In Mission Creek Mortgage Ltd. v. New Recreations Ltd., the British Columbia Court of Appeal recently held that a lienholder whose liens had been discharged by an order made under the Companies’ Creditors Arrangement Act (CCAA) upon payment of security for their claims did not have any priority over or entitlement to that security.  This decision depended upon the wording of the Order by which the liens were discharged. Accordingly, this decision may alert owners, lienholders and mortgagees to the importance of the wording of orders discharging their liens and the submissions that are made when those orders are made, and may give rise to disputes over those orders in the future.

Background  

New Recreations was the owner and developer of property and obtained mortgage financing from Mission Creek Mortgage.   New Recreation contracted with construction companies for the construction of the project and the construction company registered liens when they were unpaid.  The project was delayed due to municipal bylaw issues. New Recreations ran into financial difficulties and brought an application for creditor protection under the CCAA.

During the CCAA proceedings, Mission Creek Mortgage advanced Debtor-in-Possession (“DIP”) funds to New Recreations. The funds were to be used, in part to satisfy the claims of lienholders which at that time amounted to about $750,000. The liens were discharged pursuant to a court order which provided that a security fund in the amount of $722,162.37 was to be held in trust pending the determination of the validity of the lien claims.

The order stated that:

4. The cancellation of the Liens against the Property pursuant to the provisions of the Builders Lien Act shall not deprive New Recreations, the respondents, or any other interested party, including secured or unsecured lenders, of the benefits of the provisions of the Builders Lien Act applicable to the Liens, the Security being in substitution for the Property;

5. The Order shall not affect the right of any person to claim that the Liens are improper or defective, or that the filing of the Liens has been improper or defective, nor shall the Order affect any right of any person under the Builders Lien Act;

6. Payment of the Security and the discharge of the Liens shall in no way change the relative priority of all creditors of New Recreations to the Security or the Property, the Security being substitution for the Property. For greater certainty, the secured creditors ….shall maintain any and all rights of priority that may exist to the Security, the Security merely standing in substitution for the Property.”

At the time of the making of this order, counsel for Mission Creek Mortgage said to the motion judge:

“[I]nclusion of paragraph 6 in the notice of application which maintains the priorities in the same manner as they are against the land such that if at the end of the day recovery was not sufficient from the land to pay out my client in full, my client would be in first priority on these funds. Hopefully that won’t be the case, but that’s what I understand paragraph 6 to be doing and on that basis we don’t have an issue with the application.”

Counsel for the lienholders on the motion advised the court they had no position to take on the application and the funds being held in a solicitor’s trust account.

The subsequent development was unsuccessful due to the bylaw problem. Mission Creek Mortgage caused the property to be sold.  The amount due under the mortgage financing was about $19 million and the amount advanced under the DIP financing was about $3.1 million. The amount realized on the sale was about $17.9 million or about $4 million less than the amount owing under the mortgage and DIP financing. The DIP financing was paid back out of the proceeds of sale. The lienholders asserted that their claims to the moneys being held in the security fund took priority over the mortgage and DIP financing.

The motion judge held that the mortgage and DIP financing had priority over the liens.  The motion judge said, in part:

“To interpret the Security Order as now suggested by the Lien Claimants would wholly re-order existing priorities when the clear intention of New Recreations Ltd. and the petitioner as made known by their counsel to the court was directly opposite the position now advanced by the Lien Claimants….I am not prepared to conclude in the face of the Lien Claimants’ silence at the time the Security Order was made, that Sigurdson J. intended the ordering of priorities they now assert.”

The British Columbia Court of Appeal upheld that decision.

The Decision

The lienholders relied upon a number of appellate decisions in Canada to the effect that, when liens are discharged by the provision of security, then the lienholders have an inviolate entitlement to first priority over that security, and that the mortgagee’s priority with respect to interests in the land did not apply to the security fund put in place when the liens were discharged.  The lienholders submitted that “the funds ordered to be held in a solicitor’s trust account are impressed with a first charge in favour of the lienholder appellants in priority to any claim that can be asserted by the mortgagee respondent.”

The Court of Appeal disagreed with the lienholders on this fundamental point. The court held that the order discharging the liens did give the lienholders a priority which they did not have at that time and that the mortgagee had an existing priority which applied to the security.  This conclusion appears to have rested on two points.

First, at the time the order discharging the liens was made, the mortgagee had priority to the liens, the land was worth less than the amount due under the mortgages and therefore there was no value in the land for the lienholders. In that circumstance, the order could not be interpreted to put the lienholders into a priority they did not then have. The court said:

“It must be remembered what the situation was at the time that the initial order of October 28, 2010 was made in the CCAA proceedings. An appraisal of the property expressed an opinion that a sale of the lands would realize less than the amount of the Mission Creek mortgages, but if the development could continue successfully, the property value should suffice to cover all outstanding indebtedness including the liens and another outstanding mortgage. Therefore, at that point in time and also at the point in time when the order of December 6, 2010 vacating the liens upon payment of security was made, there was no prospect of lienholders realizing anything on a present sale of the land…. In order to continue with marketing of the lands, it was necessary that the liens be vacated, hence the proceeding of December 6, 2010 to achieve this. It was the wish of all concerned, the landowner, the mortgagee and the lienholders that the development proceed to fruition so that all outstanding debts could be paid. ….. All parties who were before Sigurdson J. on December 6, 2010 were of a mind to have the development project continue in the hope and expectation that the successful completion of the project would accrue to the financial benefit of all concerned. If, for instance, the mortgagee respondent or any of the lienholders had sought a realization of security at that point in time, financial loss was a near certainty. In these circumstances, the inclusion of the crucial paragraph 6 of the order set forth in para. 9, supra, is entirely explicable.”

Second, the Court of Appeal expressed the view that the order discharging the liens was based upon the particular circumstances and understandings that could be gleaned from the events at that time – including the statements and silence of counsel – and importantly, that the order discharging the liens had been made in the CCAA proceeding. The court said the following:

“If this were a normal builders’ lien situation, the submissions made on behalf of the lienholders would have great force. However, this was far from the normal situation. The order of December 6, 2010 was made in course of the CCAA proceedings and purported to be made under the provisions of that Act and the Builders Lien Act.  Sigurdson J. was the judge dealing with the CCAA proceedings…. I think it is abundantly clear from paragraph 6 of the order made by Sigurdson J., which provided for the removal of the liens and the substitution of a fund as security for the lienholders, that the then extant priorities between the respondent mortgagee and the appellant lienholders would be unaffected by the posting of security to vacate the liens from title to the property. That term of the order is entirely in accord with the expressed wishes of all counsel before the judge. Those counsel included counsel for the lienholders.”

The Court of Appeal was also of the view that upholding the submissions of the lienholders could lead to “mischief and uncertainty in future CCAA proceedings” as the court would be “hobbled in the exercise of discretion to make necessary orders fostering the continuance of the enterprise.”

Accordingly, the Court of Appeal upheld the mortgagee’s priority to the security fund.

Discussion

The impact of this decision depends upon what is the true basis for it.

One view of this decision is that it is a one-off example of how the submissions of counsel at the time of the granting of the original order influenced the proper interpretation of the order. If that is the case, then counsel for lienholders may want to insist at the time of the making of the order that the order DOES entitle the lienholders to priority over the monies placed in trust when their liens are removed.  Normally, this should not be necessary and the effect of the order should be based entirely upon what it says, not the submissions (or silence) of counsel.

Another view would be that this decision is an example of the “super-priority” that can be given to DIP financing during a CCAA proceeding. However, if DIP financing could be given priority over pre-existing lien rights that had actual value at the time of the CCAA order removing the liens, that would cause a severe confrontation between the CCAA and the lien regimes and directly contradict the priority scheme set forth in the builders’ and construction lien legislation.

The third and better view appears to be that this decision is based upon the liens having no economic value due to the priority of the mortgages. Both the motion judge and the Court of Appeal proceeded on the basis that the advances under the mortgages having full priority over the liens.  In effect, the mortgage and DIP financing was given priority equivalent to the prior advances under the mortgage financing, even though the DIP financing was advanced after the work was done and the liens were registered and the liens would normally take priority over that financing under section 32(2) of the British Columbia Builders Lien Act.  The priority accorded to the DIP financing was due to two factors –

-the existence of the CCAA legislation empowering the court to keep the company alive while further business is conducted (in this case, the construction and sale of the project and land) with protection given to the lender who funds that business;

-and the liens having no economic value unless that further construction and sale occurred.

The result in the present case may be entirely due to the existing mortgages having priority over the liens, quite apart from the DIP financing. If, however, the decision is based upon the DIP financing gaining priority over the liens in respect of the security funds, then  the CCAA order was effectively held to be akin to an order under sub-sections 32(5) and (6) of the B.C. Builders Lien Act.  Under those subsections, the court may order that further advances made under a mortgage take priority over lien rights if the court is satisfied that the advances will be applied to complete the improvements and will increase the value of the lands.  However, sub-sections 32(5) and (6) require the court to be so satisfied before the order is granted and the order will expressly state that the further advances are accorded priority over the existing liens. Those requirements were not apparently met in the case of the CCAA order granted in the present case, and the order seems to have said to the contrary namely, that it did not affect the priorities between lienholders and the advances under the mortgages.

The result in this case may not be the same in other circumstances and other provinces. What if the lien rights did have value at the time of the CCAA order vacating the liens? Could that order still give the DIP financing priority over those liens, especially in the absence of the judge considering the factors and stating the priority of the DIP financing in accordance with subsections 32(5) and (6) of the B.C. Builders Lien Act before making the order?   And would the result be the same in Saskatchewan, New Brunswick and Prince Edward Island where the lien legislation states that when a lienholder’s lien is discharged by payment into court, the lienholder has a first charge upon those monies?  This issue was considered in my article dated March 13, 2012.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 11, part 4(l) and (m)

Mission Creek Mortgage Ltd. v. New Recreations Ltd. 2014 CarswellBC 760

Construction and builders liens   –  priority -liens and mortgages-order discharging liens  – Companies’ Creditors Arrangement Act

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                June 10, 2014

www.heintzmanadr.com

www.constructionlawcanada.com