Background
A recent Court of Appeal for Ontario (the "Court of Appeal") decision, 660 Sunningdale GP Inc. v. First Source Mortgage Corporation (2024 ONCA 252), highlights the importance of carefully drafting lenders' fee arrangements in commitment letters to finance real estate development projects.
The respondent, 660 Sunningdale GP Inc. (the "Borrower"), is a developer who pursuant to a commitment letter (the "Loan Agreement") agreed to pay a lender fee in the amount of $426,500 (the "Lender Fee") to the appellant, First Source Mortgage Corporation (the "Lender"), as part of the consideration for a multimillion-dollar loan offered by the Lender. The Loan Agreement provided that the Lender Fee was to be partially payable with a $100,000 initial payment made at the time the Loan Agreement was accepted and executed, with the remaining payment of $326,500 to follow.
The Borrower paid the $100,000 initial payment upon executing the Loan Agreement but later decided not to proceed with the loan and did not pay the remainder of the Lender Fee. Litigation then ensued between the parties to resolve the payment obligations under the Loan Agreement.
The relevant provisions of the Loan Agreement dealing with the payment of the balance of the lender fee were identified by Justice Paciocco of the Court of Appeal as follows:
Article 2.01 is the clause that specifically identifies the Lender Fee as part of the consideration owed to First Source in return for First Source obtaining the loan commitment. It provides, "[i]n consideration of First Source obtaining this Commitment, the Borrower hereby agrees to pay a fee ... in the amount of 2.75% of the Loan Amount" (emphasis added). Article 2.01(b) also provides that "[t]he Lender Fee is deemed earned upon acceptance and execution of this Commitment."
At the lower court, the motion judge held that the $100,000 initial payment was payable to the Lender, but the Borrower was entitled to the release of the remaining balance of $326,500, plus interest, as the balance amounted to an unconscionable and unenforceable penalty. The motion judge also invoked relief from forfeiture as a second ground for relieving the Borrower of the obligation to pay the balance of the Lender Fee.
The Court of Appeal's Decision
The Court of Appeal held a different view from the lower court on whether the balance of the Lender Fee was payable. On appeal, the Court of Appeal found that the motion judge erred in finding the balance of the Lender Fee to be an unenforceable penalty. Under the terms of the Loan Agreement, the balance of the Lender Fee was not a "stipulated remedy" for a breach of the contract. Instead, the balance was payable irrespective of whether the contract was breached.
Justice Paciocco stated:
By the terms of the Loan Agreement, the Lender Fee is not payable as a stipulated remedy for a breach of the contract, but rather as consideration for First Source obtaining the loan commitment. As Article 2.01 states, "[i]n consideration of First Source obtaining this Commitment, the Borrower hereby agrees to pay a fee", identified as the Lender Fee. By its terms, the Lender Fee is payable as consideration whether or not the contract is ultimately breached by 660 Sunningdale. Put otherwise, the obligation to pay the Lender Fee does not arise because of conduct by 660 Sunningdale, as a remedy for that conduct. The Lender Fee provision is therefore not a stipulated remedy clause and, in my view, cannot be an unenforceable penalty clause.
The Court of Appeal further ruled that the motion judge also erred in granting relief against forfeiture as such a remedy is appropriate to relieve applicants of the consequences provided for in a contract as the result of their non-compliance with its terms. However, the Loan Agreement stated that the Lender Fee was earned at the time of acceptance and execution of the Loan Agreement regardless of whether the deal closed or not. Specifically, Justice Paciocco stated, "[r]elief against forfeiture may be available to relieve a party of the consequences of its non-observance or breach of the terms of a contract or covenant. The balance of the Lender Fee was payable under the terms of the Loan Agreement regardless of any breach or non-observance of its terms." As such, the Lender Fee was not compensation for breach of contract, it was a fee incurred for obtaining the Loan Agreement.
As a result, the Court of Appeal ordered that the $326,500 balance of the Lender Fee be paid by the Borrower to the Lender.
Key Takeaways
In this case, the Borrower had to pay $426,500 to the Lender in order to obtain a loan which ultimately failed to close.
The Court of Appeal's decision provides an illustrative example of the consequences that can occur when a contract is not drafted precisely to meet a client's objectives. The case provides guidelines to consider as to how contractual obligations and penalty clauses are interpreted in light of one another, and when relief against forfeiture will be granted.
If you are a borrower, you want to ensure that your commitment letters are carefully drafted so you need not pay unwanted lender fees. On the other hand, if you are a lender, you want to ensure that your costs incurred in sourcing, investigating, underwriting and preparing a loan are rightfully compensated to you.
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.