Legal Blog

Improvident Sale

Debtors give security over assets to creditors, who would never lend money without that security. Of course, a debtor never expects to default on its obligations and it certainly never expects a creditor to exercise its powers over the security, sell it, and apply the net sale proceeds to the amount due for the debt. However, it happens – more often in a recession. Debtors do not have an extensive array of remedies to oppose creditors’ actions.

One available remedy is an action for, or a defence based on, improvident sale. The debtor will allege that the creditor sold the secured asset for a song and therefore the creditor either should not be able to claim for a shortfall or actually has to pay damages to the debtor if the sale proceeds fully repaid the debt. Regardless of the action or defence, the asset is still gone.

We have previously discussed the necessity of dealing prudently with secured assets (see December 2006 newsletter), but thought that, to keep our collective memories fresh, we would trot out another relevant case, Bank of Nova Scotia v. Scholaert, a 2017 Ontario Superior Court of Justice decision dealing with allegations of improvident sale.

Debt

A corporate debtor was a Second Cup franchisee. Unfortunately, the franchisor terminated the franchise and the debtor, no longer having an income, defaulted under its loan agreement with the bank. The bank then demanded payment from the debtor’s principal director, officer, and owner, who had guaranteed the debtor’s loan. The debt was approximately $160,000, but the guarantee was only for about $61,000.

The bank had the debtor’s assets appraised. The appraiser opined that the assets had only a $7,200 value on a distress sale or a $21,600 value if the restaurant were sold as a going concern.

The bank negotiated a sale of the assets to the franchisor for $30,000.00 – except that the bank never received anything. Canada Revenue Agency had a $40,000 priority charge against the debtor’s assets and scooped all of the sale proceeds.

The guarantor, instead of just paying the bank and being thankful that he only guaranteed a portion of the debt, alleged that the assets had a value of $120,000 and that, in effect, he should be given credit for that amount and the bank should pay him the difference between the amount of his guarantee and the alleged real value of the assets.

Reasonable

The guarantor’s position had a number of problems.

The bank’s standard form guarantee document stated that when the bank sold the assets, it only needed to act reasonably and was not required to get the best price possible. The judge held that the guarantor had not demonstrated that the bank had acted unreasonably. That would have been difficult given that the bank sold the assets for far more than its independent appraiser stated they were worth.

The guarantor relied on an asset sale agreement, entered into before default between the debtor and a third party purchaser, valuing the assets at $149,000. He also relied on an accountant’s letter, received and produced after default, discussing the accounting details of the assets and referencing a possible valuation of $124,000.

As to the accountant’s letter, the judge noted that an unexplained letter, inserted into the motion materials, is not evidence; the accountant would have had to submit an affidavit setting out his opinion and the reasons for it and been subject to cross-examination. Similarly, the guarantor never explained the circumstances of the asset sale agreement and, in particular, why it had not been completed.

Finally, the judge noted that, even if the assets had been worth approximately $120,000, the first $40,000 payment would have gone to CRA. The remaining $80,000 would then have been available to repay the loan. This would have resulted in a loan shortfall of $80,000 (i.e. $160,000 debt less the $80,000 repayment), a shortfall that, even in the best case scenario for the guarantor’s asset valuation argument, was still more that the $61,000 that the guarantor had guaranteed.

The judge also dismissed the guarantor’s counterclaim: first, because the guarantor’s arguments regarding improvident sale had been rejected and, second, because only the debtor could claim damages for an improvident sale of its assets, not a guarantor of its debt.

Why

The debtor had legal representation. We are not sure why this case was fought. It seems to have had no merit. Aside from wasting time and money, the guarantor had to pay an additional $7,000 in costs.

Image courtesy of DodgertonSkillhause.

Written by Jonathan Speigel, the founding partner of Speigel Nichols Fox LLP, leads the litigation and construction practices.