Good news for mortgagees has arrived with the July 2006 decision of the BC Supreme Court in CMIC Mortgage Investment Corporation v. Virdi et al. The Court concluded that a mortgage granted by a borrower who had forged a transfer of the title to the property to himself was, despite the forgery, a valid charge on the property because the mortgagee relied on the state of title and was a bona fide "purchaser" for value under the Land Title Act (British Columbia). This case establishes that, in the absence of evidence arousing suspicions that a fraudulent transfer has occurred, mortgagees may rely on the state of title as conclusive evidence of the validity of the title of the property and of entitlement to place a mortgage and will not be required to make further inquiries beyond determining the registered ownership of the property.

Jaspal Virdi ("Mr. Virdi") executed a fraudulent transfer of a commercial property in Surrey owned by his mother ("Mrs. Virdi") to himself. He then registered that transfer in the Land Title Office. He obtained a $215,000 mortgage from CMIC Mortgage Investment Corporation secured against the fraudulently transferred property, and bought a Ferrari with the proceeds. Shortly thereafter, he transferred the title back into his mother’s name and registered that transfer in the Land Title Office. Not surprisingly, the fraudster soon defaulted on the mortgage and left his poor mother to defend the foreclosure petition CMIC initiated in December 2004.

Mrs. Virdi argued that (a) the mortgage should be set aside because her son did not have a beneficial interest in the property since he had forged the transfer of legal title and had registered that fraudulent transfer and (b) CMIC knew or ought to have known that the mortgage was obtained through fraud and that Mr. Virdi was not the owner of the property.

In response to these arguments, the Court said that Mrs. Virdi had to show that CMIC "participated in the fraud". The Court said that she needed to establish that CMIC’s suspicions were aroused, and that it should have taken further steps and made additional inquiries into the problem but failed to do so.

Mrs. Virdi set out the following circumstances that she argued should have put CMIC on notice that the state of the title was in issue and that further investigations were warranted:

1. CMIC knew that her son was intending to use the mortgage proceeds to buy a Ferrari;

2. her son was anxious to get the mortgage proceeds;

3. her son had a low credit rating and the only credit cards he had were from department stores;

4. the reference letters provided as proof of income on the property did not have phone numbers on them; and

5. Mr. Virdi’s sister had told the mortgage broker, who advised the CMIC director involved in approving the mortgage, that Mr. Virdi "should not be putting a mortgage on the property."

The Court considered all five of these circumstances, finding that on the facts of the case, none of them should have aroused CMIC’s suspicions that Mr. Virdi did not own the property against which he wanted to secure the mortgage. CMIC understood that Mr. Virdi was buying the Ferrari for resale, and that for that reason, the mortgage was to be short term with interest only payments. CMIC also understood that Mr. Virdi had recently been given the property by his parents and that his low credit limit and few credit cards arose because he lived at home and had just obtained a job and the property. CMIC attributed Mr. Virdi’s anxiousness to close on the mortgage to its further understanding from Mr. Virdi that the Ferrari was only available for a short period of time at the negotiated price. As a result, the Court found that there was no evidence that CMIC failed to make inquiries for fear of learning the truth.

The Court concluded that Mrs. Virdi did not prove that CMIC should have made further inquiries about the title of the property. The Court said that although it could be said that CMIC’s suspicions were aroused regarding who owned the property, there was no evidence to suggest that there was any suspicion raised that a fraudulent transfer of the property had occurred. The Court pointed to a number of factors that supported CMIC’s view that the transaction was legitimate, and concluded that on the facts and circumstances of this case, CMIC made the appropriate inquiries regarding registered ownership of the property. Once it was determined that Mr. Virdi was the registered owner, no further inquiries were required – CMIC was entitled to rely on the state of the title to the property. The Court declared that the mortgage was a valid mortgage charge on the property and granted judgment in favour of CMIC.

If you have any questions about this case, please call Kerstin Tapping at 604.643.3122 or email krt@cwilson.com.

It is prudent practice for mortgagees of landlord borrowers to obtain tenant estoppel certificates from the landlord’s tenants as part of their security requirements. Estoppel certificates provide independent confirmation from the tenants to the lenders as to the state of accounts under the leases. They contain pertinent information as to the lease terms including, among other things, lease commencement and expiry dates, the status of any defaults under the lease, the status of rental payments, any prepayments of rent, and generally the status of other rights and obligations between the landlord and tenant. In addition, if the lender requires a priority agreement for its mortgage security over the tenant’s lease, the tenant may in return request a non-disturbance agreement ("NDA") from the lender, which will provide assurance to the tenant that if the lender enforces its mortgage security, it will not foreclose the tenant off title provided the tenant’s lease is in good standing. The recent Ontario Court of Appeal decision in 473807 Ontario Ltd. v. The TDL Group Ltd. emphasizes that estoppel agreements and NDAs must be carefully drafted in order to insulate lenders from the potential consequences, including an interruption in the stream of rental revenues, where a mortgagor/landlord has defaulted under a lease agreement.

In 1998, the Tenant, Tim Hortons, leased property from the Landlord. In January 2000, the Landlord granted to its Mortgagee as security a first mortgage on the property and a first assignment of rents. The Tenant and Mortgagee also signed an NDA whereby the Mortgagee agreed, among other things, that if it enforced its security and went into possession of the premises, it would be bound under the lease as landlord and would continue to recognize the Tenant provided the Tenant’s lease was in good standing.

In April 2000, the Landlord posted a termination notice on the door of the restaurant, evicted everyone and tried to close down the business, all without justification. The Tenant obtained an order returning possession to it and successfully sued the Landlord, receiving a judgment for over $700,000. The Court decided the Tenant could set-off its award against the rent it owed to the Landlord under the lease. Soon after, the Landlord defaulted on the mortgage and the Mortgagee took possession. The Mortgagee demanded rent but the Tenant claimed it was entitled to apply its court-ordered set-off against the rent payable.

The Ontario Court of Appeal overturned the lower court decision and held that the Tenant could set-off its award against rents payable to the Mortgagee in possession. The Court stated that the NDA was the key factor in the case: it had been open to the parties to exempt the Tenant’s right of set-off under the NDA, but because they did not, when the Mortgagee enforced its security and took possession, it stepped into the Landlord’s shoes and took subject to the equities between the Landlord and Tenant, including the Tenant’s set-off rights. The NDA did contain a provision that the Tenant was not to prepay rent beyond one month. The Court said this single "carve out" indicated that the Mortgagee otherwise accepted and was bound by the state of accounts between the Landlord and Tenant.

The Court said that the Mortgagee in this case could have protected itself by requesting an estoppel certificate from the Tenant and by negotiating an appropriately worded NDA exempting it from responsibility for the Tenant’s state of accounts with the Landlord and more appropriately allocating the risk of landlord/mortgagor default. The Mortgagee had done neither.

The Court realized the Mortgagee would be deprived of virtually all of the benefit under the balance of the 20-year lease if the Tenant could apply its court-ordered right of set-off against the rents it owed. Although acknowledging that the Mortgagee bore no responsibility for the wrongs done by the Landlord to the Tenant and could not have anticipated that those wrongs would result in a judgment for over $700,000, the Court said its job was not to relieve sophisticated commercial parties such as the Mortgagee from the consequences of bad bargains.

In light of this decision, lenders should make certain that they obtain a tenant estoppel certificate and form of NDA that will preclude a tenant from asserting against its landlord’s lender any rights of set-off the tenant might have against the landlord that arose prior to the date on which the lender succeeds to the interest of the landlord under the lease. Specifically, the form of NDA should include, among other things, a provision that if the Mortgagee succeeds to the interest of the Landlord under the Lease, the Mortgagee will not be liable for any act or omission of the Landlord or be subject to any rights of set-off, defences, claims, counterclaims, abatements or deductions which the Tenant might have against the Landlord.

If you have any questions about this case or NDA provisions, please call Kevin MacDonald at 604.643.3117 or email kjm@cwilson.com.

In Business Development Bank of Canada v. Gahagan, 2006 BCSC 788, Mr. Justice Cole held that advising the defendant guarantor under two guarantees of the default of the borrower and making demand under the guarantees by means of email satisfied the demand requirements of the guarantees.

BDBC sought judgment on two guarantees in respect of the indebtedness of a company, of which the defendant was a minority shareholder. The guarantees required payment on demand and stated, "A demand is effectually made when a letter is posted to the address of the Guarantor last known to the Bank."

The loan fell into arrears. BDBC sent the defendant a demand letter under both guarantees by registered mail to her last known address.

The letter was returned to BDBC because the guarantor had moved shortly after executing the guarantees and had not lived at the address for a number of years. On return of the demand letters, BDBC sent an email to the defendant advising her that it had sent the demand letters to her last known address. It repeated the demand and offered to resend the demands by post to her new address.

The defendant responded to the email through her lawyer, who requested the demand, copies of the guarantees, and other documents. At trial, the defendant argued that BDBC failed to prove it made demand under the guarantees.

The Court granted judgment in favour of BDBC. Sending the demands by regular mail constituted technical compliance with the guarantees which only required delivery to the "last known" address. The Court held that this placed an onus on the defendant to keep BDBC apprised of her current address. The Court also held that the email satisfied the standard to be met when a demand for payment is required under guarantee. Those standards are that there must be an imperative request directed to the guarantor herself (not merely to the principle debtor) that the creditor is now looking to the guarantor to pay.

It appears from the case that the Court would have been willing to accept the demand by email even if the demand letters had not been mailed. The demand provision of the guarantee merely set forth that mailing to the last known address would constitute effectual demand. "Effectual" simply meant that mail was sufficient, but did not mandate that mail was the only means of making demand.

It is always advisable to strictly comply with the notice requirements of any agreement. In the case of a guarantee, it appears the Court may accept other forms of service if not barred by the agreement. The Court will look at substance over form. If it is necessary that a demand must be sent by means not stipulated in the guarantee, it is important to ensure that the demand is sent to the guarantor in the name of the guarantor expressly demanding the guarantor to pay the debt of the principle.

If you have any questions about this case, please call Sean Vanderfluit at 604.643.3176 or email sdv@cwilson.com.