The recent Court of Appeal decision in Winona Park Towns Ltd. and Alleghe Mortgage Fund Ltd. provides a useful judicial assessment of the current state of the duty of good faith as it applies to mortgage lenders.

In this case, Alleghe Mortgage Fund Ltd. loaned $2 million to Winona Park Towns Ltd. for a seven month term with interest at 12% per annum for the first 6 months and 18% thereafter.  Winona provided security in the form of a second mortgage on land being developed by Winona.

The loan was intended to cover some of the development costs, and about $1.76 million of the $2 million was paid directly to the City of Toronto to cover the cost of building permits.

Winona signed a document at the outset authorizing Alleghe to cancel the building permits and having the money that had been paid to the City refunded to Alleghe, presumably in the event of default.

The mortgage agreement also included a term allowing Alleghe to pay out any encumbrance on title and add the amount paid to the encumbrancer to the principal owing under its loan.

Three months after the loan was made, Winona breached the agreement by missing an interest payment.  Alleghe delivered a Notice of Sale and started a lawsuit against Winona.  Winona asserted a counterclaim.

As Alleghe had the right to pay out any encumbrancers, it elected to pay about $6.2 million to the 1^st mortgagee to discharge the first mortgage on the property.

The matter went before the Court by way of summary judgment.  The motion judge granted summary judgment to Alleghe in the amount of the original loan, the amount paid to the 1^st mortgagee, and interest at 18% per year.

Winona appealed to the Court of Appeal.  Winona’s argument was that Alleghe had breached its duty of good faith by failing to exercise its right to cancel the application for building permits and require the City to return the funds paid to it for those permits, amounting to all but about $250,000 of the original loan.  Winona’s argument was that had Alleghe done so, Winona would have been in a position to pay the relatively nominal balance owing under the mortgage to Alleghe and solve the problem.  Instead, Alleghe chose to pay out over three times the amount of the original loan to the 1^st mortgagee which increased the amount of the debt exponentially, thereby ending up with an enormous judgment bearing interest at a high rate.

The Court of Appeal dismissed the appeal.  It declined to interfere with the conclusion of the motion judge that the lender was not under any duty of good faith in the performance of its contractual duties to act in a manner that was in the best interest of the borrower, rather than pursuing what it reasonably believed to be its own best interest.  In this case, if Alleghe concluded that it made the most sense to sell the property with building permits attached, it was at liberty to do so.

The Court of Appeal observed that while Alleghe could have obtained partial repayment by cancelling the building permits, that cancellation would have reduced the value of the property, thereby putting at risk its prospects of obtaining repayment of the balance of its loan from a sale under power of sale.

This is a remarkable conclusion given that on the evidence before the Court, the property had substantial value and this was apparently Alleghe’s belief given that it had been attempting to sell it for at least $8.5 million.  While this type of valuation might well put Alleghe at risk in terms of recovering the balance under its own loan together with the amount paid out to the 1^st mortgagee, one could easily conclude that the value of the property would have been more than enough to cover the approximately $250,000 that would have remained owing had Alleghe cancelled the building permits.

In any event, and notwithstanding these points, the Court of Appeal determined that the motion judge had every right to conclude that Alleghe’s conduct in exercising its rights did not demonstrate bad faith and given that there was evidence upon which that conclusion could be reached, the Court of Appeal declined to interfere with it.

This is a case in which, on a business basis, it would be easily to sympathize with Winona’s position.  Without a doubt, it would have been reasonable for Alleghe to cancel the permits and reduce the amount outstanding by substantial margin.  Nevertheless, it made the business decision not to do so.  That decision was open to it under the documentation and that ended the matter.  The fact that other lenders might have acted differently in these circumstances is simply not relevant.  This is an important consideration for borrowers to bear in mind.