In proceedings pursuant to the Companies’ Creditors Arrangement Actconcerning The Cash Store Financial Services et al., the Court of Appeal for Ontario dismissed an appeal from a decision of the Superior Court of Justice (Commercial List)1 finding that the parties to a broker agreement in fact stood in a debtor-creditor relationship.

This case is significant as it demonstrates the Court’s willingness to adopt a holistic approach to contract construction and interpretation.

Background facts

The appeal concerned the nature of the relationship between The Cash Store, a payday lender, and certain third parties that had provided funds to The Cash Store pursuant to “broker agreements.” The broker agreements set out an arrangement whereby the third party lenders would provide funds to The Cash Store, and The Cash Store would use these funds to broker loans between payday lending customers and the third party lenders. In theory, both the interest and the risk of these loans would flow through to the third party lenders.

In practice, however, the arrangement between The Cash Store and the third party lenders differed from that set out in the broker agreements. Instead of making payments to the third party lenders based on the accrued interest value of the loans brokered on their behalf to customers, The Cash Store made consistent monthly payments of 17.5% interest on the total amount advanced by the third party lenders. Further, the third party lenders had elected not to avail themselves of certain protections provided for in the broker agreements, including fund segregation.

Dispute over ownership

After The Cash Store obtained an initial order pursuant to the CCAA, a dispute arose concerning the ownership of the funds provided to The Cash Store by the third party lenders (the TPL Funds). The third party lenders brought a motion seeking a declaration that the TPL Funds were owned by the third party lenders, and should thus be removed from the estate of The Cash Store and not made available to other creditors.

The key issue on the motion in the court below was whether the total commercial relationship between The Cash Store and the TPLs was in fact reflective of a “broker agreement” as stated in the written contracts. Justice Morawetz of the Ontario Superior Court conducted an examination of “the relationship as originally set out in the broker agreements and [traced] the relationship between [The Cash Store] and the [third party lenders] subsequent to the execution of the broker agreements.”2

While Justice Morawetz noted that the broker agreements expressly recognized that ownership of the TPL Funds was to remain with the third party lenders, this was not the end of the matter. Justice Morawetz found the fact that the third party lenders were paid consistent rates of interest of 17.5% per month by The Cash Store undermined their position that The Cash Store acted merely as a broker pursuant to the broker agreements. Indeed, the third party lenders were aware of and even expected these consistent 17.5% returns, notwithstanding the significant risk in the payday lending business.

Based on a holistic review of the evidence, Justice Morawetz found that, in practice, the parties had never fully implemented the terms of the Broker Agreements, and instead had built a relationship in which The Cash Store accepted and used the TPL Funds as a debtor to the third party lenders. In other words, the third party lenders did not own the TPL Funds.

On appeal

The third party lenders appealed the motion decision, arguing (among other things) that Justice Morawetz rewrote the contract between the parties, and that the written agreement should govern the relationship.

In dismissing the appeal, the Court of Appeal for Ontario recognized that the analysis carried out on the motion was a characterization exercise – Justice Morawetz considered the evidence before him and used it to determine the legal nature of the arrangement between the parties. Accordingly, the third party lenders were asking the Court of Appeal to revisit the factual determinations of Justice Morawetz. The court below had been asked to determine the true legal characterization of the relationship between the parties in the CCAA context, and found that the text of the broker agreements “did not accord with reality.” The Court of Appeal found ample support for Justice Morawetz’s findings and characterization of the relationship as being between debtor and creditor.

Holistic characterization of contracts

It is not uncommon for parties to a written contract to deviate in practice from a strict application of the terms of a written agreement. The Cash Store case is significant insofar as it demonstrates the court’s willingness to adopt a holistic approach to interpreting a contract and identify the relationship the parties actually implemented. Understanding the legal character of a commercial relationship requires a review of all of the facts, including how commercial dealings occur in practice in addition to how they are set out on paper.

This holistic approach to contract interpretation will be particularly important in future situations in which individuals dispute the legal nature of contracts formed between other parties. These circumstances may arise in contested CCAA proceedings in which one party attempts to rely on a particular construction of a contract for its own benefit to the detriment of other creditors. The Court of Appeal’s description of this exercise as being one of fact-driven characterization should give judges some guidance in how to approach similar circumstances in the future.