Collateral Mortgages

(including, but not limited to, mortgages on collateral)

Simon Crawford, Partner, Bennett Jones LLP

Nicholas Arrigo, Student at Law, Bennett Jones LLP

I. What is a Collateral Mortgage?

Good question. There is the broad sense of the term and there is the technical sense of the term.

In common banking parlance, a collateral mortgage is one type of security document over so-

called collateral security, which The Court of Appeal in Royal Bank of Canada v Slack1 defined as

"any property which is assigned or pledged to secure the performance of an obligation and as

additional thereto, and which upon the performance of the obligation is to be surrendered or

discharged".

And, of course, this is where we want to make a distinction, because the use of the word

"collateral" is not, in our intended usage, referring to the asset (in the sense of the house charged

was collateral), but rather is referring to the security interest itself (in the sense that the charge

granted is collateral to something else).

Nor do we, in this paper, mean that a collateral mortgage means (only) an additional mortgage

given in support of a so-called "primary" mortgage, such as when one charges a second house as

additional credit support for the "primary" mortgage on one's main house. This is the usage

referred to in Falconbridge on Mortgages:

"Collateral security is a commercial rather than a legal term. It is a question of

construction in each case with particular reference to the course of dealings between the

parties, the type of transaction and the nature of the securities whether one mortgage is

to be resorted to first as the primary security or whether they are all to be considered as

parallel security."2

1 [1958] OR 262, 11 DLR (2d) 737. 2 Walter M. Traub, Falconbridge on Mortgages (Toronto: Thomson Reuters, April 2016), 1-11.

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What we do mean, however, by the term "collateral mortgage", in the context of this discussion,

is any mortgage that is not a self-contained conventional mortgage. A self-contained

conventional mortgage is a mortgage that, within the four corners of the document, contains the

primary obligation to repay a debt, the terms of such repayment and the grant of the security

interest over the real estate as security therefor.

In contrast, therefore, in our usage, a collateral mortgage, is any mortgage which stands as

security for an obligation created outside of the mortgage, or for an obligation wherever or

howsoever created, that is a performance and not a payment obligation. So to get our heads in

the right space for this, a collateral mortgage may include but is not limited to:

(a) a mortgage delivered as security for the repayment of a grid promissory note;

(b) a mortgage delivered as security for the payment and performance of a

guarantee;

(c) a mortgage delivered as additional security for the primary debt borrowed under

another mortgage;

(d) a mortgage delivered as security for an indemnity; and

(e) a mortgage delivered to secure the performance of a transactional obligation,

such as an undertaking to perform environmental work or to hold the seller of a

property harmless under an assumed mortgage that it was not released under.

Stated simply, although there may be arguable exceptions, collateral mortgages are (generally

speaking), security documents only. Their purpose is to create a security interest in real estate to

support a primary obligation that (more often than not) is contained in another unregistered

instrument or contract. As a consequence, the obligations secured by a collateral mortgage can,

generally speaking, more easily be amended from time to time without affecting or amending

the mortgage itself.3

3 Daniel Kofman, "Collateral Mortgages and Revolving Loan Facilities: What Makes Collateral Mortgages Different?", Commercial Mortgage

Transactions 2013, p 2.

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Although purists will no doubt balk at this, I am (again for the purposes of this discussion) also

going to lump in real property debentures in the collateral mortgage category, because they

satisfy my definition. While admittedly they secure both real and personal property, they are

invariably used (most often in the context of real estate bond issuances) only for the purposes of

creating a security interest in the property as security for obligations otherwise located.

When we think of mortgage enforcement or mortgage remedies, we don't generally think to

differentiate between conventional and collateral mortgages. More often, we think only of

ranking and priorities. But there are some concepts that we would do well to think of from time

to time as they are specific to collateral mortgages.

With that convoluted introduction behind us, let's consider our first collateral mortgage scenario

and issue.

II. Guarantees

A Co. borrows money from the bank and provides to the bank a conventional mortgage over its

office building. However, the bank is dissatisfied with the loan-to-value and so asks that A Co.'s

sister company, B Co. provide additional security over its manufacturing plant in support of the

loan. B Co. provides a mortgage over its manufacturing plant to the bank. You will note that I

have been intentionally cheeky and ambiguous about the nature of B Co.'s mortgage.

Questions that arise from this fact scenario are:

1. Is B Co.'s mortgage a collateral mortgage?

2. If it is a collateral mortgage, does B Co. have to provide a guarantee to the bank of A Co.'s

debt?

3. If it is not a collateral mortgage, does B Co. have to provide a guarantee to the bank of A

Co.’s debt?

4. Upon default, can the mortgagee enforce against the B Co.'s mortgage before enforcing

against A Co.'s mortgage?

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(a) Is a guarantee necessary?

Our first question was, "is B Co.'s mortgage a collateral mortgage?", and the

answer to that very much depends on the drafting of both A Co.'s mortgage and

B Co.'s mortgage. Arguably, if B Co.'s mortgage states only that it is provided as

security for the debt incurred under A Co.'s mortgage, then it is quite clearly a

collateral mortgage. However, if B Co.'s mortgage is, on its face a conventional

mortgage that appears in all respects to be a "mirror" of the mortgage granted by

A Co., it may in fact be that what has been created is a "co-borrower" situation in

which both A Co. and B Co. have agreed to be primarily liable for the repayment

of the same debt and to satisfy that debt from the security of their respective

charged assets, if need be.

In the context of a co-borrower situation, there is little controversy over the

structure of the loan, as both mortgagors have not only created a charge, but have

promised to repay the primary debt as primary obligor. However, if B Co. has

created a collateral charge, then what is its relation to A Co., and what is the

nature of the debt secured?.

Obviously, the best answer would be if B Co. had delivered a written guarantee in

favour of the bank, guaranteeing the payment by A Co. of the debt created under

A Co.'s mortgage. But what if no such guarantee exists?

Steven Pearlstein has taken the position that a guarantee is not required.4 His

reasoning is that a collateral mortgage itself creates a surety relationship. To

support this, he points to a line of arguments found in the 1938 case Re Conley,5

in which Clauson LJ of the English Court of Appeal wrote that suretyship may be

based on a simple pledge deposited with a lender, and that a collateral mortgage,

viewed as a pledge of land deposited with the primary obligor's creditor, is

4 Steven I. Pearlstein, "Collateral Mortgages – Do you need a Guarantee?", 8th Annual Real Estate Law Summit 2011. 5 [1938] 2 All ER 127.

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arguably analogous. Clauson LJ runs through the history of suretyship, tracing the

concept back to its inception as a pledge of property:

“… there is no reason to believe that in its inception the idea of suretyship

necessarily involved the idea of the surety making himself generally liable

in person and property for the satisfaction of the obligation he undertook.

His obligation in its inception seems to have been limited to the pledge

deposited or indicated. In the gradual development of suretyship, the

obligee, as one would expect, would call for a simpler and wider obligation

on the part of a surety – namely, the obligation to satisfy the principal debt

to the full by his person or property, without regard to the value of the

pledge or gage – and more and more the delivery or indication of a

particular piece of property as a pledge tended to become a form. If this

be a correct account of the development of the law of suretyship, it is quite

intelligible that the terms surety and guarantor should become associated

mainly with cases where the sanction for the obligation of the surety or

guarantor was not limited to the pledge, but consisted of the surety’s

liability to answer his obligation in person or in any property available for

execution.”

So we might reason that, if suretyship exists by virtue of delivery as a pledge of

property for the obligations of another, it includes a charge of property likewise

delivered.

But what if Steven is wrong (sorry Steven, I'm just saying "what if"…)? Generally

speaking, you have to have an obligation to a third party in order for that third

party to be able to enforce a security interest against you. So in the absence of the

surety "at law" argument, a guarantee is required in order for the collateral

mortgage to be enforceable…..a written guarantee. Guarantees are part of a

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special class of deeds and contracts subject to the Statute of Frauds,6 which

provides as follows:

Writing required for certain contracts

4. No action shall be brought to charge any executor or administrator

upon any special promise to answer damages out of the executor's or

administrator's own estate, or to charge any person upon any special

promise to answer for the debt, default or miscarriage of any other person,

or to charge any person upon any contract or sale of lands, tenements or

hereditaments, or any interest in or concerning them, unless the

agreement upon which the action is brought, or some memorandum or

note thereof is in writing and signed by the party to be charged therewith

or some person thereunto lawfully authorized by the party.

While there is no common law requirement that a guarantee be evidenced in

writing, Section 4 of the Statute of Frauds imposes a formal requirement that

either a guarantee itself, or some memorandum or note thereof, be evidenced in

writing.7 The application of the Statute of Frauds turns on whether the agreement

(or such portion of the agreement at issue) gives rise to a primary obligation or

rather a "special" secondary or collateral obligation that constitutes a guarantee.

In short, every agreement which is a guarantee in substance must comply with the

Statute of Frauds in form and, while the Statute of Frauds does not require that

any particular form be adhered to, the essential elements of the agreement

generally must be in writing.8

As an aside, the law of guarantee does not require that consideration given by the

creditor benefit the guarantor directly. As Kevin McGuinness notes, "the

6 R.S.O. 1990, c. S. 19 (the "Statute of Frauds"). 7While there are a number of situations in which the requirement for written evidence may be dispensed with, the starting point of the analysis is

that such written evidence is required. 8 A. MacDonald & Co. v. Fletcher, [1915] 22 BCR 298.

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consideration given by the creditor is to act in accordance with the request of the

guarantor in respect of the principal".9

That's all well and good, but in the context of collateral mortgages, it is not a bad

idea to always ensure that the consideration flowing to B Co (the second entity

providing the additional security by way of collateral mortgage) is sufficient. It is a

contract, after all.

The consideration for a guarantee may take the form of a benefit flowing from

lender directly to the guarantor, and oftentimes guarantees (as well as other

contracts) will include a statement to the effect that some nominal payment has

been exchanged which, together with other "good and valuable consideration",

constitutes sufficient consideration. More often than not (or dare I say, nearly

always) the nominal consideration never actually changes hands and so, if the

nominal consideration is all you've got (or rather, purport to have), you may find

yourself a few peppercorns shy of an enforceable bargain. Furthermore, while

courts will generally not inquire as to the adequacy of consideration, some courts

have recognized a distinction between "nominal consideration" and "valuable

consideration" and have held that, notwithstanding the freedom of parties to

make bad bargains, nominal consideration which is not "real" consideration of

some value in the eyes of the law does not constitute sufficient consideration.10

In most instances the reference to nominal consideration is simply boilerplate

language that does not reflect the actual consideration changing hands, and the

presence of such boilerplate language certainly does not render a guarantee

unenforceable: the consideration for a guarantee need not be set out in writing,11

nor is it necessary that consideration flow to the guarantor,12 as the consideration

9 Kevin McGuinness, The Law of Guarantee, 3rd ed (Markham, ON: LexisNexis, 2013), p 161. 10 See, for example, Glenelg Homestead Ltd v Wile, 2003 NSSC 155 (CanLII) at para. 26. 11 Statute of Frauds, at s. 6. 12 Canada Mortgage and Housing Corp. v. Elbarbari, 1996 CanLII 6712 (SK QB) per MacLean, J.

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may simply be the lender suffering some detriment or providing some benefit to

a third party, such as the granting of credit by the lender to the borrower.

However, a potential issue arises where a guarantee (and associated collateral

mortgage) are provided in circumstances where a borrower has defaulted or is on

the brink of default under an existing loan. The potential issue is that, while it is

generally sufficient that the lender has granted some specific type forbearance in

consideration for a guarantee and/or collateral mortgage, for example refraining

from commencing legal proceedings against the borrower or granting an

extension for repayment of the underling debt, mere voluntary inaction on the

part of the lender does not constitute sufficient consideration.13

So what's to be made of all of this? Although a collateral mortgage need not

explicitly describe the consideration for which it is granted, it is prudent to

consider whether, given the context of the transaction, valid consideration has in

fact moved from the lender. When in doubt, spell it out (particularly when acting

for the lender). Ensure that the collateral mortgage given in support for another's

debt, or the associated guarantee, contains an accurate (but sufficiently broad)14

description of the legally valuable consideration (for example making available

credit facilities or granting some specific forbearance to the borrower) for which

the guarantee is granted.

In summation…the enforcement of a collateral mortgage given by one person in

support of another's debt can be susceptible if the collateral mortgage has not

been structured in some manner (either as a primary obligation, as collateral for

a written guarantee, or (maybe) in a manner that creates a common law surety

13 Crears v. Hunter (1887), 19 QBD 341 at 346. 14 There is case law suggesting that, by describing the consideration in overly-specific terms, the scope of the guarantee may inadvertently be limited

because, while the description of consideration is not conclusive, it is relevant in construing the terms for the contract itself. See, for instance, ING Lease (UK) Limited v. Harwood [2007] EWHC 2292 (QB), in which the High Court of Justice (Queen's Bench Division) partially relied on the wording of a guarantee's consideration clause in finding that certain obligations of the borrower did not fall within the scope of the guarantee. See also Neil Levy & John Phillips, "Aspects of Guarantee Clauses and Their Drafting" (September 2009), online: Guildhall Chambers <http://www.guildhallchambers.co.uk/files/AspectsofguaranteeclausesFormattedNL.pdf>.

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relationship) that allows the lender to enforce the obligation or liability against

the grantor.

(b) Can the mortgagee enforce against the collateral mortgagor before enforcing

against the primary mortgagor?

Turning now to the fourth question above, assuming we have a valid

surety/guarantee relationship in place, generally speaking a mortgagee can

enforce under a collateral mortgage granted by a surety before enforcing against

a so-called primary mortgage. The basic rule is that "the bringing of an action

against the principal is not a condition precedent to a claim by the creditor against

the surety".15

This rule is, however, subject to certain qualifications. First, it does not mean that

the lender can seek to enforce the collateral mortgage at any time. As a guarantee

and its collateral mortgage is contingent in nature, the principal must be in default

before the guarantor becomes liable. Second, it follows from the first qualification

that if the primary obligation is a demand obligation, such as a demand mortgage,

then the collateral mortgagor cannot be liable until the mortgagee has made a

formal demand and has given the primary debtor the opportunity to respond.16

(c) Nominees and Beneficial Owners

Another structural issue arises in the context of nominees and beneficial owners,

and the issue is raised here because too often lenders misunderstand how

collateral mortgages are to be structured in the context of a split between legal

and beneficial ownership, and much of the issue relates to the law of guarantees.

The following is a typical manner in which commercial real estate in Ontario is

owned. A Co owns the beneficial interest in a property. A Co. owns all of the issued

and outstanding shares of B Co. and has directed (under a nominee or bare trustee

15 McGuinness, p 888. 16 McGuinness, p 889.

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agreement) that B Co. hold legal title to the property as nominee for A Co. As a

matter of law, B Co. hold the registered interest only and holds all rights and

benefits and all obligations and liabilities in respect of the property as nominee

and bare trustee for A Co. As a consequence it has financial statements that show

no assets or liabilities, notwithstanding that its name shows upon the title registry.

So then, as between A (the beneficial owner) and B (the nominee/registered

owner) how do you structure the loan documentation to create a valid charge over

the property and the obligation that such charge secures? Here is what we often

see:

Structure 1. The lender requires that the beneficial owner of the property act

as the borrower, and sets up the nominee title holder of the property as a

guarantor of the loan, who in turn grants a registered collateral mortgage as

security for its guarantee.

Structure 2. The lender requires that the legal title holder of the property act as

the primary borrower of the loan, signing the mortgage as evidence of its

mortgage debt, with a guarantee from the beneficial owner.

Now there is a third structure, but for the time being I am going to keep that one

for later.

Let's look at these two structures and ask ourselves whether they are effective

and immune from attack. And perhaps even more importantly, what problems

would they give counsel if counsel were required to give an enforceability opinion

with respect to the loan documents

In the first structure, the beneficial owner of the property is named as the

borrower and the nominee title holder is to sign a guarantee of its obligations

secured by a collateral mortgage.

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The structural problem arises from the nature of the nominee relationship. If

properly established, a nominee has, as it relates to the property, no assets and

no liabilities of its own, it being merely a holder of title and obligations for another.

Which is to say that, even when it signs a guarantee, it incurs that obligation for

and on behalf the beneficial owner (incurring them for that principal)…and if that's

the case, the beneficial owner is, by virtue of the guarantee, guarantying its own

primary obligation as principal debtor/borrower.

So in this one example, we have flushed out the cardinal rule of the construction

of guarantees: Thou shalt not guarantee thy own debt.

To quote the (strikingly sexist) language of the court in an 1898 decision in Bowen

v. Needles National Bank17:

"Now…. men do not guaranty their own debts, nor do they employ that

word to designate an original undertaking. A guarantee is a promise to

answer for the debt, default or miscarriage of another person."

For clarity, women too do not guaranty their own debts.

So, in the law of guarantees, there must be at least "three to tango". A guarantee

is a trilateral relationship. There must be a primary obligor, a person to whom the

obligations is owed, and a distinct third person who guarantees that primary

obligation on its own account. Now this is not to say that there cannot be more

than three persons on the dancefloor, but there must be at least three, and any

attempt to guarantee one’s own obligations, directly or indirectly, runs the risk of

being a legal nullity (which, of course, may make the enforcement of the

supporting collateral mortgage suspect). Now, as a practical matter, a court

considering this structure will in all likelihood step back from the transaction and

impose on the legal imperfections a commercially reasonable interpretation,

having regard to the intentions of the parties, but I would venture that this is not

17 Bowen v. Needles National Bank (87 F 430 at 440)

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the type of law you want to practice. The type where you intentionally or even

just consciously create or allow structures that are technically broken, relying on

the fact that ultimately a court may gloss over the imperfections in favour of

commercial intentions.

Why? Because you may not always get what you want. Consider for example, the

equitable defenses, based on longstanding principles of equity, that attach to a

guarantee that has been properly constituted. If, as counsel to the borrower, you

were to implement this structure is it your position that your nominee/guarantor

enjoys the benefits of these equitable defences? Is it your position, more

generally, that the guarantee given by the nominee is a valid guarantee? Would

you put those opinions in writing? If you do, you do so at your own peril.

Lender's counsel may care less, because ultimately the guarantee given by the

nominee title holder will likely still be acknowledged by a court as an admission by

the nominee of an obligation for the debt, whether as primary or secondary

debtor, and so it may matter less, so long as the lender can enforce the mortgage,

but again I would stress that it is precisely these imperfections in structure, and

taking these holidays from legal principles, that can lead to litigation. The point

being that, where your structure is broken technically, or you create ambiguity as

to what was intended, your structure can be misinterpreted. The same court

noted:

"In determining whether a promise is a guaranty or an original

undertaking, the language made use of, the situation and the surroundings

of the parties, and every other fact and circumstance bearing upon the

question, should be taken into consideration"

Hardly sounds like the scope of interpretive tools most lawyers want read into

their carefully prepared legal structure does it? Which is why your structure

should be precise. One note however: We have attacked this structure on the

factual assumption that we are dealing with a nominee who is nothing but a

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nominee. If the facts are that the nominee owns additional assets besides the

assets it holds as nominee, and that the lender is looking for that additional

covenant, then a guarantee from that company, on its own account, may have

merit.

Let's look at the second structure we contemplated at the outset. In the second

proposed structure, the legal title holder/nominee is the primary borrower. It

grants the mortgage as security for its debt and the beneficial owner guarantees

the debt of the nominee.

Of course, this is the same problem. The nominee only ever incurs its debts for

and on behalf of the beneficial owner, which of course means that the guarantee

given by the beneficial owner is a guarantee of its own debts. Which of course

means that it is not a guarantee. And if any client or any party was under the

misapprehension that any of the rights, obligations, remedies or defenses that are

particular to guarantees would apply to this document, they may find themselves

rudely awakened…on account of trying to tango with only two dancers.

What then is the correct structure? Well, curiously, to observe and respect the

legal nature of the nominee relationship that has been created, the better view is

to do one of two things: One favoured approach is to have the registered owner

act as the borrower and to charge the property in favour of the lender. The lender,

having a copy of the nominee agreement, and knowing that the nominee

relationship exists, has the beneficial owner acknowledge contractually that all of

the covenants, agreements and security interests made by the nominee are made

on its behalf, has the beneficial owner specifically direct the nominee in writing to

enter into those loan documents on its behalf, has the beneficial owner agree

specifically in favour of the lender to perform, and to be bound by, those

covenants as principal obligor, and has the beneficial owner grant a beneficial

charge over those assets charged by the nominee.

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It is similarly correct to have both nominee and beneficial owner act as co-

borrowers, recognizing that ultimately all obligations are incurred by the

beneficial owner, alone or in combination, with its nominee. The trick here, of

course, is to ensure always that careful thought is put into how to describe the

obligations that are secured by the collateral mortgage security package, as,

ultimately, the enforceability of the collateral mortgage may depend heavily of

the structure of the loan.

III. Marshalling and Subrogation

(a) Marshalling

The equitable doctrine of marshalling is a remedy that, by definition, requires that

one lender have security over more than one asset, and so it is particularly suited

to a situation where a debtor has provided mortgage security over multiple assets

to the same lender. The remedy is designed to lessen the chance that a junior

creditor may lose its security solely at the whim of a senior creditor's choice of

security to pursue.18 The doctrine requires that if a creditor has two funds of a

debtor (i.e. two properties) to which it can look to satisfy its claim, and a second

creditor has available only one of those funds (i.e. properties), then the first

creditor should order its recovery against the funds in a manner that reserves the

fund (property) available for the second creditor.19 In effect, this prevents a

creditor who can resort to two funds of a debtor from defeating another creditor

who can only resort to only one of them. For the doctrine to apply, five basic

criteria must generally be met:

(i) Two creditors;

(ii) One common debtor;

18 CIBC Mortgage Corporation v. Branch, 1999 CanLII 6394 (BC SC) at 6, citing Bruce MacDougall, "Marshalling and the Personal Property

Security Acts: Doing Unto Others…" (1994) 28:1 UBC L Rev 91,at 92. 19 Allison (Re), 1995 CanLII 7146 (ON SC).

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(iii) Two funds of the debtor with the superior creditor having access to both

and the inferior creditor to only one;

(iv) No interference with the choice of remedy of the superior creditor; and

(v) No prejudice to third parties.20

As set out in (iv) and (v) above, the right to marshall assets is subject to two

qualifications: marshalling will not be permitted if it interferes with the paramount

right of the senior creditor to pursue its remedies against either of the two funds,

and marshalling will not be applied to the prejudice of third parties. Where the

senior creditor chooses to recover its debt from the fund available to both

debtors, courts may apply the doctrine to provide the junior creditor a right of

subrogation, which is discussed below.

Little in the way of case law or scholarly writing has been produced about the

intersection of collateral mortgages (in particular) and marshalling. One relatively

recent case which dealt with both is Balemba v R.21 After a complex series of

transactions, the end result was that the debtor owned two properties, both of

which were mortgaged to a single numbered corporation. One of these mortgages

was described in the agreement as being "collateral" to the other. The Crown also

had an interest in the property subject to the collateral mortgage, and argued

under the doctrine of marshalling that the numbered corporation should enforce

against the other property, as that mortgage was not "collateral". The court noted

that merely calling a mortgage "collateral" does not make it so, and that, in any

event, there is no requirement to enforce against a collateral mortgage first.

Moreover, on the facts, it was financially disadvantageous for the numbered

corporation to enforce against the property in which the Crown had no interest.

20 Green v. Bank of Montreal, 1999 CanLII 821 (ON CA) at 10. 21 [2009] 175 ACWS (3d) 429 (“Balemba”).

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Thus the court did not apply the doctrine of marshalling to require enforcement

against the collateral mortgage.

This case reminds second mortgage holders that, on realization, they should

always have one eye as to whether the senior mortgage holder can be compelled,

by the doctrine of marshalling, to seek recourse against other secured assets.

(b) Subrogation

Subrogation is the equitable right of a party (a "subrogee") to be substituted in

place of some other party (a "subrogor") in relation to a third party who is

indebted or otherwise liable to the subrogor, so that the subrogee succeeds to the

rights of the subrogor in relation to the debt or claim.

Subrogation serves to prevent double-recovery by the subrogor, and to also

prevent unjust enrichment by entitling a subrogee to seek reimbursement from

the debtor for payments made by the subrogee in respect of the debtor's

obligations. 22 In common speak, subrogation allows one party to "step into the

shoes" of another party.

As we have discussed, many collateral mortgages are given in support of another's

primary debts, and are therefore supported by a guarantee. Although most

guarantees will provide that the guarantor (grantor of the collateral mortgage) is

prevented from claiming any amount from the debtor until the creditor is paid in

full. Such language is intended to prevent a guarantor, who has guaranteed only

part of a debt, from paying only the guaranteed amount (that is, less than the

entire debt of the primary obligor) and claiming rights in the lender's security.

22 Subrogation is not the only manner by which a guarantor can seek reimbursement, as a guarantor who pays a guaranteed debt is also entitled to

be indemnified by the principal debtor, and to obtain contribution from other guarantors. Although the right to be indemnified is quite similar to the right of subrogation, these are distinct rights. For example, the right of indemnity allows a guarantor to sue the debtor in the guarantor's own name, while a guarantor who is subrogated to the rights of creditor can be in no better position than the creditor. So, if the creditor's right of action against the debtor is barred, so too is the right of the subrogated guarantor. See, for example, Canada (A.G.) v. Becker, 1998 ABCA 283 (CanLII).

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While the waiver of subrogation case law is most developed in the context of

insurance contracts, it is clear that courts will generally give effect to a clause

which waives the rights a party may otherwise hold as creditor. In Wimpey

(George) Canada Ltd. v. Northland Bank,23 a guarantor provided a limited

guarantee of the debts of another company. The debtor defaulted and the

guarantee was called by the lender. The guarantor paid the maximum amount that

the guarantor was obliged to pay under the guarantee, which was less than the

amount owing by the debtor to the lender, and demanded that the lender assign

to the guarantor a proportionate share of the mortgage granted by the debtor.

The lender refused, relying in part on the express terms of the guarantee to argue

that the guarantor was only entitled to claim against the lender's securities upon

payment in full of the amount owing to the lender. McFadyen J. agreed, holding

that

“…even assuming that by the applications of certain general principles of

law or equity the plaintiff would be entitled to a pro rata share of the

mortgage held by the bank, the plaintiff has expressly contracted out of

any such right.”24

The express terms in question dealt with an assignment by the guarantor of

indebtedness owed to it by the debtor, and a postponement by the guarantor of

its claims against the debtor. However, the crux of this line of reasoning in Wimpey

was that the guarantor had contracted out of rights the guarantor may otherwise

have had, as creditor of the debtor, prior to the repayment of the whole of the

debt owing to the lender.25

23 1985 CanLII 1223 (AB QB) ("Wimpey"). 24 Wimpey at para 13. 25 McFadyen J. also held at para. 22 that, even if the lender could not rely on the contracting out provisions, the guarantor's claim must fail on the

basis that, because the guarantee was a guarantee of the whole debt but with a limitation on the amount that the guarantor was liable to pay, the guarantor may only claim the right to an assignment of securities upon the payment of the whole of the debt. For further discussion of the distinction between a guarantee of the whole debt with a limit on liability, and a guarantee of only part of the debt, see QK Investments Inc. v. Crocus Investment Fund et al., 2008 MBCA 21 (CanLII).

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Accordingly, we are left with the curious question of whether the

guarantor/grantor of a collateral mortgage can pay to the lender the maximum

amount of the guarantee/collateral mortgage and be entitled to a pro rata share

of the primary mortgage held by the bank. Wimpey suggests that it can.

IV. Limitation Periods

The question of when the limitation period for enforcement of a demand collateral mortgage

begins to run has received some judicial attention in the past decade. A full understanding of the

issue requires consideration of conventional demand mortgages as well. Three key cases made

the law of limitation periods what it is today, as it applies to mortgages: Hare v Hare,26 The

Mortgage Insurance Company of Canada v Grant Estate,27 and Bank of Nova Scotia v

Williamson.28

(a) Hare v Hare

The first case, Hare, does not concern collateral mortgages, but it sparked the

judicial interest in demand obligations more broadly. Hare dealt with the

transition from the old Limitations Act, RSO 1990, to the new Limitations Act,

2002. The plaintiff loaned money to the defendant in return for a demand

promissory note. When the defendant ceased to pay interest, the plaintiff waited

several years before making a demand. The question before the court was when

the limitation period began to run. A majority of the Court decided that, under

both the old Act and the new Act, the rule is the same: the period begins upon

delivery of the demand note, not on the making of a demand. As a result, the

plaintiff's action was barred.

Following Hare, new retroactive language was added in 2008 to the Limitations

Act, 2002. The new subsection 5(3) states that the limitation period for demand

obligations begins "once a demand for the performance is made". This language

26 [2006] 83 OR (3d) 766 (“Hare”) 27 2009 ONCA 655 (“Grant Estate”) 28 2009 ONCA 754 (“Williamson”)

19

applies to all demand obligations created after January 1, 2004. But neither Hare

nor this legislative change sheds any light on the limitation period for demand

mortgages under the Real Property Limitations Act RSO, 1990, which is the subject

of the second in our trilogy of cases, Grant Estate.

(b) The Mortgage Insurance Company of Canada v Grant Estate

In Grant Estate, TD Bank loaned Rebanta Holdings a sum of money, and Mortgage

Insurance Company of Canada (MICC) acted as surety. MICC then entered into an

Indemnity Agreement with multiple parties, one of which was the borrower

Rebanta itself. Rebanta and the other indemnitors provided demand collateral

mortgages to MICC as security for the Indemnity Agreement. Rebanta defaulted

on the original loan and MICC made a payment to TD, on account of the

suretyship. MICC then waited over ten years before commencing an action under

the Indemnity Agreement. The Court dealt with several issues, but the important

question for our purposes is when the limitation period of ten years on the

demand mortgages began to run.

The Court's answer turned on two key distinctions: first, whether the mortgage is

conventional or collateral and, second – if there is a collateral mortgage – whether

the collateral mortgagor is also the primary obligor. Based on these distinctions,

Grant Estate creates three possible scenarios:

(i) If the mortgage in question is a conventional mortgage, the limitation

period begins running immediately, at the creation of the obligation.

(ii) If the mortgage in question is a collateral mortgage, and the collateral

mortgagor is not the same person as the main mortgagor, the limitation

period begins running on the demand.

(iii) If the mortgage in question is a collateral mortgage, and the collateral

mortgagor is the same person as – or a principal of – the main mortgagor,

the limitation period begins running when the obligations under the main

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mortgage are triggered. The reasoning here is that "there is no special

need for demand under the collateral security as the principal debtors

have full knowledge of, and control over, the status of their debt" (para

24). This was the scenario applicable in Grant Estate, as Rebanta was

both the main borrower and one of the indemnitors that provided a

collateral mortgage.

Since Grant Estate was decided under the Real Property Limitations Act, the

amendment to the Limitations Act, 2002 stating that all limitation periods begin

on demand did not factor into the ruling. That amendment was addressed in the

third case, Williamson.

(c) Bank of Nova Scotia v Williamson

The facts of Williamson are simple: a borrower defaulted on a loan from the bank,

and the bank sought to enforce against a guarantor. The guarantor argued that

the limitation period had elapsed. This case gave the Court of Appeal the

opportunity to confirm that the 2008 legislative amendments to the Limitations

Act, 2002 do indeed mean that the limitation period on all demand mortgages

subject to the Act begins to run on the making of a demand, whether the mortgage

is primary or collateral. It is worth pointing out, though, that the transactions at

issue in Williamson predate January 1, 2004. As a result, the legislative

amendments do not apply, and the Court's comments on the subject are

technically obiter dicta. Nonetheless, the Court notes that it is relying on the

amendments as an indication of legislative intent.

(d) Summary

We can distil this line of cases into a short summary of the state of the law. First,

after the legislative amendments and the persuasive obiter dicta in Williamson, it

seems clear that the limitation period on a primary or collateral demand obligation

subject to the Limitations Act, 2002 begins to run from the demand. This is not

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helpful, however, in the case of demand mortgages, as they would likely be

subject to the Real Property Limitations Act. Instead, unless the legislature decides

to amend the RPLA in a manner consistent with the LA, it appears that Grant

Estate is still good law. Thus, to determine the relevant starting date for the

limitation period, we must always ascertain the type of mortgage (conventional

or collateral) and the identity of the mortgagor (principal or third party).

As a final point on limitation periods, there may be situations in which it is difficult

to tell which of the LA or the RPLA should apply. The ONCA offered some guidance

in Equitable Trust Co v 2062277 Ontario Inc, 2012 ONCA 235, noting:

"…it may not always be easy to determine whether a particular guarantee,

like the guarantee in Bank of Nova Scotia v. Williamson, is subject to the

Limitations Act, 2002 or, like the guarantee in the case at bar, is subject to

the Real Property Limitations Act. However, it does not follow that all

guarantees should be treated the same way. It has been the case

historically that guarantees associated with land transactions have

different limitation periods from guarantees associated with contract

claims. Moreover, as already noted, it is my view that the Legislature

intended that all limitation periods affecting land be governed by the Real

Property Limitations Act."

Thus, following Equitable Trust, a guarantee that is not itself a collateral mortgage,

but that guarantees a primary mortgage transaction, would have a sufficient

nexus to real property to fall within the jurisdiction of the RPLA, rendering it

subject to Grant Estate rather than Williamson.

V. Foreclosure

All of the issues discussed so far have been sensitive to whether the collateral mortgagor is the

same person as the primary mortgagor. The following topic – foreclosure – is not so sensitive.

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In Price v Letros29, the defendant gave both a main and a collateral mortgage to the plaintiff. The

plaintiff foreclosed on the main property and sold it, then sold the second property under power

of sale, and finally sought to recover the deficiency that remained after both sales. The court held

that the plaintiff was not entitled to the deficiency, and that the plaintiff also had to account to

the defendant for the sale of the second property. The foreclosure and subsequent conveyance

of the first property fully satisfied the debt, such that the collateral mortgage was extinguished.

Some years later, the ONCA explained the law in more detail, in Bank of Nova Scotia v Dorval et

al.30 Here, the defendant husband gave two promissory notes to the plaintiff wife. The husband

gave the wife a mortgage, collateral to the notes. On the husband's default, the wife foreclosed

on the real property that was the subject of the mortgage, then sought to bring an action on the

promissory notes claiming the deficiency. The court ruled in favour of the husband; by foreclosing

on the property, even though it was collateral security, the wife settled the debt in full. The ONCA

helpfully summarized the principle as follows, citing Falconbridge:

"If a mortgagee holds collateral security for the payment of the mortgage debt, he should

realize the security before seeking to foreclose under the mortgage because, if he obtains

foreclosure first, 'he deprives himself of the benefit of the security in the sense that the

foreclosure will be reopened if he subsequently realizes the security".

Crucially, it is not any realization on the primary mortgage that extinguishes a collateral

mortgage. Rather, it is specifically the mortgagee's act of giving up its ability to reconvey the

mortgaged property. As the Court notes in Dorval, referring to some preceding cases:

"These cases do not … stand for the proposition that the holder of both primary and

collateral security must, as a matter of law, realize upon the collateral security first;

rather, they support the more general proposition that where security is pledged for a

debt and the lender has put it beyond his power to restore the pledge, he must be taken

to have elected to accept the amount realized in satisfaction of the debt and to have

29 (1974), 2 OR (2d) 292 (CA). 30 [1979] 25 OR (2d) 579 (“Dorval”)

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foregone recourse to any other security for that same debt, whether that other security

be characterized as secondary, additional, primary or collateral".

Thus it would be perfectly acceptable to seek to enforce a collateral mortgage after enforcing a

main mortgage through power of sale or judicial sale, without prejudicing one's other security.

Note to self: do not foreclose under a collateral mortgage as I may extinguish my rights to claim

under any other security, including any other collateral mortgage.

VI. Venue

We now get to the hot topic of venue. A recent amendment to the Rules of Civil Procedure,

effective March 31, 2015, has introduced sub rule 13.1.01(3), which provides that mortgage

enforcement proceedings must be commenced "in the county that the regional senior judge of a

region in which the property is located, in whole or in part, designates within that region for such

claims". If claims fall into more than one designated centre, it has been suggested that the

plaintiff may choose the jurisdiction in which to sue, though the rule does not say how or on what

basis.31

The types of actions caught by the rule include those that contain a "claim relating to a

mortgage". The phrase "claim relating to a mortgage" is undefined, but clearly includes collateral

mortgages and an action to enforce a collateral mortgage that is supplemental to a main

mortgage would be caught by the rule. A more uncertain scenario, however, may arise if the

collateral mortgage is collateral to a non-mortgage debt obligation. At what point is the nexus to

the mortgage so tenuous that the claim no longer "relates" to a mortgage?

As discussed above, the Court in Equitable Trust held that the test for whether the Limitations

Act, 2002 or the Real Property Limitations Act applies is whether it is a limitation period "affecting

land". It may be the case that a similarly broad test will be applied to the new venue rule, with

the result that the mere presence of a mortgage within a series of transactions would trigger

subrule 13.1.01(3).

31 Doug Bourassa, “New Issue in Mortgage Enforcement – Changes in the Venue Rules: There’s No Place Like Home” (Aug 31, 2015).

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VII. Further Advances and Tacking

(a) Further advances on a revolving line of credit

When a collateral mortgage secures a primary debt obligation that allows for

further advances by the lender to the primary debtor (for instance, a revolving line

of credit), the priority of these further advances may come into question. The

following discussion is based on a simple scenario. Suppose that Lender has given

a revolving line of credit to Debtor. This debt is secured by a collateral mortgage

by Mortgagor. Further suppose that Mortgagor gives a second mortgage on his

property to Second Mortgagee. The question is whether further advances made

on the line of credit from Lender to Debtor would be subordinated to the interest

of Second Mortgagee.

The basis for this subordination is the equitable doctrine of tacking. The doctrine

has two limbs. The first, not at issue here, is described in Falconbridge as follows:

"In a mortgage context, [tacking] arises where a third mortgage is taken

without notice of the second. If the third mortgagee gets in the legal estate

by purchasing the first mortgage, he or she is allowed to 'tack' the third

mortgage to the first mortgage, and obtains priority as to both over the

second mortgage".32

More significant in our situation is the second limb of the doctrine of tacking,

which deals with further advances. The common law rule was that a lender making

further advances enjoyed priority over subsequent encumbrancers so long as

notice of such intervening interests was not given to the lender.33 The common

law rule appears to date back to the 1861 House of Lords decision in Hopkinson v

Rolt,34 which was cited favourably in Ontario some thirty years later in Pierce v

Canada Permanent Loan and Savings Co.35 This rule has been codified in a number

32 Falconbridge, 9-11. 33 Law Reform Commission of British Columbia, "Report on Mortgages of Land: The Priority of Further Advances" (1986), pp 8-9. 34 (1861), 9 HL Cas 514, 11 ER 829. 35 (1894), 24 OR 671 (Ch Div), affd 23 OAR 516.

25

of provinces, the relevant provisions in Ontario being Subsection 93(4) of the Land

Titles Act and Section 73 of the Registry Act.

The underlying problem with this branch of tacking, of course, is that a second

mortgage lender can cause further advances under a senior mortgage (perhaps

securing a revolving line of credit) to be subordinated to its subsequent

encumbrancer upon notice. Curiously, notice is not deemed to be given simply by

virtue of the registration of the second mortgage, and so the first mortgagee

actually has to know of the second mortgage registration. One might argue that a

first mortgagee may simply take a position of "ignorance is bliss" and never

subsearch title before subsequent advances, but this would prove a precarious

practice given the statutory priority that certain liens are given over subsequent

advances.36

The protection for first mortgage lenders against tacking is imperfect. Firstly they

should contractually prohibit second mortgages; secondly they should provide

that the registration of any second mortgage is an immediate default giving rise

to the payment of makewhole amount; and thirdly, they should specifically

provide that, to the extent any second mortgages are permitted, they are

permitted only on the grounds that a satisfactory subordination and

postponement agreement is entered into.

The concern for first mortgage lenders is that they might unknowingly receive

actual notice of a subsequent mortgage, which would then take priority over

further advances on the first mortgage. The test for actual notice was articulated

in CIBC v Rockway Holdings37, in which Justice Salhany wrote:

36 See, for instance, Subsection 78(4) of the Construction Lien Act, which reads:

“Subject to subsection (2), a conveyance, mortgage or other agreement affecting the owner’s interest in the premises that was registered prior to the time when the first lien arose in respect of an improvement, has priority, in addition to the priority to which it is entitled under subsection (3), over the liens arising from the improvement, to the extent of any advance made in respect of that conveyance, mortgage or other agreement after the time when the first lien arose, unless,

(a) at the time when the advance was made, there was a preserved or perfected lien against the premises; or (b) prior to the time when the advance was made, the person making the advance had received written notice of a lien.”

37 (1996), 29 OR (3d) 350 (Ont Gen Div) (“Rockway”).

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“[T]he term “actual notice” means actual notice (as opposed to

constructive notice) of the nature of the prior agreement and its legal

effect. There is no requirement that there be actual notice of the precise

terms of the agreement, such as the amount of the consideration passing

between the parties or the term of the agreement. The test, in my view, is

whether the registered instrument holder is in receipt of such information

as would cause a reasonable person to make inquiries as to the terms and

legal implications of the prior instrument”.

So if a second mortgage lender requests a statement of indebtedness from the

first mortgage lender, it would constitute actual notice on the Rockway analysis.38

A first mortgage lender should therefore protect itself contractually, as described

above, either by prohibiting subsequent mortgages outright, or by subordinating

them explicitly.

(b) Cap on advances

As discussed, collateral mortgages are often designed as such because they secure

debts created outside of the four corners of the document. Revolving credit

facilities and lines of credit are common examples. Therefore, because they so

often involve the extension of additional credit or the advance of additional funds,

they are more prone to being caught by the caps on advances concepts set out in

the legislation.

Subsection 93(4) of the Land Titles Act and Section 73 of the Registry Act provide

that the "money or money's worth" acts as a cap on the security realizable by the

lender.39 As explained in Falconbridge:

"A registered mortgage is only security for the money or money's worth

actually advanced under it up to the amount for which the mortgage is

38 Kofman, p 7. 39 Kofman, p 4.

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expressed to be security and any advances over and above the registered

amount of the mortgage may not be secured and may lose priority to any

subsequently registered interests".40

Sounds simple enough. Your security cannot secure indebtedness above and

beyond the stated cap of the mortgage. Put another way, a lender only has

security to the extent of the funds advanced, and the funds may only be advanced

to the extent of the collateral mortgage's principal amount without risking the loss

of priority. As the line of credit is paid down, the repaid amount once again

becomes available for future advances.41 A contrary view, now seemingly defunct,

is what has been called the “ratchet advances” problem.42 The idea, historically,

was that the cap on further advances is reduced with every payment, up to the

principal amount of the loan. In other words, it was thought that a $500,000

payment, made on a $1 million loan and subsequently repaid, meant that only

another $500,000 could be advanced, regardless of the repayment. Intuitively,

this makes little practical sense, and the more palatable modern approach has

found favour with commentators. Kofman suggests that the “ratchet advances”

problem is not a risk, as “no one would sensibly claim that a mortgage lender

which advances $6 million, but then is subsequently repaid $6 million, continues

to have enforceable mortgage security for $6 million”.43 I tend to agree with Mr.

Kofman, but would add that this notion of a cap should remind lenders that

collateral mortgages are on their terms capped their stated principal amounts.

Too often, lenders amend or modify the terms of their loans in unregistered

instruments without revisiting their collateral mortgages to ensure that they are

securing the full amount of indebtedness.

40 Falconbridge, 8-28. 41 Kofman, p 10. 42 Bryan G. Clark and Jeffrey W. Lem, “Debenture Pledges: A Buggy Whip for your Porsche… Wound into the Crankshaft?”, Best Practices for

Commercial Mortgage Transactions, LSUC, March 26, 2003. 43 Kofman, p 10.

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I will also pause here to go off topic (not the first time, I know) on the broader

issue of amending the unregistered instrument that creates the primary obligation

secured by the collateral mortgage. It is not unusual, for instance, for the collateral

mortgage to state that it secures all obligations and liabilities as set out in a

commitment letter, indemnity, undertaking, credit agreement or similar

instrument. Over time, the commercial terms of the unregistered instrument are

amended, modified, supplemented, added to, restated, replaced or otherwise

recast, without regard to the collateral mortgage on title. The concern is that the

collateral mortgage may need to be amended or reaffirmed to ensure that it

secures such new or modified obligations, and that such obscene things as

novation have not inadvertently happened.

(c) Reduction to zero

A third issue raised by attaching a collateral mortgage to a revolving debt

obligation is the possibility that, if the debt is paid down to zero, the mortgage

may be automatically redeemed. This rule is codified in Ontario in Subsection 6(2)

of the Land Registration Reform Act, which reads: "A charge ceases to operate

when the money and interest secured by the charge are paid, or the obligations

whose performance is secured by the charge are performed, in the manner

provided by the charge". The words “in the manner provided by the charge”

suggest that an easy workaround is to include in the charge language that keeps

the charge alive despite a reduction to zero.

While such a workaround would be necessary in Ontario, other provinces have

enacted rules to prevent the automatic redemption of collateral mortgages upon

the reduction to zero of the underlying revolving debt obligation. For instance,

Subsection 28(3) of the British Columbia Property Law Act provides a special rule

for running accounts like revolving lines of credit. It reads:

"If a mortgage is expressed to be made to secure a current or running account, it

is not deemed to have been redeemed merely because

29

(a) advances made under it are repaid, or

(b) the account of the mortgagor with the mortgagee ceases to be in debt,

and the mortgage remains effective as security for further advances and retains

the priority given by this section [i.e., further advances are subordinated to

subsequent mortgages with notice] until the mortgagee has delivered a

registrable discharge of the mortgage to the mortgagor but, if the mortgagor is

not indebted or in default under the mortgage, the mortgagee must, on the

mortgagor's request and at the mortgagor's expense, execute and deliver to the

mortgagor a registrable discharge of the mortgage".

But, to reiterate, in practice, an Ontario mortgagee wishing to prevent the

automatic redemption of a mortgage should simply include in the charge a clause

providing that the mortgage is not redeemed on the reduction to zero of the

underlying running account.

VIII. Securing a Performance Obligation

We now will touch on issues that arise when a collateral mortgage secures a

performance obligation that is not yet monetized – for instance, a promise to complete

a particular task, an undertaking, or an indemnity against a future loss. Should a

subsequent mortgagee wish to "pay off" the collateral mortgage and exercise a right of

subrogation, it is unclear what value the subsequent mortgagee should ascribe to the

mortgage when seeking to discharge it or if it can exercise a right of subrogation at all.

Legislation is silent on the interaction between collateral mortgages and performance

obligations, with the exception of Subsection 6(2) of Ontario's Land Registration Reform

Act, discussed above, which provides that "a charge ceases to operate when … the

obligations whose performance is secured by the charge are performed". Thus, as in the

"reduction to zero" problem for revolving debt obligations, a collateral mortgage

securing a performance obligation could be redeemed upon the completion of the

obligation.

30

The difficulty arises because, in a situation where the collateral mortgage secures an

unquantified amount, the subsequent mortgagee does not want to pay to the first

mortgagee the face value (or maximum secured amount) under the mortgage, nor can it

ask the senior mortgagee for a mortgage statement evidencing the amount then due (it

may in fact be zero at the time). So what to do?

Your author spent a good deal of time noodling on this one, and much to his dismay

(after trying to analogize to any manner of argument, including on whether one could

seek relief on the basis of it being a clog on the equity of redemption) has come to this

rather unsatisfactory conclusion. The best that a subsequent mortgagee could attempt

to do, is to make application to court for the cash or near cash (i.e. letter of credit)

collateralization of the senior mortgage in an amount equal to the maximum amount of

the senior mortgage.

IX. Conclusion

As noted at the outset, the term "collateral mortgage", though used by courts, does not

have a well-settled judicial definition. It is more a commercial term than a legal one. It is

therefore unsurprising that, when courts and lawyers comment on collateral mortgages,

they do so meaning different things at different times. That said, there is one

commonality, and that is that all collateral mortgages are posted as security for an

obligation that is not entirely contained within that mortgage. It is not a self-contained

loan and security document. Accordingly, any analysis or enforcement of a collateral

mortgage requires a complete view of the loan and security package, its construction,

and those particular remedies and defenses set out herein.

WSLEGAL\000850\00997\16039376v1