In this issue:
- Mistaken Discharge and Loss of Priority Remedied By Equity (British Columbia)
- Spotlight on Security Documents: The Tenant's Acknowledgement / Estoppel Certificate (Alberta)
- Guarantees Included Within Mortgages Entitled to Longer Limitation Period in Ontario
- Update on Ontario PPSA Computer Conversion
- A Banker Asked Us: Making Guarantors Parties to the Loan Agreement
Mistaken Discharge and Loss of Priority Remedied By Equity (British Columbia)
A recent British Columbia Supreme Court case illustrates the dangers posed by a technical loophole in the British Columbia Personal Property Security Act ("PPSA") and, at the same time, provides some hope for secured creditors who may have fallen victim to the loophole—losing their registered security interest through no fault of their own.
In KBA Canada1, the Court considered whether a mistakenly discharged security interest could be given priority despite the strict priority regime in place under the PPSA.
The facts were not overly complex. The Plaintiff KBA Canada, Inc. ("KBA") sold printing press equipment to a leasing arm of Wells Fargo, who then leased it to the Defendant 3S Printers Inc. ("3S"). As part of the sale to Wells Fargo, KBA agreed it would purchase and take an assignment of the lease if 3S defaulted. Upon making the lease, Wells Fargo registered a valid Purchase Money Security Interest ("PMSI") against the equipment in the BC Personal Property Registry ("PPR"). 3S defaulted and pursuant to the sale agreement KBA took an assignment of the lease and security interest from Wells Fargo. Wells Fargo was deleted and KBA was formally substituted as the secured creditor in the PPR registration. Subsequent to the sale transaction, in what appears to be simply an administrative error, Wells Fargo discharged the registered security interest in the PPR. KBA did not approve this discharge, nor did it have knowledge of it at the time. KBA eventually learned of the mistake after which Wells Fargo immediately re-registered the financing statement. The re-registration occurred after the statutory 30-day grace period for the reversal of mistaken discharges. As a result, by the strict operation of the priority regime under the PPSA, KBA lost its PMSI priority to the two prior registered general security holders. KBA sued to regain its priority.
The Court noted it odd that someone other than KBA could discharge KBA's PMSI, but neither the PPSA legislation nor the standard practice of BC Registry Services, which administers the PPR, have any safeguards to prevent this from happening. Evidence was deposed by the Deputy Registrar that there is "no system notification or administrative process to ensure that an application for discharge has been authorized by the registered security interest holder"2.
The source of this unfortunate state of affairs is s. 48 of the PPSA which provides that:
s. 48 A registration may be effected in the registry without proof that
(b) the registering party has authority to submit the discharge.
The Court found that the registry treats a discharge as a registration.
KBA argued successfully that despite the discharged registration, it was entitled to regain its priority by the operation of ss. 68 and 70 of the PPSA and the principles of unjust enrichment.
The Court held that ss. 68 and 70 of the PPSA allow the Court to apply principles of equity and fairness, and exercise limited discretion in determining priorities between secured interests. In this case, the Court determined that the circumstances were such that it would be unjust to punish KBA while granting a windfall to the general security holders.
It is important to consider the specific circumstances which allowed for the favourable result for KBA. The registration was discharged in error and no notice of it was received by KBA. Furthermore, no further secured advances were made by any of the affected parties after the discharge. As a result there was no prejudice whatsoever to the remaining secured creditors by the court granting the result it did. Rather, if the Court did not act the remaining creditors would receive a windfall.
This decision is a good reminder that exceptions may be made to the strict priority regime under the PPSA and that unregistered interests may be given priority over registered interests—but only in very limited circumstances. It is also a good illustration of a weakness in the PPSA/PPR system, and a reminder that creditors should be ever vigilant in maintaining and verifying their registrations.
*Lorena Vlad is a law student at the University of British Columbia. She summered with Gowlings in 2012 and will be returning to Gowlings as an articled student after her graduation in 2013.
1 KBA Canada, Inc. v 3S Printers Inc., 2012 BCSC 1078 ["KBA Canada"].
2 KBA Canada, at paragraph 20
Spotlight On Security Documents: The Tenant's Acknowledgement / Estoppel Certificate (Alberta)
By: Brian Twerdoff (Calgary)
Due to a lender's reliance upon the income streams associated with real property to be used as security in a commercial mortgage financing transaction, the leases that exist upon a borrower's property are the most important assets of that borrower next to the value of the land to be mortgaged. As those leases are a key element of the security taken by a lender in connection with a financing, a lender would do well to carefully assess their value in evaluating the risk associated with the financing transaction.
An Estoppel Certificate, also known as a Tenant's Acknowledgement or Status Statement, serves as independent verification to a lender of the terms and status of a particular lease of land from the tenant's perspective, enhancing a borrower's disclosure to a lender. Although they are not immune from challenges, these documents can serve to prevent a tenant from making claims in the future which are inconsistent with the certificate regarding matters that existed prior to the date of the certificate.
The strength of a borrower's leases will factor into the decision to provide financing and an Estoppel Certificate can assist in assessing a lease's value by providing a lender with a current snapshot of a lease, confirming its terms, parties and any outstanding current obligations. They bolster the disclosure of the borrower by revealing whether a landlord borrower is liable for items such as completing "Landlord's Work" and making payments to the tenant in the form of a tenant improvement allowance. This information can be used by a lender as a baseline in assessing risk and provide a window into the operational realities of the landlord/tenant relationship that are not discoverable by a review of the lease documentation and rent roll alone. This allows a lender to have a clearer picture of the revenue streams it can expect to receive in the event it must enforce its security.
Estoppel Certificates also give information to a lender regarding whether there have been defaults by the landlord or the tenant, whether options to extend the term or expand the premises have been exercised, and give an indication of the level of cooperation between the parties. They also allow a tenant to provide its perspective regarding the landlord's ability and willingness to satisfy its obligations.
Subject to the limitations contained in a particular lease, an Estoppel Certificate should typically contain the following provisions:
- Certification that the lease is valid, unmodified, in full force and effect and is presently in good standing
- A statement as to whether the tenant has accepted and taken possession of the premises
- Confirmation of the commencement date, the expiry of the term and any renewal rights the tenant may have
- A statement as to whether the tenant has sublet all or any portion of the premises
- An acknowledgement as to the basic rent for the term, whether there are any prepaid rent or security deposits and the date to which the rent has been paid
- Confirmation as to whether there are defaults under the lease by the landlord or the tenant that remain outstanding or uncured
- A statement that any improvements that the landlord is responsible for have been satisfactorily completed or, in the alternative, a list of outstanding items
- A declaration as to whether the tenant has any expansion, contraction, renewal, termination or purchase options and whether such options have been exercised
- A statement that there is no existing dispute, claim, set-off, defence or counterclaim by or against the landlord; and
- A statement that there are no allowances, incentives, inducements, or benefits or money owing or which may become due to the tenant under the lease
Overall, having a number of comprehensive Estoppel Certificates prior to closing will provide a lender with a level of enhanced disclosure of the details of its borrower's income stream and lease obligations to supplement and support its mortgage security package.
Guarantees Included Within Mortgages Entitled to Longer Limitation Period in Ontario
By: Richard Dusome (Toronto)*
A recent Ontario case has confirmed that guarantees included within registered mortgage documents enjoy the longer limitation period of ten years available under the Real Property Limitations Act1 rather than the standard two year limitation period for traditional guarantees under the Limitations Act, 20022.
The Marsig3 case arose from a motion for summary judgment made by the defendant guarantor ("Mr. Marsig") to dismiss a claim made against him on his guarantee of a mortgage which had gone into default. The mortgagee ("Equitable") had sued Mr. Marsig for the deficiency arising after the completion of its power of sale proceedings. Mr. Marsig had argued that his guarantee was a demand obligation, and that all demand obligations, including guarantees within a mortgage document, are governed by the Limitations Act, 2002. He submitted that the action against him on the guarantee was therefore statute-barred under Section 5 of that Act which establishes a general two year limitation period for all demand obligations. Mr. Marsig's initial motion was dismissed and he appealed.
The Court of Appeal dismissed the appeal, finding the Real Property Limitations Act was the governing statute, not the Limitations Act, 2002, stating the legislature clearly intended that all limitation periods affecting land be governed by the Real Property Limitations Act. Thus, the fact that almost three years had elapsed between the time the notice of sale under mortgage was served on the guarantor (which was held to constitute a demand for payment), and the commencement date of the action for the deficiency claim, was irrelevant as the operative limitation period was ten years, not two years.
In support of its ruling, the Court noted that it would cause more confusion and uncertainty in the law if the limitation period for enforcing a mortgage debt was different from the limitation period for enforcing a guarantee of that debt4. The Court determined that mortgagees confronted with a shorter limitation period for the guarantee than for the mortgage debt would undoubtedly sue and attempt to collect the whole debt outstanding from the guarantor first to preserve the limitation period.5 Such action would be taken rather than proceeding in a more cost effective manner to realize on the security over the real property first, and then suing the guarantor only for the deficiency as Equitable had done in this case.6 The Court found this would be an undesirable situation for mortgage guarantors generally.
Section 43(1) of Real Property Limitations Act is drafted fairly broadly such that the ten year limitation period applies to any action upon a covenant contained in an indenture of mortgage, or "any other instrument made ... to repay the whole or part of any money secured by a mortgage". As such, the reference to any other instrument might be interpreted as making the ten year limitation period available to stand-alone guarantees relating specifically to real property, even though the guarantee is not embedded within the registered document itself. In Marsig, the Court did not have to address that issue based upon the facts before it. However, extending the Court's reasoning and statements that limitation periods affecting land were intended to be separate and distinct from general limitation periods, it seems likely that the Court would interpret Section 43(1) as extending to a stand-alone guarantee provided it relates solely to a mortgage debt. Until we have a case on that specific point however, the better practice for lenders wishing to lock in the benefit of a longer limitation period would appear to be to include any such guarantee within the registered document itself.
*Nate Appleton, an articling student in the Toronto Office, also contributed to this post
1 Real Property Limitations Act, R.S.O. 1990, c. L. 15, as amended.
2 Limitations Act, 2002, S.O. 2002, c. 24, Sch. B, as amended.
3 The Equitable Trust Company v. Marsig et al., 109 O.R. (3d) 561 ["Marsig"].
4 Marsig, at page 568
5 Marsig, at pages 568-9.
6 Marsig, at page 569.
Update on Ontario PPSA Computer Conversion
By: Richard Dusome (Toronto)*
In an earlier edition of Fully Secured (July 14, 2010 - Volume 1, No. 1), we reported on the Ontario Government's deferral of the August 1, 2007 amendment to the Ontario PPSA which was designed to repeal the "Check the Box" system used on financing statements to identify the collateral charged. A new system requiring full collateral description narratives similar to that used in most other provinces and in the United States had been proposed. However, the implementation of that replacement system has been deferred to provide the Ministry with time to modify its PPSA computer search and registration system to accommodate the narratives.
The initially contemplated two year implementation period has now stretched into five years and counting. Based upon our discussions with Ministry officials, no implementation date has been set, and so far as we are aware, no regulations, Minister's orders or Registrar's orders have been drafted to effect the change. Therefore, it seems we will be using with the "Check the Box" system for a while longer. We will continue to monitor this matter and report on future developments.
*Nate Appleton, an articling student in the Toronto Office, also contributed to this post
A Banker Asked Us: Making Guarantors Parties to the Loan Agreement
By: Richard Dusome (Toronto)
The bank is obtaining several guarantees for a new loan in Ontario secured on personal property.Do I need to make each of the guarantors signatories or parties to the commitment letter or loan agreement?
As a general rule, it is always a good practice to include guarantors as signatories on the principal documents evidencing a loan.
Corporate guarantors and other business entities within the borrower's corporate group should be made parties to the commitment letter or loan agreement. In most cases these guarantors will be providing unlimited guarantees and joining in some, if not all, of the representations, warranties and covenants of the borrower. Making them parties to the loan agreement will ensure that they cannot claim they were unaware of the terms of the debt they are guaranteeing. As parties to the principal loan document, they will also be parties to any amendment to that document and will thereby be consenting to the terms of that amendment and the impact of those amended terms on their guarantees.
For guarantors providing guarantees that are either limited in amount or limited in recourse to certain assets, these guarantors must also be made parties if they are joining in some of the representations, warranties and covenants of the borrower. However, if they are not joining in those provisions, both the guarantors and the borrower will probably request that the guarantors not be included as parties. The guarantors will probably wish to avoid all the negotiations and circulation of document drafts prior to signing. In addition, the borrower will likely wish to avoid involving these guarantors in its affairs until the business deal has been settled. In these instances however, it will be necessary to ensure a guarantor's written acknowledgment is obtained to every post-closing amendment to the commitment letter or loan agreement.
For guarantors who are individuals, it is appropriate to have them be parties to the principal loan document where those individual guarantors are also officers or directors or shareholders of the borrower and have a close connection to its operations. If these individuals do not have that connection, then once again the borrower will likely wish to avoid making them parties and to avoid involving them in the transaction until the business deal with the lender has been settled. Provided all appropriate certificates of independent legal advice are obtained at the time of the execution and delivery of the guarantee, and periodic guarantor's acknowledgments are obtained on amendments and for the passage of time, those unconnected guarantors need not be parties to the principal loan document. Indeed, they will likely be limited guarantors or limited recourse guarantors in any event.
Overall, including guarantors as signatories on the principal documents evidencing a loan is a good approach unless client relationship issues or special circumstances like those described above exist.
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.