Court of Appeal for Ontario

Citation: Empire Life Insurance Company v. Arnold, 2010 ONCA 3

Date: 2010-01-08

Docket: C49718

Between:

The Empire Life Insurance Company Plaintiff (Respondent)

and

Krystal Holdings Inc., Donna Arnold, Robert Arnold, Joseph Atherton, Jody Atherton, John E. Atkinson, Jacqueline Atkinson, John W. Baber, Douglas Beer, Marlene Beer, Harry Berholz, Arthur Biffis, Ronald Blais, Pauline Blais, Angelo Bonomo, James Bonter, Cheryl Bonter, Hagob Boyrazian, Louis J. Brisson, Arthur Brook, Leonard Bujokas, Glenda Bulzgis, Addie Bulzgis, George Butcher, G.C. Butcher Ltd., David W.C. Chan, David Cheifetz, Sam C. Cheung, Robert Childs, Bonnie J. Childs, Alan Christie, B. Elizabeth Clark, Douglas F. Clark, John Gary Cook, Barbara E. Cook, Peter D. Copeland, Aldo Cundari, Livian Cundari, Tony J. Desanti, John C.W. Dodds, Mary Ellen Dodds, John Dorsay, Mildred Dorsay, Flavia Dos Remedios, Joseph Drago, Sylvia Drago, Michael Emond, Joan Euler, Donald James Euler, Allan Olsen as litigation administrator for The Estate Of Margaret Fawcett, Allan Olsen As Litigation Administrator For The Estate Of Allison Fawcett, Claudette Goulet The Executrix Of The Estate Of Marcel J. Goulet, Claudette Goulet, George Harrap, Stuart Hayward, Ruth I. Hayward, Norman R. Heitbohmer, Herbert Herman, Geraldine Berholz As Executrix of The Estate Of Jack Hilf, John Hohner, Arthur G. Hubert, Margaret Jones, Margaret Jones as litigation administrator for The Estate of Walter Jones, Bruce King, Dennis King, Jules Kroeker, Andrew Ihor Kuchtaruk, Jerry Kuhlmann, also known as Jerry Kuhlman, Denis Lacroix, Luc Lalonde as litigation administrator for The Estate Of Ivan Lalonde, Irene Lawrence, Therese Lecours as litigation administrator for the Estate Of Laurent Lecours, Wayne Levine, Alec Li, Ann Li, Sam Louli, also known as Sami Louli, Patricia Werner as litigation administrator for The Estate Of Eric Malling, James G. Matthews, Alex Douglas Mcgregor, Michael H. Mclafferty, Melvyn Merker, Donald F. Miller, Murray B. Naiberg, John R. Nephew, Sherril A. Nephew, also known as Sherri Nephew, Harold Niman, Gilda Niman, William O'connor, Park Creek Estates Inc., John Paul Prevett, Henry Proulx, Marjorie Proulx, Frances Quarrington as Executrix of The Estate of George Ross Quarrington, Brock H. Rutledge, M. Dale Rutledge, Stephen L. Sandler, Steven Sharpe, Joseph Shaw, John A. Smith, Kenoth Spreen, Donald Steel, Lina Steel, Elizabeth Thorn, Joseph Tortolo, Carol Ann Walmsley, Patricia J. Werner, Robert Westhaver, David W. Whetham, Robert M. Willson, Amy C. Wong, Graeme Young, And Jean Mclafferty as litigation administrator for The Estate Of Hugh Mclafferty, Jesse Winters as litigation administrator for The Estate Of Dorothy Winters, And Jesse Winters as litigation administrator for The Estate Of Eric John Winters Defendants (Appellants)

Before: MacFarland, Rouleau and Watt JJ.A.

Counsel:

Thomas J. Corbett and Kelly L. Webster, for the defendants (appellants) except for Krystal Holdings Inc., David Cheifetz, John Dorsay, Mildred Dorsay, Sami Louli, also known as Sam Louli, Harold Niman, Gilda Niman, Elizabeth Thorn, David W.C. Chan and Sam C. Cheung

Wendy H. Greenspoon-Soer and Ronald Birken, for the plaintiff (respondent)

Heard: December 14, 2009

On appeal from the judgment of Justice Todd L. Archibald of the Superior Court of Justice dated November 18, 2008.

By the Court:

[1] The appellants are limited partners whose involvement in a London condominium complex in the late 1980’s went horribly wrong. The respondent, Colonia, who provided the limited partners with loans through a fractured mortgage arrangement, is seeking the deficiency remaining after power of sale proceedings. The limited partners claim damages from Colonia for negligent misrepresentation and in the alternative, for breach of fiduciary duty; they also offer a number of defences to the shortfall action.

[2] The appeal focuses on a single incident: a renewal letter, prepared by Colonia that was sent by the general partner to the limited partners in 1992 which implicitly represented that the project, which was the subject of their investment, had no property tax arrears.

[3] At the time the renewal letter was prepared, Colonia was not aware there were outstanding property taxes. However, between the time that letter was sent to the general partner, Clanson, and the time the letter was forwarded by Clanson to the limited partners, Colonia became aware that the 1991 property taxes were outstanding. During that period Colonia and Clanson entered into a forbearance arrangement whereby it was agreed that Clanson would pay the tax arrears over a limited time period. The tax arrears were never paid and by the time the limited partners learned of the arrears in 1994 it was too late because by then the project was no longer salvageable.

[4] The trial judge dismissed the investors’ claims for negligent misrepresentation essentially on the basis that Colonia’s duty of care did not include the duty to communicate directly with the limited partners to keep them appraised of the property tax arrears and in any event there had been no reliance as the limited partners did not understand the renewal agreement as an implied statement that there were no tax arrears.

[5] As to the claim for breach of fiduciary duty the trial judge concluded:

With no suggestion that Colonia was acting on behalf of, or would look out for, the interests of the limited partners, the imposition of the obligations of a fiduciary is not appropriate.

[6] He also dismissed the various defences offered by the limited partners to the shortfall action concluding:

1. Colonia’s failure to collect or monitor the tax payments was not a material alteration of the original contract of debt such that their personal covenants were discharged.
2. It was not open to the limited partners to argue they were not bound by the renewal agreement. They were primary covenantors by virtue of the mortgage assumption agreement, not sureties and they had throughout acted as though the loan had been properly renewed.
3. The most logical interpretation of the parties’ interactions and intentions is that the loan was renewed with the consent of the limited partners. For those who signed and returned the renewal document, they are bound and for those who did not, their consent is inferred as a matter of fact.
4. The limited partners acted through the general partner who negotiated the renewal on their behalf. They could not argue Colonia failed to disclose a material fact when their agent was a party to the forbearance agreement.

[7] For the reasons that follow we are of the view that the appeal should be dismissed.

[8] The relationship between Colonia and the limited partners is a contractual one. That is not to say there cannot be a claim against Colonia in tort. But when consideration is given as to whether a duty of care arises on the particular facts, the contractual nature of the relationship cannot be ignored.

[9] The limited partners were investors and this investment opportunity was not without risk. The offering memorandum described the securities as “speculative” and noted that there was no market for the partnership units. Investors were told they would be largely dependent on the rental manager’s and general partner’s good faith and expertise in the operation and management of the project as well as on the financial ability of Mountainside generally and in particular its provision of the gross rent and operating expense guarantees. They were told that neither the general partner nor Mountainside (an affiliate of the general partner) had any net worth. As the trial judge noted “This was clearly an investment for reasonably sophisticated investors who were prepared to risk their investment.” The offering memorandum clearly stated that each limited partner would be required to assume the Colonia mortgage and would thereby become personally liable for the mortgage amount associated with his or her partnership unit. As such the limited partner might be required to make additional payments if the mortgage went into default. When the partnership unit was purchased, the limited partner would direct the general partner to make the Colonia payments, for which the limited partner was liable, from the building’s gross rents. Each limited partner was required to execute a mortgage assumption agreement which was a schedule to the offering memorandum. That document caused the limited partners to become personally liable for the mortgage debt and adopt all of the mortgagor’s covenants. Paragraph 4, the “principal debtor” clause, emphasized the mortgagee’s right to refrain from enforcing its rights without prejudice. The clause is an important one:

4. The Covenantor hereby covenants, promise and agree to and with the Mortgagee as principal debtor and not as surety, to pay the Assumed Debt, and to observe, perform, keep and be bound by every covenant, attornment, term, condition and agreement contained in the Mortgages, and the Covenantor hereby waives notice of default under the Mortgages. The Covenantor further agrees that the Mortgagee may at any time or times and from time to time release or discharge any part or parts of the Mortgaged Property or any securities now or hereafter held as collateral or otherwise to the Mortgages for such consideration as the Mortgagee may see fit, and that the Mortgagee may allow the principal moneys[sic] and/or interest or any part or parts thereof to be in arrears and may alter, extend or revise in any way whatsoever the terms and conditions of repayment, and may refrain from enforcing payment, or otherwise deal with the Mortgages, the Covenantor and with the Limited Partnership in whatsoever manner as the Mortgagee shall think proper, from time to time without the prior approval or knowledge of or notice to the Covenantor.

[10] The general partners arranged for the Mortgage Assumption Agreement to be signed by the limited partners and returned to Colonia. Throughout the dealings Colonia made it clear that it would deal only with the general partner and would not deal directly with the limited partners.

[11] Colonia was in the commercial mortgage business. It did not deal in residential mortgages. The original take-out financing was a single loan amount which covered the entire project. To facilitate the marketing of the project as a limited partnership, the developers sought Colonia’s agreement to fracture the mortgage into units which would correspond to the partnership units which were associated with one or two specific condominium units. Colonia agreed to fracture the mortgage but only on the conditions set out in their letter dated May 2, 1988 to Colbourne York Limited Partnership including:

5. Colbourne York Limited Partnership is to provide for the ongoing administration of these individual mortgage loans in collecting all monthly payments from individual unit owners. Colbourne York Limited Partnership will then submit one monthly payment cheque to Colonia, which cheque will be submitted to Colonia in the form of a series of twelve post-dated cheques.

Should any or all of the individual loans go into default, requiring Colonia to then collect all or any individual payments, there shall be a two percent annual administration fee charged and payable monthly to Colonia.

[12] The partnership was to be responsible for all costs associated with the fracturing of the mortgage and pay Colonia an administration fee of $14,700.00.

[13] There can be no doubt that the arrangements, clearly understood by all, were that Colonia would deal only with the general partner in relation to the mortgage debt.

[14] We turn now to the critical document, the renewal offer. The renewal offer, dated June 16, 1992 is addressed to Krystal Holdings Inc. (for Colbourne York Limited Partnership). The offer to renew stated that it was “subject to the terms and conditions set out in the original commitment letter dated April 30, 1987 and the amending agreement dated May 2, 1988.” and to CMHC approval. The renewal also provided that each limited partner provide Colonia with a signed consent to the renewal and an acknowledgement of his or her proportionate share of the outstanding principal. It is agreed that both CMHC and Colonia underwriting requirements did not permit arrears of property tax.

[15] Between the times the renewal letter was sent to the general partner and June 26, 1992 – Colonia became aware that the 1991 property taxes had not been paid. After discussion Colonia entered into a forbearance agreement with the general partner whereby it would continue with the renewal on the understanding that the 91 taxes would be brought current within 12 to 18 months.

[16] The general partner sent Colonia’s renewal letter to the limited partners but not the subsequent letter of June 25, 1992 which evidences the forbearance arrangement in relation to the outstanding property taxes. The limited partners were asked to sign and return the letters and to address any questions in relation to the renewal to the author of the letter under the heading Financial Information the letter stated:

The building has been operating in a deficit position due to the inability to increase rents as originally projected. The recession and the current problems facing the real estate market in general have been major factors influencing the lack of any rental increase in your building. As mentioned in previous correspondence, half of the $500,000 letter of credit, held by the Registrar and Transfer Agent, was used to cover shortfalls in 1991. It is expected that the remaining amount will be used to cover shortfalls occurring in 1992. The General Partner has agreed to fund the deficit on the building (approximately $10,000 per month) until the end of 1993.

[17] In our view, Colonia was entitled to assume that the General Partner would pass all relevant information on to the limited partners. Throughout their dealings Colonia had only ever dealt directly with the general partner; it had no direct dealings with the limited partners. It’s agreement to fracture the mortgage was conditional on the general partner undertaking all of the necessary administration.

[18] In these circumstances, Colonia had no obligation to communicate directly with the limited partners; all of their correspondence went to the general partner and there was no reason to assume then, that the relevant information was not being passed along.

[19] In Hercules Management Ltd. v. Ernst & Young (1997), 2 S.C.R.165 LaForest J. noted at para. 22:

The first branch of the Anns/Kamloops test demands an inquiry into whether there is a sufficiently close relationship between the plaintiff and the defendant that in the reasonable contemplation of the latter, carelessness on its part may cause damage to the former. The existence of such a relationship – which has come to be known as a relationship of “neighbourhood” or “proximity” – distinguishes those circumstances in which the defendant owes a prima facie duty of care to the plaintiff from those where no such duty exists. In the context of a negligent misrepresentation action, then, deciding whether or not a prima facie duty of care exists necessitates an investigation into whether the defendant-representator and the plaintiff-representee can be said to be in a relationship of proximity or neighbourhood.

[20] Here Colonia and the limited partners relationship is defined between the contracts between them and the general partner. Absent the contracts they are strangers in law. The limited partners granted mortgages as security to Colonia for the loans advanced by Colonia to financially facilitate the limited partners’ acquisition of their partnership units. In consenting to fracture the original mortgage Colonia made it clear that the administration in relation to the 147 fractured mortgages was for the general partner and not Colonia. Indeed the record discloses that when, on one occasion, the general partner requested of Colonia that it provide certain information to the individual limited partners, Colonia refused to do so. In fact, Colonia never communicated with the limited partners for any reason. The mortgage assumption agreements that the limited partners signed were sent by Colonia to the general partner for execution and return. There can be no doubt on this record that the only party the limited partners relied on in relation to the Colonia mortgages was the general partner. There was no reason for Colonia to have the limited partners in its contemplation when it had specifically refused to have any relationship with them. Colonia’s relationship of proximity was with the general partner and on this record the general partner was in full possession of all the facts long before the loan was ever renewed- it just did not pass the information along to the limited partners.

[21] Their letter of renewal which by implication suggested there were no property tax arrears was sent to the general partner as was their subsequent letter after they learned about the outstanding taxes. What has been characterized as the “misrepresentation” in the renewal letter was corrected by the letter which followed 10 days later and over a month before the mortgage came due. As stated above at the time the renewal letter was sent Colonia did not know the 91 taxes had not been paid; they did not knowingly misrepresent anything.

[22] In the circumstances and particularly in view of the nature of the contractual arrangements among the parties and their interactions one with the other, we are of the view that no duty of care was owed by Colonia to the limited partners.

[23] Further the evidence of Mr. Pyle, the expert lender, was that he would not have communicated with the limited partners directly in the circumstances which prevailed.

[24] Mr. Pyle also opined about “correcting the misrepresentation”. While Colonia’s Mr. Harper was of the view that to correct the “misrepresentation” it would be necessary to inform the limited partners that there were outstanding tax arrears, Mr. Pyle took a different view. As the trial judge noted at para. 147 of his reasons:

The appropriate question for the standard of care, then, is whether the standard of care required Colonia to inform the limited partners of the Forbearance Agreement. Mr. Pyle stated that he would have expected the general partner to send the forbearance letter to the limited partners. In his view, it was not the lender’s role to communicate information that was available within the partnership. He repeatedly, stated that he would not have communicated directly with the limited partners. He particularly noted that he would not have sent such a letter to them directly.

[25] And after noting that industry standards are instructive but not determinative of the standard of care he went on at para. 149:

Mr. Pyle’s opinion is not determinative by itself of the standard of care but is of significance. Given the way that this transaction was structured and the history of the interactions between the parties, I have concluded that the requisite standard of care did not require Colonia to circulate the forbearance letter to the limited partners.

[26] We agree with the trial judge’s conclusion that Colonia did not owe any duty to the limited partners to “correct” what later turned out to be misinformation in the renewal letter. In all the circumstances and on the particular facts of this case it was reasonable for Colonia to assume all relevant information would be passed from the general partner with whom it dealt, to the limited partners including of course the forbearance letter.

[27] Similarly the claim for breach of fiduciary duty must fail where there is no duty owed.

Defences to the Shortfall Claims

[28] Those defences and the trial judge’s conclusions in respect thereto are set out above in paragraph six. We agree with the trial judge and would add only that clause four of the mortgage assumption agreement gives to Colonia broad powers to deal with the mortgage “..without prior approval or knowledge of or notice to the Covenantor…”

RELEASED: January 8, 2010 “JMacF”

“J. MacFarland J.A.”

“Paul Rouleau J.A.”

“David Watt J.A.”