Ksena J. Court and Francis N.J. Taman

HELOCs[1], STEPs[2], EPMs[3]…these are just some of names for the new wave collateral mortgages that are being offered by the major lenders these days.  In fact, some lenders do not even offer a standard conventional mortgage any more (much to our dismay).  The collateral mortgage is marketed as an easy way for borrowers to access their home equity and other credit without having to go through the hassle of signing mortgage document after mortgage document every time they need more money from the bank.  But are the lenders in Alberta giving up too much by using this method of financing?

In our blog post “Line of Credit Mortgages – Once More into the Breach!”, we reported on the Bank of Nova Scotia v. Mawer[4] case which involved an application for a deficiency judgment on a Scotiabank STEP mortgage.  At that point in time, there were several Masters level decisions from the Alberta Court of Queen’s Bench, some of which (like Mawer) denied the bank’s application for a deficiency judgment, and others where judgment for the deficiency was allowed.[5]

The decision in Mawer was appealed.  It is this Justice level decision[6] that may have put a nail in the coffin for lenders wanting to obtain deficiency judgments on their collateral mortgages that secure various credit facilities.

The problem for lenders in Alberta is s. 40(1) of the Law of Property Act, which prohibits an action on the covenant to pay contained in a mortgage.  It is because of this section that lenders seeking to enforce their mortgage are generally limited to recovery of the mortgaged lands.  As Master Smart noted in Mawer, the concept of a mortgage that encompassed a variety of loan facilities was not “contemplated or even conceivable” when s. 40(1) was enacted.[7]

There are a few exceptions to this general rule.  A specific exception was created for high ratio insured mortgages in the Law of Property Act.  There is also case law which creates exceptions for collateral mortgages where there is evidence that in advancing credit the bank is relying solely on the borrower’s ability to pay and not the property, where the collateral mortgage is taken as part of a debt consolidation plan, or the collateral mortgage is taken where the loan was for business purposes.  In these instances, the bank isn’t seen as trying to “end run” s. 40(1).

In Mawer, the collateral mortgages initially involved debt incurred for the purchase of the properties.  Subsequently, the bank extended credit by way of Visa accounts.  Under the STEP financing, these Visa debts were also secured by the collateral mortgages.  In affirming the Master’s decision not to allow the bank a deficiency judgment against the borrowers, the Justice found that the mortgages were at the centre of the financing arrangements.  This was not a situation where financing arrangements were entered into and the mortgages were registered later to shore up the debt.  Essentially, where a lender is at all times looking to the mortgage as security for the indebtedness, it will be caught by s. 40(1) and the lender will be prohibited from claiming any deficiency judgment against the borrower.  One wonders in what circumstance a lender won’t be looking to its security!

This result is problematic for lenders in Alberta who choose to extend credit under various loan facilities that are secured by a collateral mortgage.  Unless the lender is able to clearly demonstrate to the Court that the loan falls within one of the limited exceptions, lenders who offer this type of mortgage facility will be at risk for taking a loss where the property value ends up being insufficient to cover the total debt.  By securing a Visa debt, for example, the lender may be prohibiting its ability to collect on that debt from other sources, such as the borrower’s wages through garnishment proceedings.  One may argue that if the borrower is in default, recovery of an unsecured debt is doubtful in any event.  However, judgments in Alberta are good for 10 years and can be renewed.  The borrower’s financial circumstances could certainly change over the course of time to make full recovery possible.

Exceptions to s. 40(1) have been made to the Law of Property Act in the past.  Lenders should seriously consider lobbying for another change.  Until then, it will be difficult for lenders to recover anything but the property when they are enforcing their collateral mortgages which secure various loan facilities that are traditionally unsecured debt.

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

[1] “Home Equity Line of Credit” is the generic term for referring to a line of credit secured by a collateral mortgage.

[2] “Scotia Total Equity Plan” is the form of collateral mortgage offered by ScotiaBank.

[3] “Equity Power Mortgage” is the form of collateral mortgage offered by HSBC Bank Canada.

[4] 2013 ABQB 587 (Master).

[5] See for example Chinook Credit Union Ltd. v. Clarke, Alberta Court of Queen’s Bench action no. 1201-10614 (unreported) and HSBC Bank Canada v. Pleskie, Alberta Court of Queen’s Bench action no. 1108-00291 (unreported).

[6] 2014 ABQB 462 (Alta. Q.B.).

[7] Supra, note 4 at para. 15.

Sometimes the law seems to be something of a pendulum – becoming more or less restrictive as it seeks to find a middle ground that correctly respresents the proper interpretation of the law.  The law respecting mortgages which are collateral to lines of credit (“LOC Mortgages”) and other agreements is one area that has experienced such ebb and flow over the last few years.

Bank of Nova Scotia v. Mawer[1] is a recent decision of the Court of Queen’s Bench of Alberta that reflects a more restrictive approach with respect to the enforcement of LOC Mortgages.  In Mawer, the Defendants applied for a conventional mortgage from the Bank of Nova Scotia (the “Bank”) in December, 2006 for a conventional mortgage for a revenue property.  They provided proof of employment income.  The property was appraised at $375,000.00 and the Defendants were approved for a loan that was 75% of the purchase price.

The Bank and Defendants entered into a Scotia Total Equity Plan (“STEP”) agreement which allowed for a variety of different types of loans to be made by the Bank to the Defendants, all secured by the mortgage.  A separate agreement was to be signed for each loan.

The mortgage loan of $235,000.00 under the STEP was documented by a Personal Credit Agreement (the “First PCA”) and an initial collateral mortgage registered for the same amount (the “Original LOC Mortgage”).

In May, 2007, the Defendants applied to have their STEP limit increased to include a Scotialine Visa.  The Bank considered their employment income and property ownership over 3 properties.  The Bank’s underwriting notes indicated that an appraisal of the mortgaged lands would be completed and that that the Defendants’ would have a monthly surplus of rental income.

The property securing the STEP was appraised at $445,000.00 and the STEP limit was increased to $356,000.00, which was 80% of the appraised value.  The Defendants signed a Personal Credit Agreement (the “Second PAC”) for the Scotialine Visa.  A new collateral mortgage for the appraised value was registered against the property (the “New LOC Mortgage”).  The Original LOC Mortgage was discharged.

A second Scotialine Visa account was established in 2008 under the STEP and over the course of 2009 and 2010 the limit was increased 3 times.  In each instance, a Personal Credit Agreement was signed by the Defendants which referenced the prior credit limit of $356,000.00 established by the STEP and referred to the security as being the New LOC Mortgage.

Ultimately, the Bank commenced foreclosure proceedings.  The property was sold to the Bank for less than what was owed by the Defendants and the issue before the Court was whether the Bank was entitled to a deficiency judgment.

The starting point for the analysis was s. 40(1) of the Law of Property Act[2] which in general terms limits the Bank’s recovery for the debt to the land itself.  The Master noted that although s. 40(1) appears to be an absolute prohibition, there are a number of exceptions which could apply.  However, the “court must inquire into the whole of the surrounding circumstances at the time of the transaction to determine its substance whatever form it may have taken”.[3]

While additional security beyond the mortgage is generally enforceable, the Court wants to ensure that the lender is not able to indirectly recover a personal judgment on a mortgage simply by re-structuring its security.  Put another way, the issue before the Court is whether the lender is trying to “end run” s. 40(1) of the LPA.

The Master reviewed the circumstances to be considered in order to determine whether s. 40(1) should limit the lender’s recovery.[4]  One factor was the lack of a covenant to pay in the mortgage.

This factor is a common feature of almost all collateral mortgages.  The mortgage is collateral to another document, such as a line of credit agreement, guarantee or a promissory note.  The covenant or requirement to pay is contained in that other document.  In Mawer, while the New LOC Mortgage was one which did not contain a covenant to pay on its face, it incorporated by reference Standard Mortgage Terms that were registered at the Land Titles Office which did contain a requirement to pay.

Master Smart went on to note that the Original LOC Mortgage was one where the funds were advanced to purchase the lands in question and it was conceded that “the Mortgage Debt acted as Mortgage Debt”.[5]  The Master took this as an acknowledgement that the Original LOC Mortgage and the First PCA were caught by s. 40(1) of the LPA.[6]

This portion of the decision makes a good deal of sense.  In Stallman, Master Hanebury described the test to be applied was whether the loan and mortgage were “coextensive in form and substance”.[7]  From this perspective, it is fairly easy to see that the Original LOC Mortgage would be caught by the restriction on recovery in s. 40(1).  The Defendants had applied for a conventional mortgage loan and had been approved on that basis.  Viewed together, the STEP agreement, the Original LOC Mortgage and the First PCA were essentially a conventional mortgage loan.  The loan was used to acquire the residence and was advanced in a single tranche for a single loan product.  For the Bank to concede that the Original LOC Mortgage was caught is correct.

Master Smart then added that not only was the Original LOC Mortgage and First PAC caught by s. 40(1) of the LPA, but “by extension” the New LOC Mortgage was as well.[8]  This is a bit more difficult to rationalize.  Indeed, the Bank argued strongly against this position.

One of the problems, as Master Smart noted, is that the concept of a mortgage that encompasses a variety of loan facilities was not “contemplated or even conceivable” when s. 40(1) was enacted.[9]  Master Smart stated that the Court’s functional analysis was to take into account common sense and commercial reality.

Master Smart noted that the STEP agreement tied all the loans together and linked them to the New LOC Mortgage.  While the New LOC Mortgage was for the full amount of the value of the house, the STEP loans were restricted to 80% of the loan to value ratio.  His view of the STEP package was that it simply allowed the Defendants to borrow up to the STEP limit without having to remortgage.  This analysis was sufficient for Master Smart to dismiss the Bank’s application for judgment for the deficiency and limited the Bank’s recovery to taking title to the property alone.

While this is one perspective on the commercial reality of the underlying transaction, it is important to note that the two lines of credit are actually Scotialine Visas.  This is less the situation of a number of additional advances under a mortgage loan and more an extension of a credit limit on a credit card. Moreover, the increases in the credit limit on the second Scotialine Visa account appear to have been done without any reference to the then current value of the mortgaged lands.

Although the above analysis sufficed to dismiss the application, Master Smart chose to continue his analysis.  The Bank argued that while the First PCA was for the purposes of financing the acquisition of the mortgaged lands, the Scotialine Visas were personal lines of credit.  Moreover the New LOC Mortgage was for more than 75% of the loan to value ratio.  The Master simply stated that the protection provided to borrowers by s. 40(1) is given for all mortgages, not just for conventional mortgages.  While there have been some exceptions created, they have been in often extraordinary circumstances.

The Bank also asserted that they were looking that the Defendants’ ability to pay rather than solely at the land.  Master Smart dismissed this argument by noting that the Defendants couldn’t support the payments being proposed without the rent from the mortgaged premises and concluded that the Bank was not relying upon the ability of the Defendants to pay.

This is somewhat problematic for lenders from a cash flow perspective.  One point not argued by the Bank was that these were clearly business loans.  It appeared that the purpose of the loans was to acquire income properties, which would, by definition, produce cash flow.  Moreover, it appeared that the Defendants already owned a number of income properties when they purchased the mortgaged lands.

The commercial reality was that the cash flow from the mortgaged premises and the other buildings were legitimately part of the income of the Defendants.  Once the Defendants owned the mortgaged lands, it made perfect business sense to consider the income from the mortgaged lands to determine whether the Defendants could financially support increased payments.  If the Defendants had run a retail business or restaurant from the mortgaged lands, it would have been clear that the income should be considered.  The fact that it was a different type of income shouldn’t, at least in our opinion, matter.

Although the Bank did not make this argument, the Master did note that business loans were involved in a number of the cases where s. 40(1) was held to not apply to limit the lender’s recovery.  Master Smart noted that those cases were distinguishable as in each instance the loan had been in the context of a commercial or farming operation and the mortgage was a part of a larger bundle of security.

Another issue which hadn’t been raised by the Bank was that the face amount of the New LOC Mortgage was the full appraised value of the mortgaged lands, but no explanation or rationale was given for using that amount.  Master Smart noted that the STEP had a lower credit limit that was 80% of that amount.  He found that the difference between the two numbers was one of form not substance.  This comment is a bit difficult to understand outside of the context of the prior case law.  In essence the Master appears to be suggesting that the real limit was the STEP credit limit.  The New LOC Mortgage face amount, however, acts as a limit to how much principal advanced under a line of credit will be secured.  It is a hard, legal limit that will not change even if the STEP credit limit changes.  So while the face amount isn’t determinative, it certainly is not irrelevant.  Indeed, as noted earlier, the limits under the Scotialine Visa were increased apparently without any reference to the value of the mortgaged lands or the face amount of the mortgage.

Certainly, not all Masters have taken the same perspective.  We have had success in obtaining deficiency judgments for our lender clients in a number of instances, both with business loans for condominium rental properties (Chinook Credit Union Ltd. v. Clarke)[10] and with multi-loan facilities similar to the STEP facility (HSBC Bank Canada v. Pleskie )[11].  It will be interesting to see whether this judgment signals a move by the Court to an even more restrictive approach than currently exists.

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