Court File and Parties
COURT FILE NO.: C-500-14 DATE: 2016-06-13 ONTARIO SUPERIOR COURT OF JUSTICE
BETWEEN: Marshallzehr Group Inc., Applicant J.G. Murdoch, Counsel for the Applicant
– and –
Callidus Capital Corporation, Respondent D. Bourassa, Counsel for the Respondent
HEARD: May 5, 2016
Reasons for Decision
THE HONOURABLE MR. JUSTICE D.J. GORDON
[1] In this proceeding, the applicant sought an accounting, determination of priorities and payment. The dispute is between the first and second mortgagee. Counsel agree the issue requiring determination is the date the respondent became a mortgagee in possession. The facts are not in dispute and, hence, counsel further agree the issue can be determined without a trial.
Facts
[2] The facts in this case can be stated in the following manner:
- Property - 181 Pinebush Road, Cambridge, Ontario
- Owner - Cheese Factory Road Holdings Inc. (“Cheese Factory”) acquired the property by deed No. 1457331, registered May 17, 2000, for $750,000
- Cheese Factory is a real estate investment or holding company and is one of several related corporations
- First Security - Bank of Montreal (“BMO”) charge No. 1581583, registered November 15, 2004, securing principal of $1,300,000 and bearing interest at prime plus (blank). While the underlying agreement specifies interest at prime plus .75%, the charge limits interest to prime
- BMO also holds a general assignment of rents No. 1581584, registered the same day
- BMO provided credit facilities to Cheese Factory and its related corporations, taking security on other property as well
- Second Security - Marshallzehr Group Inc. (“Marshallzehr”) charge No. WR 509124, registered December 10, 2009, securing principal of $500,000, being collateral to a promissory note
- Marshallzehr also holds an assignment of rents No. WR 509125, registered the same day
- Third Security - Wichita Falls Economic Development Corporation charge No. WR 522232, registered February 26, 2010, securing principal of $5,500,000
- chargee is not involved in this action
- Tenant - UTi Canada Contract Logistics Inc., formerly Span Manufacturing Ltd., by lease dated May 6, 2009, amended on May 6, 2011 and on October 8, 2012
- net net lease required base rent of $15,437.50 monthly plus additional rent for taxes and insurance
- tenant responsible for repairs and maintenance, reasonable wear and tear excepted
- Cheese Factory defaults on BMO security
- BMO demanded payment in May 2011 as a result of default by Cheese Factory and related corporations
- Cheese Factory Forbearance Agreement with BMO
- Cheese Factory entered into a forbearance agreement with BMO on June 20, 2011
- BMO assigns to Callidus
- BMO assigned all of its security regarding the indebtedness of Cheese Factory and related corporations to Callidus Capital Corporation (“Callidus”)
- as it relates to this property, the transfer of charge No. 1581583 and assignment of rents No. 1581584 was registered on December 8, 2011 as No. WR 659506
- Cheese Factory Forbearance Agreement with Callidus
- Cheese Factory and related corporations entered into a forbearance agreement with Callidus on December 2, 2011, prior to the above assignment
- additional security was granted to Callidus, the debt was restructured and new credit facilities of $5,000,000 at 21% interest established
- Cheese Factory was obliged to market and sell the property
- Marshallzehr did not execute a postponement agreement
- Cheese Factory defaults on Callidus security
- as a result of default by Cheese Factory and the related corporations, Callidus issued a notice of sale under mortgage regarding this property on April 16, 2012 claiming principal of $1,300,000, interest and costs
- interest rates, for different time periods, are stated to be prime plus .75%, prime plus 4% and 21%
- Cheese Factory is bankrupt
- Cheese Factory filed a notice of intention to make a proposal on October 31, 2013 and made an assignment in bankruptcy on November 7, 2013
- related corporations also make assignments
- Property Sold by Callidus
- the property was sold by Callidus, as mortgagee, in August 2015 for $1,720,000.
Issue
[3] The issue requiring determination is the date Callidus became a mortgagee in possession of the property. Mashallzehr says it was on December 2, 2011, being the date of the forbearance agreement with Cheese Factory. Callidus claims it was not until November 7, 2013, being the date Cheese Factory made an assignment in bankruptcy.
[4] The date will determine the indebtedness of Cheese Factory to Callidus as at the time of the sale of the property. With the earlier date, the principal owing is said to be approximately $1,083,000, and with the latter date it is about $1,445,000. Counsel advise they will be able to complete the calculations. Marshallzehr, as second mortgagee, and if successful, would have an interest in the difference.
Legal Principles
[5] The critical evidence is the terms of the forbearance agreement between Cheese Factory and Callidus. Before reviewing same, it is helpful to set out the relevant principles of law. Those principals are not in dispute.
[6] The leading case on mortgagee in possession is still Noyes v. Pollock (1886), 32 Ch. D.53 (C.A.), adopted in Ontario by, for example, Beckstead v. Ball, , [1961] O.R. 127 (H.C.J.). Those and other decisions, as summarized in “Marriott and Dunn Practice in Mortgage Remedies in Ontario”, 5th edition, and “Falconbridge on Mortgages”, 5th edition, establish the following:
- a mortgagee is in possession when it has taken control and management of the mortgaged property out of the hands of the mortgagor
- a mortgagee may be in possession even without physical re-entry
- merely intercepting the rents and profits after they have been paid by the tenant does not take the mortgage property out of the control of the mortgagor
- a mortgagee is not in possession until it asserts its rights as mortgagee
- the court will not lightly find a mortgagee is in possession because of the almost penal liabilities that are thereby imposed on the mortgagee
Forbearance Agreement
[7] In a forbearance agreement, the creditor agrees not to enforce its security provided the debtor complies with the terms. The agreement here added additional parties, as guarantors of the original debtors, and new terms. The aggregate debt of the original debtors, including Cheese Factory and others, was said to be $4,804,076.94 CDN. And $81,233.28 USD. The borrowers acknowledge their default under the BMO security and provided additional security to Callidus. The credit facilities were amended. A monthly monitoring fee of $3,000 was imposed.
[8] The forbearance agreement is of critical importance with respect to indicia of possession. As expected, counsel have a different perspective.
[9] Mr. Murdoch, on behalf of Marshallzehr, identifies terms in the agreement that indicate, he says, Callidus took complete control of the property. Mr. Murdoch refers to the following new restrictions and obligations of Cheese Factory:
- provide a daily list of cheques requested to be paid
- cash management system whereby a new bank account established, identified as a block account owned by Callidus, into which all rental income would be deposited, Cheese Factory acting as trustee for Callidus receiving, as the property of Callidus, the rent from its property
- the rental income of Cheese Factory was applied to aggregate loan, not the property mortgage
- Cheese Factory’s sole ability to access funds was to borrow back from Callidus on a new credit facility at 21 per cent interest
- the property was to be marketed and sold by March 31, 2012 and the realtor was required to report to Callidus, Callidus reserving the right to appoint a receiver to sell the property
- if property sold, proceeds to be applied to the aggregate loan, not the property mortgage
- capital expenditures were not permitted unless prior approval obtained
- access provided to the property, books and records.
[10] Mr. Murdoch, with reference to the summary of funds received by Callidus, identified the property tax paid by the tenant as additional rent being deposited to the block of account of Callidus. However, Callidus did not use those funds to pay the property tax owing, resulting in significant tax arrears when the property sold. This, Mr. Murdoch says, eroded the equity in the property as the interest rate on tax arrears was 15 per cent, but only at prime on the mortgage. The alternative was for Cheese Holdings to borrow back funds at 21 per cent to pay the taxes already paid by the tenant to Callidus.
[11] Mr. Murdoch also referred to the cross-examination of Ralph Rossdeutscher, formerly the sole officer and director of Cheese Factory, that took place on January 14, 2016. Mr. Rossdeutscher disclosed:
- neither Cheese Factory nor Callidus had a key to the building on the property
- Callidus would determine whether he could sell the property and at what price
- Cheese Factory did not have funds to pay for required roof repairs, the repairs attended to by the tenant who then sought a rent reduction which had to be approved by Callidus
- while he negotiated with the tenant on the 2012 lease renewal, he communicated with Callidus who approved the terms.
[12] Mr. Bourassa, on behalf of Callidus, identified the following terms or events to demonstrate his client was not in control of the property, to the extent it would be deemed in possession:
- Callidus agreed not to enforce its security and to advance further funds
- tenant paid rent to Cheese Factory who then deposited to the block account until the Fall of 2012 when the tenant started to deposit rent directly
- Cheese Factory chose how to leverage its income stream by entering into the agreement, thus retaining its assets for a longer period of time
- the deposit of all funds to the block account was a choice Cheese Factory made
- the rental income allowed Cheese Factory to borrow more funds
- Cheese Factory was marketing the property and the obligation to keep Callidus informed was not tantamount to Callidus listing or selling the property
- Callidus’ permission to renew lease by Cheese Factory is not enforcement of security
- Callidus not directly involved in negotiating lease renewal terms
- Cheese Factory had the option of borrowing funds to pay realty taxes
- Callidus had no obligation to pay realty taxes.
Analysis
[13] Cheese Factory was insolvent when it entered into the forbearance agreement with Callidus in December 2011. While the rental income was likely sufficient to cover its obligations to the first and second mortgagees, the indebtedness of the related corporations meant Cheese Factory remained insolvent. In all likelihood, Mr. Rossdeutscher was excessively optimistic of turning his corporations around. It appears, on my review, bankruptcy was inevitable.
[14] Nevertheless, the starting point is December 2011 and the forbearance agreement. Mr. Bourassa correctly asserts that Mr. Rossdeutscher and Cheese Factory had a choice. But, as Mr. Rossdeutscher said, he did not have a lot of bargaining power.
[15] A mortgagee does not have to be enforcing its security to be found in possession. Falconbridge uses the phrase “asserts its rights”, not enforcement. In this sense, Callidus can be seen as asserting its rights by requiring the forbearance agreement that changes the terms, adds guarantees and increases its security. Cheese Factory was already in default of the BMO security.
[16] I agree with Mr. Murdoch. The purpose of this forbearance agreement was for Callidus to obtain complete control of the property and the business operation of Cheese Factory and the related corporations. The critical term of the agreement was the enhanced security not previously available to BMO. I am not persuaded this was merely a situation of rent payments going to the mortgagee. Callidus controlled every decision, including lease renewal, repairs and marketing.
[17] Not every forbearance agreement puts a mortgagee in control. This agreement, and the conduct of the parties, does.
[18] The only choice Cheese Factory had was to accept the new terms or continue to be in breach. While it may have been involved in negotiating the lease renewal, clearly it acted as agent for Callidus. This is made evident by the significant repairs required that only Callidus could approve, as it controlled the funds. Cheese Factory no longer had the decision-making ability once the forbearance agreement was signed.
[19] The use of the additional rent is compelling. This money was paid by the tenant for municipal taxes and was deposited to the block account owned by Callidus. Callidus chose not to pay over to the municipality. Cheese Factory had no say. In my view, receiving funds for a specific purpose made Callidus a trustee of those funds. It should have delivered same to Cambridge.
Summary
[20] For these reasons, I conclude Callidus became a mortgagee in possession on December 2, 2011. Counsel advised they would be able to attend to the necessary calculations resultant from that determination.
[21] If the parties are unable to resolve the issue of costs, counsel shall deliver brief written submissions to my chambers in Kitchener within 30 days.
D.J. Gordon J.