Canada: Financing Implications

Copyright 2010, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Real Estate Joint Ventures, October 2010

The financing of a project has an impact on the ability of a joint venture participant to transfer its interest in the project. Issues also arise for both the lender and the non-mortgaging joint venture participant when one of the joint venture participants wishes to separately mortgage its interest in a project. These matters are explored in more detail below.

Third-Party Financing

Depending on the nature of the financing, many loan agreements contain a "due-on-sale" clause, pursuant to which each of the joint venture participants agrees that it will not sell or otherwise dispose of all or any part of its respective interest in the project without the prior written consent of the lender. The inclusion of a "due-on-sale" clause in a loan agreement complicates matters for a joint venture participant intending to invoke the buy-sell shotgun or the right of first refusal. In such event, any attempt on the part of a joint venture participant to purchase the interest of the other joint venture participant may result in a default under the loan agreement, requiring the purchasing joint venture participant to refinance the project. Occasionally, loan agreements will provide that lenders will not invoke the "due-on-sale" clause as long as one or more of the original joint venture participants owns the entire project. In a situation in which the project is only partially developed and the transferring joint venture participant has the development and management expertise, the lender will be very concerned with the identity and qualifications of the remaining owner.

Financing Provided by One of the Joint Venture Participants

In some joint venture transactions, one of the joint venture participants is a financial or investing party that provides financing to the other joint venture participant on favourable terms. This type of joint venture has an obvious appeal to the joint venture participant providing the financing. If the other joint venture participant defaults under the joint venture agreement, the joint venture participant that provided the financing could simply step into the shoes of the defaulting joint venture participant. It could foreclose and become the owner of the entire interest or sell the interest of the defaulting joint venture participant.

If the shotgun were reversed and the joint venture participant that provided the financing were bought out, such joint venture participant could invoke the "due-on-sale" provision contained in the loan agreement and thereby extricate itself from the situation in which it held a mortgage on an undivided interest in the project in which it was no longer a joint venture participant. It may well be that the terms of the financing provided by a joint venture participant appeared favourable at the time the financing was put in place but, due to a subsequent decline in interest rates, becomes less favourable to the borrowing joint venture participant. In order to guard against this possibility, the borrowing joint venture participant may wish to ensure that the joint venture agreement contemplates a pre-payment privilege in the event of a buy-sell shotgun being invoked, thus permitting the unfavourable financing to be discharged and new project financing to be arranged at the prevailing lower rate of interest.

Separate Mortgaging

In some circumstances, a joint venture participant having considerable equity in the project will want to cash out some of that equity to invest for other purposes. To address this eventuality, joint venture agreements often permit the joint venture participant to mortgage its separate, undivided interest in the project in favour of a third-party lender as security for a loan.

In such a situation, the non-mortgaging joint venture participant will want to ensure that there is a cap on the principal amount and interest rate, and that there are other terms specified in the loan arrangement with the third-party lender protecting the non-mortgaging party. Among these terms are the following:

• The third-party lender will be required to agree that if it assumes ownership, possession or control of the interest of the mortgaging joint venture participant, the lender will perform the obligations of the mortgaging joint venture participant under the joint venture agreement.
• The non-mortgaging joint venture participant will require the third-party lender to provide written confirmation of the amount required to pay out the loan, so that the non-mortgaging joint venture participant has the assurance that, upon payment of such amount, it will be able to obtain a discharge of the mortgage in the event the mortgaging joint venture participant fails to do so.
• The non-mortgaging joint venture participant will want to know who is holding the mortgage, and will not want the mortgage to be assigned or syndicated.
• If the third-party lender were to enforce its security, the non-mortgaging joint venture participant will want to ensure that such lender is bound by the right of first refusal and the other restrictions on transfer contained in the joint venture agreement. Many lenders will be reluctant to be bound by the right of first refusal provisions contained in the joint venture agreement when realizing on their security; however, the nonmortgaging joint venture participant will want to insist that this be the case.
• The non-mortgaging joint venture participant will want to ensure that if the third-party lender were to sell the interest of the mortgaging joint venture participant under power of sale (i.e., a sale by the creditor) or judicial sale, the purchaser of such interest executes and delivers an assumption agreement agreeing to be bound by the provisions of the joint venture agreement.
• Often, the non-mortgaging joint venture participant will want the third-party lender to provide it with written notice of any default by the mortgaging joint venture participant under the loan and an opportunity to cure such default.

While the non-mortgaging joint venture participant is concerning itself with the nature of the loan arrangement with the third-party lender, the lender will be familiarizing itself with the joint venture documentation, particularly to determine whether there is a buy-sell shotgun that would permit it to either purchase the entire project or be bought out on terms acceptable to it if it were to enforce its mortgage security.

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.