Priority in Alberta
In Alberta, it is possible, and relatively common, to register multiple mortgages against the same property to finance property acquisitions or the development of properties. This has become more important as traditional first lenders have reduced the amount that they are prepared to lend on a loan-to-value basis. Where multiple mortgages are utilized, the mortgages are ranked according to their relative priority such that they are referred to as first mortgages, second mortgages, etc. Priority under the Alberta land titles system is based upon the registration numbers assigned to each mortgage with the lower registration number having priority over the higher registration number. In other words, a mortgage registered against title to a property will have priority over subsequent mortgages registered against that same title.
Once mortgages are registered, their priority to each other cannot be changed save and except if the holder of the lower registration number mortgage (the “First Lender”) signs a postponement in the prescribed form in favour of the holder of the higher registration number mortgage (the “Second Lender”) which, when registered, reverses the priority of the two mortgages. As between mortgages, therefore, priority is rarely, if ever, an issue.
The primary benefit of having a higher priority mortgage is that the First Lender is entitled to be paid prior to the Second Lender if there is a default and the property is sold to satisfy the outstanding debts. Accordingly, if the proceeds of sale are not sufficient to payout both the First Lender and the Second Lender, the First Lender is paid in full before any funds are paid to the Second Lender. In addition, if the First Lender forecloses upon the mortgaged property and takes title to the mortgaged property in satisfaction of the first mortgage debt, the second mortgage is removed from the property and the Second Lender loses its security with respect to the mortgaged property. Therefore, being a Second Lender is much riskier than being a First Lender and, for this reason, the interest rate and fees charged by a Second Lender are generally substantially higher than the interest rate and fees charged by a First Lender.
For years, Second Lenders would mitigate their risks by ensuring that the first mortgage either did not go into default or that any default under the first mortgage was able to be cured by the Second Lender. In this sense, a substantial second mortgage was seen as being beneficial to a First Lender in that it was unlikely that the Second Lender would allow the first mortgage to go into default.
Priority and Standstill Agreements
Recently, many First Lenders in Alberta have adopted the practice of requiring Second Lenders to sign a Priority and Standstill Agreement (“P&S Agreement”). The general effect of a P&S Agreement is firstly, to confirm the priority of the first mortgage over the second mortgage and secondly, to prevent the Second Lender from taking any steps to enforce the second mortgage for a prescribed period of time following default (referred to as a standstill period) or until the First lender has been paid in full (a full standstill). P&S Agreements are based upon the assumptions that: (a) there is some need to have the Second Lender acknowledge the priority of the First Lender’s mortgage security and (b) restricting the Second Lender’s rights to enforce its mortgage security is necessary to protect the First Lender.
Obviously, as previously stated, there is no need to confirm the priority of registered mortgages in Alberta so, in this regard, P&S Agreements are redundant. In addition, as enforcement proceedings in Alberta must proceed through our courts, the priority position of the First Lender is recognized and protected. On the other hand, to the extent that a P&S Agreement prevents the Second Lender from protecting itself through enforcement of its mortgage security (while keeping the first mortgage in good standing), the risks related to the second mortgage are substantially increased, perhaps to the point at which the higher interest rate and higher fees cannot justify the higher risk.
Why is this an issue? As stated above, in many situations, a second mortgage loan is needed to allow an acquisition to proceed or to allow a property to be developed. As stated above, in many situations, the second mortgage is actually beneficial to both the borrower and the First Lender. If First Lenders arbitrarily require every Second Lender to execute a P&S Agreement, many potential Second Lenders will either refuse to provide second mortgage loans or the cost of second mortgage loans (i.e. the interest rates and fees payable) will be increased to the point where they become uneconomical.
Considerations for First Lenders
In our view, rather than requiring P&S Agreements in every instance, it is important to determine, on a case-by-case basis, whether the First Lender should insist upon a P&S Agreement. For example, where the Second Lender’s mortgage loan is an essential part of the acquisition or development financing (and where the borrower is also contributing substantial equity) a P&S Agreement is likely not appropriate.
Having said that, we also believe that there are instances in which a P&S Agreement can be justified without adversely affecting borrowers or Second Lenders. Examples of such instances are as follows:
- Instances in which the Second Lenders are related to the borrower as shareholders or non-arms-length creditors and the second mortgage secures funds advanced to the borrower by these related parties; and
- Instances where the Second Lender is a financial institution granting large credit facilities to the borrower and/or related companies to finance operations or other projects or acquisitions.
In the first instance, we would be concerned about related parties acting in a manner to assist the borrower in defending or delaying an enforcement action by the First Lender. In the second instance, we would be concerned about the Second Lender attempting to include the property in a global receivership of the borrower or the entire related group of companies. Also, in either instance, the requirement for a P&S Agreement would not prevent the acquisition or development from proceeding, as the credit facilities secured by the second mortgage would not relate to the acquisition or development of the property in question. The key is to understand the nature of the second mortgage financing and to understand whether a P&S Agreement is necessary in the circumstances.
Considerations for Second Lenders
For Second Lenders who have been asked to sign a P&S Agreement by a First Lender, they are often led to believe they have no choice but to agree. However, Second Lenders often have more bargaining power than they realize (as stated above, often the acquisition or development does not happen without the Second Lender’s involvement). In those situations, Second Lenders can negotiate with First Lenders when it comes to P&S Agreements as follows:
- Simply refuse to sign the P&S Agreement and explain why it is unnecessary in Alberta as previously outlined.
- If the First Lender insists on a P&S Agreement, include a “standstill period” in the P&S Agreement rather than a full standstill (i.e. Second Lender cannot take steps for 90 days following default under the second mortgage).
P&S Agreements in Alberta between First Lenders and Second Lenders, while not required in every instance, are useful in certain situations. Both the First Lender and Second Lender should take time to consider whether a P&S Agreement is necessary and, if so, what appropriate and reasonable terms are. If you are curious about whether a Priority and Standstill Agreement is necessary for your transaction, please contact Roger I. Swainson or Graeme R. Swainson.
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