Is there a general equitable duty on a lender to act in good faith?

The recent High Court decision in Standish[1] has considered a claim that a Lender (RBS) breached an equitable duty to act in good faith by taking a substantial shareholding in a Borrower via a subsidiary. The shares were transferred in the context of debt restructuring following a breach of one of the Borrower’s financial covenants and its referral to RBS’ Global Restructuring Group.

The unlawful means that were alleged by the Claimants (who were the shareholders of the Borrower) fell into three categories of claim:

  1. the Lender acted in breach of an implied contractual duty of good faith;
  2. the Lender acted in breach of certain equitable duties arising from the fact that the Lender held security over real property; and
  3. RBS’ subsidiary (or its representative) acted in breach of fiduciary duties as a shadow director.

The context of this decision was an application by the Lender to strike out the Claimants’ claim on the basis that the particulars of claim showed no reasonable grounds for bringing the claim.

In this article we focus on the decision relating to the second category, being the alleged equitable duties arising from the fact that the Lender held security over real property. This is the issue of widest application to ASTL members.

How was the security position said to give rise to a wider duty?

The Claimants’ argument was based on the case of Medforth v Blake[2], and the principle that receivers and mortgagees owe equitable duties (including the duty to act in good faith) to mortgagors when selling a mortgaged property.

Medforth provides that “duties imposed on a mortgagee in possession, and on a mortgagee exercising his powers whether or not in possession, were introduced in order to ensure that a mortgagee dealt fairly and equitably with the mortgagor."

Medforth specifically related to the actions of a receiver managing a mortgagor’s business. It concluded that a receiver owes similar duties when managing a mortgagor’s business as when selling a mortgaged property.

The Claimants argued that Medforth was authority for the proposition that a lender with the benefit of security over land has a general implied duty to act in good faith even when not exercising the powers conferred on them under the security.

The view of the Court

The Claimants’ argument was comprehensively rejected by Chief Master Marsh who commented that it was “impossible to extrapolate from the very specific facts in Medforth … [to] a wide-ranging proposition that will apply to a lender, if it happens to have security by way of a mortgage of land but has not exercised, or threatened to exercise, that security”.

Fundamentally, the security provided by the Borrower was incidental to the facility terms and the Claimants’ complaints about the transfer of shares were wholly unrelated to the security.

So what does this mean for ASTL members?

The decision in Standish should be welcomed as it avoids what would have been an artificial extension of a mortgagee’s duties to something far more extensive than currently exists.

An adverse decision for RBS could have opened up a series of challenges to other secured lenders arising from such matters as pricing changes, additional covenants, lender protections or (as in this case) a transfer of equity, negotiated in the context of a variation or restructure of facilities.

No one can guarantee that other borrowers may not try similar imaginative arguments. (In Standish the Claimants also sought, and failed, to argue an overarching ‘Customer Agreement’, separate from the security and the numerous facility agreements, into which a similar duty was alleged to be implied). However, the Court has sent a clear message that such imaginative attempts to extend lender duties should be given short shrift.

This article is intended only as a synopsis of certain recent developments. If any matter referred to in this article is sought to be relied upon, further advice should be obtained. Any questions arising from this article should be referred to Rob Payne (https://gateleyplc.com/people/rob-payne/) at Gateley Plc.

[1] Tracy David Standish (and 8 others) v (1) The Royal Bank of Scotland Plc and (2) Sig Number 2 Ltd (formerly West Register Number 2 Ltd) [2018] EWHC 1829 (Ch)

[2] Medforth v Blake [2000] Ch 86