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Perfecting the S118(3) hypothec

26 May 2016

Introduction
This article is one in a series dealing with the consequences of the judgement handed down in the matter of City of Tshwane Metropolitan Municipality v PJ Mitchell (38/2015) [2015] ZASCA 1 (29 January 2016)(“hereinafter referred to as Mitchell”). In this article we look at what is required in terms of our law to “perfect” the hypothec created in favour of the municipality in terms of Section 118(3) of the Local Government: Municipal Systems Act (“the Act”). In order to understand the legal institution of perfection in terms of our credit security law, it is necessary to first understand several general principles. For this reason hypothecs, perfection, and notification will be discussed generally, and thereafter an analysis of how the section 118(3) hypothec is to be understood in this context follows.

What is a Hypothec?
A hypothec is a right afforded to a creditor in terms of our law of credit security, which entitles the creditor to retain power or control of a thing owned by the debtor until such time as the obligation owed by the debtor to the creditor has been satisfied. The manner of control of the thing, and the times at which the creditor is entitled to exercise that control, and the manner in which the creditor needs to assert his right to that control, differ from one hypothec to the next. The idea behind a hypothec is to give a creditor security for the repayment of the loan or the satisfaction of the obligation owed to the creditor by the debtor.

What does “perfecting” mean?
Perfection refers to any action that the law requires the creditor must take in order to “activate” its credit security right to take possession of the debtor’s property that is subject to the hypothec; and to sell that property to satisfy the debtor’s obligation to the creditor. Perfection is required in most (but not) all types of credit security arrangements. In most cases, permission from the court is required before the creditor can take possession of the object of security.

Common Hypothecs
Common law pledges
A pledge is a hypothec in terms of which the creditor is voluntarily put into the possession of an object of value by the debtor, and the creditor retains possession of that object until such time as the debt or obligation owed to the creditor has been satisfied in full. Note that in relation to common law pledges, physical possession of the item of security is essential. Note further that only movable objects can be pledged in this fashion in terms of our common law. The creditor is entitled, if the debtor defaults, to sell the object of value that is subject to the pledge to satisfy the debt or obligation owed to the creditor by the debtor. In this type of hypothec, because the debtor has voluntarily given up possession of the object of value to the creditor and the creditor is in possession of it already, the creditor does not need to obtain a court order authorising the taking of possession of the object and the sale of it to satisfy the debt. However, there are strict rules that govern the manner in which the sale must occur, to protect the debtor from abuse of the system by the creditor.

Mortgage
A mortgage is another type of hypothec in which a limited real right is registered over an immovable property (for example a piece of land) in favour of the creditor (who is usually the bank), which right entitles the creditor to perfect its security right by applying to court for an order taking possession of the property and selling the property at auction to satisfy the debt or obligation owed to the creditor by the debtor, if the debtor defaults in terms of the loan agreement. Note that mortgages can only be registered over immovable property or certain types of rights associated with immovable property.

Notarial bonds
Another common hypothec is a pledge in terms of the Security by Means of Movable Property Act. This type of pledge is different to a common law pledge, and is recorded in a notarial bond. The notarial bond is then registered in the Deeds Office, in a manner very similar to a mortgage bond. The aforementioned act provides that the nature of the hypothec created is essentially the same as a pledge created in terms of our common law, with certain crucial differences (the most important one being that the creditor does not take the object of security into its physical possession, but the law deems the creditor to have done so to create a fictional pledge). This type of hypothec is perfected by the creditor applying to court for permission to take possession of the object that is the subject of the notarial bond, and to sell it to satisfy the obligation or debt owed to the creditor by the debtor.

Common Elements of Hypothecs
Notification or publication
Firstly, in all hypothecs the creditor has to take some kind of action that notifies the rest of the world of that creditor’s right over the object of security. In a case of a common law pledge the creditor takes the item of security into its physical possession; in the case of a mortgage the creditor registers a mortgage bond over immovable property in question; and in a case of notarial bond the creditor registers a notarial bond over the movable property in question (the two bonds in question being recorded in an office of public record that can be accessed by any interested party). In all of these cases the purpose of the notification by the creditor to the rest of the world of the creditors’ right in that item is to ensure that other creditors are not misled by the debtor into providing further credit to the debtor based on that same item of security, and further to ensure that the first debtor has stronger rights to that item of security than any other creditors that might subsequently acquire if the debtor has disingenuously held out to other creditors that the item of security in question is available to provide security to them.

Perfection
Secondly, in all cases the creditor needs to perfect its hypothec before it is allowed to sell the property in question. In relation to a pledge, the act of perfection occurs when the debtor voluntarily gives possession of the property to the creditor. In relation to mortgage bonds and notarial bonds, the act of perfection occurs when the creditor makes application to, and is granted an order by a court to the extent that the creditor can take the property concerned into its possession and sell it to satisfy the debt owed the creditor by the debtor. This is because in our law, self-help or vigilantism is frowned upon, and were a creditor to seize property in possession of a debtor without either the consent of that debtor or a court order authorising seizure, such conduct would be unlawful even if the creditor had a security right in respect to the property concerned. In the case of a common law pledge the debtor has already voluntarily placed the creditor in possession of the property concerned and so there is no need for a court order, perfection having occurred when the debtor voluntarily relinquished control of the property to the creditor.

The Section 118(3) Hypothec
The wording of section 118(3) of the Local Government: Municipal Systems Act 32 of 2000 provides only that a municipality has a hypothec over the property concerned for all charges incurred in connection with it. The Act itself is not clear on precisely how a creditor needs to go about perfecting its hypothec in terms of section 118. It most certainly does not give the municipality any special rights or preferences to exercise its hypothec in any manner other than in accordance with the general principles of our law of credit security.

The authors are of the view that, based on the general principals described above that apply to hypothecs in terms of our law of credit security, a municipality needs to follow the steps described below to exercise its hypothec:

  1. Ordinarily an attachment order is applied for and granted only after the municipality has already obtained an order against the person who incurred the debt for payment of that debt. It may be possible for a municipality to apply for an interdict on an urgent basis preventing the owner from transferring the property to another, and attaching it in the interim, to secure its hypothec, before obtaining judgment against the debtor concerned, based on the ordinary court rules. Whether our courts will grant such an order, however, remains to be seen.

  2. After obtaining judgment against the debtor, the municipality needs to apply to court for an order attaching the property burdened by the hypothec and authorising a municipality to sell that property at auction to satisfy the debt owed to the municipality. Logically, this would apply at any time that the municipality choses to exercise its rights in terms of the hypothec – regardless of whether the property is at that time owned by the person who incurred the debt owed to the municipality, or a subsequent owner.

  3. Once an attachment order is granted, the municipality would then, in the ordinary course as any other creditor would in the circumstances, forward a copy of the court order to the registrar of deeds in whose jurisdiction the property is located, such that an interdict can be registered against the property in the deeds office, which will prevent transfer of the property to any third party until such time as the amount owed to the municipality in terms of the court order concerned has been paid in full. In the authors’ view it is only when the interdict is registered in the deeds office notifying the world at large that the municipality has a hypothec over the property, that the municipality has perfected its hypothec in terms of section 118. To regard the municipality as having perfected a hypothec before the attachment occurs in the deeds office (i.e. once a court order is granted attaching a property but without any action being taken by the municipality to register its hypothec against the property in the deeds office) would be to ignore the established principles of credit security in our law. When the municipality makes application to the court for the attachments and sale of property concerned, the owner of the property (who may or may not be the person who incurred the municipal charges that the municipality is seeking to recover by the sale of the property) will then have the opportunity to put any defences before the court as to why the property should not be sold to defray those expenses. This ensures that the municipality does not take the law into its own hands and seize the property from the property owner without following the due process of obtaining a court order authorising seizure.

Interesting Observation on the Termination of Hypothecs
The rules that regulate hypothecs ensure that no third party who is innocent of the debt owed by the debtor to the creditor becomes liable for that debt when acquiring the item of security from the debtor, unless the third party has expressly agreed to take over the debt. In the cases of pledge, for example, a creditor would sell the item of security in order to satisfy the debt owed by it to the debtor, thus discharging the debtors’ debt and passing transfer of the item of security to the purchaser thereof, free of the debt. In the case of mortgage bonds, the mortgage bond has to be cancelled in the deeds office before such time as the property can be transferred to the successor in title thereof, unless the successor in title agrees to take over the debtors’ liability to the creditor – in which case the property is transferred to the successor entitled thereto simultaneous to either a substitution of the debtor for the third party transferee in terms of the mortgage bond, or the cancellation of the mortgage bond. In the case of a notarial bond, the same principals apply as in relation to a mortgage bond. In all of these cases the law prevents an innocent third party who acquires the property from becoming liable for the prior owner’s liability to the creditor – unless the transferee agrees. The authors thus question how the court in the Mitchell case could have reached the conclusion that when the property is transferred from the debtor to an innocent third party, the hypothec could “survive transfer” and be enforced against that innocent third party, when in terms of all (or at least most) other hypothecs there is no provision for this unless the third party acquiring the property expressly agrees to take on that liability.

The authors argue that at the very least, for section 118, it cannot reasonably be understood in terms of our law of credit security that the hypothec should “survive transfer” and be enforceable against an innocent third party successor in title unless at the very least the municipality has perfected its hypothec in the manner described above and in that manner notified the entire world of the existence of its hypothec. A purchaser wishing to acquire the property once the hypothec has been perfected and an interdict has been registered against the property for the judgment debt concerned, would then have notice of the existence of the hypothec and the property would not be able to be transferred to that purchaser free of the hypothec unless that hypothec were cancelled in the deeds office first. As the deeds office rules and regulations require that once an interdict has been registered against the property, it must be uplifted before the property can be transferred to a subsequent owner, the practical effect of the registration of the interdict (i.e. the perfection of the municipality’s hypothec) would be that the municipality would need to be paid all amounts outstanding (or agree to a payment arrangement for same) before the interdict could be uplifted by the deeds office and the property could be transferred to the purchaser concerned, meaning that the purchaser concerned would always receive the property free of the hypothec unless the purchaser has agreed to take over the liability. It is conceivable that a purchaser acquiring a property subject to a hypothec in terms of section 118 would agree to take transfer of that property subject to the hypothec (and accordingly subject to the municipality’s rights to attach and sell that property to satisfy the debt owed to it by the debtor who was not the purchaser). This could be achieved by the purchaser expressly agreeing in the offer to purchase to take over the debtor’s liability to the municipality, and by the municipality agreeing to uplift the interdict on this basis – which would presumably only happen if the municipality had secured some sort of guarantee or repayment plan from the new owner in respects of the outstanding debt.

Conclusion
The authors are of the view that the court’s ruling in the Mitchell and Mathabathe (*Tshwane Metropolitan Municipality v Mathabathe 2013 (4) SA 319 (SCA) at 325) judgments did not adequately or properly investigate the qualities of hypothecs in terms of our law of credit security, and that this lead to the incorrect interpretation of section 118 as creating a hypothec in favour of a municipality that “survives transfer”. In our view, such a hypothec should firstly not survive transfer unless the successor in title has expressly agreed to take on the liability to the municipality. Secondly, in our view the municipality has not perfected its hypothec until it has notified the public at large of the existence of the hypothec by way of registration in the Deeds office of an interdict attaching the property in favour of the municipality, which simultaneously prevents transfer of that property to a successor until such time as the debt owed to the municipality has been paid in full. This protects both the creditor and an innocent purchaser. Understanding and interpreting section 118 as described in this article would bring the operation of the section 118 municipal hypothec within the ambits of the normal operation of hypothecs in terms of our law of credit security, and would rationalise the principles applicable to it with all other hypothecs that exist in terms of our law of credit security. Interpreting section 118 in any other way is (in the authors view) nonsensical and legally incorrect.

Disclaimer
Our law of credit security is rather complex, and the authors do not intend nor purport to deal extensively with all aspects of it referred to above. We describe the general rules for the purposes of illustrating the principles discussed, but do not deal with all exceptions and qualifications to these rules, as this would unduly burden the reader. Further, for the same reasons as above, the definitions/descriptions provided are given to illustrate the principles involved, and are not the full and proper legal definitions/descriptions (which are much more involved).

Chantelle Gladwin, Partner and Rogan Heale, Candidate Attorney
Schindlers

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