Jason Bryk 

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Effect of Foreclosure on a Secured Creditor's Rights

November 2008


Most lenders and informed lawyers are aware of the rule which provides that where a mortgagee forecloses upon mortgaged real estate - as opposed to exercising the mortgagee's right to sell the real estate - the debt secured by the mortgage is extinguished.  In Manitoba, this rule is found in Section 16 of The Manitoba Mortgage Act (the "MMA"), and is actually broader than specifying extinguishment of the mortgage secured debt by way of foreclosure; in fact, Section 16 provide, in effect, that the mortgage secured debt is extinguished where the mortgagee forecloses by court order, forecloses through the Land Titles system (without the assistance of the court) under The Manitoba Real Property Act (the "MRPA"), or the mortgagee "otherwise" becomes the owner of the mortgaged realty.  Section 16 also clearly applies to mortgages of interests in real estate less than freehold or fee simple ownership, such as mortgages of leaseholds, mortgages of easements etc.

The MMA Section 16 rule is of fairly ancient heritage and it is the writer's understanding that it is based on a matter of policy or principle to the effect that where a mortgagee ends up with ownership of the mortgaged property, the mortgagee then has the realty "for better or worse".  Thus if the value of the realty is less than the previously secured debt, the mortgagee - who will probably try to sell it sooner or later - will suffer a deficiency.  On the other hand, if the mortgagee waits until the value of the realty increases and such increase is in excess of the amount of the previously secured debt, the mortgagee gets to keep any "profit" it may make on its eventual sale of the realty (ie., all proceeds in excess of the previously secured debt).  Where a mortgagee merely sells the mortgaged realty as part of its mortgage realization process, any sale proceeds in excess of the debt owed to the mortgagee must go to subsequently ranking (ie.,subsequent to the selling mortgagee) monetary claimants to the realty, (and to the mortgagor).

What about a creditor who holds a security interest in personal property?  Section 61(2) of The Manitoba Personal Property Security Act (the "MPPSA") contains a rule applicable to personal property security interests which is somewhat the same as the rule for real property security in Section 16 of the MMA.  The rule for security in personalty is, in effect, that where, after default has occurred under the security agreement, the secured party gives notice to the debtor and certain other specified interested persons that the secured party intends to "take the collateral in satisfaction of the obligation secured", and, none of the persons to whom such notice is given object to such proposal within 15 days after receiving the notice, the secured party, immediately following the end of such 15 day period is "deemed to irrevocably elect to take the collateral in satisfaction of the obligation secured…".  Section 61 doesn't say that the debt is extinguished, but it comes pretty close to stating what amounts to the same thing.

Some questions which may arise in the application of Section 16 of the MMA and Section 61 of the MPPSA are:

(i)            what happens when a creditor holds two or more real property mortgages and/or security agreements covering multiple parcels of real estate and/or multiple items of personal property, with each of the securities securing payment of one particular loan only, and, the mortgagee/secured party acquires ownership of some, but not all, of the realty and/or personalty, with the thus acquired realty and/or personalty having an (aggregate) value less than the amount of the outstanding indebtedness?  Is the mortgagee/secured party now barred from acting under its then existing not yet realized real property and/or personal property security by virtue of the operation of either one (or both) of Section 16 of the MMA and Section 61 of the MPPSA?  Consider the situation of a creditor who is owed, say, $1,000,000.00 and has taken, say, a real property mortgage on one parcel of land worth $100,000.00, a further real property mortgage on a second parcel of real property worth $150,000.00, a further real property mortgage on a third parcel of realty worth $200,000.00, and, a personal property security agreement against certain equipment belonging to the debtor worth $300,000.00, each of these securities securing payment of the same $1,000,000.00 debt. Even if the creditor was to simultaneously (which may be impossible!) foreclose upon all three parcels of realty and the equipment, it would still suffer a shortfall of $250,000.00. What if the creditor foreclosed upon the equipment only? - if each of the three real property mortgages and one security agreement by their terms secured the same $1,000,000.00 debt, would the creditor be unable to realize under its real property mortgages by virtue of the operation of Section 61 of the MPPSA (i.e. it has taken the equipment "in satisfaction of the debt" so that there is nothing left for the real property mortgages to secure)?  Even if the aggregate value of the pledged realty and personalty was in excess of the amount of the debt (i.e. in excess of $1,000,000.00), is it really possible to coordinate the creditor's foreclosure proceedings such that it would be able to take title to the real estate and take ownership of the equipment at precisely the same point in time, thereby avoiding the debt extinguishment provisions contained in Section 16 of the MMA and Section 61 of the MPPSA? Would a possible solution to this dilemma be for the creditor to ask the Court to issue a vesting order vesting (foreclosing upon) all of the pledged realty and personalty simultaneously?

(ii)           what happens where one or more real property mortgages and/or one or more security agreements held by a mortgagee/secured party, by their terms secure all of the mortgagor's/debtor's present and future liabilities, indebtedness and obligations from time to time owed to the mortgagee/secured party, where the value of each security (ie the value of what is mortgaged/secured by each security) as well as the value of all of the securities is less than the total aggregate indebtedness owed by the mortgagor/debtor at the time that the creditor goes to/wishes to realize upon its securities?  Consider the situation of a creditor who has obtained the same security described in (i) above except that each security by its terms secures the payment of all present and future obligations owed by the debtor to the creditor, present and future; if the creditor is owed a total of $1,000,000.00 by the debtor and the creditor forecloses upon one or more (but less than all) or, even upon all of its securities, given that each of the securities provides that it secures all of the debtor's obligations owed to the creditor, upon any foreclosure, wouldn't all of the indebtedness (ie., $1,000,000.00) be extinguished?


Here are some possible solutions to these problems:

(a)          In the situation where there are multiple securities securing one only particular debt, consider:

(i)            utilize one security agreement only, such as a "debenture" which covers both realty and personalty, and which may be amended from time to time to add further, new or additional parcels of real property to be specifically mortgaged to secure the particular debt (this type of security is typically utilized in multiple jurisdictions and may also make it easier for the courts to order one or more (simultaneous) vesting orders where the creditor wishes to foreclose upon all of the property);

(ii)           have each mortgage and security agreement (where there are multiple mortgages and/or security agreements) specifically state that while each of them secures the same particular debt, each of them will, in the case of foreclosure, secure only that portion of the debt which is equal to the value of the pledged realty and/or personalty at the time of foreclosure (this may convince a court called upon to determine the effect of Sections 16 and 61 upon the foreclosure(s) to conclude that it is only portions of the total debt which are to be extinguished (or satisfied) upon each separate foreclosure;

(b)          in/for both real property mortgages and personal property security agreements, specify maximum principal or face amounts thereof where such face or maximum principal amounts approximate (or are only slightly higher than) the anticipated (i.e. anticipated near term) values of each respective property pledged; and

(c)          do not foreclose against any of the secured property until after all reasonable efforts have been made to sell the pledged assets, utilizing foreclosure only as a last possible resort. In some cases, it may be appropriate to sell everything except for secured assets which are only of very small value and, then simply discharge the remaining security; this would at least leave any yet to be satisfied debt remaining in existence.

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