THE EQUITY OF REDEMPTION:
THE VALIDITY OF COLLATERAL AGREEMENTS WITHIN
MORTGAGE TRANSACTIONS
Bonnie McClain
Independent Resear
Prof. Skillern
April 22, 1983
V»vl> M,
The doctrine of the equity of redemption was developed
in England as a Common Law protection against unjust enrichment.
The equity of redemption guarantees to the mortgagor
that, prior to foreclosure, upon satisfaction of all obligations
under the mortgage, he may redeem his property in toto.
In
other words, when the mortgagor satisfies the mortgage obligation,
he will be in the same position as he was prior to executing
the mortgage.1
This doctrine was originally developed by
the Courts of Equity, which held that it was inequitable for
a good faith mortgagor to be forced to relinquish his land
when the mortgagee could be made whole by acceptance of a
2
complete monetary payment.
The equity of redemption is often confused with the
statutory right of redemption.
These two doctrines, however,
do not grant a mortgagor identical protection.
The equity of
redemption protects a mortgagor's right to redeem his property
prior to foreclosure upon full payment of the debt.
The right
of redemption protects the mortgagor after the foreclosure sale
has occurred by allowing him to repurchase the land at a
2.
reasonable price within a statutory time limit.
3
The two re-
demption doctrines were differentiated in Hummell v. Citizens'
k
Building and Loan Association
when the court stated, "The
right of redemption after sale on foreclosure is distinct
from the equity of redemption after breach of condition and
before the sale.
ends.
The former commences only when the latter
One rests on the principles of equity, the other on
the terms of the statute."
Both the equity of redemption and the statutory right
of redemption are important concepts in property law.
Because,
a great deal of material has been written on the right of
redemption
it will not be examined further in this paper.
However, there has only been a small amount of analysis done
on the equity of redemption.
Thus, this paper will focus
exclusively on the equity of redemption in order to better
understand the public policy behind its conception and the
modern problems which arise due to its existance.
Problems arise with the equity of redemption when a mortgagee includes agreements in the mortgage that do not concern
the debt itself.
These agreements are called "collateral
agreements," and generally include bonuses, options to purchase,
and grants of interests.^
When these agreements are included
in a mortgage, the mortgagor may still owe an obligation to
the mortgagee after paying off the monetary debt represented
7
by the mortgage.
An example of such an extended debt occurs
when a mortgagor gives a note containing both an option to
3-
purchase and a pre-payment provision to the mortgagee as
security for the mortgage agreement.
In that case, if the
mortgagor decides to pay the full monetary debt prior to the
due date of the note, he must still respect the mortgagee's
right to purchase until the specified due date.
Thus, the
mortgagor still owes an obligation to the mortgagee after paying
the monetary debt, and because he may have to sell the property,
the mortgagor is not put back in the same position as he was in
prior to the mortgage agreement.
I. The Common Law Equity of Redemption
The problems which deal with the equity of redemption
doctrine were first analyzed under the English Common Law system.
Therefore, to better understand the equity of redemption doctrine,
English judicial opinions should be examined.
Historically,
English courts applied the equity of redemption strictly
to any case in which the mortgagor was not returned to his
8
pre-mortgage position.
It became well settled that the
courts would not enforce any collateral agreement which had
9
been placed m a mortgage document.
Relaxation of this strict
rule began after the English usury laws were abolished in
10
the late nineteenth century.
During this period, more
power was being granted to the banks and other lending institutions throughout the country.
Courts began holding that
mortgagees could place collateral agreements in the mortgage,
provided that the court determined
that the equity of redemption was not "fettered." 11 In order to sustain a collateral
agreement, courts also required that the bargain be fair,
• Ma A! O)-^
reasonable, and entered into between the parties while on
equal terms without any improper pressure, unfair dealing,
12
or undue influence.
English courts have examined the affect
of the equity of redemption on two main collateral agreements:
options to purchase and grants of bonuses.
A. Options to Purchase
In the early English case of Kreglinger v. New Patagonia
13
Meat and Cold Storage Company,
J
the court upheld the use
of a collateral agreement in a mortgage document.
In this
case, Kreglinger, a firm of wool brokers, agreed to loan New
Patagonia Meat and Cold Storage Company (New Patagonia)
$ 10,000 at six percent interest.
In addition to the monetary
loan provisions, the mortgage included a collateral agreement.
It provided that for five years the mortgagor would sell sheep
skins only to the mortgagee as long
Ik as the mortgagee was willing
to buy at the best price offered.
If the mortgagor sold
the skins to other persons, it was to pay a commission to
the mortgagee.
The loan was not due for five years, but the
agreement permitted the mortgagor to repay at any time upon
giving one month's notice.
After giving the proper notice, the mortgagor paid
the loan amount in three years.
The mortgagee believed
that it still had the right to exercise the option to
purchase for the full five years as was specified in the mortgage
agreement.
5-
The House of Lords, in Kreglinger, held that the equity
of redemption did not affect the validity of the option to
purchase agreement.
The House of Lords concluded that the
option to purchase was not part of the mortgage transaction,
but rather a collateral contract entered into as a condition
of the company obtaining a loan. ^
The court stated that in
this case the lenders had restricted sales without "fettering"
the equity of redemption.
The House of Lords found that before
the option to purchase agreement would be invalid, the option
16
must have been part of the terms of the mortgage.
The court
held that the option agreement was seperate from the mortgage,
even though it was in the same document, and was, therefore,
intended to last the full five years notwithstanding repayment
of the loan.
B. Bonuses
English courts also have examined the validity of a grant
of a bonus within a mortgage agreement.
Early English cases
had held any collateral agreement invalid if the agreement
was contained in the mortgage document.
However, by the late
nineteenth century, the equity courts began making exceptions
to this rule if the collateral agreement granted the mortgagee
a bonus that was reasonable and was made by parties at arms length.1'7
1R
In Mainland v. Up,john
the Court of Chancery made bonus
agreements am exception to the general rule of invalidating
any collateral agreement.
The court stated that the general
bViO-J
6-
rule was, "that any device by which a mortgagor is made to
pay on redemption more than the principal, interest, and
costs, will not be upheld." 19
The court held that, where
a loan had been given by a mortgagee to a mortgagor upon
collateral of a speculative character, the mortgage agreement
could specify that the mortgagee was to receive a bonus
or commission which would be deducted from the loan amount
at the time the loan was made.
The court explained further
that the allowance of a bonus would be valid only if the parties
were on equal footing, knew what they were doing, and made
the agreement voluntarily, fairly, and without undue
influence.^
The English cases have engrafted these exceptions onto
the general rule, so that now collateral agreements and other
agreements unrelated to the debt security may be made contemporaneously with a mortgage, so long as the equity of redemption
is not "fettered."
In addition, the courts have made an exception
to the general rule for bonuses even if they fetter the equity
21
of redemption.
A narrow exception also has been created for
any agreement which the court may determine to be a condition
of the loan, rather than part of the mortgage transaction,
22
even though it is contained in the same document.
II.
The Equity of Redemption in the United States
A.
Texas Law
Texas case law has rarely discussed the equity of
redemption as that doctrine applies to collateral agreements, Howeve
0313.-2
7-
two early cases briefly mention the doctrine.
23
A. & T.R. Company v. Whitaker
J
Both St. Louis
?
and Shelton v. O'Brien
stated that, "the equity of redemption is considered in
itself tantamount to the fee in law."
Thus the holder of
the equity of redemption is considered the owner of the
property during the period of redemption, even if legal title
is technically in another.
It was not until the recent case of Crestview v. Foremost
?6
Insurance Company
that a Texas court emphasized again
the equity of redemption.
Crestview mentioned the equity
of redemption in reference to the enforceability of a "due on
sale" clause.
In Crestview, Foremost Insurance Company (Foremost) held
a deed of trust on a certain piece of property.
The deed of
trust contained a "due on sale" clause, which would become
effective if the mortgagor sold the property without Foremost's
consent.
Crestview purchased the property knowing that
there was such a deed of trust and that Foremost had not
approved the sale.
Foremost immediately declared the note
due, relying on the clause in the deed of trust.
Crestview
filed suit alleging that Foremost had acted inequitably in
several respects, in particular, by including a clause in the
deed of trust which did not relate to debt security.
The court in Crestview stated that:
The ancient and dominant purpose of a
•VIO-3
8mortgage instrument is obviously that of
securing the mortgagor's debt. There is
however, no intrinsic illegality in attatching
to the mortgage agreement other special
stipulations or agreements unrelated to
debt security. These stipulations or
agreements are, of course, subject to
public policy. 27
The court expanded on this statement in a footnote which
read, "the primary public policy involved is that which
prohibits any provision which may "clog" the equity of redemption; thus
mortgagorJ7 may not simply waive his right
pO
of redemption or otherwise agree to frustrate its exercise,"
Therefore, the Crestview court held that a collateral
agreement unrelated to debt security is valid if it does not
violate public policy considerations.
One policy consideration
noted by the court was the protection of the equity of redemption.
The Crestview court made it clear that mortgages made in Texas
today are still subject to the equity of redemption,2^
Although
the Crestview court never expanded on its discussion of the
equity of redemption, it apparantly did apply the equity of
redemption doctrine to deeds of trusts as well as mortgages
since the court referred to deeds of trust and mortgages interchangeably in its opinion.
B.
New Jersey
The New Jersey courts have examined the doctrine of the
equity of redemption as it relates to options to purchase.
CO-136
The courts have realized that a problem could, arise when a
borrower is able and willing to repay the loan when it is due,
but may be prevented from redeeming his property if the mortgagee
has already exercised the option to purchase the property or
at least has retained the option after repayment.
The Superior Court of New Jersey in Humble Oil Refining
Company v. Doerr 30 held that an option to purchase for
a fixed price, contained in the mortgage, constituted a clog
31
on the equity of redemption.
J
to expand his service station.
In Humble, Doerr was attempting
He was successful in obtaining
a bank commitment for a $ 20,000 construction loan which would be
secured by a mortgage on the premises.
A Humble Oil representitive,
who serviced the present station, told Doerr that Humble
could help him get better loan terms- a $ 35>000 loan at
a lower interest rate and for a longer term.
These terms
were to be obtained by leasing the station to Humble at a
rental charge equal to the amount to be charged each month on
the new mortgage.
Doerr was then to assign the Humble rental
payments to the bank as additional security.
Humble would
then lease the premises back to Doerr at the same rental cost
so that he could continue operating the station.
The sublease gave Humble the option to purchase the
premises "at any time" for $150,000.
Before the end of the
lease term Humble told Doerr that it chose to exercise
its option.
Doerr refused to perform the option, so Humble
brought suit for specific performance and, in the alternative,
for damages.
10.
The Humble court found that the lease was really a
guarantee of payment and that the option contained in the
lease was an equitable mortgage securing that guarantee.
Based on its finding that the agreement constituted a mortgage, the court held that Humble was not entitled to either
specific performance or damages.
The court held that the
option was unenforceable because it was a "clog" on the equity
of redemption.
The court stated, "it is well settled that
an option to buy property for a fixed sum cannot be taken
contemporaneously by the mortgagee."
Humble was consistant with the early English "option to
purchase case" Kreglinger, even though their holding differed.
In Kreglinger, the mortgagee had to match the "best price
offered" before being granted the option, whereas in Humble,
the option remained at a fixed price.
Therefore, Kreglinger's
option closely resembled a right of first refusal, in which
the mortgagor could still redeem his land; he simply had agreed
to sell his product to a certain party at the "going rate."
These facts differ from those in Humble, where the mortgagor
had to sell the actual mortgaged property at a fixed rate.
In Humble, the mortgagor was taking the chance that he might
lose the real property prior to repayment, thus "fettering"
his right to redeem.
The Humble court was careful to limit
its holding to mortgages.
The Humble decision also was brought
closer to agreeing with the Kreglinger holding when the
court indicated that a different rule might apply where
f\f»IOC;
t« VAVVJ
(1) the optionee has a right of first refusal; (2) the optionee
is a joint venturer with the owner-lessor; or (3) the parties
enter into a three party lease.-'
C.
Florida
The Florida Supreme Court also has considered options
to purchase and the relationship of the options to the doctrine
of the equity of redemption.
It granted specific performance
of an option to purchase in MacArthur v. North Palm Beach
Utilities. •JJ
In that case, MacArthur sold a tract of land
to North Palm Beach Utilities (North Palm Beach) taking back
a purchase money mortgage.
MacArthur also agreed to loan
North Palm Beach $800,000 for the construction of a water
supply and sewage disposal facility.
The $800,000 was evidenced
by notes and secured by a first mortgage upon the property
where the water system was to be located.
The mortgage agreement contained an option, which gave
MacArthur the right to purchase the water system any time
after the due date of the first note and any time prior to
the full payment of any summ due under the mortgage agreement.
The Florida court noted that, absent a loan, a seller
may sell his property to a third party and reserve an option
37
to repurchase.
The court decided that MacArthur should
not be penalized simply because he held a mortgage.
The
court decided that the option agreement was valid under these
circumstances.
According to the commentator, "The court's
12.
decision clearly reflects its opinion that although North
Palm Beach gave MacArthur an option contained in the mortgage,
the option was incidental to the sale and not to the mortgage."
39
The court considered in depth the original intent of the parties.
The court concluded that the original intent of the seller
was to sell his property and not to grant a mortgage.
Although the results are different, the MacArthur and
Humble decisions are consistent.
The Humble court carefully
distinguished the case before it from those where the intention
AM
of the parties was not to create a mortgage.
This holding
is consistent with MacArthur, stating, that if the parties had
not intended to create a mortgage, then any collateral agreement
would be upheld since it would not clog the equity of redemption.
Two judges joined in a dissent to the majority opinion
in MacArthurr
The dissenting judges believed that the option
was, "exacted and given contemporaneously with and as an
integral part of the loan transaction and has the effect of
permitting the optionee to defeat the borrower's right to
K2
redeem the mortgaged property."
Based on the state court decisions outlined above, an
option to purchase contained in the mortgage will be valid as,
long as it does not violate the equity of redemption.
The equity
of redemption is not violated as long as the mortgagor may
redeem the property, upon repayment, in thek-3
same condition
as it was prior to the mortgage agreement.
J
In order to
decide if the equity of redemption has been fettered, a
13-
court must determine if the collateral agreement is actually
part of the mortgage transaction.
In deciding if the collateral
agreement is part of the mortgage, a court will analyze the
intent of the parties.
If the stipulation is found to be
part of the mortgage agreement, it may be found invalid as
44
a clog on the equity of redemption.
D.
Oklahoma
A second area of cases that mention the equity of
redemption are those which deal with a percentage interest
which has been granted a lender through a mortgage agreement.
The case which best explains this concept is the Oklahoma
case of Coursey v. Fairchild.
J
This case disallowed an
interest agreement, an interest percentage given the mortgagee as security for the mortgage.
The court's holding was
based on certain Oklahoma statutes
46which have codified
equity of redemption principles.
Although these statutes
use the term "right of redemption," they establish the
principles usually referred to as the equity of redemption;
the principles deal with the mortgagor's right to redeem before
any foreclosure sale occurs.
The Oklahoma statute provides
that, "all contracts in restraint
of the right of redemption
47
from a lien are void..."
A following section states,
"Every person having an interest in property subject to a
lien, has a right to redeem it from the lien at any time
r»,f> M
after the claim is due, and before his right of redemption
is foreclosed."
I n Coursey, the mortgagor gave the mortgagee a mineral
interest in a portion of the mortgaged property as additional
consideration for the lender's agreement to extend the time
of payment of an existing mortgage.
The interest in the
property also was granted the mortgagee so that he would accept
a renewal note secured by a new mortgage.
The court found
that all of the instruments concerned in the agreement formed
kg
part of a single transaction.
7
The borrower prepaid the
debt in full, but the mortgagee refused to reconvey the
mineral interest.
The Oklahoma Supreme Court held that under the equitable
theory of mortgages, "a mortgagor is entitled by force of
law, to have the mortgaged premises relieved from the lien
and his entire estate restored to that extent which he would
have had if the mortgage transaction had never taken place."
Thus, the court held that the agreement was a clog on the
equity of redemption and was therefore void.
Although the Coursey holding was based on Oklahoma
statutes, other jurisdictions might decide along the same
lines as the Coursey court, due to the fact that relevent
statutes simply codify the Common Law doctrines which form the
equity of redemption.
III.
Conclusion
t> * Jl
15.
The courts have been inconsistent in deciding what
constitutes a clog on the equity of redemption.
Thus, a
mortgagee should attempt to use an alternative collateral
device rather than placing a collateral agreement in the mortgage
document.
As stated by one writer:
It may well be that modern day courts
will be willing to disregard the old case law
that was developed to curb abuses which are
no longer relevent and recognize that an
option to purchase £~ar other collateral
agreement_7 is simply another method for a
lender to secure a fair and reasonable return
for loaning money given the inflationary
economic realities of the eighties. J
However, if the courts choose to continue to enforce
the equity of redemption, there are a few drafting methods
which have been suggested that may persuade a court to
uphold a transaction which contains a collateral agreement.
These drafting suggestions may tend to show the court
that the agreement was not intended to be part of the mortgage
and therefore not in violation of the equity of redemption.
If possible, the option agreement or other collateral
agreement should be placed in a document which is seperate
from the mortgage agreement or deed of trust.
No reference
to the collateral agreement should be made in the mortgage
or deed of trust.
If the documents are kept seperate, the
court may find that there was no intent to include such
00® 3
collateral agreement in the mortgage or deed, of trust, therefore not offending the equity of redemption.
It may be helpful to evidence in the seperate agreement
that the mortgagor was a sophisticated and experienced
business person or at least that he had been represented by
an attorney during the transaction.
If the court can
determine that the parties were at arms length, it may find
that there was no unfair advantage taken by the mortgagee.
An offer of seperate consideration for the collateral
agreement may also be helpful in persuading the court that the
equity of redemption has not been violated.
If the mort-
gagee gives the mortgagor added consideration for the collateral
agreement other than the mortgagee's willingness to make a
loan, the court may consider this an indication that the
collateral agreement was seperate from the mortgage agreement.
Case law has indicated that collateral agreements will be
carefully scrutinized, but are generally allowed if they do not
clog the equity of redemption.
Avoidance of a clogging problem
may be difficult if certain collateral agreements are contained
in the mortgage. Therefore it is necessary for a mortgagee or
his counsel to be very careful in the drafting of mortgage
documents.
ENDNOTES
1. Kane, The Mortgagee's Option to Purchase Mortgaged
Property, Financing Real Estate During the Inflationary 80's
123 (B. Strum Ed. 1980), /"hereinafter cited as Kane, Mortgagee's
Option to Purchase 7»
2.
Id. at 125.
3.
Murphy v. Casselman, 24 N.D. 336, 139 N.W. 802,
803 (1913).
4.
296 P. 1014 (Ariz. 1931).
5.
Id. at 1015.
6. Kane, Mortgagee's Option to Purchase at 126.
7.
Id.
8.
Id.
9.
Id.atl29.
10.
Id.
11.
231 The Law Times 117 (March 3, 1961).
12.
Id.
13.
191^ A.C. 25.
14.
Id. at 27.
15.
Id. at 41.
16.
Id.
17.
231 The Law Times at 118.
18.
60 L.T.R. 6l4, 4l jQh. D. 126 (I889).
2.
19.
Id. at 633,41 Ch. D. atl46.
20.
Id.
21.
231 The Law Times atll9.
22.
191^ A.C. at 41.
23.
68 Tex. 630, 5 S.W. 448 (1887).
24.
285 S.W. 260 (Tex. Comm'n App. 1926, Judgmt adopted).
25.
5 S.W. at 499; 285 S.W. at 264.
26.
621 S.W.2d 816 (Tex. Civ. App.- Austin 1981, writ
granted), (appeal taken on other grounds).
27.
Id. at 821.
28.
Id. n. 4, citing 9 Thompson, Real Property ^4668, 66,68,
29.
Id*
30.
303 A.2d 898 (N.J. 1973).
31. Id. at 900.
32. Id. at 910.
33.
Id. at 906.
34.
Id. at 913.
35.
202 So. 2d 181 (Fla. 1967).
36.
Id. at I83.
37.
Id. at 184.
38.
Id.
90496
3.
39• Kane, Mortgagee'5 Option to Purchase at 131.
40.
202 So. 2d at 186.
41.
303 A.2d at 914-.
42.
202 So. 2d at 186.
43.
Kane, Mortgagee's Option to Purchase at 123
44.
Id.
436 P.2d. 35 (Okla. 1967).
46.
Okla. Stat. Ann. tit. 42, § 11 (West 1971);
Stat. Ann,. tit. 42,
9
18 (West 1971).
47.
Okla. Stat. Ann. tit. 42, § 11 (West 1971).
48.
Okla. Stat. Ann. tit. 42, § 18 (West 1971).
49.
436 P.2d at 39.
50.
Id. at 38.
51. Kane, Mortgagee's Option to Purchase at 135•
00497