Canada: Get Your Priorities Right: Arrears Of Prior Mortgages Before Liens

Overview

The Court of Appeal for Ontario recently confirmed that where a mortgage has priority over a construction lien, all related mortgage interest, enforcement fees and other expenses will have priority over the lien, even if the mortgage-related fees, charges and expenses arise after the lien arises.

Facts

In Scott, Pichelli & Easter Limited v. Dupont Developments Ltd., 2022 ONCA 757 (CanLII), the appellants are construction lien claimants who, along with several other service providers, registered liens against the subject property in 2013. The respondents are the mortgagees under a vendor-take-back mortgage registered on title to the property before the date on which the first lien arose.

In 2015, the property was ordered to be sold under power of sale pursuant to the Amended and Restated Approval and Vesting Order of Newbould J. The order required the lesser of the net proceeds of sale or the sum of $1,289,524.14 be paid into court, pending resolution of the priority dispute between the construction lien claimants and the vendor-take-back mortgagees.

The problem for all parties was that the net proceeds of sale that were paid into court fell far short of what was required to satisfy all claims. The total net proceeds paid into court were $608,119.43. From that, $195,896.27 was paid to the mortgagees following settlement of four of the lien claims, thereby reducing the amount held in court to $412,223.16.  The balance of the lien claims were valued at $329,135.43. The mortgagees claimed arrears in interest in the amount of $429,104.15, enforcement expenses in the amount of $463,892.46, and $108,676.64 for other charges.

In considering the above, if the lien claimants were successful, then they would stand to recover the full amount of their liens at $329,135.43, leaving the balance for the mortgagees; but, if the mortgage interest has priority, then all the remaining funds would go to the mortgagees.

Judicial History

After the vesting order was issued and the sale proceeds paid into court, the judicial saga to determine priority between the lienholders and mortgagees is summarized as follows:

Master Albert found that the mortgage principal, together with interest and related charges, have priority over the lien claims (Cam Moulding & Plastering Ltd. v Dupont Developments Ltd. 2018 ONSC 3126).

The lienholders then brought a motion before Sossin J. seeking to oppose confirmation of the report of Master Albert (Scott, Pichelli & Easter Ltd. et al. v. Dupont Developments Ltd. et al.,  2019 ONSC 4555). Sossin J. found that the mortgagees' entitlement to the value of the actual mortgage funds advanced (together with legal expenses and expenses directly relating to the sale of the property and property taxes) took priority over the liens but the lien claims had priority over the mortgage interest arrears and other enforcement charges. Sossin J. affirmed this decision on a request for reconsideration (2019 ONSC 6789).

The Divisional Court (per Sutherland J.) then reversed the motion's judge findings and restored Master Albert's ruling ( 2021 ONSC 6579). The Court of Appeal (per Lauwers J.A.) dismissed the appeal and upheld the Divisional Court's ruling ( 2022 ONCA 757).

Analysis

The dispute in this matter centres around the interpretation of section 78 of the Construction Act, R.S.O. 1990, c. C.30, as amended by the Construction Lien Amendment Act, S.O. 2017, c. 24.

Subsections 78(1) and (3), read together, create a priority in favour of lien claimants over the interests of mortgage lenders for all purposes unless one of the exceptions applies. Mortgages registered prior to a lien claim are an exception. A lien claimant does not have priority over a prior registered mortgage where the amount advanced under the mortgage was not more than the value of the property when the first lien arose.

In the Court of Appeal's decision, Lauwers J.A. noted that the purpose of the Construction Act  is to protect lien claimants by ensuring that they are compensated for the increase in the value of a property to which their work contributed. But this purpose is hedged about with exceptions, including mortgages.

The lienholders took the position that a literal interpretation of the language of subsection 78(3)(b)(i), which protects only amounts that were “advanced in the case of a mortgage,” would render the mortgage subordinate to the liens.

First, the lienholders argued that a vendor-take-back mortgage is not a mortgage in which an advance of cash has taken place. Accordingly, the entire mortgage amount is subordinated to the interests of lien holders.  This argument was rejected on the basis that it would impair the use of vendor-take-back mortgages in the real estate market. A vendor-take-back mortgage is therefore the equivalent of an advance for the purposes of the Construction Act.

Second, the lienholders argued that interest and other costs are not advances of funds to the mortgagor and are accordingly not given priority over liens under the Construction Act.   In rejecting this argument, the Court of Appeal relied upon the Supreme Court of Canada's decision in M. Sullivan & Son Ltd. v. Rideau Carleton Raceway Holdings (“M. Sullivan”) that “[p]rincipal and interest are equally secured under the mortgage. The right to interest is an essential, inseparable, constituent part of the advance made on account of the mortgage.”

Although M. Sullivan was decided in the context of the Mechanics Lien Act, R.S.O. 1960, c. 233, the Court ruled that the statutory scheme was not sufficiently different than the Construction Act to distinguish M. Sullivan from the facts in this case. From a practical perspective, the Court noted that the proposed approach by the lienholders would introduce a “sea change in risk” on purchase money mortgagees, who might then be required to actively monitor properties to ensure that improvements made by owners did not deplete the mortgagee's entitlement to payment for interest.

Conclusion

The priority that a prior mortgage has over lien claims extends to arrears of interest and related charges under section 78(3) of Ontario's Construction Act.

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.