Lender claims - have the floodgates opened?

Updated January 2012

The case of Paratus AMC Ltd and another v Countrywide Surveyors Ltd produced the first decision of its kind in the current cycle of lender claims and provides a helpful commentary as to the approach the courts may be taking in the future in professional negligence cases involving residential buy-to-let properties.

We are expecting there to be further decisions over the course of 2012 and beyond, although we are unlikely to see a return to the litigious landscape that followed the previous spate of lender claims.

The case

In July 2004, Mr Stockton (the Borrower) applied to the first claimant for a remortgage of his property. The valuer defendant provided a valuation report in the sum of £185,000 for mortgage purposes. In reliance on the valuation, the first claimant lent £166,500 representing a 90% loan to value (LTV) ratio. Following default by the Borrower, the property was repossessed and sold for £123,500. The claimants argued that the correct valuation at the relevant time was £154,000 (representing a 20% variance) and therefore the original valuation by the valuer defendant was negligent.

The decision

Whilst it was held that the defendant valuer was not negligent and the valuation was within an acceptable range of values, the judge considered in detail the following issues:

1. methodology used in reaching a valuation/extent of valuer’s duties;
2. acceptable margin of error;
3. securitisation and the claimants’ right to recover the loss; and
4. contributory negligence.

Implications for lenders

This is a useful decision in that it sets out the court’s more recent approach to a number of key issues that have long been rehearsed by reference to 1990’s/early 2000’s case law.

The most salient points to note are:

• Nothing novel was decided in relation to the appropriate valuation methodology and margin of error.
• Securitisation as a defence was quite rightly found to be the red herring that it had always been. It is hoped that Claimants will now see an end to this time consuming, expensive, and ultimately pointless argument.
• The Court quite rightly chose not to criticise commercially riskier lending per se. Significant errors were made in relation to the specific decision to lend which led to the Court making a hypothetical deduction for contributory negligence of 60% without any guidance as to how that deduction was calculated.
• It sets a useful benchmark for lenders when assessing the commercial viability of a claim and in many instances the decision will be distinguishable by reference to the detailed comments of the first claimant’s failings in this case.
• It should also be remembered that Platform Home Loans v Oysten Shipways Ltd remains good law. This allows for a 'cushion' between the usually higher cost of funding loss and the capped loss which often negates contributory negligence arguments.

The key issues considered by the court were as follows:

Methodology / Parameters of valuer’s duties

The court preferred the valuation method put forward by the defendant, which was based on the comparable sale evidence obtained from the Land Registry for the period prior to the valuation rather than the claimant’s arithmetical method of calculation based on the application of price per square metre.

It was accepted that the lower level of fee set some parameters to what is reasonably to be expected, although it did not excuse a valuer from failing to do what was necessary to provide a competent valuation.

Acceptable margin of error

The acceptable margin of error or so called ‘bracket’ of non negligent values on either side of the correct valuation was held to be 8% in this case.

The court referred to the dictum in K/S Lincoln and others v CB Richard Ellis Hotels Ltd [2010] EWHC 1156 (TCC) and recognised the various commonly accepted margins of error (standard residential properties at 5%, one-off properties at 10% and properties with exception/unique characteristics up to 15%). The court however felt that the margin of error here was higher than the accepted 5% because (i) the comparable evidence available lacked consistency and clarity, (ii) the market was buoyant and volatile for this type of property at the relevant time and (iii) the analysis of comparable evidence for flats contained in blocks was more difficult than ‘standard houses’, which were more suitable for a meaningful external inspection.

Securitisation

The first claimant had entered into a Mortgage Sale Agreement (the MSA) with the second claimant, a special purpose vehicle, in respect of a portfolio of mortgages which included the subject loan. Pursuant to the MSA, the first claimant remained the legal title owner and the second claimant became the equitable owner of the portfolio.

The court considered in detail the consequences of the securitisation and the terms of the MSA. The defendant argued that the first claimant could not claim for its losses as it had assigned its cause of action to the second claimant, whilst the second claimant equally could not claim as it had not suffered the loss. The MSA provided that any assignment of the cause of action was to take place following completion of the sale of the relevant mortgages either (i) on issue of relevant notes by the second claimant, or (ii) at a later date as agreed between the parties. It was therefore held that completion had not taken place and the first claimant could claim for its losses. The court went on to clarify that the securitisation did not affect the scope or quantum of the cause of action and if the first claimant did not assign its cause of action in due course, it simply had to account to the second claimant for the proceeds of the cause of action where it was to sue in its own name.

His Honour Judge Keyser QC made a point of clarifying that whilst the securitisation had the effect of spreading the loss legally attributable to the cause of action to third parties it did not result in disposing with the recoverable loss. The court criticised the defendant for trying to exploit the consequences of a strict application of technical rules and concluded that if its arguments were allowed to succeed in such a standard and widely used form of a securitisation scheme, this would lead to injustice as loss otherwise recoverable from a negligent valuer would become irrecoverable.

Contributory negligence

The decision usefully explained the court’s approach to contributory negligence by a mortgage lender:

• Riskier lending

The court was reluctant to criticise the business model of the first claimant and the accepted lending practices of the financial institutions at the relevant time in respect of underwriting high loan to value loans. The defendant’s expert similarly did not challenge the lending of 90% LTV which was in accordance with “a significant, although small, sector of the market”. It was emphasised that such high LTV lending created higher risks but it was not imprudent in case of a lender whose business was to make such loans, as was the case here.

The court stressed, however, that if a lender were to make loans at such a high LTV, it had to ensure that it had properly investigated and verified matters of central importance to the underwriting process.

• Failures to follow up obvious lines of enquiries

If the claimants had succeeded in the claim, the court considered that it would have made deductions of 60% for contributory negligence as the first claimant had failed to investigate matters of central importance.

As a result, this decision should be distinguished on the case specific facts. Here it was shown that no steps were taken to follow up important unanswered questions on the application form and no enquiries were raised in respect of obvious discrepancies in the application form (such as the apparent oddity that this was a residential mortgage that was at a considerable distance from the Borrower’s successful property business). Further, the first claimant’s own systems recorded three different figures that had been submitted for the Borrower’s income (£200,000, £149,000 and £85,000) and the lender failed to verify and/or investigate the reasons for the considerable discrepancies between the different income figures. The only information/evidence obtained of the Borrower’s income was his assertion in the application form. In addition, there were further numerous discrepancies in the disclosed commitments which were identified from internal credit checks. The Borrower had disclosed three commitments totalling £640,000 whilst the lender’s internal checks uncovered substantial debts of more than double the value disclosed. This again was not investigated.

The court held that the first defendant failed to investigate matters of central importance by its disregard of the obvious discrepancies in the disclosed income and liabilities by the Borrower. The first claimant was held to be imprudent in failing to raise queries in this regard. The other failures, although minor in themselves, had confirmed the need for proper enquiries of the Borrower’s financial position. It was held that if such enquiries had been made, the first claimant would have seen that the Borrower was dishonest and it would not have proceeded with the loan.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at January 2012. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.

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