A frequently encountered issue faced by many lenders in mortgage backed loan transactions is the use by the borrower of a nominee title holder, or bare trustee.
What is a Nominee and Why are They Used?
A nominee is an entity (usually a corporation) who holds
registered legal title to a property while an off title entity
(often a limited partnership or real estate investment trust) holds
the beneficial title. The existence of a nominee divides the
ownership interest in the subject property. While legal title is
held by the nominee, the beneficiary receives (as the name implies)
the benefits of ownership.
Nominees are used for a variety of reasons, including creditor
protection, where the beneficiary cannot hold registered legal
title to the property under applicable Provincial law, or where it
is preferable to have a corporation hold the title to simplify day
to day transactions in respect of the property.
Generally the beneficiary, or a combination of beneficiaries,
holds 100% of the shares in the nominee company, and the
beneficiary and nominee enter into a nominee agreement which sets
out the rights and obligations of each of the parties
vis-à-vis one another in respect of a specific property or
properties.
Terms of nominee agreements may vary, but the following tend to be
found in one form or another in each agreement:
- The nominee holds legal title to the property for and on behalf of the beneficiary;
- That the nominee may only mortgage or dispose of the land at the direction of the beneficiary; and
- The nominee has no entitlement to any revenues arising from the property.
The nominee itself has little to no discretion on how to deal with the property subject to the agreement (which is often the only asset of the nominee), and all tax and economic benefits of the property accrue to the beneficiary.
The Loan
How is this relevant to a mortgage based loan transaction?
All provinces in Atlantic Canada have either deed or title
registration legislation enacted. Both systems act as notice to the
public of the interest holders in the land. In Nova Scotia for
example, the Land Registration Act provides that a parcel register
(being the record of all registered interests in a given property)
is a complete statement of all interests affecting that property.
The prevailing practice in most jurisdictions is not to include
reference to a beneficiary in the registry.
Therefore, absent any other factors, a lender is entitled to rely
on a mortgage signed by the registered title holder regardless of
whether a beneficiary exists behind the legal title.
The difficulty with this is that the Know Your Client
rules in the Proceeds of Crime (Money Laundering) and
Terrorist Financing Act (Canada) require many lenders to conduct
due diligence on their borrowers including a determination as to
whether an account is held on behalf of a third party. As outlined
above, any account held by a nominee would be held in trust for the
beneficial owner and therefore disclosed to the lender, thereby
giving them actual notice not only of the beneficial interest, but
also of the restrictions imposed on the nominee when dealing with
the subject property pursuant to the nominee agreement.
Lenders will often also want security from the beneficiary to
capture rents or other benefits arising from ownership of the
mortgaged property.
The Solution
Prudent lenders and their solicitors will take steps to ensure
that the enforceability of their security is properly authorized by
the beneficial owner. Such steps may include (i) a review of the
nominee agreement; (ii) delivery of a resolution or other direction
from the beneficial owner authorizing and directing the nominee to
enter into the mortgage transaction; (iii) addressing the
beneficial interest in the various security documents granted to
the lender in exchange for advancing funds. Alternatively, an
opinion from counsel to the borrower may address some or all of
these issues.
In many circumstances the interest of the beneficiary is addressed
directly in the relevant security document. For example, the
beneficial owner may guarantee or indemnify the lender for the
obligations of the nominee borrower under the loan. Some solicitors
advocate naming the beneficiary as a borrower and not guarantor
because of additional protections afforded guarantors in some
jurisdictions. However, a properly drafted guarantee should grant
equivalent protection to a lender while permitting flexibility in
structuring loans - which can be important to borrowers who
structure their holdings for reasons such as tax planning or
creditor protection.
Security agreements can and often do include the beneficiary
alongside the nominee, either in the same or in a standalone
agreement.
Since the use of nominee is intended to keep the beneficiary off
the title record to a property, it is often either not possible or
not desirable to reference them in a mortgage or other land charge.
Instead, a beneficial owner's agreement (a
"BOA") from the nominee and beneficiary
is an off title agreement to charge the beneficial owners interest
in the subject property.
A well drafted BOA will do the following:
- Confirm the relationship between the nominee and the beneficial owner;
- Authorize the nominee to enter the mortgage and other charges of land (if applicable);
- Confirm that the beneficial interest in the property is subordinate or postponed to the mortgage and other security and confirm that there are no existing liens on the beneficial owner's interest in the property; and
- Restrict transfer of the beneficial interest.
Conclusion
The use of nominee companies is a common occurrence when structuring real property ownership and should not be ignored whether disclosed through the Know Your Client rules or otherwise. As outlined above, there are straight forward and effective solutions for managing a lender's risk in these circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
