Revisiting the Bona Fide Purchaser Doctrine: Implications for Financial Institutions in Land Title Disputes

27 November 2024

1. A registered document of title is conclusive evidence of the indefeasibility of title pursuant to section 89 of the NLC, unless any of the vitiating factors in section 340(2) of the NLC are present to render the title defeasible. Hence, even if the Bank did not conduct a site visit of the borrower’s land prior to disbursement of the loan, it does not defeat the Bank’s good faith as long as the Bank had carried out a land search which shows that the borrower is the registered owner of the land.


2. The common law doctrine of constructive or equitable notice is not applicable under the NLC as it has been replaced by the caveat system. Therefore, the rights and good faith of a subsequent purchaser should not be negated through the application of the equitable doctrine of notice concerning any unregistered interest, unless actual notice has been officially recorded in the form of a private caveat lodged on the land.


3. It is erroneous to impose an unduly heavy and commercially unrealistic burden on a financier to prove that it was "impossible" to discover any unlawfulness in the transaction after conducting a critical examination of documents to which the financier is not privy. This was clarified in the case of Bayangan Sepadu Sdn Bhd v Jabatan Pengairan dan Saliran Negeri Selangor & Ors, which laid down the correct principle for measuring good faith or bona fide of a purchaser within the meaning of the proviso to section 340(3) of the NLC. 

• Question 2: Must the Bank prove it was impossible to know of the unlawfulness to qualify as a subsequent purchaser in good faith? 
  
  Answer: Negative.

• Question 3: Must the bank critically look into the documentation leading up to the sale and purchase of the Lands even though the sale and purchase transaction has been completed, and title transferred and registered in the name of the chargor free from encumbrances prior to the creation of the charge? 
  
  Answer: Negative

• Question 4: Between the conflicting decisions of Bayangan Sepadu Sdn Bhd v Jabatan Pengairan dan Saliran Negeri Selangor & Ors⁴ (“Bayangan Sepadu”) and Au Meng Nam & Anor v Ung Yak Chew & Ors⁵ (“Au Meng Nam”), which is correct in measuring good faith under section 340(3)? 
  
  Answer: Bayangan Sepadu is the correct decision in measuring the extent of good faith and/or bona fide required of a purchaser within the meaning of the proviso to section 340(3) of the NLC.

• Question 5: Must the burden of proving valuable consideration of a subsequent purchaser under the proviso to section 340(3) of the NLC extend to proving that valuable consideration has passed between the immediate purchaser and vendor? 
  
  Answer: Negative

The central issue in this appeal revolved around the extent of good faith or bona fide required of a subsequent purchaser under the proviso to section 340(3) of the NLC, which is the focus in answering Question 4. Hence, the Federal Court answered Question 4 before proceeding to answer the remaining Leave Questions.
 
Question 4 required the Federal Court to determine which of the two conflicting decisions -  Bayangan Sepadu or Au Meng Nam - prevails in defining the requisite standard of good faith or bona fide for a purchaser under section 340(3) of the NLC.
 
In Bayangan Sepadu, the Federal Court held that the indefeasibility of title is maintained so long as the registered title remains unencumbered, even if the successful bidder had not inspected the property prior to acquisition. Thus, a registered purchaser obtained an indefeasible title, regardless of any later inspection that may have revealed occupation by other parties.
 
On the other hand, in Au Meng Nam, the Court of Appeal adopted a broader concept of good faith, suggesting that to be deemed a bona fide purchaser for valuable consideration under section 340(3) of the NLC, a purchaser must demonstrate not only the absence of fraud or dishonesty but also that they had exercised the reasonable care expected of a prudent purchaser. The Court in Au Meng Nam further held that even if a subsequent purchaser is untainted by fraud or forgery, they may still fail to meet the standard of bona fide if they were negligent or failed to exercise due diligence.
 
The Court of Appeal in the present case apparently relied on the sentiment expressed in Au Meng Nam, which were subsequently adopted by the Federal Court in T Sivam A/L Tharamalingam v Public Bank Bhd⁶ and Liputan Simfoni Sdn Bhd v Pembangunan Orkid Desa Sdn Bhd⁷, to hold that an obligation was imposed on subsequent purchasers to investigate underlying transactions beyond the register in order to qualify as bona fide purchasers.
 
In the instant case, the Federal Court clarified that Au Meng Nam should not be broadly interpreted to mean that negligence or failure to exercise due diligence undermines good faith under the Torrens system. The Torrens system is based on the principle of conclusiveness of the title register, precluding the need for purchasers to investigate beyond the title unless statutory exceptions are met. This approach, consistent with the apex court’s positions in Pushpaleela a/p R Selvarajah & Anor v Rajamani d/o Meyappa Chettiar and other appeals⁸ and Teh Bee v K Maruthamuthu⁹, protects registered proprietors and subsequent purchasers who have duly reviewed the title register, and thereby reinforces the system’s reliability and security.
 
Financial institutions, such as the Bank (as a chargee) are not legally obligated to investigate previous transactions if the register does not show any encumbrances. The Court of Appeal’s approach, which imposes an obligation on financial institutions to investigate beyond the registered document of title, conflicts with the foundational purpose of the Torrens system, which is to streamline and secure land transactions by making the register the definitive source of title.
 
The Court of Appeal’s decision introduced uncertainty for financiers using land as collateral, requiring them to verify the legality of prior transactions, even when the financier has no direct involvement. This approach compels financiers, such as the Bank in the present case, to conduct exhaustive checks beyond the register, thereby undermining the Torrens system’s principle of reliability and certainty in the register. In this regard, the Federal Court was aligned with the Bank's position that such an obligation is impractical, as it imposes a substantial burden on financial institutions and complicates financing, particularly for projects involving multiple land titles.
 
In this case, the Bank took significant due diligence steps, including conducting company and land searches, verification of encumbrance-free status, and obtaining confirmation from the Borrower’s solicitors regarding the settlement of the purchase price. In the Court’s view, these efforts were reasonable based on objective standards expected of a prudent financier. The fact that the Bank did not inspect the lots occupied by the Plaintiffs does not invalidate the Bank’s indefeasible title under the Torrens system. The Bank's registration as a chargee conferred clear title upon the Bank despite any unregistered interests, consistent with Bayangan Sepadu, which found that unrecorded physical occupation of a land parcel does not alter the registered title.
 
The Court thus found the Court of Appeal’s decision of requiring purchasers to trace and verify all prior transactions, to be overly onerous.
 
Furthermore, as no evidence was led to suggest that the Bank should suspect any irregularity in the Borrower’s purchase, as distinguishable from situations in prior cases such as Au Meng Nam where reasonable suspicion of irregularity was present, the Federal Court held that Bayangan Sepadu is the correct precedent, affirming that under section 340(3) of the NLC, a purchaser or financier need not go beyond the register, provided there is no indication of fraud or dishonesty.
 
The Federal Court also took the opportunity to clarify that the Torrens system deliberately omits the doctrine of constructive notice, which would otherwise require purchasers to investigate unregistered claims. Section 6 of the Civil Law Act 1956 expressly excludes English land law principles in Malaysian property law. Under the Torrens system, purchasers need not investigate beyond the register, and the mere knowledge of an unregistered interest does not constitute fraud unless accompanied by moral turpitude. The court cited academic commentaries¹⁰ and past case law, notably Doshi v Yeoh Tiong Lay¹¹ and Tai Lee Finance Co Sdn Bhd v Official Assignee & Ors¹², which reaffirmed that the English doctrine of notice does not apply under the NLC, thus preserving the system’s focus on registration as the sole determinant of legal interests in land.
 
In summary, the Federal Court rejected the imposition of an investigatory duty on subsequent purchasers and financial institutions to examine prior transactions or unregistered interests. The apex court held that section 340(3) protects the title of bona fide purchasers unless fraud is established, and reaffirmed the Torrens system’s principles, thereby excluding the application of the English equitable doctrine of notice.
 
Premised on the analysis set out in answering Question 4, the Federal Court answered the remaining Leave Questions in the negative.
 
Setiakon Engineering Sdn Bhd v Mak Yan Tai & Anor
 
The recent Federal Court case of Setiakon Engineering Sdn Bhd v Mak Yan Tai & Anor¹³ (“Setiakon”) which was decided on 29 July 2024, i.e. before the Federal Court issued its written grounds in Affandi, similarly involved the issue of indefeasibility of title of a subsequent purchaser under section 340(3) of the NLC. In Setiakon, the majority judges did not accept the argument that the “conclusive evidence” declaration within section 89 of the NLC obviates the need for due diligence or proper investigation beyond the register document of title. It was held that such a proposition would conflict with the doctrine of deferred indefeasibility.
 
Conversely, the minority judgment concluded that the rights of the registered owner, i.e. Setiakon Engineering Sdn Bhd, and the preceding registered owner, Paragon Capacity Sdn Bhd, were indefeasible, unless fraud, forgery, or a void instrument, as envisaged under section 340(2) of the NLC, could be proven. The minority judgment took a narrower view on the scope of a subsequent purchaser’s duty to establish that title was acquired in good faith and for valuable consideration. The minority judgment rejected the attempt to impose additional requirements on purchasers as this would undermine the Torrens system’s core principle by deviating from a straightforward and conclusive registration-based system.
 
The minority judgment also rejected any assertion that the appellant was obliged to demand proof of payment or further documentation from Paragon Capacity Sdn Bhd as requiring such steps would impose an onerous burden contrary to the Torrens system’s objective, which seeks to eliminate extensive investigations into past dealings between previous purchasers and vendors.
 
While the minority judgment in Setiakon aligns with the Federal Court’s view in the present case, Setiakon is distinguishable on its facts and circumstances. In Setiakon, the existence of a rapid sequence of transfers of the subject land prior to the impugned transfer ought to have raised questions as to the legitimacy of those transactions and suggested a coordinated scheme to defraud the original owner. Given the evidence, it was unreasonable for the appellant to claim ignorance of potential fraud. In the context of pleading fraud, the majority judgment in Setiakon stated that “although the word ‘fraud’ was not used and not pleaded against the appellant…all particulars of the fraudulent and deceitful acts were properly pleaded and disclosed in the respondents’ Statement of Claim.” It was further held that there was no need for the respondents to plead fraud specifically against the appellant since the allegation of fraud was directed at the fraudster, Chia Moy, which was proven through evidence.
 
Conversely, there was no allegation pleaded by the Plaintiffs in Affandi of any wrongdoing by the Borrower or the Bank. Allegations concerning non-payment by the Borrower to the Vendor and fraud against the Bank were only introduced at the last minute in the Plaintiffs’ witness statements for trial. The unpleaded issue of non-payment by the Borrower was raised as an afterthought in the submission post-trial. No evidence was led to demonstrate collusion between the Bank and the Borrower or any awareness by the Bank of the alleged failure of payment. Moreover, the Plaintiffs did not invoke any exceptions to the indefeasibility of title under section 340(2) of the NLC or argue that the Bank had any knowledge of a defect in title.
 
The majority judgment in Setiakon undoubtedly sets a very high threshold on the subsequent purchasers seeking to be protected under the proviso to section 340(3) of the NLC, although it may serve as a valuable reference for assessing the good faith of a subsequent purchaser in situations where such purchaser has actual notice of alleged fraud or forgery (and not mere constructive notice as this equitable doctrine does not apply in Malaysia).
 
In cases where no allegations of fraud, forgery, or a void instrument under section 340(2) of the NLC are pleaded, the standard imposed on subsequent purchasers should not be elevated to such a stringent level. The standard set out in Bayangan Sepadu should prevail whereby subsequent purchasers are permitted to rely on the conclusiveness of the title without the obligation to investigate beyond the register for the history and origin of the title.
 
Although these two cases may appear to conflict, the standards imposed by each remain applicable and relevant, contingent upon the specific facts and circumstances surrounding each case.
 
Comments
 
The Federal Court's decision in Affandi clarifies that the equitable doctrine of notice does not apply within the context of section 340(3) of the NLC. Without any existing encumbrances on the subject land, the rights and good faith of a subsequent purchaser cannot be undermined by invoking the equitable doctrine of notice concerning any unregistered interest.
 
The Federal Court further established the test for determining the good faith of a financial institution in instances where land is offered as collateral or security by a borrower. The Federal Court has delineated the standard of due diligence required of a financial institution to qualify as a subsequent purchaser under the proviso to section 340(3) of the NLC.
 
Essentially, when contemporaneous documents clearly indicate that the sale and purchase transaction has been completed and the register document of title shows that the property title has been transferred to the purchaser free from encumbrances, with the vendor's consent, the financial institution is entitled to rely on such documentation.
 
The Court concurred with the Bank's position that it was appropriate for the Bank to rely on representations made by a solicitor, particularly in the absence of any suspicious circumstances. Thus, there is no obligation for the Bank (or any financial institution) to investigate the underlying transaction between the vendor and the borrower.
 
Finally, the Federal Court's ruling provides further clarification on the law regarding the conclusiveness of the register document of title under a system of registration of land such as the Torrens System in Malaysia. The Federal Court unequivocally rejected any attempt to incorporate the English equitable doctrine of constructive notice into the NLC, thereby upholding the integrity and principles of the Torrens system as practised in Malaysia.
 
Our Partners, Khoo Guan Huat, Claudia Cheah and Aufa Radzi, and Associate, Anson Liow, represented the Bank in this case.
 
This alert contains general information only. It does not constitute legal advice nor an expression of legal opinion and should not be relied upon as such. For further information, kindly contact skrine@skrine.com.