The Prince Edward Island Court of Appeal's recent decision that determined a collateral mortgage could not be enforced when it was granted as additional security to secure existing indebtedness, will leave lenders and the courts grappling with its implications.
This case calls into question:
- what constitutes consideration; and
- the general rule that lack of independent legal advice is not a stand-alone defence.
There are two important lessons for lenders. The first is to ensure they are able to establish "fresh" consideration when a mortgage is provided under these circumstances. The second, ensuring that guarantors, and those in similar relationships, receive independent legal advice when providing security can go a long way when faced with having to rebut the principle of presumed undue influence. As this case demonstrates, failing to do so puts the lender, and the transaction, at risk.
Orville Lewis was a potato farmer and heavily indebted to Central Credit Union Limited ("Credit Union"). He and his mother, Ella Lewis granted collateral mortgages and entered into a forbearance agreement with the Credit Union.
2004 - The first mortgage was granted as additional security for Orville's existing debt to the Credit Union. Due to financial pressures, he and his mother granted a collateral mortgage to the Credit Union on their jointly held property. At the time, Ella received independent legal advice, as recommended by the Credit Union.
2008 – Orville's financial situation had not improved and he decided to get out of potato farming in favour of carrots. Earlier that year, Orville's father had passed away and deeded him lands, subject to a life interest in favour of his mother. When Orville sought additional financing from the Credit Union, Ella was asked to sign a collateral mortgage in favour of the Credit Union, and consent with respect to her life interest in the property, to secure her son's debts. This time she was not advised of her right to obtain independent legal advice, and proceeded without.
Later that year, after he suffered further financial loss, Orville received notification that the Credit Union intended to realize on its security.
2009 - In an effort to prevent the sale of the lands under mortgage sales he and his mother executed a forbearance agreement with the Credit Union. Ultimately matters could not be resolved and the Credit Union started mortgage proceedings.
Orville filed an application seeking an injunction against the foreclosure proceedings. He argued that there was no valid consideration provided in respect of the 2004 collateral mortgage (only past consideration) and that the wording was unclear.
Both mortgagors argued non est factum — a defense that exempts a party from performance of a contract when a document signed is radically different from what the person believed it to be. Ella also provided evidence to the effect that she was not aware of the extent of her son's indebtedness.
The application judge, Mr. Justice Cheverie, concluded that the 2004 mortgage was valid and enforceable against both applicants. When determining the enforceability of the 2008 mortgage, Justice Cheverie found the only valid argument arose from the fact that Ella did not receive independent legal advice before signing the 2008 mortgage wherein she signed off on her life interest.
Despite finding that there was no evidence to support the defense of non est factum, nor any basis for claiming undue influence, misrepresentation or fraud, he held that the 2008 collateral mortgage was valid and enforceable against Orville, but not Ella. Justice Cheverie asserted that the Credit Union should have insisted that Ella obtain independent legal advice before signing the 2008 mortgage.
Two separate appeals proceeded to the Prince Edward Island Court of Appeal. Orville Lewis appealed the lower court decision denying his injunction to prevent the Credit Union from preceding to mortgage sale, and the Credit Union cross-appealed the ruling that it could not enforce the 2008 collateral mortgage as against Ella Lewis.
Court of Appeal Decision
In a decision that involved three separate written decisions, including the dissenting opinion of Mr. Justice J. A. McQuaid, the Prince Edward Island Court of Appeal allowed Orville's appeal, in part, and dismissed the Credit Union's cross-appeal.
First, the majority held that Orville was entitled to an injunction against the Credit Union in respect of the 2004 mortgage because no "fresh" consideration had been granted. They did not accept the argument advanced by the Credit Union that its decision to not call the existing loans, although they were in a position to do so, constituted valid consideration.
Second, based on the doctrine of presumed undue influence, it upheld the lower court's decision that the Credit Union could not enforce the 2008 mortgage against Ella because she had not received independent legal advice. While the lower court clearly held there was no evidence to support the defence of undue influence, and did not address the princible of presumed undue influence, the majority of the Court of Appeal based their decision on this principle. Their decision makes it clear it would be unconscionable to permit the lender to take advantage of a transaction against a party who received no independent legal advice and took no financial benefit from the transaction.
In such cases, the party trying to enforce the transaction (e.g. a lender) has to provide evidence that the contract was the product of an informed and free mind in order to rebut the presumption. Independent legal advice provides such evidence. This is a cautionary tale — and more reason to ensure independent legal advice is provided.
To read the full decision, including the dissenting opinion of Mr. Justice J.A. McQuaid (with whom many lenders may be inclined to agree, including his interpretation of the facts and applicable law), click here.
The foregoing is intended for general information only. If you have any questions, or for more information on our practice group visit our Commercial Real Property and Lending page. For more on our firm see www.stewartmckelvey.com.