Canada: Indemnity Agreement For Costs Of Enforcing On Security Undermined By An Exercise Of Judicial Discretion

Secured lenders typically expect to be fully indemnified for legal fees and costs associated with enforcing on their loans. Standard general security agreements provide for recovery of such fees. However, a recent decision of the Ontario Superior Court of Justice appears to expand the circumstances in which courts will disregard such provisions and fix a lender's costs of enforcing their loan in court at an amount materially lower than costs actually incurred.

Background

In Crystal Lakes Developments Inc. v. Dongab Co. Inc., ¹ Dongab Co. Inc. and its affiliated company, Network Sewer and Watermain Limited (together, the "Lender") advanced mortgage funds over a series of properties owned by the property-developer plaintiff, Crystal Lakes Developments Inc. (the "Borrower"). The mortgage went into default, but the Borrower argued that the preconditions for repayment were not met such that the Lender ought to be precluded from enforcing on its security. The Lender nevertheless took control of the properties, and delivered a Notice of Sale pursuant to the Mortgages Act.

The Borrower moved for an interlocutory injunction prohibiting the Lender from exercising its power of sale in respect of two mortgages registered on title. The Lender successfully blocked the injunction and the Borrower's motion was dismissed.

Cost Award

As is common under standard charge terms for mortgage loans, the contract between the Lender and Borrower called for full recovery of the Lender's legal fees. Having succeeded in blocking the injunction, the Lender sought costs on a full indemnity basis in the amount of $269,353.44. However, the Court only awarded the Lender its costs on a partial indemnity basis (which are generally calculated as between 50-60% of actual legal costs incurred) in the amount of $163,000.00.

The Ontario Courts of Justice Act leaves costs of a legal proceeding, or step in a legal proceeding, in the discretion of the court. A line of cases going back more than 50 years holds that as a general proposition, where there is a contractual right to costs, the court will exercise its discretion to reflect that right. In a 1995 decision, however, the Ontario Court of Appeal held that "it is open to the court to exercise its discretion contrary to the agreement [in special circumstances or where the lender has conducted itself inequitably]."²

In Crystal Lakes, the motion judge acknowledged that the Lender had a right to enforce its mortgage, and did so in the usual way. However, he found that the amounts the Lender sought for costs to be "extraordinarily high",³ and were "a bit much to impose on the opposing side in a costs request",⁴ despite Lender's counsel having done "an excellent job and [being] entirely successful".⁵ His Honour did not describe anything about the circumstances of the case that might be characterized as "special" or suggest that the Lender had acted inequitably such that the court might depart from the usual practice of exercising its discretion in a manner that upholds the agreement between the parties. Rather, the Court turned to the guidance under rule 57.01(1)(0.b) of the Rules of Civil Procedure to take into account the amount of costs that the unsuccessful party could reasonably expect to pay,⁶ and found that a full indemnity cost award in this case "well exceeds the [Borrower's] reasonable expectations."⁷

What Does this Mean for Lenders Wishing to Rely on Cost-Indemnity Clauses?

The decision in Crystal Lakes builds on existing jurisprudence that cost awards are always a matter for the court's discretion. The case does not go so far as to say that provisions in lending agreements for full indemnity of legal costs are not enforceable. However, the case does make it more difficult for lenders to predict when all legal fees incurred in connection with a court proceeding pertaining to enforcement of a loan will be recoverable notwithstanding the terms of the lending agreement.

Particularly on account of this uncertainty, prudent lenders will factor in anticipated legal fees associated with any court proceeding that may result from one possible enforcement strategy over another. A security enforcement strategy that guarantees a slightly discounted recovery without the need for a court proceeding may be preferred over a strategy that results in a greater recovery on a gross basis, but risks a greatly discounted recovery on a net basis owing to a judge's exercise of discretion on the issue of costs.

Footnotes

1. 2023 ONSC 2009 [Crystal Lakes].

2. Bossé v. Mastercraft Group Inc., 1995 CanLII 931 (Ont CA).

3. Crystal Lakes at para 6.

4. Crystal Lakes at para 7.

5. Crystal Lakes at para 6.

6. Rules of Civil Procedure, RRO 1990, R. 194, R. 57.01(1)(0.b).

7. Crystal Lakes at para 8.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2021