The Court of Appeal’s reasons in L-Jalco Holdings v. MacPherson reminds us that the concept of subrogation extends beyond the realm of insurance and into the realm of mortgage priority claims. In L-Jalco, the plaintiff lender advanced funds to a property owner who discharged only one of two prior mortgages with the funds advanced, while registering a new mortgage in its favour. The prior (then undischarged) second mortgage moved into first position and the plaintiff’s mortgage fell into second position. When the property owner defaulted, the plaintiff sold the property under power of sale and sought an order that its mortgage had priority against the first mortgage and in so doing attempted to in effect cut the first mortgagee out of participation in the sale proceeds.
The plaintiff floated two arguments:
- the ‘new’ first mortgagee had undertaken to discharge its mortgage and failed to do so and would be unjustly enriched if they maintained priority; and
- the plaintiff could have preserved the priority by taking an assignment of the original first mortgage and therefore it would be equitable that the plaintiff receive priority through being subrogated to the discharged first mortgagees priority position
The court rejected both arguments.
Importantly there was a finding that the plaintiff was aware of the undischarged mortgage and seemed not to care at the time of the original closing. This knowledge was critical to the court’s finding because it took it out of the realm of cases where there was a mistake that lead to an unjust result. The Court of Appeal’s 1997 decision in Mutual Trust v. Creditview was referred to in the underlying reasons to juxtapose circumstances where a mortgagee has knowledge of prior encumbrance vs a circumstance where a mortgagee has no knowledge as a result of a mistake. Mutual Trust involved a mortgagee who was unaware of CPL’s registered on title when its mortgage was registered and when it discharged first mortgages held by Scotia. The court held that Mutual Trust was unaware of the CPL’s as a result of its solicitor’s mistake. They found that if Mutual Trust was not subrogated to Scotia’s interest as the prior first charge, the holder of the CPL would be unjustly enriched as a result of a solicitor’s error. The court also identified that the plaintiff could have taken an assignment of the discharged mortgagee’s interest. However, the lack of knowledge was critical to the court’s finding.
Subrogation in the context of mortgage priorities embraces the same underlying concept as traditional subrogation – one party standing in the shoes of another. However, there is no automatic statutory or common law right of subrogation for mortgagees. Rather it is available only if facts support the fairness of granting it.
For those keeping score, subrogating insurers have been coming up on the short end of the stick in cases involving commercial leases. The Court of Appeal’s decision in Royal Host v. 1842259 Ontario (released May 18, 2018) goes the other way in permitting an insurer of a landlord to advance a subrogated action against an at fault tenant. On that basis alone, it is worth a close look.
The lease in issue in Royal Host contained provisions we often see in commercial leases. The landlord was required to obtain fire insurance and the tenant contributed financially to the premiums for that insurance. The lease contained a provision that the tenant was not relieved of any liability arising from or contributed by its acts, fault or negligence.
The motion judge ruled in favour of the tenant and dismissed the subrogated action commenced by the landlord’s insurer, relying on what he called the ‘general rule’ in the Supreme Court of Canada’s risk shifting trilogy ( Agnew-Surpass v. Cummer-Yonge, 1975 CanLII 26 (SCC) ,  2 S.C.R. 221; (ii) Ross Southward Tire v. Pyrotech Products, 1975 CanLII 25 (SCC) , and (iii) T. Eaton Co. v. Smith et al., 1977 CanLII 39 (SCC) ) that ‘subrogation rights will be limited where a landlord covenants to pay for the insurance and agrees to look to its own insurer for any loss’. On appeal, Ontario’s Court of Appeal overturned the motion judge and permitted the matter to proceed. The appeal court relied on a number of lease provisions which in their view made it clear that the risk of loss by fire was to be borne by the tenant if they were responsible for the loss.
The Trilogy is the starting point for the analysis of commercial leases in subrogation claims in the Canadian environment and is worthy of brief review. In Surpass , the landlord covenanted to maintain fire insurance on the premises. There were no tenant repair covenants in the lease. The lease did require the tenant to take good and proper care of the leased premises, “except for reasonable wear and tear…and damage to the building caused by perils against which the lessor is obligated to insure hereunder”. The landlord’s insurer was precluded from subrogating in Surpass, and with good reason. There was a clear relationship between the tenant’s covenant to repair and the landlord’s covenant to insure. The provisions worked together harmoniously – the tenant was not required to repair if the damage was caused by a peril against which the landlord was required to insure.
In T. Eaton, the lease provisions were similar although the tenant’s covenant to repair was not tied in any way to the landlord’s covenant to insure as it had been in Surpass. Despite this distinction, the Supreme Court found in favour of the tenant and prevented the landlord’s insurer from subrogating. In effect, the covenant to insure trumped the covenant to repair.
How did the Court of Appeal reach a different result in Royal Host? The devil is in the details as they say and in this case, the details are the lease provisions. Specifically, the section of the lease that required the landlord to obtain insurance also included the following language:
Notwithstanding the Landlord’s covenant contained in this Section 7.02, and notwithstanding any contribution by the Tenant to the cost of any policies of insurance carried by the Landlord, the Tenant expressly acknowledges and agrees that
- the Tenant is not relieved of any liability arising from or contributed to by its acts, fault, negligence or omissions, and
- no insurance interest is conferred upon the Tenant, under any policies of insurance carried by the Landlord, and
- the Tenant has no right to receive any proceeds of any policies of insurance carried by the Landlord.
The effect of using the word ‘notwithstanding’ is to provide a limited circumstance in which the benefit conferred to the tenant will not apply; namely when the tenant’s ‘acts, fault, negligence or omissions’ result in loss or damage. The parties had turned their minds to the issue of which party was to bear the risk of loss in this circumstance and despite the landlord’s covenant to insure, the lease precluded the tenant from enjoying the benefit of that insurance if the loss resulted from its negligence.
It is worth noting that the motion judge in this case repeatedly referred to the ‘general rule’ derived from the Trilogy which was to limit subrogation rights when the landlord agreed to obtain insurance. The Court of Appeal disagreed with this interpretation and clarified that the Trilogy did not pronounce a general rule of application nor did it enunciate freestanding principles. Rather, ‘the principles drawn from the trilogy are contractual in nature. They are conclusions that flow from and reflect the particular provisions of the leases that were in issue in those cases’. This underscores the first rule in analyzing subrogation rights when commercial leases are involved: try to discern the intention of the parties based on the lease language. https://bit.ly/2KCPH0p