In an earlier edition of Fully Secured (June 27, 2012 – Volume 3, Number 2), we reported on the Ontario Court of Justice decision in Snoek 7 where security granted by a borrower (“HSLP”) to a group of individual creditors (“B”) was held to constitute an improper preference and declared invalid following a challenge by the trustee in bankruptcy. B had been one victim of a Ponzi scheme involving numerous unsecured creditors of HSLP.

The security had been granted to B in the form of a transfer of an undivided interest in a registered mortgage asset held by HSLP. B was originally an unsecured creditor of HSLP that demanded the security following the occurrence of a payment default, and accepted extended payment terms on its debt in exchange for the granting of the security. The Ontario Court of Justice concluded that the security constituted an improper preference under Section 4 of the Assignments and Preferences Act 8, and was not saved by one of the available exemptions under Section 5(1) or 5(5)(d) of the Act. 

In particular, the lower Court found that HSLP had clearly granted the security at a time when HSLP was insolvent with the clear intent to prefer B over other creditors of HSLP who were also demanding repayment from HSLP at the same time but did not receive similar security. Moreover, B had not shown the characterization of the security granted to it as an improper preference was saved by virtue of one of the exemptions available under Sections 5(1) or 5(5)(d) of the Act.  Specifically, the lower Court held that B had not proven that either (i) the security was granted for a present actual advance of money, or (ii) the security was granted for a pre-existing debt and B made a new advance to HSLP in the belief that the advance would enable HSLP to continue its business and pay its debts in full.

Madam Justice Mesbur stated that the Act requires an actual advance of money to satisfy the saving provisions, and noted that Section 5 did not expand the plain meaning of the term “money” or expressly contemplate any other types of consideration like money’s worth or a forbearance. However, as she had questioned whether B’s actions actually constituted a forbearance, she did not technically have to determine if a proper forbearance could in any circumstances be sufficient to qualify as an advance of money.

B appealed the decision of the motion judge to the Ontario Court of Appeal on two grounds:

  1. that there was no evidence of an intent to give B an unjust preference, and
  2. that Section 4 of the Act did not apply because the interest in the mortgage asset was granted by HSLP to B “as security for a present actual advance of money” within the meaning of Section 5(1) of the Act.

In a brief endorsement judgment 9, the Ontario Court of Appeal dismissed both grounds of appeal. Firstly, the Court of Appeal held that the motion judge’s finding that the interest in the mortgage asset was granted to B with the intent to give B an unjust preference over other creditors was amply supported by the record.10 The appellate Court also rejected B’s argument that B had notionally advanced money to HSLP when it surrendered the existing promissory notes issued to it by HSLP in exchange for new notes issued to it on slightly different terms relating to the capitalization of interest, a reduction in the interest rate and an extension of the term.11 It then confirmed the lower Court’s finding that the beneficial interest in the mortgage asset was not granted by HSLP to B as “security for a present actual advance of money” as required by Section 5(1) of the Act 12, but it did not provide detailed analysis or reasons for doing so. As such, the Court of Appeal did not take the opportunity to specifically address whether a proper forbearance in demanding payment could in any circumstances be sufficient to qualify as an advance of money. Lenders must therefore continue to exercise caution in obtaining shore-up security after a borrower’s default to ensure that proper consideration is received by the borrower for that delivery.