Volume 27, Issue Number 1, Fall 2022
Financial Matters


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Trust in Me

The Pitfalls of Paying Purchase Funds Directly to Developers

By Matilda Lici, Ava Naraghi | Other articles by Matilda Lici, Ava Naraghi

Building a condominium development is a massive financial undertaking. Any sudden fluctuations in the developer's liquidity may adversely impact any number of parties with a stake in the development project. In an attempt to improve liquidity and fund the ongoing construction, some developers resort to asking purchasers to pay some or all of the purchase funds to the developer directly. Ordinarily, such funds would be paid by the purchaser into a trust account set up for the benefit of secured creditors, such as first mortgagees.

When developers divert sale funds to pay for their construction costs, they inevitably deplete the pool of sale proceeds available for when they later need to pay back the secured loans of mortgagees. Such deficits can impair a developer's ability to close the sale of the condominium units and convey clear title to the purchasers of those units.

Two recent Ontario decisions shed light on the priority disputes that arise when an insolvent developer is unable to satisfy its obligations to secured creditors and the serious consequences befalling those purchasers who elect to pay purchase funds directly to the developer.

1. Equity will favour bona fide purchasers
The protections afforded to condominium purchasers will vary depending on how far the purchase has progressed at the time when a priority dispute arises. Those who have paid for their unit in full are more likely to garner the court's sympathies.

In Centurion Mortgage Capital Corp. v. Brightstar Newcastle Corp., 2022 ONSC 1059, the Court was dealing with a priority dispute between a purchaser who had paid the entire purchase price for a condominium unit and the remaining mortgagee of the condominium development. The developer, Brightstar, had pressured the purchaser, Mr. Rasmussen, to prepay the final balance of his purchase price ($270,320) to Brightstar. Brightstar had told Mr. Rasmussen that it needed money to complete construction of the project, and the balance of his purchase price could not be used for construction purposes unless it was paid to Brightstar directly, rather than into the trust account of the deposit trustee. While initially reluctant, Mr. Rasmussen ultimately acquiesced.

Guarantee Company of North America (GCNA), the remaining secured creditor with an interest in the condominium project, claimed that its security had priority over any interests Mr. Rasmussen may have and he should not receive clear title to the unit. GCNA argued that Mr. Rasmussen had a valid claim for repayment of, what GCNA characterized as, his loan to Brightstar and he should (a) advance a further $270,320 into the deposit trust account in order to receive clear title and (b sue Brightstar to recover his money back on the loan.

The Court dismissed that argument, finding that the risk should fall squarely at GCNA's feet. GCNA's interest was purely financial, whereas Mr. Rasmussen's interest was both proprietary in nature (in that this was his home) and financial. GCNA was in the business of offering bonds and taking on, and managing, the risks of doing so. It had unlimited joint and several indemnity claims available against Brightstar, its affiliates and its principals. Additionally, there was no evidence that any of these entities and individuals were unable to make good on any liabilities they may have under their indemnities and guarantees.

The recourse available to Mr. Rasmussen paled in comparison. Mr. Rasmussen was simply the purchaser of a residential condominium unit who had made the final payment on his unit in good faith. He did not have the means to make the final payment for his unit twice. The Court found that equitable considerations were "entirely" in his favour and a vesting order giving him clear title to the unit was appropriate.

By contrast, in C & K Mortgage Services Inc. v. Camilla Court Homes Inc., 2020 ONSC 5071, the Court considered whether the purchaser of a condominium unit, who had already paid a sizeable deposit but had yet to pay the full purchase price, had an equitable or proprietary interest that should take priority over the secured interest of the first mortgagee on the property. The purchaser, Mr. Tan, paid $400,000 directly to the builder, Elite Homes, based on the builder's assurance that paying a larger deposit to the builder directly would speed up the closing on the property. A receiver was subsequently appointed over the condominium project, and they sought to disclaim the Agreement of Purchase and Sale between Mr. Tan and Elite Homes.

Mr. Tan argued that if the APS was disclaimed, he would not recover his deposit and would suffer financial hardship. In contrast to Mr. Rasmussen, this Court was not as sympathetic to his plight. The Court accepted "that Mr. Tan is a victim of the improper use of the $400,000 deposit he paid directly to Elite Homes in the belief that this payment would expedite the construction of the Mateo Property". Nevertheless, the Court concluded that Mr. Tan "ran a risk when he paid $400,000 directly to Elite Homes" and would have to look to Tarion Corporation or other parties for recovery of his deposit.

The Court noted that if Mr. Tan had previously paid the full purchase price and attempted to complete the sale before the developer became insolvent, he could have sought an order of specific performance and may have been successful in enforcing a transfer of title. As a non bona fide purchaser, however, he was simply out of luck.

2. Courts Will Give Effect to Clear Contractual Rights and Obligations
In addition to the proportion of the purchase price paid by each purchaser at the time of the priority dispute, the other key factor that impacted the different outcomes in these two cases is the contractual language within their respective Agreements of Purchase and Sale.

In Centurion Mortgage Capital Corp., Mr. Rasmussen did not breach any of his obligations under the APS when he advanced his final payment to Brightstar. The APS explicitly stated that the balance of the purchase price was required to be paid to the vendor (i.e. Brightstar) or "as the vendor might direct". Therefore, Mr. Rasmussen was entitled to rely and act on Brightstar's direction that the balance be paid directly to it. In paying for his unit in full, Mr. Rasmussen fulfilled his financial obligations under the APS and reasonably expected that he would be able to close the transaction and obtain clear title.

Notwithstanding that Mr. Rasmussen may have had specific knowledge of GCNA's mortgage when he advanced the final payment to Brightstar, the fact remained that he had no contractual obligations to GCNA. He was not a party to any contract with GCNA, nor privy to the dispute between GCNA and Brightstar. The Court found that he had no notice that the manner of his final payment would put Brightstar offside its obligations or be detrimental to any third parties, including GCNA. There was no evidence that he assisted or conspired with Brightstar to breach its obligations to GCNA or anyone else.

On the other hand, in C & K Mortgage Services Inc. v. Camilla Court Homes Inc., Schedule A to the APS explicitly stated that the APS was subordinate to any mortgage arranged by the vendor (i.e. the developer), and Mr. Tan would not have an interest in the unit until a Transfer/Deed of Land was registered in his favour. The Court distinguished this case from Armadale Properties Ltd. v. 700 King Street (1997) Ltd., 2001 Can LII 28461, in which the APS made no reference to a contractual provision negating the purchaser's interest in land or subordinating it to the mortgagee's interest (in addition to the fact that the purchaser was bona fide and the sale had effectively concluded prior to the receivership and bankruptcy).

The Court found that the mortgagee's interest had legal priority over Mr. Tan's interest by virtue of the contractual provisions in the APS. A subordination of the mortgagee's interest would run contrary to the terms of the APS. The Court of Appeal in C & K Mortgage Services Inc. v. Camilla Court Homes Inc., 2020 ONCA 817, affirmed the lower court's decision, holding that Mr. Tan purchased a unit "that was subject to a prior mortgage" and the unit could not be conveyed to him unless the mortgage was redeemed.

Conclusion
Those who purchase condominium units in insolvent or financially languishing developments are often the most vulnerable stakeholders: their financial stake in a single unit is comparatively small to that of banks, financiers, and other institutional security holders, yet they, as prospective homeowners, stand to lose the most when disputes about priority arise. Before advancing any purchase funds directly to developers, purchasers should be conscious of the risks associated with this manner of payment and ensure that they fully understand both their contractual rights and obligations.

 

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Fall 2022
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