The unintended regulated mortgage contract

The unintended regulated mortgage contract


What happens if an unregulated lender offers a regulated mortgage contract to its client? Clive Whitfield-Jones, Solicitor Director Jeffrey Green Russell Limited Solicitors explains more…

An unauthorised lender lends Mr Brown £500,000 for a 6 month term, upon the security of a first charge over a house he owns. Mr Brown has assured the lender that the house is let to unrelated tenants; it is a condition of the loan agreement, as stipulated by the FSA, that the house is not to be occupied by the borrower or any related person. In fact, Mr Brown’s sister, recently estranged from her husband, is living in the property temporarily. Mr Brown defaults on the loan. 

Can the Lender enforce the loan and security for it? 

If at least 40 per cent of the property was occupied by Mr Brown’s sister at the date of the loan agreement, the lender has entered into a regulated mortgage contract (“RMC”) (see Article 61 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001). Entering into an RMC is a regulated activity under FSMA if it is done by way of a business (section 22).

There are arguments available to the lender that unintentionally entering into a one-off RMC is not done by way of a business even if the lender is in the business of lending (see article 3A(1) of the Financial Services and Markets Act 2000 (Carrying on Regulated Activities by Way of Business) Order 2001; the FSA’s guidance at PERG 1.6.5(2), 2.3.2 and 4.3.3; and Helden v Strathmore Ltd [2011] 1 BCLC 45 and [2011] 2 BCLC 665).

However, if on the facts and the law, the true analysis is that the lender entered the RMC in the course of a regulated activity, the RMC is only enforceable to the extent that a court may be persuaded that enforcement is just and equitable (sections 19, 26(1) and 28(3) of FSMA).  

Mr Brown is obliged to repay the capital in any event (FSMA section 28(7)) but enforcement of the security and recovery of interest and other charges are in the discretion of the court. 

What should the lender do? 

If the lender is authorised under FSMA for other activities, its authorisation may be jeopardised by its conduct in relation to an unintended RMC.  The FSA requires authorised entities to take all reasonable steps to establish whether a mortgage will be an RMC before it is granted (MCOB 1.6.3R).  

Where an authorised entity only realises during the course of an RMC that it is an RMC, the FSA’s requirements for an RMC are still to be met (at least going forwards, by for example treating customers in arrears in accordance with MCOB 13). The borrower must be informed, as soon as practicable, that it is an RMC and what his rights are in relation to the RMC, including the application or otherwise of the Consumer Credit Act 1974 (MCOB 1.6.4R).

Similar transparency is advisable even where the lender’s business does not depend upon any authorisation under FSMA in order to reduce the risk of prosecution under section 23 of FSMA or under the Consumer Protection from Unfair Trading Regulations 2008 - particularly if the lender’s practices may have resulted in a number of unintended RMCs.

What if the lender has/has not turned a blind eye?

When considering whether to enforce the RMC on the just and equitable ground, the court must have regard to whether or not the lender reasonably believed that it was not entering into an RMC (FSMA section 28(4)(a) and (5)).

The better the lender’s due diligence in seeking to confirm that the actual use and intended use of the property does not fall into the remit of a RMC, the better the prospects of enforcement of the charge and the lower the risks of regulatory action against the lender. 



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    Steve Reynolds

    What of the high street bank who grants a bridging loan to facilitate a purchase of a run down property by the borrower to do up and reside in for himself and family? To my mind, that is an article 61 regulated mortgage contract and if not at the point of purchase, becomes so once the bank renews the bridging loan and charges a fee in the process, particularly where the bank now knows that the borrower resides in the said security having sold previous property.

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    Clive Whitfield-Jones Solicitor

    The meaning of article 61 of the Regulated Activities Order is clear: if the property is in fact used as a dwelling by a related person at the date of the agreement, that aspect of the criteria for a regulated mortgage contract is met whatever the borrower has said. The lender could, of course, issue proceedings on the basis that the agreement is not a regulated mortgage contract and then argue that the defendant is estopped from alleging that it is. However, an estoppel might be difficult to establish. The borrower might claim, for example, he had inadvertently misled the lender by saying that the property was let to unrelated tenants when a tenancy agreement had been entered into with unrelated tenants but was yet to commence, and his sister was living in the property temporarily in the meantime. Even where it appears to the lender, on the facts, that the borrower has deliberately lied about the occupation of the property, it cannot safely be assumed that fear of allegations of mortgage fraud will prevent the borrower from raising the argument that the agreement is a regulated mortgage contract or that the matter will not come to the attention of the FSA.

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    Surely the lender received a copy, or at very least details, of the AST before lending? If so, regardless of it being a relation, she is occupying under a proven document, which should entitle the lender to serve appropriate notice in the event of repossession?

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    Peter Roberts

    I disagree. There is another argument available to the lender. In this instance, Mr Brown is unlikely to be able to allege, as his defence, that his lender entered into a Regulated Mortgage Contract with him. At the outset he 'assured' the lender that the house would be let to unrelated tenants. The lender, in relying on this warranty, acted in good faith. Any Court would remind the borrower of his conduct in using this defence; he can't initially declare his position one way to obtain monies only to declare his position the other to avoid repaying that debt. The borrower cannot take legal action against the lender unless his own behaviour is beyond reproach. In this case it is not. The borrower, in pursuance of the RMC argument, would perjure himself and be subject to criminal proceedings - there has already been unrecorded case history in this regard. As Mr Whitfield-Jones says, the lender's due diligence, at application stage, regarding the actual use of the property is paramount.

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    Bill Nelson

    Perhaps this excellent summary begs a further article on appropriate due diligence and events after the start of the contract? For example, if the prospective lender were to contact the tenant to obtain a declaration that s/he is not a related person, would there be a potential breach of the borrower's rights under DPA? If the borrower is asked to obtain that declaration from the tenant, could the lender safely rely upon it for evidence of compliance/exemption, or would the enquiry indicate doubt? Should the lender take steps to monitor changes of tenant during the life of the loan? Are there any validated statistics throwing light on the potential for and reality of incidence of this problem?

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