff – in part because the word “reasonably” is used in Conditions 7.4 and 8.4 of the respective mortgage contracts to affirm that any exercise of the discretion must be reasonable.

Via Swift 1^st Limited v McCourt

the exercise of a like unilateral discretion in a mortgage contract such as that relied on in this case by the plaintiff must not be unreasonable (in the Wednesbury sense), dishonest, for an improper purpose, capricious or arbitrary, but the relevant discretion in the present cases is not in my opinion inherently unfair. That said, in the present case the bar may be said to be somewhat raised because there is an express term to the effect that the discretion shall be exercised “reasonably”.

And in these cases, Bank of Scotland had not exercised the discretion reasonably. But what should be the result?

I am satisfied that the plaintiff has acted in a manner that has been so unreasonable that no lender acting reasonably would have so acted and is therefore in breach of the mortgage contract. However on one view the capitalization per se might not have been unreasonable given that in my 21 years of specializing in mortgage possession applications I do not recall any in which capitalisation of arrears as normally understood (ie resulting in the wiping out of the current arrears) was alleged by a borrower to be unfair or unreasonable – even where the capitalisation had been automatic and without prior consultation with the borrower or might otherwise be categorized by the FCA (most correctly in my view) as being “poor” and potentially prejudicial in particular cases. In the present cases, however, the plaintiff has gone further and acted unconscionably (as I shall shortly particularise) by its remarkable insistence that for all practical purposes the payment of the arrears had not been spread over the remaining lifetime of the mortgage. Accordingly it is necessary to address the resultant prejudice by insisting that the plaintiff be held strictly to its election to consolidate the arrears. Indeed irrespective of whether the plaintiff was in breach of the mortgage contract because of the actual intention with which or manner in which it consolidated the arrears, I am satisfied on the material before me in these cases that this is a situation in which equity should treat as done that which ought to have been done (or perhaps, impute an intention to fulfill an obligation), ie it is necessary to deem the plaintiff to have elected to consolidate arrears in a manner consistent with the mortgage contract and established principles and practice and thereby to have also waived by election the right to demand immediate payment of the arrears that had been consolidated. I refer to the relevant principles as to waiver by election (which unlike promissory estoppel is always final, not suspensory, in effect) in Motor Oil (Hellas) Corinth Refineries v Shipping Corporation of India [1990] 1 Lloyds Law Reports 391.

Further, the steps taken by Bank of Scotland effectively impacted the Court’s exercise of its discretion under section 36 of the 1970 Act as revised by section 8 of the 1973 Act. These provision cannot be contracted out of, but because the bank wholly failed to distinguish between arrears that predated consolidation and those that arose on the consolidated monthly payments, it made it impossible for either the borrower or the court to know over what period a proposal for additional payments would address the arrears.

Citing Bank of Scotland Plc v Zinda [2011] EWCA Civ 706 [our note], the Court states:

Once arrears have become part of the contractual monthly instalment their payment is from that point on required not as a matter of addressing but rather as a matter of avoiding a breach of the mortgage contract. The only thing borrowers have to do to address the “arrears” is comply with the requirement to pay the new contractual monthly instalments. They should not have to face a risk of losing their home as long as they do so. If, as stressed by the English Court of Appeal in Zinda, arrears of the post-consolidation monthly instalments accrue, those arrears can be relied on in a claim for possession. However, in the present cases the evidence about arrears is as I have indicated wholly unsatisfactory and, among other things, fails to distinguish between the pre-consolidation arrears which no longer exist and the post-consolidation arrears of the revised increased monthly instalments.

And then, although this might not seem possible, Bank of Scotland made things worse for themselves. In the course of  a discussion on proleptic discharge of suspended possession orders where arrears satisfied by payment or consolidation, and in relation to the requirement that “An adjournment, suspension or postponement under section 36 must be for a defined or ascertainable period”, Bank of Scotland took the view that the requirement didn’t actually matter, their counsel arguing:

“It doesn’t matter” because there were borrowers who “came forward” and engaged with the lender and made payments and it was the lender’s unwavering policy to ensure that those borrowers had every chance to avoid repossession. Therefore in many cases, even where a suspended possession order was in place, if the borrowers were paying sums which met or exceeded the contractual monthly instalments the lender might not seek possession unless (as I understand it) the borrowers ceased to engage or to make any decent effort to resolve the situation by payment proposals or continued payments. (The onus he emphasised, was on a borrower who felt confused by the plaintiff’s information about his account and requirement to pay, or who would have difficulties paying both the consolidated monthly instalments and the additional sum required by the S.P.O, to approach the plaintiff for help.) The nub of what he is saying was that his client and indeed all the banks constituting the Lloyds Banking Group were so imbued with a culture of responsibility toward their borrowers – or at least those who were “coming forward” and making a worthy effort – that this responsibility was a key feature in all that they do with respect to mortgages.

Oh dear. The Court was not impressed, and reached for the Court of Appeal judgment in Roberts v Bank of Scotland Plc [2013] EWCA Civ 882, where the bank’s approach to a customer with modest overdraft and credit card debts was found to constitute civil and criminal harassment. Moreover the bank consistently failed to comply with “Practice Direction 2003 No 9) requiring grounding affidavits by mortgagees seeking possession to exhibit a copy of what may fairly be described as a key component of the mortgage contract, namely the offer of advance, side letter or equivalent document”.

And then there was the bank’s handling of the present defendants. For example:

Confidence in the plaintiff’s sense of responsibility toward its customers (in particular, those who “come forward”) is not helped either by the uncontradicted affidavit evidence of Ms Rea as to her own endeavours to obtain an explanation from the plaintiff’s Collections Centre of the reasons for the “migration” increase in her monthly mortgage instalment from £809.92 to £846.24 allegedly notified to her in March 2013. She asserts that she had not been notified of that change until receipt of a letter from K Stafford of the Collection Centre dated 1 May 2013 to which she was replying when she claimed in her letter of 12 May that the failure to notify her had resulted in £51.02 “arrears being added to my account”. Ms Rea received no reply and wrote again on 12 November 2013 with a reminder and a request for further particulars and explanation. The plaintiff’s Customer Services Department eventually replied by letter dated 3 December 2013 from a Ms Lucy Maller expressing sincere apologies for the delay and explaining:-

“As the Collections Department is telephony based, they do not respond to written correspondence. However, I appreciate you weren’t aware of this procedure.”

The lesson being that one really shouldn’t assert one’s caring, responsible approach in the face of a deeply sceptical court with plenty of ammunition to the contrary.

Could it get worse for Bank of Scotland? Why yes, it could. The court noted that “There would be no circumstance more relevant to the matter [suspending a possession order] than the fact that the arrears will be discharged in full without the need for any additional payment if the borrower simply complies with the contractual obligation to pay the normal contractual monthly instalment as it falls due”, but then went on to find that the bank said it was ” unable or unwilling to quantify the arrears component in monthly instalments if called upon to do so” via correspondence with the Housing Rights Service:

There is accordingly no simple and straightforward way for our client to provide a breakdown of the portion of the monthly instalment attributable to payment of arrears without a manually intensive account reconstruction on a case by case basis which would result in considerable expense and delay.

As it turns out, that is tough on the bank, because it will have to do just that, and then some (see [62] below).

I will quote the whole summary of the judgment in full below. It sets out the Court’s findings, but also what will be required of Bank of Scotland/Lloyds in any future mortgage possession cases, which is precisely the identification of consolidated arrears, that cannot be relied upon, and separately, any post consolidation arrears that could found a possession claim or warrant, as per Zinda.

While there are clearly some elements of the judgment and reasoning specific to the NI jurisdiction, as far as I can see the general principles, based on AJA and Zinda, should apply in England and Wales, if Bank of Scotland/Lloyds group have been carrying out similar ‘unilateral consolidations’ here. Many congratulations to Housing Rights Service for their dogged and successful work on these cases and pursuing the suspicious rise in monthly payments in the first place.

SUMMARY

[52] The plaintiff’s practice of restructuring mortgage accounts so that arrears of monthly instalments are included in increased monthly instalments so that they will be paid over the remainder of the mortgage term constitutes capitalisation or consolidation of such arrears. This is so whether or not the plaintiff does this with the consent of the borrower and whether or not it is done as an act of forbearance.

[53] The relevant mortgage conditions conferring on the plaintiff a unilateral discretion to restructure the mortgage and increase the monthly instalments are not unfair terms within the meaning of the Unfair Terms in Consumer Contracts Regulations 1999. However, it is clear, by reason of the findings of Mr Justice Horner in Swift 1st Limited v McCourt, citing Paragon Finance Plc -v- Nash, that there is an implied term in such unilateral discretions that they must not be exercised unreasonably (in the “Wednesbury” meaning of that word). Moreover, the express conditions relied on by the plaintiff include the requirement that the discretion will be exercised “reasonably”.

[54] Where, as in the present cases, the plaintiff consolidates arrears unilaterally, without any attempt to secure the borrower’s agreement and without any assessment of affordability, that is extremely “poor” capitalisation according to the definition and criteria of the Financial Conduct Authority.

[55] Where, as in the present cases, the plaintiff goes further and also insists as a separate exercise on relying on the consolidated arrears to ground proceedings for possession it is acting inconsistently with primary and secondary legislation (the 1970 Act, s36, the 1973 Act s8 and, in this jurisdiction, Order 88 rule 5(3) of the Rules. Parties cannot in a mortgage agreement contract out of the possible exercise of the court’s statutory discretion to defer possession under section 36 as revised by section 8: Northern Bank Limited v Jeffers, per Mr Justice Girvan.

[56] It follows that in its unilateral consolidation the plaintiff is also in breach of the established principle that arrears of instalments are “wiped-out” to the extent that they have been consolidated: a principle at the heart of a decision described as one of “great practical significance” in the recent judgment of the Court of Appeal of England and Wales in Bank of Scotland Plc v Zinda. As I understand the underlying rationale for that principle and its application to the present cases, it is essentially straightforward. The mortgagee has chosen to revise the mortgage contract to spread the payment of arrears over the remaining lifetime of the mortgage, meaning the mortgagors are required and permitted to pay them over that time as part of the contractual monthly instalments. The plaintiff has therefore waived its expectation and right to demand earlier payment of the capitalised arrears, which must be eliminated from the computation of subsisting arrears. To that significant extent the mortgagee is barred by its own actions from resiling from the contractual position which it has elected to take, whether or not the mortgagor agreed to the consolidation. The plaintiff has waived by election its right to rely in court proceedings upon the arrears which it has extinguished. The effect of waiver by election is somewhat different from promissory estoppel (the effect of which may be merely suspensory) and it is final, ie irrevocable: Motor Oil (Hellas) Corinth Refineries -v- Shipping Corporation of India {1990] 1 Lloyds Law Reports 391.

[57] The plaintiff’s reliance on extinguished arrears may fairly be described as double-billing. Unilateral consolidation with double-billing creates very real problems for borrowers, their advisers and the court. To the extent at least of the double-billing, it is unconscionable.

[58] First, the practice unfairly and confusingly distorts perceptions of affordability. Borrowers in default are faced with a monthly instalment increased to address a sum representing the arrears over the rest of the mortgage term and a demand (and indeed threat of repossession) for the immediate payment of the erstwhile arrears. This is, to say the least, confusing and must be a disincentive for many borrowers to make best realistic proposals to the lender or the court to address the arrears – particularly in light of an undisclosed “arrears element” in the monthly instalments. It also distorts the true arrears figures in the minds of those approached for advice and the court.

[59] Secondly, the practice means that if there is a proposal for an order for possession suspended or an adjournment on terms as to payment of a monthly sum towards the arrears as well as the ongoing monthly instalments, the court will not be able to define or ascertain the period within which that proposal, if maintained, will clear the arrears. The “reasonable period” within which under s8 of the 1973 Act the borrower must be likely to be able to address the arrears must be a “defined or ascertainable” one: Royal Trust Co of Canada –v- Markham as affirmed by successive Chancery Judges in this jurisdiction in Alliance & Leicester Building Society -v- Carlile and National & Provincial Building Society -v- Lynd. The court cannot accurately define or ascertain the period where an undisclosed amount of the consolidated contractual monthly instalment relates to part of the arrears relied on by the plaintiff.

[60] Thirdly, that undisclosed “arrears element” in post-consolidation instalments must lead to a nonsensical and troubling situation of “double-counting” when the plaintiff adds arrears of post-consolidation monthly instalments to those of pre-consolidation instalments (even accepting as correct the plaintiff’s incorrect submission that the earlier arrears were not extinguished by the consolidation). To some extent, the arithmetic must mean that the plaintiff is overstating, by duplication or double-counting, the total “arrears”.

[61] Fourthly, the plaintiff’s failure to explain its unilateral consolidation and double-billing in previous proceedings means that many suspended orders for possession (and indeed many other resolutions agreed between the parties) were made on erroneous assumptions as to: (a) the correct amount of arrears (since pre-consolidation “arrears” no longer existed); (b) how and when the arrears would be addressed in the future (as the undisclosed “arrears” element in consolidated monthly instalments would accelerate payment of the true arrears) and, as I have mentioned, the court’s ability to ascertain the true repayment period was significantly impaired, and (c) the future computation by the plaintiff of the contractual monthly instalments requiring to be paid in addition to the arrears.

[62] Fifthly, the misassumptions I have mentioned persuade me that when this plaintiff brings an application for leave to enforce a suspended order for possession it may face an uphill struggle unless by its grounding affidavit it: (a) confirms that any future “material” consolidation of arrears in the case will be in a strict compliance with the requirements of “good capitalisation” as defined by the Financial Conduct Authority (thereby requiring among other things the informed agreement of the “customer”); (b) discloses with particulars all past consolidations (save permitted “immaterial’’ capitalisations of minimal amounts) and all past double-billing events; (c) states the current state of account between the parties as to monthly instalments, arrears and so forth as prescribed (for affidavits grounding claims for possession) in Order 88 rule 5(3) of the Rules, (d) states the true arrears when the relevant suspended order and where appropriate any order varying its terms were made; (e) clarifies the particular circumstances in which it would be just to permit enforcement of the original order for possession (as varied by any subsequent order which had been made) notwithstanding the misassumptions I have mentioned; and (f) confirms in terms that the plaintiff in its figures is not relying on any pre-consolidation arrears.

[63] For like reasons I believe future applications by this lender for possession should also include the particulars of the state of account and of any consolidation and the express confirmations I have just specified for applications for leave to enforce. It would be open to the court on making any suspended order for possession to include a provision that in the event that the arrears are discharged by payment or consolidation the effects of the order shall cease: Zinda.