Unscrupulous borrowers and mortgagors are coming up with more sophisticated ways to avoid liability for failure to return funds which are not always managed by legislation and case law. In this article we will look at 5 difficulties that banks often face when applying for a mortgage, and explain how to avoid them.
A mortgage has always been one of the most common and safe ways to secure an obligation. The popularity of a mortgage is explained by the fact that creditors believe the risks of losing real estate are minimal and therefore it can always be foreclosed. At the same time, unscrupulous borrowers and mortgagors are coming up with more sophisticated ways to avoid liability for failure to return funds which are not always managed by legislation and case law. In this article we will look at 5 difficulties that banks often face when applying for a mortgage, and explain how to avoid them.
1. Choosing a mortgage foreclosure method
In the event of a default, financial institutions are primarily interested in returning of funds rather than in the acquisition of ownership of real estate. That is why, the most common mortgage foreclosure methods are selling the property by the bank on behalf of the seller to a third party or acquiring the ownership of the mortgage by the bank and then selling it.
According to the law, the sale of a mortgaged property by the mortgagee to any person-buyer can be made both in a court and an out-of-court way of the foreclosure. Recently, the Supreme Court established a new rule for these legal relations: if the said mortgage foreclosure method is stipulated in the mortgage agreement as an out-of-court procedure, then it is not possible to apply the same claim to the court (Decision of 29 May 2019 in Case No. 310/11024/15).
Nevertheless, if the contract provides for a court mortgage foreclosure method, it should be noted that a dispute over the amount of the debt may arise during a court hearing over the mortgage foreclosure. In such a case, the court may refuse to satisfy the claim for a mortgage on the grounds of the necessity for preliminary settlement of the dispute about the amount of the debt under the loan agreements.
If, however, the mortgagee decides to become the owner of the property, then it is worth remembering the established case law by which the recognition of ownership of the mortgage by the mortgagee is only out-of-court foreclosure method which can be realized by appealing to any state registrar, including notary (Supreme Court Decision of 21 March 2018 in Case No. 760/1443829/15, Supreme Court Decision of 18 October 2018 in Case No. 910/17423/17 and others).
In order to choose the right mortgage foreclosure method, it is reccomended to carefully analyze the mortgage contract and keep up to date with the latest trends in case law.
2. Mortgaged property valuation
From a practical point of view, one of the fastest and most convenient ways of a mortgage foreclosure is to register the ownership of the mortgaged property in favour of the mortgagee. Of course, the mortgagor usually tries to find any opportunity to challenge such a transfer of ownership in court. In order to prevent such opportunities, the mortgagee has to valuate the mortgaged property before registering the ownership. It is also important to note that such valuation should meet the requirements of current legislation on its implementation. As the Supreme Court case law shows, violation of the National Standard No. 1 “General Principles of Property and Property Rights Valuation” approved by the Cabinet of Ministers of Ukraine Resolution No. 1440 of 10 September 2003 may be the ground for canceling the registration of a mortgaged property in favour of a bank (Supreme Court Decision of 19 June 2019 in Case No. 917/2101/17).
It is also worth paying attention to the Part 6 of the Article 38 of the Law of Ukraine “On Mortgage”. This provision stipulates that the sale price of the mortgaged property is set on the basis of the valuation of certificated appraiser at a level not lower than the usual prices for this type of property. If this condition is not fulfilled, the mortgagee shall be liable to other persons according to the priority and size of their registered rights or requirements and to the mortgagor in the last instance for compensation of the difference between the sale price of the mortgaged property and the adequate price for it. In fact, this means that the debtor may require the mortgagee to compensate for the difference between the sale price of the property and its market value. That is why, it is recommended to set an appraised value at the level of the market prices and sell the mortgaged property at a price not lower than its appraised value .
It is also necessary to recall that the valuation of the mortgaged property in the case of court foreclosure is no longer obligatory and can be carried out even at the stage of enforcement proceedings (Supreme Court Decision of 21 March 2018 in Case No. 235/3619/15).
3. Liens on the mortgaged property
Unfortunately, there are numerous cases when unfair debtors which do not want to return the borrowed funds try to establish a lien or any other encumbrance on the mortgaged property (liens within criminal proceedings are especially common) in order to prevent foreclosure on the property. From a legal point of view, such a lien is unlawful but its cancellation acquires court decision and takes considerable time and resources.
In order to prevent such schemes from being used, amendments were made to the Law of Ukraine “On State Registration of Real Property Rights and Burdens”.
In particular, now the denial of state registration of real property rights, because of registered encumbrances to mortgaged property, is not possible in a process of registering the ownership of mortgaged property by financial institution in the manner provided by Articles 33-38 of the Law of Ukraine “On the Mortgage”. Given that a lien in criminal proceedings is a form of encumbrance, the existence of such a lien in practice should not be an obstacle for registering the ownership of real estate with a financial institution.
Some registrars refuse to register ownership in favour of a foreign financial institution since the latter does not meet the requirements of a “financial institution” under Ukrainianlegislation. From our point of view, such a refusal is unlawful and we managed to prove it to the registrar in a similar case with references to the rules of the Agreement on the Promotion and Mutual Protection of Investments as well as the legislation of Ukraine on financial services.
4. Bankruptcy of a debtor or a mortgagor
If a debtor or a mortgagor initiates a voluntary liquidation procedure or the third-party files for bankruptcy of a debtor/mortgagor, the prospects for a foreclosure outside the bankruptcy procedure are very low. In such situations success depends solely on the prompt financial institution reaction and on the legal ability to prevent bankruptcy proceedings.
In accordance with Ukrainian legislation, a court decision initiating bankruptcy proceedings imposes a moratorium on satisfaction of creditors claims. This means that no lender can recover the property of the debtor being a mortgagor outside the bankruptcy case.
In such cases, we recommend the financial institution to object to the initiation of bankruptcy proceedings because of the failure of the initiating creditor to meet the requirements or the violation of the voluntary liquidation procedure (or any other reason). Since such bankruptcies in most cases do not have a proper basis, it is almost always possible to find violations.
If the mortgagor and the debtor are different persons, it is worth paying attention to the recent changes in the legislation, according to which the liquidation of the debtor being the legal entity is not an obstacle to mortgage foreclosure. At the same time, the law establishes an important condition – the lender must send a notice to the mortgagor about his intention to foreclose the mortgaged property before the end of debtor’s liquidation process.
5. Powers of the parties to conclude the contract
When concluding a mortgage agreement, the bank should pay attention not only to its content but also to the order of signing. Formal violations at this stage may complicate or even make impossible the further foreclosure. Therefore, when concluding a contract with a mortgagor being legal entity, it is necessary to carefully analyze a potential signatory authority to sign the contract on behalf of the mortgagor. Therefore the following documents should be examined: the latest version of the charter, the decision of the general meeting (if necessary), the power of attorney (if signed by the representative). Recently, the Supreme Court declared invalid two mortgage agreements for 41 land plots with a total area of several hundred hectares concluded by PrivatBank (Supreme Court Decision of 18 June 2019 in Case No. 910/15832/17). The ground for declaring these contracts invalid were as follows. In accordance with the mortgagor's charter, all contracts must be signed by both the director and the chief accountant. The contract in question was signed by a representative who acted on a power of attorney given by the director and chief accountant. However, the charter provided for the possibility of delegating the right of signature of the director and didn’t provide the same right for chief accountant. Therefore, the court concluded that the representative had no right to sign the mortgage agreement on behalf of the chief accountant.
If the mortgagor is an individual, then the financial institution should make sure that the second spouse’s consent for signing this contract was given. Not too long ago, the Grand Chamber of the Supreme Court has reverted to the practice of past years, according to which the absence of such consent constitutes a ground for invalidation of a mortgage agreement (Supreme Court Decision of 21 November 2018 in Case No. 372/504/17).