In todays marketplace where re-mortgages are common, lenders are effectively doubly-secured in the event of subsequent default by virtue of subrogation.
What is subrogation?
Subrogation is not a right or a cause of action, but an equitable restitutionary remedy against a party who would otherwise be unjustly enriched. In a typical re-mortgage situation, it enables the later lender to "stand in the shoes" of the earlier lender and enforce its security as if it had the benefit of the earlier charge. In short, lender B whose mortgage is used to discharge a prior mortgage in favour of lender A, is subrogated to the rights of lender A. There is a little more to it than that.
When does it apply?
There are three main principles:
- (1) Was D enriched at C's expense?
- (2) Was the enrichment unjust?
- (3) Are there any policy reasons to deny C a remedy?
(Banque Financiere de la Cite v Parc (Battersea) Ltd  1 AC 221 per Lord Hoffmann at p 234D)
Mr and Mrs Smith are the joint legal and beneficial owners of a house:
There are two main scenarios:
- Lender 3 begins standard mortgage possession proceedings against Mr and Mrs Smith for repayment of the balance of £150,000 plus arrears and possession.
- Mrs Smith puts in a Defence alleging forgery.
- Lender 3 amends Particulars of Claim to seek order for sale (in respect of equitable charge against Mr Smith AND subrogation against both on the basis that Lender 3 stands in the shoes of Lender 2 to the extent of £100,000 plus interest (which will probably be ordered at the lower of the rates charged by Lenders 3 and 2: Eagle Star Insurance Co Ltd v Karasiewicz  EWCA Civ 940) and can seek possession in the normal way.
- Lender 3 may also be entitled to subrogation in respect of the discharge of the £20,000 unsecured liabilities (Filby v Mortgage Express (No 2) Ltd  EWCA Civ 759 - discharge of joint account overdraft).
- The combination of subrogation and enforcement of the equitable charge should be sufficient to obtain a full recovery.
- Mrs Smith seeks to defend the subrogation claim by alleging undue influence by Mr Smith in obtaining the second Charge.
- Lender 3 may have to resort to sub-subrogation and stand in the shoes of Lender 1 to the extent of £50,000 plus interest (UCB Group Ltd v Hedworth  EWCA Civ 1717).
Some important principles
1. Subrogation is a flexible remedy but one which has to be applied in a principled fashion. The principles have been reviewed and summarised most helpfully in Cheltenham & Gloucester plc v Appleyard  EWCA Civ 291.
2. The common phrase that the later lender "steps into the shoes" of the earlier lender does not mean that the earlier charge is kept alive. Usually it will be discharged. It means that the later lender has the same rights as if the earlier charge had been kept alive and the benefit of it assigned to the later lender (Banque Financiere, per Lord Hoffmann, p 236F).
3. Subrogation is not based on the agreement or intentions of the parties (Banque Financiere, per Lord Hoffmann, p 234B etc; Cheltenham & Gloucester at para 40). Consequently it is not necessary that it is a condition of the later loan that the earlier loan is discharged, so long as the later lender's money is in fact used to discharge the earlier loan, so that the borrower(s) are thereby enriched at the later lender's expense (Filby para 62).
4. Nor does it matter whether the later lender (or its solicitors) failed to take proper precautions to ensure it obtained a valid security (Banque Financiere, per Lord Hoffmann at p 235E etc, Lord Hutton p 242H etc). Despite the dicta of Walton J in Burston Finance Ltd v Speirway Ltd  1 WLR 1648 to the effect that a lender who fails to obtain his desired security by reason of non-registration under the Land Registration Acts is not entitled to subrogation because he has obtained everything he bargained for, it has recently been held that the later lender’s carelessness in obtaining the desired security (in the particular case by failing to register the charge) does not, by itself, defeat a claim for subrogation. See Anfield (UK) Ltd v Bank of Scotland Plc  EWHC 2374 (Ch).
5. Subrogation usually only arses where the earlier loan is discharged in full, although it may be possible to obtain subrogation pro tanto (Boscawen v Bajwa  1 WLR 328).
7. BUT if the later lender obtains all the security he bargained for, he cannot claim subrogation. Nor can subrogation be invoked so as to put the later lender in a better position than that in which he would have been had he obtained all the security he bargained for (Cheltenham & Gloucester, paras 38, 41).
8. Normal equitable defences apply to subrogation (Cheltenham & Gloucester, para 44). Thus the equitable right of subrogation can be overridden by a bona fide purchaser for value of the legal estate without notice (Halifax Plc v Omar  EWCA Civ 121).
9. It is technically possible to exclude the right to subrogation by contract (Fisher & Lightwood's Law of Mortgage, 12th Edn, para 43.8 citing Banque Financiere).
A recent example
Subrogation and unpaid vendor’s lien
 UKSC 66
A bank that had released security over one property in the expectation of taking a replacement security over another property was entitled to a remedy of subrogation in order to reverse unjust enrichment. This gave it an equitable interest in the replacement property and an entitlement to enforce it by way of an order for sale.
A bank (B) held a charge over property owned by the parents of D (P). There was negative equity in this property. P decided to sell the property and purchase a smaller property in D’s name using part of the sale proceeds, subject to an agreement with B to release the charge on P’s property and take a charge on the smaller property.
The transaction completed but D did not sign the replacement charge on the smaller property. She sought a declaration that the charge was void. B counterclaimed for a declaration that it was entitled to subrogation to an unpaid vendor’s lien over the smaller property.
The High Court dismissed B’s counterclaim, holding that whether one applied a “narrow or traditional approach” to subrogation to an unpaid vendor’s lien, or a “wider approach”, the fact that the monies provided for the purchase of the smaller property were not paid by and did not belong to B was fatal. B appealed
Court of Appeal
The Court of Appeal allowed the bank’s appeal holding that an unpaid vendor’s lien arises on exchange of contracts and entitled a vendor of property to retain an equitable lien on the property until full payment is made. What the bank sought to do was to be placed in a position equivalent to that of the vendor of the parents’ property at the point where the purchase money had not been paid. Applying Lord Hoffmann’s three-part test on subrogation in Banque Financiere de la Cite v Parc (Battersea) Ltd  1 AC 221, it was accepted that the daughter had been enriched at the bank’s expense and that her enrichment was unjust. The issue was whether the unjust enrichment was at the expense of the bank. The cases showed that the court look at the economic reality of the situation. Here the bank provided value by agreeing to release a security interest rather than by advancing specific funds. Since the Ps’ property was in negative equity, the whole of the purchase price was to be regarded as having been transferred to the daughter. M appealed to the Supreme Court.
The Supreme Court dismissed the appeal. Lord Clarke and Lord Neuberger (with whom Lord Kerr and Lord Wilson agreed) held that this was a case of unjust enrichment. The court must ask itself four questions: (1) Has the defendant been enriched, (2) Was the enrichment at the claimant’s expense, (3) Was the enrichment unjust, and (4) Are there any defences available to the defendant?
There was no doubt that M was enriched when she became the owner of the smaller property. The question is whether she was enriched at the bank’s expense. Plainly the answer to this was yes. The bank was central to the scheme from start to finish. M only became the owner of the smaller property because the bank agreed to release its charge over Ps’ property in the expectation of taking a charge over the smaller property. As a result she became the owner of the smaller property unencumbered by the charge and was therefore enriched at the expense of the bank to the extent that the value of the property free of charge was greater than it otherwise would have been. It was not necessary for there to be a direct payment by the bank to M. There were no defences open to M.
As to the form of remedy, the bank was subrogated to an unpaid vendor’s lien. Subrogation is available as a remedy to reverse an unjust enrichment. The cases supported a flexible approach. The bank was entitled to a lien on the property which is an equitable interest which can be enforced by sale. Since it was not necessary to decide the point, the court left open whether the bank would have a personal money claim against M, and if so in what amount.
Lord Carnworth agreed but considered that the bank’s case could be supported by a strict application of the rules of subrogation. There was a necessary ‘tracing link’ between the bank and the money used to purchase the new property.
This case reviews the principles of unjust enrichment and the remedy of subrogation in the fairly unusual context of a mortgage lender being entitled to an unpaid vendor’s lien. In other words, this allowed the bank to stand in the shoes of an unpaid vendor when it facilitated the sale of one property (by releasing its security) and the purchase of another property (when it expected to, but did not, obtain replacement security). The majority of the Supreme Court adopted a wide, flexible approach based on the principles developed in Banque Financiere and Benedetti.