Banking and Finance Legal Update Spring 2018

You Don’t Send Me Flowers Anymore – You Send Me to “Special Accounts”

Willowbrook Nurseries, a seasonal plant growing business in Ontario, sued its Bank, RBC, when it applied for a temporary increase on its credit line for the winter for growing and producing plants sold in the spring and summer when the increase would be paid down.  After a really bad year in 2008, Willowbrook did not repay the preceding year’s increase and (boldly) asked RBC for more money and a further increase during that the winter of 2008.  RBC, sensing that Willowbrook’s business may be failing, denied the request for more money and sent the account to its Special Credit department.  Within months, Willowbrook refinanced with another bank.  After refinancing, Willowbrook sued RBC for acting in bad faith by not giving reasonable notice when it restricted access to credit and transferred the account to Special Credit.  The Ontario Court of Appeal[1] found there was no bad faith and that the “principle of good faith performance of contractual obligations does not extend so far as to require RBC to subjugate its own financial interest by extending additional credit that it does not want to advance”.  It is in the Bank’s sole discretion to transfer an account to Special Credit and doing so does not breach any lending terms.

Interest Disclosure in Loan Documents and Section 4 of the Interest Act

Section 4 of the federal Interest Act governs interest disclosure in loan agreements and makes it a requirement for loan agreements (excluding mortgages) that provide for payment at a rate or percentage per day, week, month (or any period less than a year), contain an express statement of the yearly rate or percentage of interest OR interest will be limited to 5% per annum.

In a recent Ontario Court decision[2], a lender’s loan to a borrower bore interest at 12% per annum, compounded and calculated monthly, with a step-up to 24% per annum on default.  In addition, they provided for two “fees”: (a) an administration fee (found to be properly characterized as a fee and not interest); and (b) a discount fee (0.003% of outstanding balance calculated daily found to be interest for the purposes of s. 4 of the Interest Act).  The borrower argued that the discount fee was interest and did not comply with s. 4 of the Interest Act.  The lender argued that the conversion formula contained in the loan agreement saved the discount fee because it was as express a statement of the fluctuating rate as possible.  The Court did not agree with the lender and held that the conversion formula was not an “express statement” of the annual rate, as required by section 4 and reduced the lender’s interest rate to 5% per annum.

Given this Court’s strict interpretation of section 4, how does a lender actually comply with respect to floating rates, where an express statement of an effective annual rate cannot be provided other than by a formula?  Earlier cases stated that formulas were sufficient.  We will be watching to see if this decision is appealed and how it will be treated by subsequent cases.

A Debtor’s “Special Circumstances” can Affect Foreclosure Remedies

In a private mortgage enforcement action in Ontario[3], a private lender sought to foreclose on a borrower’s residence and obtained default judgment ordering foreclosure on the borrower’s property.  The lower level court had granted the foreclosure on the basis that the borrower had borrowed $350,000, used his family homestead as security, made no payments on the mortgage, failed to pay property taxes and did not defend after the lender commenced its foreclosure action.

On appeal, the borrower explained why he did not defend, that the lender was going to gain a windfall as a result of the foreclosure order and would not be prejudiced by a judicial sale of the property.  The borrower was a 61-year old bachelor in ill health who was illiterate, low income and physically disabled.  The mortgaged property was the family farm, passed down through three generations, and worth at least $600,000.  The borrower presented medical evidence that he was “severely mentally challenged” with “significant cognitive impairment”.  As an example of the borrower’s mental condition, it was shown that in 2013 he had purchased a small herd of 16 cattle to live on his farm and all but two of them died when he forgot to feed them.

Because of the “special circumstances” of this case, namely the explanation of the borrower’s inaction, the windfall to the lender under a foreclosure order, and the significant equity in the property, the Court of Appeal set aside the foreclosure order, and granted costs of the appeal and the lower court application to the borrower.

This case is a reminder to lenders that the Courts will weigh the fairness to each side in determining the appropriate remedy on a mortgage enforcement action.

How a Limitation Period Can Extinguish a Mortgage

In a recent BC Court of Appeal decision[4], a private lender (and friend of the borrower) was granted a mortgage by the borrower to secure a loan that was payable on demand with interest-only annual payments required prior to demand.  In October 2013, the borrower stopped making the required interest payments.  In November 2015, the parties exchanged correspondence about the debt and its repayment.  The borrower again failed to pay the interest payment due in October 2016 and the lender issued their demand letter and commenced a foreclosure action in December 2016.

In 2012, the BC legislature enacted a new limitations act which reduced the limitation period for contractual claims from 6 years to 2 years (Alberta is also 2 years) and stated that the limitation period for a lender seeking to enforce their security runs from the first day that the right to enforce their security arises.

In applying their limitations act, the BC Court of Appeal held that the lender could have first sought to enforce on its security on the date of the first default, October 2013.  Because the default occurred more than 2 years before the action was commenced on the mortgage in November 2016, the lender was out-of-time to recover the interest payments that were due in October 2013 and the lender’s ability to enforce the security (through the foreclosure action) was statute barred.  But, because the full amount owing on the loan was not owed until the lender demanded payment in December 2016, the lender still had an unsecured claim against the borrower for the debt.

While it may be new to BC, Alberta has had a 2-year limitation period that applies to security enforcement for a number of years.  This case is a good reminder to lenders of the risk they take in not acting on loan defaults.

Bank Found to be Landlord, Ordered to Pay Security Deposit

In December 2013, tenants entered into a year-long residential tenancy agreement (subsequently extended) with the owner of a condominium and paid a $950 security deposit to the owner.  Towards the end of their tenancy and unknown to the tenants, CIBC took steps to foreclose on the mortgage granted by the owner.  CIBC took title to the property.  The tenants received no notice of the foreclosure, no notice of the change in ownership and no notices were posted on the property.  The tenants moved out, unaware of the change in ownership.  The tenants initially sought the return of their security deposit from the previous owner – to no success.  After learning that CIBC had taken title to the property, they brought an application against CIBC to the Residential Tenancy Dispute Resolution Service (RTDRS).

An RTDRS hearing took place with both the tenants and CIBC appearing.  The Tenancy Dispute Officer granted a decision in the tenant’s favour – CIBC must pay their security deposit.  CIBC appealed to the Alberta Court of Queen’s Bench who upheld the Tenancy Dispute Officer’s decision.  The tenants did not appear at the appeal.  The Court held that the Tenancy Dispute’s Officer’s reasoning and decision to find CIBC was a landlord and had acquired the interests of a landlord under s. 47 of the Residential Tenancies Act was reasonable.

The Court found that notwithstanding a Court order that contemplated that the property could have tenants and required CIBC to inform possible tenants of a change of ownership, CIBC made no efforts to determine if there were tenants at the property and never gave notice to the tenants that the property had been foreclosed on (i.e. posting on the door).  While the decision does not go this far, I suspect that had CIBC made an effort to notify the tenants, it may have avoided the liability for the security deposit.

CRA’s Deemed Trust Updates

Our first CRA deemed trust case comes from Newfoundland[5] and deals with a priority dispute between Canada Revenue Agency (“CRA”) through its deemed trust on unremitted source deductions and a tax debtor’s mortgagee with a Standard Mortgage Clause over insurance proceeds arising from a fire loss.  CRA argued that the insurance proceeds were subject to the deemed trust and enhanced garnishment provisions of the Income Tax Act, Canada Pension Plan and Employment Insurance Act.  The Court found that the Standard Mortgage Clause creates a separate, independent and distinct insurance contract between a mortgagee and an insurer.  The mortgagor/tax debtor has no interest in the insurance proceeds payable to a mortgagee under its insurance contract created by a standard mortgage clause  – CRA’s deemed trust does not attach to the insurance proceeds.

Our second CRA deemed trust case[6] comes from a common strategy utilized by secured lenders with an insolvent debtor corporation – to petition the debtor corporation into bankruptcy to eliminate CRA’s deemed trust for collected but not remitted GST/HST debts and give the secured lender priority.  In a recent Federal Court of Appeal decision, the Court held that a bankruptcy does not reverse CRA’s priority to proceeds obtained by a secured creditor prior to bankruptcy.  Following this decision, secured creditors who enforce their security prior to a debtor’s bankruptcy may no longer be relieved, upon the debtor’s bankruptcy, of the obligation to pay unremitted GST/HST.  The decision has caused lenders to consider whether an early bankruptcy filing is preferable rather than forbearing and taking the risk that payments they receive may be captured by CRA’s deemed trust.  Leave to appeal this decision to the Supreme Court of Canada has been filed.

In 2004, the borrower obtained a credit facility from Bank of Montreal and granted security in all of its assets. By 2011, the borrower was in default. Pursuant to an assignment of debt and security agreement, the Bank assigned all debt owing and the security to Callidus Capital Corporation (“Callidus”). The borrower and Callidus then entered into a forbearance agreement, pursuant to which, amongst other things, Callidus received funds from the borrower’s sale of real property. Those funds were used to partially reduce the debt owed to Callidus.  In April 2012, the CRA wrote to Callidus, claiming amounts collected but unremitted by Cheese Factory for GST/HST, based on the deemed trust mechanism of the Excise Tax Act (ETA) The amounts in question owing to the CRA went back to as early as 2010. Following receipt of the CRA’s letter, at Callidus’ request, the borrower assigned itself into bankruptcy.  The CRA then commenced an action against Callidus for the unremitted amounts.

The Federal Court Trial Division held that the ETA became ineffective against Callidus upon the borrower’s bankruptcy for collected but unremitted GST/HST. The Federal Court of Appeal overturned this decision and held that, as against the proceeds of assets sold which were remitted to Callidus to repay the debt it was owed by the borrower, the bankruptcy did not extinguish Callidus’ liability to pay pursuant to subsection 222(3) of the ETA – it was a separate cause of action. The FCA found that because the property had been sold, the extinction of the deemed trust over the assets of the borrower on its bankruptcy was irrelevant with respect to the assets that generated proceeds for Callidus. Those assets had already been sold and were not the property of the borrower. As a result, Callidus was liable for collected but not remitted HST/GST funds received prior to the bankruptcy by the borrower  The legislation “does not say that, upon the debtor’s bankruptcy, all rights that arose as a result of the deemed trust are extinguished.” Instead, Callidus’ liability under subsection 222(3) of the ETA survived the borrower’s bankruptcy.

It will be interesting to see how much of this decision turns on the facts that Callidus received written notice from the CRA and ignored it.  In the meantime, secured creditors should consider requiring tax remittances at the time of advancing funds and enforcement, and may need to consider early bankruptcy of a debtor in order to avoid liability for GST/HST arrears.  For debtors, the FCA’s decision may have the effect of causing secured creditors to move faster in enforcing and bankrupting the debtor.

[1] Willowbrook Nurseries Inc. v Royal Bank of Canada, 2017 ONCA 974 (CanLII).

[2] Solar Power Network Inc. v ClearFlow Energy Finance Corp., 2018 ONSC 7286 (CanLII).

[3] Winters v Hunking, 2017 ONCA 909.

[4] Leatherman v 0969708 BC Ltd., 2018 BCCA 33.

[5] Travelers Canada v Elite Builders Inc., 2017 CanLII 86944 (NL SCTD).

[6] Canada v Callidus Capital Corp., [2017] F.C.J. No. 767, (FCA).