June 22, 2021 | Christianah
A commitment letter can be defined as a legal document between a lender and borrower that indicates the important aspects of a loan, such as the interest rate, loan term, etc. When commitment letters are used for development deals, both the lender and developer have to exercise extra caution as there may be a probability of these arrangements falling through. In today’s blog post, we are discussing the recent case of Marshallzehr Group Inc. v. Ideal (BC) Developments Inc., 2021 ONCA 229 and examine the risks that may arise through commitment letters.
In this case, Ideal Developments Inc (“Ideal”) and Marshallzehr Group Inc (“MZ”) executed a Commitment Letter which provided that MZ would finance a residential real estate project. The Commitment Letter contained the following terms:
- MZ intended to syndicate the loan and lend Ideal $15.2 million;
- the Loan was to act as a first mortgage land loan for Ideal’s development of the project;
- the funds for the project were to consist of the loan plus $5.9 million in equity;
- the loan was for a 13-month term;
- the loan would consist of three facilities, with the facilities bearing interest rates
- subordinate financing was subject to MZ’s consent;
- the closing date for the loan was scheduled for December 5, 2018; and
- MZ was not required to advance any funds prior to Ideal having fulfilled to MZ’s satisfaction the “Initial Funding Conditions”, as set out in the commitment letter.
It is important to state here that the Commitment Letter contained a general provision which allowed MZ to unilaterally terminate the Commitment Letter, at its discretion, without notice to Ideal. There was also a “default and demand provision” that required MZ to provide notice to Ideal where there was a default on its part, so that it could be addressed.
On December 17, 2018, MZ gave notice to Ideal that the syndicated lenders had started to advance funds and reported on December 21, 2018, that interest was accruing on the loan. MZ then advanced the syndicated funds to its counsel to hold in trust, pending Ideal’s fulfillment of the initial funding conditions. Consequently, the loan was not closed, and the funds were not given to Ideal. On January 23, 2019, MZ sent a letter to terminate the Commitment Letter because the initial funding conditions were not met by Ideal. Ideal, on the other hand, was of the view that MZ should have given notice and an opportunity to remedy its default.
Court’s decision and the appeal
The motion judge was of the view that MZ had no obligation to provide Ideal with notice before termination of the Commitment Letter in view of the unilateral termination right that it had. The Court also held that the notice to be given under the “default and demand provision” was for the post-funding period, which would not become applicable here since the funds were never sent to Ideal. Ideal’s case was therefore dismissed, and judgment was given in favour of MZ, who was awarded $508,071.09 in damages, including standby interest, legal fees, and a lender’s fee of $346,000.
Ideal appealed the judgment on the grounds of the failure to give notice and the damages awarded. The Court of Appeal reiterated the view that MZ could unilaterally terminate the Commitment Letter without giving notice to Ideal. However, the Court of Appeal held that MZ was not entitled to be awarded “lender’s fees”. This is because the Commitment Letter provided that the lender’s fees were to be deducted from the initial advance of funds. As the funds were never advanced, there was no requirement for Ideal to be liable for that amount. Thus, the damages awarded to MZ were reduced.
Importance of this case
This case is very essential in highlighting the various risks presented to both lenders and developers when considering Commitment Letters. There is a risk for developers who are not able to satisfy conditions precedent to a lending, and the additional risks that come with unilateral termination rights. Lenders also face a risk when they decide to terminate a Commitment Letter, as they may not be adequately compensated for the opportunity cost associated with holding those funds for a future advance.
If you have any questions about the use of Commitment Letters and how to properly structure them to protect your interest in future real estate matters, kindly book a free consultation with Northview Law on this link, or contact us at 416-639-7639. We look forward to hearing from you soon.