April 2021 Jason M.J. Bryk

I have recently been contacted by several solicitors in respect of the British Columbia Court of Appeal decision Griffin v. Martens, 1998 CanLii 2852 (BCCA).

By virtue of Griffin it has been suggested, and the writer does not agree, that if a condition precedent is boldly subjective it may render the entire contract unenforceable.

In Griffin the question in the appeal turned on the meaning of the following italicized clause in an interim agreement for the sale of land:

 

SUBJECT TO PURCHASER BEING ABLE TO ARRANGE SATISFACTORY FINANCING ON OR BEFORE FRIDAY, MAY 31, 1985, AT 6 P.M. THIS SUBJECT IS FOR THE BENEFIT OF THE PURCHASER AND SHALL BE REMOVED IN WRITING ON OR BEFORE 6 PM. MAY 31, OTHERWISE THIS OFFER IS NULL AND VOID.

The italicized clause is one which, in one form or another, is all too common in Manitoba real estate transitions.

There are real reasons why a contract may be unenforceable, void or voidable (illegality, unreasonable restraint of trade, minor, drunkard who promptly avoids a transaction upon sobriety) and thereby,  notwithstanding any application of severability, revocable; however in my opinion a boldly subjective condition precedent like the one written in italics above is not one of those reasons, nor should Griffin be used to support an opinion contrary to mine.

When reference is made to Griffin attention should be paid to the decision of Gordon Nelson Inc. v. Cameron, 2018 BCCA 304 (CanLII) in which the British Columbia Court of Appeal states:

"the case [Griffin] deals with a particular contract, does not lay down any general rule applicable to all financing conditions, and, expressly, does not purport to construct a contract for the parties to it. The case explicitly recognizes the right of parties to reach their own bargain. The most that can be said as a general proposition, in my opinion, is that the principle of good faith imposes a general duty of honest performance in all contracts: Bhasin v. Hrynew, 2014 SCC 71".

Thereby, Gordon Nelson has distinguished Griffin.

Notwithstanding Gordon Nelson distinguished Griffin, attention should also be paid to what a conditional real estate sales "contract" (i.e. residential or commercial form of offer) is; in my opinion a conditional real estate sales "contract" is one of the following:

(a)       an accepted "option" supported by consideration and thereby it is an "option given for valuable consideration" and is irrevocable (Friedman, "The Law of Contract in Canada", Sixth Edition, Carswell, 45) unless the parties bargained otherwise to permit revocation in certain circumstances; or

(b)      an accepted "offer" and thereby a contract and like an option, is also irrevocable (Friedman, The Law of Contract in Canada, 45) unless the parties bargained otherwise to permit revocation in certain circumstances.

Importantly, irrespective of the subjective or quasi-subjective meaning of "satisfactory", use of the word "satisfactory" within a purchaser's condition pursuant to an accepted conditional real estate sales "contract", whether it be an accepted option or an accepted offer and thereby a contract does not mean the "contract" is revocable and unenforceable but rather it means there is an implied term whereby there is a general duty of honest performance (Griffin, Gordon Nelson, Bhasin) which is a standard less than the standard of "best efforts" referenced in Griffin which decision is now distinguished by Gordon Nelson.

Jason M.J. Bryk

March 2009

Sometimes when properties are surveyed, it is discovered that an improvement which is primarily on a particular parcel of land encroaches (ie., trespasses) across the property's boundary onto the adjacent/neighbouring property.  Encroachments by garages, tool sheds and other "out" buildings are common examples.  In older commercial areas where buildings are typically built up to or very close to the lot lines, encroachments of substantial portions of walls, roof overhangs, drainpipes and similar "appurtenances" frequently occur.  Aside from the fact that the owner of an encroaching improvement is thus committing a trespass against its neighbour which in many cases would entitle the neighbour to forcibly remove (or obtain a court ordered removal) of the trespass with attendant costs, dislocation and related problems - mortgagees, purchasers and persons contemplating taking mortgages in or purchasing the encroaching owner's property will be reluctant to complete their transactions, at least until the "encroachment problem" is solved.

A frequently utilized, and probably the least expensive manner of solving an "encroachment problem" involves the encroaching property owner (the "Dominant Tenement Owner") entering into an agreement with the owner of the property upon which the encroachment(s) exist (the "Servient Tenement Owner") in which the Servient Tenement Owner agrees with the Dominant Tenement Owner that the encroachment from the Dominant Tenement Owner's property can continue to exist on the Servient Tenement Owner's property, notwithstanding what would otherwise be a trespass, typically, during the remaining "lifetime" or existence of the building or other improvement of which the encroachment forms part.

In such an agreement ("Encroachment Agreement"), the parties purport to bind and benefit the respective future owners of the two properties and will usually describe the rights or interests granted to the Dominant Tenement Owner (and its successors in title) as an easement.  To ensure that all successors in title of both properties (and others acquiring or thinking of acquiring interests in them) are made aware of the rights and interests of the parties under the Encroachment Agreement, the Dominant Tenement Owner will usually register a notice of the Encroachment Agreement (ie., by way of caveat) against the title to the Servient Tenement Owner's property.  Under current Land Titles Office practice, particulars of the registration of that caveat will appear on the titles to both properties.

The question which the writer wishes to raise in this memo is whether or not the rights and interests granted to a Dominant Tenement Owner under an Encroachment Agreement are really a legally recognized easement which constitute an interest or interests in land which are capable of binding the successors in title to the original Servient Tenement Owner?  Clearly, if such an arrangement is an easement, it  is a species of interest in land which does "follow" successors in title - but can an easement be established/created for/to protect an encroachment?  Or does an Encroachment Agreement intended to protect an encroachment create only contractual rights enforceable between the immediate parties to the Encroachment Agreement, but which do not, as a matter of law, "follow" the titles to the properties affected - at least in the absence of successors in title specifically agreeing to be bound by the Encroachment Agreement?

The reason why the writer raises this question is because his recent review of the law pertaining to easements suggests that, while a right granted to a property owner to do something on its neighbour's land is generally recognized as an easement, the act, action, activity or usage made by the benefitted property owner must not amount to a right whose exercise completely excludes the neighbour's use of the affected property.  For example, if the owner of Parcel "A" grants its neighbour the owner of Parcel "B", the right to use a pathway over "A"'s land, "A" still has the right to use its land, including the pathway.  But where "A" grants it's neighbour "B", the right to maintain on "A"'s land, a part of a garage primarily situated on "B"'s land which encroaches over part of "A"'s land, then the encroaching portion of the garage, by the very nature of things, excludes "A" from in any way using the land underlying the encroachment.

In other words, for the period of time during which the Encroachment Agreement is in effect, what "A" has granted to "B" is probably what amounts to a right of exclusive use/possession of the land underlying the encroachment.  The writer submits that whatever such arrangement may be, it is strongly arguable that it is not an easement.

But if an Encroachment Agreement does not create an easement, does it create any rights or interests in the affected lands over and above contractual rights and obligations between the original parties to the Encroachment Agreement?  The writer submits that the answer to this question may, in many cases, be "yes", and that the rights or interests granted in the foregoing example are in the nature of a lease whereby "A" as lessor leases the land underlying the encroachment to "B" as lessee.  As we all know, a lease is in fact an interest in land which is legally recognized as being capable of binding successors in title to the lessor.

So if the parties to an Encroachment Agreement refer in it to the rights granted to the Dominant Tenement Owner as an "easement" (or "easements"), might a Court called upon to review the matter hold that the Encroachment Agreement is in substance a lease?  Perhaps - or perhaps not - but even if an Encroachment Agreement is characterized as a lease, rather than as an easement, this raises another problem for the parties concerned (and their counsel).  That problem is the existence of subdivision control rules (in The City of Winnipeg Charter Act and in The Manitoba Planning Act) which specifically exempt easements from the need to comply with subdivision control requirements, but which do not do so for a lease in excess (or capable of running in excess of) of 21 years.

The writer believes that his above argument that one cannot obtain an easement to protect an encroachment is supported by the existence of Sections 27 and 28 of The Manitoba Law of Property Act.  These Sections permit a (superior) Court to confirm or grant rights to an encroaching property owner in its neighbour's land to protect/with respect to encroachments made by the encroaching property owner on its neighbour's land.  Why would the Legislature have enacted these Sections if it was not recognized that an easement either couldn’t be legally obtained, or was difficult to legally obtain, to protect an encroachment?  In any event, these Sections make it clear that whether or not the Court provides relief to the encroaching property owner is in the discretion of the Court, so an encroaching property owner has no guarantee that it will achieve legal protection for its encroachment.

If the writer is correct in the foregoing analysis, then it would appear appropriate for the Legislature to vary subdivision control rules to exempt leases which merely protect encroachments (regardless of their length or potential length) from subdivision control requirements.

In most cases, the roles played by each "participant" in a construction/development project (the "Project") are quite distinct.  There is the owner/developer which holds title to the property and wishes to develop it with the Project (the "Owner"), the (general) contractor which is engaged by the Owner to oversee and effect construction of the Project (the "General Contractor") and those engaged under the General Contractor to provide the labour, services, materials and components required to complete the Project (the "Subcontractors").  Some of the Subcontractors will be engaged directly by the General Contractor, and others will be engaged by other Subcontractors.  In this sense, the individual persons who are engaged to provide labour can be considered Subcontractors.  An additional - and usually critically important - participant is the Owner's financier/lender who will typically take a real property mortgage from the Owner on the Owner's interest in the realty which includes the Project as it is constituted (the "Mortgagee).  The Mortgagee's financing (usually provided over a period of time and made available as the improvements are put in place) will be secured by the Mortgagee's mortgage.

The Builders' Liens Act (Manitoba) (and similar legislation in other jurisdictions) provides some measure of security for those Subcontractors who do not have the benefit of a direct contractual relationship with the Owner.  The legislation (the "Act"), among other things, gives such Subcontractors a monetary charge (a "builders' lien") against the Project.  This is a mechanism which performs a similar function to the Mortgagee's mortgage security.  If not paid, the Subcontractor (or more likely, a substantial portion or all of the Subcontractors, acting collectively) can cause the realty to be put up for sale, with theproceeds (or some of them) being then made available to satisfy the claims of the unpaid Subcontractors.

Wherever a debtor has two or more creditors, each of whom have acquired security in the same assets of the debtor, there is a potential for conflict between the secured creditors - unless the collateral available to all of the secured creditors is sufficient to satisfy all of their claims, a situation which usually doesn't occur when the debtor is in financial difficulties or is otherwise unable to fulfill its obligations to its creditors.  Thus there are sometimes disputes ("priority disputes") which arise between Subcontractors holding builders' liens and an Owner's Mortgagee.  Where an Owner finds itself in financial difficulties, typically in the midst of completion of a Project, you have the Mortgagee who has provided value to the Owner (financing) and the Subcontractors who have provided value to the Owner (their "inputs").  So the Owner has received value from all of these parties, and the Mortgagee and the Subcontractors - who are not being paid when due - feel "stiffed".  In other words, the Mortgagee and the Subcontractors are the "good guys" and the Owner is the "bad guy".  Of course there can be situations where the Mortgagee, without justification, reneges on its financing commitment and/or situations where the Subcontractors' inputs are deficient or defective.  But in most cases the contest - insofar as the secured creditors are concerned - is between two different sets of "good guys", the Mortgagee and the Subcontractors.  To the extent that the Mortgagee can achieve legally enforceable priority over the Subcontractors, the Mortgagee "wins", and, to the extent that the Subcontractors can achieve legally enforceable priority over the Mortgagee, the Subcontractors "win".  It will be appreciated that in most situations, nobody really "wins", so it's a matter of which of the competing secured creditors can get the most out of the collateral.

The Act spells out differing rights and obligations of each of the Owner, the Subcontractors (and the General Contractor) and the Mortgagee.  Generally speaking, the Subcontractors' and the Mortgagee's interests are both protected , provided that each of them follows the rules set out in the Act.  For the reasons aforementioned, the Mortgagee's position is better protected (under the Act) than the Owner's.  Thus, where unpaid Subcontractors are able to legally establish that a Mortgagee has been acting like an Owner, a Court may hold that the Mortgagee is an "Owner" under the Act.  If this happens, the Mortgagee's position under the Act, including with respect to its security, may end up being subordinated to that of the Subcontractors.

"Owner" is defined in the Act to mean: "…any person having any estate or interest in the structure and the land occupied thereby or enjoyed therewith, or in the land upon or in respect of which work is done or services are provided or materials are supplied, at whose request:

(a)          upon whose credit, or

(b)          on whose behalf, or

(c)          with whose privity or consent, or

(d)          for whose direct benefit,

the work is done or the services are provided or the materials are supplied, and all persons claiming under or through him whose rights are acquired after the work or services were commenced or after the materials were supplied."

An Owner (as so defined) and a Mortgagee clearly both each have an estate or interest in the realty and the improvements forming part thereof.  Also clearly, both the Owner and the Mortgagee benefit from the creation of the improvements on the Owner's realty.  The Owner gets a more valuable parcel of realty and the Mortgagee's security attaches to a more valuable parcel of realty.  But is the benefit so flowing to the Mortgagee a "direct" benefit?  While the Subcontractors are not being extended credit directly by the Mortgagee ("credit", in the usual sense of the word, is provided by the Mortgagee to the Owner), could one argue that the creditworthiness of the Mortgagee enhances the creditworthiness of the Owner, thereby inducing the Subcontractors to provide their inputs?  Again, while there is no "privity of contract" (a contract between parties) between the Subcontractors and the Mortgagee, in providing financing to the Owner, the Mortgagee desires - and contractually obligates the Owner to - effect the improvements, so could it be argued that the Mortgagee, in so requiring, has given its "consent" to the Subcontractors providing their inputs?

Whenever a Mortgagee's loan agreement with an Owner specifies (typically in great detail) the Mortgagee's requirements of the Owner in connection with the improvements which the Mortgagee is financing, and where the Mortgagee takes an active role in overseeing and monitoring completion of the improvements, there is a danger that the Mortgagee will end up being "too close" to the Owner (and the effecting of the improvements).  This may result in the Mortgagee being held to have acted so as to be deemed to be an "owner" under the Act.  That would then put the Mortgagee at a distinct disadvantage vis-à-vis the Subcontractors.

A recent judgement of the Alberta Court of Queen's Bench (Westpoint Capital Court v. Solomon Spruce Ridge Inc., judgement issued April 6, 2017, hereinafter, the "Westpoint Case") is an example of priority dispute in which a mortgagee (Westpoint) was alleged to have acted so as to be deemed to be an "owner" under the (Alberta) version of the Act.  In the Westpoint Case, S acquired a parcel of realty, entered into a loan agreement with Westpoint whereby Westpoint undertook to finance improvement of the realty, and S (as required by the loan agreement) provided a mortgage on the property to Westpoint.  Work on the project started, but in fairly short order, S defaulted in the performance of its obligations owed to Westpoint.  Westpoint commenced to enforce its security, and in the realization proceedings, B purchased the property.  B filed a caveat against the property's title giving notice of its purchase rights.  Subsequently, P (a subcontractor) filed a builder's lien claim against the title.  B's purchase money was paid into Court, and each of Westpoint, B and P claimed those monies, Westpoint as mortgagee, B as purchaser and P as a builder's lien claimant.

As between B (as purchaser) and P (as builder's lien claimant), although P's input to the Project predated B's contracting to Purchase the property, P did not register its lien claim until after B had registered its purchase notice. Thus as between those two, B had priority.  As between P (as builder's lien claimant) and Westpoint (as mortgagee), "normally", Westpoint, having registered its mortgage and made its advances before P registered its lien claim, Westpoint would have priority.  However, if it could be established (to the Court's satisfaction) that Westpoint had acted as, or was in substance, an "owner", then (arguably) Westpoint's mortgage interest would be merged or subsumed into its ownership interest.  Then, as between P and Westpoint, P's lien claim would hold priority over Westpoint's interest (such interest having started out as a mortgage interest, and then becoming "converted" to an ownership interest).  If P's claim interest held priority over Westpoint's interest, and, B's purchase interest held priority over P's lien claim interest, then B would hold priority over Westpoint's interest.  The result would be that B would be entitled to acquire ownership of the property "free and clear" of Westpoint's (mortgage) interest.

It was alleged that Westpoint was an "owner", essentially on these basis, namely:

(i)         because of its interest or "stake" in completion of the project, it was or became a "beneficial" owner (although clearly, not the titleholder);

(ii)        Westpoint benefitted from having the property improved to such a degree that it could be said that P's input was provided "on behalf of" Westpoint; and

(iii)       S had no realistic ability to effect the improvements without Westpoint's credit (in other words, P and the other parties inputting did so, only because of Westpoint's - as opposed to S's - creditworthiness).

The Court held that, on the basis of the evidence before it, Westpoint was not an "owner".  In so concluding, the Court noted the following:

(a)        The protections given under the Act (in particular, the right of lien) are extraordinary remedies in that they advantage persons (lien claimants) who have no (direct) contractual dealings with the Owner.  As such, it is proper for Courts to interpret (and they have traditionally done so) such rights and remedies "strictly";

(b)        The assertion that Westpoint had acted as an "owner" was a substantially "bald" assertion, with no adequate evidence having been presented to back it up.  In particular, there was no evidence of the following:

(i)            that there were non-arm's length dealings between Westpoint as mortgagee and B as purchaser on the one hand, and S on the other hand.  The same individual person controlled both Westpoint and B, but there was nothing "particularly sinister or suspicious" about this.

(ii)           that S left a "wake of creditors behind", given the purchase price that B paid to acquire the property in mortgage realization proceedings.  This did not appear to be an "engineered insolvency" whereby the debtor intentionally "stiffed" the Subcontractors and then colluded with the mortgage realization purchaser to acquire the property at a "cheap price".

(iii)          that there were any direct dealings between Westpoint and any of the General Contractor and/or the Subcontracors.  In particular, there was no evidence that P had any dealings with Westpoint until after it filed its lien.

(iv)          that Westpoint paid any of the General Contractor and/or the Subcontractors directly.  "Westpoint had no involvement with the construction on the lands, other than to release monies…after it was satisfied that certain work had been completed".

(v)           that at any time prior to when S defaulted in its obligations owed to Westpoint, Westpoint had any intention of acquiring an interest in the lands, "other than as mortgagee".

(vi)          that any request was made by Westpoint, "express or implied, that any (General Contractor) or Subcontractor (do) any work on the property".  As the Court stated, privity and consent are not made out, and "direct benefit" is at best doubtful.

Additionally, the Court held that:

(I)            There was nothing in the builder's lien claim document, or even in P's statement of claim, to indicate that it was taking the position that Westpoint should be treated as an owner for the purposes of the Act.  "Indeed, Westpoint is named in the statement of claim as a prior encumbrancer".

(II)           Any builder's lien claim against Westpoint (itself) would be well past the filing deadline.  "Not by a few days or weeks, but rather years".  In fact, Westpoint did not make its lien claim against Westpoint's interest in the land (rather, the claim was recorded against S's interest in the land).

(III)          B's position is "curious".  It would "have a purchaser's lien caveat improve its "priority" position because of the filing of an unrelated builder's lien by a claimant who is unable to prove that the mortgagee acted as "owner" within the meaning of the Act.  As the Court rhetorically asked, "Why would a mortgagee lose priority (for) its bona fide advanced mortgage to a subsequent encumbrancer with whom it had no dealings?".  And the Court concluded that "There is no legal or equitable theory that supports the notion of a subsequent encumbrancer improving its priority position against a mortgagee simply because a builder's lien claimant is able to show that the mortgagee acted in the position of an owner with respect to its builder's lien claim".

(IV)         B's alternative argument that even if Westpoint was not an "owner" within the meaning of the Act, it was a beneficial owner of the property, and thus, should be held to be an "owner" under the Act, is simply wrong.  The Court held that "The Act and the cases in this area do not support an argument that if a mortgagee (or a landlord) has become an "owner" for the purposes of a particular claimant's builder's lien, that mortgagee (or landlord) becomes an "owner" for the purposes of every other claimant's lien claim (or for that matter, any other interest claimant who doesn't hold a lien).".

Somewhat incidentally, the Court also observed that "There is no authority to the effect that a lien claimant can piggy-back on another claimant's lien…".  Each lien claimant's claim "must be perfected by proper registration and the filing of a certificate of lis pendens".  A lien claimant may (in fact) shelter under another lien claimant's law suit, but that "is only to avoid a multiplicity of actions and reduce costs and complexity in managing builder's lien actions, especially when a project fails and there are multiple lien claims at various levels".  This last statement - although not really required in order for the Court to have reached its other conclusions concerning the law in this particular case - should be kept in mind by those attempting to understand the relationship between an Owner, a General Contractor, the Subcontractors under a General Contractor and other persons having an interest in an improved (or being improved) parcel of real estate.

 

January 1997

The case which this comment deals with (the Bills Investments Case, decided by the Saskatchewan Court of Appeal on July 5, 1990, hereafter the “Bills Case”) is not a recent court decision. Nevertheless the ruling must be kept in mind by persons giving or taking what are commonly known as “blanket” or “wrap-around” mortgages.

What is blanket mortgage? By its nature, it must be at least a second mortgage, although in some cases, it could end up being a third, fourth or even a fifth mortgage. The core of what it’s about is that the mortgagor agrees with the mortgagee that the face amount of the blanket mortgage will include not only the “new” advances being made by the mortgagee to the mortgagor, but also the balance or balances outstanding on one or more pre-existing mortgage or mortgages held by third parties. The mortgagor will make loan payments to the mortgagee which include not only the amount required to service the debt arising out of the new advances made by the mortgagee, but also the amounts required to service the debt(s) under the prior mortgage(s). Provided all of those payments are made, the mortgagee agrees that he will make timely payments on the prior loan or loans thus keeping them in good standing. In other words, the mortgagee’s mortgage “blankets” or “wraps around” one or more pre-existing prior mortgages.

Why would a lender want to take a blanket mortgage, and why would a borrower want to give one. Consider the following:

(i)            For whatever reason, the prior mortgages are not to be paid off, and the blanket mortgagee wishes to take control of the loan repayment process for the prior mortgages. Perhaps the blanket mortgagee does not entirely trust the mortgagor to properly service the prior mortgage debt. One can see an analogy here to the situation where a mortgagee collects monies from the mortgagor (over and above repayment of the debt with interest) to ensure that the property taxes and/or the condominium common element expenses are properly paid. Failure to pay such amounts - or failure to pay the debt service on the prior blanketed mortgage(s) - would clearly put the blanket mortgagee’s position in jeopardy.

(ii)           The rate of interest stated in the blanket mortgage applies not only to the new advances being made by the blanket mortgagee, but also to the balance(s) outstanding under the prior blanketed mortgage loan(s), and, the interest rate(s) applicable to those other loan(s) are lower than the rate under the blanket mortgage. Thus the blanket mortgagee obtains an additional benefit (ie. in addition to the interest he collects on the new advances he has made) which is the interest differential between the blanket mortgage interest rate and the mortgage rate(s) on the prior blanketed mortgages. Incidentally, if getting the benefit of this interest differential is the mortgagee’s sole motivation to take a blanket mortgage, he can probably accomplish the same thing - without running some of the risks dealt with in the Bills Case by taking an “ordinary” (i.e., not a blanket) mortgage (which would be a second, third, fourth, or as the case may be, mortgage) with a higher interest rate.

(iii)          The property owner is selling his property subject to one or more existing mortgages which have what then appear to be very attractive (i.e., low) interest rates with relatively long terms. This will only work if the existing mortgages are assumable, but assume they are assumable. Also assume that the purchaser needs more money to pay the purchase price to the vendor (i.e., something over and above the amount covered by the purchaser’s assumption of the existing mortgages). That additional credit can come either from a new lender or from the vendor acquiring a take-back mortgage from the purchaser. In either case, the person extending the additional credit may find that a mortgage blanketing the prior mortgages is attractive because of the opportunity of getting the interest differential, plus the right to take control of servicing the debt on the prior mortgages. These advantages compensate for the relatively greater risk undertaken by holding a second, third, fourth, or as the case may be, other subsequent mortgage. Where the new credit is being provided on a relatively short term basis and the blanketed mortgages (with their longer terms and low interest rates) will continue after the blanket mortgage is paid off, the arrangement can be seen to be quite advantageous from the purchaser’s/mortgagor’s point of view.

In the Bills Case, after providing the mortgagee with a blanket mortgage covering one prior mortgage, the mortgagor argued that, in spite of the wording of the mortgage contract, the mortgagor should not have to pay interest on the amount owed under the prior blanketed mortgage loan. Its position was that it should only have to pay interest on the monies actually advanced to it by the blanket mortgagee. This of course would deprive the blanket mortgagee of the benefit of the interest differential. The mortgagor agreed that if the blanket mortgagee had made payments on account of the blanketed mortgage debt (no doubt to protect itself from a default by the mortgagor), then the blanket mortgagee would have been entitled to receive interest on any such “new” advances made by the blanket mortgagee. In other words, the mortgagor took the position that even if it had contractually promised to pay the blanket mortgagee interest on the prior mortgagee’s debt, since that debt was not incurred by reason of advances made by the blanket mortgagee, the mortgagor was not lawfully obliged to pay such interest and should be relieved of its promise.

The Court held that there were two principles involved. The first was the general rule that a mortgagee could only charge interest from the time when it advanced credit. This principle supported the mortgagor’s argument. However, the second principle was that, notwithstanding the first principle, if the parties have clearly agreed that the mortgagee is entitled to interest on credit not actually advanced by the mortgagee, then such an agreement will be enforced against the mortgagor. Obviously, this principle supported the position of the blanket mortgagee. The question then became, did the transaction evidence a clear intention by the parties that the mortgagor would pay the blanket mortgagee interest on the prior blanketed mortgage loan even though none of that loan had been advanced by the blanket mortgagee?

The Court decided that although there wasn’t a “black and white” statement in the mortgage that the mortgagor was to pay interest on the prior loan, the rest of the terms of the loan and the surrounding circumstances offered sufficient evidence that that indeed was the parties’ intent.

The Bills Case may suggest that in drawing a blanket mortgage, it would be helpful for the blanket mortgagee’s lawyer to include an unequivocal “black and white” promise by the mortgagor that the mortgagor will pay the mortgagee interest on the full (i.e., face) amount of the blanket mortgage including that portion which represents the prior blanketed mortgage loan or loans, notwithstanding that the blanket mortgagee may never make any payments out of its own monies on account of such prior loans.

April 2007

You have decided to provide financing to the owner/developer ("Mortgagor") of a single tenanted real estate development ("Realty").  Your loan agreement/commitment letter agreement with the Mortgagor obligates the Mortgagor to provide you with a mortgage charging the Realty and a security assignment of the Mortgagor's from time to time existing rights as landlord under its lease ("Lease") of the Realty to the tenant thereof ("Tenant"), including the Mortgagor's right to the payment of rental.

From a "security" point of view, what you now hope and expect you would have to cover potential losses in the situation where the Mortgagor fails to repay the loan would be:

(i)            the right to sell the Realty (with the Lease) and thus recoup the loan indebtedness, in whole or in part, and if in part only, a continuing right to claim against the Mortgagor - and perhaps under other securities including guarantees - for any shortfall, and, if there was no meaningful "market" for a sale of the Realty, the right to foreclose upon and become the absolute owner of the Realty; and

(ii)           under the security assignment covering the Mortgagor's rights and claims under the Lease ("Security Assignment"), the right to collect the rents payable under the Lease, and the right to "step into the shoes" of the Mortgagor as landlord under the Lease and thus hold the Tenant to all of its from time to time existing obligations under the Lease (including the obligation to pay rent).

You would also (typically) want an understanding with the Tenant whereby, in essence, the Tenant agrees to subordinate its rights and interests in the Realty under the Lease in favour of your rights in the Realty under the Mortgage.  In exchange therefor, you would undertake to the Tenant that if you realized your security (including by way of mortgage sale proceedings, taking possession or by way of foreclosure) consequent upon default by the Mortgagor, neither you nor any mortgage purchaser from you would (notwithstanding your priority under your mortgage with respect to the Realty) extinguish/terminate the Lease, provided that the Tenant continued to fulfill its obligations under the Lease.  In other words, you would enter into what is commonly known as a "postponement and non-disturbance agreement" ("PNDA") with the Tenant.  Now assume that, some time after advancing the loan, the Mortgagor defaults in its loan obligations to you.  You demand repayment in full (having given an acceleration notice to the Mortgagor), start mortgage realization proceedings, and, in order to try to maintain some cash inflow from your investment, you notify the Tenant that you are proceeding to realize your security (including under your Security Assignment) and that you now require the Tenant to immediately commence to pay its rentals to you, rather than to the Mortgagor.

Imagine your shock, dismay - and perhaps disgust - when the Tenant responds by advising you that its obligation to pay rent under the Lease must be set off against a judgment previously obtained by the Tenant against the Mortgagor ("Judgment").  The Judgment is for a very substantial amount of money and arose out certain previous outrageously bad conduct of the Mortgagor as landlord under the Lease.

The foregoing is almost exactly what happened to the mortgage lender (the "Mortgagee") in a Ontario Court of Appeal decision (the "TDL Case", judgment rendered July 27, 2006).  Unfortunately for the Mortgagee, the Court agreed with the Tenant's position, with the result that the Mortgagee was unable to collect rent from the Tenant. 

It is interesting to note (in the context of the discussion which follows below) that the Security Assignment in the TDL Case - unlike the one described in the hypothetical situation set forth above - was not an assignment of all of the Mortgagor's rights and claims as landlord under the Lease; rather it merely covered the Landlord's right and claim to the rentals payable by the Tenant.  It is also interesting to note that the Lease - which established a contractual relationship between the Mortgagor and the Tenant - specified that the Tenant was to pay rental "without any set off" (with one minor exception).

The Mortgagee's problem here was the wording in the PNDA.  Obviously, the Mortgagee would have preferred that the Court hold that its relationship with the Tenant was governed by the terms of the Lease  which negatived the possibility of the Tenant setting-off any claims it had against its landlord, against the rental.  However, the Court noted that - unlike the Lease, which established a contractual relationship between the Mortgagor/landlord and the Tenant - the PNDA established a contractual relationship between the Mortgagee and the Tenant, and it was this contractual relationship which governed the Mortgagee's claim to rentals.  In particular, under the PNDA, the Mortgagee promised the Tenant that if the Mortgagee realized its security and "stepped into the shoes" of the Mortgagor/landlord under the Lease, then the Mortgagee (in the Court's words) "simply took over the landlord's position under the Lease, (and), absent an agreement to the contrary, the Mortgagee was bound by the state of accounts between (the Tenant) and (the Mortgagor/landlord), which included (the Tenant's) right of set-off".  Unlike what is included in many similar agreements between mortgagees and tenants, the PNDA did not contain a promise by the Tenant that it would not be entitled to set-off its Lease related claims against the rent that it would otherwise be obliged to pay to the Mortgagee.

There is a suggestion in the TDL Case that had the Mortgagee taken a Security Assignment which covered not just the rentals payable under the Lease, but also all of the Landlord's rights under the Lease - and presumably, did not enter into the PNDA - the Mortgagee might well have been able to claim rents from the Tenant and enforce the Tenant's Lease promise or agreement not to set off.  Nevertheless, it is the absence in the PNDA of a provision prohibiting the Tenant from setting off which really did in the Mortgagee here.  The Court noted that the PNDA was in the Tenant's form, and that it appeared that the Mortgagee (and/or its advisors) did not attempt to modify the contents of the PNDA.  The Court also observed that "…both sides were represented by experienced commercial lawyers…".

Also, the language of the PNDA was not ambiguous, so there was no room for the Court to employ the rule of interpretation which requires a contractual ambiguity to be resolved against the interest or position of the party who drafted the contract.

An even more frightening scenario from a mortgagee's point of view would be a situation in which the PNDA not only failed to prohibit set-off by the tenant, but also - perhaps inadvertently - obligated the mortgagee to completely honour all of the mortgagor/landlord's obligations under or by virtue of the lease existing at the time that the mortgagee starts to realize its security and, in effect, "steps into the shoes" of the mortgagor/landlord.  What if, given such an arrangement, the tenant then had a claim - whether in the form of a judgment or some other claim such as a right to reimbursement for leasehold improvements - which exceeded all of the rentals payable under the lease for the balance of its term?  Arguably, the mortgagee would not only lose the benefit of rental, but would also be liable to the tenant for the excess of its claim over the rental!

What should mortgagees do to protect themselves from the problems encountered by the Mortgagee in the TDL Case?  Consider the following:

1. Ensure that any PNDA entered into with a tenant makes it clear that the tenant must, following the mortgagee's "stepping in", continue to fulfill the tenant's ongoing obligations under the lease, including its obligation to pay rent, without any set-off, and notwithstanding the occurrence of any pre-existing default or defaults by the mortgagor/landlord under the lease.
2. Ensure that the lease clearly provides that the tenant's promise to pay rental is buttressed by a further promise not to set-off any claims which the tenant may have against the landlord against the tenant's rent obligation, and, take an assignment of all of the mortgagor/landlord's rights, claims and entitlements under the lease, not just an assignment of the rentals payable, and, make sure that the security assignment makes it clear that the benefit of the tenant's agreement not to set-off is included in the assignment.
3. Ensure that the PNDA includes a promise by the tenant to periodically provide the mortgagee with written statements (commonly called "estoppel certificates") advising as to the estate of accounts between the mortgagor/landlord and the tenant.  Depending on the frequency with which the mortgagee obtains such information from the tenant, these statements will probably alert the mortgagee to a recently developing problem in the landlord - tenant relationship.  However, if a long time passes between when the mortgagee obtains these statements, by the time it does get a current one, a full-blown problem may have arisen and "matured".