Encumbrance instruments — [2010 ] NZLJ 10 PDF

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[2010] NZLJ 10

Encumbrance instruments Rod Thomas, Auckland University of Technology discusses real burdens and Jackson Mews

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ne of the issues facing the Law Commission in its review of the Land Transfer Act 1952 (LTA) concerns the future utility of encumbrance instruments (previously memoranda of encumbrance). This issue has achieved prominence with a submission by the Property Law Section of the New Zealand Law Society, promoting the use of these instruments to ensure that covenants for personal services (covenants ‘in gross’) can bind successors in title to the covenanted land. This discussion must be put in context. It is fundamental to our understanding of property law concepts that personal covenants do not normally bind successors in title. This is in contrast to land covenants granted in favour of other land, statutory easements in gross and, since the advent of the new Property Law Act 2007, personal covenants in leases, which may bind successors provided they were entered into from 1 January 2008. Encumbrance instruments are a creature of the LTA. Created as a form of statutory mortgage, they can be used to charge the land with payment of a rent charge or annuity. Unlike mortgages, there is no advance to repay. Importantly, the charge can be created in perpetuity. Given they secure periodic payments, there is provision for encumbrance instruments to be discharged by payment of sufficient funds into court (s 115 of the PLA 2007).

Indeed, the breadth of covenants that can be imposed may be limited only by the imagination of the draftsperson. In Auckland one could require, in perpetuity, future owners of the secured land to continuallyapplyto join the Northern Club or to present a bolt of purple cloth to the Governor-General every midsummer’s night. Similarly, in Jackson Mews Management Ltd v Menere [2009] NZCA 563 each owner of a unit title in a retirement village was required, for 99 years, to enter into a contract for personal services with a management company. This imposed obligations likely to have been unenforceable had covenants been granted in favour of the applicable body corporate (see ss 15(1)(a), 16 and 37(5) of the Unit Titles Act 1972).

MORTGAGE REASONING Whether such securities should be redeemable as mortgages is the subject of a published debate between Brookfield and the writerin (1997) 8 BCB 1and 13. It is notintended to repeat that debate here. Nevertheless, it remains a matter of interest that proponentsof this use place obviousreliance on encumbrance instruments being within the definition of mortgages as defined under the PLA. This acceptance is obviously necessary to achieve the benefit of s 203 of that Act. Yet the same proponents then argue the securities are not mortgages under the same legislation for the purpose of redemption of the charge. THE ISSUE In enacting the equivalent of s 203 in 1952, the legislature This outdated mode of security would be of little interest, were it not for s 203(1)(a)(ii) of the PLA. This is the successor of accepted personal covenants should be binding on purchasers s 104(1) of the PLA 1952. Section 203 provides that all cov- of mortgaged properties. However, this was undoubtedly with enants contained in mortgage securities will bind purchasers the comfortable knowledge no harm was done to the law of real property. This would seem a self-evident proposition, as of the charged property. The latent potential in this provision was developed by those covenants would be discharged with redemption of the Professor Brookfield at [1970] NZLJ 67. He suggested the mortgage security. Indeed, refusal to discharge mortgage securities in order to section could be used to ensure local authority restrictions on land use were notated on the face of titles in terms that bound obtaina collateraladvantagehasgivenriseto awell-established purchasers of the land. This built on an earlier suggested use of line of case law defining clogs on the equity of redemption: see encumbrances to enable restrictive covenants to be notated on Kreglinger v New Patagonia Meat and Cold Storage Company Ltd [1914] AC 25. The jurisprudence in this area suggests titles (Adams [1950] NZLJ 171). The need for this device for these purposes has since been there is a balance to be struck between enforcement of freely obviated by legislative changes. Now, s 307 of the PLA pro- assumed obligations and anything that clogs the equity of vides land covenants can be notated on titles. By s 221 of the redemption. It is interesting that, notwithstanding the Brookfield/ Resource Management Act 1991 (RMA), consent conditions Thomas debate, there has been continued use of this device. related to subdivision of land can also be notated on titles. Why then, is the use of encumbrance instruments still a live Indeed, some territorial authorities continue to notate consent conditions by encumbrance instruments, rather than using the issue? The same reasoning that accepts this device can be used to powers conferred by s 221 of the RMA. A cynic may conclude this continued use is due to a realisabind successors in title to land covenants and council restrictions on land use, also extends to anyother covenants, whether tion of the potent power of the encumbrance instrument. By the covenant relates to the land, or is in gross. Because of the way of example, many encumbrances include the deterrent of effect of s 203(1)(a)(ii), subsequent owners of the charged land a rather significant deferred “penalty payment” on default in can be obligated to carry out any obligation identified in the performance of the personal covenants. Use of encumbrance instruments instead of s 221 may therefore enable a local security.

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New Zealand Law Journal February 2010

authority to impose obligations otherwise challengeable as being ultra vires the consent procedure if stated as conditions in the issued resource consent.

JACKSON MEWS Thisshortarticleisnotintended to bea comprehensivecasenote on Jackson Mews, which is receiving significant attention within the profession, since the Court of Appeal released judgment on 27 November 2009. However, the Court’s judgment does provide an important illustration of some of the issues discussed in this article, and therefore requires some comment. In Jackson Mews, the encumbrance instrument required the title owner to pay ten cents per annum (if demanded) to the appellant, Jackson Mews, for 99 years. In addition, the encumbrancer was to enter into the services agreement with Jackson Mews Management, and pay a fortnightly levy for the provision of services, as fixed by that company. The Court appears to have been aware of some of the difficulties now discussed in this article. Consequently, the Court sought to limit its reasoning to positive covenants intended to benefit developments. This wasdone byanalogous reasoning with the English law position regarding positive covenants. TheCourtsoughtto separatetheseoutbycategorising them as “third category rentcharges”. In doing so, the Court went to some pains to make clear they were not dealing with “the problems associated with covenants in gross …” (see Hammond and Chambers JJ, para [51]). In justifying this separate categorisation, the Court noted encumbrance instruments had been “commonly used in housing developments and retirement villages in New Zealand since the 1970s …” (see Hammond and Chambers JJ para [2]). Manyin the profession maybe surprised bythisassertion. It is not known what evidence the Court was presented with which enabled it to make such a finding. On the writer’s own experience, this finding may be disputed as a matter of fact. The risks and inherent difficulties in using this device have been well-known to practitioners for years. Further, in England and Wales, third category rentcharges relate to those types of developments where there is a distinct grouping of separate freehold houses or where a single building is divided into separate freehold parts, such as a retirement village or housing estate. It is said that in England, the position is that rentcharges form “an integral part of schemes beneficial, directly or indirectly, to the land charged” and thus were sufficiently beneficial to preserve. This law has not previously had relevance in New Zealand, or required any examination, because, since 1 January 1987, positive covenants could be secured in favour of other land under the predecessor to s 303 of the PLA 2007. A further quirk in the Jackson Mews encumbrance instrument was that the fortnightly levy under the services contract itself arguably fell squarely within the definition of mortgage under the LTA 1952, in that it constituted a “charge on land … for securing … the payment to any person or persons by … periodical payments or otherwise of any annuity, rentcharge or sum of money other than a debt”. That being the case, one wonders why liability for this levy (instead of the nominal rentcharge of 10c per annum (if demanded)) was not created as the rentcharge? S 97(2) PLA In giving judgment in Jackson Mews, the Court of Appeal did not explain how its reasoning could be limited to third

New Zealand Law Journal February 2010

category rentcharges, and not found to apply to encumbrance instruments securing covenants in gross, or indeed, mortgages at large. In what might be thought to be a very general statement, in its reasoning the Court placed some reliance on s 97(2) of the PLA, which provides that a mortgage may not be discharged until “the performance of all other obligations secured by the mortgage” has occurred (see Hammond and ChambersJJ para [43]). The use of the expression “mortgage” in s 97(2) is the same as that found in s 3 of the Act. Thus “mortgage” under s 97(2) includes “any charge over property for securing the payment of amounts or the performance of obligations, any registered mortgage, and any mortgage arising under a mortgage debenture”. Consequently, this part of the Court’s reasoning cannot be limited only third category rentcharges, but appears to have broader application. With respect, is the Court in its analyses of s 97(2) stating that any mortgage cannot be discharged, where there are residual obligations under the mortgage security that may be incurred into the future? This will be news to many in the securities market, where “all obligations” mortgages are commonly drafted to secure future liabilities to the bank. Does this now mean that mortgages cannot be discharged, where personal liabilities may occur into the future, post redemption of the charge? It is hoped these issues may be tested and clarified further before the Supreme Court. OPEN ISSUES FOR COVENANTS IN GROSS In the ANZCO Foods Waitara Ltd v AFFCO New Zealand Ltd [2006] 3 NZLR 351, paras [46]–[52], a differently composed Court of Appeal, after expressing doubt as to whether restrictive covenants in gross can run with the servient land, stated that it would refrain from commenting on the conveyancing efficacy of the encumbrance instrument device. Further, an earlier Court of Appeal in Underwood v Bevin [1992] 3 NZLR 129 faced an argument that encumbrance covenants merely sat on the title, and did not denigrate from ownership in any meaningful way. In that case, the personal restriction was against developing the land further without additional earthworks. The Court neatlydealt with this point. It recognised that the collateral covenants under a memorandum of encumbrance “represented a serious restriction on the ability of the purchaser to deal with the land freely” and consequentially would degrade the market value of the title (p 133). When these two Court of Appeal authorities are read together with Jackson Mews, it appears that the enforceability of personal covenants in gross contained in encumbrance instruments remains very much a live issue. Furthermore, the Court in Jackson Mews appears to have deliberately left open for argument that where such instruments secure only covenants in gross (and are not a third category rentcharge) the instrument may not in fact be a mortgage at all (see paras [61]–[65] as per Baragwanath J). DoesthisthereforemeantheencumbranceinstrumentinJackson Mews may not properly have been accepted by the Registrar for Torrens’ registration, even though it was clearly in registerable form?

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REVIEW OF THE LTA With respect, Jackson Mews may have raised more issues for determination than it has resolved. While there appears to be a sentiment amongst some property lawyers that there is utility in preserving (and indeed enhancing) the benefits of encumbrance instruments, there needs to be wider dialogue. In this respect, the Property Law Section is correct that this issue needs to be addressed. The Law Commission should consider, as part of its deliberations, whether the present use of encumbrance instruments undermines accepted principles of property law, and indeed contract and equitable principles also. Pragmatism has its place. However, no matter how much present value we may ascribe to a covenant to provide purple cloth to the Governor-General every year for the next 999 years, how much utility will this covenant have, even 50 years from now? In particular, three discrete points need to be made.

The abolition of rentcharges in England (apart from third categoryrentcharges) maytherefore prove a warningto enthusiastic proponents of the use of encumbrance instruments as devices in New Zealand. The question has to be posed whether the indiscriminate and haphazard use of these dealings will, over time, degrade the quality of issued Torrens titles. E & W Law Commission interim report

A further English Law Commission report (released as an interim report in 2008) deliberated whether personal covenants in gross should be recognised as an interest in law, capable of running with the land (see (E & W) Law Commission Report, CP 2008 “Easements, Covenants and Profits a Prendre”). From para 8.72, the Law Commission confirmed that its preliminary view was in sympathy with a Scottish Law Commission Report: “The privilege accorded to the real burden is Statute of Quia Emptores Prior to the Statute of Quia Emptores 1290, in terms of estates that it runs with the land, but in exchange for that privilege it in land, subinfeudation was often related to the provision of must concern the land. An obligation to repair a car … or write services. Thus, a tenant could hold land from the lord, condi- a song cannot be created as a real burden”. tional on personal services being provided, and then the tenant In the preceding paragraph, the English Law Commission could require further services down the title chain. These ser- had confirmed “it would of course be wrong for a landowner vices were known as rent services. Again, the nature of these to make use of … obligations in order to impose an obligation services may have been limited only by the imagination of the of any kind which might happen to take his fancy … [such as] grantor.Recorded examples includeproviding peasant labour, to buya certainquantityof petrolfrom his garageeverymonth. restrictions on alienation (on grounds of race, religion or sect), The old rule that a covenant must ‘touch and concern’ … the as well as swearing fealty. dominant land was established for good reason”. Megarry and Wade, The Law of Real Property (7th ed), Hopefully, these deliberations will be of benefit to the New confirm Quia Emptores brought this to an end. One of the effects of the statute was that on a conveyance of an estate in Zealand Law Commission. land, personal services could no longer be preserved (p 29). Since Quia Emptores, “it has been impossible for a grantor to CONCLUSION reserve any services on a conveyance of freehold land in fee With respect, the utility of encumbrance instruments to secure simple” (p 1318). Indeed, the strictures inherent in Quia Emptores are likely personal services against successors needs careful considerto have affected the subsequent development of propertyinter- ation. ests as we now know them. I refer to the present requirement In this regard, the following points are made: that land covenants have to “touch and concern the land” and (1) If the Law Commission is considering protecting existbenefit other identified land, before they run with the land and ing encumbrance instruments from challenge, this may bind successors. (subject to final determination of the issues in Jackson The question, therefore, has to be asked as to whether Quia Emptores (which remains in force in New Zealand) is underMews) remove a present right to seek discharge. Such mined by use of this device, intended to support only for retrospectivity should not be lightly undertaken. mortgage covenants. (2) Given the Brookfield/Thomas debate, it can hardly be argued this device has been relied upon with any degree Blots on titles into the future of comfort since 1997. The Court of Appeal in Jackson Mews drew much support from the law of England. With regard to encumbrance instru(3) On public policy bases, it may be questionable that such ments in the form advocated by Professor Brookfield, the a device should be permitted to continue. The breadth of relevance of English legislation may be further supported by the personal covenants that can be imposed under this the fact that in England, as with the Brookfield device, device must be a point of concern. rentcharges do not include a power of sale over the encum(4) If the imposition of personal covenants in gross, binding bered property. It should, however, be noted that in Jackson successors, is now a desirable feature of our property Mews, the power of sale was not in fact removed from the encumbrance instrument, so technically that document was law, this debate should be addressed in terms of adjustnot in the category promoted by Brookfield and utilised in ment of the checks and balances inherent in the general England. law of property, not in terms of personal covenants, Further, England (on advice of its Law Commission) legisenforceable under mortgage securities. lated to abolish rentcharges by the Rentcharges Act 1977. (5) At the root of this issue, it should be asked whether While this is noted by the Court of Appeal in Jackson Mews, short-term pragmatism should undermine a key tenet of what is not stated is that this occurred due to an eventual our property law system, that personal covenants for realisation in England that rentcharges were both inconvenient and unpopular. services do not run with the land and bind successors. ❒

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