Canada: Lenders Should Consider Remedies Under the Construction Lien Act

Copyright 2010, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Real Estate–Mortgage Lending, October 2010

The recent decision in Romspen Investment Corp. v. 1514904 Ontario Ltd. serves as a reminder of potential remedies that may be available to secured lenders with respect to the protection of their security over real property under construction. Specifically, the Romspen case provides an example of where a secured lender might have benefited from the extraordinary remedies available under the Construction Lien Act (Ontario) (CLA).

In Romspen, the lender was owed more than C$11‑million, which amount was secured by first mortgages given by the borrowers on 11 properties. The borrowers, who were engaged in the business of property development and management, had difficulty completing the development of the subdivision in which the mortgaged properties were situate. The loan was in financial default and there were substantial outstanding payables. The borrowers asked the lender to extend its trust and indulgence on faith that it would all work out in the end.

On an application by the lender to the court for the appointment of a receiver, the court found that the subdivision was some time and much money away from readying the mortgaged properties for market. There was a daily erosion of equity and every day that passed meant less recovery for the creditors. The court appointed a receiver and manager under the Bankruptcy and Insolvency Act (Canada) (BIA) and the Courts of Justice Act (Ontario) (CJA), of all the assets, undertakings and properties of the borrowers.

Although relief under the BIA and CJA may have been appropriate in the Romspen case, the CLA might have offered distinct benefits for the lender. The extraordinary remedies available under the CLA should not be overlooked by a lender looking to realize on its real property security. In certain circumstances, a trustee may be appointed under the CLA, which trustee may, subject to the supervision and direction of the court:

  1. act as a receiver and manager and, subject to the Planning Act (Ontario) and the approval of the court, mortgage, sell or lease the real property;
  2. complete or partially complete the improvement on the lands;
  3. take appropriate steps for the preservation of the real property; and
  4. subject to the approval of the court, take such other steps as are appropriate in the circumstances.

The appointment of a trustee under the CLA can assist a construction project suffering from an owner's insolvency or mismanagement. This extraordinary remedy recognizes that, in some cases, the interests of lien claimants could be better protected if a different person were to take control of the real property, refinance the improvement on the lands, and complete certain repairs and construction in order to market and sell the real property.

The CLA further provides extra protection for lenders that advance amounts to the court-appointed trustee. The trustee is empowered to grant mortgages over the real property and any interest in the real property acquired by a lender takes full priority, to the extent of the amount advanced, over every lien existing as at the date of the trustee's appointment. In addition, the amount received by the trustee is not subject to any liens existing as at the date of the trustee's appointment.

This remedy under the CLA is available to any person having an interest in the real property, including an owner, mortgagee, or lien holder and can be considered and exercised at any stage of the construction project. Although there must be a lien in existence, there is no requirement that a lien be preserved or perfected at the time of the application in order for the remedy to be available to the lender.

The appointment of a trustee will require the court to consider certain factors, such as whether:

  1. the owner/borrower has abandoned the real property, is insolvent, or is acting irresponsibly;
  2. there is an income flow that could otherwise satisfy the lien claimants; and
  3. there is a danger of deterioration of the services that have been installed or a risk to the security of the lien claimants.

Failure to appoint a trustee under the CLA when appropriate could have adverse consequences to a secured lender. In Avenue Structures Inc. v. Pacific Empire Development Inc., a secured lender became a mortgagee in possession after the borrower could not pay the tradespeople working on the project and construction ceased. The secured lender made expenditures for the preservation and protection of the property, including realty taxes, winter protection, insurance premiums, legal fees and city inspection fees. Without a trustee having been appointed under the CLA, the court held that none of the lender's expenditures could take priority over the liens, except for the realty taxes, which have a statutory priority under the Municipal Act, 2001 (Ontario). If a trustee had been appointed under the CLA, the lender could have recovered all reasonable business expenses and management costs incurred, which expenses and costs would be given priority over all liens. In the event of a challenge by lien claimants, the trustee could have applied to the court for directions and authorizations.

Although a trustee's fees can be substantial, the trustee can take steps to preserve the value of the real property and creditors may collect more than if the project were not completed. A secured lender may want to take steps to complete the improvement, recover expenses incurred to preserve its security, or protect new amounts advanced. Where a construction project is unfinished and security is at risk, a secured lender would be wise to consider this extraordinary remedy under the CLA.

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.

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