The recent case of Westminster City Council v Gems House Residences Chiltern Street Limited [2025] EWHC 1789 (Ch) has clarified the effectiveness of mortgagee exclusion clauses in section 106 agreements.
Mortgagee exclusion clauses are common in section 106 agreements, in particular where there are affordable housing provisions restricting use of properties to affordable housing. The mortgagee exclusion clause enables a mortgagee to sell free of the affordable housing provisions, usually subject to a requirement for the mortgagee or receiver enforcing security to use reasonable endeavours to sell the properties to another Registered Provider of social housing (RP) within a set period. This provides comfort that a mortgagee would aim to keep affordable housing properties within the sector, whilst at the same time enabling the RP to achieve the more favourable valuation of market value subject to tenancies (MV-ST) rather than the valuation being restricted to existing use value for social housing (EUV-SH).
This decision provides crucial guidance for local authorities, RPs, lenders and developers on the scope and operation of these important protective provisions, at a time when maximising the value of properties to unlock development and funding capacity whilst ensuring affordable housing remains in the sector is key.
Background
Planning permission was granted by Westminster City Council in 2013 for a 60-unit scheme, of which 16 homes were designated as affordable housing under a section 106 agreement. Between 2015 and 2016, a transaction structure was implemented whereby the original RP, London District Housing Association, took debt from connected companies, then assigned the leases to a second RP, Kinsman Housing Limited, which was also connected with the lender.
In 2018, the Regulator of Social Housing (RSH) investigated both RPs which revealed that the transactions had potentially been structured in a manner designed to circumvent the affordable housing requirements whilst maintaining the appearance of compliance. Kinsman was subject to RSH regulatory notices, enforcement action and subsequent deregistration, thereby defaulting the loan.
The mortgagee enforced its security and sold the units to Gems for £12.6m at a market value subject to tenancies for refurbishment and reletting on the open market. This sale triggered the dispute with Westminster City Council, which contended that the disposal breached the section 106 agreement because Kinsman was no longer an RP at the time of the sale.
The key issue
The key question examined in the case was whether the mortgagee exclusion clause wording meant that the chargor still needed to be an RP as at the date of disposal by its mortgagee, or whether RP status as at the date of grant of the original charge was sufficient.
The Council argued that registration status should be assessed as at the date of disposal, contending that the words "deriving title" used in the mortgagee exclusion clause were in the present tense (i.e. that the clause only benefitted mortgagees of borrowers who were still RPs at the time of disposal, which was when the buyer was deriving title from the mortgagee).
Part of the concern here was that the mortgagee exclusion clause in question was an absolute exclusion which didn't include any cascade requiring the lender to attempt to sell the homes to another RP. Since Kinsman had already been de-registered by the time of the disposal, the statutory moratorium did not apply either.
Conversely, the buyer argued that registration status should be assessed as at the date of grant of charge, pointing out that lenders would be at the mercy of actions of the RP and RSH if the Council's interpretation were correct, and that the Council's interpretation perversely incentivises early disposal by the lender, rather than seeking to dispose to another RP.
The judgment
HHJ Hodge KC concluded that, "Not without some regret at the consequent loss of much-needed affordable housing, I have no hesitation in preferring [the buyer's] submissions." The judge strongly reaffirmed purposive interpretation of mortgagee exclusion clauses, identifying the purpose as being "to encourage sufficient commercial lending for a registered provider to acquire the long leases of the affordable housing units". He emphasised that these clauses exist to facilitate the financing of affordable housing by providing lenders with certainty about their security.
The judge added that "No lender would be prepared to run the risk of subsequent deregistration imperilling the value of their security" and explained that "The root of the mortgagee's title remains granted by a registered social provider; and the same applies to any third-party disponee of the mortgaged property by the mortgagee". This interpretation ensures that lenders can rely on the protection of the mortgagee exclusion clause at the time they advance funds, without fear that subsequent events could retrospectively undermine their position.
Key implications
The judgment reaffirmed that standard principles of interpretation apply to section 106 agreements, with the exact wording of the mortgagee exclusion clause being crucial. In order to avoid a similar situation in the future, mortgagee exclusion clauses should be drafted in a market standard form, protect all parties' interests and ensure that affordable housing schemes remain financeable by lenders and maximise value achieved for lending purposes. It is clear that mortgagee exclusion clauses will remain under scrutiny to ensure that the wording provides certainty for all parties, whilst not restricting value.
Should you wish to discuss the impact of the case, require assistance with reviewing and negotiating mortgagee exclusion clauses at the point of acquisition or deal with varying an existing mortgagee exclusion clause in a section 106 agreement to maximise the value of properties for security purposes, please do not hesitate to contact Jo Judge in the Real Estate Finance Security team and we would be happy to help.
