Legal Blog

Prudence

A security holder (e.g. a mortgagee) has a duty to deal prudently and diligently with the security that it holds. For example, if a creditor holds shares in stock as security for a loan and the creditor wishes to sell that stock, the creditor must obtain a reasonable price for it. Selling stock that is worth $20.00 per share for $4.00 per share will result in the secured creditor being liable to the owner of the stock for $16.00 per share.

This duty to act prudently was front and centre in Manufacturers Life Insurance v. Elgie, a 2006 decision of the Ontario Superior Court of Justice.

Hard Times 

A developer owner, who ran a good shop, suffered reverses because his developments were in Sault Ste. Marie, a city that had fallen on hard times. The developer wrote to the mortgagee requesting that its mortgage payments be reduced from $26,000 per month to $20,000 per month; in response, the mortgagee demanded repayment of the $6,000 in arrears. Within a month, the mortgagee demanded repayment of the mortgage loan of approximately $2 million. Two weeks later, the mortgagee took possession of the property and notified all tenants to make their rent payments to it.

The mortgagee appointed a new property manager. The manager operated his business from the basement of his residence in Aurora. Although he testified that he visited the property every two to three months, he had no evidence to support that contention, no gas receipts, no airline tickets. His contract with the mortgagee required that he visit the site weekly, but he obviously breached that provision. Further, he did not hire competent staff to take his place. His sole hire was a superintendent with no property management experience. She was often unavailable to tenants and to tradespeople.

For the first four months of his appointment, the manager did nothing to advertise vacancies or seek tenants. After that, the manager made lacklustre attempts to attract tenants, placing bi-weekly advertisements in a community flyer/newspaper in the “professional services” section, rather than the “apartments for rent” section.

The manager did not maintain the property. This resulted in a safety order under which the balcony doors had to be nailed shut. No doubt, this did wonders for the image of the building.

Results 

The property’s vacancy rates, which had already increased due to hard times, continued to increase and, indeed, skyrocketed. Even when the economy recovered, the vacancy rates remained 35-50% higher than the vacancy rates for the city and, worse, the vacancy rates were 37% higher than a twin building 100 metres down the street that the developer still owned and managed.

The mismanagement continued for five years. At the end, the economy had fully recovered. The mortgagee sold the property for $2.31 million and sued the developer for the mortgage deficiency. The developer claimed that there would have been no deficiency had the manager properly managed the property and claimed that the property would have been sold for $3 million had the vacancy rate at the time of sale been at market levels. 

Damages 

The judge used the vacancy levels of the twin building as a benchmark. She determined that the mortgagee’s mismanagement of the building resulted in lost rent over the period of $1.12 million. From that, she deducted approximately $200,000 to account for the extra money that the mortgagee would have spent to properly advertise and maintain the building and the utility expenses that would have been commensurately higher with increased occupancy. She deducted an additional 20% to account for the reality that, upon default on a mortgage, a mortgagee must react on short notice and without the advantage of full knowledge of the property. Accordingly, after all deductions, she allowed the developer $676,000 for foregone rent.

Although the judge heard evidence that the property’s sale value was proportionate to the rental stream, the judge concluded that any knowledgeable purchaser would have factored the high vacancy rate into the income flow (i.e. a knowledgeable purchaser would have known that, with proper management, the vacancy rate would not remain at 20%). However, the judge held that a purchaser would also have factored the time, and resulting foregone rent, it would take to bring the vacancy rate down to an acceptable rate and the increased advertising cost to do so. The judge awarded $59,000 for this head of damage.

Finally, the mortgagee had claimed the expense of $105,000 that it spent on balcony repairs. The judge reduced that amount by $49,000 to account for the fact that had the mortgagee performed routine maintenance, it would not have had to spend the extra amount on capital restoration.

The aggregate reduction from the monies that the mortgagee claimed was $785,000. The mortgagee had also claimed $93,000 for costs, but the judge postponed that issue until costs of the entire proceeding were argued. We suspect that the mortgagee will not be awarded anywhere near the legal costs that it requested and may end up paying a good deal of the costs of the developer.

Conclusion – when a mortgagee moves into possession and does not act properly, the mortgagee will pay the price.