Take Care When You Forbear – mortgage forbearance agreements do not automatically rank in the same priority as the mortgage being forborne.

By May 17, 2024 May 20th, 2024 No Comments

It is well-known that the Bank of Canada’s interest rate increases over the past two years have caused financial strain on many Canadian households. In March 2024, Equifax Canada released a report raising alarm bells that credit delinquencies are rising, with the key indicator of missed mortgage payments being highest in Ontario and British Columbia.

Mortgage lenders, aware of the impact higher rates have had on their borrowers, may be willing to work with homeowners to try to avoid the harsh consequences of immediate mortgage enforcement.  One approach is the forbearance agreement: in exchange for the lender holding off enforcing a mortgage in default, the borrower will acknowledge the principal, interest, and other amounts then owing, and will enter a revised repayment schedule and other terms to bring the mortgage into good standing.

A recent decision of the Court of Appeal illustrates why lenders must be careful when entering into such forbearance agreements so as not to jeopardize their priority over subsequent mortgagees.  In Greenpath Capital Partners Inc. v. 1903130 Ontario Ltd. (2024 ONCA 42), the first mortgagees appealed an application judge’s decision that certain amounts the borrower had agreed to pay pursuant to a forbearance agreement did not have priority over the second mortgagee’s claim to proceeds from a power of sale.  The appellants also sought to overturn a ruling that the pre-payment fees and default fees they were seeking to recover were unenforceable because they violated section 8 of the Interest Act (see our article for a discussion of that topic).

With respect to the priorities dispute, the Court of Appeal agreed with the application judge that because the second mortgagee was not a party to the forbearance agreement, and that agreement was separate from the first mortgage itself, it did not have priority over the second mortgage.  The first mortgagees tried to argue that the standard charge terms of the first mortgage permitted them to increase the principal balance owing by way of the additional fees.  The court disagreed, concluding that the amounts sought could not be considered a part of the first mortgage, and therefore did not have first priority.

Greenpath points to a few lessons for lenders.  The most obvious would be that, wherever possible, lenders seek the consent of subsequent creditors before entering into a forbearance agreement with the borrower.  An express acknowledgment that additional amounts owing under the forbearance agreement have priority at the time the agreement is entered into will avoid disputes down the road.

When such consent is impractical or a lower ranking creditor refuses to accede to the position of the lender, the first mortgagee will have to try to frame the forbearance agreement in a way that anticipates the argument that such an agreement is separate from the first mortgage agreement itself.  The Court of Appeal noted that the appellants had not put forward any evidence that the forbearance agreement in question was a renewal of the first mortgage, nor that the alleged renewal fee was an actual cost incurred by the first mortgagees.  This conclusion suggests that a forbearance agreement that expressly or effectively amounts to a renewal of the first mortgage should be expressed as such, with whatever actual or reasonably anticipated costs to renew ought to be built in to the revised payment schedule.

Finally, to the extent lenders seek to impose something akin to a default fee as part of a forbearance agreement, they are cautioned to ensure such a fee reflects real costs legitimately incurred, in the form of actual administrative costs or otherwise.  Otherwise, as in Greenpark (and numerous other decisions before it), the court will likely conclude that the only reason for the charges was to impose an additional penalty or fine on the borrower, thereby violating section 8 of the Interest Act.

Forbearance agreements are a practical way to deal with mortgage delinquencies, and in many cases they lead to better outcomes for borrowers and lenders alike.  But because sometimes mortgage enforcement ultimately becomes necessary, lenders are encouraged to consider the question of priorities upfront, to avoid unpleasant surprises when dealing with competing claims from lower ranking creditors.

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