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Francis N.J. Taman and Ksena J. Court

It is interesting how a bit of time can change one’s perspective. We review a number of current services trying to keep current on new foreclosure and insolvency decisions.  When Zypherus Holdings Inc. v. Dorais Estate[1] was reported by one of the current services recently, we looked at it with some interest. Court of Appeal cases dealing with foreclosure issues are uncommon.  When we pulled it up, it turned out to be a 2013 case that Francis had looked at as a possible blog topic when it first came out.  Rereading it, it became evident that the case was far more significant than it had appeared to be at first glance in that it contained a bit of obscure law that had the potential to significantly impact lenders who are trying to do workouts with clients.

The facts of Zypherus are a bit unusual.  S and D were co-owners of equal undivided interests in two properties.  D needed some funds and got S to agree to take out a second mortgage on the properties to obtain those funds.  The debt under the mortgage was joint and several.  To protect S, who received no real benefit from the loan, D executed an indemnity agreement in favour of S guaranteeing payment of the entire debt under the mortgage.  When the mortgage matured, D couldn’t repay.

Rather than repay the mortgage himself, S bought the debt and mortgage through a holding company called Zypherus.  A writholder of D’s registered their writ against the title to the properties, making it impossible for D to transfer his interest to S unencumbered.  D passed away and his estate declared bankruptcy.  S had Zepherus release him and then tried to foreclose solely on D’s joint interest in the properties.

The Master refused to grant the foreclosure order on the basis of marshalling, a legal doctrine relating to the order in which a creditor can recover its debt when it has security on multiple properties.  At the Justice and Court of Appeal levels, the argument surrounded the release of S by Zypherus.

The interesting part of the decision at the Court of Appeal surrounds its discussion of the law relating to the release of a co-debtor (or co-obligor).  The basic rule of law is that if two debtors are jointly or jointly and severally liable to another person (the “Releasing Party”), and the Releasing Party signs a release with one of the debtors, the effect of that release is to release both debtors.  It is irrelevant that it may not have been the intention of the Releasing Party to do so.  Over time, the Courts recognized that this is perhaps somewhat harsh and developed some exceptions.  One exception is where there is clear wording in the release that shows the Releasing Party intended to reserve their rights against the other joint or joint and several debtor.[2] In this particular instance, the majority of the Court of Appeal presumed such wording existed in the release because the release was not put into evidence and the appellant had acknowledged in their factum that it was not defective.[3]

It’s quite alarming that it is possible for a Mortgagee’s decision to settle with one of two joint debtors could effectively eliminate the right of recovery against the other.[4]  The saving grace is that normally one is more likely to release a guarantor than a joint debtor.  Those are unconnected obligations, so the principle does not apply.  But even then, there remains the potential for a lender, if there is a joint and several guarantee, to inadvertently release the deep pocketed guarantors when settling with a guarantor who has very little in the line of wealth.  Thankfully, most guarantees include wording that permits one guarantor to be released without the other guarantor also being released.   While the traditional common law rule did not permit one to look outside the release, it appears at least in Alberta,[5] that such wording in other documents can be considered, at least with respect to guarantees.[6]  Those looking to rely upon documents other than guarantees may face various public policy arguments as to whether such rights can be waived.[7]

The takeaway for lenders is that caution is necessary when settling with some debtors but not others.  The nature of the debt and of the obligations needs to be analyzed as do the various pieces of security granted to the lender. If it is potentially joint or joint and several liable, a great deal of care needs to be taken in drafting any settlement documents.  Otherwise, you risk giving up more than you bargained for.

[1] 2013 ABCA 287 (“Zypherus”).  Leave for appeal to the Supreme Court of Canada has been denied so we will not have their perspective on the issue, which is unfortunate for lenders engaging in inter-jurisdictional loans.

[2] Another exception is where instead of releasing the one joint debtor, you enter into an agreement not to sue the joint debtor who you wanted to release.  Since an agreement not to sue is not technically a release, the law regarding release of joint debts does not apply.  For more on this odd bit of law, see G.L. Williams, Joint Obligations (London: Butterworth, 1949).

[3] Interestingly, the wording in the mortgage permitting release of the Mortgagor was not discussed by the majority, though the dissenting Justice held that the wording in the mortgage did not support the release of just one of the Mortgagors.

[4] To be clear, this applies regardless of the number of joint debtors.  The idea is that there is a single debt owed by all the debtors collectively, so to release the debt for one releases it for all, unless the right to sue is somehow preserved.

[5] Other jurisdictions need to be approached with some caution.  In Ontario, for example, it appears that the common law rule regarding the release of joint obligors has been abolished by statute – see Courts of Justice Act, R.S.O. 1990, c. C.43, s. 139(1).  In British Columbia, Shoker v. Vollans, 110 B.C.A.C. 225 suggests that, at least where a co-guarantor has paid their proportionate share of their obligation under a guarantee, they may be separately released without affecting the obligation of the other joint or joint and several guarantors.

[6] Re: Koska, 2003 ABCA 87.  This appears to be the sole Alberta Court of Appeal decision on the issue. Interestingly enough,  Re: Koska, was not cited in Zypherus.

[7] See the dissenting decision in Zypherus at 62.