The Ontario Court of Appeal’s decision in Mortgage Insurance Co. of Canada v. Grant Estate, et al.1 (“Grant Estate”) provides a helpful summary of the complex rules that apply in determining whether an enforcement action in respect of an indemnity or collateral mortgage is statute-barred. In that case, the Court of Appeal applied a number of legal principles governing limitation periods applicable to different enforcement actions to deal with a dispute involving unique factual circumstances. Aside from clarifying some of the general rules applicable to enforcement actions, the decision serves as a reminder to lenders of the risks attendant in delaying enforcement action.

facts

Under a Surety Guarantee Bond (the “Bond”), Mortgage Insurance Company of Canada (“MICC”) was a surety on a $4M credit facility (the “Loan”) granted by the Toronto-Dominion Bank (“TD”) to Rebanta Holdings Inc. (the “Borrower”). MICC agreed to pay TD if the Borrower defaulted on the Loan. MICC subsequently entered into an indemnity agreement under seal (the “Indemnity Agreement”), under which an individual, a corporate entity and the Borrower (together, the “Indemnitors”) agreed to indemnify MICC in the event that it was called upon to pay TD upon a default on the Loan. The Indemnitors also provided three demand mortgages to MICC as collateral security for the Indemnity Agreement (the “Collateral Mortgages”).

In October 1992, TD made demand on MICC under the Bond on the basis that the Borrower had defaulted on the Loan. On April 30, 1993, MICC paid TD just over $2.6M, the amount outstanding on the Loan at that time. For unexplained reasons, MICC did not take any action to recover under the Indemnity Agreement for nearly a decade. On April 25, 2003, MICC commenced an action against the Indemnitors to recover under the Indemnity Agreement and to enforce the Collateral Mortgages.

The Indemnitors’ primary defence was that MICC’s claim was statute-barred since it was not commenced within the time permitted by law. The trial judge held that claims in respect of the Indemnity Agreement and the Collateral Mortgages were brought within the limitation period provided under the relevant limitations legislation. The Indemnitors appealed these determinations.

the Court of Appeal decision

While the Court of Appeal allowed the appeal in part, it upheld the trial judge’s conclusions regarding the applicable limitation periods, finding that the claims were not statute-barred.

the indemnity

Since the Indemnity Agreement was entered into prior to January 1, 2004, the legislation governing limitation periods in Ontario that was in place prior to such date, the Limitations Act2 (the “Former Act”), applied rather than the legislation currently in place, the Limitations Act, 20023 (the “Current Act”).4

The Former Act provided a 20-year limitation period for “an action upon a bond, or other specialty, except upon a covenant contained in an indenture of mortgage.”5 A specialty is akin to a bond or a mortgage covenant. For a contract to be a specialty, it must secure a debt and be affixed with the seals of the parties. Furthermore, at common law, the parties must have intended to create an instrument under seal in order to create a specialty. If the Indemnity Agreement was a specialty, the action to enforce it clearly would have been taken within twenty years of the commencement of the limitation period. However, if the Indemnity Agreement was not a specialty, but rather a “simple contract or debt grounded upon any lending or contract without specialty”, a limitation period of six years would have applied under the Former Act and the action to enforce the Indemnity Agreement would have been out of time.6

The appellants argued that the Indemnity Agreement was not a specialty as at the time that the contract was executed, there was no debt to be secured as MICC had not yet advanced money to TD Bank.

This argument was rejected by the Court of Appeal. The Court held that money does not have to be advanced at the time that a mortgage or other debt is executed to qualify as a specialty. A specialty assures a present or future debt. Here, the Indemnity Agreement secured MICC’s surety obligations, it was made under seal, and there was no evidence to suggest that the parties did not intend the Indemnity Agreement to be under seal. Therefore, the Indemnity Agreement was a specialty and the action was commenced by MICC within the 20-year limitation period.

the collateral mortgages  

With respect to the Collateral Mortgages, it was agreed that the applicable limitation period was ten years.7 The issue in dispute was when the ten-year period began to run.  

The Court of Appeal upheld the trial judge’s conclusion, holding that since the mortgages were collateral to the Indemnity Agreement, the limitation period started running when the debt obligation crystallized. This occurred on April 30, 1993, the date that money was advanced under the Indemnity Agreement, thereby creating the debt obligation. Though the action was not commenced until nearly a decade later, it was still brought within the ten-year limitation period.  

In making this determination, the Court rejected the appellants’ argument that the cause of action arose on the date that the mortgages were executed (June of 1989). While the Court accepted that the limitation period with respect to the enforcement of demand mortgages will generally begin to run upon the execution of such mortgages,8 it noted that there are exceptions to this principle, depending on the specific terms and circumstances of the mortgages. One such exception applies when funds are not advanced upon execution of the demand mortgage. A limitation period with respect to enforcement of a demand mortgage will not begin to run until funds are actually advanced in respect of the mortgage, regardless of when the mortgage is executed. In this case, as no funds were advanced upon the execution of the Collateral Mortgages, no debt obligation arose at such time. The limitation period did not begin to run until the debt obligation crystallized, which was upon advancement of funds by MICC under the Indemnity Agreement in 1993.

Notably, the Court of Appeal held that although the trial judge arrived at the correct conclusion, he erred in reaching his determination. The trial judge held that the case fell under another exception to the general principle that the limitation period with respect to the enforcement of a demand mortgage begins to run upon execution of the mortgage. This exception applies to collateral demand mortgages. The limitation period applicable with respect to collateral demand mortgages only begins to run upon a demand being made.

The Court of Appeal held that the trial judge erred in finding that the case fell within such exception, noting that there is an exception to such exception. Generally, a cause of action begins to accrue in respect of a demand collateral mortgage upon the making of a demand where the collateral mortgage is given by a third party who is guaranteeing the primary debt of another. In such cases, a demand on the surety is required to trigger the surety’s obligation and, therefore, the commencement of the limitation period. Such exception does not apply, however, where collateral security is provided by principal debtors to secure their own debt. The Court noted that in such case, the collateral is provided as a source of payment by the principals to collateralize their own debt. As the principal debtors/mortgagors have full knowledge of, and control over, their obligations, no demand is required to trigger such obligations or the commencement of the running of the limitation period.

Applied to the present case, the Indemnitors included the Borrower and a principal of the Borrower and the Collateral Mortgages were thus given by the principal parties to secure their own debt. As a result, no demand was required to trigger the commencement of the limitation period.

implications for creditors

While this decision is not a marked departure from existing law, it serves to clarify and reinforce existing rules with respect to the limitation periods applicable to enforcement actions against sureties.

The key rules with respect to actions to enforce indemnities are as follows:

  • As the Current Act makes no reference to specialties, the characterization of a non-mortgage obligation as a “specialty” or a regular debt is irrelevant in respect of indemnification agreements executed after January 1, 2004, the date on which the Current Act came into force (“Newer Debts”). The applicable limitation period in respect of Newer Debts is two years.
  • The Former Act may still govern indemnification agreements executed prior to January 1, 2004 (“Older Debts”).
    • If an Older Debt is a specialty, a twenty-year limitation period applies.
    • If an Older Debt is not a specialty, a six-year limitation period applies.
    • In order to successfully show that a particular contract is a specialty, the contract must secure a debt and be made under seal. The parties must also have intended to create an instrument under seal. This last requirement does not appear to be a difficult standard to meet. The Court of Appeal found the signature and seal of the parties, along with the lack of evidence suggesting any intentions to the contrary, to be sufficient evidence of intent.

The key rules with respect to actions to enforce collateral mortgages are as follows:

  • The limitation period applicable to actions to enforce collateral mortgages is ordinarily ten years.
  • With respect to collateral mortgages payable on demand:
    • the limitation period usually does not begin to run until funds are advanced in respect of the mortgage, such that a debt obligation has crystallized;
    • if funds are advanced upon the execution of the mortgage, the limitation period ordinarily starts to run upon demand being made upon the mortgagor if the mortgagor is a third party and not the borrower in the transaction in respect of which the mortgage was given as collateral (the “Primary Debtor”) or a principal of the Primary Debtor; and
    • if the mortgagor is the Primary Debtor or a principal of the Primary Debtor, the limitation period ordinarily begins to run upon the triggering of the mortgagor’s obligations under the primary security, regardless of whether or when a demand is made on the mortgagor.  

As is evident from the decision in Grant Estate, the application of these rules is factdependant and relatively complex. Accordingly, the decision provides further impetus to lenders to ensure that enforcement action is taken in a timely manner so as to better avoid unnecessary challenges.