Changing the game

Both developers and financial institutions are paying more and more attention to the amended land and mortgage register act. The new regulations, which entered into force on 20th february 2011, significantly modify the previous market practice for the calculation of mortgage amounts, as well as introduce new solutions for over-securing and empty mortgage entry

Before the amendment of the law, banks calculated the capped mortgage amount only in relation to the amount of the secured loan, at the level of 130 pct to 200 pct of the principal of the loan, so that apart from the principal amount it includes related costs, such as default interest or contractual penalties. For the majority of financial institutions, it was of no importance that the value of secured receivables could be much lower than the mortgage amount. After the enactment of the new regulations, the method for calculating mortgage amounts will have a significant impact on the incidence of risk of excessive mortgages, i.e. so-called 'over-securing'.
Over-securing basically consists in the property owner claiming a reduction in the mortgage amount if it significantly exceeds the amount of the secured claim. As the term 'largely exceeds' is not defined in the Act, certain doubts arise. It is commonly assumed that over-securing can be of primary or secondary character. The primary type occurs when the mortgage amount largely exceeds the amount of the secured claim at the time the mortgage is set up, for instance, just after signing the loan agreement. The secondary type may occur during the existence of the mortgage, for example, due to the decreasing debt resulting from its gradual repayment. In either case, the property owner may demand a reduction in the mortgage sum through the courts. Therefore, the consequence of introducing the new regulations concerning over-securing is that banks have to carefully estimate the potential aggregate amount of the claims that are to be secured by the mortgage (including interest, default interest, contractual penalties and other ancillary claims), so that at the moment of mortgage registration the amount of the mortgage corresponds to the amount of the secured claims.

Empty mortgage entry
Another point that lenders should carefully consider in connection with the over-securing is the possibility of an empty mortgage entry, i.e. an empty entry created after the expiry of a previous mortgage. Only the property owner may "dispose of" such an entry, and can do so within the limits of the mortgage that has expired, e.g. (s)he may establish a new mortgage under such an entry or move any other mortgage on the premises to that entry after having obtained the consent of the beneficiary of the mortgage. Another possibility is the occurrence of the so-called 'partially empty mortgage entry', when the mortgage registered under a given entry has only partially expired. In particular this will occur in connection with over-securing, when the property owner demands and receives a reduction in the mortgage amount. In such circumstances, the mortgage expires to the extent that it has been reduced. As a consequence, following the execution of the necessary formalities, the property owner may obtain the right to dispose of the 'partially empty mortgage entry'. This means that (s)he may move another mortgage to that entry or establish a new one in its place. The mortgage moved to the empty entry, including the partially empty entry, will have the same priority as the expired mortgage. This means that the financial institution granting the loan, being initially the only secured creditor (and thus holding a first-ranking mortgage), will have to bear in mind that due to subsequent events (the occurrence of over-securing due to the gradual debt repayment and the property owner's disposal of the partially empty mortgage entry) another creditor may be granted a mortgage of the same priority. It may therefore turn out that in the case of debt recovery, the funds from the sale of a property are not sufficient to satisfy both creditors and so they will have to be satisfied proportionally.

What can be done?
With the above-mentioned factors in mind, the process for calculating the mortgage amount under the new regulations could become more complicated. For financial institutions, a careful calculation of the receivables to be secured with a mortgage will be crucially important. In order to reduce the risk connected with the over-securing or disposal of an empty mortgage entry, one can also consider including in the loan agreement specific provisions limiting the property owner's possibility to exercise the right to demand a reduction in the mortgage amount. As is the case for loan agreements in financing transactions that usually provide for not encumbering a property and not disposing of it, a similar obligation to avoid demanding a reduction in the mortgage amount could be introduced. Alternatively, the catalogue of events of default can be extended so that it includes situations in which the property owner files an application with the court for a reduction in the mortgage amount or disposes of a partially empty mortgage entry. However, there is the risk that the court will not approve of such solutions and will regard such provisions as invalid when a dispute arises.
The new regulations may also bring about a change in the approach of financial institutions to the financing of projects secured by mortgages. For instance, to mitigate the risk of over-securing, which could potentially lead to a decrease in the amount of their mortgages and the appearance of a new mortgage creditor with the same ranking, banks involved in commercial real estate financing may decide to modify their lending offer by replacing loans with higher loan-to-value ratios but having an appropriate repayment schedule, with non-amortising loans having a lower LTV whose repayment schedule will provide solely for a balloon repayment at maturity. However, it will only be in the next few months that we will be able to see the mechanisms that are actually put in place to mitigate this type of risk.
Dominika Uberman, advocate, partner and head of the banking and international finance department, CMS Cameron McKenna
Małgorzata Chruściak, advocate, partner and head of banking regulatory, insolvency and restructuring practice within the department, CMS Cameron McKenna
Anna Tomalska-Wcisło, associate of the banking and international finance department, CMS Cameron McKenna