Law Times

Page 8 January 13, 2014 • Law Times FOcUs ON Real estate law Properties in default When can second mortgagee take control? BY MARG. BRUINEMAN For Law Times W hen can a second mortgagee take control of the sale of a property that has gone into default? "The only way to do that is to put the first one in good standing" and comply with all of the covenants, says Lisa Laredo, who works in commercial and residential real estate. The role of the second mortgagee arose recently in Business Development Bank of Canada v. Pine Tree Resorts Inc. after both the first and second mortgages had gone into default. In April, the Superior Court of Justice appointed the Business Development Bank of Canada as receiver over the assets, undertakings, and properties of the company owning the Delawana Inn in Honey Harbour, Ont. The bank held the first mortgage on the property and was the secured creditor owed about $2.6 million. The company also owed about $4.3 million to Romspen Investment Corp., which held the second mortgage. There was also a $250,000 harmonized sales tax bill outstanding. But the Delawana Inn and its second mortgagee, Romspen, wanted to sell the property as a going concern and on their own terms. Romspen intended to initiate power-of-sale proceedings. They sought leave to appeal under s. 193 of the Bankruptcy and Insolvency Act as they moved for a stay pending the outcome. Rompsen argued it had the right as a subsequent mortgagee to put the bank in good standing and could then take over the sale of the property through the power-of-sale proceedings. But it had no intention to pay the outstanding $250,000 bill. "As a result of the decision in Pine Tree, second mortgagees generally find themselves facing more significant costs before they are in a position to enforce their second position mortgage, at which point they may be more reluctant to advantage of the upcoming summer. "There has been a movement towards a more expansive and flexible approach more recently," wrote Blair, adding that there have been two approaches in the jurisprudence. "The jurisprudence has evolved to a point where the test for leave to appeal is not simply merit-based. The problem is that Romspen has not offered to put the BDC mortgage in good standing, but has only offered to do so partially. It proposes to leave unperformed a $250,000 covenant — payment of the outstanding HST arrears." Blair looked at whether the proposed appeal raises an issue that's of general importance to 'If you're in a second position, bankruptcy and insolvency matters or the adminyou want to take a close look istration of justice, is prima facie meritorious or at the security document unduly hinders the progress of the proceedings. of the person in the first He found the "discretionary considerations" position,' says Kym Stasiuk. presented by Romspen to be factual and case specific and suggested they didn't give rise to enforce their security ahead of a first mortgage," says Laredo. general issues of significance to the practice of "In this case, the second mortgagee did pay the prin- bankruptcy and insolvency matters or to the administracipal and arrears in default and all expenses incurred by tion of justice as a whole. He also had serious reservathe first mortgagee. However, there was still $250,000 tions given that the HST remained unpaid. owning for HST. The mortgage contained a covenant As a result, he found Romspen and Pine Tree didn't requiring the owner to pay his HST. Consequently, the meet the test for leave. court concluded that the mortgage was still in arrears." Kym Stasiuk, a corporate lawyer working in secured In seeking to appeal the order, Romspen questioned lending transactions at Blaney McMurtry LLP, notes that the rights of subsequent mortgagees under s. 22 of On- a partial cure of a default isn't enough to bring the morttario's Mortgages Act. The court was to decide which se- gage into good standing. cured creditor would have control over the sale to deter"There are certain rights for mortgagees who are in mine how it would proceed. subsequent priority position," says Stasiuk. "If you're in a In hearing the application, Justice Robert Blair of the second position, you want to take a close look at the secuOntario Court of Appeal found there's no automatic right rity documents of the person in the first position." to appeal from an order appointing a receiver. In his deciA successful appeal, he says, would have required a sion, he acknowledged there has been recent movement very creative interpretation of s. 22, one that would potoward a more flexible approach. tentially create an undesirable element of uncertainty in There was some concern over the timing given the field of mortgage enforcement because no one would that the property functions as a seasonal business and know which covenants could remain unperformed and the interest in resolving the issues in time for it to take which could not without litigating each case. LT Communication a big pitfall in real estate deals BY MARG. BRUINEMAN For Law Times T alking — or not — at the appropriate time has got us all into trouble at one point or another. But it can be particularly problematic in a professional relationship. "Poor communication with the client is the No. 1 area of claims," says Nadia Dalimonte, claims counsel at LawPRO. That's a fairly substantial concern given that real estate-related claims accounted for a 10-year average of $19.7 million per year, a number representing 30 per cent of LawPRO's claims costs. Dalimonte points to key areas where lawyer-client communication or a lack thereof most often results in an accusation. For the most part, she adds, these problems are avoidable through the development of a checklist lawyers can review with every client at the start of any transaction. A frequent oversight is asking whether there might be spousal interest in a property. A lack of spousal consent to change the ownership status or add or alter a mortgage is a problem that frequently arises. An issue can arise even if there's only one person registered on the property's title. Dalimonte suggests taking some time to review the related issues with the client is well worth the effort. One example Dalimonte refers to dates back to 1996. In Yamada v. Mock, the court was critical of a lawyer acting for both a private lender and a borrower in a real estate transaction where the purchaser had another woman forge his wife's signature. The court concluded the lawyer should have asked for identification even though he had previously done work for the couple. "I find that the failure to ask for identification is below the standard of care of solicitors in this situation. Indeed, if the practice were not to ask for identification in such circumstances, I see the risk in these circumstances to be plainly foreseeable and, regardless of the practice, the law would impose liability on the solicitor to deal with the foreseeable risk," wrote Justice Gerald Day. Lawyers can avoid many of the communication problems in real estate transactions by doing the final report first, suggests Miller Thomson LLP partner and Law Times columnist Jeffrey Lem. It's simply a matter of changing the tense from past to future and changing the title to preliminary report. "We're going to do the reporting letter anyway," he says. "Now we do it before closing and it could save your butt. When it comes to a negligence lawsuit, it always comes down to: 'Did you put it in writing?'" As lawyers are reviewing the information required for the report, they'll deal with many of the issues that will arise in a transaction. Something as www.lawtimesnews.com simple as asking the spouse to sign the report, for example, will open the door to inquiries about spousal interest. Lem suggests the process can also reduce the anxiety the client may feel. And it's work the lawyer will have to do anyway. But by taking this approach, it's more of a pre-emptive strike done in a compressed timeline instead of the last bit of work done to close the file. "One of my great ironies is by covering your own butt . . . you've actually done the client a service," he says. Other areas where lawyers have failed in communicating with their clients that have resulted in lawsuits include future use of the property, title insurance, and communicating with the lender. The client's intentions following the purchase of the property also need to be clear. "As long as the zoning is in place . . . they're going to think everything will be fine," says Dalimonte. "Maybe there's another entity they're not going to know about." If the purchaser wants to make changes to the property, what are they? Are there easement issues or other matters that could prevent clients from fulfilling their plans? Communicating and meeting with the lender could reveal any relevant or material information before it advances funding for the mortgage. Related to that is relaying anything that might suggest the property isn't worth what the purchaser is paying for it. Exploring the issues around title insurance is another area that could reveal potential problems. "It's an insurance policy like any other with limitations," says Dalimonte, noting the importance of communicating in advance any intentions around changing the property or zoning after closing. Lastly, Dalimonte suggests lawyers explore with the client any potential need for survey searches or whether permits were in place for any renovations. LT

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