Ksena J. Court and Francis N.J. Taman

Sometimes the race to negotiate pays off.  Servus Credit Union v. JRD Investments Inc.[1] demonstrates how lenders should be cautious when negotiating forbearance agreements with debtors.

JRD Investments Inc. (“JRD”) and Lurch Holdings Ltd. (“Lurch”) were in a joint venture respecting certain lands.  Each owned a 50% interest in the lands as tenants in common.  First and second mortgages were placed against the lands.  Craftex Builders (“Craftex”) was retained to perform renovations to the night club that was operated on the lands, but it wasn’t clear which entity it contracted with.

The joint venture fell behind in its mortgage payments and Craftex did not get paid for its work.  Craftex registered a builders’ lien.  Lurch entered into a forbearance agreement with Craftex, who then opted to carry on with the renovation work.  Craftex did not commence legal proceedings within the statutory requirements and its builders’ lien was discharged from title.  Some further payments were made to Craftex but ultimately it remained fully unpaid.  On August 26, 2016, Craftex commenced legal proceedings against JRD and Lurch for the indebtedness respecting the renovations and for breach of the forbearance agreement.

Meanwhile, Servus Credit Union Ltd. (“Servus”) demanded and commenced legal proceedings on its second mortgage.  It obtained a Redemption Order with a four month redemption period.  During the redemption period, JRD and Lurch agreed that they would each obtain refinancing for half of the mortgages.  JRD obtained its refinancing but Lurch did not.

In January 2017, Craftex brought a motion for summary judgment.  Lurch negotiated an agreement which allowed further time to pay.  As part of the deal, Lurch granted a mortgage to Craftex against its 50% interest in the lands (the “Craftex Mortgage”).  The Craftex Mortgage was signed March 29, 2017.

While Lurch was negotiating with Craftex, it was also negotiating with JRD.  JRD agreed to fully redeem the Servus mortgage with its refinancing.  In exchange, Lurch agreed that it would reimburse JRD for the arrears paid on behalf of Lurch and the legal costs.  Lurch also agreed to grant JRD a mortgage over Lurch’s 50% interest in the lands (the “JRD Mortgage”).  The JRD Mortgage was signed February 16, 2017.

The JRD Mortgage was registered on title on March 1, 2017.  The Craftex Mortgage was registered on March 31, 2017.

Ultimately, the Servus mortgage matured.  Neither party was able to obtain refinancing and the lands were sold in foreclosure proceedings.  After payment of the first and second mortgages, half of the net sale proceeds were paid to JRD as owner.  The issue was whether JRD was entitled to receive the other half of the net sale proceeds pursuant to the JRD Mortgage.  Craftex challenged the JRD Mortgage as being a fraudulent preference under the Fraudulent Preferences Act[2] (the “FPA”) and oppressive under the Business Corporations Act[3] (the “BCA”).

Transactions can be set aside under the FPA if a person makes a transfer knowing that they are insolvent or about to be become insolvent and the transfer is intended to prevent the person’s creditors from recovering their debts or has the effect of preferring one creditor over another.  Although Craftex was a creditor of Lurch at the time the JRD Mortgage was entered into, the Court found that it did not prove that Lurch was insolvent or on the eve of insolvency.  Just because Lurch was not paying its debt to Craftex did not mean that Lurch was insolvent.  The condition of insolvency depends upon an analysis of Lurch’s assets and liabilities, of which there wasn’t any evidence.  It is necessary to provide evidence of other creditors who aren’t paid.  Therefore, the test under the FPA was not met and the JRD Mortgage was not set aside by the Court.

The Court went on to give some guidance on whether there was an intent to prefer one creditor over the other in this instance.  The granting of security can itself be considered to be a preference.  Sometimes the Court will also look for factors which are referred to as “badges of fraud”.  Here, the Court held that the consideration given by JRD for the JRD Mortgage in the form of payment of the arrears was not “grossly inadequate”.  Both JRD and Lurch were acting in their own self-interest and there was no evidence that one entity was subject to pressure or undue influence from the other.  While the effect of the JRD Mortgage was to favour JRD over other creditors, it was not clear that this was the principal intent.  Additionally, the JRD Mortgage also fell within the exception in s. 6(b) of the FPA, which provides that where there is fresh consideration that is fair and reasonable, a transfer won’t be considered a preference.

The Court then addressed whether the JRD Mortgage was “oppressive” under the BCA.  In determining whether there has been fair treatment of stakeholders, the Court will look at what those stakeholders are entitled to reasonably expect.  Directors of a corporation have to consider a variety of interests and the Court should generally have deference to their decisions.  Here, the Court was not satisfied that the reasonable expectations of Craftex as a creditor were violated.  It was a reasonable commercial decision for the JRD Mortgage to have been granted.

This case demonstrates that care should be taken in negotiating forbearance agreements to ensure that the lender is getting what they are bargaining for.  It is reasonable to assume that if the debtor is negotiating with one creditor, it may also be negotiating with others.  In drafting its forbearance terms, it would have been prudent for Craftex to have specified that its mortgage was to be in third position directly behind the Servus second mortgage.  If such forbearance terms had been concluded quickly enough, this may have avoided the granting of the JRD Mortgage.

Additionally, lenders who are advancing funds to a borrower who is in questionable financial circumstances will want to make sure that security taken is fair and reasonable, and that the consideration is fresh consideration for the transfer or granting of security, as JRD did in this case.

Ksena J. Court and Francis N.J. Taman practice commercial and residential foreclosure and secured and unsecured debt collection at Bishop & McKenzie LLP in Calgary, Alberta.

---

[1] 2020 ABQB 249 (Alta. Q.B.)

[2] R.S.A. 2000, c. F-24

[3] R.S.A. 2000, c. B-9