Court File and Parties

COURT FILE NO.: CV-12-108282-00 DATE: 2013-03-07 CORRIGENDA: 2013-03-18

SUPERIOR COURT OF JUSTICE - ONTARIO

RE: Bank of China (Canada), Plaintiff AND: Ocean Sands Developments Limited, Ermidio F. Alves and 255”B” Rutherford Road South Limited Partnership, Defendants

BEFORE: The Honourable Madam Justice C.A. Gilmore

COUNSEL: Martin Greenglass, for the Plaintiff Ritchie J. Linton, for the Defendants

HEARD: February 25, 2013

REVISED ENDORSEMENT

The text of the original endorsement has been corrected with the text of the corrigendum (released today’s date)

Overview

[1] This is a motion for summary judgment brought by the plaintiff, the Bank of China (“the Bank”), requesting judgment to be granted in relation to a loan advanced to the defendant, Ocean Sands Developments Limited (“Ocean”) in its capacity as the principle debtor (“borrower”) and as against the defendant, Ermidio F. Alves (“Alves”), in his capacity as guarantor of the obligations of the defendant, Ocean.

[2] The Bank admits that the borrower is current with respect to payments due and owing on the loan. Further, it was not disputed that the outstanding amount of the loan as of the date of hearing of this matter was $2,892,970.98.

[3] The Bank also seeks possession of the lands and premises described in Schedule “A” to the statement of claim and municipally known as 255”B” Rutherford Road South, Brampton, Ontario (“the subject property”), over which the Bank holds collateral mortgage security for the debt obligation and which is also sued upon.

[4] The 255B Rutherford Road South Limited Partnership (“Partnership”) is a defendant because the Bank alleges that the partnership is the true owner of the subject property.

The Issues

[5] The issue to be determined in this case is a narrow one, namely, can the Bank make demand for the entire loan, where there has been no financial default in relation to the monthly payments? The Bank argues that the non-financial default of the borrowers is sufficient. The defendants counter with two arguments. First, while enforcement of the demand loan is discretionary on the part of the Bank, that discretion cannot be exercised in an unreasonable manner. Second, there are a considerable number of factual disputes in the case, which means that it falls far below the “full appreciation test” on a motion for summary judgment. More specifically, evidence is required from the borrower’s accountants to fully explain the corporate structure and complex income streams and the defendant Alves should be given an opportunity to explain his actions given that his credibility has been challenged by the Bank.

The Position of the Bank

[6] The loan in this matter is evidenced by a demand promissory note, dated December 30, 2010. The promissory note specifically indicates that it is payable on demand. In addition, the mortgage security sets out the mortgagor as the defendant Ocean and the chargee as the Bank. The principle secured is $3,120,000.00 and the balance due date is noted as “on demand”.

[7] There is also a guarantee, dated September 30, 2010, which is payable on demand and signed personally by Alves and witnessed by Mr. Linton.

[8] In 2010, the subject property was mortgaged in favour of Bank of Montreal with respect to a construction loan which became due. The borrower needed more permanent financing and used the services of Mr. Peter Santos, a mortgage broker to assist in arranging the financing. The guarantor, Alves, is a developer and real estate agent who owns a real estate brokerage and is familiar with commercial financing.

[9] An opinion letter prepared by Mr. Linton as counsel to the borrower and Mr. Alves as the personal guarantor, sets out as follows:

The loan documents executed by each person or corporation included in the borrower entity constitute valid and legally binding obligations of each such person or corporation as the case may be, as of the date hereof, enforceable against each of them in accordance with their terms.

The Bank submits that there is nothing in the opinion letter that indicates any qualification to the Bank’s right to make a demand.

[10] The Bank argues that even if a simple demand for repayment is insufficient for the loan to be repaid, then there are certain triggering events which, pursuant to the loan documentation, would entitle the Bank to make a demand. These triggering events are listed and set out by the Bank as follows:

(a) The mortgaged premises were sold without the Bank’s consent. The loan commitment document addressed to the borrower and dated September 9, 2010, contains negative covenants restricting the sale or transfer of the subject property without the consent of the Bank.

(b) The Bank alleges that Alves misrepresented the circumstances with respect to two sworn statutory declarations. In the facility letter, the events of default based on inaccurate representation are described as follows:

The lender may at its option declare the principle amount of all of the indebtedness to the borrower to the lender plus unpaid interest, to be immediately due and payable and the borrower shall forthwith pay all such amounts whether or not such liability is of a fixed term nature or otherwise and all security held by the lender shall become enforceable and the obligation of the lender to make additional advances or other availment under any credits shall cease upon the happening of any one of the events:

(g) any inaccuracies of any representation or warranty provided.

The Bank alleges that Alves swore under oath in a statutory declaration that as of September 30, 2010, the borrower was the sole legal and beneficial owner of the property. The Bank’s position is that this was a clear misrepresentation.

(c) The Bank alleges that the borrower is in default because it has failed to provide financial statements on time. Specifically, pursuant to the facility letter, the reporting requirements stipulated the borrower must deliver to the Bank:

(i) Review engagement financial statements of the borrower to be provided to the bank annually within one-hundred and twenty (120) days of the fiscal year period.

The Bank argues that while financial statements have been provided for 2010 and 2011, they were late on both occasions. Further, the financial statements provided for the year end of December 31, 2010, which were not delivered until June 2011, showed that the borrower’s income producing properties had decreased from $4,591,732.00 value in 2009 to $20,953.00 in 2010. The Bank was, of course, concerned that the subject matter of their loan was no longer owned by the borrower. The December 31, 2010 financial statements also referenced the sale of the borrower’s property to the Partnership. Specifically, note 7 to the financial statements shows a mortgage receivable of $6,126,781.00 from the Partnership. It is described as a:

Vendor take back mortgage receivable arising from the sale of commercial property to 255B Rutherford Road South Limited Partnership. The company has an option to register the mortgage against the property 255B Rutherford Road South until this mortgage is fully paid. The security in this mortgage is currently not registered. Instead, to secure this mortgage as agreed to in the agreement of purchase and sale of August 31, 2010 and until such time as the remaining principle balance of this vendor take back mortgage receivable is fully paid, the property, 255B Rutherford Road South, shall remain in the company’s name in trust for 255B Rutherford Road South Limited Partnership.

The Bank argues that to any third party, the title abstract would show the borrower remaining as the owner of the subject property, yet according to the notes to the 2010 financial statements, the borrower is a mere bare trustee for someone else.

In response to the Bank’s further inquiries, the borrower provided updated financial statements for the year end, ending December 31, 2010, with an amended note 7. In that note, the reference to the trust arrangement was removed, although references to the vendor take back mortgage receivable and the sale remained.

(d) The Bank alleges that the borrower has failed to maintain the minimum debt service ratio required. The financial covenant requirements under the facility letter stipulate as follows:

The borrower covenants and agrees with the bank that it will adhere to the following condition at all times as long as it is indebted to the bank; a minimum debt service coverage (DSC) ratio of 1.2 to 1 at all times. The DSC is defined as annual net operating income (NOI) on the Property, divided by the aggregated debt obligation (principal and the interest payments) on both the first mortgage and the second mortgage.

The Bank argues that this means that the borrower’s income has to be 1.2 times the required mortgage payments on the first and second mortgages. The Bank alleges that there was insufficient rental income in both 2010 and 2011 to meet this financial covenant. While the borrower does show that in 2011 it made substantial interest income, this is not an income that counts for the loan arrangement with the borrower. The Bank submits that they asked for financial statements for the limited partnership to ensure that the income was sufficient to meet the financial covenant. What they were provided was the financial statements and balance sheet of the borrower as of December 31, 2011. The income statement showed that the borrower’s rental revenue had decreased from $299,642.00 in 2010 to $4,437.00 in 2011. The Bank asked for production of the contract between the borrower and the Partnership, but was refused. The Bank speculated that the limited partners were not paying rent, but their share of the limited partnership purchase of the subject property so that in fact, no rent was being paid and the defendant was therefore in breach of the terms of the loan.

(e) The Bank alleges that the borrower has paid their realty taxes late and is therefore in breach of the terms of the loan. The facility letter stipulates under positive covenants, as follows:

the borrower shall (a) make all tax payments as due.

There was no dispute during the hearing of this matter that the borrower is now up to date with respect to its realty tax payments. However, based on the certificate issued by the City of Brampton and dated February 20, 2013, it is clear that penalty and interest charges of $1,630.38 were paid in 2012. The Bank argues that this is clear evidence that tax payments were not made as due, and the borrower is therefore in breach.

The defendants’ position on taxes are that they are paid by the second mortgagee and that sometimes rental lease payments and tax payments overlap, resulting in some small interest and penalty charges. The Bank’s response is that they have no privity of contract with the second mortgagee, and therefore it is up to the borrower to ensure that tax payments are made on time notwithstanding any arrangement they may have had with the second mortagee.

(f) Alves has misrepresented the borrower’s circumstances when swearing statutory declarations. The Bank’s counsel referred the court to a statutory declaration sworn by Alves on September 30, 2010. In that statutory declaration at paragraph 3, Alves solemnly declares that:

except as may be disclosed by the registered title, there is no encumbrance or easement whatsoever affecting the property.

At the time Alves made this declaration, an unregistered vendor take back mortgage had been in existence since August 31, 2010 and therefore Alves was not in a position to make such a declaration. A further statutory declaration made by Alves on September 30, 2010 declares as follows:

The borrower is the legal and beneficial owner of the Property. The Partnership has entered into a series of leases with various tenants for units at the property as set out in Exhibit “A” attached hereto. The Partnership has signed all of the leases to the borrower by assignment of leases dated the 15th day of September 2010. A notice of direction directing the tenants to pay all future rents to the borrower has been given to each tenant.

The Bank submits that this declaration was also misrepresented because at the time the declaration was made, the borrower was no longer the legal owner of the property.

[11] The Bank submits that the creditor does not need to breach any terms of the loan commitment for it to demand repayment as the security clearly sets out that payment in full may be made on demand. The exception to this would be if the bank was demanding repayment for an impermissible purpose, such as requiring the debtor to do something outside of the loan arrangement, or, for example, upon discovering the heritage or race of the borrower, the Bank determined they would not lend to the borrower for that reason. The Bank’s position is that it need need not be right or wrong in its opinion not to do business with the borrower, but they may still demand their loan. Doing otherwise means that the court can substitute its own decision and force the lender to do business with someone it does not want to in circumstances where the Bank has no further confidence in the borrower.

[12] In response to the defendant’s allegations that the Bank was well aware that there had been a transfer of the property, the Bank points to certain emails between its employee, Mr. Eugene Chan (“Chan”), and mortgage broker, Peter Santos (“Santos”). Chan prepared an organization chart based on information given to him by Santos about the legal entities owned by Ocean. That chart can be found at page 2 of tab 5 in the Bank’s Document Book.

[13] The chart shows Alves as the one-hundred percent (100%) owner of Ocean. It also shows him as the one-hundred percent (100%) owner of Bugsy Developer and ELFA Realty Inc. (“ELFA”). ELFA is the general partner in the Partnership. In addition to ELFA as the general partner, there are eight (8) limited partners. In the organization chart, the Partnership is shown as the borrower of funds from Ocean. A further email from Chan to Santos on August 6, 2010, sets out a request by Chan to have the client amend the lease agreement since the landlord under the current lease agreement was shown as the Partnership instead of Ocean. Chan made a handwritten note on the email (the author of this note was not in dispute) as follows:

On August 5, 2010, discussed with Peter Santos. Peter informed the title owner is Ocean Sands Development Limited because client would like to save the Land Transfer Tax and capital gain from transfer.

[14] A memo prepared by the bank’s risk manager, Donald Bridge, dated August 27, 2010, also makes specific reference to ownership of the subject property as follows:

Also, as confirmed by the AM, the current 100% owner of the Borrower continues to be Ermidio Alves – despite the commentary in the LTS regarding the ELFA General Partner. We understand that ownership may be changed in the future – although not without the Bank’s prior written approval. Notwithstanding the above, we understand that the leases are currently with the Limited Partnership. In the circumstances, appropriate documentation must be obtained through our lawyer prior to funding to confirm that the leases will be valid and binding with the Borrower.

[15] The Bank submits that they agreed to lend money to the borrower on this basis. Although the Bank may have been prepared to loan money to the limited partnership, they would have required the personal guarantee of Alves and also all of the limited partners. Alves refused to approach the limited partners to request such guarantees. The Bank argued that this was likely as a result of the arrangement Alves had with the limited partners to purchase the subject property as per the Agreement of Purchase and Sale, dated August 2010. The Bank alleges that because of this requirement, Alves went behind the back of the Bank and structured a form of transfer to the limited partnership in any event, and sold it to the limited partners at well over the appraised value. The Bank takes the position that their security has been considerably weakened as a result of the borrowers and Alves’ actions, and it chooses not to continue doing business with the borrower and Alves.

[16] In support of its position, the Bank relies on the case of Canadian Imperial Bank of Commerce v. Hurlburt, 2008 NSSC 408, 2008 274 N.S.R. (2d) 104. In that case, the court reviewed foreclosure actions where the Bank made the demand for repayment on a revolving personal line of credit (“PLC”), which was expressly stated to be repayable on demand and secured by a collateral mortgage. In the circumstances, the court took the position that the PLC agreement and collateral mortgage were plainly worded and although they did not have a term, they were payable on demand. There was nothing in either document that allowed the customer the right to the continued use of the line of credit, even where she continued to pay interest.

The Position of the Defendants

[17] The defendants take the position that Chan’s email chart shows the Bank’s pre-commitment knowledge about the transfer. Further, they knew enough about it to consider the possibility of providing financing to the limited partnership on certain terms. Those terms were not acceptable to Alves.

[18] The initial demand letter from the Bank was sent to Alves on August 9, 2011 by the bank’s former counsel, Sun & Partners. In that letter there were four allegations of default. Specifically; that the borrower had breached its negative covenant by transferring the subject property to the Partnership; that there had been a material adverse change in the financial position of the borrower as a result of their December 31, 2010 financial statements showing the depletion of their income producing properties and converting same into a mortgage receivable; that the vendor take back mortgage given by the purchaser pursuant to the transfer was not registered against the subject property; and that the sworn declarations made by Alves, dated September 30, 2010, were a misrepresentation of the borrowers’ circumstances.

[19] A further and more formal demand was made by the Bank by way of letter, dated February 6, 2012, from Mr. Greenglass. In that letter, a formal demand was made for payment, in default of which the Bank would enforce on their collateral mortgage and personal guarantee of Alves. A notice of intention to enforce security under the Bankruptcy and Insolvency Act was attached. The defendant argues that the Bank has now resiled from any allegation of default and simply made a bald demand for payment. They are now looking for excuses to justify which what it has already done in its demand for payment. Since the defaults are either unsustainable or have been rectified, there is no basis for such a demand. Further, the bank’s position is creating a negative impact on Alves as a Brampton businessman and interfering with his ability to obtain alternate financing. In response, the Bank argues that the borrower and Alves have had over one year since the February 6, 2012 demand letter was sent to make arrangements for refinancing and have simply failed to do so.

[20] The defendant states that there has been no closing or no transfer of property. The agreement of purchase and sale was self generated by Alves and signed only by him on behalf of both Ocean and the Partnership. The limited partnership was created simply because it was less expensive than creating condominium units.

[21] Alves resents the insinuation that he has misrepresented the circumstances of the borrower in the statutory declarations. In fact, there is no encumbrance as the vendor take back mortgage has never been registered. Title to the subject property is still the same and the payments from the limited partners to the borrower are partly rental payments, and partly an amortization of the purchase price of the subject property over time. The defendants’ counsel likens this to a conditional sales contract for an inchoate right.

[22] Alves is an experienced businessman. He is not looking for short term money or an arrangement where he paid only interest on a revolving line of credit. He sought and obtained a fixed term contract with amortized payments. He expected to pay for a specific term and the Bank’s expectation was to receive payments on an amortized loan and improve its equity position over time.

[23] The defendants reference the facility letter which stipulates that while the borrower can repay the loan, it cannot be done without a significant penalty. The defendants argue that this is clearly an example of the Bank wanting a specific arrangement for a fixed term and ensuring that the penalty on payout was significant enough that the borrower would remain committed for the term. Neither party wanted an open loan, nor did they bargain for one. Further, the borrower is making the payments, has insurance in place, is paying the taxes, and the bank continues to accept their monthly payments.

[24] The defendants rely on Bank of Nova Scotia v Suthakaran, 2011 ONSC 6970 for the proposition that where there is any ambiguity in the terms of the loan, the ordinary contra proferentem rule applies and therefore the provisions must be construed in favour of the borrower. The defendant therefore submits that the court should rely on the contractually agreed fixed term of five (5) years and that that should apply to the other security provisions.

Summary Judgment

[25] The defendants submit that this is not a proper case for summary judgment. There are contentious factual issues, such as the extent of the Bank’s knowledge of the transfer to the Partnership. Further, the financial statements are complex with respect to the income streams and an accountant is needed for further explanation if the Bank intends to rely on them as a cause for the demand. The defendants offered to submit written interrogatories to the accountants but the Bank did not accept this.

[26] The Bank argues that it is the defendant’s obligation to put their best foot forward on a motion for summary judgment and if they wished the evidence of the accountants to be made available to the court, they could have provided an affidavit accordingly.

[27] The defendants argue that, given there has been no financial default, this is a somewhat unique debtor/creditor case with a considerable number of factual disputes. The case therefore falls far below the full appreciation test set out in Combined Air Mechanical Services Inc. v. Flesh, 2011 ONCA 764.

[28] The Bank responds that even if there are factual inconsistencies on the financial default it is clear that they have given legitimate business reasons for doing what they are doing and default is triggered even where the default is non-financial. The fact that the Bank, borrower, and Alves entered into a fixed term agreement does not matter when the promissory note, mortgage and guarantee are clearly payable on demand.

[29] Finally, the Bank submits that the defendants’ own evidence shows that even if they are somehow successful in demonstrating that the bank knew about the arrangement the borrower had with the Partnership, the fact that the partners are paying a combination of both rental payments and a portion of the purchase price, shows that the Bank’s mortgaged interest in the subject property is eroding as each payment by the limited partners is made.

Analysis and Ruling

[30] Summary judgment shall be granted to the Bank for the following reasons:

(a) The borrower executed a demand promissory note and a demand collateral mortgage. Alves executed a personal demand guarantee. The security given by the borrower by Alves prevails over any conflict in the wording of the facility letter. I find that the Bank was entitled to make demand in accordance with these documents and that those documents do not restrict the Bank from making such a demand prior to the conclusion of the five (5) year term of the loan.

(b) In the event that I am wrong and that a triggering event is required for a proper demand to be made, I find as follows:

(i) There is sufficient evidence to support that the borrower and/or Alves was in breach of various positive, negative and financial covenants given in the loan commitment. They may be summarized as follows:

1. There is evidence in the borrower’s own documentation that a transfer of the subject property took place to the Partnership and that the income stream was converted from that of rental income to interest income paid either on the vendor take back mortgage directly, or in the form of rental and purchase monies paid by the Partnership to the borrower pursuant to the agreement of purchase and sale from August 2010. This can be verified from the borrower’s financial statements which showed an increase in the category of investment assets from $467,499.00 to $6,592,456.00. The notes to the financial statements indicate that this increase was due to the unregistered vender take back mortgage in relation to the sale of lands from the borrower to the Partnership. Further, the agreement of purchase and sale sets out clearly that the deed was not to be registered and that the borrower would hold title as trustee for the Partnership. The agreement of purchase and sale also included chattels, making the PPSA registration of the Bank unable to be executed.

2. The statutory declarations of Alves were inaccurate with respect to the entitlement of the borrower to receive rent on the basis that the borrower was the legal and beneficial owner of the property and that there were no encumbrances on the subject property. In fact, a vendor take back mortgage had been given. The actions of the borrower in transferring the property, including chattels, was clearly a breach of the commitment letter, and I find that the Bank was in a position to demand repayment, should they have chosen at that point and had they known of the transfer.

3. The borrower is in breach of the commitment letter with respect to its debt service ratio, as the financial statements for the fiscal year ended December 31, 2010 do not show any rental income being generated from the property and therefore the debt service ratio required for the continuation of the loan would not be met.

4. Alves, in his cross-examination, admitted that the promissory note signed by him is payable on demand without any limitation on the ability of the bank to make demand. While he states that demand can only be made for a good reason, such as default, he does not concede that he is in default. He also acknowledged in his cross-examination that the mortgage security was payable on demand[^1]. Further, Alves conceded that the structuring of the facilities letter was on the basis that the borrower was to be both the legal and beneficial owner of the landlord’s interest under the leases and that as of August 31, 2010, the borrower was collecting rental income from the Partnership and holding it in trust for the Partnership[^2].

5. Alves acknowledged that the financial statements as required by the facility letter were late[^3]. Finally, Alves admitted that the Partnership has paid a portion of the deferred purchase price, at the same time claiming that the Partnership had no beneficial interest in the lands[^4].

[31] The defendant argues that a trial is needed because the evidence of an accountant will ensure that the court can fully understand the complex nature of the relationship of the various legal entities and income streams involved. With respect, I disagree with the defendant. The financial statements produced were clear. Rental income and income producing properties were reduced substantially when the income to the borrower changed from rental income to interest income and a portion of the deferred purchase price from the limited partners. This was not necessarily in dispute by the defendant, and in my view does not require extensive explanation by accountants.

[32] As to the credibility of Alves, I also disagree that a trial is needed to determine this. It is clear that Alves took the position that the Bank already knew about the transfer to the limited partnership, and even if it didn’t, it was of small consequence since no closing had taken place. While the Bank took the view that Alves had misrepresented the borrower’s circumstances, I prefer to take the view that Alves simply had a different perspective on those circumstances. It seems that he took the view that so long as monthly payments were being made, it was of small consequence to the Bank as to how and from whom those payments came. Unfortunately for Alves, the Bank was very interested in any changes in the payment and corporate structure of the borrower and its relationship to the Partnership, especially where the Bank had made it clear that they would refuse to loan money to the Partnership without the personal guarantee of each and every limited partner.

[33] I also disagree with the defendant on its view that there must be something more than simply a demand made by the Bank where the borrower was otherwise in complete compliance without any financial breaches of the facility letter or security given. While I agree that this is somewhat an unusual debtor/creditor case because the debtor is in good standing with its ongoing financial commitments, I also find that it is reasonable not to constrain commercial lenders to lend to borrowers whom they no longer trust or with whom they no longer wish to do business. In my view, that is an interference by the court which is not tenable so long as the Bank has not made a demand which is either capricious or impermissible. I find in this case, the demand made by the Bank was supported by the loan and security documents which stipulated very clearly that they were payable on demand, that the validity of those documents was confirmed by the borrower’s own counsel who argued the case at this hearing, and finally that the non-financial breaches of the facility letter by the borrower were concerning, real and created an understandable breakdown of the parties’ business relationship.

[34] Given all of the above, summary judgment is hereby granted to the Plaintiff for the full amount owing and for possession on the collateral mortgage described in Schedule “A” to the Statement of claim.

Costs

[35] Both parties have provided costs outlines to the court. The defendants cost outline seeks partial indemnity costs of $20,231.25 or $28,012.50 in full indemnity costs. In their bill of costs, the Bank sets out partial indemnity costs at $29,962.95 and substantial indemnity costs of $39,320.76 plus a further $7,907.17 for legal services rendered by Sun & Partners for a total of $47,227.93.

[36] The parties have not yet provided written submissions to accompany their cost outlines. I understand that the Bank will be arguing that the terms of its loan documents permit it to seek costs at a full indemnity rate. Therefore, submissions in support of the cost outlines provided shall be made available to the court (no more than 3 pages in length) by March 21, 2013, starting with the Bank on a seven (7) day turnaround.

Justice C.A. Gilmore

Released: March 18, 2013

CORRIGENDA

1. Paragraph [32]: “…took the position that the borrower already knew…” has been changed to “…took the position that the Bank already knew…”.

[^1]: Cross examination of Mr. Alves, questions 50 – 57 and 80 – 93. [^2]: Cross examination of Mr. Alves, questions 343 and 359 – 360. [^3]: Cross examination of Mr. Alves, questions 539 and 540. [^4]: Cross examination of Mr. Alves, page 188.