PROTECTION FOR "PROTECTIVE ADVANCES" IN EXCESS OF A MORTGAGE'S FACE AMOUNT

Posted: December 31, 2019 | Last Updated: December 31, 2019
Written by: Edward D. Brown

Edward D. (Ned) Brown
Pitblado LLP
December, 2019

The owner (the "Owner") of a parcel of real estate (the "Property") decides to develop the Property into a multi-unit mixed use condominium project (the "Project"). The Owner pre-sells units in the Project to a number of buyers ("Unit Purchasers"), each of whom pre-pay substantial portions of their respective purchase prices ("Unit Prepayments"). Pursuant to the Owner's agreements with the Unit Purchasers, the Owner is entitled to use - and uses - the Unit Prepayments to, in part, finance the Project. Additional financing is obtained by the Owner from:

(i) Lender "B" who advances, say, $4,000,000.00 to/for the Owner, which enables the Owner to acquire title to the Property. Lender "B" obtains a mortgage against the Property with a face amount of $4,000,000.00;

(ii) Lender "A" who agrees to advance and does advance, say, $15,000,000.00 to/for the Owner, which the Owner also uses to finance the Project. Lender "A" obtains a mortgage against the Property for a face amount of $15,000,000.00.

As a condition to making its advances, Lender "A" requires that Lender "B" postpone its mortgage in favour of Lender "A"'s mortgage. Anticipating a substantial increase in value of the Property (as improved by the development of the Project), Lender "B" agrees to so postpone. The Unit Purchasers are not formally secured with respect to their Unit Prepayments, but by law hold equitable liens against the Property (as improved by the development of the Project), although no such liens are actually registered against the Project's title. Also, assume that Lender "A" is actually comprised of two separate lenders acting together, namely lender "X" ("Lender "X"") and lender "Y" ("Lender "Y""). Lender "X" and Lender "Y" each fully advance their respective shares of the total amount which they have together agreed to advance to the "Owner" (through Lender "A"), namely $7,500,000.00 each. Unfortunately, and due to a variety of reasons*, ongoing development of the Project stalls and the Owner requests Lender "A" (ie, each of Lender "X" and Lender "Y") to make further advances under their mortgage to allow the Project to be completed. Each of Lender "X" and Lender "Y" make further advances as follows:

  1. Each of them advance a further $1,000,000.00 for property tax arrears and additional insurance costs/premiums; and
  2. each of them advance a further $1,500,000.00 each for additional costs required to complete the Project.
  3. Lender "X" alone and without the formal consent of Lender "Y", advances a further $2,000,000.00 for the purpose of covering further costs required to complete the Project.
     

Although these additional advances ("Overadvances") are made by Lender "X" and Lender "Y", the Project nevertheless continues to flounder. Eventually, the various stakeholders determine that it would be better for all concerned if the Project ceased to proceed, at least with the support of the current stakeholders, and in consequence thereof a receiver/manager ("Receiver") is appointed for the Owner and the Project.

Assuming that the Project is liquidated and the proceeds of such liquidation ("Liquidation Proceeds") are available for distribution amongst the stakeholders, who is entitled to how much of same, and in what priority? In particular, assuming that the Liquidation Proceeds are not sufficient to repay all of Lender "X", Lender "Y", Lender "B", the Unit Purchasers and the Owner (with respect to whatever equity the Owner itself put into the Property and the Project):

(I) would priority of entitlement strictly follow the registration priorities of the various stakeholders, that is, Lender "A" on behalf of each, respectively, of Lender "X" and Lender "Y" (as to their respective advancements through Lender "A"), followed by Lender "B", followed by the Unit Purchasers (with respect to their Unit Prepayments), followed by the Owner (the Owner being entitled to whatever is left as its equity)?;

(II) to the extent that Lender "X" and Lender "Y" have together advanced $5,000,000.00 in excess of the face amount of their mortgage (the "Lender "A" Overadvance"), are Lender "X" and Lender "Y" actually secured under their mortgage for the Lender "A" Overadvance?;

(III) are Lender "X" and Lender "Y", if so secured, entitled to priority over the other stakeholders with respect to the Lender "A" Overadvance to the same extent that Lender "X" and Lender "Y" are entitled to priority with respect to the amount that they have advanced up to the face amount of their mortgage ($15,000,000.00)?; and

(IV) to what extent - if any - is Lender "X" entitled to priority over one or more of the other stakeholders with respect to its own "super-overadvance" (i.e. the extra Lender "X" overadvance" of $2,000,000.00)?

These questions - and more - were recently considered in the British Columbia Supreme Court case of Forjay Management Ltd. v. 0981478 B.C. Ltd., 2019 BCSC 238, judgement issued February 25, 2019 (hereinafter, the "Forjay Case"). The fact scenario in the Forjay Case was more convoluted and complex than the fact scenario set forth above; in addition to there being a mortgagee who had financed the property owner's acquisition of the project lands, there were two other groups of lenders, various of whom made "overadvances", one group comprising two lenders and a second group comprising three lenders, with one of the three lenders being a member of each of the two lending groups. However, these complexities can be ignored for the purpose of answering the questions stated above in subparagraphs (I) to (IV).

In the Forjay case, the Court held as follows:

(a) the overadvancing mortgagees were entitled to have their overadvances secured by their respective mortgages. This was primarily due to the fact that, by the terms of their mortgages, the overadvances which were actually made were specifically contemplated and provided for in the mortgages.

(b) the overadvancing mortgagees' mortgages secured the overadvances in priority to other competing mortgages and monetary claims. Again, this was primarily due to the fact that by their terms, the overadvanced mortgages clearly stated that the overadvances would not only be secured, but secured in priority to all other mortgages and other secured monetary claims. Of particular interest here is the Court's view that third parties contemplating providing credit to the project owner who took the trouble to read the terms of the previously registered mortgages would ascertain that it was possible that the mortgagees would make overadvances in particular situations, those situations being, in the main, where the overadvancing mortgagees would be providing further funds for the purpose of protecting their existing mortgage security. In other words, where overadvances are contemplated by the mortgage's terms, a third party is deemed to have notice of same and will be bound by (ie, subordinate to) same.

(c) where a member of a "lending group" of mortgagees overadvances without the agreement or consent of its other co-lenders in the lending group, such overadvancing mortgagee will be both secured and secured in priority to the other mortgagees, including the overadvancing mortgagee's other co-lenders, provided that the overadvancing mortgagee (lender) hasn't entered into an interlender agreement with the other members of its lending group which prohibits such overadvances without the other co-lenders' consents. In this situation, the overadvancing mortgagee is entirely justified in unilaterally overadvancing with a view towards protecting its mortgage security.

The Court's conclusions appear to have been based on two premises:

(i) that the overadvancing mortgagees' mortgages contained terms which specifically contemplated and provided for overadvances being made in certain circumstances; and

(ii) that British Columbia law did not prohibit or restrict a mortgagor and a mortgagee from agreeing (in their mortgage) to provide for overadvances which were to be secured and secured in priority to other competing monetary claims.

Sections 28(1) and 28(2) of the British Columbia Property Law Act provide that advances by a mortgagee, including the initial as well as subsequent advances, will only rank in priority to subsequent monetary charges where:

(a) the subsequent registered monetary charges agree in writing to the priority of the further advances; or

(b) at the time that the further advances are made, the advancing mortgagee has not received a notice in writing of the registration of the subsequent (monetary charges) from the owner or holder of the subsequent monetary charges; or

(c) at the time that a further advance is made, the subsequently registered monetary charge has not yet itself been registered; or

(d) the overadvancing mortgagee's mortgage, by its terms, requires that the overadvancing mortgagee make the further advances.

In the Forjay Case, the Court held that although the non-overadvancing mortgagee(s) had the right and opportunity to give notice to the overadvancing mortgagee(s) (as per (b) above), none of them had clearly and properly done so.

In Manitoba, there is no precise equivalent to Sections 28(1) and 28(2) of the British Columbia Property Law Act.  Section 17 of The Mortgages Act (Manitoba) deals with the same subject matter, at least to some extent. Section 17 provides that any advance made by a mortgagee will be subordinated to advances made by a subsequently registered mortgagee where the prior mortgagee's advances are made with actual knowledge of the existence of the subsequently registered mortgage. However, this statement of law must be considered in relation to the meaning and effect of the additional statement in Section 17 that a mortgage is security "up to the stated maximum principal or face amount of that mortgage." The question becomes "Can a mortgagee and a mortgagor "contract out" of the "maximum principal or face amount" limitation contained in Section 17 by specifying in their mortgage that advances - in particular "protective security advances" may be made in excess of the face amount of the mortgage and if they are made, they will hold priority over all other subsequently registered monetary claims/interest holders?". Because Section 17 appears to provide rights to subsequent registered mortgagees, it may be difficult to convince a Manitoba Court that the prior registered mortgage's mortgagor and mortgagee can, themselves, "contract out" of those rights given to subsequent registered mortgagees under Section 17.

If the parties can so "contract out" then it is this writer's opinion that the Forjay Case could be used to argue in Manitoba for the securing - with priority over subsequent monetary interests/claims - of overadvances (ie., beyond the stated maximum principal or face amount of a mortgage), at least for protective overadvances, This would be subject to:

(I) the terms of the overadvancing mortgagee's mortgage specifically contemplating and providing for the possibility of the making of protective overadvances; and

(II) as per Section 17 of The Mortgages Act (Manitoba), the overadvancing mortgagee either does not obtain actual notice of the existence of a subsequently ranking mortgage (or other monetary claim/interest), or if it obtains such notice, that it gets a postponement of advances undertaking from the subordinately ranking party.

The British Columbia Court's thinking regarding the effect of having provisions dealing with overadvances clearly contained in mortgages. It's an interesting concept. We all know that, as a general rule, if a mortgagee has advanced $1,000,000.00 to the mortgagor under a mortgage with a face amount of $1,000,000.00, it can be risky for the mortgagee to advance - even for protection purposes - beyond the $1,000,000.00 amount, at least without getting consents or postponements from subsequent monetary registrants. The Forjay Case appears to stand for the proposition that a mortgagee's entitlement to have protective overadvances secured and secured in priority to subsequently ranking monetary charge holders, will be dependent upon the existence - or non-existence - of protective advance provisions in the mortgage. If I, as someone who contemplates advancing credit to a property owner on the security of a mortgage, wish to ascertain what secured debt the owner has already created in the past, and what increases thereof might occur in the future, I must search the title and search the terms of all pre-existing mortgages. If I do this, and I find that one or more prior registered mortgages contain protective overadvance provisions, then I know in advance that there is a possibility that when I acquire my mortgage to secure my loan, the prior mortgagee - or mortgagees - may hold priority over me for something in excess of the face amount (or amounts) of their mortgages. Thus, at the outset, I am "put on notice". If I have concerns about the dilution of my mortgage priority, I can approach the existing mortgagees and seek postponements with them which limits the priority of any future advances such mortgagees may make.

This reasoning - what I might call the concept of "If it's in the prior mortgage, then a subsequent monetary charge holder will be stuck with it" - could be used to argue a similar proposition with respect to the amendment of mortgages. Generally speaking, if I as a mortgagee agree with you as my mortgagor to amend the terms of our mortgage, (whether to increase the maximum principal amount, or change the interest rate, term or virtually any other term or terms), I cannot - in Manitoba - effectively do so without getting all subsequently registered monetary charge holders to specifically consent to the amendment(s). It is the writer's understanding that so far, Manitoba Courts have not looked favourably on the argument that if a prior registered mortgage's mortgagor and mortgagee agree to an amendment and the original mortgage contained provisions which contemplated and permitted the mortgagor and mortgagee to amend without the consent of subsequently registered monetary charge holders, the amendment will be binding on the subsequently registered monetary claim holders. It is the writer's view that notwithstanding such reluctance on the part of our Courts, mortgages should contain amending provisions which do specifically provide that the mortgage, as amended, will bind subsequently registered monetary charge holders without their consent. The worst that can happen is that a Court may hold that the amendment(s) are not binding on subsequent charge holders.  But perhaps the Courts will - in the future - agree with the reasoning in the Forjay Case.

 
*construction completion costs and other related costs may have increased for a variety of reasons including, without limitation, an increase in interest rates not contemplated by the parties at the outset, unexpected costs to remediate certain problems encountered during the course of construction, government "red tape" restrictions and requirements, eg., getting subdivision approval, permits, zoning approval, etc., and changes in government imposed rules dealing with various matters such as income tax, rent control restrictions etc.
 
 
Edward D. (Ned) Brown has extensive experience in Corporate and Commercial law. Ned is focused on the areas of lending and secured transactions, banking law, subdivisions and commercial real estate development.