July 25, 2024

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Balancing the rights of lenders and commercial property owners when a dispute regarding payment of municipal charges arise | Knowledge

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A charge imposed by a municipality upon a property enjoys preference over any mortgage bond registered against that property which, if not paid, may potentially jeopardise a lender’s security. As such, in the event of a dispute relating to municipal charges levied in respect of a property (a dispute which is common), the interests of lenders and commercial property owners need to be carefully balanced.

Introduction

In the recent Supreme Court of Appeal (SCA) judgment in 68 Wolmarans Street Johannesburg (Pty) Ltd and Others v Tufh Limited[1], the applicants appealed against an order of the Gauteng Division of the High Court wherein the respondent, Tufh Limited (Tufh), had initially brought an application in terms of which it sought (i) to exercise its right to accelerate a debt under a loan agreement after the first applicant, 68 Wolmarans Street Johannesburg (Pty) Ltd (Wolmarans), failed to settle the municipal account in respect of rates, water, electricity, sanitation and refuse levied on a property owned by Wolmarans and (ii) the foreclosure of a mortgage bond over such property executed in its favour. Both the High Court and the SCA judgments are of particular importance to lenders as they re-enforce that a charge in favour of a municipality imposed by section 118(3) of the Systems Act[2] enjoys preference over any mortgage bond registered against that property, which, if such charges remain unpaid, may potentially jeopardise a lender’s security, particularly if the lender fails to act timeously. In addition to lenders, as commercial properties are encumbered by a mortgage bond in favour of lenders as security for a loan or debt facility advanced to the commercial property owner, commercial property owners are encouraged not only to carefully consider the provisions of their loan agreement and mortgage bond, particularly in relation to any event of default clause (or such similar clause that enables acceleration of its debt) but also to be weary of withholding payments in a dispute with the relevant municipality under circumstances where their loan agreement or mortgage bond imposes an obligation on the commercial property owner to pay all municipal charges when they fall due.

Background

In 2013, Tufh and Wolmarans entered into a loan agreement in terms of which Tufh would make available a facility in the sum of R5 771 166.00 (Facility Amount) for drawdown by Wolmarans (Loan Agreement) to purchase and refurbish a property known as the Wolbane Mansions (Property). Clause 17 of the Loan Agreement recorded that Wolmarans (as borrower) shall on the due date for payment, promptly pay all rates, taxes, water and electricity charges, sanitation charges and other like imposts that may be payable in respect of the Property to any governmental, provisional, divisional council, municipal or other like authority. A failure by Wolmarans to pay any amounts due in terms of the Loan Agreement and a failure to comply with any municipal by-laws each, amongst others, constituted an event of default, which entitled Tufh (as lender) to accelerate and declare all amounts owing to it under the Loan Agreement notwithstanding that such amounts may have not been due and payable.

As part of the security package for Tufh advancing the Facility Amount, Wolmarans registered a mortgage bond in favour of Tufh over the Property (Mortgage Bond). Clause 3 of the Mortgage Bond provided that Wolmarans shall, “pay promptly on [the] due date for payment all rates, taxes and other like imposts that may be payable in respect of the property to any Governmental, Provisional, Divisional Council, Municipal or other like authority… and exhibit proof of such payments to the Mortgagee or its assigns whenever requested to do so…”.

Whilst Wolmarans duly paid its monthly instalments on account of the Facility Amount to Tufh in terms of the Loan Agreement, it breached clause 17 of the Loan Agreement and clause 3 of the Mortgage Bond by (i) failing to pay its City of Johannesburg (CoJ) account in respect of municipal service charges levied by the CoJ in respect of the Property for a period of 4 years and (ii) failing to provide Tufh with proof of such payments following Tufh’s demand for this. In defence, Wolmarans indicated that there was a disputewith the CoJ as to the manner in which the CoJ had been billing Wolmarans. In terms of a 2016 court order from the Johannesburg High Court, the CoJ was ordered to (i) provide Wolmarans with a proper statement and (ii) for a debatement thereof. For almost 5 years since the court order, Wolmarans failed to pay any amount for services provided to the Property. Whilst Wolmarans may have been acting as such on the basis that there was a dispute with the CoJ, this did not negate that their conduct was still in conflict with the terms of the Loan Agreement and the CoJ’s by-laws, amounting to a breach of the Loan Agreement.

Issue

The central issue to be determined was whether, despite Wolmarans keeping up with its monthly instalments in terms of the Loan Agreement, Tufh was entitled to accelerate payment and claim the full amount outstanding under the Loan Agreement in circumstances where Wolmarans had failed to pay the CoJ for municipal services rendered.

The Decision of the SCA

Although Wolmarans had a dispute with the CoJ regarding water and electricity, it failed to make payments for those portions of the account which were not disputed. A key consideration was whether the enforcement of a provision in a loan agreement to accelerate payment and to execute against immovable property based upon a failure to pay municipal charges was unconscionable or contrary to public policy.

In the court of first instance, it was found that because there was a historical dispute between Wolmarans and the CoJ which resulted in an order for a statement and debatement and since the CoJ had itself not asserted any rights to payment since the order, it would be unconscionable for Tufh to claim that Wolmarans was in breach of the Loan Agreement and to foreclose on the Mortgage Bond. However on appeal to the full court, the full court found that Wolmarans had failed to explain why it had not made payments of the undisputed indebtedness to the CoJ on the due date. The full court further held that by failing to perform its contractual obligations Wolmarans destroyed the commercial purpose of the contract (Mortgage Bond) as the significant municipal arrears impaired Tufh’s security, which Tufh required in order to advance the loan facility, on the basis that a charge in favour of the municipality imposed by s 118(3) of the Systems Act enjoys preference over any mortgage bond registered against the Property.

Wolmarans then applied to the SCA for special leave to appeal and was required to demonstrate that ‘there is a sound rational basis to conclude that there is a reasonable prospect of success on appeal’. The SCA found that Wolmarans was unable to show how the enforcement of the Loan Agreement would be unconscionable and contrary to public policy. By placing reliance on the principle of pacta sunt servanda, the SCA held that the full court was correct in finding that ‘generally, contracting parties have considerable freedom in choosing how they structure their agreements, and it is not the function of the court to protect consenting adults from bad bargains’.

It is noteworthy to mention that like the full court, the SCA concurred that the CoJ is a preferred secured creditor in terms of section 118(3) of the Systems Act and that a charge in favour of the municipality (in this case, the CoJ) imposed by s 118(3) of the Systems Act enjoys preference over any mortgage bond registered against the applicable immovable property[3]. It is clear that section 118(3) of the Systems Act jeopardises, prejudices and impairs Tufh’s mortgage bond which is the security it bargained for with Wolmarans at the outset.

Key Takeaways

This SCA judgment is particularly important to lenders and commercial property owners (with mortgage bonds and loan agreements in place). Lenders are encouraged to monitor, on a regular basis, whether their borrowers are up to date with payments of their municipal charges, as the security granted to local municipalities under section 118(3) of the Systems Act enjoys preference over any mortgage bond registered against the property in their favour, which, if it remains unpaid, may potentially jeopardise the lender’s security, particularly, if the lender fails to act timeously.

Any agreement which gives rise to an obligation or an undertaking, such as the Loan Agreement or Mortgage Bond in the above case, should be carefully considered with particular reference to the events or circumstances that would constitute, what is commonly referred to in these transactions as, an ‘event of default’. Commercial property owners are to note that keeping up with your monthly bond payments may not be enough to guard against lenders accelerating payment of the debt outstanding under your loan facility and foreclosing on your bond. It is, therefore, critical to comprehend the full scope of your obligations under a loan agreement or mortgage bond, as a failure to do so, may have some unforeseen consequences.


[1] Unreported case no 1263/2022 (15 April 2024).

[3] BOE Bank Ltd v City of Tshwane Metropolitan Municipality [2005] ZASCA 21; 2005 (4) SA 336 (SCA) para 5.


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