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Second Mortgage? Hold on a Second…

By: Michael Cappabianca and Brian Benford

We often see parties seeking to take out a second mortgage on real property, usually to access equity in the property and use the proceeds to further certain business goals and objectives. However, borrowers and their advisors should proceed cautiously when seeking to further mortgage a property already encumbered by a first mortgage.

Let us assume a borrower (“CorpA”) is the registered owner of a parcel of land (the “Land”). The Land is currently subject to a $1,500,000 charge on title (the “First Mortgage”), of which only $1,000,000 of the funds were advanced to CorpA by the lending institution (“LenderA”). This occurs in situations where the principal amount listed on the charge is greater than the initial advance, making subsequent advances possible. This structure is typically seen in construction projects through progress draws, but it is also common with revolving lines of credit, where borrowers need continuous access to funds for capital expenditures and other legitimate business purposes.

CorpA has been making regular payments under the First Mortgage in due course and has never defaulted. Instead of further drawing money from LenderA under the First Mortgage, CorpA considers obtaining secondary financing from another lender (“LenderB”), because LenderB might offer more favourable interest rates or lending terms. LenderB’s loan to CorpA is then secured by a second mortgage on the Land in the amount of $250,000 (the “Second Mortgage”).

Consent to Subsequent Financing & Priority of Mortgages

The above scenario presents several consequences. First, CorpA would require LenderA’s consent to further encumber the property if the terms of the First Mortgage contain restrictions on secondary financing. Consequently, CorpA and its advisors must be aware that without LenderA’s consent, registration of the Second Mortgage is considered an event of default under the First Mortgage. This may trigger LenderA’s right to “call” the First Mortgage and demand payment in full, or exercise any other rights available to LenderA upon an event of default.

Second, although the First Mortgage was registered on title prior to the Second Mortgage, the First Mortgage will only secure the amount initially advanced to CorpA, and not the entire principal amount stated on the charge.[1] Therefore, the First Mortgage only secures $1,000,000. The remaining $500,000 under the First Mortgage would be subordinate to the Second Mortgage if LenderA receives “actual notice” of the Second Mortgage before advancing the remaining funds. In other words, despite the principal amount listed on the charge, a lender only has security to the extent of the funds advanced. It is worth noting that registration of the Second Mortgage on title, on its own, does not constitute “actual notice” to LenderA. [2]

Best Practices for Subsequent Advances

Prior to making subsequent advances, prudent practice would require a sub-search of title to the Land which would reveal any potential encumbrances registered after the First Mortgage, such as liens, notices, and further charges.

From an enforcement perspective, actual notice of the Second Mortgage prior to registration – assuming LenderA consents to the Second Mortgage – gives LenderA the opportunity to negotiate and enter into a priority and standstill agreement with LenderB to establish the priority of the mortgages and assign the responsibility for initiating and controlling enforcement proceedings against CorpA in the event of default.

Whether you are LenderA, LenderB, or CorpA seeking to draw further equity from your already-encumbered Land, it is important to examine existing title registrations to effectively protect your security interests, or to avoid accidentally inducing default.

[1] 93(4) of the Land Titles Act, R.S.O. 1990, c. L.5

[2] Ibid.

This article is not intended to serve as a comprehensive treatment of the topic and is not legal advice. All legal matters are dealt with pursuant to their specific facts and circumstance. Nothing replaces retaining a qualified, competent lawyer.