Marshalling – what is it and how can it help a second registered mortgagee?

Marshalling is an equitable doctrine designed to protect second registered mortgagees from not being paid because of the arbitrary or capricious realisation of a security property by a prior mortgagee. In certain circumstances, a second registered mortgagee may be able to access surplus proceeds of sale from a property which it did not hold a mortgage in priority of other creditors.

When will a claim for marshalling be successful?

Courts will permit marshalling by a second mortgagee in circumstances where:

1. the debt is secured by a second mortgage over a property (the common property)
2. the first mortgagee of the common property is also a creditor of the debtor
3. the first mortgagee also has security for its debt in the form of another property (the other property).  The second mortgagee does not hold security over the other property
4. the first mortgagee has been repaid from the proceeds of sale of the common property
5. the second mortgagee’s debt remains unpaid
6. the proceeds from the sale of the other property are not needed (at least in full) to repay the first mortgagee’s debt.[1]

In such a case, the second mortgagee can look to the other property to satisfy the debt owed to it. If a court did not permit marshalling, the second mortgagee, who did not obtain the benefit of the proceeds of sale of the common property, would lose the benefit of its security and be required to prove its debt as an unsecured creditor.

Recent example

The case of Burness v Hill [2019] VSCA 94 examines the equitable doctrine of marshalling. The facts of the case illustrate circumstances where a court will permit a second mortgagee to access the surplus proceeds of sale from a property which it did not hold a mortgage in priority of other creditors.

Mr Hill was the solicitor of Mr Love in respect of the compulsory acquisition of a number of properties owned by Mr Love.  We will call these Property A, B and C.

Each of the properties had registered mortgages by the Commonwealth Bank of Australia (CBA).

Around August 2009, Mr Hill took a second registered mortgage over Property A in respect of his unpaid legal fees.

In 2011, CBA sold Property A as mortgagee for the sum of approximately $10.3 million.  The proceeds of the sale were not sufficient to repay the whole of Love’s debts to CBA.

In 2012, Mr Hill commenced proceedings in the County Court to recover unpaid legal costs of approximately $4.15 million.  The parties attended mediation in 2013, where it was agreed that Mr Love would pay Mr Hill the sum of $2.2 million and would consent to judgment against him in the County Court proceeding for that amount.

CBA later took possession of Property B and the proceeds were again insufficient to repay the debt owed Mr Hill. Mr Hill subsequently lodged a caveat over Property C, claiming an interest as an equitable mortgagee, and commenced proceedings in the Victorian Supreme Court.  Relying on the doctrine of marshalling, Mr Hill claimed that his second mortgage gave him the right to stand in the shoes of CBA as first mortgagee of Property C and be paid the amount secured by the second mortgage.

Mr Love was made bankrupt by a sequestration order made in February 2016.

CBA later sold Property C in November 2016, which returned a surplus of approximately $5.8 million and was paid into court.

Bankruptcy Trustees’ arguments

The bankruptcy trustees argued that:

1. at the time Property A was sold, Mr Hill’s judgment debt did not exist and was not secured by the second mortgage.  Mr Hill’s claim for unpaid legal fees and disbursements were extinguished by the County Court judgment, and thus could not form the basis of the marshalling claim
2. because of an informal arrangement between CBA and Mr Love as to the order of sale of the properties, to the effect that Property A would be sold first.  CBA had not acted arbitrarily or capriciously
3. Mr Hill released his marshalling rights by the terms of settlement in the County Court proceeding
4. Mr Hill’s marshalling claim was estopped under Anshun principles[2] (which prevents a party from bringing claims which have been pursued in former proceedings).

Appeal Court’s ruling

The Court of Appeal held that:

1. it is not necessary to show that the first mortgagee acted capriciously or arbitrarily to be successful in a claim for marshalling, though, this may be the policy reason for equity’s intervention
2. marshalling is permitted, even to discharge a fluctuating debt and even if the debt increases after the sale of the principal security property.

Entering into a consent judgment did not extinguish the secured debt.  Rather, the debt merged and continued to be secured and was able to support a claim for marshalling.

Key takeaway

Marshalling can be a useful tool to improve a subordinate mortgagee’s prospects of recovery in instances where the mortgagor has become insolvent. In such circumstances, a subordinate mortgagee, who would have otherwise lost the value of their security, will trump the rights of other unsecured creditors.

[2] Port of Melbourne Authority v Anshun Pty Ltd (1981) 147 CLR 589