A recent case has demonstrated what can happen if a collateral mortgage and the associated documents that need to go along with it are not properly prepared.
Re: 667402 Alberta Ltd. arose out of proceedings commenced under the Companies’ Creditors Arrangement Act brought by the Canada North Group of companies. “Weslease” was a company and partnership that did business with 1919209 Alberta Ltd. (“191”), one of the Canada North Group of companies, by leasing certain equipment to it. The principal of the Canada North Group, Mr. McCracken, approached the principal of Weslease, Mr. Talbot, about a proposed sale and lease back transaction in relation to a wastewater treatment plant that was owned by 191. Mr. Talbot took the position that Weslease would need personal guarantees from Mr. McCracken and his wife, along with mortgage security from them, as part of the transaction. Mr. McCracken instead proposed that the transaction would be guaranteed and mortgage security would be provided by two other companies within the Canada North Group, 1371047 Alberta Ltd. (“137”) and Canada North Camps Inc. (“CNC”).
The following documents formed part of the transaction:
- Approval of Lease and Lease – where the lessees were 191 and Mr. McCracken
- General Security Agreement – where the debtors were 191 and Mr. McCracken
- Promissory Note – where the borrowers were 191 and Mr. McCracken
- Collateral Mortgage – from 137
- Collateral Mortgage – from CNC
The issue was that the collateral mortgages stated that 137 and CNC were securing the indebtedness that they owed to Weslease under the “Lease Agreements”, however 137 and CNC were not parties to those Lease Agreements. Weslease argued that even though there was the absence of the word “guarantee” in the collateral mortgages, it was intended and understood that 137 and CNC would be guaranteeing the obligations of 191 and therefore the mortgages should be construed so that this guarantee existed.
Section 4 of the Statute of Frauds still applies in Alberta. When a person guarantees the debt of another, the Statute of Frauds requires that this promise be in writing.
The wording of the collateral mortgages did not create a debt. The wording only acted as security for a debt that otherwise existed. Neither 137 nor CNC were listed as co-lessees or guarantors. As such, there was no underlying debt that the collateral mortgages secured. Further, neither 137 nor CNC received any consideration for granting the collateral mortgages and they were not executed under seal, which constitutes consideration at law. A finding that 137 or CNC granted an enforceable guarantee would require the Court to rewrite the written agreements between the parties, which is not something that the Court does. The documents clearly stated that the collateral mortgages were given to secure the debts of 137 and CNC, not the debts of 191 and Mr. McCracken.
Weslease argued that the Statute of Frauds was avoided because of the doctrine of part performance. “Part performance is an equitable doctrine that grew out of concern from common law judges that the application of the Statute of Frauds may lead to injustice in situations where contracts had been partly performed” but the contract was not in writing as required by the statute. The Court held that the doctrine of part performance does not apply to guarantees.
Because the alleged guarantees were not in writing and there was no underlying debt instrument to the collateral mortgages, the Court directed that the mortgages be discharged from title.
This case confirms that lenders will want to be cautious when using collateral mortgages. Lenders need to ensure not only that there is a mortgage from the borrower, but also that there is an underlying debt instrument whereby the borrower is making its promise to pay to the lender. Without this underlying debt instrument, the lender will have no security or claim against the borrower.
 Supra, note 1 at para. 42