October 23rd, 2010
Keeping a check on checklists
Anyone who practices in the area of real estate or real estate lending is aware that these are practices built upon and dependent upon checklists. Everyone uses them–there are search checklists, funding checklists and closing checklists to name a few. These can be fairly simple and basic reminders or they can be elaborate closing agendas. Regardless of the form that they take though, they all seem to have one thing in common: they tend to get longer over time. When I was a more junior lawyer, I made a point of trying to find new searches to perform or additional documents to prepare with the idea that these new searches or additional documents would somehow protect my client better and prove to the world that I was a better, more industrious and more thorough lawyer than my competitors. Many of my competitors did the same thing and, as a result, the searches and the documentation involved in real estate transactions expanded greatly.
The question is this: do these additional searches and documents actually provide greater protection to purchasers of real estate or real estate lenders? In my view, while some of the searches (such as fire department searches on multi-residential) are definitely useful in identifying potential problems, many of the new searches give little or no practical information and may in fact give a false sense of security to those who rely upon them. For example, if a municipality confirms that they have searched their files and can find no outstanding work orders on a particular building, that doesn’t mean that there are no problems with that building. Rather, it means that the municipality has nothing in its file which would indicate a problem and given the fact that almost no municipalities inspect buildings anymore unless they receive a complaint, the fact that their file is empty should come as no surprise. However, a potential purchaser or lender may take this as a “no news is good news” response–a seal of municipal approval. If a purchaser or potential lender has a concern about the phsical condition of a building therefore, they should not simply rely upon a file search but should have a qualified expert provide a report on the building based upon an actual inspection.
With searches, the key is to identify exactly what information is required and why and then to order a seach that will actually provide the required information and satisfy the need.
In future blogs I will point out other instances relating to searches and documents where more does not necessarily mean better.
May 31st, 2010
Here is the usual scenario: a commercial lender agrees to finance a shopping centre and requires, as part of its security, that the leases be assigned to it by the borrower. The leases each contain the normal subordination clause whereby the tenant agrees that the lease is subordinate to the interest of a lender and whereby the tenant agrees that, if the lender takes title through a foreclosure, the tenant will attorn to the lender as the new landlord. In this scenario, is it enough for a lender to simply have an Assignment of Leases executed by the borrower and registered against title concurrently with the mortgage security?
It has always been our view that a simple two party assignment is not enough if the lender wants to secure the revenue stream from the leases over the term of the leases. The key is to create privity of contract between the lender and the tenant. Without privity of contract, the tenant’s obligation to pay rent exists only for so long as the tenant wishes to occupy the leased premises. If the tenant vacates the premises, its obligation to pay rent comes to an end unless the tenant is bound contractually to occupy the premises and pay rent for the entire term of the lease. The mere existence of a subordination clause in the lease (as described above) is not enough to bind the tenant to the lender if the lender has no contractual relationship with the tenant. Clearly, a lender will want to have a contractual relationship with each tenant (or, at the very least, each of the important tenants) whereby the lender has the ability to enforce all of the lease terms.
Therefore, privity of contract must be created between the lender and the tenant at the time when the loan security is put in place. To accomplish this, we normally recommend that a Non-Disturbance and Attornment Agreement be entered into between the lender and the tenant. In this agreement, the lender agrees to recognize the tenant’s rights under its lease and to carry out the borrower’s obligations (as landlord) under the lease in the event of a foreclosure. Likewise, the tenant agrees with the lender to be contractually bound to the lender under the lease in the event of a foreclosure. Some give and take is obviously required but, in the end result, the lender can be assured that the lease revenues required to repay the mortgage loan have been properly secured.
April 5th, 2010
Most amortized mortgages give the lender the option to “accelerate the balance” (or some other words which describe the concept of “calling the loan”) if a default by the borrower occurs. By “amortized mortgage” I am referring to the most common type of mortgage whereby the principal and interest is repaid by fixed monthly payments. These types of mortgages usually either disallow prepayment completely or only allow prepayment if a penalty is paid. The penalty is generally an additional payment intended to compensate the lender for the lost interest income which would result from the loan being repaid sooner than the scheduled maturity date. These types of mortgages also contain a multitude of covenants by the borrower (besides the obvious agreement by the borrower to repay the loan secured by the mortgage) which, if breached by the borrower, will result in the borrower being in default under the mortgage.
Where a prepayment of a mortgage loan is made by a borrower acting voluntarily, the right of a lender to either refuse prepayment or extract a penalty from the borrower (depending upon the wording of the mortgage) is clear. However, where a default by the borrower occurs and it is the lender that requires the early repayment of a mortgage by calling the loan, can the lender also demand payment of a penalty? If not, can a lender protect itself by adding wording to the mortgage which requires the payment of a penalty in all situations, including the acceleration of the balance by the lender?
In Alberta, it has always been clear that, in the absence of express wording in a mortgage, the acceleration of the mortgage by the lender “opens” the mortgage to prepayment without penalty. As a result, during periods of low mortgage interest rates, many enterprising borrowers have been known to intentionally default under their higher interest rate mortgages in an attempt to trick their lenders into calling their loans thereby opening up the mortgages for prepayment without penalty. In response to this, many lenders have added provisions to their mortgages which give them the right to charge a prepayment penalty even in situations where it is the lender that forces the prepayment by accelerating the loan. However, in at least one court case in Alberta, the court found that such a penalty provision was not sufficient to allow the collection of a penalty upon acceleration. Rather, the court affirmed that, regardless of the provision, the loan became due and payable without penalty immediately upon the lender exercising its right to accelerate. I would also suggest that, once the lender accelerates the loan, this election cannot be reversed without further agreement between the lender and the borrower. Therefore, a lender that elects to accelerate a loan as a result of a default by a borrower forfeits any contractual right that it may have to collect a penalty.
March 30th, 2010
Many lenders financing real estate construction loans feel that they should make and maintain a builders’ lien holdback. Certainly the legislation in Alberta allows them to do so. However, the legislation does not require a lender to do this and I generally advise lenders against making a builders’ lien holdback for the following reasons: firstly, a holdback offers no legal protection to a lender in terms of ensuring the priority of that lender’s mortgage security. This priority is obtained by registering the lender’s mortgage on title subject only to those prior encumbrances that the lender has agreed to accept and the lender maintains its priority during the progression of construction simply by obtaining a clear title search dated on the same day that each construction advance is made. Secondly, I am concerned that a lender that takes it upon itself to make builders’ lien holdbacks during construction may in fact be taking on an obligation to the various contractors, subcontractors and suppliers involved in the construction project to ensure that the holdbacks are properly calculated and released.
In relation to this second concern, there is an unreported case in Alberta where a lender was required to account to sub-trades for “completion holdbacks” which had been deducted by the lender from each construction advance. The property went into forclosure before completion and the lender took the property back at a substantial loss. To add insult to injury, the court found that the completion holdbacks made by the lender were, in fact, builders’ lien holdbacks and directed that the funds be made available to the builders’ lien claimants whose builders’ lien has been foreclosed off title in the lender’s foreclosure action.
Therefore, while a lender may believe that it is acting prudently by making and maintaining a builders’ lien holdback, doing so offers no benefit to the lender and may, in fact, create potential liabilities for a lender.
March 30th, 2010
Welcome to Dirt and Debt Law. In this blog, I ( and my partners and associates in the Real Estate and Banking Group at Brownlee LLP) will post our thoughts and suggestions on issues related to real estate law and lending law in Western Canada. While we are based in Alberta, we have extensive experience in dealing with these issues across Western Canada and in both the Northwest Territories and Nunavut. Luckily for us, all of these areas are land titles jurisdictions so, although our comments are written from an Alberta prospective, much of what we write will be applicable to all.
We invite your comments and suggestions.
