A recent Ontario Court of Appeal decision highlights the risks facing lenders that rely on standard form security agreements to enforce the obligations of defaulting borrowers. In Royal Bank of Canada v. El-Bris Limited,1 the Court applied the remedy of rectification to the plaintiff bank’s (the “Bank”) standard personal guarantee and collateral mortgage forms, allowing the Bank to enforce only on the collateral mortgage, even though the personal guarantee was a separate obligation.
The Bank extended a $700,000 line of credit to El-Bris Limited, obtaining security for the loan from James Ellis, El-Bris’s president and sole shareholder. Ellis personally guaranteed the loan for $700,000 and also pledged a $700,000 collateral mortgage on property that he owned. The collateral mortgage was in the Bank’s standard form providing that its charge was in addition to any other security held by the Bank.
By the time El-Bris became insolvent and defaulted, the company’s debt under the line of credit had increased to $3.5 million. The Bank called the loan and claimed against Ellis, who paid $700,000 to the Bank and requested a release from the personal guarantee and a discharge of the collateral mortgage. The Bank discharged the collateral mortgage but demanded an additional $700,000 under the guarantee on the basis that it constituted a separate obligation. The Bank sued Ellis and El-Bris when Ellis refused to pay.
At trial, the court granted judgment against the insolvent El-Bris but dismissed the action against Ellis. The trial judge acknowledged that the terms of the Bank’s standard form security documents would ordinarily create separate obligations under the mortgage and guarantee. Nevertheless, he concluded that the documentary and oral evidence demonstrated a common intention that the collateral mortgage was to act merely as security for Ellis’ personal guarantee. The court therefore granted a declaration that Ellis’s guarantee obligation was extinguished by the payment of $700,000 to the Bank under the collateral mortgage.
The Court of Appeal affirmed the trial decision, agreeing that the standard forms did not reflect the parties’ intentions. In such a case, permitting the Bank to collect $1,400,000 on what was intended to be a $700,000 security would amount to unfair dealing and would unjustly enrich the Bank. The court therefore applied the remedy of rectification to essentially rewrite the standard forms to reflect the parties’ intentions that the collateral mortgage stand as security for the guarantee.
Although the Court emphasized that this case turned narrowly on the facts and would not “open the floodgates” to rectification claims, El-Bris demonstrates the potential for courts to rectify standard form security documents at the expense of financial institutions. Its holding provides compelling reasons for lenders to consult with counsel on whether their standard forms require transaction-specific modifications to avoid the risk of court rectification. The case may also prove to be an unhelpful precedent for financial institutions seeking to enforce terms in standard form documents, particularly on motions for summary judgment. Bank customers will no doubt rely on this case to allege that terms in standard form agreements ought not to bind them, or that such terms should be rectified, in light of their particular dealings with the bank or factual circumstances.