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The tide of mortgage shortfall claims in which limitation is raised as a defence appears to be ebbing. This is due in part to the fact that by the mid-1990s the number of mortgage possession claims had begun to fall and at the same time house prices had begun a sustained period of recovery, so that fewer mortgagors found themselves with insufficient equity to discharge the mortgage debt upon the forced sale of their property.

The reduction in the number of disputed cases has also come about as a result of the House of Lords' decision in West Bromwich Building Society v Wilkinson [2005] UKHL 44, which has resolved many of the uncertainties that previously existed in this area.

Whereas prior to this decision questions as fundamental as the applicable section of the Limitation Act 1980 were the subject of argument, the Wilkinson case has finally resolved many of these issues so that the battleground between the parties to a shortfall claim is clear (for a review of the judgment see (2006) 150, SJ 48, 20.01.06). It is now beyond argument that s20 will apply and not, as had previously been contended, s5 (a claim in simple contract) or s8 (an action on a specialty). A continuing uncertainty has been the circumstances in which an offer of settlement of the debt by the debtor will be admissible, so as to cause the re-accrual of the limitation period. The guidance provided by the House of Lords in Bradford & Bingley plc v Rashid [2006] UKHL 37 has given some assistance, although determining whether an acknowledgment is admissible remains a highly fact sensitive exercise.

In this case, the resale value of the mortgaged property being insufficient to discharge the mortgagor's indebtedness, the mortgagor's representatives entered into protracted correspondence with the mortgagee in an effort to settle the shortfall debt. None of this correspondence was marked 'without prejudice'.

In one letter they wrote: 'Please find attached Mr Rashid's financial statement, which clearly indicated that at present he is not in a position to repay the outstanding balance, owed to you. However, my client requests that once his financial situation is stable he will start to repay'.

In a second letter the representatives wrote: 'He [the mortgagor] is willing to pay approximately £500 towards the outstanding amount as a final settlement. He is only able to afford this amount by borrowing from friends and family'.

Two issues arose from this. Firstly, were these letters acknowledgments for the purposes of s29(5) of the 1980 Act; and secondly, were these letters subject to without prejudice privilege as negotiations directed towards a compromise. The Court of Appeal ([2005] EWCA Civ 1080) and the House of Lords were each unanimous, but each coming to different conclusions. Moreover, while their Lordships were unanimous in their decision as to the disposal of the appeal, each came to different conclusions.

Acknowledgement under s29(5)

Were the letters an acknowledgement for the purposes of s29(5)? This section provides:

'(5) Subject to subsection (6) below [which deals with payments of rent or interest], where any right of action has accrued to recover:

(a) any debt or other liquidated pecuniary claim; or

(b) any claim to the personal estate of a deceased person or to any share or interest in any such estate; and the person liable or accountable for the claim acknowledges the claim or makes any payment in respect of it the right shall be treated as having accrued on and not before the date of the acknowledgment or payment.'

The Court of Appeal did not consider whether the letters amounted to an acknowledgment (having held that they were subject to privilege). The House of Lords was unanimous in concluding that the letters did constitute admissions. It was argued on behalf of the mortgagor that unless there is an admission of a specific sum due or an amount ascertainable by mere calculation, there is no acknowledgment within the statute. These arguments were given short shrift, it being sufficient that a liability to pay was admitted, although the quantum may still be the subject of dispute.

Offers of settlement and the 'without prejudice' rule

The more complex issue was whether the letters were protected by the without prejudice rule. The Court of Appeal held that they were. In delivering the only reasoned judgment, Sir Martin Nourse held that such an admission should be subject to privilege as a frank 'cards on the table' approach was to be encouraged in settlement negotiations between the parties.

The public policy arguments which formed the basis of the Court of Appeal's decision were held by the House of Lords to cut both ways. The Court of Appeal had erred in considering only the interest of allowing the debtor to be open with his creditor. There was also an interest in encouraging the creditor not to initiate legal proceedings and to come to an arrangement with the debtor as to repayment terms. The acknowledgment rule plays an important part in furthering this policy because it means that the creditor, negotiating on the basis that the debt is acknowledged, can proceed with the negotiations without 'being distracted by the sound of time's winged chariot behind him' (per Lord Hoffman, para 3).

If their Lordships were in agreement as to the public policy behind the admissibility of the admissions, they differed in the route by which privilege was to be withdrawn. The reasoning is important, because it is from this that those advising parties to mortgage shortfall claims can circumvent or apply 'without prejudice' privilege.

Lord Hoffman was alone in holding that the without prejudice rule did not apply at all to the use of a statement as an acknowledgment for the purposes of s29(5). This was because the admission was not relied upon as to the truth of its contents (in effect, what was said) but as evidence that it was made (that is, the fact that it was said). If this view were to be followed, the acknowledgment will be admissible unless the parties have expressly agreed in negotiations that any admissions made will not amount to an acknowledgment for the purposes of s29(5), which will alert the creditor to the fact that the debtor will rely upon the statute. The only other way that s29(5) can be avoided on this reasoning is by ensuring that no admissions are in fact made. This will present its own difficulties, as any offer to pay presupposes a present liability and existing debt.

Lord Hope approached the question of the admissibility of an acknowledgment by reference to Scottish authority. In these cases a distinction was drawn between 'offers, suggestions and concessions' made in the course of negotiations and 'clear admissions or statements of fact which although contained in the same communication, did not form part of the offer to compromise'. In the former case, privilege will apply; in the latter, the acknowledgment will be admissible. The first letter was simply a request for time to pay and was not an offer of a compromise payment of the debt which might attract without prejudice privilege. In the second letter there was an admission and an offer to compromise. However it did not contest the outstanding amount as the offer to pay was referable to the debtor's means and not what he believed to be due. Neither letter therefore attracted without prejudice privilege because there had been unqualified admissions.

This approach has its own disadvantages, as it leads to complicated distinctions between 'qualified' or 'hypothetical' admissions and actual admissions of liability. Correspondence or negotiations would have to be dissected and the former separated from the latter. A further effect would be that it would encourage parties to express all admissions as 'hypothetical', which is hardly in the interest of the openness which the without prejudice rule is intended to promote.

The majority (Lord Walker, Lord Brown and Lord Mance) disagreed with both Lord Hoffman's and Lord Hope's analyses. The use of the term 'without prejudice' will provide protection from disclosure as there is an implied agreement that the communication is subject to privilege. This is subject to the exceptions set out in the judgment of Unilever plc v The Procter & Gamble Co [2000] 1 WLR, 2436, 2444'“5. On this reasoning a clear unambiguous admission of liability, when expressed to be made without prejudice, will not be admissible in evidence. It is not an abuse of the without prejudice rule to tell the truth (even if one's pleading advances a contrary case). Only if the exclusion of the evidence would act as a 'cloak for perjury, blackmail or other 'unambiguous impropriety'' will the cloak of privilege be lifted (Unilever plc at p2444). Lord Mance, however, did not agree with this conclusion, holding that the use of the word 'without prejudice' could not be used by the parties to extend privilege to communications which were not an attempt to compromise a genuine dispute.

Where the exchange is not marked 'without prejudice' there can be no implied agreement and the critical question then becomes whether it is clear from the surrounding circumstances that the parties were seeking to compromise the action. Deciding this turns on construing the communication in its context. In this case, the letters were not negotiations genuinely aimed at settlement, but were designed only to discuss the repayment of an admitted liability, rather than to negotiate and compromise a disputed liability. For this reason, they were not privileged.

Privilege in practice

Clearly this is an area which presents hazards to the unwary. A letter intended to negotiate payment terms for the debtor may have the effect of extending the limitation period and exposing the debtor to a liability which might otherwise have been extinguished.

For those representing defendants to mortgage shortfall claims, there may already be a history of correspondence from the debtor which will have to be considered to see whether the liability has already been admitted. Equally a creditor may be beguiled into continuing to negotiate with a debtor and foregoing the issue of a claim, by relying upon an apparent acknowledgment which is not in fact admissible. The significance of the Rashid decision goes beyond mortgage cases and applies in any case where a debt is claimed.

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