COURT FILE NO.: 234/09
DATE: 20091125
ONTARIO
SUPERIOR COURT OF JUSTICE
DIVISIONAL COURT
whalen, dambrot and swinton JJ.
B E T W E E N:
167986 CANADA INC.
Applicant (Appellant)
- and -
GMAC COMMERCIAL FINANCE CORPORATION-CANADA/SOCIÉTÉ FINANCIÈRE COMMERCIALE GMAC-CANADA, BLACK SAXON QRC INC. and QRC LIMITED PARTNERSHIP
Respondents (Respondents on Appeal)
Alan Lenczner and Philip Cho, for the Applicant (Appellant)
Alan B. Mersky and Katherine Smirle, for the Respondent GMAC Commercial Finance Corporation-Canada/Société Financière Commerciale GMAC-Canada
Daniel S. Murdoch, for the Respondents Black Saxon QRC Inc. and QRC LIMITED PARTNERSHIP
HEARD at Toronto: November 6, 2009
SWINTON J.:
Overview
[1] 167986 Canada Inc. (“167”) appeals with leave from the order of Morawetz J. dated May 14, 2009, in which he dismissed 167’s motion under rule 45.02 for an order preserving a certain sum of money. At issue in this appeal is the application of the law relating to guarantees to the rights and obligations under a Letter of Credit Agreement between 167 and GMAC Commercial Finance Corporation-Canada (“GMAC”).
The Background
[2] On January 9, 2006, GMAC entered into a Loan Agreement to provide a revolving credit facility to SAAN Stores Ltd., a company operating a chain of discount retail stores. 167 is a long-term supplier of goods to SAAN and, as it was owed money for goods sold to and received by SAAN, it was also a creditor of SAAN.
[3] The Loan Agreement was altered three times, the third time on June 21, 2007. Prior to the third change, GMAC indicated that it was prepared to increase its lending to SAAN if a third party guaranteed a portion of the increased lending. 167 came forward as a guarantor and entered into an agreement with GMAC and SAAN entitled the Letter of Credit Agreement (“LC Agreement”).
[4] Under the LC Agreement, 167 agreed to obtain a Letter of Credit from the Bank of Montreal (“the Bank”) in the amount of $3.5 million. Section 2.01 of the agreement begins with the words “Limited Recourse Guarantee”. In the first sentence, 167, defined as the Investor, “unconditionally guarantees and promises to pay to the Lender, on demand” the indebtedness of SAAN (defined as the Borrower) under the Loan Agreement, subject to the terms and conditions of the LC Agreement. The section goes on to say,
Notwithstanding the preceding sentence or anything to the contrary contained herein, the liability of and recourse to the Investor hereunder will be limited to the Letter of Credit, the Lender will not have any right to sue or commence any action against the Investor to recover any amounts owing by the Investor pursuant to the provisions hereof except to the extent necessary to permit the Lender to realize upon the security constituted by the Letter of Credit …
[5] Section 2.04 permits SAAN, the Borrower, to substitute another Letter of Credit, cash collateral or letter of guarantee in certain circumstances. Section 2.05 deals with the renewal of the Letter of Credit. It states that the Letter of Credit will expire on March 31, 2008, and the Investor will have no obligation to renew it. However, the Borrower is obligated to have the Letter of Credit replaced or renewed annually for additional one-year periods. If the Letter of Credit has not been renewed within three months of maturity, the Lender has the right to draw against it within 30 days of maturity and to hold the proceeds as Cash Collateral.
[6] Section 2.06 deals with enforcement of the Letter of Credit, permitting the Lender to retain the Letter of Credit or the Cash Collateral as security against any ultimate shortfall in recovery of the Borrower’s indebtedness, if the Lender issues a notice of intention to enforce security pursuant to the Bankruptcy and Insolvency Act (“BIA”).
[7] Section 2.07 then deals with realization of the security. It requires the Lender to dispose of all of the Borrower’s inventory before claiming any payment under the Letter of Credit or the Cash Collateral. If there is a shortfall on the loan after disposal of the inventory, the Lender can draw against the Letter of Credit or the Cash Collateral. Once the loan is paid in full, if there are funds remaining on the Letter of Credit or from the Cash Collateral, the Lender is to notify the Bank to cancel the Letter of Credit or return the remaining funds to the Investor.
[8] Pursuant to section 2.10, the Investor states that it will not have, and hereby waives, any rights of subrogation until the Borrower’s indebtedness under the Loan Agreement has been paid in full to the Lender. Finally, section 2.11 deals with the Cash Collateral, stating,
To the extent that the Lender is, in accordance with section 2.05, to hold the Cash Collateral, the Investor hereby irrevocably assigns, pledges, hypothecates, transfers and sets over to the Lender, and grants to the Lender a security interest in, hypothec on, and right to set off (compensate) against the Cash Collateral. The hypothec created herein is for the amount of the Cash Collateral. The Cash Collateral shall be held by the Lender, without interest, in an account designated by the Lender for such purposes in its books and records and may be commingled with the Lender’s own funds. …
[9] Section 3.04 provides that the agreement will enure to the benefit and be binding on the Investor, Borrower, Lender and their successors and assigns.
[10] In consideration for the LC Agreement, SAAN entered into a Credit Support Agreement with 167, which provided 167 with the right of subrogation. SAAN also provided guarantees from the Chahine II Family Trust and Tony Chahine, principal of SAAN, in the event the Letter of Credit was drawn on by GMAC.
[11] As required, 167 obtained the Letter of Credit (entitled a “Letter of Guarantee”) from the Bank with GMAC named as beneficiary. According to that document, payment was to be made under the Letter of Credit if GMAC provided appropriate documentation. The documentation must state that the amount claimed is due to GMAC, as GMAC is entitled to draw under the Guarantee in accordance with the terms and conditions of the Letter of Credit Agreement dated June 4, 2007. In return for the Letter of Credit, GMAC increased SAAN’s credit facility to $25 million.
[12] On October 25, 2007, GMAC gave SAAN notice of default under its credit facility and notice of its intention to enforce its security pursuant to s. 244(1) of the BIA. SAAN advised that it was seeking to restructure its affairs and intending to dispose of its assets en bloc.
[13] On December 17, 2007, GMAC entered into a Forbearance Agreement to the Loan Agreement with SAAN. The Forbearance Agreement provided for an increase in the maximum advance under the Loan Agreement from $25 million to $30 million, to be available from December 17, 2007 until December 31, 2007, when the maximum reverted to $25 million. GMAC also agreed to forbear until the earlier of March 31, 2008 or the occurrence of additional acts of default.
[14] In conjunction with the Forbearance Agreement, the respondent Black Saxon and GMAC entered into Loan Put Agreements dated December 17, 2007 and January 2, 2008. By these agreements, Black Saxon granted GMAC put options requiring Black Saxon to purchase and acquire, by way of assignment, GMAC’s interest in the credit facility provided to SAAN. The combined put option price was $12.8 million.
[15] On December 28, 2007, SAAN obtained protection under the Companies Creditors Arrangement Act, R.S.C. 1985, c. C-36 (“CCAA”). In the Initial Order made by Morawetz J. in the CCAA proceedings, the Forbearance Agreement was specifically referred to and approved
[16] In addition to providing the Letter of Credit, 167 was a trade creditor of SAAN. It retained counsel in February 2008 and participated in the CCAA proceedings. The evidence shows that 167 became aware of the Forbearance Agreement in February or March 2008.
[17] On March 31, 2008, the Letter of Credit expired. Rather than renew it, 167 directed GMAC to call upon the Letter of Credit and convert it into the Cash Collateral.
[18] On April 25, 2008, 167 brought a motion to be declared an unaffected creditor under the CCAA proceedings.
[19] On June 6, 2008, GMAC sought and obtained the appointment of PriceWaterhouseCoopers LLP (“PWC”) as the interim receiver and receiver of SAAN. The Receiver’s task was to ensure the orderly completion of SAAN’s liquidation. 167 did not oppose the Receivership.
[20] Up to this point, 167 had raised no issue with respect to GMAC’s entitlement to the Cash Collateral. Lee Karls, president of 167, gave evidence that he had become aware of the CCAA proceedings in December 2007 or January 2008. On cross-examination, he said the following (Transcript, pp. 103-104):
- Q. Okay. And were you waiting to see if that was going to happen?
A. I was waiting for everything to happen. I didn’t know what was going to happen. I really didn’t know what was going to happen. So it’s not like I waiting until that happened to – the picture was painted that everything was going to be beautiful. And that’s kind of where, the end of March when it wasn’t such a rosy picture and I didn’t believe everything I heard anymore, that might be the time when the rift started. So –
- Q. What was going to be beautiful?
A. Stalking horse. Everything getting moved over to the new company. Everything’s status quo.
- Q. Your LC would be okay and wouldn’t get called on?
A. Correct.
[21] At another point in his cross-examination, Mr. Karls stated (Transcript at pp. 112-13, Q. 506):
… I thought there was a deal that the stores were being bought. So I didn’t really care. If the stores had been bought, my money’s secure … Each one of those things that I was told, I knew I was getting my money back, and besides my LC money back I was getting, I was getting merchandise money back.
[22] On July 4, 2008, 167 first took the position that its obligations under the Letter of Credit Agreement may have been terminated. It took the position that the Cash Collateral was not assignable, and that GMAC’s loan had been or would be satisfied in full.
[23] Subsequently, on July 18, 2008, 167 took the position that the Forbearance Agreement invalidated the LC Agreement.
[24] On October 3, 2008, GMAC advised 167 that it would be assigning on an “as is where is” basis to Black Saxon all of its rights and obligations under the Loan Agreement with SAAN and the security documents relating thereto, including the LC Agreement. This prompted 167 to launch an application to determine whether its obligations under the LC Agreement were terminated because of amendments to the Loan Agreement by the Forbearance Agreement in December 2007. As noted by the motions judge, 167 is concerned that if it succeeds on its application, it may be required to seek payment from Black Saxon, which it believes to be of “questionable solvency” (Reasons, at para. 27).
[25] On October 14, 2008, Morawetz J. ordered, on consent, that the Cash Collateral be paid into escrow by GMAC to Stikeman Elliot LLP as the escrow agent.
The Rule 45.02 Motion
[26] 167 then brought a motion under rule 45.02 to preserve the Cash Collateral by an order paying it into court. Rule 45 deals with orders for interim preservation of property. Rule 45.02 provides:
Where the right of a party to a specific fund is in question, the court may order the fund to be paid into court or otherwise secured on such terms as are just.
[27] The motions judge dismissed the motion for reasons found at 2009 24224. He concluded that 167 has no proprietary interest in the Cash Collateral, as the funds paid under a letter of credit are the funds of the issuing party, here the Bank. He also noted that the LC Agreement provides that the title to the Cash Collateral was assigned to GMAC upon conversion of the Letter of Credit. Moreover, the LC Agreement did not provide for the Cash Collateral to be held as an indivisible and traceable fund. Therefore, he concluded that 167 has no proprietary interest in the Cash Collateral: “The Cash Collateral was derived from the LC Agreement and 167 has no proprietary interest in the Letter of Credit” (at para. 40). Therefore, “167 has, in my view, failed to establish a right to any specific fund” (at para. 42).
[28] The motions judge also concluded that 167 had failed to establish a serious issue to be tried with respect to 167’s claim to the Cash Collateral (at para. 55). 167 had argued that it was released from its obligations under the LC Agreement and entitled to the return of the Cash Collateral because GMAC entered into the Forbearance Agreement. This argument rests on the proposition that the LC Agreement is a guarantee, and 167, as guarantor, was released from its obligations because there was a material change to the indebtedness under the Loan Agreement that it guaranteed.
[29] The motions judge held that the law of guarantee was not applicable to the LC Agreement. He described that agreement as a contract entered into by 167 to supply a standby letter of credit, with 167’s only rights being to have that letter of credit drawn upon in accordance with the terms of the agreement (at para. 45). Changes to the Loan Agreement, including GMAC’s decision to enter into the Forbearance Agreement, are irrelevant to the LC Agreement and do not discharge 167’s obligations (at para. 48).
[30] In the alternative, if 167 were a guarantor under the LC Agreement, the motions judge concluded that 167 was not entitled to a release under the law of guarantee, as 167 had implicitly ratified any forbearance by its conduct through the CCAA proceedings (at para. 49).
[31] The motions judge also held that the assignment to Black Saxon was valid, a conclusion that was not appealed.
[32] Given his conclusions, the motions judge did not find it necessary to deal with the issue of the balance of convenience. He dismissed the motion and stated that the Cash Collateral should be transferred by GMAC to Black Saxon pursuant to the Loan Put Agreements.
The Test on a Rule 45.02 Motion
[33] The test for relief under rule 45.02 requires the moving party to show:
that the party claims a right to a specific fund,
that there is a serious issue to be tried regarding the party’s claim to that fund, and
the balance of convenience favours granting the relief sought. (News Canada Marketing Inc. v. TD Evergreen, [2000] O.J. No. 3705 (S.C.J.) at para. 14)
The Issues on Appeal
[34] There are four issues on this appeal:
Did the motions judge err by resolving conflicts in the evidence and determining difficult questions of law on a rule 45.02 motion?
Did the motions judge err in finding that the Cash Collateral was not a specific fund within the meaning of rule 45.02?
Did the motions judge err in applying the law governing letters of credit to the LC Agreement, rather than applying the law governing guarantees?
Did the motions judge err in finding an implied ratification by 167?
Analysis
Issue No. 1: Did the motions judge err by resolving conflicts in the evidence and determining difficult questions of law on a rule 45.02 motion?
[35] This Court should intervene only if the motions judge made an error in law or a palpable and overriding error in his appreciation of the evidence.
[36] The order under appeal was made by an experienced judge of the Commercial List in his role as the supervising judge of the CCAA proceedings involving SAAN. As the Court of Appeal has indicated, the expertise of such judges in insolvency proceedings is deserving of deference (BNY Capital Corp. v. Katotakis, [2005] O.J. No. 623 (C.A.) at para. 8; Algoma Steel Inc. (Re), 2001 5433 (ON CA), [2001] O.J. No. 1943 (C.A.) at para. 8).
[37] 167 submits that the motions judge went too far in his scrutiny of the merits of the case. While he was required to determine whether 167 had established there was a serious issue to be tried with respect to 167’s claim to the Cash Collateral, he in fact determined the merits of the application. This is contrary to the instruction in Metropolitan Stores Ltd. (MTS) v. Manitoba Food & Commercial Workers, Local 832, [1987] 1 S.C.R. 10 at para. 40 that a court at the interlocutory stage should not try to resolve conflicts of evidence or decide difficult questions of law.
[38] In my view, the motions judge did not determine the merits of 167’s application. He was required to decide if there was a serious issue to be tried with respect to 167’s claim to the Cash Collateral, and he determined that 167 did not meet even this low threshold. He came to this conclusion based on the application of well-known legal principles to the uncontested facts and in light of the terms of the LC Agreement.
Issue No. 2: Did the motions judge err in finding that the Cash Collateral was not a specific fund within the meaning of rule 45.02?
[39] In his reasons, the motions judge stated the first part of the test under rule 45.02 required the moving party to establish “a right to a specific fund”, rather than a claim of a right to a specific fund (at paras. 30, 42). However, it is clear from his reasons that his first question was whether there was a claim to a specific fund.
[40] To determine that question, a motions judge has to make a preliminary assessment as to whether the moving party has a proprietary claim. Here, he concluded that there was no specific fund, and that 167 had no basis to make a proprietary claim against the Cash Collateral. Therefore, he held that 167 did not satisfy the first part of the test. I agree with his conclusion.
[41] A “specific fund” is a reasonably identifiable fund, earmarked to the litigation in issue (Rotin v. Lechcier-Kimel (1985), 3 C.P.C. (2d) 15 (Ont. H.C.J.) at para. 5). The party seeking a rule 45.02 order must have a proprietary claim against the specific fund (DIRECTV, Inc. v. Gillott (2007), 2007 4313 (ON SC), 84 O.R. (3d) 595 (S.C.J.) at paras. 59 and 62). Establishing a possible claim for payment of damages for breach of contract does not establish a right to a specific fund (Assante Financial Management Ltd. v. Dixon, [2004] O.J. No. 2237 (S.C.J.) at para. 28).
[42] The motions judge correctly held that the Cash Collateral was not a specific fund against which 167 could make a proprietary claim. The law governing letters of credit is clear: the funds paid on a letter of credit are the property of the issuing bank (Bank of Nova Scotia v. Angelica-Whitewear Ltd., 1987 78 (SCC), [1987] 1 S.C.R. 59 at para. 10). As Blair J. (as he then was) said in 885676 Ontario Inc. (Trustee of) v. Frasmet Holdings Ltd., 1993 8656 (ON SC), [1993] O.J. No. 113 (Ont. Ct. (Gen. Div.)) (“Frasmet”) at para. 29:
Letters of credit are a specialized form of commercial credit, designed by their very nature to be free and clear of the equities between the parties to the underlying transaction which they are issued to secure. They constitute an independent contract between the issuer (usually a bank, as in this case) and the beneficiary (one of the parties to the underlying transaction – a landlord in this case). This principle of “autonomy” goes to the root of the practice surrounding their issuance. The only admitted exception to the principle is fraud.
[43] In the present case, the Bank paid the Cash Collateral to GMAC pursuant to the Letter of Credit, an autonomous agreement to which the Bank and GMAC were the only parties. 167 had no proprietary claim to the Letter of Credit or its proceeds at the time they were drawn upon by GMAC.
[44] 167 relies on the terms of the LC Agreement to show that it has a claim to the Cash Collateral. In particular, it relies on the fact that GMAC is not entitled to draw down on the Cash Collateral unless there is a shortfall on the SAAN loan after the SAAN inventory has been liquidated. If the liquidation is sufficient to satisfy the loan, 167 is entitled to the return of the Cash Collateral. Alternatively, 167 is entitled to any amount of the Cash Collateral that is surplus after the funds from the liquidation are used to pay down the loan.
[45] In my view, these provisions do not create a proprietary claim to a specific fund. According to the LC Agreement, GMAC has a contractual obligation to account for the Cash Collateral funds it received from the Bank after the liquidation and to pay the balance owing after the liquidation, if any. Until the liquidation occurs, 167 has no right to claim any part of the Cash Collateral funds.
[46] As the motions judge noted, section 2.11 of the LC Agreement expressly provides that 167 “hereby irrevocably assigns, pledges, hypothecates, transfers and sets over to the Lender” the Cash Collateral. This wording indicates that 167 had no proprietary interest in the Cash Collateral.
[47] Moreover, the wording of the LC Agreement permitting GMAC to commingle the Cash Collateral with its own funds indicates that there is no specific fund to which 167 could assert a proprietary claim.
[48] This is not a case where there is a claim for trust funds, as in some of the cases relied on by 167 (see, for example, Rotin, supra at para. 13; 1463150 Ontario Ltd. v. 11 Christie Street Inc., 2007 CarswellOnt 6937 (Ont. Master)).
[49] In any event, 167 is not claiming the return of the Cash Collateral under the LC Agreement. In its Notice of Application, it seeks payment of the amount of the Cash Collateral plus interest on the basis that its obligations under the LC Agreement are discharged under the law of guarantee. This is a claim in damages, as 167 has no proprietary interest in the Letter of Credit or the funds drawn on it. What 167 is seeking is execution before judgement; it cannot do so through a rule 45.02 motion.
Issue No. 3: Did the motions judge err in applying the law governing letters of credit to the LC Agreement, rather than applying the law governing guarantees?
[50] 167’s application is based on the assertion that the LC Agreement was a contract of guarantee. It then asserts that the acts of forbearance by GMAC were material amendments to the guarantee, and, therefore, 167 was discharged from its obligations under the guarantee. It relies on the decision of the Supreme Court of Canada in Manulife Bank of Canada v. Conlin, 1996 182 (SCC), [1996] 3 S.C.R. 415 at para. 2, where the Court referred to the well-established principle of law that a guarantor will be released from liability on the guarantee where the lender and the principal borrower agree to a material alteration of the terms of their loan agreement without the consent of the guarantor.
[51] 167 argues that the motions judge’s error in refusing to apply the law of guarantee is rooted in his failure to distinguish the substance of a guarantee from the substance of a standby letter of credit. He is said to have erred by defining the parties’ relationship based on the form of security given for the LC Agreement, rather than the substance of the agreement.
[52] 167 relies on The Wichita Eagle and Beacon Publishing Company, Inc. v. Pacific National Bank of San Francisco (1974), 493 F. 2d 1285 (U.S.C.A. 9th), where the Court held that it was not bound by the label on an instrument describing it as a letter of credit. The Court in that case went on to look at the terms of the agreement, concluding that the instrument was really a contract of guarantee, because the issuer was not required to deal only with documents in order to determine whether payment would be made. Rather, the issuer would be required to determine facts relating to the performance of a separate contract, a lease, in order to determine whether to make payment. Therefore, the instrument was held to be, in substance, a guarantee.
[53] In the present case, the motions judge carefully considered the terms of the LC Agreement to determine whether the law of guarantee applied to it. He recognized that the classification of the agreement should be determined by its substance and not just by the title given to a particular document.
[54] It is significant that 167 contracted with GMAC in the LC Agreement to cause the Bank to issue an irrevocable standby letter of credit as security for the obligations of SAAN as borrower. As Blair J. observed in Frasmet Holdings, supra,
There is a fundamental difference between a letter of credit, which is a very specialized form of security, and a guarantee, which is not a form of security at all (except in a loose, non-legal sense of that term). (at para. 26)
Thus, it can be seen that a letter of credit is a creature quite different from a simple guarantee. It is a form of security which may be called upon by the secured creditor when the event for which the security has been given occurs, without regard to the circumstances existing between the parties to the underlying transaction. (at para. 34)
[55] While 167 argues that the motions judge improperly let form triumph over substance, I disagree. Because of the qualities of a letter of credit, its use as a form of security is a fundamental part of the substance of the LC Agreement. As Farley J. stated in Westpac Banking Corp. v. Duke Group Ltd., 1994 7315 (ON SC), [1994] O.J. No. 2203 (Ont. Ct. (Gen. Div.)), “a standby letter of credit is critically different from a guarantee or indemnity” (at para. 17). Farley J. quoted with approval from Re Carley, 119 B.R. 646 (W.D. Wis., 1990), which held that a letter of credit creates a primary liability – to pay on the presentation of documents – rather than a secondary liability, to pay in the event that the borrower defaults.
[56] In Westpac, Farley J. stated (at para. 28):
One must remember that the parties chose the letter of credit method as the way of satisfying the requirements; thus they chose how the substance of this transaction would be dealt with. The autonomy principle is not form, it is a foundation of the letters of credit regime. It is this regime which on a policy basis is recognized as being quite valuable to society (and the economy) as a whole.
[57] 167 argues that Carley can be distinguished because, in that case, there was no privity of contract between the lender and the party who arranged the letter of credit. Here, there is privity between GMAC and 167 because of the LC Agreement.
[58] It is common to find side agreements between a party who provides a standby letter of credit and a lender in order to deal with issues such as enforceability and conditions of payment (see Lazar Sarna, Letters of Credit: The Law and Current Practice, 3rd ed. (Thomson Carswell) at pp. 3-8 to 3-8.1). However, the existence of privity between GMAC and 167 does not turn the LC Agreement into a contract subject to the law governing guarantees. To determine whether the law of guarantee applies, one must consider the terms of the LC Agreement, including the fact that the security provided in it is a letter of credit.
[59] Moreover, an examination of the terms of the LC Agreement confirms that it is not a contract of guarantee. The only recourse available to GMAC under the agreement is to the Letter of Credit (or the Cash Collateral derived from it).
[60] As well, there is no provision for waiver of forbearance in the LC Agreement, as one would expect in a commercial guarantee instrument (see Geraldine Andrews and Richard Millet, Law of Guarantees, 4th ed. (London: Sweet & Maxwell, 2005) at p. 528).
[61] In addition, 167 entered into a separate Credit Support Agreement with SAAN in order to create a right of subrogation. As a guarantor, 167 would have no need to obtain such a right, as the right of subrogation arises by law for a guarantor (Westpac, supra, at para. 17).
[62] If 167 wanted the right to have its obligations discharged in the event of a material change to the Loan Agreement, it could have sought such rights by contract as well. Instead, the LC Agreement appears to contemplate the possibility of further amendments to the Loan Agreement, defining it “as the same may be further amended, modified, replaced, restated or supplemented from time to time.”
[63] 167 argues that its obligations under the LC Agreement were secondary obligations and, therefore, it is a guarantor. In fact, 167’s obligations under the agreement are primary obligations to GMAC – to provide the Letter of Credit on which GMAC could draw if the proper documents are presented to the Bank. 167 was required to provide the Letter of Credit before and irrespective of any default by SAAN, the principal borrower. The proceeds ultimately drawn on the Letter of Credit by GMAC were the Bank’s funds; it was the Bank, not 167, that paid the debt of SAAN.
[64] In contrast, a guarantee creates a secondary obligation, requiring payment by the guarantor on the default of the borrower (Re Carley, supra at p. 2). That is not the situation under the LC Agreement.
[65] 167 argues that the LC Agreement creates a secondary obligation on the part of 167 because payment from the Letter of Credit or the Cash Collateral can be made only if the loan is not satisfied by SAAN or by the liquidation of the SAAN inventory. Again, it is not correct to say the obligation is secondary. 167’s obligation under the LC Agreement is primary; the agreement does not require 167 to do anything after it has provided the Letter of Credit. 167 may, in certain circumstances, have a right to monies from GMAC, but only if there is a surplus from the funds advanced by the Bank after the liquidation of the inventory and payment of the loan. As Blair J. said in Frasmet, supra, at para. 33:
An irrevocable letter of credit has been said to be the equivalent of cash or moneys worth placed at risk to its full face value the moment it is issued, subject to the happening of certain specific events …
[66] 167 also argues that the Letter of Credit is security for 167’s guarantee under the LC Agreement, and not security for SAAN’s indebtedness. However, the terms of the LC Agreement and the Letter of Credit make it clear that the Letter of Credit was security for SAAN’s indebtedness under the Loan Agreement and not security for a guarantee provided by 167. Section 2.06 states clearly that in the event of insolvency proceedings against SAAN, “GMAC may retain the Letter of Credit, or the Cash Collateral, as the case may be as security against any ultimate shortfall of the Borrower’s indebtedness.”
[67] Therefore, reading the LC Agreement as a whole and in light of the obligation assumed by 167, there is no serious issue that the law of guarantee applies to the agreement so as to permit 167 to argue that its obligations as a guarantor were discharged as a result of the Forbearance Agreement.
Issue No. 4: Did the motions judge err in finding an implied ratification by 167?
[68] In the alternative, if the LC Agreement is subject to the law relating to guarantees, the motions judge held that 167 implicitly ratified the changes to the Loan Agreement.
[69] 167 argues that a guarantor has no legal obligation to warn a creditor when the creditor engages in conduct that may discharge the guarantee (see Birch Lake (Municipal District) v. London Guarantee & Accident Co., 1930 290 (AB SCTD), [1930] 3 W.W.R. 634 (Alta. S.C.) at para. 11).
[70] However, if a guarantor, upon learning of a material variation in the guaranteed loan, continues to allow a creditor to supply credit to the debtor, the guarantor is deemed to have ratified the variation after a reasonable period has elapsed (Transamerica Commercial Finance Corp. Canada v. Northgate RV Sales Ltd., 2006 CarswellBC 3180 (B.C.S.C.) at paras. 37 and 39).
[71] 167 concedes the possibility that ratification may exist in the context of guarantees, but submits that the motions judge erred in determining that there had been ratification. There was no express ratification of the changes to the Loan Agreement, and 167 argues that any implied ratification must be clear and unequivocal (John Ziner Lumber Ltd. v. Kotov (2000), 5 C.L.R. (3d) 44 (Ont. C.A.) at para. 31). 167 submits that its participation in the CCAA proceedings, as a trade creditor, could not constitute clear and unequivocal ratification of amendments to the Loan Agreement.
[72] I see no error on the part of the motions judge with respect to ratification. The evidence is clear that 167 was aware of the Forbearance Agreement at the latest in February or March 2008. It participated in the CCAA proceedings over the course of several months, including the Receivership motion, without raising any issue about the Letter of Credit or the termination of its obligations under the LC Agreement. While 167 states that it participated in the CCAA proceedings as a trade creditor rather than guarantor, it is clear that 167 knew of the Forbearance Agreement through its participation, and it raised no objection.
[73] As well, it directed GMAC to draw down the Cash Collateral, rather than renew the Letter of Credit at the end of March 2008, again without raising any issue about the termination of the LC Agreement. The evidence of Mr. Karls shows that 167 raised no concerns because he hoped that a restructuring of SAAN would result in the recovery of the monies advanced under the Letter of Credit and payment of amounts owing to 167.
[74] While the motions judge did not determine whether there were material changes that would affect the validity of the Loan Agreement, the evidence suggests that the Forbearance Agreement would not discharge the Loan Agreement. SAAN defaulted under the Credit Facility in October 2007, leading GMAC to issue a notice of its intention to enforce its security. By section 2.06 of the LC Agreement, GMAC was then entitled to retain the Letter of Credit or Cash Collateral as security against any ultimate shortfall in recovery of SAAN’s indebtedness. Thus, GMAC’s rights against the guarantee crystallized before the Forbearance Agreement. As noted in Alberta Opportunity Co. v. Wilson, [1994] A.J. No. 498 (Q.B. Master), once a guarantor becomes liable on the guarantee, later accommodations to the borrower would not change the terms of the guarantee (at para. 41).
Conclusion
[75] For 167 to succeed in this appeal, it was required to show that the motions judge erred on each of three issues: the specific fund, the applicability of the law relating to the law of guarantee, and ratification. In my view, the motions judge did not err in concluding that there was not a specific fund to which 167 had a proprietary claim. Nor was there a serious issue with respect to 167’s claim that the LC Agreement was terminated, thus entitling 167 to the Cash Collateral. Given this conclusion, there is no need to address the balance of convenience.
[76] The appeal is dismissed. If the parties cannot agree on the costs of the motion for leave to appeal and the appeal, they may make brief written submissions through the Divisional Court Office within 21 days of the release of this decision.
Swinton J.
Whalen J.
Dambrot J.
Released: November 25, 2009
COURT FILE NO.: 234/09
DATE: 200911##
ONTARIO
SUPERIOR COURT OF JUSTICE
DIVISIONAL COURT
WHALEN, DAMBROT and SWINTON JJ.
B E T W E E N:
167986 CANADA INC.
Applicant (Appellant)
- and -
GMAC COMMERCIAL FINANCE CORPORATION-CANADA/SOCIÉTÉ FINANCIÈRE COMMERCIALE GMAC-CANADA, BLACK SAXON QRC INC. and QRC LIMITED PARTNERSHIP
Respondents (Respondents on Appeal)
REASONS FOR JUDGMENT
SWINTON J.
Released: November 25, 2009