Does a clause in a guarantee offend the anti-deprivation rule?

Javeri sold lands to Windsor Park in 2016. Part of the consideration for the sale was a vendor-take-back mortgage (the “VTB Mortgage”) granted to Javeri. Javeri agreed to subordinate the VTB Mortgage to construction financing. The VTB Mortgage was guaranteed by Brava for a guarantee fee of $180,000.00 (the “Guarantee Fee”). The Guarantee Fee reduced the principal under the VTB Mortgage by the amount of the fee, which was to be paid out of the construction financing. This fee reduction was subject to a clause (the “Clause”) in the VTB Mortgage stating that if Brava became bankrupt or insolvent, the Guarantee Fee would be forfeited and the lender would be entitled to repayment of the full principal sum.

After Windsor Park failed to repay the outstanding principal and interest on maturity, Javeri made demands for payment and subsequently commenced an action against Windsor Park and Brava. Javeri alleged that Windsor Park and Brava failed to make payments on the Guarantee, and Brava was insolvent within the meaning of the BIA. He sought, among other things, declarations that the security was valid and enforceable and Brava was insolvent, and summary judgment against Brava pursuant to its Guarantee. Among the issues to be decided was whether the Clause offended the common law anti-deprivation rule.

Windsor Park argued that the Clause violated the anti-deprivation rule, given that the effect of the Clause was to remove property from Brava’s estate that would otherwise be available to its creditors upon a declaration of insolvency.

Javeri argued that the Clause did not offend the anti-deprivation rule because: (a) it did not have the effect of creating a debt that would not exist but-for the insolvency, and (b) it did not remove value from the insolvent Windsor Park’s estate. According to him, the situation did not fall within the application of the anti-deprivation rule because the Clause was triggered by Brava’s insolvency, a third party to the VTB Mortgage. Furthermore, he argued that, although the Clause increased Brava’s guarantee obligation, that increase was offset by the $180,000 benefit it received, so no value was being removed from Brava’s estate in any event.

The Court held that Javeri’s description of the Guarantee Fee as a form of security was inconsistent with the statement of claim and previous documents filed in this action. Consequently, since there was doubt about the proper characterization of the Guarantee Fee and whether it was paid, the Court declined to award judgment in an amount that includes the amount of the Guarantee Fee.

Furthermore, at common law, the anti-deprivation rule renders void any contractual provision, triggered by an event of insolvency, that removes value from the insolvent’s estate to the prejudice of creditors. It is an effects-based test. If the Guarantee Fee were to be added back in after the mortgagor defaults and the guarantor is declared insolvent, it could not be considered security for repayment of a debt. It would be increasing the amount of the mortgage, and effectively removing value from the estates of Windsor Park and Brava, who were now both liable for the mortgage debt.

Removing value from these estates had the potential to affect recovery by subordinate creditors. While the other two mortgagees had notice of this application, no other creditors of Windsor Park were served with notice. These unsecured creditors (including trades people) would be most affected by the removal of value. The lack of notice to those who would be most likely to be affected by this Application comprised another reason not to the award the requested judgement.

The Court dismissed the application for summary judgement against Brava. The declaration of insolvency vis-à-vis Brava was granted since there was evidence of such insolvency.

Judge: Madam Justice D.L. Shelley

Counsel: Daniel Jukes of Miles Davison LLP for the Applicant; Taylor Grantham and Natalie Reeder of Stonetree Law for the Respondent Brava Development Group; Kimberly Howe of Goodfellow Scheuttlaw for the Third Mortgagee, 1863387 Alberta Ltd. and Jose Cuzzani

Fullcase: https://canlii.ca/t/jl9qp

By Matilda Lici