Inadvertently surrendering security?

What is the test for determining whether a creditor has surrendered its security?

Saugeen Economic Development Corp. v. Peuser, 2023 ONSC 5037
What is the test for determining whether a creditor has surrendered its security?

Overview: In this case, the Court determined that a creditor who had a second mortgage on a property had not surrendered its security by electing to make a claim as an unsecured creditor. A surrender of security must be irrevocable, unequivocal and unconditional. There was no express surrender of security in the circumstances of this case.

Both the Plaintiff and the Defendants brought respective motions for summary judgment. The Plaintiff sought judgment entitling it to enforce a second mortgage registered against title to a house owned by the Defendants. The Defendants sought a final order discharging this second mortgage without any payment to the Plaintiff.

The Defendants became indebted to the Plaintiff pursuant to a business loan for $20,000. When the business failed, the Defendants and the Plaintiff renegotiated the loan arrangement such that, among other things, the Defendants granted to the Plaintiff a second mortgage on their property to secure the loan. The Defendants started missing payments on the second mortgage and, eventually, each of them made an assignment in bankruptcy. The Plaintiff initially filed a proof of claim as a secured creditor in the wife’s estate but, after being advised by the trustee that the property was valued at less than the value of the first mortgage and the trustee was, therefore, releasing its interest in the property, the Plaintiff filed an amended proof of claim claiming an unsecured debt. The amended proof of claim explicitly stated that the Plaintiff did not claim a right to a priority. The Plaintiff also subsequently filed a proof of claim in the husband’s estate, claiming an unsecured debt of approximately $25,000.

Both Defendants have since been discharged from bankruptcy. The Plaintiff did not receive any dividend payment as an unsecured creditor from the wife’s bankruptcy, but did receive $415 as an unsecured creditor from the husband’s bankruptcy. The loan by the Plaintiff and the payments under the second mortgage remained in default. The value of the Defendants’ property increased over the years, but no party ever took any steps to discharge the second mortgage from title to the property. On February 26, 2021, the Plaintiff served a Notice of Sale Under Mortgage with respect to the second mortgage.

The Plaintiff argued that it had a valid secured interest in the property, which interest survived the bankruptcy. It maintained that it did not expressly surrender its security interest. The Defendants argued that, by filing an amended proof of claim as an unsecured creditor in the wife’s bankruptcy, which claim indicated that the Plaintiff did not hold any assets of the debtor as security, the Plaintiff expressly surrendered its security interest.

When an individual makes an assignment in bankruptcy, a secured creditor may proceed in one of three ways. Under s.69.3(2) of the Bankruptcy and Insolvency Act, the bankruptcy does not prevent a secured creditor from enforcing its security in the normal course. It does not have to prove its claim. If required by the trustee in bankruptcy, it may have to provide full particulars of the security and the value at which it is assessed. Alternatively, the secured creditor can proceed under s. 127 of the BIA. Under this section, where a secured creditor realizes its secured interest and there is anything left due and owing, it may prove that remaining amount as a claim in the bankruptcy. Thirdly, if a secured creditor surrenders its security to the trustee for the general benefit of the creditors, it may prove its entire claim in the bankruptcy. The surrender of the creditor’s security may be expressed or inferred from a course of conduct.

Whether a secured creditor has made an election to surrender its security by a course of conduct is a question of fact. To constitute a surrender, the actions taken must be irrevocable, unequivocal and unconditional. Here, the Court found no express surrender of the Plaintiff’s security interest. There was no evidence that the Plaintiff expressly stated to the trustee that it surrendered its secured interest for the general benefit of the creditors. Such a surrender must be clear and specific to the secured interest. In its first proof of claim, the Plaintiff identified its claim as a secured claim. In the amended proof of claim, the Plaintiff stated it held no assets of the debtor as security, but this was after the subject property—at the election of the trustee—was no longer part of the bankruptcy, and the Plaintiff believed its secured interest had no value at that time. All creditors were aware that the Plaintiff had a second mortgage and that there was insufficient equity in the property to pay anything towards the second mortgage. The Plaintiff received no dividends from the wife’s bankruptcy so, therefore, no other creditor was prejudiced by the steps taken by the Plaintiff. Finally, the Plaintiff never sought to discharge its mortgage, and the Defendants never attempted to do so either.

In the circumstances, the decision to make a claim as an unsecured creditor was not an express surrender of security, as contemplated by the BIA. The Plaintiff’s actions were consistent with proceeding under s.127(1) of the Act. Accordingly, the Court granted summary judgment to the Plaintiff.

Judge: Fowler Byrne J.

Counsel: Nicholas Lovell of Middlebro & Stevens LLP for the Plaintiff

Jennifer Lillie of Lillie Law for the Defendants