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The dangers of granting a home loan to a lender, before lodgement of a mortgage bond
08 June 2020 | Views: 646
 
I recently became aware of a situation in which a client's personal banker approved a mortgage bond for her long-serving client, who is a property developer, in order to secure payment of debt incurred by the client four months before the bond was lodged at the relevant registrar of deeds for registration.

This unsettled me, as I am well aware of the provisions of section 88 of the Insolvency Act (which I elaborate on below). It also raised some red flags regarding the considerable financial risk this could hold for the bank, since it has approved the bond more than two months prior to lodging it with the registrar of deeds.

Let me explain. A mortgage bond is registered over immovable property to serve as collateral for a loan amount paid to the debtor. In most cases, the bank will only advance the loan amount to the lender after the bond has been lodged and successfully registered with the relevant deeds registrar. 

However, circumstances may exist under which the bank has no other option than to advance funds to the debtor without the bond first being lodged for registration. 

This may occur where the debtor is a long-term trusted client of the bank and the bank wants to maintain a good business relationship with the debtor. In this instance, the bank has to balance maintaining this relationship with the risk that section 88 of the Insolvency Act 24 of 1936 (the “Act”) presents to the bank.

Section 88 of the Act states that a mortgage bond passed to secure the payment of a debt not previously secured, which was incurred more than two months before the bond was lodged with the registrar of deeds for registration, does not confer on the creditor any preferential claim if the estate of the debtor is sequestrated within six months after such lodging.

A preferential claim means that a creditor has the right to claim first from the estate of the insolvent person. Section 88 was designed to prevent a creditor who, in anticipation of the sequestration of its debtor’s estate, tries to gain an advantage for himself by having a mortgage bond registered over the debtor’s property in its favour.

The effect of this section therefore, is not to void the mortgage bond, but to not recognise any preference conferred by the bond if the estate of the debtor is sequestrated within six months of lodging the bond.

In the facts I had at hand, the bank lent the money to the debtor more than two months before lodging the bond. Therefore, section 88 applies and this means that the bank will not have any preference if the debtor is sequestrated within six months after the lodgement and subsequent registration of the mortgage bond.

Nonetheless, the bank still has an unsecured claim against the borrower’s estate for the loan amount, pending settlement of the preferential claims of the other creditors against the insolvent estate, provided that there is still enough money in the insolvent estate to settle the loan amount, even if it is not in full settlement thereof.

Moreover, if the borrower happens to be sequestrated after the six month period following lodgement of the mortgage bond, the bank will retain its preference over the borrower’s estate in the event that the borrower is sequestrated. 

Evidently, section 88 may have severe financial consequences for banks if careful consideration is not given when lending money to lenders prior to lodgement of the relevant mortgage bonds at the registrar of deeds. 

That's why is is advisable to curb the application of this section by rather lodging the bond for registration first, and then advancing the loan amount to the purchaser. It is further prudent to ensure that the mortgage bond is registered before a further two months lapse after advancing the loan amount.