Preference of security in terms of a mortgage bond potential impact of COVID-19 protocols

Introduction

Many lenders are going to disburse funds, and some may be requested to do so on an urgent basis pending registration of a mortgage bond as a form of security of debt. The lender, also referred to as the mortgagee, should note section 88 of the Insolvency Act, which section provides as follows:

“A mortgage bond, other than a kustingbrief, whether special or general passed for the purpose of securing the payment of a debt not previously secured, which was incurred more than two months prior to the lodging of the bond with the registrar of deeds concerned for registration or for the purpose of securing the payment of a debt incurred in novation of or substitution for any such first-mentioned debt, shall not confer any preference if the estate of the mortgage debtor is sequestrated within a period of six months after such lodging: Provided that a mortgage bond shall be deemed not to have been lodged as aforesaid, if it was withdrawn from registration.”

Implications of section 88 of the Insolvency Act for lenders

In terms of section 88, should a mortgage bond be registered for the purposes of securing the payment of a debt which was previously not secured and should such unsecured debt have been incurred more than two months prior to the lodgement of the mortgage bond in the applicable deeds registry, such mortgage bond shall not confer any preference in favour of the lender should the borrower be sequestrated (or the borrowing entity be liquidated in the case where the mortgagor is an entity) within a period of six months after lodgement of the mortgage bond.

This essentially means that in the scenario described above the lender will not have a preferent claim. In terms of section 2 of the Insolvency Act, a preferent claim means the right to payment of a claim out of the assets of the insolvent estate in preference to other claims.

In the case of Joint Liquidators of Glen Anil Development Corporation Ltd (in liquidation) v Hill Samuel (SA) Ltd (SA) Ltd 1982 (1) SA 103 (A), the court considered whether a debt was incurred in terms of section 88 of the Insolvency Act when an indemnity was furnished or whether such debt was only incurred when the contingent debtor was called upon to pay. If the former was the case, then the debt would have been incurred more than two months prior to the lodgement of the mortgage bonds registered by the contingent debtor as security for its “contingent liability”, however, if the latter was the case then the debt would have been incurred after lodgement of the said bonds which would accordingly confer a preference. The court acknowledged that:

“A mortgage bond... passed for the purpose of securing the payment of a debt not previously secured, which was incurred more than two months prior to the lodging of the bond... shall not confer any preference if the estate of the mortgage debtor is sequestrated within a period of six months after such lodging...”

The court therefore reiterated the principle of section 88 but held that the debt secured by the bonds had not been incurred more than two months prior to the lodging of the bonds and that the bonds registered in favour of the respondent did confer preferent status.

Conclusion

The provisions and implications of section 88 should be noted by all lenders in respect of delays and especially during any COVID-19 lockdown period. Should a lender have unsecured debt or should a lender be in the process of securing debt by way of a mortgage bond, such lender should note the date on which it furnish the unsecured debt to the borrower. The lender should then consider that, should such mortgage bond not be lodged within the prescribed two-month period, the bond in question shall not confer any preference if the borrower is sequestrated or liquidated within a period of six months after such lodgement.