Priority between Competing Equitable Interests in Real Property and how best to address the risk of losing priority in New South Wales

Written by: Alexander Demlakian

Introduction

As a lender in New South Wales, if commercial circumstances present you with the option of securing your interest in real property, and you elect to proceed in obtaining a secured interest in that property, more often than not, you will encounter the scenario where more than one party hold a secured interest in the property.

Walking hand in hand with this scenario, is the question of priority. When multiple parties have a secured interest in real property, and each are asserting a competing interest, who stands first in line to enforce their security?

General Rule

When it comes to Priority, the general rule established by the High Court’s decision in Lapin v Abigail [1930] HCA 6; 44 CLR 166 is that the ‘equitable interest which arose first in time generally holds the priority’ (General Rule).  

As such, if your equitable interest arose (generally being the date that the Agreement which granted your secured interest was entered into and came into effect) before that of a party asserting a competing secured interest, then your interest will generally hold the priority.

Whilst this General Rule holds weight in the determination of priority between competing equitable interests, it can be a common misconception that this general rule is impenetrable and sufficient on its own merits to safeguard from any competing interests.

This is especially the case in New South Wales where lenders under this misconception rely upon the ‘General Rule’ as the sole protection of their equitable interest in lieu of lodging a caveat, or as justification for any extended delay in registering a caveat.

Approach taken by the Court in determination of priority

With reference to recent authorities on the matter, in Australia Capital Financial Management Pty Ltd v Linfield Developments Pty ltd; Guan v Linfield Developments Pty ltd [2017] NSWCA 99 , Ward JA clarified that ‘the task of determining who has better equity, has regard to all of the circumstances and all of the parties conduct rather than simply answering the question of who’s interest arose first’.

What this ultimately means is that every priority dispute before the Court is assessed on a ‘case by case’ basis where the specific circumstances of that case, and each parties’ conduct holds more weight to the question of priority than who’s interest arose first.

If after those considerations the parties’ equitable interests remain viewed as generally equal, only then would the General Rule apply providing priority to the party whose interest arose first.

Circumstances and Conduct

When it comes to the circumstances that the Court takes into account, given that these circumstances differ from case to case, the obvious lack of consistency makes trying to pinpoint what each of these relevant circumstances are and the weight they hold difficult.

Despite the case by case differences, within the authorities there is general criteria of circumstances the Court considers, and a pattern in ‘external factors’ that give weight to the relevance of these circumstances..

These include:

• How a party’s interest was acquired;

• Whether a party’s interest is a genuine equitable interest;

• Whether a party’s interest is its first ranking security;

• The amount of money owed to each party under their interest;

• The extent of a parties interest (if any) which has been satisfied to date contrasted against what remains outstanding and secured; and

• The proportion of a party’s debt that could be paid out if their security is enforced.

External Factors

Reliance

To determine priority when it appears that the party’s equitable interests are generally equal, significant weight is given to reliance. Where one party’s equitable interest was created in circumstances where it is more heavily dependant and reliant upon realising its interest than the other, the Court will view that party on having the ‘better equitable interest’.

For example in LTDC Pty Ltd v Cashflow Finance Australia Pty Ltd [2019] NSWSC 150 (LTDC), Party A acquired its interest in January 2017, notified their interests on the Personal Properties Security Register, but did not lodge a caveat. Party A’s position was that it was their standing business practice to not lodge caveats unless a default occurred.

A default did not occur until 10 months later, and a caveat was subsequently lodged.

Party A also confirmed that the charge over the property was a secondary form of security, and that it had not carried out any property searches when entering the transaction.

Part B’s interest arose 3 months after Party A’s, however Party B:

1. Performed property searches and valuations prior to acquiring it’s interest;
2. Identified the secured creditors that would rank ahead of it in priority and evaluated that there would be sufficient equity in the property to satisfy their debt should a default occur;
3. Had acquired it’s interest with the property being its primary form of security; but
4. Had failed to search the PPSR.

The Court considered the General Rule and applied the relevant authorities and found,  having regard to all of the circumstances:

1. Party A’s conduct had been undertaken deliberately risking it’s interest by electing not to lodge a caveat at the time the underlying security interest was created;
2. Party B’s interest was created on the reliance on the proceeds of the property to satisfy it’s interest – which justified failing to search the PPSR; and
3. Party B had acquired it’s interest reliant upon the searches it conducted and the equity that appeared to be available in the property.

As a result, the Court found that Party B held the better equity in the property, despite its interest arising 3 month after Party A’s.

Plainly, with respect to reliance, what this means, is that where it is clear one party’s equitable interest was created more heavily reliant than the others on satisfaction of the security, that consideration will hold significant weight in the determination of who has the better equity.

Conduct

A party’s conduct before, during, and after its interest arose will also hold significant weight with the Court’s when determining priority.\

Whilst in LTDC this conduct manifested as a result of Party A deliberately electing not to lodge a caveat, in Applications of Bizcap AU Pty Ltd; Applications of Hengyi Zhao; Applications of FundIT Ltd [2024] NSWSC 588 (Zhao) the Court made a determination with reference to a party’s conduct quite differently.

In Zhao three parties disputed priority.

Party A, who was related to the party who provided security to all three, the Court found to hold the earliest arising interest.

Party’s B and C were non bank, financial institutions, who had failed to search the register prior to acquiring their interests.

Notwithstanding Party A’s interest arising earlier, and Party’s B and C being in the business of financial lending would be expected to be aware of the necessity to conduct the relevant searches prior, the Court found that Party A’s interest should be postponed to Party B and C’s interests.

In making this determination the Court, on the facts and circumstances, found that:

1. Party A’s interest was a related party loan, on ‘unreal’ terms;
2. The terms of Party A’s loan lacked proper documentation;
3. There were constant breaches of the terms of the Party A’s loan by the granting party;
4. Despite the breaches Party A deferred seeking repayment for many years – and all whilst ‘being in the unique position of being able to readily assess the granting party’s financial position’ (to which Party’s B and C were not).

Ultimately, the Court found that Party A, being fully aware of the granting party’s financial situation, and amidst constant breaches to the loan, in failing to seek repayment, acted negligently by failing to take any steps to protect its interests despite them being readily available.

Given Party A’s conduct (or failure of), whilst Party B and C’s failures were considered, they were not sufficient to prevent Party A’s conduct from being postponing.

With respect to Conduct, the Court makes it clear that it is not just the failure to lodge a caveat that can place your priority at risk. Failure to take the necessary steps to protect your interest whilst holding the knowledge and ability to do so will hold significant weight in a determination of priority.

How best to minimise the risk of losing your priority

For lenders, disputes arising over competing priority interests in real property is a common issue , but steps can and should be taken to minimise the risk.

Should a dispute over priority reach the Courts, the practices, conduct, and circumstances of each of the parties in dispute will be placed under the microscope, simply relying upon the General Principle is insufficient.

For lenders in New South Wales, lodge a caveat immediately upon the security interest arising, but it is also advised for a lender to:

1. conduct all relevant property and PPSR searches prior to obtaining a charge;
2. conduct valuations of the property and seek details of any indebtedness that may affect the available equity of the property;
3. identify (if possible) the reliance on the available equity of the party of any prior registered interests;
4. take enforcement action as soon as it becomes enlivened; and
5. registering its interests on the PPSR immediately

The process of resolving a priority dispute can be a long and costly one. But if you take the appropriate steps and act promptly to protect your interests, you leave little room for a party to dispute or question your priority ranking.