The special case of private mortgages

Consumers are increasingly turning to private lenders for mortgage financings and re­financings. Whether this uptick is caused by mortgage stress tests, rising interest rates or borrowers simply wanting to cash in on the equity in their homes, the fact is that, in my opinion, lawyers are being asked to close a growing number of real estate transactions involving private lenders.

Consumers are increasingly turning to private lenders for mortgage financings and re­financings. Whether this uptick is caused by mortgage stress tests, rising interest rates or borrowers simply wanting to cash in on the equity in their homes, the fact is that, in my opinion, lawyers are being asked to close a growing number of real estate transactions involving private lenders. And while private mortgages are not something new in the legal profession, practitioners are faced with a unique set of challenges when dealing with private lenders. It is, therefore, crucial that lawyers understand these unique challenges and how best to overcome them.

The first question lawyers need to answer is whether the mortgage is, in fact, a private mortgage. A private mortgage is one involving a lender that does not fall into any of the exceptions listed in s.  24(2) of bylaw 9 of the Rules of Professional Conduct (such as Schedule I or II banks, registered loan or trust companies, licensed insurers, pension funds or other entities that lend money in the ordinary course). If a lender does not fall into any of these exceptions, chances are you are dealing with a private mortgage.

If the mortgage is a private mortgage, the next question a lawyer should ask is: Who is my client? Rule 2.04 (11) of the Rules of Professional Conduct expressly prohibits lawyers from acting for both a lender and borrower in a mortgage transaction unless one of the exceptions under Rule 2.04 (12) (the lawyer is practising in a remote location, the lender is a bank, trust company, insurance company or credit union or the consideration for the mortgage does not exceed $50,000) applies. Unless one of the exceptions listed in Rule 2.04(11) applies, a lawyer is prohibited from acting for both the lender and borrower on the same transaction. This is in contrast to real estate transactions not involving private lenders, where lawyers routinely act for borrowers and lenders on the same transaction. It is, therefore, crucial for lawyers to determine at the outset who their client(s) will be and whether the lawyer is prohibited from acting for one or both of their clients. It is also important to recognize that certain practices acceptable in the context of institutional mortgages are not acceptable when dealing with private mortgages. For example, where a property being acquired by a purchaser is subject to a mortgage in favour of an institutional lender, the purchaser’s lawyer can rely on an undertaking from the vendor’s lawyer to discharge that mortgage post-closing. This practice greatly simplifies and expedites closings and is standard practice among the real estate bar.

However, where the mortgage on that same property is a private mortgage, lawyers cannot give or accept an undertaking from the vendor’s lawyer to discharge that mortgage post-closing. A private mortgage must be discharged on or before closing. The purchaser’s lawyer will, therefore, be in a position where they cannot release funds to the lender’s lawyer to pay out the existing private mortgage (i.e., the new mortgage funds cannot be released until the private mortgage is discharged) and the lender’s lawyer will not discharge its mortgage until it receives closing funds. How does the purchaser’s lawyer deal with this challenge? It is acceptable practice to proceed on the basis of a three-party document registration agreement, signed by the vendor’s lawyer, purchaser’s lawyer and lender’s lawyer, which includes a discharge of the private mortgage by the private lender in the schedule of documents to be registered on closing. This way, payout funds can be paid to the lender’s lawyer in escrow pending registration of the discharge.

While not required, it is also recommended that a purchaser’s lawyer request, prior to closing, an acknowledgement and direction signed by the lender authorizing its lawyer to register a discharge of its mortgage on closing to ensure that the lender’s lawyer is in a position to register the discharge at the appropriate time.

Another challenge specific to private mortgages relates to title insurance. Policies of title insurance often include an exception to coverage to the effect that the policy will be voided in the case of mortgage/title fraud where funds from a private mortgage were paid to anyone other than the registered owner, the holder of a prior registered charge or encumbrance or certain other creditors. Title insurers have, at times, interpreted this exception to mean that, if a lawyer acting for a private lender disburses funds to the lawyer acting for the borrower, the policy could be voided in the event of fraud. This interpretation has been rejected by the courts on at least one occasion and certain title insurers have revised their private lender exception to allow payment by the lender’s lawyer to the borrower’s lawyer provided the borrower’s lawyer undertakes to pay the mortgage proceeds to the registered owner, prior encumbrancers or other creditors described in the title insurance policy. It is, therefore, good practice for lawyers to review the lender’s policy of title insurance and discuss the private lender’s exception with the client prior to any advance being made. In terms of documenting the transaction, private mortgages are not much different from other mortgages. However, lawyers should keep in mind that, when acting for a private lender, they will need to complete a form 9D (Investment Authority) and 9E (Report on Investment), both of which are required by the Law Society of Ontario.

Private mortgages are not new for the legal profession and should not be looked upon with dismay. By thinking through some of the challenges particular to private mortgages in advance of closing, lawyers can position themselves to successfully close the deal on time and in accordance with their professional obligations to their client.

Kenneth Pimentel is an associate with Daoust Vukovich LLP in Toronto.

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