Defaulting on a Mortgage After Filing for Bankruptcy

In a recent Alberta decision, the court dismissed a claim against a mortgagee who had defaulted on his mortgage after filing for bankruptcy.

Mortgagee Defaults on Mortgage After Bankruptcy

The mortgagee had an insured, high-ratio mortgage with a mortgage finance company. His mortgage was in good standing when he became insolvent.

The mortgagee assigned into bankruptcy on March 8, 2019. After assignment, he kept the mortgage current for seven payments until June 2019. He continued to live in the house until September 2019, after which he gave it up. The mortgage payments were included as accommodation expenses in the list of discretionary expenses prepared by his trustee.

The mortgagee is set to be discharged from bankruptcy in 2022.

The mortgage was listed on the mortgagee’s statement of liabilities at $208,091.

After the mortgage went into default and the mortgagee moved out, the mortgage finance company started foreclosure proceedings and obtained a direct listing order. The Judicial Listing started at $249,900 and was reduced to $240,000 in January 2020.

However, the property did not sell and a new appraisal was obtained in March of 2020, which found the value to be $203,000.

The mortgage finance company sought an order for sale to itself at the $203,000 value and a judgment for the deficiency.

The mortgage contained an ‘ipso facto’ clause, stating:

“Default and Acceleration of the Outstanding Loan Amount

The Outstanding Loan Amount will become payable immediately, at our option, if:

[…]

e)   a petition in bankruptcy is filed against you, you make a general assignment for the benefit or your creditors, a receiver or a similar person is placed or is threatened to be placed in control of your affairs or your property, or in our opinion, you become insolvent.”

Legal Issues and Legislative Provisions

The court was faced with two issues:

1) the effect of reaffirmation and subsequent breach of a covenant to pay, post-assignment but pre-discharge;

2) whether reaffirmation amounts to a novation such that the reaffirmed obligation amounts to a new, post-bankruptcy debt not caught by section 121 of the Bankruptcy and Insolvency Act (the “Act”).

Section 84.2 of the Act provides:

“Certain rights limited

84.2 (1) No person may terminate or amend — or claim an accelerated payment or forfeiture of the term under — any agreement, including a security agreement, with a bankrupt individual by reason only of the individual’s bankruptcy or insolvency.

…

Provisions of section override agreement

(5) Any provision in an agreement that has the effect of providing for, or permitting, anything that, in substance, is contrary to this section is of no force or effect.

Powers of court

(6) On application by a party to an agreement or by a public utility, the court may declare that this section does not apply — or applies only to the extent declared by the court — if the applicant satisfies the court that the operation of this section would likely cause the applicant significant financial hardship.”

Section 84.2, which was part of the 2009 amendments to the Act, bar acting on the ipso facto clause unless the mortgage is actually in default, or the court grants relief from that provision.

Additionally, section 121 of the Act provides:

“Claims provable

121 (1) All debts and liabilities, present or future, to which the bankrupt is subject on the day on which the bankrupt becomes bankrupt or to which the bankrupt may become subject before the bankrupt’s discharge by reason of any obligation incurred before the day on which the bankrupt becomes bankrupt shall be deemed to be claims provable in proceedings under this Act.

Contingent and unliquidated claims

(2) The determination whether a contingent or unliquidated claim is a provable claim and the valuation of such a claim shall be made in accordance with section 135.”

Court Dismisses Mortgage Finance Company’s Claim 

In its analysis, the court first explained that an action on the covenant to pay, where it is available, is contingent on two things: first, the mortgage must be in default, second, the value of the property must be less than the amount owing under the mortgage. If the two conditions are met over the course of the bankruptcy, pre-discharge, a claim on the covenant becomes a provable claim. If no proof is made, the debt is discharged with the bankrupt.

The court found that the deficiency was a provable claim that extinguished on discharge unless it fit within one of the exceptions, none of which applied.

The court also found that the deficiency itself had not been sufficiently proved and the opinions of value conflicted.

Additionally, the court noted that the mortgage finance company’s action on the covenant was a provable claim and, as such, was only a declaration, not a judgment.

Finally, the court explained that:

“Liability on a covenant to pay in an insured mortgage that is reaffirmed post-assignment (or post-discharge) is not a novation and not a new (post-bankruptcy) debt. It is thereby not outside the bankruptcy. Accordingly, a default pre-discharge makes it a provable claim unless and until the default is cured, or waived by the creditor. The obligation created by a reaffirmation is best thought of as a continuation of an existing, or underlying obligation, on a potential liability that existed at the time of assignment.”

As a result, the court dismissed the mortgage finance company’s application for an order for sale with a deficiency judgment.

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For more than 25 years, the experienced litigation lawyers at DBH Law in Calgary have advised clients on a wide range of mortgage and foreclosure issues. We represent both borrowers and lenders in this highly technical and generally complex area of law. Our goal is to always resolve mortgage disputes and foreclosure issues quickly and efficiently and to bring them to the most satisfactory end for our clients. Our knowledgeable team of lawyers and staff will be with you every step of the way, providing perspective by focusing on what’s important and working to keep your property in your hands. Please contact us online or by phone at 403.252.9937 to see how we can help you today.