A mortgagee protection clause is an important provision in a lease. It is designed to safeguard the interests of a mortgagee (lender) if the tenant (borrower) breaches the covenants of the lease and the landlord seeks to forfeit the lease.
The absence of a mortgagee protection clause does not necessarily mean that a lease is invalid or that a property cannot be sold. However, it can raise concerns for a lender. Where a mortgagee protection clause is missing from a lease, the parties may need to consider whether a deed of variation or indemnity insurance is required.
This article explains what a mortgagee protection clause is, why it matters to mortgage lenders, and what options may be available where the clause is missing.
Written by Claire Leung, Solicitor
What is a mortgagee protection clause?
A mortgagee protection clause is to protect the mortgagee in cases where the landlord seeks to forfeit the lease.
The precise drafting varies but the clause typically requires the landlord to notify the mortgagee in writing before initiating forfeiture proceedings, regardless of the grounds for forfeiture. This notification allows the mortgagee a reasonable period to remedy the breach that has triggered the forfeiture, thereby preventing the lease from being terminated.
In some cases, the clause may also allow the mortgagee to obtain a new lease if they undertake to remedy the breach that led to the forfeiture.
What is the issue if there is no mortgagee protection clause?
The mortgagee protection clause is important because the lender’s security is normally the borrower’s leasehold interest.
A lease generally contains covenants which the tenant must comply with. If the tenant breaches those covenants, the landlord may, depending on the circumstances and the terms of the lease, have rights to take enforcement action. Without mortgagee protection, the lender may not have an express contractual right to receive notice of the breach or to remedy it before the landlord exercises its rights.
If the lease is forfeited or otherwise terminated, the value of that security could be seriously reduced or lost altogether. This creates a potential risk to the lender because the mortgage is secured against the leasehold interest. If that interest is lost, the lender’s security may also be compromised.
How can you rectify the issue if there is a lack of mortgagee protection clause?
If a lender identifies that an existing lease does not contain the required mortgagee protection clause, there are several possible ways of addressing the issue:
- Deed of variation
The most obvious solution is usually to enter into a deed of variation to amend the lease and insert an appropriate mortgagee protection clause.
This has the advantage of providing the lender with the contractual protection it requires and, where necessary, ensuring that the amended lease is properly documented and registered.
However, obtaining a deed of variation can take time and cost and may involve the cooperation of the landlord and tenant. The registration of the deed of variation at the Land Registry also requires time.
- Side letter or separate agreement
In some circumstances, the parties may consider a side letter dealing with the lender’s concerns. The side letter will be signed by the Landlord who agrees to give the lender a written notice of their intention to commence forfeiture proceedings. Whether this is acceptable will depend entirely on the lender’s requirements. Some lenders will accept alternative contractual protection, while others will insist that the protection appears expressly in the lease itself.
- Indemnity insurance
Indemnity insurance may also be considered as a means of addressing the lender’s concerns if the parties want to avoid the time and expense of obtaining a deed of variation. The insurance is intended to provide financial protection against specified losses arising from the insured risk.
However, indemnity insurance is not automatically a substitute for a mortgagee protection clause. Whether indemnity insurance is an acceptable solution depends on the nature of the risk, the terms of the proposed policy and, crucially, whether the lender is prepared to accept it.
Why do some lenders not require a deed of variation to include the mortgagee protection clause?
Not every lender takes the same approach.
A lender may decide that a deed of variation is unnecessary because, after reviewing the lease and the wider transaction, it considers the risk acceptable. For example, the lender may take into account the amount of the ground rent and the service charge, whether the property involves shared ownership.
The lender may also consider that statutory provisions already give it sufficient practical protection. Paragraph 2.4 of Practice Direction 55 of the Civil Procedure Rules provides that if the claimant knows of any person (including a mortgagee) entitled to claim relief against forfeiture as underlessee under section 146(4) of the Law of Property Act 1925 (or in accordance with section 38 of the Senior Courts Act 1981, or section 138(9C) of the County Courts Act 1984), the particulars of claim in a possession claim must state the name and address of that person, and the claimant must file a copy of the particulars of claim for service on them. The mortgagee will eventually obtain notice of the issue and service of forfeiture proceedings despite lack of the mortgagee protection clause.
On the other hand, some lenders take a much stricter approach and require the mortgagee protection clause to be incorporated into the lease. The benefit of such a clause is advance notice before the case gets to the stage of having been issued; whereas CPR PD55A, para 2.4 merely mean that the mortgagee obtains notice of the issue and service of proceedings. Having the protection expressly included in the lease gives greater certainty as to the lender’s position.
The lender’s requirements may be driven by its own internal risk management, regulatory, valuation or securitisation requirements. Given the risk to a lender of the loss of security if a lease is forfeited, a lender may insist on its standard form of protection even where, from a purely commercial perspective, the risk appears relatively small.
Conclusion
A mortgagee protection clause is primarily intended to protect a lender’s security by ensuring that enforcement actions under a lease cannot adversely affect the lender without appropriate notice or an opportunity to protect its position.
The absence of such a clause does not automatically mean that a transaction cannot proceed. However, it may create an issue for a lender. There is no single solution in every case. The key point is that different lenders have different risk appetites and lending requirements.
Where the issue is identified during a transaction, it is therefore sensible to establish the lender’s requirements as early as possible. This can help avoid unnecessary delay and ensure that the appropriate solution is considered before completion.
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