The Supreme Court of New South Wales has delivered a practical reminder on “consent not to be unreasonably withheld” in the context of security substitution.
In B32 Investments Pty Ltd v The Owners – Strata Plan 81539 [2026] NSWSC 160, Hammerschlag CJ in Equity dismissed a mortgagor’s bid to compel a mortgagee to accept replacement collateral, holding that the mortgagee could reasonably refuse consent where the proposed substitute was materially inferior in value and marketability to the existing security.
This decision matters for settlement and finance practitioners who draft “switch-out” rights in deeds and facilities, and for secured counterparties deciding whether to accept substitute collateral.
Background and the Deed
- The Owners Corporation (defendant) had sued the developer group (plaintiffs) for building defects. On the eve of judgment, they settled for $3m payable by instalments. Defaults ensued, statutory demands issued, and winding up proceedings followed.
- On the morning of the winding-up hearing, the parties executed a new Deed of Settlement under which the Owners accepted $2m (the Settlement Sum) in full and final settlement. Recognising clawback risk if a liquidation later occurred, the developer entities indemnified against any recovery and granted a first mortgage over 32 Cooper Street, Strathfield (valued ~ $4.3m) to secure that indemnity. A deed of priority gave the Owners first ranking for $2m.
- Clause 5.2(a) of the Deed permitted the plaintiffs to seek consent to substitute “alternative security” during the registration period “provided that the unencumbered market value of that substitute security is a value equal to or greater than the Settlement Sum,” with consent “not to be unreasonably withheld.”
The plaintiffs sought to swap the Cooper Street mortgage for a first mortgage over 36 Leicester Avenue, zoned RE1 (Public Recreation) within a precinct identified for eventual council acquisition. Two valuation reports were tendered: the plaintiffs’ valuer at $2.5m, the defendant’s at a $1.8–$2.2m range (mid-point $2m). The Owners refused consent, citing inferior value, limited marketability (essentially one real buyer—Council—at an unknown time), and enforcement cost/shortfall risks. The plaintiffs sued for a declaration that consent was unreasonably withheld and for specific performance.
Issues and Principles
The Court identified a key issue: whether, on the probabilities, the refusal was unreasonable.
- Construction approach: Commercial contracts are construed objectively by text, context and purpose (Wilkie v Gordian Runoff; Electricity Generation Corporation v Woodside; Mount Bruce Mining v Wright Prospecting). Clause 5 (and the Deed) aimed to protect the Owners against clawback risk by adequate security; cl 5.2(a) provided a pathway for substitution subject to a reasonableness constraint.
- “Consent not to be unreasonably withheld”: The Court applied well‑known propositions (International Drilling Fluids v Louisville Investments), adopted in NSW:
- The onus is on the party alleging unreasonableness.
- Consent may be refused for reasons a reasonable person might hold in the circumstances; reasons need not be correct in every respect.
- The decision-maker may consider its own interests consistent with the clause’s purpose.
- Reasonableness is assessed on all the circumstances.
- Reasons are not confined to those articulated at the time (Secured Income Real Estate v St Martins); subjective intention may be relevant but is not determinative (Fulham Partners v NAB).
Held: Value Differential and Marketability Were Legitimate Grounds
- Clause construction. The plaintiffs’ core submission—that once the proposed collateral met the $2m threshold, the mortgagee could not rely on the fact the existing security was worth more—was rejected. The threshold is a gatekeeper. It does not exhaust the mortgagee’s right to consider other rational factors, including that the replacement would leave it worse off. Value is the “very essence” of security; a material value differential will almost inevitably be crucial to a security holder’s decision.
- Reasonableness on the facts. The existing Cooper Street security (~$4.3m) was about double the proposed Leicester Avenue security. That non‑trivial impairment alone could reasonably justify refusal. Further:
- Marketability and enforcement risk: Leicester Avenue’s RE1 zoning meant no real market other than Council, at Council’s timing and price. If a forced sale arose before Council acted, the Owners faced a real risk of under‑recovery and holding costs—risks not grappled with by either valuer.
- Litigation and cost context: The Owners had already compromised the original claim by $1m, incurred costs from prior defaults, and faced a non‑negligible prospect of future enforcement costs. The inferior security provided little buffer for such costs; the current security did.
- No current purchase offer from Council; valuations near the threshold heightened risk of a sale below $2m.
None of the refusal reasons was “unreasonable, irrational, unfounded, or eccentric.” The plaintiffs did not discharge their onus. The summons was dismissed; costs to the Owners on a provisional basis.
Practical Drafting and Enforcement Lessons
- Express your benchmark: If the commercial intent is “no worse off,” say so. Replace “equal to or greater than the Settlement Sum” with “equal to or greater than the unencumbered market value of the existing security” or “no less favourable in value, marketability and enforcement prospects.”
- Define relevant factors: List legitimate considerations for consent, including value differential, liquidity/marketability, enforcement horizon, priority arrangements, and likely costs of realisation.
- Valuation protocol: Mandate registered valuer reports on agreed bases, dual valuations or an expert determination mechanism, and address special purchasers (e.g., councils) and time‑to‑realise.
- Risk buffers: Permit refusal where the substitute would erode buffers for interest, fees and enforcement costs.
- Priority and intercreditor: Tie substitution to contemporaneous and satisfactory deeds of priority; make bank/third‑party conditions explicit.
- Onus and evidence: Parties seeking to compel consent must build a robust evidentiary case on value and realisation risk, not merely threshold value.
For secured parties, the case confirms you may reasonably refuse a swap that leaves you materially worse off, even if the substitute technically meets a minimum dollar threshold. For drafters, precision in articulating “equal or better” security, across value, marketability and enforcement, will reduce disputes and align outcomes with commercial expectations.