DIVISIONAL COURT FILE NO: 57/03

COURT FILE NO.: 1424/99

DATE: 2004-04-23

ONTARIO

SUPERIOR COURT OF JUSTICE

DIVISIONAL COURT

O’DRISCOLL, E. MACDONALD AND CAPUTO JJ.

B E T W E E N :

XDG LIMITED Plaintiff (Respondent)

• and -

1099606 ONTARIO LIMITED and GENERAL ELECTRIC CAPITAL CANADA INC. Defendants (Appellants)

Leonard Ricchetti for the Appellant, General Electric Capital Canada Inc.

Irwin Duncan for the Plaintiff/Respondent, XDG Limited

Anthony Speciale for the Cross-Appellant Wm. Green Roofing Inc., a lien claimant

Heard at Toronto: January 14, 2004

ENDORSEMENT

NATURE OF PROCEEDINGS

[1] General Electric Capital Canada Inc. (GECC) appeals from the December 23, 2002 judgment and February 27, 2003 award of costs of Gordon J. in a consolidated construction lien action in which judgment was granted in favour of XDG Limited (XDG) (representing several claimants) on the issue of the validity and priority of GECC’s mortgage as against the lien claimants. Costs were awarded against GECC on a substantial indemnity basis.

[2] GECC requests an order:

(a) setting aside the December 23, 2002 judgment and the February 27, 2003 costs order of Gordon J.;

(b) dismissing the claims of XDG (and all lien claimants) to any claim of priority over the GECC mortgage; and,

(c) awarding costs of the trial and appeal on a partial indemnity scale to GECC.

CROSS-APPEAL

[3] Wm. Green Roofing Ltd. (“Green”), one of the lien claimants, cross-appeals and requests that the February 27, 2003 costs order of Gordon J. be set aside and that the costs at trial be awarded on a substantial indemnity basis to Green. Green seeks an increase in costs to the total amount of $83,937.50, plus $1,500 for disbursement, plus G.S.T. (See Appeal Book and Compendium, Tab 2) (Factum of cross-applicant, para. 12).

STANDARD OF REVIEW

[4] On questions of fact, the standard of review for an appeal from the order of a judge is whether or not the decision of the judge was “clearly wrong”. (Stein v. “Kathy K” (The Ship), [1976] 2 S.C.R. 802). A judge must have made a “palpable and overriding error” or a “manifest error” before interference can be justified (Housen v. Nikolaisen, 2002 SCC 33, [2002] 2 S.C.R. 235).

[5] Judicial discretion should not be interfered with unless it is apparent that the judge applied erroneous principles or disregarded or misinterpreted material evidence in a way that rendered the result “clearly wrong”. (Cosyns v. Canada (A.G.) (1972), 7 O.R. (3d) 641).

[6] On questions of law, however, a judge’s decision must be correct. On matters of law, the appellate court is free to replace the opinion of the trial judge with its own. (Housen v. Nikoaisen, supra).

APPEAL AS TO COSTS

[7] A costs award is a discretionary decision and even after the introduction of specific costs grids, the court retains an inherent power in relation to costs that is not exhausted by statute. A court retains the authority to diverge from statutory guidelines if it considers it fair and reasonable to do so. (Basedo v. University Health Network, [2002] O.J. No. 597). Matlow J. concluded that, despite the new rules and Costs Grid in Ontario, judges were left with a very broad statutory discretion and were entitled to consider anything that is relevant to the question of costs when determining by whom and to what extent costs shall be paid. (Toronto (City) v. First Ontario Realty Corp., [2002] O.J. No. 2519).

[8] The new rules indicate that trial judges are to fix costs; only in exceptional circumstances are cases to be referred to assessment. (Delrina Corporation v. Tridel Systems Inc. et al., [2002] O.J. No. 3729). Generally, the practice of a reviewing court is to grant judges deference in all decisions not vital to the disposition of a lawsuit. (Noranda Metal Industries Ltd. v. Employers Liability Assurance Corp. (2002), 49 C.P.C. (4th) 336); (Bank of Nova Scotia v. Liberty Mutual Insurance Co., [2003] O.J. No. 4474 (Div. Ct.))

[9] For the reasons that follow, the appeal is dismissed.

BACKGROUND

[10] GECC financed the operations of Euro United Corporation (“Euro”) through a credit agreement, dated November 1998, that offered Euro a revolving line of credit of $127,000,000, subject to a margin formula. By March, 1999, Euro was in default of the margin formula. In exchange for continued and increased financing, the President and controlling shareholder of Euro, Sam Rehani (“Rehani”), gave GECC a first mortgage (“Mortgage”), registered on April 15, 1999, on property at 1 Deilcraft Place in Kitchener, Ontario, (“property”) owned by 1099606 Ontario Limited (“109”), a company of which Sam Rehani was also the sole Director, Officer and Shareholder. Euro leased the property from “109”.

[11] At the time of the Mortgage, GECC obtained statutory declarations to the effect that no construction had been commenced or negotiated on the property and the Mortgage was not in breach of the financial assistance provisions of s. 20 of the Ontario Business Corporations Act, R.S.O. 1990, c. B. 16 (OBCA).

The Lien Claimants

[12] Under a construction agreement, dated April 15, 1999, “109” retained XDG to perform certain improvements on the property. XDG asserts that work on the site had commenced in August 1998. By August 1999, “109” had failed to pay its progress invoice. XDG and various contractors and sub-contractors registered construction liens on title to the property in late 1999. The lien claimants then sought priority over the mortgage. By that point, Euro and “109” were insolvent and both were adjudged bankrupt on June 12, 1999.

TRIAL

[13] At trial, Gordon J. found that the mortgage was not valid as against the lien claimants and that the lien claimants would be entitled to priority over GECC’s Mortgage on the basis that (a) “109” failed both solvency tests in s. 20 of the OBCA (b) the Mortgage was void as against the lien claimants as being a fraudulent conveyance in contravention of both s. 2 of the Fraudulent Conveyances Act, R.S.O. 1990, c. F. (FCA) and s. 4 of the Assignments and Preferences Act, R.S.O. 1990, c. A. 33 (APA) and (c) GECC’s Mortgage was registered after the first lien arose giving the lien claimants priority, pursuant to the priority provisions of the Construction Lien Act, R.S.O. 1990, c. C. 30 (CPA). In addition, Gordon J. found that GECC failed to conduct a due diligence review in addition to obtaining the representations and warranties of “109” and its officers and that GECC was not acting in good faith and was willfully blind, negligent or aware of Rehani’s intent to defeat creditors, thereby depriving GECC of the benefit of its Mortgage. Gordon J. awarded costs on a substantial indemnity basis.

KEY ISSUES

1. Was the Mortgage void for:

(a) contravening the financial assistance provisions of s. 20 of the OBCA?

(b) contravening the FCA?; and,

(c) contravening the APA?

2. Do the lien claimants have priority over the Mortgage by virtue of s. 78 of the CLA?

3. Was it appropriate to award costs on a substantial indemnity basis?

4. Is the cross-applicant, Green, entitled to an increase in its costs award?

POSITIONS OF THE PARTIES

GECC’s Submissions

The Mortgage did not violate s. 20 of the OBCA

[14] There was no evidence in April, 1999 when the Mortgage agreement was entered that either “109” or Euro would become insolvent. Advent, the Teachers’ Pension Fund and Lehman Bros. all extended funds to Euro and none of these parties could have foreseen the eventual demise of Euro. Before August 1999, there was no evidence that “109” could not meet its financial obligations as they became due. “109” could pay all its liabilities as they became due as long as Euro paid the rent. The rent was paid until August, 1999. According to what was known in April 1999, “109” was in excellent financial condition. (Appellant’s Factum, paras. 62-66)

[15] The guarantee was not a liability or deduction from the realizable assets of “109”. There were no reasonable prospects of the guarantee being called in April, 1999. There were no reasonable grounds for believing that the guarantee would cause the realizable assets to be exceeded by “109’s” liabilities. (Appellant’s Factum, paras. 68-69; Clarke v. Trustee of Technical Marketing Associates Ltd. (1992), 8 O.R. (3d) 734).

[16] The “safe harbour” provision applies to GECC because it was a “lender of value” pursuant to s. 20(3) of the OBCA. GECC advanced monies to Euro that permitted Euro to continue to pay rent to “109”. There is clear and uncontradicted evidence of continued and increased financing being provided in consideration of “109’s” grant of the Mortgage.

GECC Acted in Good Faith

[17] GECC was acting in good faith and it did not turn a blind eye to the obvious. GECC sought and obtained all the necessary representations and certificates from “109”. GECC had no reason to question those representations in April, 1999. The courts have held that a solvency certificate would suffice in lieu of other inquiries. (Upper Mapleview v. Stolp Homes (1997), 36 B.L.R. (2d) 31). GECC obtained a solvency certificate. (Appellant’s Factum, para. 75)

Fraudulent Conveyances Act (“FCA”)

[18] XDG can only seek to set aside the Mortgage transaction if it was a creditor on April 14, 1999. XDG only became a creditor on September 17, 1999. The conditions that would allow a subsequent creditor to impeach a fraudulent conveyance were not proven in this case. XDG did not prove that “109” granted the Mortgage with the “intent to defeat, hinder, delay or defraud creditors”. (Appellant’s Factum, paras. 77-79) The FCA also requires proof that the transferee had “notice or knowledge” of that intent. There is no evidence that GECC had knowledge of any intent on the part of “109” to defraud creditors. (Appellant’s Factum, para. 81)

Assignment and Preferences Act (“APA”)

[19] In order to defeat the Mortgage, XDG must prove that “109” was unable to pay its creditors or was insolvent or on the eve of insolvency in April, 1999, that XDG was a creditor at the time and “109” had the intent to defeat, hinder, delay or prejudice creditors and GECC knew or ought to have known of “109’s” intentions to do so. There was no evidence in April 1999 that “109” was unable to pay its debts. If this cannot be proven, then the APA cannot apply to defeat the Mortgage. (Appellant’s Factum, paras. 82-84)

[20] It also cannot be proven that XDG was a creditor of “109” at the time of the transfer. As of April 14, 1999, there was no debt owing to XDG. There is also no evidence that “109” intended to prefer GECC over its creditors, nor is there evidence that GECC had knowledge of any intent to defeat other creditors. A court is not likely to set aside conveyances upon a mere suspicion that they are fraudulent. There must be firm evidence of fraudulent intent. (Appellant’s Factum, paras. 86-88)

Construction Lien Act (“CLA”)

[21] Section 78(6) of the CLA states that “any advance made in respect of that conveyance, mortgage or other agreement” enjoys priority unless there has been registration or written notice of a claim for lien. Section 78(6) does not require that the advance be made to the owner. It simply states that the advance must be made in respect of that conveyance, mortgage or other agreement. GECC made advances in respect of the Mortgage; none of the subsequent advances to Euro would have been made if the Mortgage had not been granted. (Appellant’s Factum, paras. 91-93)

Costs

[22] Only conduct of a reprehensible nature should give rise to an award of solicitor and client costs. Gordon J. awarded substantial indemnity costs on the basis of his conclusion that GECC failed to conduct due diligence, was not acting in good faith and was willfully blind. The evidence does not support those conclusions Moreover, the actions described do not constitute reprehensible conduct. (Appellant’s Factum, para. 103)

XDG’s Submissions

[23] The Mortgage violated s. 20 of the OBCA. At all relevant times, s. 20 of the OBCA prohibited financial assistance between affiliated corporations such as “109” and Euro where there were reasonable grounds for believing that the corporation granting the assistance was insolvent. The two tests that must be met to prove solvency are the “Cash Flow” test and “Balance Sheet” test. “109” could not meet either of these solvency tests at the time the Mortgage was granted to “109” to provide assistance to Euro. “109” was not able to pay its outstanding liabilities in April 1999. As well, the assets less the liabilities and stated capital of “109” were significantly less than the amount of the financial assistance or guarantee of $11.5 million. If “109” failed either of these two tests, the provision of the Mortgage violated s. 20 of the OBCA. (XDG’s Factum, paras. 31-39)

[24] GECC cannot rely on the “safe harbour” provision (s. 20(3) of the OBCA) because it was not a lender for value. The guarantee did not facilitate the extension of new credit. It merely provided security for pre-existing indebtedness. The “safe harbour” provision, therefore, cannot apply even if further credit was extended after the execution of the guarantee. (Upper Mapleview Inc. v. Stolp Homes (Veterans Drive) Inc. (1997), 36 B.L.R. (2d) 31).

[25] Section 20(3) of the OBCA also imposes a positive obligation on a lender to exercise reasonable diligence to determine the solvency of the guarantor. Any evidence of suspicious circumstances is sufficient to put a creditor on its inquiry. Where a creditor is put on inquiry, but fails to inquire, it cannot rely on the “safe harbour” provisions of the OBCA.

The Mortgage was void pursuant to the FCA

[26] A transaction is void by operation of s. 2 of the FCA if it is “made with intent to defeat, hinder, delay or defraud creditors or others”. Badges of fraud have been developed to allow a court to infer intent from the circumstances of a transaction. Badges of fraud, such as: the transfer was made to a related party, the transaction was effected with unusual haste, and the transaction was supported with inaccurate documents are present in the GECC Mortgage transaction. (XDG’s Factum, paras. 45-48)

[27] Section 3 of the FCA provides some protection to creditors declaring that a transaction is not void where the transaction was made “upon good consideration and in good faith”. The transaction in question was not made for good consideration. “109” received no funds from GECC and it received no benefit from Euro. It cannot be said that GECC acted in good faith because GECC ensured that “109” received none of the benefit of the Mortgage. (XDG’s Factum, para. 51-53)

The Mortgage was void pursuant to the APA

[28] A transaction is void under the APA if it was made with the intent to defeat, hinder, delay or prejudice creditors. The badges of fraud outlined in paragraph 47 of XDG’s factum are evidence of an intent to defeat, hinder, delay or prejudice creditors. (XDG’s Factum, paras. 54-57)

GECC failed to meet the onus under the CLA

[29] The CLA is to be interpreted liberally in favour of lien claimants. The overarching principle of the CLA is that lien claimants have priority over other interests. It is necessary for a mortgagee to persuade the court that it falls within one of the exceptions to the general priority of lien claimants. (XDG’s Factum, para. 58)

[30] GECC failed to demonstrate that its Mortgage should take precedence over the lien claimants. The Mortgage was registered after the first lien arose. As such, GECC’s priority was limited to the extent of any advance made in respect of the Mortgage. GECC did not advance any amount in respect of the Mortgage. Any advances made were made to Euro, not to “109”, and they were made in respect of the Credit Agreement, not in respect of the Mortgage. (XDG’s Factum, paras. 59-61; David Schaeffer Engineering Ltd. v. D.T.A. Investments Inc. (1998), 37 C.L.R. (2d) 26). The courts have held that where a mortgage was registered to secure a pre-existing debt for the purposes of the CLA, no monies were advanced. (561861 Ontario Ltd. v. 1085043 Ontario Inc. (1998), Kirsh’s C.L.C.F. 78.50 at 78.166-167 and 169).

Costs Award

[31] GECC required leave to appeal the costs award. There are no grounds to support a request for leave. Gordon J. provided lengthy, detailed reasons for the costs award. The CLA costs provisions suggest that substantial indemnity costs should be awarded more readily than in regular civil proceedings. It was reasonable to censure GECC for relying on a mortgage that was grossly excessive and found to be void. (XDG’s Factum, para. 66)

CONCLUSION

[32] The overriding issue in this appeal is whether the trial judge’s finding that, on the facts of this case, GECC had a legal obligation to conduct a due diligence of “109” and that a due diligence would have put GECC on notice of the financial problems of “109” and likely consequences that, in fact, flowed. That finding was the substantial basis for declaring the mortgage invalid with respect to the lien claimants.

[33] The trial judge, in his reasons, carefully analyzed the evidence, both testimonial and written. There was no demonstrable error shown in the substantial factual findings of the trial judge. Gordon J. applied the correct legal principles to the facts.

[34] GECC has failed to establish that Gordon J. was clearly wrong in his finding of facts or in his application of legal principles. The trial judge had a basis for his findings of fact and he applied the correct legal principles to those facts.

[35] Because the trial judge concluded that GECC failed to conduct due diligence, was not acting in good faith and was willfully blind, his award of costs, on a substantial indemnity basis, was not an improper exercise of his discretion.

Costs of the Appeal

[36] Prior to reserving judgment, we asked each of the three (3) counsel for his submissions as to costs of the appeal. Counsel for GECC produced a draft bill of costs showing a total of $47,179.34, all inclusive. Counsel for XDG filed a draft bill of costs requesting $21,545.89, all inclusive. Counsel for Wm. Green Roofing Ltd. (Green) requested costs on the appeal at $8,500.00 plus G.S.T. The question of Green’s costs on appeal is decided later in these reasons.

[37] GECC’s appeal has been dismissed. There is no reason that costs should not follow the event. No one suggested that XDG’s draft bill of costs on appeal contained any improper claims, was inaccurate or excessive in any way. XDG’s costs on appeal, payable forthwith by GECC, are fixed at $21,545.89, all inclusive.

Cross-Appeal of Green as to its costs

[38] In paragraph [3] above we refer to Green’s cross-appeal. Green asks that the February 27, 2003 costs order of Gordon J. be set aside and substituted for a costs on either a partial or substantial indemnity basis fixed at $83,937.50 plus $1,500 for disbursements and applicable G.S.T.

[39] Before Gordon J., Green was awarded costs against GECC in the amount of $9,000.00 for fees, $1,500 for disbursements and $735.00 for G.S.T. for a total of $11,235.00.

[40] In this cross-appeal, Green asserts that the amount of $9,000.00 for fees is unjust and inconsistent with the conduct of GECC throughout, Green’s Rule 49 offer, the factors enumerated in Rule 57.01(1) and s. 131 of the Courts of Justice Act. Green takes no issue with the $1,500.00 awarded by Gordon J. for disbursements.

[41] All counsel consented that this court could hear this cross-appeal without a formal disposition of the leave which was sought, “if necessary”, in the amended Notice of Cross-Appeal.

[42] The award of costs is in the discretion of the trial judge. The material presented to us on this appeal addresses some of the concerns noted by Gordon J. While we do not say that Gordon J. was clearly wrong, we are compelled to the view that it would be clearly wrong if Green was held to an award of $9,000.00 for fees now that it has “backed out” of the bill of costs the items which Gordon J. specifically complained about. In our view, these adjustments compel an increase in the amount of costs that were awarded to Green.

[43] More specifically, in the cross-appeal, Green has backed out the costs it incurred in the insolvency proceedings and in the litigation between it and XDG. In his reasons on costs, Gordon J. noted that Green sought costs on a substantial indemnity basis fixed in the amount of $249,170.50. Gordon J. specifically referred to a number of problems with Green’s material as follows:

(a) no docket entries were provided;

(b) costs are claimed regarding the insolvency proceedings;

(c) costs are claimed regarding the litigation between Green Roofing and XDG.

[44] In paragraph [20] of his costs endorsement, Gordon J. correctly stated that a lien claimant is entitled to have its counsel participate in the proceedings even where the carriage of the action is granted to another claimant.

[45] Now that Green has “backed out” the items referred to above, he seeks costs in this cross-appeal in the amount of $83,937.50. The materials contain a summary of the docketed time and hourly rates of participating lawyers. [^1]

[46] In our view, there is one other matter which compels an upward adjustment of costs in favour of Green. Gordon J. awarded $9,000.00 to Janick Electric for its time spent in the insolvency proceedings. The Janick lien was for $108,243.55. Green’s lien was for almost six (6) times greater. Janick’s counsel did not participate at the trial. We do not consider it fair to Green to measure its entitlement to costs by comparing its role to that of Janick. Their roles were substantially different. Green was substantially more involved in the proceedings and needed to be there to protect its interest.

[47] In all of the circumstances we find the award of $9,000.00 of costs unreasonably low. The combination of factors set out above compel us to allow the cross-appeal and substitute our finding for costs which we would award to Green on a party and party basis and on the basis that the costs regarding the insolvency proceedings and the litigation between Green Roofing and XDG are backed out of the bill of costs of Green.

[48] The process of fixing these costs is inherently arbitrary but it must be done in a manner that “reasonably and without arbitrary diminution acknowledges the efforts legitimately expended in that connection”. See: Carpenter et al. v. Malcolm (1985), 6 C.P.C. (2d) 176 at 178 per Catzman J. (as he then was). Fixing costs in this cross-appeal is made more difficult by the fact that we were not provided with actual docket entries.

[49] We fix these costs at $40,000.00 together with $1,500.00 for disbursements and applicable G.S.T. These costs are payable by GECC forthwith. The cross-appeal is therefore allowed. $40,000.00 includes costs of the cross-appeal.

O’DRISCOLL J.

E. MACDONALD J.

CAPUTO J.

DATE:

[^1]: These are summarized at paragraph [12] of Green’s Factum in the cross-appeal.