Law Times

Law Times • augusT 4, 2014 Page 7 www.lawtimesnews.com COMMENT Mortgage fraud case raises questions about insurance exemptions By Tim hyde For Law Times have been out of the title insurance business for some time, but as First American Financial Corp.'s chief title underwriter and then as president of LandAmerica Financial Group Inc.'s Canadian venture, I spent considerable time drafting policies and getting them accepted by Canadian financial institutions in the 1990s. Roughly 20 years on, I am surprised there has not been more Ontario Court of Appeal consideration of the language of the policies. Although the Court of Appeal did have occasion to consider double recovery in Krawchuk v. Scherbak in 2011, reported title insurance matters deal mostly with issues such as building or zoning compliance, so- licitor discipline hearings, and business interest spats. The recent Ontario Court of Appeal mortgage fraud decision in Re Gray has reminded me of ques- tions I wondered about when I first read what are known as the "suffered, created or assumed" and knowledge exclusions. In Gray, an acquaintance used a Royal Bank of Canada employee as a straw man. The acquaintance, John Roberts, convinced Evan Gray to take title to a residence with him and co-sign a mortgage to RBC. Although Gray received $2,500 for his participation, the court found his discharge from bankruptcy should release him from his debt to the Canada Mortgage and Housing Corp. on the basis that he hadn't made the misrepresentations to the bank at origination. There had been plenty of misrepresentations made to the bank, but the court found they were all from Roberts and his co-conspirators rather than Gray. The court also found Gray had not been wilfully blind and that even though he worked for the bank, his action, or lack thereof, was in his capacity as a borrower and not in his capacity as a fiduciary or employee. The Ontario Court of Appeal dismissed CMHC's appeal. CMHC had insured RBC's $516,370.13 mort- gage on the fraudulently inf lated purchase price of $529,000 and was the assignee of the RBC debt. Title insurers have the right to subrogate and it may be that the invalidity or unenforceability against title of the mortgage was insured, but it is my understand- ing that a title insurer was not involved. In any event, the mortgage in this case was valid and enforced against the title. The source of the bank and CMHC's loss was a valuation fraud. As someone who used to sit at the top of the under- writing escalation ladder used by most title insurers, I know that had RBC required title insurance on this mortgage, the underwriters would have discovered at least some of the following important facts: Gray had no plans to live in the house; the mortgage broker had previously been on title with Kavita Naik, one of the vendors; Naik planned to live in the house after closing; the mortgage broker had provided the valuation; Gray had never even seen the house; one solicitor was acting for both the vendor and the purchaser; and Gray was getting money to take title with Roberts and sign the mortgage. The red f lags on this file were so numerous that any title insurance underwriter would have made every inquiry imaginable to ferret out the story on this mortgage. It is what they have training to do. The case led me to wonder about the exclusions I mentioned earlier. Title insurance policies exclude losses "suffered, created or assumed" by the owner or lender. Could a title insurer have denied coverage on the basis that the bank employee had been the straw man? On the facts of this case, I don't think so. The courts found Gray so unaware of what was go- ing on that he was not caught by s. 178(1) of the Bankruptcy and Insolvency Act that would have prevented release of the mortgage debt due to fraud, false pretences or fraudulent misrepresen- tation. It's hard to imagine, then, that the bank could have "suffered, created or assumed" the loss when even its employee was found not to have taken part in the scheme or to have been wilfully blind to it. But what about the knowledge exclusion? Title policies define knowledge as actual knowl- edge and specifically exclude constructive knowledge or notice that may be imputed. Here, an RBC employ- ee actually knew quite a lot about the facts surround- ing the fraud (such as the fact he wasn't going to live in the home), but the court did not seem to believe he had an overall sense of what was happening. Absent any special endorsement someone may have negotiated, would the knowledge exclusion allow a title insurer to deny coverage when a corporate client's employee knew many of the facts of the fraud but claimed not to be aware of the overall scheme? What if he knew of the scheme? Could that knowledge have been only in his capacity as a borrower and not as a fiduciary to his insured employer? It is too bad there was no title insurance for this mortgage. From a public policy point of view, I won- der if this is the type of risk CMHC should be taking on. What expertise does it have to manage this type of risk? Perhaps it is time for CMHC to revisit entering the title insurance business. I suspect a title insurer's underwriters would have stopped the deal, but had it closed, it would have been interesting to have the Court of Appeal comment on the exclusions and any endorsement that may have limited them. LT uTim Hyde is founder and chief executive officer of real estate advisory service HouseVault. u SPEAKER'S CORNER Rare ruling clarifies impact of non-competition clauses on notice period mong the factors for assess- ing the quantum of damages in wrongful dismissals is the impact of non-competition clauses in employment contracts on the employee's ability to find comparable em- ployment. In Ostrow v. Abacus Manage- ment Corp. Mergers and Acquisitions, the Supreme Court of British Columbia had a rare opportunity to consider the impact of that factor on the length of the reason- able notice period. Having acknowledged the scarcity of jurisprudence on the relationship be- tween a non-competition clause and the length of reasonable notice, the court con- cluded the presence of a non-competition clause serves as a factor that may increase the length of reasonable notice. In Ostrow, a 42-year specialist in inter- national and U.S. taxation provided ser- vices to Abacus, a private equity company with approximately $5.5 billion in hold- ings. He did so first as an employee serv- ing in the capacity of a senior manager and then as a consultant through his new employer, C2 Global Solutions Inc. In Feb- ruary 2011, Abacus decided to re-employ Adam Ostrow. In furtherance of its goal, it provided the draft employment contract that permitted it to terminate the employee by providing him with the minimum no- tice under the Employment Standards Act. It also contained a six-month non-compe- tition clause restricting him from working for other employers. Following the ensuing negotiations, Abacus agreed to revise the termina- tion provision, which, along with other amendments, provided Ostrow with the assurance he needed regarding job security. In the summer of 2011, the Grosvenor Group contacted Ostrow about a potential op- portunity as a director of tax. In response, he approached Aba- cus for, and obtained reassur- ances about, his job security. He decided not to follow up with the Grosvenor Group. In Oc- tober 2011, Abacus suggested Ostrow should start looking for a new job. In December 2011, it dismissed him on a without- cause basis. He went on to sue Abacus for wrongful dismissal. At trial, Ostrow argued the existence of the non-competition clause in his employ- ment contract was a factor for the court to consider when assessing the quantum of damages. In response, Abacus argued Ostrow couldn't have believed the non- competition clause restricted him and that, if he did, such a belief was unreasonable be- cause the company didn't seek to enforce it. In deciding the issue, Justice Jeanne Watchuk observed: "There is a surprising lack of jurisprudence on the relationship between a non-competition clause in the employment contract and the length of the reasonable notice period." Even though the jurisprudence is scarce, it's consistent. For example, in Wat- son v. Moore Corp. Ltd., the British Colum- bia Court of Appeal specifically considered the impact of the non-competition clause upon the length of the reasonable notice period. In that case, despite the finding that the provision was unenforceable because the contract was void, the court awarded a 25-year employee 18 months' notice after considering the existence of an onerous non- competition clause. Similarly, in Ontario, the Court of Appeal affirmed in Murrell v. Burns International Security Services Ltd. the trial judge's decision to award a three- year employee eight months' pay in lieu of notice after accounting for the non-competition clause. In another Ontario case, Khan v. Fibre Glass-Evercoat Co., the plaintiff brought an action for wrongful dismissal arguing the notice period should take into account the five-year non-com- petition clause in his employment contract. The Ontario Superior Court of Justice al- lowed the action and added five months to the period of notice because the employer had insisted that the employee abide by the five-year non-competition agreement. Having considered the limited juris- prudence, Watchuk dismissed Abacus' argument. She found that when assessing the impact of the non-competition clause upon the period of reasonable notice, the issue wasn't whether the employer en- forced the restrictive covenant but wheth- er such a clause existed in the employ- ment contract and it had led the employee to believe he was bound by it. In Ostrow, Abacus had given Ostrow a formal letter after his dismissal that reminded him of the non-competition clause in his employment contract. As a consequence, Watchuk concluded the ex- istence of the non-competition clause in Ostrow's contract was a factor that served to increase his entitlement to reasonable notice of termination. She awarded Os- trow, an 11-month employee at the time, six months' pay in lieu of notice after considering his specialization, Abacus' assurances of job security, and the non- competition clause. Historically, Canadian courts have been antagonistic towards enforcement of re- strictive covenants. Ostrow reinforces this proposition, albeit from a different per- spective. In light of the Ostrow line of cases, prudent employers should consult their legal advisers about the enforceability of a non-competition clause in the dismissed employee's employment contract before in- sisting on compliance. If the enforceability of the non-competition clause is suspect, employers should relieve the employee from compliance and instead capitalize on the duty to mitigate with a view to minimizing their financial obligations. Should the dismissed employee argue the existence of a non-competition clause negatively affects the chances of getting an- other job, employers should recall the On- tario Court of Appeal's judgment in Link v. Venture Steel Inc. in which it found the existence of a non-competition obligation wouldn't completely relieve someone of the legal duty to mitigate. LT uNikolay Chsherbinin is an employment lawyer at Chsherbinin Litigation and au- thor of The Law of Inducement in Cana- dian Employment Law published by Car- swell, a Thomson Reuters Business. He can be reached at 416-907-2587, nc@nclaw.ca or nclaw.ca. Labour Pains Nikolay Chsherbinin A I

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