Zhong v Lanbo Constructions Pty Ltd; Lanbo Constructions Pty Ltd v Zhong

The issue before the Court is whether registered second mortgagees have or a registered third mortgagee has priority in respect of money paid into court by the registered first mortgagee, after it conducted a mortgagee sale of the property that was the subject of the three mortgages.

The plaintiff in the proceedings is Overseas Union Finance (Aust) Pty Ltd, whose first mortgage over certain property at Merrylands New South Wales was registered on about 23 April 2019. The plaintiff exercised its power of sale as mortgagee to sell the property for a price of $1,320,000. The contract for sale settled on about 29 August 2022. On 8 September 2022, the plaintiff paid into court the sum of $208,591.25. That sum was the balance of the proceeds of sale of the property, after the plaintiff had deducted the amounts owed to it under its mortgage and the costs that it incurred in selling the property and in paying the net proceeds into court. The money was paid into court pursuant to s 95 of the Trustee Act 1925 (NSW) and Uniform Civil Procedure Rules 2005 (NSW) (UCPR) r 55.9.

A second mortgage in favour of Sanchun Zhong and Lingwan Jin (collectively, the “second mortgagees”) was registered on about 18 January 2022. I will call the debt that was secured by the second mortgage the “first loan” and will call the debtor, who is named Hong Zhai, the “mortgagor”.

A third mortgage was registered in favour of Lanbo Constructions Pty Ltd (the “third mortgagee”) on about 17 March 2022. The third mortgage secured a debt owed by the mortgagor to the third mortgagee.

The second mortgagees and the third mortgagee filed notices of motion on 20 September 2022 and 9 November 2022 respectively, in which they seek orders pursuant to UCPR r 55.11(1), that the sum in court be paid out to them pursuant to their respective rights under their mortgages over the Merrylands property. Under its notice of motion, the third mortgagee also seeks a declaration that it is entitled to receive all of the monies paid into court.

The third mortgagee accepts the general principle that the entitlement to the balance of the proceeds of sale paid into court by a first mortgagee, as between later mortgagees, depends upon the order in time of registration of the mortgages. Hence, ordinarily, the second mortgagees would be entitled to receive the money that has been paid into court.

However, the third mortgagee submits that the present case is exceptional because, in the events which have happened, the second mortgage, though registered before its own mortgage, does not secure any loan. That is, so the third mortgagee argues, because events have occurred that extinguished the debt secured by the second mortgage.

The competing claimants to the money that has been paid into court provided a statement of agreed facts to the Court which, in addition to facts related above, stated:

It is necessary to provide the following elaboration of the facts that have been agreed between the claimants.

The second mortgage contained the following term:

This standard provision has the consequence that the second mortgage was granted to secure the first debt, with the legal effect that the mortgage will secure nothing if the debt is legally extinguished before it has been repaid.

The additional terms in Annexure A to the second mortgage contained the following relevant provisions:

Under Item 2 of the Schedule, the date for repayment of the $600,000 was 23 December 2018. Item 3 provided for an interest rate of 18% per annum.

The mortgagor did not repay the debt owed to the second mortgagees by the due date of 23 December 2018 or at all. Subject to the validity of the third mortgagee's argument that the debt owed to the second mortgagees has been extinguished, it is accepted by the third mortgagee that the debt owed by the mortgagor to the second mortgagees remains substantially in excess of the amount that has been paid into court.

By a deed of guarantee and indemnity dated 24 May 2018 (the day after the second mortgage was executed by the mortgagor) made between the second mortgagees, the mortgagor, and a company called TYZ Development Pty Ltd (the “guarantor”) of which the mortgagor was the sole director and shareholder, the parties to the deed agreed as follows:

The background evidence does not explain the genesis of these terms of the deed of guarantee and indemnity. It is evident that the guarantor was engaged in a development project that would lead to the construction of what were called Lot 14 and Lot 26. Clause 8 created an option in the second mortgagees to acquire the two lots for prices of $450,000 each. Upon the exercise of the option, the consequence would be under clause 9 that the first loan would be extinguished. It may be assumed that it was understood by the second mortgagees that the right to exercise the option to acquire the two lots for a total price of $900,000 may be more advantageous to them than their right to insist upon repayment of the first loan plus interest by the mortgagor. The evidence does not permit or require the Court to speculate on the commercial relationship between the second mortgage and the deed of guarantee and indemnity.

Subject to what may be the legal effect of clause 14 of Annexure A to the second mortgage, the parties to the second mortgage and to the deed of guarantee and indemnity do not appear to have agreed to a written form to be completed by the second mortgagees if they wished to exercise the option.

The copy of the deed and guarantee in Exhibit SY1 tendered by the third mortgagee at the hearing contains as Annexure B to the deed and guarantee a draft contract of sale for Lot 14.

Exhibit SY1 contains an additional deed made on 31 May 2018 between the second mortgagees, the guarantors and a different borrower (the “second deed”). The guarantor parties to the second deed are the guarantor, the mortgagor and Shui Yui (in their personal capacities). The borrower party to the second deed is Shui Yu atf ZHYA Family Investment Trust. Shui Yu is the husband of the mortgagor. It is sufficient to note that this deed relates to a further loan of $300,000 (the “second loan”) made by the second mortgagees to Mr Yu, secured by a mortgage over a property in South Wentworthville. The second deed contains terms that are materially the same as clauses 8 and 9 of the deed of guarantee and indemnity relating to the first loan, save that clause 8 confers on the borrower party the option to acquire Lot 25 and Lot 26 in the Wentworthville development. As I understand it, the second loan was the subject of order 2 made by Stevenson J.

On 31 May 2018, the deed of guarantee and indemnity that is relevant to the present dispute was amended to substitute Lot 25 for Lot 14. This variation is not material to the outcome of the dispute, but had the effect that the option to acquire in clause 8 of each of the deeds referred to the same lots.

It is the third mortgagee's claim that the debt the subject of the second mortgage was extinguished because the second mortgagees exercised the option to purchase the two lots in clause 8 of the deed of guarantee and indemnity, so that the debt was extinguished by operation of clause 9.

The third mortgagee relied upon an affidavit affirmed on 10 March 2023 by Mr Yu. It is evident from the affidavit that, notwithstanding that Mr Yu did not claim any formal authority to act as agent for the mortgagor or the guarantor, he had in fact acted for both in the course of communications with the second mortgagees. The second mortgagees did not suggest that Mr Yu did not have authority in the circumstances.

Relevantly, Mr Yu's evidence was as follows (omitting references to pages in the exhibit to the affidavit where the content of the documents exhibited are set out in the affidavit):

The document that was exhibited to Mr Yu's affidavit was called "Deed of Settlement and Release”. The second mortgagees were described as "the Lender" in the draft deed. The mortgagor and Mr Yu (the latter ats ZHYA Family Investment Trust) were described as the “Borrower” on the cover page and the “Guaranteed Party” in the list of parties to the draft deed. The guarantor, Mr Yu and the mortgagor were described jointly as the “Guarantor”. The draft deed dealt with both the first loan and the second loan. Those loans are recited in Recitals A and B.

The Recitals to the draft deed also include:

Clauses 1 and 2 of the operative provisions of the draft deed contained mutual releases of the parties. Clause 4 obliged the guarantor to transfer the proceeds of the sale of Lot 25 to the second mortgagees and also obliged the guarantor to transfer the title to Lot 26 to the second mortgagees. The parties described as the Borrower and the Guarantors were also required, by clause 3(a) to pay the second mortgagees $93,000.

There is no explanation in the evidence as to why the draft deed provided by Mr Wong to Mr Yu was not executed.

I infer from the evidence that the guarantor retained the proceeds of sale of Lot 25. The evidence does not establish what has happened to Lot 26.

Although Recital G of the draft deed stated that the second mortgagees had sought to enforce their right to purchase the two lots in addition to default interest, that statement is equivocal, and is not an assertion that the second mortgagees had formally exercised options to purchase the two lots, so that they had a right to the transfer of the proceeds of sale of the lot that had been sold and the transfer of the lot that had not been sold.

As stated in the statement of agreed facts, on 22 April 2020 the second mortgagees commenced proceedings in this Court's Commercial List against the mortgagor (as the first defendant), Mr Yu, and the guarantor (as the second defendant). Mr Yu was sued as trustee for the ZHYA Family Investment Trust (as the third defendant), and in his personal capacity (as the fourth defendant). The final relief sought in the summons was relevantly as follows:

The second mortgagees filed an amended commercial list statement on 10 February 2021. It appears from the statement of the “nature of the dispute” and “the issues which the plaintiffs believe are likely to arise” that the plaintiffs sought to enforce the two loans, and for that purpose to exercise the powers of attorney granted to them in the two mortgages to sell the mortgaged properties.

The statement of the “plaintiffs' contentions” (in their original and amended commercial list statement) contained the following allegations concerning the options that were granted to the second mortgagees in the first deed and the second deed:

The defendants' commercial list response to the amended commercial list statement, filed on 23 February 2021, pleaded in par 22:

The defendants made the following allegations in their commercial list response concerning alleged representations made by the plaintiffs:

The defendants alleged in pars 55 to 60 of their commercial list response that the so-called “Alternative Arrangement” became the subject of a contractual variation of the terms of the first and second loans. The defendants also pleaded an estoppel defence based upon the alleged representations in pars 61 to 71.

The result of the commercial list proceedings instituted by the second mortgagees is recorded in the orders made by Stevenson J by consent contained in the statement of agreed facts and set out above. It is implicit in those orders that the mortgagor ultimately accepted that a judgment be entered against her on the basis that the first loan was contractually enforceable.

In legal theory, as this Court entered judgment against the mortgagor to enforce the first loan, a question arose as to whether, because the contractual obligation to repay the first loan merged in the judgment, the second mortgage ceased to be enforceable against the Wentworthville property. The second mortgagees made submissions on this issue, based substantially upon the principles stated in Fisher and Lightwood’s Law of Mortgage (3rd Aust ed, 2013, LexisNexis Butterworths) at [36.13] and the judgment of McLelland J (as his Honour then was) in Elders Trustees & Executor Co Ltd v Eagle Star Nominees Ltd (1984) 4 BPR 9205 at 9207, where his Honour said:

The second mortgagees also relied upon clauses 7 and 12 of Annexure A to the mortgage, which have been set out above, to support their submission that, even if the contractual obligation on the mortgagor to repay the first loan merged in the judgment, as the judgment was not satisfied, the second mortgagees remain entitled to exercise their security rights under the second mortgage to recover the amount of the debt, so that they have priority over the amount that has been paid into court by the first mortgagee.

As I understand the submissions that were made on behalf of the third mortgagee, it did not submit that the second mortgage had ceased to be effective by reason of the fact that the contractual obligation on the mortgagor to repay the first loan had merged in the judgment. Its submission was that, in fact, the option granted to the second mortgagees by clause 8 of the deed of guarantee and indemnity had been exercised, so that the first loan was extinguished by operation of clause 9. It is implicit in this submission that, as the third mortgagee was not a party to the Commercial List proceedings, it is not bound by the res judicata that arose as between the parties to those proceedings by reason of a judgment being entered by consent, on the basis that the first loan continued to be payable.

Ultimately, the priority dispute between the second mortgagees and the third mortgagee turns upon the issue of whether, as a matter of fact, the second mortgagees exercised the option in clause 8 of the deed of guarantee and indemnity. If they did, the first loan was extinguished.

It is material in this case that the issue has arisen in the context of a relatively summary dispute that has been raised by the notices of motion filed by each of the claimants for orders under UCPR r 55.11(1) that the money paid into court by the first mortgagee be paid out to them. The hearing of the notices of motion took place on the basis of the documents that were available to be tendered, the affidavits sworn by or on behalf of the parties and the affidavit of Mr Yu. Mr Zhong did not give evidence, and none of the witnesses who did give written evidence was cross-examined.

If the option in clause 8 of the first or second deed of guarantee and indemnity was exercised by the second mortgagees, that exercise was informal in the sense that it was made in oral discussions or in short, WeChat messages, rather than by the formal execution by the second mortgagees of a written exercise of option. It is of some forensic significance that, in the circumstances in which the question has arisen, there has been no cross-examination of the persons who participated in the alleged exercise of the option. The Court must therefore determine the issue on the balance of probabilities, having regard to the limited evidence before the Court, and the fact that the third mortgagee has the burden of proving that the debt the subject of the second mortgage was extinguished.

I am satisfied that the third mortgagee has not established on the available evidence on the balance of probabilities that the option in clause 8 of the deed of guarantee and indemnity was effectively exercised by the second mortgagees, so that the debt secured by the second mortgage was extinguished.

First, I consider that, in cases where a party with the benefit of an option to purchase property is not required to exercise the option in a formal way by the execution of an exercise document, there must be reasonably clear evidence of an absolute and unequivocal exercise of the option. In this case, I consider that the wording of the WeChat texts and the oral statements by Mr Zhong were too equivocal to be a valid exercise of the option. It may not be necessary for the party entitled to exercise the option to use the expression "exercise the option," but it must be objectively clear that the exercise of the option is intended. In the present case, the statements made by Mr Zhong do not rise higher than statements of present preference as to an intended choice between two alternatives, subject to the qualification that the second mortgagees needed advice from their solicitor as to how to proceed.

Mr Yu's evidence that, on 8 August 2019, Mr Zhong said: "My wife and I have made it clear that we want the properties, and I told you that already”, should be understood as a statement of the second mortgagees' preference and not an unequivocal election to exercise the option, so that the second mortgagees were bound to purchase the two lots. Mr Zhong retained the right to talk to Mr Wong about how to "make the necessary arrangements for the transfer", and, at the same time, Mr Zhong claimed an unspecified amount of additional compensation for delay. Mr Zhong's statements were therefore not an unequivocal exercise of the option.

The evidence given by Mr Yu concerning the negotiations with Mr Zhong between 8 and 23 August 2019 satisfies me that the second mortgagees engaged in a renegotiation process with Mr Yu that was inconsistent with an unequivocal exercise of the option.

The fact that Lot 25 was sold on 15 October 2019 militates against a finding that Mr Yu understood, at that time, that the second mortgagees had exercised their option to purchase Lot 25.

Paragraph 22 of the second mortgagees' contentions in their commercial list statement is also consistent with the second mortgagees having an understanding at the time the document was filed that they had not already exercised the option.

Although the defendants alleged in par 35(b) of their commercial list response that the second mortgagees had exercised the first option on the basis of the facts relied upon by the third mortgagee in these proceedings, the defendants also alleged in par 59 of their commercial list response that they had accepted the alleged offer made by the second mortgagees in what they called the Alternative Arrangement.

The final matter that requires the Court's attention is the effect of that part of clause 9 of the deed of guarantee and indemnity that provided: "Operation of this clause is explicitly agreed to be pursuant to an instrument duly executed in writing by the Mortgagee for the purposes of clause 14 of the Mortgage". The third mortgagee submitted that the effect of this clause was that an informal, oral exercise of the option could be effective notwithstanding that clause 14 of Annexure A to the mortgage provided that the second mortgagees' rights could only be "waived by an instrument duly executed by the Mortgagee”.

The second mortgagees responded to this argument with the contrary submission that the true meaning of the relevant part of clause 9 was that there was an explicit agreement that the option could only be exercised pursuant to an instrument duly executed in writing by the second mortgagees.

It is not necessary for the Court to resolve this argument, as I have found that the third mortgagee has not established as a matter of fact that the second mortgagees exercised the option informally.

However, while the issue is finely balanced, I prefer the second mortgagees' construction of the relevant part of clause 9, so that the clause required that the option be exercised by an instrument duly executed in writing by the second mortgagees. The wording of this part of the provision is not entirely clear, but the clause would have a more sensible and effective commercial operation if it required that any exercise of the option be evidenced by a written instrument, so that there would not be scope for dispute as to whether or not the option had been exercised based upon inexact evidence.

Having said this, I note that in the second mortgagees' reply to the defendants commercial list response filed on 10 February 2021, the second mortgagees did not allege that the option could only be exercised by them by instrument in writing. The second mortgagees pleaded in par 2 that the words and conduct claimed by the defendants to constitute the exercise of the option "lacked any formality, were not unequivocal and were not consistent with an election to exercise the First Option as is alleged."

In all of these circumstances, I find that the second mortgagees are entitled to an order that the money that has been paid into court by the first mortgagee be paid out to them.

They are also entitled to an order that the third mortgagee pay their costs of the application.

The final issue that requires determination by the Court is a claim by the second mortgagees for an order that the third mortgagee pay to them $3,752.76, which is the amount of the costs incurred by the plaintiff as a result of having to respond to the third mortgagee's claim for priority and the payment of the balance of the proceeds of sale into court: see Exhibit A.

When asked what the legal basis was for the power of the Court to order the third mortgagee to pay to the second mortgagees an amount deducted by the first mortgagee before it paid the balance of the proceeds of sale of the property into court, counsel for the second mortgagees submitted that the power could be found in s 98 of the Civil Procedure Act 2005 (NSW).

I reject the second mortgagees' application. Although the amount deducted by the first mortgagee included professional costs of $3,550.31 and disbursements (including filing fees) of $202.45, I do not accept that it would be correct for the Court to characterise this amount as falling within the meaning of "costs" as it appears in s 98 of the Civil Procedure Act. The first mortgagee's professional costs are costs incurred by it, which I infer it was entitled to retain out of the sale proceeds under a term of the first mortgage. Those costs are not costs of these proceedings in any direct sense.

Although the third mortgagee has failed in this priority contest, I accept that it was reasonable in all of the circumstances for the third mortgagee to have contested the issue, given that it was initially a stranger to the arrangements between the second mortgagees and the other parties to the deed of guarantee and indemnity. The third mortgagee took the risk that it would be ordered to pay the costs of the application, but those costs should not include any costs that the first mortgagee was entitled to deduct from the proceeds of sale of the property under the terms of the first mortgage.

The orders of the Court are: