In 2015, and just before his retirement, Justice Murray of the Ontario Superior Court of Justice left us with a challenging legal decision that, for the time being at least, will matter to mortgage lenders.
Mortgage lenders rely on one fundamental thing when they issue a commitment letter for a mortgage: good title. And good title is something that a lender, its lawyer and its title insurer get comfort on from the land titles registry. The land titles registry, therefore, is the root of our confidence in the state of title. Registered instruments are, by virtue of their being on the registry, fixed in place, reliable and immutable. And we expect that only a handful of statutory exceptions to title, deemed trusts or liens can colour our certainty on the priority of a registered mortgage.
The case this post considers is CIBC Mortgages Inc. v Computershare Trust Company.
Our main characters in this particular story are Mr. and Mrs. Lowtan, who we will consolidate into one person and who we will ominously call "the Malfeasants".
The Malfeasants owned a home on the sleepy suburban street of "Chipmunk Crescent" in Brampton.
In 2008 the Malfeasants applied to Computershare and received a first mortgage in the approximate amount of $280,000 to refinance existing mortgage debt. A mortgage was registered on title on November 21, 2008.
Nine months later, on August 26, 2009, without the consent or knowledge of Computershare, the Malfeasants somehow managed to fraudulently register a discharge of the Computershare mortgage on title to the Property.
However, our Malfeasants, being relatively clever, continued to pay the monthly debt service payments to Computershare for the next four and a half years.
Almost two years passed, and in March 2011 the Malfeasants, through a mortgage broker, applied to CIBC for a first mortgage. In their financial disclosure the Malfeasants omitted any reference to their Computershare debt, and on July 28, 2011, CIBC provided a mortgage loan to the Malfeasants in the amount of $252,800, and took what it believed to be a first ranking mortgage of the property.
Then, a year and a half later in December 2012, the Malfeasants approached Secure Capital for a second mortgage. Their application (of course) disclosed the existence of the CIBC mortgage but again made no reference to the fraudulently discharged Computershare mortgage.
All along, Computershare was receiving its monthly debt service payments happily, and I like to think was probably still sending the Malfeasants an annual Holiday card. Secure Capital approved and granted a second mortgage to the Malfeasants for $32,000, and registered what it believed to be a second ranking charge on December 11, 2012.
On February 1, 2013, the Malfeasants defaulted on both the CIBC mortgage and the Secure Capital Mortgage.
By April 12th, the Malfeasants had stopped making debt service payments to Computershare, and so Computershare discovered that its mortgage had been fraudulently discharged.
By April 25th, the Malfeasants had made an assignment into bankruptcy and had vacated the house.
Notices of sale were issued and the three lenders made their applications to court.
The proceeds of a court ordered sale of the property amounted to $298,000, which is to say (if you are not doing the math):
- 94 percent of the amount owing to Computershare;
- 96 percent of the aggregate amounts owing to CIBC and Secure Capital; and
- all three outstanding mortgages combined were 190 percent of the available sale proceeds.
One more important fact. All three lenders are innocent. No lender was complicit. No lender participated in the fraud, knew about the fraud, or should have known about the fraud.
Before we consider the decision, a little refresher on the Land Titles Act and the law of deferred indefeasibility might be helpful.
The land titles system was established in Ontario in 1885, and its general purpose, and what we all rely on, is that it provides the public with security of title and facility of transfer.
The sanctity of title is established by a register and the guarantee of the government that (subject to certain statutory exemptions) the person named on the register is the owner and has perfect title subject only to registered encumbrances.
And so there are three main principles or concepts that underlie the land titles system and its registry:
- The Mirror Principle. That is, that the register is a perfect mirror of the state of title;
- The Curtain Principle. That a purchaser (or a lender) need not investigate the history of past dealings with the land and search behind the register; and
- The Insurance Principle. That the state guarantees the accuracy of the register and compensates any person who suffers a loss as a result of inaccuracy.
Common law courts have applied these principles when interpreting the Land Titles Act and have come up with what is called the "doctrine of deferred indefeasibility of title". It's called that because lawyers want to make things appear daunting and mysterious.
There are a couple of concepts built into the principle. Firstly, it includes the concept that the registration of an instrument on title cannot make an invalid or fraudulent instrument valid in favour of the purchaser named in the instrument (i.e., a transfer or a mortgage). So for example, if you are the buyer of a property and the seller signed the transfer fraudulently, you as the buyer cannot point to the transfer and claim that the "registration" of the transfer protects you from the true owner. Why? Because as the recipient of the fraudulent instrument you were closest to the fraud (even if you are innocent) and you had an opportunity to investigate and avoid the fraud.
However, if having purchased the property for consideration you were to then, in good faith, sell the property to a third party who had no notice of the fraud, the doctrine of deferred indefeasibility will protect that end purchaser from the claims of the true owner, on the basis that the end purchaser has the right to rely on the register and need not look behind it.
Or to put it another way, the recipient of title under a fraudulent instrument cannot rely on its registration to defeat the true owner, but if it sells the property to another, that other end purchaser can. Why? Because the recipient of the fraudulent instrument was closest to the fraud (even if innocent) and had an opportunity to investigate and avoid the fraud whereas the end purchaser had no opportunity to investigate or discover the fraud.
And intuitively, I think you will agree that this makes sense in a world of forgeries and fraudulent instruments. A mortgage lender should have a duty to investigate its borrower, its signature, its identity and its capacity (which is why lenders and their lawyers have strict "know your client" rules and underwriting standards), and it makes sense that if you accept a fraudulently executed mortgage, you should bear some risk of being defeated by a claim of the true owner.
The person who receives title or an interest under a fraudulent instrument may be defeated by the true owner but an ultimate third-party buyer, one step removed from the fraudulent instrument, may not be so defeated. It may rely on the registry and on the transfer, even if fraudulent, as forming its root of title.
The court calls that mortgagee in the middle the "intermediate owner".
It's the one person who could have investigated the fraud and is vulnerable to a claim even though its mortgage is registered.
In our case, the court found that not only was the discharge of the Computershare mortgage a fraudulent instrument, but the new mortgage in favour of CIBC was also a fraudulent instrument, not in the sense that it contained an impersonation or identity theft or forgery but because it was wrongly trying to convey an interest that the Malfeasants no longer owned.
What does this mean?
Because the court found that CIBC was the co-called "Intermediate Owner", CIBC was determined to be the lender closest to the fraud; the one that received its interest under a fraudulent instrument and therefore (apparently) could have investigated the fraud.
Accordingly, Computershare had its mortgage reinstated, the CIBC mortgage was determined to rank second and Secure Capital ended up in third.
Now if you don't immediately understand the importance of that, I will spell it out. The court's decision means:
- Lenders cannot just rely on the register to be satisfied that a prior mortgage discharge was valid granted, even if the discharge has nothing to do with the lender's advance.
- According to the court, CIBC apparently could have investigated the fraud somehow. The court said that "for example, an inquiry as to how the Malfeasants were able to pay off the Computershare mortgage given their financial circumstances might have raised concerns". This means (it would seem) not only having a view of the borrower's current financial situation, but an understanding and reconciliation of their historical major dealings with the property.
- It means that the level of diligence that lenders have to put into the circumstances of the loan they are granting has been somehow elevated by this case. It begs such questions as:
- Must lenders always get additional evidence of how past registered transactions were funded? Do lenders need copies of old record books? payout statements? financial records? Old certificates of incumbency?
- Do lenders need to call their prior lending institutions to ensure that they confirm what is evidenced on title with respect to prior mortgages or other dealings? In other words, do lenders need to pull back the curtain of the registry?
- Will lenders' solicitors start qualifying their opinions on title because they cannot give an absolute answer based on the title registry anymore?
- And if a lender can no longer just rely on the register, how far back does it need to investigate?
As you can see these kinds of questions quickly lead to the unravelling of the "Mirror" and "Curtain" principles described earlier, because this decision means that the absolute protections afforded by the registry are not only eroded but potentially altogether undermined.
Here are my two cents:
- If the case is correct on a technical interpretation of the statute, then it is correct technically only and entirely incorrect as a law of general application. Which is to say, it is bad law. Nonetheless, for the time being, it is the law.
- The notion that a purchaser or mortgagee cannot hide behind the fact that its mortgage or transfers is registered where the fraud was discoverable, is not bad law. Those are the forgery and identity theft cases, and those would have applied here had the mortgages been forged or had they been granted by strangers. But the mortgage documents were, in and of themselves sound and their fraudulent nature was undetectable. They were granted by the owners and there was nothing about the mortgage documents themselves that CIBC could have discovered. The fact that the mortgages were one step in the larger fraud should not have put CIBC to the obligation to investigate old registered instruments (such as the Computershare Discharge) that, on their face, had nothing to do with the new mortgages.
- If we are to take this case seriously, and for now we have to, then there are risks here that lawyers cannot absorb for lenders with a title opinion, and which can only be underwritten as either internal risks of the lender or external risks to be title insured. It is really quite that simple. In a commercial loan scenario, each of these three innocent lenders, if they had title policies, would have coverage in these circumstances. But the overriding point is that title insurance is the only available external product to fully address the risks raised in this case.
As for next steps, I would suggest as follows;
- Firstly, stay tuned. This case is going to appeal in 2016 and in my view it should be overturned. If it isn't, and the legislature doesn't fix the problem, then we will have a whole new set of things to discuss later this year.
- Secondly, in the meantime, err on the side of title insurance; and
- Thirdly, lenders should refresh their internal underwriting diligence with this case in mind. Remember the court's words that CIBC should have looked at the Malfeasants' historical financial record to determine how they could have afforded to obtain the Computershare discharge, and ask yourself if your "know your lender's clients' client" and underwriting diligence would have rooted out that fraud.