In certain circumstances, private lending is a popular and appropriate financing solution. Generally speaking, interest rates charged for private loans tend to be higher, which is attractive to the lender. Conversely, increased flexibility tends to be associated with private products, which makes it more likely that a loan may be tailored to meet the specific needs of a borrower, especially when the borrower is under pressure or requires funds for an extremely short term.
At Merovitz Potechin LLP, the Real Estate Team often receives requests from lenders and borrowers to prepare and register private mortgages. Occasionally, assumptions are made about this type of financing – that it is, by nature, a fast, inexpensive, and “easy” product to prepare. By extension, borrowers and lenders are often willing to overlook the most important document, the mortgage contract (or “Commitment”), in order to achieve faster registration and funding.
This article is a cautionary tale. It includes a brief description about the Commitment, and why it should never (ever) be overlooked.
Quite simply, the mortgage Commitment is a written contract between a lender and borrower. It functions similarly to any other written contract in law, in that it binds the parties to a series of terms (usually representations and covenants). The Commitment, which must be signed by both parties to be effective, sets out the parameters of the private loan, and governs the rights, obligations and responsibilities of both the lender and borrower.
Without a Commitment, the registration of a private mortgage on title to a piece of property (either residential or commercial) is nothing more than the registration of a “notice”, usually accompanied by a set of extremely basic terms. There is no contract between the lender and borrower establishing the parameters of the loan (unique or otherwise), and security requirements, in addition to the mortgage, are not addressed.
The lack of a Commitment may prejudice a private lender. For instance, if the borrower is a corporation with no other assets than the property, the lender may insist upon a Guarantee to back up its loan (either from a person or another corporation). Without a signed Commitment from the borrower and guarantor, consenting to the Guarantee, the lender will have nothing in writing in order to enforce this requirement. Furthermore, if the property is a multi-unit complex, the lender may wish to obtain other security, such as an Assignment of Rents, in order to garnish rents to offset mortgage payments if there is a default. Again, without a Commitment, the borrower may refuse to grant any other security before closing.
Conversely, a borrower may also be placed at a disadvantage if a Commitment does not exist. The Commitment creates a written record of the terms between the parties, so lenders are less likely to suggest a term, such as the interest rate, which is unreasonable or is against the law (i.e. breaches the Mortgages Act). A written Commitment will also discourage a private lender from requesting outlandish security or deliveries at the last minute (i.e. holding funds ‘hostage’), due to the risk that they will be accused of breach of contract.
Most importantly, for all parties, the terms of the Commitment will dictate the terms of the resulting mortgage registration. In other words, the mortgage must conform to the terms of the original contract, which both parties agreed to at the outset (and which both parties are presumably comfortable with).
Asking your lawyer to prepare a written Commitment for you will create immediate clarity about the terms of the loan, and will reduce the potential for future uncertainty. When considering a private loan, don’t forget to consider the Commitment.