Would The Real Guarantor Please Stand Up

Not all guarantees are created equal. There is considerable confusion amongst mortgage lenders when structuring a mortgage loan highlighted by a recurring tendency to insist on a guarantee from the beneficial owner of the real property subject to the mortgage. In other instances, where a partnership is a credit party, there is an equally confusing tendency for mortgage lenders to insist on a guarantee from the general partner(s) that signs the loan documents as general partner(s) for and on behalf of the partnership. These trends reflect a fundamental misunderstanding of the law of agency, guarantee and partnership, which frequently results in a muddled loan structure. Fortunately, cleaning up the loan structure is straightforward.

Mortgage Context

Mortgage lenders generally want the borrower to be the registered owner of the real property over which the mortgage is to be granted. In many cases, however, the registered owner of real property is merely a special purpose entity holding registered title as a nominee and bare trustee for and on behalf of a beneficial owner which possesses the economic interest in the real property. In these circumstances, the beneficial owner must direct its nominee to enter into the loan and to grant the mortgage. In other instances, the registered owner is simply a general partner holding registered title in its capacity for and on behalf of a general or limited partnership.  

Regardless of the ownership structure, mortgage lenders frequently insist that the beneficial owner or general partner provide a guarantee. In the beneficial owner's case, this guarantee is demanded in addition to a beneficial security agreement under which the beneficial owner directs its nominee to enter into the loan documents and charges its beneficial interest in the real property as if it were an original signatory to those loan documents.

Whether sought from a beneficial owner or general partner, any such guarantee is effectively unenforceable as a result of two legal principles. First, it is a core tenet of the law of agency that an agent can bind the principal, on whose behalf and authority the agent acts while entering an agreement, as a primary obligor to the contract formed. Second, under the law of guarantee a person cannot be both the primary obligor and the guarantor of the same obligation: one may either owe a debt, or one may guarantee someone else's debt.

Agency, Partnerships and Guarantees

On one hand, the very basis of agency law is the ability of a properly authorized agent to affect the principal's legal relations with another person. When an agent acts with express authority on behalf of a named principal to enter a contract with a third party, the resulting contract is between the principal and the third party. This means that any obligations owed to and enforceable by the third party under the contract are considered at law as obligations of the principal itself, and the principal can sue and be sued on the basis of this direct contractual relationship.

This fundamental principle of agency has direct bearing to the mortgage-lending context. A nominee or "bare trustee" that is vested with the registered title to real property—without any discretion to independently deal with such real property—is considered the agent of the beneficial owner for all intents and purposes. Ontario courts have confirmed that in the "familiar case" of land held by a nominee corporation on behalf of a beneficial owner, it is the agency relation that predominates and the beneficial owner is personally liable upon contracts entered into by the nominee in the course of administering the real property under the direction of the principal—such as a mortgage.

Along similar yet distinct lines, the general partner of either a general or limited partnership acts as an agent for the other partners when acting with authority on behalf of the partnership and managing its business, such as by executing contracts. Whereas a nominee binds the beneficial owner of the real property by signing a mortgage, a general partner applying its signature to bind the partnership is itself also personally bound by the executed mortgage as a matter of statutory law.¹ Ontario courts have specifically affirmed that a general partner is personally liable, as a primary obligor, for the debts and obligations of the partnership in the name of which the general partner acts. In fact, it is established that "there is no legal distinction between actions taken in the name of a limited partnership and the actions of the general partner."

On the other hand, courts have also acknowledged the self-evident proposition that a person cannot guarantee the performance of its own obligation. The essence of a guarantee is a collateral or "secondary" promise to answer for the default of another person's "primary" debt or obligation. Beyond being an accepted legal principle, this is a simple matter of logic: a guarantee that one will perform one's own obligation adds nothing to the original obligation. Reduced to simplest terms, an effective guarantee requires a primary obligation to be guaranteed and a primary obligor who is not the guarantor.

Applied to the mortgage-lending context, it is clear that if a person is a mortgagor (or co-mortgagor) liable to pay on the covenants contained in the mortgage, that person is a primary obligor and cannot guarantee payment of the same primary indebtedness. The law will not recognize a so-called "guarantee" given by a primary obligor, promising to pay the debt to which the person is already liable.

When these principles are brought together, the conclusions are obvious: a beneficial owner that is bound by its nominee as a primary obligor to a mortgage, or a general partner that is automatically a primary obligor by executing a mortgage, cannot also give an effective guarantee in respect of the same mortgage. While the parties are free to draw up a guarantee, it is unenforceable as the beneficial owner or general partner is already directly obligated to make good all obligations under the mortgage. Where a mortgage lender insists that the beneficial owner or general partner provide a guarantee, legal counsel to the borrower must qualify the enforceability opinion provided to the mortgage lender accordingly. At Bennett Jones, common qualifications read as follows:

"We express no opinion as to the enforceability of the Guarantee as against the Beneficial Owner where the guarantor thereunder is also a beneficial owner of the Property and is already liable to the Lender as principal debtor for the obligations guaranteed."

"We express no opinion as to the enforceability of the Guarantee as against [the General Partner] where the guarantor thereunder is also the general partner of the Borrower and is already liable to the Lender as principal debtor for the obligations guaranteed."

It is surprising that many mortgage lenders stand firm and demand a guarantee from the beneficial owner or general partner, as the case may be, only to readily accept these qualifications in a required enforceability opinion that openly disaffirm the enforceability of the guarantee. These tendencies are demonstrative of a widespread breakdown in understanding among mortgage lenders of what they are truly asking for and accomplishing when insisting on such guarantees.

Summary of Possible Structures

With respect to beneficial owners and nominees, the easiest way to rectify this common misunderstanding is to perceive the basic options for structuring the credit parties to a mortgage loan in descending order of sensibility and preference:

1. The Optimal Approach: The beneficial owner reflected as the borrower and the nominee identified as its nominee, with the parties simply referring to the nominee's agency relationship to the beneficial owner in the beneficial security agreement.
2. The Common and Sensible Approach: The nominee reflected as the borrower and the beneficial owner identified as the beneficial owner of the real property, with the parties simply referring to the nominee's agency relationship to the beneficial owner in the beneficial security agreement.
3. The Acceptable Approach: The nominee and the beneficial owner both reflected as co-borrowers, notwithstanding that the parties must still refer to the nominee's agency relationship to the beneficial owner in the beneficial security agreement.
4. The Rather Nonsensical Approach: The beneficial owner reflected as the borrower and the nominee identified as its nominee while also providing a guarantee of the loan in the nominee's personal capacity (i.e., not as the nominee and bare trustee of the beneficial owner). There is typically very little value in such a guarantee given the customary special purpose nature of the nominee such that the nominee will hold no assets beyond registered title to the real property. Moreover, obtaining such a guarantee from the nominee essentially duplicates the issues raised in connection with the beneficial owner's guarantee impugned in this blog, as mortgages very rarely indicate that the mortgagor is signing only as agent for another. Absent such express language, the mortgage – as a contract signed by the nominee in favour of the mortgagee – is personally binding on the nominee by operation of accepted common law principles. Accordingly, as the nominee is already a primary obligor for the mortgage loan pursuant to the mortgage it cannot also be a surety of its own indebtedness pursuant to a guarantee.This analysis also applies where a general partner is holding legal title to mortgaged property as a nominee and bare trustee for and on behalf of a partnership as opposed to in its capacity as a general partner of such partnership.
5. The Wholly Senseless Approach: The nominee reflected as the borrower and the beneficial owner reflected as a guarantor, with the guarantee being unenforceable for the reasons discussed above.

With respect to general or limited partnership borrowers, the optimal approach for mortgage lenders is straightforward. The general partner that holds registered title need not be identified beyond the signature block of the partnership on behalf of the partnership for which it signs the mortgage, and is thereby automatically personally liable as a primary obligor. If this arrangement is uncomfortable, the lender may structure the mortgage so that the general partner is listed as a co-borrower or simply reflected as another credit party with joint and several liability for the debt and obligations. The mortgage may expressly state that the general partner executes in its capacity as general partner for and on behalf of the partnership borrower or, where the partnership borrower would prefer to keep reference to the partnership off registered title, the parties may agree to complete an unregistered duplicate mortgage signed by the general partner for and on behalf of the partnership borrower. Regardless of the structure chosen, a general partner's guarantee adds nothing.

Key Takeaway

Mortgage lenders can save themselves material time and expense by refusing to fall victim to the legally fictitious but apparently widespread practice of insisting on guarantees from beneficial owners (or their nominees) or from general partners, as the case may be. These guarantees are unenforceable and unnecessary as the mortgage lender already has the benefit of the beneficial owner or general partner's covenant as a primary obligor, supported through the beneficial security agreement or plainly reflected in the credit parties to the mortgage.

To discuss how Bennett Jones can help your organization negotiate or navigate mortgage loans, and to receive a version of this blog with comprehensive case citations and explanatory footnotes, please contact one of the authors or another member of the firm's Commercial Real Estate Group.