The British Columbia Court of Appeal considered for the first time section 15 of that province's updated Limitation Act1 (the "Act"). The result should give security holders pause. In Leatherman v 0969708 BC Ltd2, the Court of Appeal held that the two-year limitation period on a demand mortgage ran from the first date of default under the mortgage and not from the date of demand.
On May 28, 2013, Kootenay Lake Estates Ltd. ("KLE") granted a mortgage of land to Mr. and Ms. Leatherman securing a loan in the principal amount of $1.5 million. The mortgage provided that it was repayable on demand, with interest payments due annually beginning on October 31, 2013. The mortgage also incorporated by reference Prescribed Standard Mortgage Terms which included certain common default provisions.3
Shortly after the mortgage was granted 0969708 B.C. Ltd ("708 B.C.") acquired the subject land and assumed KLE's obligations under the mortgage.
708 B.C. failed to make its first interest payment on October 31, 2013 and further failed to make payments in October 2014, 2015 and 2016. The Leathermans took no action until shortly after the missed 2016 payment. They then issued demand and subsequently filed a petition seeking enforcement of the mortgage in December 2016.
708 B.C. pleaded that the enforcement proceeding was statute-barred due to the expiry of the two-year limitation period under the Act.
The Act provides that a limitation period starts running on the day that the related claim is "discovered". The issue for determination was the date on which the Leathermans discovered their claim under the mortgage against 708 B.C. within the meaning of the Act.
The Leathermans relied on section 14 of the Act and argued that discovery occurred on the date of failure to pay after demand.4
708 B.C. relied on section 15 of the Act and argued that discovery occurred upon the occurrence of the first default.5
The chambers decision favoured the Leathermans. The Court characterized the mortgage as a demand obligation under which the lenders had a right to demand repayment of the loan at any time. Pursuant to section 14 of the Act, the limitation period to enforce the mortgage commenced the day after the borrower failed to comply with the lenders' demand. The lenders filed a claim within a few months of this date. As a result, the security interest in the mortgage was enforceable and judgment was granted against 708 B.C. on the covenant to pay.
708 B.C. appealed and was successful in preventing enforcement of the security interest under the mortgage, but not in overturning the judgment on the covenant to pay. The unanimous Court of Appeal held that the limitation period relating to the security interest under the mortgage was not governed by section 14 of the Act, but by section 15. As a result, the right to realize on the security was discovered not at the time of demand and failure to pay but at the time of the initial missed interest payment in October 2013 - well outside the two-year limitation period unless that period was extended by an acknowledgment of liability or otherwise.
The Court of Appeal upheld the judgment on the covenant, finding that the personal covenant to pay under the mortgage was indeed a demand obligation, governed by section 14 of the Act, and was discovered on the date of failure to pay after demand.
The matter of a potential extension of the limitation period for enforcing the security was remitted to the British Columbia Supreme Court and appears to be headed for trial.
As a result of this decision, secured lenders should be aware that any default under any security agreement - not just land mortgages - may trigger the commencement of the limitation period, even if the secured obligation is only payable on demand, or if enforcement after default is at the option of the lender.
In order to lessen risks, lenders should consider:
- Reviewing standard agreements to identify potential default pitfalls;
- Implementing and enforcing regular reporting requirements for debtors regarding likely events of default;
- Establishing procedures for the identification and flagging of defaults, including minor breaches of financial covenants;
- Ensuring regular extension of any limitation periods by obtaining acknowledgment of the security agreement from the debtor or evidence of performance of obligations under the security agreement; and
- Forbearing from enforcement only pursuant to written agreements that contain an acknowledgment of the security, rather than by allowing informal indulgences that can inadvertently allow a limitation period to continue running.