With the availability of title insurance, which permits a virtual immediate release of the proceeds of sale on the closing of a real estate purchase and sale transaction (such availability being of relatively recent vintage), and, with purchase financing lenders who are prepared to permit the lawyer acting for a purchaser and such lender to release financing proceeds to the seller's lender virtually upon closing (this lender practice having, amongst some lenders at least, gone on for quite some time), certain problems have arisen for the lawyers involved.
"Traditionally", on a real estate sale and purchase closing, the purchaser's lawyer pays the "adjusted" balance to close to the seller's lawyer on the understanding that the transfer of land provided by the seller's lawyer will, when registered by the purchaser's lawyer in series with the purchaser's new mortgage financing documents, result in title being recorded in the purchaser's name(s) subject only to the purchaser's mortgage and any other registrations which the purchaser has agreed to accept. Following closing (with possession typically having been provided to the purchaser), and pending the Land Titles system processing the registered documents leading to the issuance of a new title, the matter rests somewhat "in abeyance". Nevertheless, during this abeyance period, the purchaser has the benefit of possession and certain adjustments in its favour from and after the closing date. Yet the seller's lawyer and in particular the seller, do not yet have the full consideration for which the seller bargained in the purchase and sale agreement (the "Agreement"), pending completion of registrations and the purchaser/mortgagee's lawyer reporting to the mortgage lender, obtaining the mortgage loan monies and sending them to the seller's lawyer. The seller is compensated for this delay in payment by the purchaser agreeing to pay and ultimately paying interest on the unpaid balance of the sale price to the seller. This Land Titles system processing delay (commonly called the "gap" period) and the purchaser's obligation to compensate the still unpaid seller for this delay are recognized in the standard form of residential property offer to purchase mandated for use by real estate brokers in Manitoba. That form of Agreement specifies that pending the receipt of the purchase price represented by the purchaser's new financing, the purchaser will pay the seller interest on that balance at the same rate that the purchaser is paying to its mortgage financier.
The obligation of the purchaser to pay such interest ceases when the seller's lawyer receives the balance of the funds (originating from the purchaser's mortgage financier). The underlying understanding and rationale for this has usually been that with the seller's lawyer having received what he/she is supposed to receive, and, with the purchaser having received what it has bargained for, the sale proceeds can then be paid by the seller's lawyer to the seller as the seller's unconditional own property. Also, at this point in time, the seller's lawyer is then free to pay out the seller's "old" mortgage financier thus, clearing the title (now in the purchaser's name) from the seller's "old" mortgage, and consequently ending the seller's obligation to pay interest on its "old" mortgage).
The arrangements described above presume that at the point in time when the purchaser's mortgage financier's loan monies are sent to the seller's lawyer, Land Titles registrations will have been properly completed, and the seller's lawyer will, at that point in time, be entirely free to release ALL of the sale proceeds, including both the purchaser's own equity payment and the purchaser's mortgage financier's loan monies. But what happens - or should happen - if the purchaser's mortgage financier provides its loan monies to the purchaser/mortgagee's lawyer on or just before closing, on the understanding that the purchaser/mortgagee's lawyer can pay all of such loan monies immediately to the seller's lawyer at the time of closing, and in any event, before Land Titles registrations have been properly completed?
This situation arises primarily where:
(i) title insurance is obtained for the benefit of the purchaser's mortgage financier which protects the financier against not getting what it has bargained for by virtue of something going wrong with respect to the conveyancing during the so-called "gap" period. With the financier thus protected, the financier can feel safe in releasing loan monies immediately on closing without waiting for Land Titles registrations to be properly completed; and
(ii) even though the mortgage financier does not obtain title insurance, the purchaser's financier's policy is to provide the full loan monies to its own lawyer on or immediately prior to closing, allowing such lawyer to pay out the loan monies to the seller's lawyer on closing, but on the understanding that the purchaser's/financier's lawyer takes all responsibility for, and in effect, guaranteeing that, the financier obtains what it has bargained for (typically, a first registered mortgage charge against the subject property in the purchaser's/mortgagor(s) names).
In either case, when the purchaser's lawyer sends all of the purchaser's financier's loan monies to the seller's lawyer at closing, the purchaser's lawyer will take the position that the purchaser's obligation to pay interest on the unpaid balance of the sale price (as per the terms of the Agreement) ceases. But, in many cases, the purchaser/financier's lawyer will, when sending the financier's loan monies to the seller's lawyer, impose a trust condition with respect to those funds to the effect that the seller's lawyer cannot release those monies (whether to pay off the seller's "old" mortgage or to the seller itself), unless and until title to the property is transferred in the Land Titles records into the purchaser's name subject only to the purchaser's financier's mortgage and no other registrations except those agreed to by the purchaser under the terms of the Agreement. Thus the seller's lawyer has the full purchase and sale price in his/her trust account, but, just as in the "traditional" manner of closing transactions, the seller's lawyer cannot release funds until Land Titles registrations have been completed. Yet the purchaser's lawyer takes the position that with all of the consideration now having been paid to the seller's lawyer, the purchaser is no longer obligated to pay any interest to the seller's lawyer on the purchase price.
While the amount of interest thus "lost" by the seller in residential real estate transactions is, in most cases, quite small, this same situation is increasingly occurring in commercial real estate transactions where the seller's "loss" of compensation for not being able to utilize the proceeds of sale represented by the mortgage financing is very substantial.
Some might argue that, although the seller can't directly access the proceeds of sale while they continue to be "tied up" in the seller's lawyer's trust account, the seller can still benefit from such holding of the funds by having his/her lawyer invest those funds in an interest-bearing (trust) account. Unfortunately, the amount of interest that the seller's lawyer could thus earn for the seller (during the "gap" period) will almost always be much less than the rate of interest payable by the purchaser to its financier. In fact, whatever interest the seller's lawyer could obtain on the seller's money during the "gap" period will almost always be far less than the amount of interest which the seller will continue to have to pay to his/her "old" mortgage lender. Where the seller's "old" mortgagee's interest rate is higher than the interest rate being paid by the purchaser to its "new" mortgagee, even obligating the purchaser to pay interest during the "gap" period to the seller at the purchaser's mortgagee's interest rate will not adequately compensate the seller for his/her inability to obtain the proceeds of sale (and use them to pay off the "old" mortgage financier) during the "gap" period.
What could be done to "fix" this type of problem? The writer suggests that, at least for residential real estate transactions, the standard form of broker's offer to purchase Agreement be amended as follows:
(a) the amount of compensation to be paid by the purchaser to the seller during the "gap" period be made the greater of the purchaser's mortgage financier's interest rate and the seller's "old" mortgage lender's interest rate; and
(b) the purchaser be obligated to pay "gap" period "compensatory interest" until the seller's lawyer becomes entitled to release funds.
In those situations where the purchaser has obtained title insurance to cover the purchaser's risk of loss during the "gap" period and those situations where the parties and their lawyers have agreed to a "protocol" closing, the purchaser's lawyer should not impose trust conditions on the seller's lawyer so as to "tie up" the proceeds of sale in the seller's lawyer's hands after the purchaser's lawyer has paid (or ensured payment) of all of the sale proceeds to the seller's lawyer.