Property / Real Estate

Using an Encumbrance to Secure Performance of Obligations

Nature and Purpose of an Encumbrance

Local Authorities frequently use the registration of an Encumbrance against a landowner's title as a convenient means of securing the performance of obligations by the landowner where other forms of security are impractical or ineffective.

The type of obligations that can be secured by an Encumbrance are very broad. These obligations often relate to land. However, one of the advantages of an Encumbrance, as opposed to other forms of security, is that secured obligations do not necessarily need to relate to the land over which the Encumbrance is registered. Typical examples of when an Encumbrance can be used include:

  • Security for performance of land use consent conditions (ie maintenance of structures or plant and equipment);
  • Covenants by the landowner not to object to future development of neighbouring land;
  • Repayment of debt.

An Encumbrance will bind subsequent owners to the performance of the obligations specified in the Encumbrance Instrument. It will act as notification to a prospective purchaser or other person looking to deal with the land of an existing arrangement. Where the Encumbrance secures performance of financial obligations, a purchaser of the land will frequently require the Encumbrance (and the financial obligation) to be discharged as a condition of settlement.

Importance of Priority

If an Encumbrance is registered with a priority subsequent to another encumbrance, mortgage or charge against the land, there is a real possibility that on the sale of the land, in the exercise of a Mortgagee's or Chargeholder's power of sale, a purchaser will take title to the land without the burden of the Encumbrance. In other words, the Encumbrance will be removed from the title in the process of a transfer to a purchaser on a mortgagee sale. In order to avoid this possibility, and ensure that the obligations secured by the Encumbrance run with the land, regardless of the actions of a mortgagee in enforcing its security, it is essential that the Encumbrance be registered as a first charge against the title. In most cases, a Bank or other Chargeholder will agree to an Encumbrance having priority ahead of the Bank's mortgage or charge, provided its security position is not significantly affected.

Recent Attacks on an Encumbrance as a Form of Security

One of the issues that still creates some confusion and concern, is the characterisation of an Encumbrance Instrument as a mortgage. An Encumbrance Instrument falls within the definition of "mortgage" under section 4 of the Property Law Act 2007. This section defines a "mortgage" as including, "any charge over property for securing payment of amounts or the performance of obligations". While a number of terms implied by statute in a mortgage are also implied in an Encumbrance Instrument, in practice, the ability of the Encumbrancee to exercise power of sale in the event of a default is usually excluded.

An Encumbrance generally has the following characteristics:

  • the provision of a purely nominal rent charge in most instances;
  • the exclusion of a power of sale that would otherwise be implied by the Property Law Act; and
  • a term that is extremely long, often for a term of 999 years.

In its 2008 decision in Menere & Ors v Jackson Mews Management Limited, the High Court, ruled that payment of the full amount of the annual rent charge secured by the Encumbrance (In this case, 10 cents per annum for 99 years totalling $9.90 for the term of the Encumbrance) entitled the Encumbrancer to a discharge and release of the Encumbrance from the land. In effect, the Encumbrance was treated as only securing performance of financial obligations. The consequence of discharging the Encumbrance from the title was that subsequent owners were not bound by non-financial obligations secured by the Encumbrance. While the personal covenants of the original parties to the Encumbrance remained enforceable by those parties as a matter of contract, the essential purpose behind registration against the title, namely, to bind subsequent owners was lost. The decision had an immediate and widespread implication for numerous Encumbrances which were registered with a nominal rent charge requirement.

The High Court decision in the Jackson Mews case was overturned on appeal to the Court of Appeal. The Court of Appeal reached the view that all obligations secured by the Encumbrance, both financial and non-financial, needed to be fulfilled, satisfied or found redundant, in order for the Encumbrancer, to have entitlement to a discharge. However, the arguments put forward and accepted by the High Court, have persisted as a source of concern. When considering an appropriate level of rent charge, a high deterrent level is still sometimes sought as a means of dissuading the Encumbrancer from offering to pay the full amount and demanding a discharge of the Encumbrance as an entitlement. In addition, there is a persistent view that the characterisation of a Encumbrance as a "mortgage" means that its security for performance of non-financial obligations is ancillary to the financial obligations.

In a recent High Court case, Parihoa Farms Limited v Rodney District Council, Parihoa Farms Limited (Parihoa) sought to obtain a discharge of the Encumbrance registered by Rodney District Council (RDC) against land owned by Parihoa. The solicitors for Parihoa tendered a bank cheque for $49.95 payable to RDC, which was calculated as "the whole sum owed under the mortgage". The Encumbrance was for the benefit of RDC for a term of 999 years, with an annual rent charge of 5 cents to be paid on the first day of June each year if demanded by that date. The Encumbrance instrument contained a non-financial covenant by the Encumbrancer (now Parihoa as the current owner) in favour of RDC not to further subdivide the land unless specifically agreed to in the form of a written approval by RDC.

RDC refused to discharge the Encumbrance and accordingly returned the bank cheque. In refusing to discharge the Encumbrance, RDC stated that a primary purpose of the Encumbrance was "...to prevent further subdivision".

The High Court held that Parihoa had no lawful basis for requiring the discharge of the Encumbrance on payment of the amount outstanding. The High Court further held that the commitments secured by an Encumbrance inure for the period originally assumed. In this case, 999 years.

Summary

In our view, the use an Encumbrance in many situations, by local authorities and others, to secure performance of non-financial obligations will continue to be an important tool for the following reasons:

An Encumbrance provides an effective mechanism to bind subsequent owners of the land;

An Encumbrance can secure restrictive covenants in gross (ie the Encumbrancee does not necessarily need to own land intended to benefit from the obligation contained in Encumbrance);

Prospective purchasers have notice of pre-existing arrangements;

Once registered, an Encumbrance can reduce the ongoing administrative costs associated with long term monitoring of compliance with consent conditions.
As with any tool, consideration needs to be given to the particular circumstances of the landowner and the secured party before an Encumbrance is chosen as the preferred method of securing performance by the landowner. The purpose of the Encumbrance is key to determining the level of rent charge, the term, and the events which might trigger entitlement to a discharge. Notwithstanding the decision of the Court of Appeal in Jackson Mews, a high annual rent charge may still be appropriate if default by the Encumbrancer in the performance of the secured obligation would be at a high financial cost to the Encumbrancee, or if there is a significant financial obligation to be secured.

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The contents of this publication are general in nature and are not intended to serve as a substitute for legal advice on a specific matter. In the absence of such advice no responsibility is accepted by Brookfields for reliance on any of the information provided in this publication.

 

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