In Perpetual Trustees Victoria Ltd v Xiao Hui Ying & Anor  VSC 21, the Supreme Court of Victoria considered the doctrine of indefeasibility of a mortgage of a property in circumstances where the mortgagee has become registered by fraud and the owner is innocent of the fraud.
The fact that a borrower’s signature is forged on a mortgage would not, in the absence of fraud by the lender, affect the lender’s ability to rely on a registered mortgage, due to indefeasibility of title under the Transfer of Land Act, 1958.
In modern times, most banks enter into ‘all monies’ mortgages, so that they can seek repayment of all debts at the time that the mortgage is repaid. The complication is that this requires the parties to enter into loan agreements at the same time as executing the relevant mortgage documents.
The relevant terms of the loan agreements are where the obligations to repay are located, not in the mortgage itself.
In New South Wales (and New Zealand) there are numerous cases that have concluded that mortgages in such circumstances secure nothing because the signature on the loan agreement has been forged, making that agreement void. This means there is no amount secured by the loan agreement. This in turn meant that no money was secured by the ‘all monies’ mortgage, and as a result the mortgage ought to be discharged without any payment by the registered proprietor who did not commit any fraud.
A number of earlier Victorian Supreme Court decisions had declined to follow the New South Wales cases on this point. They concluded that a lender’s title obtained on registration of a mortgage was not defeated unless the lender was involved in or knew about the fraud.
In Perpetual Trustees Victoria Ltd v Xiao  VSC 21, Hargrave J of the Supreme Court of Victoria concluded that where the underlying loan agreement on which a lender relies is forged, the lender cannot rely on its registered ‘all monies’ mortgage, even in circumstances where the lender had no knowledge of the fraud.
You should bear in mind that the decision turns on the facts of the case; however, in today’s modern lending environment, the facts are not uncommon.
A summary of the factual background is as follows:
a. The first defendant (Ms Xiao) was born in China in 1960 and on moving to Australia met the husband, the second defendant (Mr Fitzgerald). Ms Xiao gave evidence that she spoke limited English and relied on Mr Fitzgerald.
b. Mr Fitzgerald required finance to make an investment in a Chinese restaurant in Burwood. He was the registered proprietor of a property in Vermont, however he had a poor credit history and knew that he was unlikely to get finance in his own name. He therefore transferred the Vermont land to Ms Xiao, subject to a “re-transfer” document and a deed of trust, which were contested at trial.
c. Mr Fitzgerald then went about obtaining finance from the plaintiff through a mortgage originator, Capital Securities (Aust) Pty Ltd (Capital). Mr Fitzgerald obtained a loan in the name of Ms Xiao from the plaintiff lender that was secured over the Vermont property.
d. The originator dealt directly with Mr Fitzgerald, but failed to verify that Ms Xiao was the borrower or the accuracy of the loan application
e. Justice Hargrave found that Ms Xiao was a pawn in Mr Fitzgerald’s fraud, in that Mr Fitzgerald acted fraudulently in obtaining the loans. He did not tell Ms Xiao he was obtaining the loans, he forged her signature on the loan documents, mortgage and related documents and otherwise falsified the loan application
f. The originator assisted Mr Fitzgerald by falsely witnessing Ms Xiao’s signature and providing a valuation prepared by Mr Fitzgerald to the trust manager when it knew Mr Fitzgerald was not independent.
g. There was a subsequent default on the loan and the plaintiff took steps to enforce its mortgage. Justice Hargrave considered himself bound to follow the reasons of the New South Wales Court of Appeal in Perpetual Trustees Victoria Ltd v English and Anor  NSWCA 32 and Perpetual Trustees Victoria Ltd v Cox  NSWCA 328 where the relevant mortgage and loan documents were in similar terms. The New South Wales decisions held that, whilst the mortgage document may have had indefeasibility under the Torrens legislation, the mortgage secured nothing as the loan documentation had been forged.
In determining whether the mortgage secured the repayment of the loan, Hargrave J decided (at paragraphs 82 and following):
82 The fact that Mr Fitzgerald forged Ms Xiao’s signature on the mortgage did not, in the absence of fraud by Perpetual, of which there was no suggestion, affect the indefeasibility of the mortgage when registered.
83 Indefeasibility, however, extends only to the covenant for payment contained in the mortgage.
84 Whether any, and if so what, amount is secured by a covenant for payment contained in the mortgage is a matter of contractual interpretation. Where the covenant for payment appears on the face of a forged mortgage, or in a document expressly incorporated by reference in the mortgage, the indefeasibility of the mortgage on registration will extend to the covenant for payment as properly construed.
85 The covenant for payment in this case is one step removed from the mortgage. The forged mortgage expressly incorporated a memorandum of common provisions, which contained a covenant for payment by reference to amounts owing under any other agreement between Ms Xiao and Perpetual — present or future. That drafting device is unexceptional and will be given effect where such an agreement can be identified. However, whether such a covenant is effective in the circumstances of this case — where the agreements to which it refers are forged — requires consideration.
The Honourable Justice Hargrave then conducted an analysis of the documents between the parties.
Relevantly, Hargrave J noted:
a. In the absence of fraud by a lender, the lender has the benefit of the mortgage once it is registered. However, that protection extends only to the covenant for payment contained in the mortgage
b. In this case, the covenant for payment was one step removed from the mortgage, and was found in the memorandum of common provisions
c. The mortgage provided that it was given in consideration of and to secure loans, advances or financial accommodation provided by Perpetual to the borrower (the wife). However, no loans were provided by Perpetual to the wife as she was unaware of the loan documents and they were forged.
The thrust of the New South Wales’ decisions was that, where the loan agreement on which the lender relies is forged and therefore void, there is no ‘secured agreement’ and therefore no ‘secured money’, being the terms commonly appearing in common provisions. In particular:
a. In Perpetual Trustees Victoria Ltd v English & Anor  NSWSC 478, the New South Wales Court of Appeal considered that a mortgage secured nothing where a husband forged his wife’s signature on the mortgage and loan agreement as there was no agreement between the lender and the borrower at the time the mortgage was executed;
b. In Perpetual Trustees Victoria Ltd v Cox  NSWCA 328, the Court of Appeal in New South Wales held that a mortgage secured nothing, even though the mortgage itself was not forged. The court considered that it was sufficient that a direction to draw down one of three facilities under the terms of the mortgage had been forged.
In contrast, in Solak v Bank of Western Australia Ltd  VSC 82, the Supreme Court of Victoria had reached a contrary conclusion on the basis that the reference to ‘you’ in the mortgage, memorandum of common provisions and loan agreement was the forger purporting to be the registered owner of the property.
Justice Hargrave declined to follow the Solak decision on the basis that it was 'plainly wrong'.
Prior to Solak, in Vassos v State Bank of South Australia  2 VR 316, the Supreme Court of Victoria held that title obtained on registration of a forged mortgage cannot be defeated on the grounds of fraud if the mortgagee was not a party or privy to the fraud. In Pyramid Building Society (in liq) v Scorpion Hotels Pty Ltd  1 VR 188, the Court of Appeal followed the Vassos decision, albeit in slightly different circumstances.
The Perpetual v Xiao decision rejected the earlier Victorian cases and adopted the New South Wales position.
However, Justice Hargrave went on to find in the particular circumstances that Ms Xiao held the loan on trust for Mr Fitzgerald. Hargrave J also found that Mr Fitzgerald was liable to Perpetual for defrauding it. The combined effect of these conclusions was that while the mortgage secured nothing and was held on trust by Ms Xiao for Mr Fitzgerald, Perpetual was entitled to have the value of the land applied in discharge of Mr Fitzgerald’s liability to it as a fraudster.
Justice Hargrave also found that Ms Xiao did not authorise Mr Fitzgerald to sign the loan agreements and she could not ratify the loan agreements as they were forged. In particular, the court confirmed that a forged loan agreement is a nullity and is incapable of ratification.
Justice Hargrave also found that the plaintiff was not prevented from enforcing the loan by reason of unconscionable conduct by the mortgage originator. The court considered that the originator had acted unconscionably. However, ultimately, the court held that Perpetual itself did not act unconscionably and was not liable for the originator’s actions.
On 27 May 2015, the Court of Appeal refused leave to appeal (see  VSCA 124). This means in effect that we now have Court of Appeal authority in this state that the decision of Justice Hargrave is the law in Victoria.
The decision makes it clear that the benefit of a registered mortgage can be lost even where a lender has no knowledge of any fraud. Perpetual was left effectively unsecured and was saved only by the unusual circumstances, which led to the finding that the husband retained a beneficial interest in the land.
The decision is also a warning for lenders who use third party mortgage originators. The court rejected legal criticisms of Perpetual’s business model and the trust manager’s failure to make inquiries with the originator about the loan. However, in practice the originator’s conduct caused Perpetual to lose the benefit of its mortgage.
Whilst fraud is often very hard to detect, lenders need to ensure their systems minimise the risk of loans being granted in fraudulent circumstances.
W G Stark
Hayden Starke Chambers