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Court Decision Increases Risk of Mortgage - Backed Loans

Court Decision Increases Risk of Mortgage - Backed Loans

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Under Austrian law, incorrect land register entries may trigger public liability. But the Austrian Supreme Court recently held that such incorrect entries only create public liability claims for of a certain group of people, thereby potentially increasing the risk management costs of mortgage-backed loans.

Background: Past Market Practice

To perfect a mortgage under Austrian law, the mortgage must be registered in the land register, a public register kept with local courts. As this registration triggers a fee of 1.2% of the secured amount, Austrian banks sometimes accept mortgages that are signed but not registered. The mortgage is then only registered if the debtor’s financial situation deteriorates. To ensure the mortgage can still be registered in the first rank, the bank will agree on a negative pledge with the debtor and will check the land register before granting the loan and regularly thereafter. Banks therefore heavily rely on the land register being complete and correct. A new decision by the Austrian Supreme Court limits public liability for incorrect entries, significantly impeding this practice. 

The Case

In 2000 a woman transferred real estate to her nephew with a prohibition on encumbrance and sale in favor of the nephew’s son. Although corresponding land register entries were then filed and approved by the land register court, the court failed to actually register the prohibition on encumbrance and sale, while registering all other approved entries. Thirteen years later, the nephew assumed personal liability for a bank loan granted to his company. Prior to granting the loan, the bank merely checked the land register for encumbrances and relied on the status in the land register, which wrongly showed that the real estate was unencumbered.

In 2014 the bank wanted to enforce its claims by obtaining an attachment on the real estate. While the court approved the bank’s lawsuit upon registering the bank’s rights in the land register, it noticed that the prior prohibition on encumbrance and sale granted in 2000 had not been properly registered. The court then corrected its past error and retroactively registered the prohibition on encumbrance and sale granted in 2000 in its original rank, i.e., with priority to the bank’s rights. The bank filed a public liability lawsuit for damages, arguing that it would not have granted the loan had the original prohibition on encumbrance and sale been registered correctly. 

The Court’s Decision

The Austrian Supreme Court found that an erroneous non-registration of an approved land register entry, as a violation of the obligation to keep the land register accurate and complete, in principle constitutes public liability. However, even if such a provision is violated, not everyone is entitled to rely on the register’s accuracy and completeness. Only a person who either already has rights registered in the land register or is aiming to constitute such rights is protected by the court’s obligation to keep the register accurate and complete. As the bank did not try to register any right in the land register when the loan was disbursed, the bank was not considered a protected person, and the Austrian Supreme Court therefore denied the bank’s claim for public liability. 

Summary and Open Question

Following this decision, banks that only check the register for prior encumbrances but do not actually register their mortgage may no longer rely on the register’s accuracy and completeness. In the future, banks will have to weigh the risk of an inaccurate or incomplete register against the costs of registering the mortgage when granting a mortgage-backed loan.

Banks may now consider registering the mortgage only for a low amount to be considered a protected person. It is not clear whether banks that do so are protected in the amount of the entire loan or only of the registered mortgage.

By Miriam Simsa, Partner and Philipp Kalser, Associate, Schoenherr Austria

This Article was originally published in Issue 6.6 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

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