A case addressing the priority of mortgage lenders and creditors in bankruptcy proceedings came before Alberta’s Court of Appeal last year in a decision released in late December of 2021. The contesting parties were a mortgage lender and a trustee/receiver in bankruptcy. The case is Crossroads-DMD Mortgage Investment Corporation v MNP Ltd. 2021 ABCA 417, https://canlii.ca/t/jlch0.
The appeal involved mortgages registered against three properties. A trio of associated companies who were in the business of mortgage investing had acquired the properties. The companies were Crossroads-DMD Mortgage Investment Corporation (Crossroads), Sun Country Mortgage Investment Corporation (Sun Country), and DMD II Mortgage Investment Corporation (DMD). The companies had the same shareholders and directors and were managed by CMS Financial Services Ltd. For reasons not set out in the decision, two of the companies wound up in financial distress, with Sun Country going bankrupt and DMD II in receivership., leaving only Crossroads as a going concern. Caplink Financial Corporation (Caplink) manages Crossroads. The respondent MNP Ltd. was the trustee in bankruptcy and receiver for the two failed companies.
The subject properties are Forest Crescent, Penworth, and Arbor Crest. Crossroads and Sun Country acquired the Forest Crescent property through a foreclosure. Crossroads paid out an existing mortgage but instead of discharging it, transferred it to Sun Country and Crossroads as mortgagees. Later, Sun Country and Crossroads granted a second mortgage to Crossroads. So, there were now two mortgages against the property: a first mortgage with Crossroads and Sun Country, and a second mortgage with Crossroads.
Crossroads and DMD II jointly owned the Penworth property, which had a mortgage against it in favour of Household Realty. Caplink advanced funds to Crossroads and DMD II that were used to pay out the Household Realty mortgage and a mortgage in favour of Caplink was placed on the property. Crossroads and DMD II subsequently paid out the Caplink mortgage and transferred it to themselves instead of discharging it. Then, they granted a second mortgage but to Crossroads alone.
DMD II was the sole owner of the Arbor Crest property. Although there had been a mortgage on the property in favour of the Home Trust Company, this was discharged at some point and consequently Caplink became the first mortgage on title. DMD II also granted a second mortgage to Crossroads. Later, the mortgage to Caplink was paid out and the mortgage transferred to DMD II alone. Thus, the Registry showed two mortgages on title: a first with DMD II as mortgagee and a second with Crossroads.
There was no evidence as to why the three first mortgages were transferred rather than discharged. The trustee in bankruptcy MNP accepted the validity of the second mortgages but also took the position that the first mortgages were valid charges such that the proceeds should be distributed to Crossroads, Sun Country and DMD II, since all three were first mortgagees. In effect, this would have given the creditors of Sun Country and DMD II a right to pro rata shares in the proceeds. In contrast, Crossroads applied to have the net proceeds distributed to it alone.
Crossroads submitted six alternative possibilities as the basis for its claim, but the interpretation and application of section 73 of the Law of Property Act would prove to be the determinative one. According to section 73:
Transfer of mortgage
73(1) When a mortgagor becomes entitled to pay off the balance owing on the mortgage, the mortgagor may require the mortgagee on receiving payment, instead of giving a discharge, to transfer the mortgage to a third party and the mortgagee is bound to transfer the mortgage as the mortgagor directs.
(a) becomes entitled or obligated to pay off the balance owing on a mortgage, and
(b) pays to the mortgagee the balance owing on the mortgage,
the mortgagee on receiving the payment, instead of giving a discharge, is bound on the request of the person who made the payment to transfer the mortgage as the person who made the payment directs.
(3) Any waiver or release of the rights, benefits or protection given by this section is against public policy and void.
A plain reading of section 73 would indicate there is nothing to prevent a mortgagor from requesting that a mortgage, once it has been paid out, be transferred to itself instead of being discharged. That is what happened in this case, absurd though the result might otherwise appear. The chambers judge decided that the purpose of section 73 is to protect a mortgagor’s equity of redemption such that a mortgagor may arrange to transfer a mortgage to its designate, including itself. In effect, while section 73 does not expressly allow a paid-out mortgage to be transferred to a mortgagor, neither does it expressly prohibit such a transaction. Finally, the chambers judge reasoned that according priority to the three Crossroads mortgages would harm the interests of the creditors of Sun Country and DMD II, who were entitled to rely on the certificates of title to the three properties and the three first mortgages registered against them.
The Crossroads appeal was based on the argument that the first mortgages were invalid because there were no debts owing, no mortgages to be registered, and the chambers judge had erred in finding that a person could owe a debt to themselves.
In a 2-1 split decision, the Alberta Court of Appeal took what may only be described as a common-sense approach to resolving the issue. It decided that despite the apparent priority of the first mortgages on title at the Registry, the respective Crossroads second mortgages were the only valid charges. A line of historical cases through common law had established the proposition that if a mortgage against land and the ownership of that land became united in the same party, the mortgage would be merged in the ownership of the land and thus extinguished as a result. This is known as the common law doctrine of merger and has been codified in section 62 of the Law of Property Act, which says: “There is no merger by operation of law only of any estate the beneficial interest in which would not be merged or extinguished in equity.” In short, the first mortgages on the three properties, having been paid out in full, had merged into the ownership title to the properties and so any subsequent encumbrances on them would advance in priority.