Canada: Second mortgage? Wait a second…
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We often see parties looking to take out a second mortgage on real estate, usually to access the equity in the property and use the proceeds to pursue certain business goals. However, borrowers and their advisers should proceed with caution when seeking to further mortgage a property already burdened with a first mortgage.
Suppose a borrower (“CorpA“) is the registered owner of a parcel of land (the “Earth“). The land is currently subject to a charge of $1,500,000 on title (the “First mortgage“), of which only $1,000,000 of the funds were advanced to CorpA by the lending institution (“LenderAThis occurs in situations where the principal amount shown on the charge is greater than the initial advance, making subsequent advances possible. This structure is typically seen in construction projects through progressive drawdowns, but it is also common with revolving lines of credit, where borrowers need continued access to funds for capital expenditures and other legitimate business purposes.
CorpA made regular payments under the first mortgage on time and never defaulted. Instead of withdrawing more money from lenderA under the first mortgage, CorpA is considering obtaining secondary financing from another lender (“LenderB“), because Lender B could offer more favorable interest rates or loan terms. Lender B’s loan to CorpA is then secured by a second mortgage on the land in the amount of $250,000 (the “Second mortgage“).
Consent to further financing and priority of mortgages
The above scenario has several consequences. First, CorpA would require the consent of LenderA to further encumber the property if the terms of the first mortgage contain restrictions on secondary financing. Accordingly, CorpA and its advisers should be aware that without the consent of LenderA, the registration of the Second Mortgage is considered an Event of Default under the First Mortgage. This may trigger LenderA’s right to “recall” the First Mortgage and demand payment in full, or exercise any other rights available to LenderA in the event of default.
Second, although the First Mortgage was registered on title before the Second Mortgage, the First Mortgage will only secure the amount originally advanced to CorpA, and do not the total principal amount shown on the charge.1 Therefore, the first mortgage only secures $1,000,000. The remaining $500,000 under the first mortgage would be subordinated to the second mortgage if LenderA receives “actual notice” of the second mortgage before advancing the remaining funds. In other words, despite the principal amount shown on the charge, a lender has security only to the extent of the funds advanced. It should be noted that the registration of the second mortgage on title, in and of itself, does not constitute “actual notice” to lenderA.
Best practices for further advancements
Before making subsequent advances, prudent practice would require a sub-search of the title to the land which would reveal any potential encumbrances recorded after the first mortgage, such as liens, notices and additional encumbrances.
From an execution point of view, real second mortgage notice prior to registration – assuming lender A consents to the second mortgage – gives lender A the opportunity to negotiate and enter into a priority and status quo agreement with lender B to establish priority mortgages and assign responsibility for initiating and monitoring enforcement proceedings against CorpA in the event of default.
Whether you are LenderA, LenderB or CorpA looking to extract more equity from your already encumbered land, it is important to review existing title records to effectively protect your security interests or to avoid accidentally inducing default. .
1. 93(4) of Land Titles Act, RSO 1990, c. L.5
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This article is intended as an overview and is for informational purposes only.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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