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In Greenpath Capital Partners Inc. v. 1903130 Ontario Ltd., the Ontario Court of Appeal confirmed that a mortgage forbearance agreement, between the borrower and a first mortgagee, did not preserve the latter’s priority over a second mortgagee’s interest.

The borrower owned a group of properties in Oakville that were subject to a first mortgage for over $7 million (“First Mortgage”). The borrower also gave a second mortgage to another lender for $700,000 (“Second Mortgage”).

Long before the First Mortgage maturity date, the borrower fell into arrears. It entered into a Forbearance Agreement with the first mortgagee, under which it agreed to pay almost $180,000 in three installments. This was in exchange for the first mortgagee agreeing to forbear its enforcement remedies temporarily. However the borrower breached the terms of the Forbearance Agreement soon after.

The first mortgagee then commenced power of sale proceedings, and managed to sell the properties for $9 million. This led to a dispute over the precise amounts due under the First Mortgage, and the extent of the second mortgagee’s entitlements.

Initially, the first mortgagee had claimed $7.5 million in its Notice of Sale. However, in its later discharge statement, it claimed nearly $8 million, which now included what were collectively termed the “Disputed Amounts”. These consisted of: (1) a “prepayment penalty” of $100,000; (2) a “default fee” of nearly $200,000 claimed under the Forbearance Agreement; and (3) about $2,000 per day in interest.

The first mortgagee then paid over $500,000 to the second mortgagee, still leaving it with a shortfall of $240,000. The second mortgagee objected to the first mortgagee retaining the Disputed Amounts for its own benefit, arguing that: (1) the so-called “prepayment fee” was invalid, since the term of the loan had already expired when the property was sold; and (2) the “default fee” was in violation of s. 8(1) of the Interest Act. The Second Mortgage accordingly claimed it had priority over $240,000 of those funds.

Both the lower court judge and the Court of Appeal agreed with the second mortgagee. Firstly, the added charges that made up the Disputed Amounts did not arise under the First Mortgage – rather, they arose under the Forbearance Agreement to which the second mortgagee was not privy. This rendered the Forbearance Agreement unenforceable as against the second mortgagee.

Next, the standard charge terms in the First Mortgage provided that the principal balance could only be increased through the addition of interest, and not otherwise. This meant that even if the full Disputed Amounts were indeed covered by the First Mortgage, they were an unlawful penalty in breach of s. 8 of the Interest Act (which provides that no fines, penalties, or rates of interest can be taken or imposed on arrears secured by a mortgage that had the effect of increasing the charge on the arrears beyond the rate of interest payable on funds not in arrears). Nowhere in their agreement had the parties contracted-out of s. 8.

Finally, even when considered separately, the components of the Disputed Amounts violated s. 8 of the Interest Act, and were unenforceable. Regarding the purported “default fee”, the first mortgagee had failed to prove that the amounts it claimed reflected its actual costs to recover the monies owed. This meant the default fee could only be reasonably characterized as added penalties or fines, also in contravention of s. 8.The same was true of the “prepayment fee”, since it didn’t cover expenses actually incurred nor were the amounts equivalent to the three months’ interest calculated in accordance with the bonus allowed-for under s. 17 of the Mortgages Act. At any rate, this fee was otherwise uncollectable since it was being levied when the first mortgagee had already commenced enforcement proceedings.  Since these added fees from the Forbearance Agreement all amounted to invalid penalties, they were unenforceable as against the second mortgagee. The second mortgagee was accordingly entitled to $240,000 of the funds in keeping with its security interest. See Greenpath Capital Partners Inc. v. 1903130 Ontario Ltd., 2024 ONCA 42.