By: Jim Shanks (Toronto) The internet is famous for transforming unique new businesses
into giant behemoths, seemingly overnight. Names like Amazon
and Facebook are just two examples. While the recent internet
phenomenon of Peer-to-Peer (P2P) lending, now starting to
accelerate in the US, may not experience nearly as much success, it
certainly bears watching as a potential new source of consumer and
small business credit. Briefly, in P2P lending, a website is established to connect
potential borrowers seeking consumer or small business loans to a
myriad of largely unsophisticated lenders looking for investment
opportunities. Typical borrowers desire loans of up to
$35,000 at interest rates potentially lower than what banks, or
finance and credit card companies might otherwise offer them.
Lenders in turn seek returns above those available from
deposit-taking institutions or from current bond yields. In order to obtain credit, a potential borrower registers with
the P2P website, describes the loan he (or she) is requesting, and
makes certain financial disclosures, including as to his (or her)
current income, debt-to-income ratio, credit score, employment
status, home ownership, occupation, existing indebtedness and
delinquencies, etc. The web operator then uses this
information to assign a proprietary risk rating and interest rate
to the loan. The risk rating, interest rate and supplied
financial information, along with a fictitious borrower screen
name, are then posted by the web operator to a webpage where
potential lenders can subscribe for a portion of the loan
requested, notably in principal amounts as small as $25. The
borrower's identity is not disclosed to potential lenders, but
is kept confidential by the P2P operator. Potential lenders, whose identities are similarly not divulged,
also register with the website. Once a sufficient number of
lenders has subscribed for the requested loan amount, the loan is
funded, often within a few days. All P2P loans are unsecured,
have terms of one, three or five years, and are repayable in equal
monthly installments over the life of the loan. Full and
partial prepayments are permitted without penalty, an important
feature that may not be available from financial institutions
offering comparable loans. Lenders diversify their individual
borrower risk by subscribing for small amounts from amongst a
number of different borrowers across a range of asset classes.
Assets classes include auto and RV loans, credit consolidation
loans, home improvement loans and small personal loans, even
wedding loans. P2P operators take a percentage of the principal loan amount
advanced as a closing fee, charge borrowers for late or failed
payments, and charge additional fees to lenders for services
rendered during the life of the loan, for example a one percent
servicing fee on the principal of loans outstanding. A
collection agency recovery fee is charged if defaulted loans are
assigned to a debt collection agency. A financial institution
assists the P2P operator with the administration of ongoing
payments and collections. One current P2P operator in the US advertises two million
members and more than $670 million in loans advanced
to-date1, while its main competitor recently reported a
total loan volume over $1 billion as of 2012.2 P2P
operators are even attracting high profile individuals to serve as
directors on their company boards.3 More notably,
sophisticated lenders have begun participating in the new
marketplace, with at least one report suggesting that hedge funds
and smaller US banks are now lending at P2P websites as a means to
earn returns ranging from 6 to 35%.4 To top it
off, Google recently announced an investment of $125 million in one
of the two main P2P web operators in the US, adding a measure of
increased credibility.5 So far in Canada, at least
one P2P lending foray has been attempted.6 Not surprisingly, there are a number of legal issues involved in
setting up a P2P lending business, including under applicable
securities laws, licensing laws, and laws governing personal
privacy, information collection, electronic commerce, consumer
protection, interest rate disclosure and usury to name but a
few. Over the shorter term, these regulatory constraints will
likely serve as high barriers to entry, especially in Canada where
the P2P marketplace is likely to be much smaller than in the
US. Nevertheless, over the longer run, regulators on both
sides of the border may be inclined to ease some of the more
onerous regulatory impediments in order to facilitate even greater
access to limited amounts of consumer and small business credit at
reduced cost, especially if the initial US experience continues to
remain positive. Beyond the imposing regulatory issues, there are also practical
hurdles as well. First and foremost is the fact that the
internet is seemingly infested with scams and scammers. P2P
operators attempt to weed out the fraudsters by verifying the
identity of the borrowers and by attempting to verify certain of
the personal financial information supplied by borrowers, including
by operator requests for backup documentation. Still, it may
not be possible to accurately verify all the financial information
posted by potential borrowers. Furthermore, as the principal
loan amounts involved are small, formal enforcement mechanisms such
as by court action may not be practical in most cases.
Instead, debt collection agencies will likely be the preferred
enforcement mechanism for P2P operators. And finally, even
though default rates are apparently declining in the US, and
additional sites now exist that assist lenders in predicting the
creditworthiness of their P2P portfolios7, default rates
may still vary widely, from less than one percent to as high as six
percent, depending on the borrower, his (or her) financial status,
and the asset class.8 What impact will this new and unique internet business have on
more traditional forms of consumer and small business lending if it
ever crosses the border for good into Canada? For now, it
seems hard to say given the relative size difference between the US
and Canadian credit markets. Whatever the expectation, it
would probably be prudent for Canadian industry participants to
watch the evolving US experience closely as this potential new
source of consumer and small business credit continues to
grow.9 1. See Prosper Market Place, http://www.prosper.com/, data current to
10/18/2013. A detailed report of the recent upsurge in loan
origination at Prosper can be found here: http://www.orchardplatform.com/blog/?p=556. By: Marie-France Beland (Montréal) and Ingrid Anton
(Montréal) Q: The bank's cross-country security package includes a
moveable hypothec registered in Québec charging the
Québec assets. Our borrower wants to know why the amount of
the hypothec is larger than the aggregate amount of the credit
facilities. How is the amount of the hypothec determined, and is it
intended to be limited to the value of assets located in
Québec? A: Québec hypothecs differ from common law security in that
the amount guaranteed by the security must always be stated and
such amount must be in Canadian currency in order for the hypothec
to be valid. Being an essential stipulation, the amount of the hypothec
cannot be changed by an amending agreement and this is the reason
why the amount of the hypothec must be sufficient to secure the
obligations described therein. The amount of a hypothec is largely
theoretical because a hypothec is an accessory: when exercising its
rights under a hypothec, a lender can only obtain the amount that
is actually owed to it, regardless of the amount of the hypothec,
insofar as the amount is large enough to cover such secured
obligations. For this reason, it is better to err on the side of
caution and stipulate a larger amount than necessary. The benefits
of this practice are twofold: they protect the lender's rights
by ensuring that all obligations are guaranteed by the hypothec,
but they also save borrowers the cost of having to prepare and
grant a new hypothec every time credit facilities are increased.
Therefore it is preferable for the lender to take a single hypothec
in an amount large enough and containing a description of
guaranteed obligations broad enough to allow some flexibility in
this respect. For these reasons, the practice has developed in Québec
to add what is referred to as an "additional hypothec" to
the principal amount of each hypothec. As a result, the amount of a
hypothec in Québec usually corresponds to the total amount
of the credit facilities granted by the lender (regardless of the
value of assets located in Québec), plus the additional
hypothec, which is meant to secure the payment of interest and
other costs, expenses and amounts payable to the lender, which are
not otherwise secured by the principal hypothec. It must be noted,
however, that Article 2667 of the Civil Code of Québec
specifically excludes extra-judicial professional fees from the
obligations than can be secured by a hypothec. Therefore, any legal
fees incurred by the lender for the recovery of principal and
interest or for conserving the charged property cannot be included
as part of the "costs" secured by the additional
hypothec. Such additional hypothec is generally granted in an amount
ranging from 15% to 30% of the amount of the principal hypothec,
but the most common practice is to add an additional hypothec of
20%. As a result, the amount of a hypothec will usually range from
115% to 130% of the total credit facilities. The additional
hypothec can be presented textually in two ways: it is either
included in the overall amount of the hypothec in a single clause
stipulating the total amount, or the amount of the hypothec is
initially stipulated in a principal hypothec clause as an amount
equal to the total amount of the credit facilities, with the
additional hypothec stipulated in a separate clause known as the
"additional hypothec clause". Finally, it should be noted that the amount of a hypothec must
always be stated in Canadian dollars. For that reason, in cases
where the credit facilities are stipulated in foreign currency, the
amount of the hypothec is adjusted in consequence. For example,
where credit facilities are stipulated in U.S. dollars, the general
practice is to obtain a hypothec in a principal amount of 150% (in
Canadian dollars) of the total credit facilities (in U.S. dollars)
in order to allow for currency fluctuations. In the same way, where
credit facilities are stipulated in Euros, for example, an even
higher principal amount would be stipulated. By: Jeffrey Oliver (Calgary) and Danielle Marechal
(Student-at-Law) (Calgary) A recent decision of the Alberta Court of Queen's Bench in
Tallgrass 10 clarifies the threshold that a company must
meet when it seeks relief pursuant to the CCAA 11,
particularly when such an application is met with a competing
application by a secured lender for the appointment of a
receiver. In this case, the Court was considering such competing
applications, as Alberta Treasury Branches
("ATB"), the Debtor's senior secured
creditor, applied for the appointment of a receiver with the
support of the second in priority secured creditor Toscana Capital
Corporation ("Toscana"). The historical attempts by the Debtor to find alternate sources
of financing were critical to the Court's ultimate analysis in
this case. The Debtor was extended two secured loans: a
credit facility from ATB and a bridge loan credit facility from
Toscana (collectively the "Secured
Lenders"). Upon the maturity of the bridge loan
facility, the Debtor began to look for traditional financing to
replace the bridge financing. As no conventional financing
was available, the Debtor began to explore the availability of
non-conventional financing. Toscana agreed to forbear from enforcement of the bridge loan
for a certain period to provide the Debtor with additional time to
finalize financing alternatives. Following the expiry of this
period, the Secured Lenders issued demands against the Debtor.
Upon the issuance of the demands by the Secured Lenders, a
financial advisor (the "Advisor") was
retained to provide reports to the Secured Lenders. The
Secured Lenders granted further forbearance until the receipt of
these reports. Once the reports were received, the Secured
Lenders advised the Debtor that they were no longer prepared to
forbear and that they intended to bring an application to appoint a
receiver. In response, the Debtor sought an initial order
under the CCAA. The Alberta Court of Queen's Bench dismissed the
Debtor's application for an initial order under the CCAA and
approved the Secured Lenders' application for a receivership
order. In the Court's Reasons for Judgment, Madam Justice Romaine
highlighted that an order under s. 11 of the CCAA is discretionary.
Notwithstanding the fact that an applicant may meet the
technical requirement for an initial order under the CCAA, an
applicant must also satisfy the court that circumstances exist that
make the order appropriate. In that regard, a key issue
addressed by Madam Justice Romaine was whether the Debtor could
establish that there was any reasonable possibility that the Debtor
would be able to restructure its affairs. For a Debtor to
establish that it has a reasonable possibility of restructuring its
affairs, Justice Romaine stated the Debtor does not need to show a
fully developed plan. Rather, the Debtor must show evidence
of a "germ of a reasonable and realistic plan",
particularly where there is opposition from the major stakeholders
most at risk in the proposed restructuring. The Court, in considering the restructuring options proposed by
the Debtor, found that although the proposed options were
sufficiently detailed, they were not realistic or commercially
reasonable. Specifically, the Court noted that the Debtor had
exhausted any chance of finding conventional funding and that the
Debtor had been unable to secure any firm commitments for
non-conventional funding. Due to the lack of realistic or commercially reasonable
restructuring options, the Court found that if an initial order
were granted, it would likely result in a liquidating CCAA.
Although a liquidating CCAA is not itself precluded, the Secured
Lenders in this case objected to the Debtor's management
controlling the liquidation process as the Secured Lenders had lost
faith in the management of the Debtor. The Court went on to
note that this was not a case where the Secured Lenders had acted
impulsively, as the Debtor had more than adequate opportunity to
canvass the market for refinancing and restructuring options and
had been unable to do so. The Court further stated that because the
Debtor and Secured Lenders were in an adversarial mode, this would
not bode well for an inexpensive CCAA restructuring. Finally, the Court noted that the fundamental purpose of an
initial order under the CCAA is to permit a company to carry on
business and, where possible, to avoid the social and economic
costs of liquidating its assets. However, in this case, the
Debtor was a company with very few employees, a handful of
independent contractors, and relatively minor unsecured debt.
In other words, the Debtor did not carry on a business that
had broader community or social implications that may require
greater flexibility from creditors. In the case of the
Debtor, the major stakeholders were the Secured Lenders, who
opposed the CCAA application. In light of these findings, the Court was not satisfied that a
CCAA order would be appropriate in the circumstances. As
such, the Court dismissed the Debtor's application and approved
the Secured Lenders' application to appoint a receiver. This case serves as a reminder that an application for a CCAA
initial order must be accompanied by a realistic and commercially
reasonable "germ" of a plan, and the court will
critically examine such proposed plans. Further, it also
illustrates that the more a debtor lacks the hallmarks of the most
large and difficult CCAA restructurings (such as groups of broad
and diverse stakeholder groups), the more the debtor must ensure
that its proposed plan is reasonable and realistic. 10. Alberta Treasury Branches v. Tallgrass Energy Corp.
2013 ABQB 432 [Tallgrass]. By: Kelby Carter (Toronto) It is well established that having a personal guarantor obtain
independent legal advice before signing a guarantee is not an
essential element to the enforceability of a guarantee by a
lender. However, a recent decision of the Ontario Superior
Court of Justice serves as a helpful reminder of some of the
benefits of obtaining independent legal advice to support a
guarantee. In reaching his decision, Justice Perell revisited earlier case
law13 confirming that (i) a bank is under no obligation
to ensure that a guarantor obtains independent legal advice, and
(ii) a bank has no obligation to advise the guarantor of the legal
risks associated with the particular transaction.14 Justice Perell specifically referred to the Featherstone
case,15 where the court stated that the primary purpose
for a bank requesting a certificate of independent legal advice is
to avoid, if possible, the guarantor later raising defences such as
non est factum, unconscionability, fraud, misrepresentation or
undue influence. Further, as the burden of proving each of
these defences rests on the guarantor, requiring independent legal
advice can serve to significantly restrict the availability of
those defences.16 Upon a review of the evidentiary record, Justice Perell
determined that the guarantors in 2240094 Ontario would not be able
to establish non est factum, however, there was enough evidence to
require a trial for misrepresentation. The bank's motion
for summary judgment was dismissed, however, this was not a
dismissal of the bank's claim against the guarantors. What is interesting about this case is that the guarantors were
both very young (19 and 21 years old) and guaranteed a small loan
of $29,325. Additionally, the guarantors were the sons of the
principal owner of the borrower. While they apparently
appreciated the liability that they were taking on, there is
question as to whether they understood the full extent of that
liability and the nature of the legal risk that they were
assuming. In assuming this liability, the guarantors solely
relied upon the information that they had received from the
bank's representative. Justice Perell stated that, in his opinion, had the guarantors
received independent legal advice, it is arguable that they would
have been advised to refuse to sign the guarantee and this case
would not have been before him.17 In his
view, a competent lawyer would have warned them about the
danger of relying on any advice or assurances from the bank
alone. Based on his comments, it appears that Justice Perell
was motivated to help the guarantors because of their young age and
lack of sophistication. The fact that the guarantors were in
a potentially vulnerable family position (signing guarantees for a
loan to their father's business) may have also played a
role. Although the final outcome of this case is currently unknown (as
it awaits trial), what is apparent is that, while not mandatory,
independent legal advice is a useful litigation avoidance
tool. There will of course be cases where the dollar value of
the loans guaranteed does not justify the costs involved in having
a guarantor obtain independent legal advice. However, where
loan values warrant it or the guarantor appears to be a vulnerable
relationship with the borrower or its principals, requiring that a
guarantor receive independent legal advice is recommended. 12. Royal Bank of Canada v. 2240094 Ontario Inc., 2013
ONSC 2947. [2240094 Ontario] By: Lisa MacDonnell (Toronto) In a recent edition of Fully Secured (June 26, 2013 –
Volume 4, No. 2), we reported on the Ontario Court of
Appeal's decision inin Samson18 and its impact on
the enforceability of standard form guarantees. In Samson, the
Court of Appeal overturned the earlier decision of the Ontario
Superior Court of Justice which held that a continuing guarantee of
a borrower's present and future debt was unenforceable on the
basis that the guarantor had not consented to material changes to
the underlying loan agreement. In summarizing its
conclusions, the Court of Appeal determined that while the
increased loan advances made by the lender to the borrower were
material alterations to the principal loan agreement, they were
also contemplated by the parties, permitted by the clear language
of the guarantee, and inherent in a continuing all accounts
guarantee that contemplates increases in the size of the underlying
indebtedness. The Guarantor applied for leave to appeal the Court of
Appeal's decision, and that application was dismissed by the
Supreme Court of Canada on November 14, 2013. Lenders can take
comfort that the clear language of a standard form guarantee
continues to be enforceable in accordance with its specific terms
in circumstances similar to those present in Samson. 18. Royal Bank of Canada v. Samson Management &
Solutions Ltd., 2013 ONCA 313 [Samson]. By: Richard Dusome (Toronto) If Peter Morton and Cinitel Corp. had their way, every lender
would have a distinct duty to a guarantor to permit the sale of a
defaulting borrower's assets as a going concern. In their
view, a lender should be required to maximize its recovery from the
borrower and to minimize any claim made on a guarantee.
Fulfilling that duty would also obligate a lender to keep funding a
borrower while that asset sale was negotiated and completed.
It is enough to make any lender cringe. Fortunately, the Ontario Court of Appeal disagreed with Morton
and Cinitel's view of the lending world. In O'Brien19, the Court faced a fairly typical
fact situation where Fifth Third Bank provided certain credit
facilities to MPI Packaging Inc., the indebtedness under which was
guaranteed by Morton and Cinitel, both of whom were related to the
Borrower20. The Borrower defaulted on its loans,
and a court-appointed receiver sold the Borrower's
assets. The Bank sued Cinitel and Morton on their guarantees
to recover the multi-million dollar shortfall following
realization, and upon a motion obtained summary judgment against
the guarantors. In advancing their appeal, the guarantors specifically argued
that (1) the Bank failed to act in a commercially reasonable manner
in realizing upon its security by failing to allow the sale of the
Borrower's assets as a going concern, and (2) the Bank and the
Borrower made material alterations and variations in the terms of
the Borrower's loan facilities without the consent of Cinitel
and Morton21. Surprisingly, Morton and Cinitel did not allege that the price
obtained by the receiver for the assets was commercially
unreasonable, but rather that the decision of the Bank to appoint a
receiver and pursue a liquidation sale rather than a sale as a
going concern was unreasonable. The Bank had a separate and
distinct obligation to the guarantors to protect and preserve the
Borrower's assets which had not been fulfilled in their view.
The Court of Appeal disagreed with the guarantors and
unanimously concluded that the Bank's conduct in realizing upon
its security was not commercially unreasonable in the
circumstances22. It held that (1) the concept of
commercial reasonableness should not be extended beyond collateral
realization, and (2) the Bank's reliance upon its strict legal
rights in the context of a commercial lending transaction between
sophisticated parties who have been represented by counsel could
not be regarded as commercially unreasonable. The Court noted
that the Bank had not entered into a formal forbearance agreement
whereby the Bank had agreed to continue to fund the Borrower while
efforts were undertaken to dispose of the Borrower as a going
concern. Consequently, there was no requirement in their view
for the Bank to continue to extend credit to the Borrower and
thereby increase its exposure when its loan agreements had
expired.23 Morton and Cinitel's allegation that material variations had
been made to the Borrower's credit facilities without their
consent was also dismissed by the Court of Appeal, which found that
all of the changes were authorized by the principal loan agreements
and the guarantees. The guarantors had been intimately
involved throughout the efforts to resuscitate and sell the
Borrower's business, and were fully aware of the Bank's
contractual arrangements with the Borrower and the terms of their
guarantees.24 It is encouraging to see that the Court of Appeal in O'Brien
held these sophisticated guarantors to the terms of the business
deal they had bargained for. The Court firmly rejected the
imposition of new duties upon lenders in making decisions about
extending credit or continuing to extend credit, and about
realization remedies to pursue. This decision should help to
close the door on inventive guarantor defences, at least for a few
minutes anyways. 19. Fifth Third Bank v. O'Brien, 2013 ONCA 5
[O'Brien] The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
P2P Lending: A New Source of Consumer and Small Business
Credit?
2. See Lending Club, https://www.lendingclub.com/, and specifically
https://www.lendingclub.com/public/lending-club-press-2013-02-06.action.
3. See note 2.
4. "P2P Lending Pulls in Big Investors – Should you
bite?", Feldman, A. and Pinsker, B., Reuters Money,
08/27/2013; http://www.reuters.com/article/2013/06/25/us-debt-loans-p2p-idUSBRE95O0M220130625.
5. "Need a Small Business Loan? Google hopes so",
Scarrow, K., The Globe and Mail, 05/09/13; http://www.theglobeandmail.com/report-on-business/small-business/sb-tools/small-business-briefing/need-a-small-business-loan-google-hopes-so/article11819232/.
6. But CommunityLend appears to have suspended its operations in
Canada as of February, 2012 (Press Release: http://www.financeit.ca/blog/2012/02/23/onwards-and-upwards/.)
7. See Nickel Steamroller: http://www.nickelsteamroller.com/.
8. See note 4 above.
9. See generally Lend Academy, a website dedicated to advising
potential lenders on various aspects of P2P lending, http://www.lendacademy.com/.A Banker Asked Us: Determining the Amount of a Québec
Hypothec
Alberta Court Clarifies Threshold for CCAA Filing
11. Companies' Creditors Arrangement Act, RSC 1985, c C-36, as
amended [CCAA]Some Benefits of Independent Legal Advice
In 2240094 Ontario 12, a motion for summary judgment
was brought by the bank against the loan guarantors. The loan
guarantors had previously signed a guarantee under which they
agreed to be jointly and severally liable for a corporation's
indebtedness. When the corporation defaulted on its loan from
the bank, the guarantors did not make payment.
13. Bank of Montreal v. Featherstone (1989), 68 OR (2d) 541 (Ont
CA); Royal Bank v. Poisson (1977), 26 OR (2d) 717 (Ont HC); Bertolo
v. Bank of Montreal (1986), 57 OR (2d) 577 (Ont CA); Royal Bank v.
Hussain (1997), 37 OR (3d) 85 (Ont Gen Div); Royal Bank v. 966566
Ontario Inc., [2000] OJ No 606 (Ont SCJ).
14. 2240094 Ontario at para. 15.
15. Bank of Montreal v. Featherstone (1989), 68 OR (2d) 541 (Ont
CA) [Featherstone]
16. 2240094 Ontario at para. 16.
17. 2240094 Ontario at para. 25.Guarantor's Application for Leave to Appeal in the Samson
Case Dismissed by the Supreme Court of Canada
Sophisticated Guarantors Held to the Terms of Their Deal
20. The Court of Appeal's judgment does not specify the
specific relationship between Cinitel and the Borrower, and between
Morton and the Borrower. The Court simply describes them as
being intimately involved in the Borrower's contractual
arrangements. The decision of the motion judge does not
appear to have been commercially reported. Thus it is not
clear if Cinitel was a subsidiary or affiliate of the Borrower, or
if Morton was an officer or director of the Borrower.
21. O'Brien, at para. 3.
22. O'Brien, at para. 9.
23. O'Brien, at paras 12 and 13. The Court also noted
that there had been no agreement or representation by the Bank that
it would continue to support the Borrower financially while sale
efforts were undertaken (paragraph 16). The judgment suggests
that there was some discussion of forbearance, but that those
discussions were not completed and formalized into a signed
agreement.
24. O'Brien, at paras 17 and 18.
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