With his iconic lyrics Bob Marley famously pleaded “Won't you help to sing, these songs of freedom?”. Borrowers in two recent distress real estate mandates may now be singing that same tune, albeit in a somewhat different context than what the late Mr. Marley intended.
The two cases have interesting similarities and differences.
In one, there was substantial equity in the redeemed property. In the other, by all accounts, the redemption amount exceeded the property value. Both cases involved private offshore lenders being repaid by funds obtained from different private lenders with similar overseas connections. Both cases involved lengthy periods of forbearance and accommodations, ending by the appointment of a receiver when the borrower couldn’t obtain the promised financing by the time the lender’s patience ran out. In each case, prior to the commencement of a sale process, the borrower arranged the necessary financing and sought the indulgence and cooperation of the applicant creditor, the Receiver and the Court to implement the redemption and effect the discharge of the Receiver.
Is this a new trend? The obvious common themes appear to centre on the availability of foreign capital being invested into the relatively stable Canadian real estate market on “covenant light” terms. The principal goal may be to move money into a capital preserving investment in a stable economy and political environment, with a rate of return as a secondary motive.
In a 2018 proceeding, three related Ontario companies borrowed in excess of US$50 million from China Machinery Engineering Corporation (“CMEC”), a private lender based in China. The funds were used for the construction of the first of three proposed 20-storey multi-residential student housing towers in Waterloo, Ontario.
Due to difficulties obtaining construction financing for the second tower, the borrowers defaulted on their loans to CMEC. After a lengthy and contentious forbearance period, CMEC brought an application to appoint a Receiver over the three properties subject to the CMEC mortgage, being the fully occupied and operating student residence tower, the partially built second tower and an adjacent parcel of land intended for the third tower. In addition to the CMEC debt, fifteen lien claims totalling approximately $12 million relating to construction of the second tower were registered on title against one or more of the three properties.
After the receivership proceedings commenced, the debtors maintained that they intended to redeem the CMEC mortgage and repatriate the projects; however, they provided little initial evidence of their ability to do so and the Receiver’s independent property valuations compared to the quantum of the CMEC debt seemed to make any redemption improbable. As a result, the Receiver retained a listing agent and a sale process was approved. In order to accommodate the requests of the debtors, the marketing of the properties was suspended for a limited period to provide the borrower a final opportunity to raise financing.
The borrowers were ultimately successful in locating sufficient capital by levering several of their other projects and obtaining a first mortgage from a Canadian institutional lender and a second mortgage from an investor/lender party whose identity was kept anonymous. The Receiver required that the borrowers enter into satisfactory arrangements with the construction lien claimants to ensure that they were aware of the redemption and its implications for them. Once these pieces were in place, the borrower, CMEC and the Receiver worked together to coordinate the borrowers’ motion to lift the stay in order to complete the redemption and to discharge the receiver. The Order approving the redemption and discharge was unopposed and was granted. The redemption was completed shortly thereafter and the borrowers resumed construction of the second tower.
The 2019 receivership proceedings involving Besco International Investment Co., Ltd. (“Besco”) involved a 150,000 square foot industrial building situated on a 25-acre property in Port Hope, Ontario (the “Besco Property”). A portion of Besco’s acquisition funding for the Besco Property was obtained from a private lender based in China, who registered a first mortgage against it. The Besco Property was occupied by a single tenant, being a prefabricated home manufacturing business owned by Besco’s principal shareholder, which at the time of the receivership, was not operating.
Following Besco’s initial defaults under the mortgage, the lender had agreed to forbear while Besco sought alternative financing. Further defaults under the mortgage and forbearance arrangement resulted in the lender subsequently attempting to foreclose on the Besco Property and Besco resisting by court proceedings asserting deficiencies in the mortgage documents. Despite several appraisals suggesting several million dollars of equity in the Besco Property beyond the amounts owed to the lender, and the passage of over six months while the mortgage documentation dispute was being litigated, Besco was unable to secure alternative financing. Ultimately, the lender succeeded in its Court application to appoint a Receiver over the Besco Property. At the borrower’s request, Mr. Justice Penny agreed to defer the operation of the order appointing the Receiver for a 30-day period to allow Besco yet another 30-day period to secure replacement financing. Besco was, again, unable to do so.
Following its appointment, the Receiver conducted its diligence on the Besco Property, identifying substantial property tax arrears and the unusual tenancy arrangement with the related party. The Receiver also commenced formulating a sale process which included soliciting proposals from realtors. During this initial period, Besco and its financial intermediaries continued their efforts to source fresh capital. As a result of those efforts, Besco presented the Receiver and the lender with three short term (under one year) loan agreements from three non-traditional financing sources for new first, second and third mortgages in an aggregate amount sufficient to repay the existing lender and cover the Receiver’s administration expenses, but insufficient to pay the property taxes, which ranked in priority to the existing mortgage. In order to address this, the Receiver required that a formal payment plan agreement be reached between the borrower and the Municipality of Port Hope, and that the three new mortgage lenders confirm that they were aware of the property tax arrears and were prepared to close notwithstanding the priority ranking and outstanding balance.
Based on the documents provided and the evidence of the availability of the redemption funds, and after consultation with the applicant mortgage lender, the Receiver advised Besco that it would support a motion seeking to lift the stay of proceedings in order to permit Besco a limited time period to redeem the existing mortgage and satisfy the administrative costs of the Receiver, failing which the Receiver would immediately bring a motion seeking approval of a sale process for the Besco Property. In his endorsement dated May 24, 2019, Justice Pattillo noted that he was “satisfied that the order requested should issue and the receiver be discharged on completion of the refinancing only”. Besco completed the redemption a week later.
Some key takeaways from these two proceedings include:
- The borrowers resisted the receivership applications and the effects of the receivership orders well after the orders were made. In each case, the borrowers were undeterred in their efforts to raise alternative financing and clearly did not want to lose control over their properties. It was evident that the borrowers wanted to avoid a sale process that could have resulted in them losing the properties to another bidder.
- The Court was sympathetic to the borrowers’ plight and granted indulgences to permit a redemption. This may be due, in part, to the relative prejudice to the parties. Real estate is not a wasting asset in the current market. The indulgences were balanced by protocols to ensure that the prejudices to the lenders were minimized and a discipline imposed on the borrowers.
- Capital appears from a variety of sources. While this situation is not unique to Canadian real estate, it certainly leads one to believe that some of the available funding is motivated by a desire to move capital to a stable asset in a stable economy. The two cases also demonstrated that the lending criteria applied by foreign investors and lenders is not as rigorous as domestic capital, governed by more traditional risk-adjusted returns on capital .
- Receivership is not always a final destination. In situations involving real estate, so long as the borrower acts quickly and credibly, the Courts will allow the “egg to be unscrambled”. It remains to be seen if such a process could be invoked in the more complex situation such as in the receivership of an operating business.
Should we expect Redemption Song to creep back into the 2020 Billboard 100? Likely not, but as long as there is international capital to be deployed, and Canada continues to be seen as a stable and secure market, then it won’t be surprising to see other real estate enforcement proceedings interrupted by a redemption rather than proceed to a sale.