Copyright 2011, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Real Estate, May 2011
Bare trustees or nominees are often encountered in mortgage lending situations. Both borrowers and lenders need to know how to deal with a bare trustee in order to avoid potentially serious consequences.
What is a Bare Trustee?
A bare trustee, or nominee, arrangement exists where:
- the bare trustee has no significant powers or responsibilities and can take no action without instructions from the beneficiary;
- the bare trustee's only function is to hold registered title to the property; and
- the beneficiary can cause the property to revert to it at any time.
Where real property is held by a bare trustee, the beneficiary is considered to be the owner of the property for all tax, economic and accounting purposes. Bare trustees or nominees may hold registered title to real property for a variety of reasons. For example, the beneficial owner may not be a legal entity that is capable of holding title in its own name, such as a real estate investment trust or partnership.
Lending Transactions involving Bare Trustees
In lending transactions involving bare trustees, the transaction can be structured either as a loan to the beneficial owner or as a loan to the bare trustee, provided in each case that certain important factual and legal considerations are borne in mind and dealt with appropriately.
Loan to the Beneficial Owner
Where the transaction is structured as a loan to the beneficial owner, the most important factual consideration is that the beneficial owner is not the registered owner of the property, yet the lender will wish to register its security against title to the property. A link must be established between the beneficial owner and the bare trustee. This is commonly accomplished by having the beneficial owner execute an authorization and direction by which the beneficial owner:
- authorizes and directs the bare trustee to execute and deliver the registered mortgage security;
- agrees to be bound jointly and severally with the bare trustee by all of the covenants and obligations of the bare trustee contained in the registered mortgage security; and
- charges its beneficial interest in the property in favour of the lender on the same terms and conditions as the terms and conditions contained in the registered mortgage security.
In the same document, the beneficial owner should represent and warrant to the lender that it is the sole beneficial owner of the property and has the power to mortgage the property.
It is not necessary to characterize either the bare trustee or the beneficial owner as a guarantor in establishing the linkage between them, and this should be avoided. The law relating to guarantees is complicated and, in some cases, uncertain. Numerous defences are available to guarantors that are not available to primary debtors. Both the bare trustee and the beneficial owner should be characterized as primary debtors.
Loan to the Bare Trustee
The transaction may equally be structured as a loan to the bare trustee. In this structure, however, it is important not to overlook or to ignore the existence of the beneficial owner. The same authorization and direction should be obtained from the beneficial owner as in the structure involving a loan to the beneficial owner. Some of the unwelcome consequences – at least from the lender's perspective – that can arise from ignoring the existence of the beneficial owner are as follows:
As a general rule, an undisclosed principal can be sued on a
simple contract entered into on his or her behalf by an agent or
bare trustee. However, this general rule does not apply in the case
of contracts under seal. By virtue of the "sealed contract
rule", an undisclosed principal can neither sue nor be sued on
a contract executed by its agent under seal. Only the parties to
such a sealed contract can have obligations and rights with respect
to it. Under Ontario law, a mortgage
constitutes a sealed contract whether or not it was in fact signed under seal. By virtue of section 13(1) of the Land Registration Reform Act (Ontario), all Ontario mortgages not executed under seal are deemed to have the same effect for all purposes as if executed under seal. Accordingly, if a loan is made to a bare trustee without also binding the beneficial owner, the lender would not be able to maintain an action on the covenant against the beneficial owner unless there was also some unsealed document by which the loan could be established.
Know Your Client Obligations
Under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (Canada), most lenders are obligated to abide by record-keeping and client identification requirements for borrowers and other customers. Under section 9(1) of the financing regulations to the Act, every person that is required to keep a signature card in respect of an account is required, at the time that account is opened, to take reasonable measures to determine whether the account is to be used by or on behalf of a third party. Generally speaking, lenders that constitute "financial entities" under the Act will be required to open an account and to keep a signature card in respect of any mortgage loan and so will be obliged to undertake reasonable enquiries regarding the beneficial ownership of the mortgaged property. It is therefore no excuse for a lender simply to ignore the existence or possible existence of a beneficial owner, and proceeding in this manner could lead to criminal or administrative penalties under the Act.
Due Diligence Omissions
In transactions involving bare trustees, all of the same credit, legal and due diligence enquiries that would ordinarily be made with respect to the registered owner should also be made with respect to the beneficial owner. Thus, there should be searches against the beneficial owner under corporate and bankruptcy statutes, the Personal Property Security Act (Ontario) and the Execution Act (Ontario). If the lender is aware of the existence of the beneficial owner and its solicitor fails to conduct appropriate searches against the beneficial owner, the mortgaged interest may be or become subject to the interests of competing claimants. In addition, under the Planning Act (Ontario), if the lender has actual notice of the existence of the beneficial owner, its solicitor must conduct applicable searches of adjoining lands under the Planning Act with respect to interests held by the beneficial owner. Failure to do so could result in the lender's mortgage being invalid.
Often, mortgage loans are structured so that the borrower must be a single-purpose vehicle. The idea is to insulate the loan and the lender from the competing interests of other creditors in a bankruptcy. Sometimes lenders fail to consider the effect that the beneficial ownership of real property can have upon this tightly controlled structure. If the lender is aware of a bare trustee arrangement and chooses to ignore it in circumstances where the beneficial owner has other assets and other creditors, the lender's single-purpose vehicle structure will not be effective.
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.