Can a Mortgagee Receive Accelerated Interest Upon the Repayment of a Closed Mortgage That Is in Default?

The Court of Appeal for Ontario recently confirmed that there is no standalone “established common law entitlement” allowing a mortgagee to claim accelerated interest on a closed mortgage when the mortgage is discharged prior to its term; rather, the common law recognizes any entitlement to accelerated interest on an early repayment that flows from the contract bargained for by the parties or, if applicable, arising from statutes such as the Mortgages Act (Ontario).

In First National Financial GP Corporation v. Golden Dragon Ho 10 Inc., Golden Dragon purchased two residential apartment buildings and assumed three mortgages, all of which were held by First National (“FN”). The mortgages permitted prepayment of principal so long as the borrower was not in default upon payment of an amount equal to the greater of an interest yield maintenance (in accordance with the formula provided) or three months’ interest, but were otherwise “closed mortgages” (i.e., the borrower had no right to prepay). Golden Dragon subsequently placed a further mortgage on one of the properties, which was held by Liahona Mortgage Investment Corp. Following various defaults by Golden Dragon on both the FN and Liahona mortgages, the Court granted FN’s application for an interim receiver of the properties.

FN initially agreed not to oppose Liahona’s motion to expand the receiver’s mandate to permit it to market and sell both properties. However, after the receiver secured an offer to purchase the properties and moved for an order to approve the sale, FN opposed the sale on the basis that its agreement to support the sale had been predicated on FN receiving, from the sale proceeds, payment of accelerated interest to the end of the terms of its closed mortgages.

The trial judge determined that nothing in the express terms of the FN mortgages gave FN a right to claim the disputed accelerated interest in circumstances where Golden Dragon was in default. This was because the mortgages only provided for accelerated interest in the case of prepayment. As a result of being in default, Golden Dragon no longer enjoyed the privilege of prepayment as set out in the mortgage. However, the trial judge held that FN was entitled to claim accelerated interest under a common law rule that a mortgagee is entitled to all accelerated interest owing to the date of maturity when a closed mortgage is vested off title before the end of the term. According to the trial judge, the accelerated interest became due when the FN mortgages were discharged prematurely upon being vested off title pursuant to the receiver’s court-supervised sale.

On appeal, the three-judge panel overturned the trial judgment and confirmed that the trial judge erred in finding a standalone common law entitlement to accelerated interest, divorced from a holistic interpretation of the contractual provisions of the mortgage contract. The Court relied on established case law that, at common law, there is no right to prepay a mortgage (because the mortgagee is entitled to repayment of the principal and interest originally bargained for) unless (i) the mortgage contains a prepayment clause or (ii) prepayment is a statutory right. Where there is no contractual prepayment clause, the common law recognizes that in order to prepay the mortgage and receive a discharge, the mortgagor must reach an agreement with the mortgagee to amend the terms of the mortgage and pay whatever penalty is negotiated. Where there is a contractual prepayment clause, the common law recognizes such a clause.

The Court of Appeal therefore confirmed that while an individual borrower has a statutory right pursuant to the Mortgages Act (Ontario) to prepay a mortgage that has a term that exceeds five years after the expiry of five years, upon payment of three months’ interest as a bonus, a corporate mortgagor or an individual within a five-year term seeking an early discharge of a closed mortgage cannot escape the obligation to amend the original contract and pay additional consideration (in the form of accelerated interest or otherwise) unless (i) the mortgagee takes steps to realize on its security; or (ii) the original contract specifically provides the mortgagee’s entitlements upon early discharge in the event of default.

In this case, because the borrower was a corporation, the provisions of the Mortgages Act (Ontario) did not apply. The trial judge was required to carry out the contractual analysis of the plain language of the FN mortgages to determine if FN had any entitlement to accelerated interest upon the early, court-ordered discharge off title of its mortgages due to Golden Dragon’s default. The FN mortgages provided for prepayment and an early discharge and set out FN’s entitlements to accelerated interest in the event that Golden Dragon was not in default. FN’s contractual entitlement to accelerated interest was predicated on Golden Dragon not being in default. Where there was a default, as was the case here, FN was contractually entitled to payment of the principal amount outstanding and interest accrued to the date of repayment of principal, but not to accelerated interest.

FN also argued that although a default had occurred, the contractual provisions nevertheless continued to apply because FN had not taken any steps to realize on its security under the mortgages; it was merely “protecting its security.” FN relied on the deeming provisions contained in the interim receivership appointment order, which recognized that the appointment of the interim receiver for the purpose of collecting arrears “will not be deemed to be a resort to the security” triggering the mortgagor’s right to redeem.

The Court of Appeal rejected that argument, finding that despite the wording of the Order, FN, by its actions, triggered the realization. FN sought the initial appointment of the receiver. Although Liahona initiated the sale process, FN agreed to and encouraged it. FN even consented to the sale of the second building (over which Liahona held no security) in order to maximize the recovery. Accordingly, the Court of Appeal noted that FN’s suggestion that it intended to maintain its mortgages on title “was disingenuous.”

Notably, while the Court of Appeal otherwise suggested that it was the “default” itself that was the triggering event resulting in its decision not to permit the payment of accelerated interest, it seems that by considering FN’s argument that it did not commence steps to realize on the mortgages, the salient test for denying such acceleration would have been “realization” and not “default”. Regardless of this distinction, as the Court ruled as a matter of fact that FN had commenced the realization of its mortgages, it nevertheless refused to permit FN to receive accelerated payments.

In light of the appellate ruling in First National, mortgagees should be mindful of the impact that the appointment of a receiver may have on their ability to claim accelerated interest upon the early discharge of a closed mortgage. In seeking the appointment of a receiver, the mortgagee may believe that they are only acting to protect their security. However, despite language to that effect in a receivership order, depending on the circumstances, a mortgagee may, nevertheless, be deemed to have taken steps to realize on its security.

The Financial Services Group and the Real Estate Group at Aird & Berlis regularly advise a broad range of stakeholders on lending arrangements and their enforcement. For more information, please contact a member of the Financial Services Group or the Real Estate Group.