In a recent decision of the British Columbia Supreme Court, a private mortgagee’s misunderstanding of the effect of a renewal and forbearance agreement cost it dearly, to the tune of approximately $500,000.

The facts in 0895249 B.C. Ltd.1 are somewhat convoluted, but the essentials are straightforward. A numbered company, 360305 B.C. Ltd. (“360305”) held a first mortgage of the subject property. After the first mortgage matured, 360305 entered into a forbearance agreement with a number of debtor parties and agreed to delay enforcement of its mortgage security. The mortgage indebtedness would now become due and payable on May 31, 2010. In exchange, 360305 received payments of $15,000 per month. A portion of the payments was used to cover the prior month’s accrued interest and the remaining amount was taken as “fees”. The fees were not related to any activity that would require administrative, underwriting, or other activities on the part of the mortgagee.

The debtors paid the monthly payments on time but when the forbearance agreement expired on May 31, 2010, the mortgage indebtedness was not repaid. Instead, 360305 subsequently entered into further forbearance agreements with very similar terms. Ultimately, the total fee portion from the monthly payments of the forbearance agreements added up to hundreds of thousands of dollars.

Crucially, the prescribed mortgage terms of 360305’s mortgage did not contemplate the payment of the fees for extension or forbearance agreements. Further, all of the forbearance agreements were negotiated and executed without the consent or knowledge of the subsequent mortgagees.

The second mortgagee, Romspen Investment Corporation (“Romspen”), eventually requested and received a payout statement from 360305, for the purpose of redeeming the first mortgage. When Romspen reviewed the payout statement, it learned of the existence of one of the forbearance agreements. Romspen then advised 360305 that 360305 was obliged to apply the fees it had received against the outstanding indebtedness on the first mortgage.

Eventually 360305 transferred its mortgage to 0895249 B.C. Ltd. (the “Transferee Mortgagee”) and the new first mortgagee provided a payout statement to Romspen of over $1 million. Romspen replied on March 28, 2013, by tendering a cheque for $645,551.97. This amount was intended to pay for the amount secured by the first mortgage, less the fees paid under the one forbearance agreement that Romspen knew about. When the Transferee Mortgagee refused to provide a mortgage discharge and returned the cheque, Romspen started its court action and subsequently learned of the other forbearance agreements.

At trial, Romspen argued that the forbearance agreements created a debt that was additional to the original terms of the first mortgage. That debt was unsecured as against a subsequent mortgagee (like Romspen) and any payments made towards that debt should be applied against the outstanding balance on the first mortgage and calculated pursuant to its original terms.

The Court ultimately agreed that all monthly payments received by 360305 since the first mortgage matured had to be applied to the amount required for Romspen to redeem the first mortgage. Holding otherwise would “inappropriately increase the return on the loan to the prejudice of the subsequent mortgagee” and “saddle the subsequent mortgagee with risks it would be impossible to assess”.

The Transferee Mortgagee’s problems did not end there. The Court held that interest calculations on the principal amount ceased as of March 28, 2013, when Romspen tendered its cheque for $645,551.97, because a mortgagee is not entitled to interest or costs after the date of a valid tender to redeem. In fact, the tendered amount was substantially more than sufficient to pay out the first mortgage, because Romspen was unaware at that time of the other forbearance agreements and the many payments that had been received pursuant to those agreements.

Ultimately Romspen paid just $536,043.58 to redeem the first mortgage, an amount that was only about half of the original amount claimed by the Transferee Mortgagee.

The broad lesson for mortgagees from this case is that any collateral agreement (such as a forbearance or renewal agreement) cannot affect a subsequent mortgagee that does not consent to, or is unaware of, that collateral agreement. Many mortgagees will enter into such an agreement at some point (usually a renewal agreement, if nothing else), so this principle is an important one to keep in mind when changing the terms of an existing mortgage.