Canada: Legal Implications Of Possession In The Context Of Mortgage Default

Copyright 2008, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Real Estate Mortgage Enforcement, October 2008

The lender's decision to take possession of the mortgaged property upon the borrower's default can have important implications.

Redemption

By going into possession, the lender may trigger the right in favour of the borrower or subsequent encumbrancer to redeem the mortgage without paying yield maintenance in some circumstances. However, the courts have held that the issuance by a lender of a statement of claim for possession, in the absence of any further action, does not itself constitute a further proceeding to enforce the mortgage and thus did not trigger the equitable right to redeem.

Further Proceedings

Taking possession of the mortgaged property would constitute a "further proceeding" within the meaning of Section 42 of the Mortgages Act (Ontario). Accordingly, the lender cannot take possession of the mortgaged property without the leave of the court during the time period given to a borrower for payment pursuant to a demand or a notice of sale. Therefore, if control of the mortgaged property is vital, it may be more prudent for the lender to take possession of the mortgaged property prior to issuing a notice of sale since the taking of possession or the proceedings to obtain possession would constitute a "further proceeding".

Assignment of Mortgage

Taking possession of the mortgaged property will prevent the borrower or a subsequent encumbrancer from taking advantage of the benefits of Section 2 of the Mortgages Act (Ontario) which permits the borrower or subsequent encumbrancer to call for an assignment of the mortgage.

Denial of Relief

If an action has been commenced to enforce the mortgage, the granting of judgment in that action, coupled with the taking of possession by the lender, will result in the denial of relief otherwise afforded to the borrower and subsequent encumbrancers to put the mortgage back into good standing under the provisions of Section 23 of the Mortgages Act (Ontario).

Defences and Parties

A tenant in lawful possession may have valid defences against a lender's action for possession. A borrower's spouse, having rights to the matrimonial home under the Family Law Act (Ontario), is a mandatory party to any mortgage action and should be named as a party in an action for possession in the absence of evidence that the mortgaged property has never been a matrimonial home.

Lender's Obligations

Once in possession of the mortgaged property, the lender incurs the obligations of a mortgagee in possession and is liable to account for the revenues that were or should have been received from the mortgaged property. The lender should take reasonable steps to secure the mortgaged property against vandalism and the elements. As well, the lender should arrange for the mortgaged property to be adequately insured and inspected on a frequent basis.

Construction Projects

If the defaulting borrower is in the process of constructing and/or developing the mortgaged property, the lender will most likely want to take possession of the mortgaged property and complete such construction and development. This is usually done through the appointment of a receiver who is brought in to manage the mortgaged property. The lender will, presumably, have obtained adequate contractual rights to enable it to complete any construction. For example, at the time of financing, in addition to obtaining a charge over all assets and undertakings of the borrower relating to the construction project, the lender should have obtained an assignment of all contracts which would allow the construction to proceed. If that is not the case, the borrower may take steps to prevent the lender from completing the construction and development or from adding the costs of same to the mortgage debt.

Repairs

The lender has not only the right but also the duty to make all necessary and proper repairs to maintain and preserve the mortgaged property and to prevent waste. A lender will be liable for all damages occasioned by gross negligence in repairing the mortgaged property.

However, the lender is liable for neglect to repair only if there is a surplus of rents after payment of interest on the mortgage. The lender is not bound to expend its own monies on repairs. As such, the lender is only bound to make such repairs as may be repaid by the rents or receipts after the lender's interest has been repaid. Nevertheless, the court will not allow the lender to recover the cost of repairs and improvements where it appears that the lender is over-improving the mortgaged property in an attempt to prevent the borrower from redeeming the mortgaged property.

Management and Operations

A lender in possession cannot itself charge a commission for the collection of rents. A lender in possession may, however, in appropriate circumstances, appoint an agent to collect the rents and charge the cost of the agent against the mortgaged estate. The lender has the onus of satisfying the court that the appointment of a manager was reasonably necessary. A fee of 5% of the rents received has been held to be acceptable. A lender in possession has only a limited role in the operation of the mortgaged property. In the absence of express provisions set forth in the mortgage, the lender will not have the right to carry on the business of the borrower, unless the mortgage contained a floating charge on the undertaking, property and assets of the borrower.

Leasing

So long as the lender in possession has not interfered with the borrower's right to redeem the mortgage, the lender has the right to lease the whole or any portion of the mortgaged property. In addition, most standard form mortgages contain a power to lease as well as a power of sale. Where the term of the lease did not expire until after the time fixed for redemption, and the mortgage by its terms gave the lender a power to lease the mortgaged property, the courts have held that the valid exercise of the power to lease created in the new tenant an interest in the land and, in the absence of fraud, there was no power in the court to interfere with the power to lease.

Continuing Obligations of Lender After Taking Possession

Having taken possession of the mortgaged property, the lender is required to continue to perform the obligations imposed upon the lender. The lender is not entitled to relinquish possession of the mortgaged property without the consent of the borrower or the approval of the court. Generally, the court will not approve the appointment of a receiver simply to relieve a lender which has taken possession of the mortgaged property of its responsibilities.

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.