Madison Joe Holdings Inc. v. Mill Street & Co. Inc. et al. Mill Street & Co. Inc. et al. v. Madison Joe Holdings Inc. et al.

[Indexed as: Madison Joe Holdings Inc. v. Mill Street & Co.]

Ontario Reports

Court of Appeal for Ontario

MacPherson, Gillese and Nordheimer JJ.A.

April 6, 2021

155 O.R. (3d) 227 | 2021 ONCA 205

Case Summary

Debtor and creditor — Promissory note — Principal debtor failing to pay principal and outstanding interest owing under promissory notes on maturity dates — Plaintiff commencing action against debtor and guarantors and bringing motion for summary judgment — Motion judge finding that guarantees were triggered by company's default and restrictions on payment pursuant to inter-creditor agreement not applying — Summary judgment granted against company for monthly interest payments and against guarantors for monthly interest and unpaid principal — Defendants' appeal dismissed — Motion judge conducted a clear and careful analysis and committed no palpable and overriding error.

Guarantee and suretyship — Interpretation — Principal debtor failing to pay principal and outstanding interest owing under promissory notes on maturity dates — Plaintiff commencing action against debtor and guarantors and bringing motion for summary judgment — Motion judge finding that guarantees were triggered by company's default and restrictions on payment pursuant to inter-creditor agreement not applying — Summary judgment granted against company for monthly interest payments and against guarantors for monthly interest and unpaid principal — Defendants' appeal dismissed — Motion judge conducted a clear and careful analysis and committed no palpable and overriding error.

The plaintiff owned a company, half of which it sold to the defendant M in 2014, and the remaining half in 2016. At the time of the second sale the purchase price was $3 million to be paid by cash or certified cheque for $1.8 million on closing, one million Class B shares in M issued to the plaintiff, and a vendor take-back promissory note to the plaintiff in the amount of $200,000 with six per cent interest payable monthly and to be guaranteed by M and the two individual defendants, N and R. At the time, M still owed payments under existing promissory notes it issued in connection with the first sale. To restructure that debt, the share purchase agreement provided that the existing notes be extinguished and that the company execute two new promissory notes to the plaintiff in their place. N, on behalf of the company, entered into a loan agreement with a bank. The bank, the company and the plaintiff entered into an inter-creditor agreement. One section of that agreement provided that the company could make payments on the notes without the bank's consent if those payments would not put the company offside its financial covenants in the loan agreement. The guarantees stated that they were to be resorted to only if the company defaulted in making a payment under a note in accordance with its terms. After the notes were executed, the company paid the required monthly interest payments but failed to pay the principal and outstanding interest owing under the notes on their maturity dates. The plaintiff commenced an action against the company as debtor and against the other defendants as guarantors. On the plaintiff's motion for summary judgment, the motion [page228] judge accepted the plaintiff's position that the guarantees were triggered by the company's failure to pay principal and interest when due under the notes and that the restrictions on payments by the company pursuant to the inter-creditor agreement did not apply to the guarantees. As a result, the motion judge granted summary judgment against the company for the monthly interest payments owing under the notes, subject to the inter-creditor agreement which she found restricted the repayment of principal given the company's financial state, and against the guarantors for the monthly interest payments and unpaid principal. The defendants appealed.

Held, the appeal should be dismissed.

Per MacPherson J.A. (Gillese J.A. concurring): The motion judge did not err in interpreting the guarantees by ignoring the "in accordance with its terms" language. The defendants contended that the failure to pay arose due to the operation of the inter-creditor agreement and that the parties had contracted that such a failure would not amount to a default. With no default, there could be no enforcement on the guarantees. The motion judge rejected that interpretation, observing that the guarantees used the generic term "default" by the company in making the payments due under the note in accordance with its terms, and did not reference the defined term "events of default" contained in the notes. It was a clear and careful analysis and conclusion, and far removed from being a palpable and overriding error. It was a three-step guarantee: the company defaulted in making payments due under the notes, as a result of which the company owed money to the plaintiff, and the guarantee was triggered.

Per Nordheimer J.A. (dissenting): The purpose of the guarantees was to ensure that, if the company, as principal debtor, defaulted in its obligations to the plaintiff, then M, N and R would make good on those obligations. That fundamental principle was ignored by the motion judge. She also ignored another fundamental principle relating to guarantees that in considering the relative obligations of the parties, all of the contractual arrangements had to be considered. Notwithstanding her finding that the company was not in default as principal, she concluded that the guarantors were liable. Her distinction between "default" and an "event of default" flowed from a tortured interpretive route through the agreements which failed to give any meaning to the words "in accordance with its terms". Leaving the guarantors liable when the principal was not was an absurd result.

Cases referred to

Heritage Capital Corp. v. Equitable Trust Co., [2016] 1 S.C.R. 306, [2015] S.C.J. No. 19, 2016 SCC 19, 65 R.P.R. (5th) 51, 395 D.L.R. (4th) 656, [2016] 6 W.W.R. 1, 48 M.P.L.R. (5th) 1, 482 N.R. 361, 6 P.P.S.A.C. (4th) 1, 2016EXP-1429, J.E. 2016-771, EYB 2016-265357; Holland-Canada Mortgage Co. v. Hutchings, 1936 CanLII 20 (SCC), [1936] S.C.R. 165, [1936] S.C.J. No. 13, [1936] 2 D.L.R. 481; In re A Debtor, [1937] Ch. 156, [1937] 1 All E.R. 1, 106 L.J. Ch. 172, [1936-1937] B. & C.R. 121, 81 Sol. Jo. 57, 156 L.T. 95, 53 T.L.R. 191 (C.A.); Manulife Bank of Canada v. Conlin (1996), 1996 CanLII 182 (SCC), 30 O.R. (3d) 577, [1996] 3 S.C.R. 415, [1996] S.C.J. No. 101, 139 D.L.R. (4th) 426, 203 N.R. 81, 94 O.A.C. 161, 30 B.L.R. (2d) 1, 6 R.P.R. (3d) 1; Moschi v. Lep Air Services Ltd., [1972] 2 All E.R. 393, [1973] A.C. 331, [1972] 2 W.L.R. 1175, 116 Sol. Jo. 372 (H.L.); Rees v. Berrington (1795), 30 E.R. 765, 2 Ves 540, 34 E.R. 797 (Ch.); Rizzo & Rizzo Shoes Ltd. (Re) (1998), 1998 CanLII 837 (SCC), 36 O.R. (3d) 418, [1998] 1 S.C.R. 27, [1998] S.C.J. No. 2, 154 D.L.R. (4th) 193, 221 N.R. 241, 106 O.A.C. 1, 50 C.B.R. (3d) 163, 33 C.C.E.L. (2d) 173, 98 CLLC para. 210-006; Sattva Capital Corp. v. Creston Moly Corp., [2014] 2 S.C.R. 633, [2014] S.C.J. No. 53, 2014 SCC 53, 373 D.L.R. (4th) 393, [2014] 9 W.W.R. 427, 59 B.C.L.R. (5th) 1, 461 N.R. 335, 25 B.L.R. (5th) 1, 358 B.C.A.C. 1, 614 W.A.C. 1 [page229]

Authorities referred to

McGuinness, Kevin P., The Law of Guarantee, 3rd ed. (Toronto: LexisNexis Canada, 2013)

APPEAL by defendants from default judgment of Kimmel J., reported at [2020] O.J. No. 1169, 2020 ONSC 1429 (S.C.J.).

Micheal Simaan, for appellants.

Jason Berall, for respondent.

MACPHERSON J.A. (GILLESE J.A. concurring): —

A. Introduction

[1] The plaintiff/respondent, Madison Joe Holdings Inc. ("MJH") brought a motion in the Superior Court for summary judgment on three unpaid promissory notes (the "notes"). The notes were issued by the defendant/appellant All Source Security Container Mfg. Corp. ("All Source") and guaranteed by the defendants/appellants Mill Street & Co. Inc. ("Mill Street"), Noah Murad ("Noah") and Roy Murad ("Roy").

[2] The notes were issued by All Source to MJH in connection with Mill Street's acquisition of All Source from MJH. Also in connection with the acquisition: (a) All Source entered into a loan agreement with TD Bank (the "loan agreement"); and (b) All Source, TD Bank and MJH entered into an Inter-Creditor and Subordination Agreement (the "inter-creditor agreement") that restricts payments from All Source to MJH under the notes that would put All Source offside the financial covenants that it is required to maintain under the loan agreement with TD Bank.

[3] According to the appellants, the payments of the principal and accrued interest owing under the notes would put All Source offside its financial covenants with TD Bank. They therefore argued at the summary judgment motion that All Source did not default under the notes because the payments were restricted by the inter-creditor agreement. They further argued that, since the inter-creditor agreement restricted All Source from making the payments, the guarantors could not be liable for those payments under the terms of the guarantees.

[4] The motion judge rejected the appellants' arguments. She accepted MJH's position that the guarantees were triggered by All Source's failure to pay principal and interest when due under the notes and that the restrictions on payments by All Source pursuant to the inter-creditor agreement did not apply to the guarantees. As a result, the motion judge granted summary judgment (a) against All Source for the monthly interest payments owing [page230] under the notes (subject to the inter-creditor agreement which she found restricted the repayment of principal given the financial state of All Source), and (b) against the guarantors for the monthly interest payments and unpaid principal.

[5] The appellants appeal from this decision.

B. Facts

(1) The parties and events

[6] Prior to the relationship between the parties, MJH was the 100 per cent owner of All Source.

[7] All Source is an Ontario corporation that is in the business of manufacturing and distributing document destruction collection containers.

[8] Mill Street is an Ontario corporation that claims on its website to own and operate a diverse range of companies in North America.

[9] Noah Murad is the president of Mill Street and All Source. Roy Murad is Noah's father.

[10] In July 2014, Mill Street purchased 50 per cent of the interest in All Source from MJH. In December 2016, Mill Street purchased the remaining 50 per cent of All Source from MJH.

[11] When Mill Street acquired the remaining 50 per cent of All Source in December 2016, the purchase price under the Share Purchase Agreement was $3 million and was to be paid as follows: (a) $1.8 million by cash or certified cheque on closing; (b) one million Class B preferred shares in Mill Street issued to MJH; and (c) a vendor take-back promissory note to MJH in the amount of $200,000 with six per cent interest payable monthly due on December 16, 2017 to be guaranteed by Mill Street, Roy and Noah (the "VTB note").

[12] When Mill Street acquired the remaining 50 per cent of All Source, it still owed payments under the existing promissory notes it issued in connection with its purchase of the first 50 per cent of All Source. To restructure that debt, the Share Purchase Agreement also provided that the existing notes be extinguished and that All Source execute two new promissory notes to MJH in their place: (a) Promissory Note A in the amount of $400,000 with six per cent interest payable monthly due on December 15, 2017 to be guaranteed by Mill Street, Roy and Noah ("note A"); and (b) Promissory Note B in the amount of $508,588.70 with 6 per cent interest payable monthly due on December 15, 2018 to be guaranteed by Mill Street, Roy and Noah ("note B").

[13] In connection with Mill Street's acquisition of the remaining 50 per cent of All Source, Noah, on behalf of All Source, [page231] entered into the loan agreement with TD Bank. The loan agreement states that TD Bank would loan All Source: (a) $2 million as a term loan to fund the acquisition of the remaining 50 per cent interest in All Source; and (b) an operating loan to support working capital requirements.

[14] Finally, TD Bank, All Source and MJH entered into the inter-creditor agreement on December 16, 2016.

[15] Section 4.1 of this agreement provides that All Source may not make, and MJH will not accept, payments of principal or interest on the notes "[e]xcept as expressly provided in Section 5.2 hereof".

[16] Section 5.2 sets out the circumstances in which All Source may make and MJH may accept "Permitted Payments", which are defined as principal and interest payments payable pursuant to the notes. In particular, s. 5.2 provides that All Source may make payments on the notes without TD Bank's consent if those payments would not put All Source offside its financial covenants in the loan agreement:

5.2 Notwithstanding any other provision of this Agreement, Borrower [All Source] may make and MJH may accept, collect and receive, Permitted Payments, provided:

(1) (a) no Default shall have occurred under the TD Loan Agreement which has not been cured or waived by TD, at the time of any such payment; and (b) the making of any such payment will not result in a Default under the TD Loan Agreement.

[17] Apart from the maturity dates and principal amounts owing, the notes and guarantees are virtually identical. Each of the notes begins with a preamble and is followed by a guarantee, all within the same document. Defined terms in the notes and guarantees are adopted from their respective preambles. The preambles to each of the notes provide: "AND WHEREAS the Guarantors (as set out below) have agreed to guarantee the obligations of the Debtor as contained in this [note]".

[18] Sections 1 and 2 of the notes provide that All Source is required to pay monthly interest throughout the term of the notes until maturity and, at maturity, is required to pay the full principal together with any accrued and unpaid interest.

[19] Section 4(a) of the notes provides that it is an "Event of Default" for All Source to fail to make any payment of interest or principal when due unless All Source is prevented by reason of the refusal of any required consent of TD Bank:

4. Events of Default. The outstanding Principal Amount and all accrued and unpaid interest thereon shall, at the option of the Holder, be immediately due and payable without notice upon the occurrence of any of the following events of default (each, an "Event of Default"): [page232]

(a) the Debtor [All Source] fails to make any payment of interest or of the Principal Amount when due under the VTB Note or fails to make any payment of interest or of the principal amount when due under Note A or Note B and such failure is not remedied within thirty (30) days (provided, however, that if the Debtor is prevented by reason of the refusal of any required consent by The Toronto-Dominion Bank from making such payment of Principal Amount or interest when due hereunder or under Note A or Note B pursuant to the [inter-creditor agreement], then such failure shall not be considered an Event of Default hereunder or under Note A or Note B for the purpose of permitting the holders of any of either this VTB Note or Note A or Note B to demand cash payment in full . . .

[20] Section 3 of the guarantees provides that the guarantors guarantee money owed by All Source to MJH if All Source defaults in making payments when due under the notes:

If, as a result of Debtor's [All Source] default in making payments due under the VTB Note in accordance with its terms, the Debtor shall owe monies to the Holder [MJH], the due payment of such monies is hereby jointly and severally guaranteed by the Guarantors [Mill Street, Noah and Roy].

[21] After the notes were executed in December 2016, All Source paid the required monthly interest payments of $5,542.94 on all the notes. However, All Source failed to pay the principal and outstanding interest owing under the notes on their maturity dates in December 2017.

[22] MJH commenced an action against the debtor All Source and the guarantors Mill Street, Noah and Roy on December 17, 2017.

[23] In June 2019, MJH brought a motion for summary judgment against the debtor and the guarantors. Justice Kimmel heard the motion in September 2019 and rendered her judgment in March 2020.

(2) The motion judge's decision

[24] The motion judge framed the issues in this fashion [at paras. 4-6]:

The issues raised on this summary judgment motion depend upon the interpretation of the inter-related contracts: the share purchase agreement, the promissory notes, the guarantees and the Inter-Creditor Agreement.

The first question that I must decide is what All Source's obligations to MJH were upon the maturity of each of the promissory notes (whether in the ordinary course or as a result of acceleration of the principal amounts due upon default) in respect of the repayment of the principal amounts and/or payment of monthly interest while the principal remained unpaid. Related to that, I must decide whether All Source was restricted by the Inter-Creditor Agreement from making payments of principal and/or of monthly interest to MJH.

The second question I must decide is whether, even if All Source is precluded by the Inter-Creditor Agreement from fulfilling any of its obligations [page233] in respect of the repayment of the principal amounts and/or payment of monthly interest under the promissory notes, the Guarantors are liable to pay those amounts.

[25] The motion judge stated her conclusions as follows [at para. 8]:

For the reasons that follow, I find that the Inter-Creditor Agreement restricts All Source from repaying the principal but not the monthly interest under the promissory notes, which is payable both before and after the maturity of the notes. The Inter-Creditor Agreement does not shield the Guarantors from their joint and several obligations to pay the principal amounts and monthly interest payable under the promissory notes. Accordingly, the plaintiff is entitled to judgment against All Source and each of the Guarantors, Mill Street, Noah Murad and Roy Murad, for the monthly interest payments under the promissory notes from the date of last payment to present. The principal amount owing under each of the promissory notes is over-due. The plaintiff is entitled to judgment against the Guarantors, but not All Source, for the principal amount of each promissory note. The plaintiff's claim for punitive damages is dismissed.

C. Issues

[26] Although the appellants raised three issues in their factum, in their oral argument they admitted, candidly and fairly, that the three issues were inextricably linked and that the result on the first issue would automatically determine the results on the second and third, and much more minor, issues. Accordingly, the sole issue on the appeal, as framed by the appellants, is:

Did the learned judge err in the interpretation of the guarantees in ignoring the "in accordance with its terms" language which prevented enforcement of the guarantees on the same terms as enforcement could be made on the promissory notes?

(Emphasis in original)

D. Analysis

[27] I begin by noting that the motion judge was required to interpret several types of documents -- the share purchase agreement, the three promissory notes, the guarantees, and the inter-creditor agreement. These documents involved all of the parties in this litigation and one additional party, TD Bank. All of the relevant documents are commercial and contractual.

[28] In Sattva Capital Corp. v. Creston Moly Corp., [2014] 2 S.C.R. 633, [2014] S.C.J. No. 53, 2014 SCC 53, at paras. 50, 52, the Supreme Court held that "[c]ontractual interpretation involves issues of mixed fact and law" and that, therefore, deference is owed "to first instance decision-makers on points of contractual interpretation". In their factum, the appellants frame the issue as "Did the learned judge err in the interpretation of the guarantees?" [page234] Accordingly, the "palpable and overriding" standard applies to this issue: Heritage Capital Corp. v. Equitable Trust Co., [2016] 1 S.C.R. 306, [2016] S.C.J. No. 19, 2016 SCC 19, at paras. 21-24.

[29] The appellants contend that the promissory notes and guarantees were two contracts that were closely connected to, and even specifically referenced by, each other. The guarantees state they be resorted to only if the debtor defaults in making payments under a Note "in accordance with its terms". The motion judge found that All Source had not defaulted in making payments due under the notes as the parties contracted that failure to pay the notes would not amount to a default under the precise situation that arose here -- the failure to pay due to the operation of the inter-creditor agreement. In other words, say the appellants, in certain circumstances, which arose here, non-payment does not equal default. And without default, there can be no enforcement on the guarantees.

[30] The appellants further submit that there is nothing commercially unreasonable about this interpretation. It is consistent with the guarantors only agreeing to be liable if the default was caused by events other than the financial situation of the debtor, which is inextricably linked to the formula under the inter-creditor agreement.

[31] The motion judge rejected this interpretation. She said [at paras. 67, 75-76]:

The guarantees, which are effectively appended to the Notes, do not reference the defined term "Events of Default" contained in the Notes. Instead, the guarantees refer to All Source's "default" in making payments due under the Note in accordance with its terms, resulting in monies owing to MJH. A "default" can be a failure to pay. I find that the trigger for the guarantee in section 3 occurred when All Source failed to pay monies due to be paid to MJH under the terms of the Notes. This respects the choice of words and the use of the generic term "default" in the guarantees, rather than the defined term, "Event of Default" and it also gives meaning to the conceptual framework of the agreement.

There is no commercial absurdity in this interpretation, as the defendants contend. It reflects an agreement to delay the payment of the purchase price payable by Mill Street for the shares in All Source, and an agreement to allow the purchaser to structure the payments to come from All Source rather than from the purchaser, with the back stop that if the purchase monies could not be generated from the business of All Source itself, they would be paid by the purchaser (Mill Street, one of the Guarantors) and its principals (the other Guarantors). This interpretation gives effect to the purchase price and security that MJH contracted for and it respects the Inter-Creditor Agreement that was concerned with the TD Bank's priority recourse to All Source and its assets (the Collateral). [page235]

The alternative interpretation that the defendants urged upon the court would render the security of the guarantees illusory because it would mean that if All Source was not in a financial position to repay the Notes because of its other financial obligations, then the Guarantors would not have to pay either. Whereas a guarantee would ordinarily be called upon in precisely that circumstance.

(Emphasis added)

[32] I agree with this clear and careful analysis and conclusion. Importantly, and at a minimum, the motion judge's analysis and conclusion are far removed from being a palpable and overriding error. Indeed, the motion judge's interpretation is the only interpretation consistent with what the leading scholar on guarantees describes as the Fair Protection Rule:

As a general principle, the courts always interpret a guarantee so that the protection or security which it affords to a creditor is rendered real rather than illusory. Alternatively stated, guarantees are read so as to give effect to the apparent intent of the parties, so as to afford fair protection to creditor in accordance with that apparent intent. This rule should be stated as the most basic principle of guarantee interpretation because it is clearly necessary to give a guarantee instrument an interpretation which is fully consistent with its apparent purpose.

See Kevin P. McGuinness, The Law of Guarantee, 3rd ed. (Toronto: LexisNexis Canada, 2013), at pp. 281-82.

[33] I conclude by setting out again the terms of the guarantee:

If, as a result of Debtor's [All Source] default in making payments due under the VTB Note in accordance with its terms, the Debtor shall owe monies to the Holder [MJH], the due payment of such monies is hereby jointly and severally guaranteed by the Guarantors [Mill Street, Noah and Roy].

[34] I would describe this as a three-step guarantee. Step 1: the Debtor's (All Source) default in making payments due under the notes. This happened. Step 2: as a result, the Debtor owes money to the Holder (MJH). This happened. Step 3: the guarantee is triggered. This happened.

E. Disposition

[35] I would dismiss the appeal. The respondents are entitled to their costs of the appeal fixed, per the agreement of counsel, at $13,500, inclusive of disbursements and HST.

NORDHEIMER J.A. (dissenting): --

[36] I have read the reasons of my colleague. I do not agree with his conclusion. In my view, the motion judge's reasons reflect a palpable and overriding error in her interpretation of the documents in question, particularly the guarantees. Further, her [page236] conclusion is inconsistent with certain fundamental principles that are applicable to guarantees generally.

[37] My colleague has set out the background facts, which I need not repeat. I agree with his synthesis of the issue to be determined, that is, the proper interpretation of the guarantees.

[38] I also accept my colleague's expression of the appropriate standard of review. However, his reference to Sattva Capital Corp. v. Creston Moly Corp., supra, at paras. 50 and 52, and the principle that "[c]ontractual interpretation involves issues of mixed fact and law" omits the point, also mentioned in that decision, at para. 48, that the meaning of words "is often derived from a number of contextual factors, including the purpose of the agreement and the nature of the relationship created by the agreement" (citations omitted). Thus, the interpretation of the documents must reflect the object and intent of the parties.

[39] In that respect, the purpose of the guarantees was to ensure that, if All Source, as principal debtor, defaulted in its obligations to the respondent, Mill Street, Roy, and Noah, as guarantors, would make good on those obligations. As is commonly the case with guarantees, the guarantor will only become liable if the principal debtor defaults in its obligations. This fundamental principle is stated in Kevin P. McGuinness, The Law of Guarantee, 3rd ed. (Toronto: LexisNexis Canada, 2013), at p. 326: "The starting point in ascertaining whether the surety is liable, therefore, is to decide whether the principal is in default, for as a general rule the surety is not liable to the creditor unless the principal is liable" (emphasis added).

[40] This fundamental principle is one of longstanding application. In Rees v. Berrington (1795), 30 E.R. 765, 2 Ves 540 (Ch.), at p. 767 E.R., Lord Loughborough L.C. said, "The surety only engages to make good the deficiency." A more modern expression of this principle can be found in Moschi v. Lep Air Services Ltd., [1972] 2 All E.R. 393, [1973] A.C. 331 (H.L.), at p. 402 All E.R., where Lord Diplock said:

The legal consequence of this is that whenever the debtor has failed voluntarily to perform an obligation which is the subject of the guarantee the creditor can recover from the guarantor as damages for breach of his contract of guarantee, whatever sum the creditor could have recovered from the debtor himself as a consequence of that failure.

[41] In this case, All Source did not fail voluntarily to perform any obligation to the respondent. To the contrary, the respondent had expressly agreed with All Source that All Source would not have to make payment to the respondent, if doing so would breach All Source's obligations to the TD Bank. My colleague has set out [page237] the express provision found in the inter-creditor agreement, namely, s. 5.2, but it bears repeating:

Notwithstanding any other provision of this Agreement, Borrower [All Source] may make and MJH may accept, collect and receive, Permitted Payments, provided:

(1) (a) no Default shall have occurred under the TD Loan Agreement which has not been cured or waived by TD, at the time of any such payment; and (b) the making of any such payment will not result in a Default under the TD Loan Agreement;

(Emphasis added)

[42] The motion judge recognized that the inter-creditor agreement restricted the obligations of All Source. She said, at para. 58:

Applying this interpretation to the circumstances of this case, MJH could only establish that All Source had committed an Event of Default in December of 2017 if it could prove that the repayment of the VTB Note and Note A would not put All Source offside of its financial covenants with TD Bank (such that it would have been a Permitted Payment under the Inter-Creditor Agreement). This has not been established.

[43] Notwithstanding this conclusion, the motion judge then proceeded to place an interpretation on the guarantees that resulted in the guarantors being liable for that which All Source was not. Her analysis in this regard ignores the fundamental principle underlying guarantees that I have set out above. It also ignores another fundamental principle relating to guarantees and, that is, that in considering the relative obligations of the parties, all of the contractual arrangements must be considered. In other words, the guarantee is not to be read in isolation to the contractual arrangements involving the principal debt. As Cory J. said in Manulife Bank of Canada v. Conlin (1996), 1996 CanLII 182 (SCC), 30 O.R. (3d) 577, [1996] 3 S.C.R. 415, [1996] S.C.J. No. 101, at para. 16: "[W]hen the guarantee clause is interpreted, it must be considered in the context of the entire transaction."

[44] I acknowledge that there may be situations where a guarantor can be liable, notwithstanding that the principal debtor is not, but such situations are uncommon. An interpretation of contractual arrangements that involve guarantees, and that would lead to that result, should be exceptional, given the fundamental principles of guarantees. It is a result that should be arrived at only if no other reasonable interpretation of the contractual arrangements presents itself. It must also reflect the special position that a guarantor (or surety) occupies in the eyes of the law, one which only makes the surety liable within the strict, or narrow, confines of the liability assumed. This special position was expressed by Davis J. in Holland-Canada Mortgage Co. v. Hutchings, 1936 CanLII 20 (SCC), [1936] S.C.R. 165, [1936] S.C.J. No. 13, at p. 172 S.C.R.: [page238] "A surety has always been a favoured creditor in the eyes of the law. His obligation is strictly examined and strictly enforced."

[45] The principle I have mentioned, that the totality of the contractual arrangements must be considered in interpreting the guarantees, is reflected in the wording of the guarantees in this case. The motion judge set out the wording of s. 3 of the guarantees in her reasons, at para. 33:

If, as a result of [All Source's] default in making payments due under the [VTB Note/Note A or Note B] in accordance with its terms, [All Source] shall owe monies to [MJH], the due payment of such monies is hereby jointly and severally guaranteed by the Guarantors.

(Emphasis added)

[46] Notwithstanding this clear provision, and the motion judge's finding that All Source was not in default as principal, the motion judge concluded that the guarantors were liable. She arrived at this conclusion by drawing a distinction between "default", referred to in s. 3 of the guarantees, and an "Event of Default" as defined in the notes. She said, at para. 67:

The guarantees, which are effectively appended to the Notes, do not reference the defined term "Events of Default" contained in the Notes. Instead, the guarantees refer to All Source's "default" in making payments due under the Note in accordance with its terms, resulting in monies owing to MJH. A "default" can be a failure to pay. I find that the trigger for the guarantee in section 3 occurred is [sic] when All Source failed to pay monies due to be paid to MJH under the terms of the Notes. This respects the choice of words and the use of the generic term "default" in the guarantees, rather than the defined term, "Event of Default" and it also gives meaning to the conceptual framework of the agreement.

[47] With respect, this result flows from a tortured interpretive route through the agreements which, among other things, does not respect the principles underlying the law of guarantees. Further, it is an interpretation that fails to give any meaning to the words "in accordance with its terms" that are expressed in the guarantees, and which directly connect the obligations under the guarantees to the obligations under the prevailing contractual arrangements between All Source and the respondent. More importantly, they expressly relate to whether a default has occurred that would trigger the liability of the guarantors.

[48] The motion judge said that her interpretation of the contractual documents did not result in an absurdity. With respect, the opposite is true. The motion judge's interpretation leaves the guarantors liable when the principal is not. It is a result that is absurd, keeping in mind the particular meaning of that term in [page239] the context of statutory or contractual interpretation.[^1] As Iacobucci J. said in Rizzo & Rizzo Shoes Ltd. (Re) (1998), 1998 CanLII 837 (SCC), 36 O.R. (3d) 418, [1998] 1 S.C.R. 27, [1998] S.C.J. No. 2,, at para. 27:

According to Côté, supra, an interpretation can be considered absurd if it leads to ridiculous or frivolous consequences, if it is extremely unreasonable or inequitable, if it is illogical or incoherent, or if it is incompatible with other provisions or with the object of the legislative enactment.

(Citation omitted, emphasis added)

[49] The motion judge justified her interpretation, at least in part, by suggesting that any other interpretation would render the guarantees illusory. She said, in the portion emphasized by my colleague, at para. 76:

The alternative interpretation that the defendants urged upon the court would render the security of the guarantees illusory because it would mean that if All Source was not in a financial position to repay the Notes because of its other financial obligations, then the Guarantors would not have to pay either. Whereas a guarantee would ordinarily be called upon in precisely that circumstance.

[50] That conclusion does not follow from the factual situation here. It is also not the result of the interpretation of the documents, particularly the guarantees, urged by the appellants and with which I agree. The interpretation urged by the appellants does not render the guarantees unenforceable for all purposes. Rather, it simply precludes enforcement of the guarantees in situations where All Source, as principal debtor, is not in default because it is not obliged to make payment to the respondent due to the provisions of the inter-creditor agreement -- an agreement to which the respondent was a party. It is an interpretation of the contractual arrangements that holds the respondent to precisely what it agreed with All Source, that is, that All Source would not have to make payments to the respondent if doing so put All Source "offside" with its obligations to the TD Bank. I reiterate that the respondent expressly agreed to that restriction, something that it now attempts to avoid by advancing a claim on the guarantees which it is precluded from making against All Source directly. A court should be loath to permit that result.

[51] There is another aspect of the conclusion reached by the motion judge that reveals the difficulty with the interpretation [page240] she adopts. That interpretation fails to take into account the rights that the guarantors have against the principal, i.e., All Source. If the guarantors are required to make good on their guarantees, they would have rights to recover payment from All Source. "There is no doubt that a surety paying a debt is entitled to recover against the principal, as for money paid to his use" (citations omitted): In re A Debtor, [1937] Ch. 156, [1937] 1 All E.R. 1 (C.A.), per Slesser L.J.

[52] In this case, however, if the guarantors attempted to do so, they would be met with the argument by All Source that it is precluded from making those same payments by virtue of the inter-creditor agreement, that is, they are just as much precluded from making the payments to the guarantors as they were to the respondent. If that argument were to succeed, the prejudice to the guarantors is obvious -- they would be prevented from recouping that which they were compelled to pay to the respondent arising from All Source's failure to do so.

[53] If, on the other hand, the guarantors could compel payment from All Source, on the basis that they were not parties to the inter-creditor agreement, and consequently not bound by its terms, then the TD Bank would be prejudiced because the respondent would have essentially done an end run around the inter-creditor agreement. I note that the TD Bank was not a party to these proceedings and was, therefore, not present to protect its own interests. In any event, the presence of either of those possible results amply demonstrates the fundamental flaw in the interpretation adopted by the motion judge.

[54] I return to the basic principle underlying guarantees to which I referred at the outset. A guarantor is only liable where the principal debtor is obliged to pay but fails to do so. There was no such failure in this case. The conclusion reached by the motion judge does not reflect that basic reality and cannot be sustained.

Conclusion

[55] I would allow the appeal, set aside the summary judgment, dismiss the summary judgment motion, and remit the matter to the Superior Court.

Appeal dismissed.

Notes

[^1]: "[T]he 'modern contextual approach' for statutory interpretation, with appropriate adaptations, is equally applicable to contractual interpretation. Statutory interpretation and contractual interpretation are but two species of the general category of judicial interpretation": Manulife Bank of Canada v. Conlin, supra, at paras. 40-41, per L'Heureux-Dube J.