Priority between mortgagee and lessee

Where an owner of land is struggling to pay loans secured over the land it is not uncommon for the owner to enter into a lease with a related party in an attempt to avoid losing control of the land should the mortgagee enter possession and attempt to sell the land. The questions which arise are whether the mortgagee is bound by the lease and, if the land is sold, whether the new owner’s title is subject to the lessee’s interest pursuant to s.42(2)(e) of the Transfer of Land Act 1958? Section 42(2)(e) excludes from the Act’s indefeasibility provisions “the interest (but excluding any option to purchase) of a tenant in possession of the land”.

In the absence of the mortgagee’s consent, the mortgagee is not bound by a lease entered into after the mortgage is entered into – this is so even if the lease is entered into before the mortgage is registered: see  Balanced Securities Ltd v Bianco [2010] VSC 162. Thus, the mortgagee can sell with land without the purchaser being affected by the purported tenant’s interest.

In 2014 the matter was put beyond any doubt by the insertion of s.87C into the Act which provides:

“The creation, variation or surrender of a lease or the creation or variation of an easement or restrictive covenant, in respect of land subject to a mortgage or charge, is not valid or binding against a mortgagee or annuitant unless the mortgagee or annuitant has consented in writing to (as the case requires)— 

        (a)     the creation, variation or surrender of the lease; or 

        (b)     the creation or variation of the easement or restrictive covenant.”

In a recent case in VCAT I appeared for a mortgagee which had taken possession of land after a company defaulted on its loan – the mortgagee had also entered into a contract to sell the land. A purported tenant sought an injunction against the mortgagee to recover the premises on the basis that he was a lessee under a long term lease. He produced a lease executed by the company and signed by him. Not only did he claim to be the tenant, he was the sole director and shareholder of the purported landlord. The mortgagee claimed that lease was a forgery but this was irrelevant to VCAT’s decision. The critical issue was that mortgage had been entered into before the purported lease. Because the tenant failed to produce evidence that the mortgagee had consented to the lease the application was dismissed with leave to the purported tenant to reapply by the following afternoon if he were able to furnish evidence of the mortgagee’s consent. The right to leave was not exercised.