Archive for November, 2009

But … What’s My Downside?

Sunday, November 15th, 2009

I met with prospective clients recently and their situation was intriguing.  They bought some commercial property that had a number of tenants.  Almost immediately after they closed the deal, they discovered that one of the tenants had left either the day of the closing or the next day.  They then proceeded to sue the tenant for breach of the lease and they relied upon an estoppel certificate purportedly signed by the tenant.  An estoppel certificate is a document which, in effect, says “everything’s fine, I’m a happy tenant and I don’t have any problems with either the lease or the current landlord [that is, the seller]“.

In defence of the lawsuit, the tenant (now defendant) said “I never signed that document, it must be a forgery.”  OK, so their lawyer sued the seller and the lawsuit is now, basically, “we don’t care what happens, one of you has to pay us – either the tenant because the estoppel certificate is valid and therefore the tenant is liable on the lease OR the seller because the estoppel certificate is a forgery and you lied to me to get me to close the deal.”

The problem, though, is that the claim as against the seller is completely dependent upon being able to prove that the estoppel certificate is forged.  The potential clients asked their current lawyer a while back, “so what happens now?”  The answer was basically that they sit back and let the two defendants point fingers at each other and, in essence, “who cares? You’re going to win against someone.”  Completely true.  But the flip-side of this is that they are definitely going to lose against the other party.

It is not uncommon to see “sue ‘em all and let God (or the Judge) sort it out” approaches to litigation.  And I am not saying that this is not a good practice – because sometimes you really just don’t know who is ultimately to blame for whatever happened.  BUT what the potential clients never asked, and their lawyer doesn’t appear to have explained (or explained well enough) is the question: “OK, but what’s my downside?”  If they had asked this, then they would have known that winning against one party means almost automatically losing against the other and you want to ensure that whomever you win against will net enough money to cover whatever you have to pay to the other party for its legal costs.  If you end up having to pay the party you couldn’t prove the case against more than you received from the party you won against, then you’ve lost money on the litigation and it probably wasn’t a worthwhile venture.

The potential clients never asked this question and by the time they came to me the question was raised.  It’s not that it’s too late, but it will certainly give them a different perspective on how to proceed with the litigation.  But this is a question that should be asked by all litigants at the very beginning of any lawsuit.  For example, a lawyer may say to you “I’ll take your case on contingency and I’ll pay all court costs, etc.” and then some will even add “You don’t pay anything until you win”, or “You don’t pay anything unless you win.”  Ask yourself if this is true.  For example, the standard rule is that the loser pays some of the winner’s costs.  If you don’t win and you don’t (or can’t) settle, you could have to pay some of the winner’s legal fees.  When you are told that you don’t have to pay anything – OK, but to whom and for what?  To your lawyer or the courts?  Fine, but what about to the other side?  Is your lawyer going to pay the other side’s legal fees if he/she cannot settle or doesn’t win the case?  If the answer is “no”, then you are the one on the hook for these costs.  Then the next question should be “what is the likelihood that I have to pay the other side?”  Often, the risk is relatively small – for example, the other side may be willing to settle and not seek costs from you.  But, this isn’t always the situation.

Litigation is not a 100% guaranteed endeavour.  Even when it is 100% guaranteed, it’s not quite that simple.  As the other lawyer said to the clients, they are going to win – and I agree with that.  But even with this 100% guarantee, the question still remains of against whom are they going to win.  In asking this question, then, you get to the bigger question of what is the downside of proceeding against both defendants or if a settlement should be made with one side or another.

I’ve said before that litigation is sometimes like gambling and, in that sense, you should always ask yourself “what am I prepared to lose?”  Similarly, asking “what’s my downside?” will allow you to decide how much you are prepared to lose if the litigation doesn’t go your way.

Something to think about.


Demand Guarantees, Mortgages & Promissory Notes

Thursday, November 5th, 2009

When is a demand not a demand?  And when is a demand required all the time?  The Ontario Court of Appeal had the opportunity to remind everyone of the rules earlier this week.

In Williamson, a company’s officer and director gave a personal guarantee for the company’s debt to the bank.  The company fell into financial trouble and the bank wrote to the officer/director regarding his personal guarantee.  The bank advised in the letter of the company’s default in payment and then went on to state:  “If payment of our demand is not made [by the company] as required, we will take steps to recover payment from you.”  This was in October, 2004.  In December of that year, the company was placed into receivership and ultimately into bankruptcy.

Two and a half years later, in June 2007, after the bankruptcy had been finalized and the bank was still owed over $100,000, the bank wrote to the officer / director and formally demanded that he pay this amount in accordance with his personal guarantee.  The guarantor refused to do so and argued that the bank knew back in 2004 that the company would not be able to pay and so it knew that it had to seek payment from the guarantor.  But two years had passed so the limitation period had expired – so the guarantor argued.  The bank disagreed and argued that the two year limitation period did not start to run unless and until demand for payment was formally made.  In response to this, the guarantor argued that formal demand for payment was made in the October 2004 letter.

The Court of Appeal has sided with the bank in this case.  As you will recall from my prior posts, a demand promissory note could be requested immediately by the person to whom the note was made – and thus the limitation period starts running right away so that the person who holds the note has to either sue on the promissory note within two years after it is made or else get a replacement note signed by the maker of the original note.  And in this regard, I must remind you that  subsections 5(3) and 5(4) of the Limitations Act, 2002  which came into effect in 2008 now provide that any “demand obligation” that is dated after January 1, 2004 does not have its limitation period start to run until after demand is made.  Thus, a promissory note that was signed on December 31, 2003 could only have been sued upon before December 31, 2005; whereas the same note if signed the next day or any day after January 1, 2004 doesn’t have time start to run until demand is made.  

When it comes to either a guarantee or else a collateral mortgage (for example, where A – for example, a parent - agrees to give the bank a mortgage over A’s house as security for payment of a debt owed by B - A’s child – to the bank), then there must be a formal demand before the time period starts.  If nothing else, there is an ultimate limitation period of 15 years – so in this case the guarantor might have had an argument if the bank did not sue until 2019.  However, the normal two year period will not start to run until a formal demand is made.

So what constitutes a formal demand?  The October 2004 letter was held to be a “courtesy” – as it simply put the guarantor on notice that a demand might be made against the guarantor at a later date.  However, a demand must be “clear and unequivocal”.  In this case, the “courtesy” was not clear and unequivocal and, as such, did not constitute a demand and thus the time did not run until the letter in 2007 formally demanding payment.

The Court of Appeal and the judge below both suggested that the guarantor could have bargained for a different result.  I suppose that’s true – except that in 99.9% of the cases the bank usually says “this is our standard form, if you want the loan, you’ll sign the document.”  So unless you have an inordinate amount of bargaining power, I wouldn’t count on the bank agreeing to have the loan be treated as having demand being made immediately or within some specified time period.

Ultimately, then, you should be careful that if you are required to give a guarantee for your business that you realize that if the business defaults, you could potentially have to look over your shoulder to see if the bank is coming after you on the guarantee for years after the failure – and that if it’s been more than two years since the business defaulted you are not automatically “safe”.


Security for Your Loans

Sunday, November 1st, 2009

The Supreme Court of Canada released reasons in three appeals dealing with the same issues yesterday.  The decision is found here.  In each of the cases there were businesses that were required to collect either or both provincial sales tax and the federal GST.  These businesses did collect the taxes but then went bankrupt.  Financial institutions that were owed loans and had registered security against the assets of the businesses claimed that they had priority over the assets.  The governments argued that the taxes required the businesses to collect the taxes as agents for the government and that, as a result, the money so collected was actually the government’s money and did not form a part of the businesses assets that were subject to the financial institutions’ security. 

If the governments were right, then they would get the money first and the financial institutions would fight over what was left.  However, the financial institutions argued that money was not specifically “earmarked” for the governments.  The money collected was mixed with other non-GST or PST monies and, ultimately, the businesses paid the governments money but not the actual monies received and, moreover, the businesses paid net amounts after taking various credits (such as input tax credits) into account so that if $100 in GST was collected it did not necessarily follow that the businesses had to pay $100 when the tax instalment was remitted.  As a result, the financial institutions argued that the governments could not say that it was “their money” and that, as a result, the governments were ordinary, unsecured creditors and that therefore the financial institutions, as secured creditors, had priority to the monies over the governments.  The Supreme Court of Canada has agreed with financial institutions with the result that the financial institutions won.

Now, at first blush you’re probably thinking “So what?”  If your busines goes bankrupt you won’t really be caring whether the bank or the government gets to pick at the bones first.  However, these cases do provide an opportunity to remind you that it may be worthwhile to grant security for any amounts you spend to start up your business.  For example, when I first started up my law practice, I had a loan given to me by a relative.  Even though I expected (and did) pay back the start up monies quite quickly, I ensured that my relative had a security agreement in place (and registered) to protect my relative’s interest.  If problems ever arose then I knew that my relative would have a chance of getting repaid before any other creditors. 

Let’s suppose that your business is operated by a corporation.  You may have personally advanced start up capital to your company which then usually takes the form of shareholder loans.  The rule that business gurus mention all the time is “pay yourself first”.  The reality, though, is that this is rarely followed with the result that the entrepreneur puts a lot of money into his/her business and is usually the last one to be paid.  If that’s the case, AND if you don’t have security, then the reality is that you will likely receive little to nothing from the business should it fail.  However, if your business grants to you a security interest in its assets, then you may have a chance of getting paid something if the business should ultimately fail.  And, based on these cases, you’ll have a better chance of getting paid than the government – at least until they change the bankruptcy or tax laws to change the result of these cases ;-)

Giving yourself security for monies you put into the business … something to think about.