A recent decision by the Ontario Court of Appeal in Business Development Bank of Canada v. Pine Tree Resorts Inc.20 illustrates the extent of exposure which a second mortgagee could potentially face when it attempts to enforce its second mortgage.

In Pine Tree, the mortgagor defaulted on a first mortgage in favour of Business Development Bank of Canada (“BDC”) and also defaulted on a second mortgage in favour of Romspen Investment Corporation (“Romspen”) with respect to an inn located in Honey Harbour, Ontario. At the time of enforcement, BDC was owed approximately $2.6 million. Romspen was owed approximately $4.3 million.

In addition to amounts owing to BDC, the mortgagor was also in arrears of approximately $250,000 for HST. Non-payment of HST was a breach of a covenant under the BDC security.

To enforce payment, BDC applied for and was granted the appointment of a court-ordered receiver over the mortgagor’s assets as it was contractually entitled to do under its security documents. In contrast, Romspen attempted to initiate power of sale proceedings over the property but the proceedings were halted by BDC’s appointment of a receiver.

Romspen, together with the mortgagor, then sought leave to appeal the application judge’s order appointing the receiver, arguing that Romspen had the right as a subsequent mortgagee to put BDC in good standing per Section 22 of the Mortgages Act21, and thus take over the sale of the property by resuming the power of sale proceedings.

Section 22 of the Mortgages Act entitles a mortgagor, where default has occurred, to perform such covenant or pay the amount due under the mortgage and thereupon relieves a mortgagor of the consequence of any default.

Romspen proposed to do so by “[putting] the [first] mortgage in good standing by paying all arrears of principal and interest, together with all of BDC’s costs, expenses and outstanding realty taxes.”22 However, Romspen did not propose to repay the approximately $250,000 in remaining HST arrears.

Romspen and the mortgagor submitted that it was not necessary for them to comply with the HST covenant in order to be able to take advantage of their subsequent mortgagee’s rights under Section 22, as the HST arrears formed a subsequent encumbrance and did not jeopardize BDC’s security in any way.

In response, BDC submitted that bringing the prior mortgage in good standing required “paying the amount due under the mortgage and – where there are unperformed covenants – performing those covenants as well.”23

The Court did not accept Romspen’s argument and instead found:

“Romspen relies upon the jurisprudence of this Court establishing that a mortgagor – and therefore, a subsequent mortgagee – is entitled as of right, upon tendering the arrears or performing the covenant in default, to be relieved of the consequence of default. The problem is that Romspen has not offered to put the BDC mortgage in good standing, but has only offered to do so partially. It proposes to leave unperformed a $250,000 covenant – payment of the outstanding HST arrears.

For Romspen to succeed on appeal would require a very creative interpretation of Section 22 of the Mortgages Act, and one would potentially create an undesirable element of uncertainty in the field of mortgage enforcement, because no one would know which covenants could be left unperformed and which could not, without litigating the issue in each case.”24

As a result of the decision in Pine Tree, second mortgagees may find themselves facing much more significant costs before they can be in a position to enforce their second position mortgage and may be more reluctant to enforce their security ahead of a first mortgage.