Copyright 2010, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Real Estate–Mortgage Lending, October 2010
Lenders advancing funds on the security of real property are no doubt aware of the extensive due diligence required prior to closing. The due diligence must be performed to ensure that the real property being secured is, among many other things, free from financial encumbrances. A review of title to the subject property will help identify whether any mortgages or other financial encumbrances are registered against title but will most likely fail to disclose the existence of any superpriority claims against the assets of the borrower.
Superpriority claims are liens created pursuant to legislation that provide the relevant governmental entity with a first priority claim over all the assets, both real and personal, of a tax collector that has collected but not remitted certain taxes and other source deductions to the relevant government entity. For the most part, all of the legislation creating superpriority liens is quite similar in that it sets up a deemed trust in favour of the government for amounts that are collected by a tax collector on behalf of the government. In addition to creating the deemed trust, the legislation will also expressly state that the deemed trust overrides any security interest that the tax collector may have granted to a creditor in its assets. Superpriority liens will almost always rank in priority to the claims of any other creditors, including secured creditors whose security has been registered in the appropriate registries. This is true even if the security interest arose prior to the superpriority lien coming into existence and even if the borrower does not have physical possession of the secured property.
Superpriority liens can arise pursuant to legislation at both the federal and provincial levels, including the Income Tax Act (Canada), the Excise Tax Act (Canada), the Canada Pension Plan (Canada), the Employment Insurance Act (Canada), the Retail Sales and Tax Act (Ontario), the Workplace and Safety Insurance Act (Ontario) and the Development Charges Act (Ontario). From a municipal standpoint, any unpaid development charges owed to a municipality that can be added to the tax roll assessment for real property will gain a superpriority status by leveraging off the superpriority lien created with respect to taxes.
The superpriorities created under the Income Tax Act (Canada) are subject to a limited number of carve‑outs for "prescribed security interests", one of which is a registered mortgage. A registered mortgage will have priority over a superpriority lien if the mortgage was registered in the applicable land titles or land registry office before any amounts in favour of the government become due under the deemed trust created by the legislation. However, the security under a registered mortgage is reduced by any payments made after the time when the amounts owed to the government become due. Further, if the mortgage secures a revolving line of credit and a deemed trust arises between the registration of the mortgage and a subsequent advance under the mortgage, the deemed trust will have priority over any security relating to the subsequent advance. It is also important to note that, where the debt under the security documents is secured by both real and personal property, although the real property mortgage will have priority by falling within the definition of "prescribed security interest", the priority of the real property security is limited by the value of the personal property security.
There are a number of steps that can be taken during the course of a lending transaction to protect against any potential harm of superpriority claims. During the due diligence period, off-title searches should be performed to ensure that all property taxes have been paid to date and that no superpriority liens can be created with respect thereto. The mortgage documentation should expressly state that superpriorities are not permitted encumbrances. The lender can also require the borrower to deliver, as part of the closing documents, a statutory declaration stating that all deductions and other amounts that could form the basis of a superpriority claim have been paid in full to the relevant governmental authority.
Secured creditors should be aware of the fact that if they realize on their security and do not pay the amounts owed under the statutory deemed trusts from the amounts collected on the realization of their security, they will be held personally liable to the government for those amounts. In an effort to avoid potential liability, the secured creditor may apply to the federal and provincial governments for clearance certificates with respect to taxes and other source deductions owed by the borrower. Unfortunately, it can take both the federal and provincial governments upwards of six months to respond to requests for a clearance certificate and, even if one is received, the federal government is not bound by the clearance certificates it issues.
If a superpriority claim does exist and the secured creditor wants to realize on its security, the creditor should know that it may be possible to negotiate with the relevant governmental authorities, including the Minister of National Revenue. A secured creditor will want to attempt to obtain assurances from the government that it will enforce its superpriority claim in a manner in which the burden is shared by all creditors of the debtor. If the superpriority claim is at the provincial level, a secured creditor can consider petitioning the debtor into bankruptcy as provincial superpriority claims generally become unsecured claims upon a debtor becoming a bankrupt.
It is worth noting that the Supreme Court of Canada has held that superpriorities apply to all of the assets of a tax collector as they are acquired. However, once the property has been disposed of, the lien no longer attaches to the property itself and attaches only to the proceeds of the disposition. For this reason, purchasers of real property need not be concerned about superpriority claims.
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.