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By Geoff Hardy Commercial Lawyer

Everyone occasionally experiences the frustration of not being able to get someone to pay a debt that they are owed, but those of you who are in business are particularly vulnerable to this because most of you sell your goods or services on credit. That means you deliver your side of the bargain first, and hope to be paid later.

There are two reasons why your customers may not pay you - either because they can’t, or because they won’t. If they won’t pay, that could be because they genuinely believe they don’t owe you the debt, or they believe they have a counterclaim against you that cancels the debt out. But in some cases, it may simply be because they are dishonest or deluded. And in those situations, or where your customer never had any hope of paying you, then you need all the help you can get.

One way you can improve your chances of getting paid is to register a caveat against the title to your customer’s land. That means that as long as the caveat remains in place, your customer can’t register a transfer, lease, mortgage or similar dealing with the land that would undermine your rights in the land, at least without notifying you and giving you a chance to uphold those rights. Naturally that shouldn’t worry the owners if they aren’t planning to do something with the title any time soon, but it is surprising how often the mere existence of the caveat does trouble them regardless. And of course if the owner does have such plans then it gives you major leverage.

There is a common misconception that everyone can register a caveat automatically, but it isn’t true. To be eligible to register a caveat you must have what’s called an “estate or interest” in your customer’s land, or the customer must hold the land in trust for you. There is a wide range of estates or interests in land, but they generally have to be granted to you by the owner. For example the owner might have agreed to give you an easement over it, or to sell it to you, lease it to you, or mortgage it to you. Normally you could register all of those on the title, which gives you much better protection than simply registering a caveat. But the situations where you would register a caveat instead are where those rights have not been formalised, so they don’t yet meet the strict criteria for registration, or they never will. We generally refer to them as “equitable” estates or interests.

In the building context, contractors often protect themselves by getting the owners to agree to give them a mortgage (usually ranking after the Bank’s mortgage) over the building site, in case the owners either can’t or won’t pay them. The agreement to grant a mortgage is typically found in the building contract itself. The contracts you get from New Zealand Standards or the Institute of Architects don’t have them, but those you get from Master Builders, Certified Builders or the high-volume residential building franchises usually do. The owners aren’t expected to sign a formal mortgage like the Bank requires them to do, because the time and cost involved would be out of all proportion to the risk to the contractor and the duration of the building project. Instead, the mere “agreement to mortgage” is sufficient to create an equitable estate, which in turn entitles the contractor to register the caveat.

It is way harder for the contractor to exercise the rights under the mortgage (such as to confiscate the rental from the property, lease the property to someone else, or to sell it) than it is for a Bank under a registered mortgage. Generally that isn’t the contractor’s intention, and the right to register a caveat is all he wants. The equitable mortgage shouldn’t worry the owners if they are not in default under the building contract, because there is no debt for the contractor to recover, and the rights under the mortgage aren’t triggered. Even if the contractor maintains there is a debt but the owners dispute it, they have nothing to be concerned about unless that dispute is resolved in the contractor’s favour, and they don’t abide by the outcome.

I have seen some building contracts that simply give the builder a right to register a caveat against the owners’ title, without mentioning any underlying equitable estate or interest at all. That is risky because the owners might successfully challenge the caveat on that basis. And it’s a brave lawyer who registers it because he or she can be personally liable for court costs and/or damages if their client did not have reasonable cause to do so, or had an ulterior motive (such as merely trying to gain bargaining power). Nevertheless there have been some cases where such caveats have been upheld, on the basis that the owners must have intended for there to be an underlying equitable estate or interest, or the owners are deemed to be holding the land in trust for the contractor to a limited extent.

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Getting rid of a caveat

Property owners who take exception to the contractor registering a caveat on their title, can do something about it. They may be able to persuade or coerce the contractor into withdrawing the caveat. Or they can apply to the High Court to have the caveat removed (which is obviously an expensive process, and won’t succeed unless you have solid grounds). Finally, they can ask the Registrar-General of Land under section 143 of the Land Transfer Act 2017 to give notice to the contractor to commence proceedings in the High Court to sustain the caveat, failing which it will be removed.

That third option is usually the preferred option because it is quick and economical to do. A lot of contractors will baulk at the thought of commencing proceedings in the High Court, with all the cost and stress that that entails, so they just throw in the towel and allow the caveat to lapse. Once they have done that, they can’t register the same caveat again without a Court order, and in the meantime they risk having the property transferred or re-mortgaged so there is no equity left in it.
But where the owner is up against a determined contractor, using the section 143 procedure is a risky gamble. That is because if the contractor has a legitimate estate or interest in the land all along (such as an agreement to mortgage in the building contract), he may well apply to the Court, and win. In that event, the owners end up paying not only their own legal costs but also roughly two thirds of the contractor’s legal costs as well. And the caveat remains.

It may be possible for the owners to persuade the Court to dispense with the caveat regardless, by paying the disputed money into Court to be held there until the dispute is ultimately resolved. But that will only work if the building project is at an end and there is no prospect of there being further disputed debts, because the agreements to mortgage in building contracts are usually intended to remain in force from the beginning to the end of the project. Alternatively, the Court may uphold the caveat on an interim basis but only on condition that the contractor compensates the owners if he ultimately fails to prove his caveat was justified. But once again a confident contractor won’t have any problem giving that undertaking.

The short answer is, caveats are useful, but you need a good building contract to be able to use one.

Article by Geoff Hardy
Auckland Commercial Lawyer

Geoff Hardy has 45 years’ experience as a commercial lawyer and is a partner in the Auckland firm Martelli McKegg. He guarantees personal attention to new clients at competitive rates.
His phone number is (09) 379 0700, fax (09) 309 4112, and e-mail geoff@martellimckegg.co.nz
This article is not intended to be relied upon as legal advice.

Published in Building Business magazine, October 2020 Edition