Mortgage Backed Loan Transactions
A frequently encountered issue faced by many lenders in mortgage backed loan transactions is the use by the borrower of a nominee title holder, or bare trustee.
What is a Nominee and Why are They Used?
A nominee is an entity (usually a corporation) who holds registered legal title to a property while an off title entity (often a limited partnership or real estate investment trust) holds the beneficial title. The existence of a nominee divides the ownership interest in the subject property. While legal title is held by the nominee, the beneficiary receives (as the name implies) the benefits of ownership.
Nominees are used for a variety of reasons, including creditor protection, where the beneficiary cannot hold registered legal title to the property under applicable Provincial law, or where it is preferable to have a corporation hold the title to simplify day to day transactions in respect of the property.
Generally the beneficiary, or a combination of beneficiaries, holds 100% of the shares in the nominee company, and the beneficiary and nominee enter into a nominee agreement which sets out the rights and obligations of each of the parties vis-à-vis one another in respect of a specific property or properties.
Terms of nominee agreements may vary, but the following tend to be found in one form or another in each agreement:
- The nominee holds legal title to the property for and on behalf of the beneficiary;
- That the nominee may only mortgage or dispose of the land at the direction of the beneficiary; and
- The nominee has no entitlement to any revenues arising from the property.
The nominee itself has little to no discretion on how to deal with the property subject to the agreement (which is often the only asset of the nominee), and all tax and economic benefits of the property accrue to the beneficiary.
How is this relevant to a mortgage based loan transaction?
All provinces in Atlantic Canada have either deed or title registration legislation enacted. Both systems act as notice to the public of the interest holders in the land. In Nova Scotia for example, the Land Registration Act provides that a parcel register (being the record of all registered interests in a given property) is a complete statement of all interests affecting that property. The prevailing practice in most jurisdictions is not to include reference to a beneficiary in the registry.
Therefore, absent any other factors, a lender is entitled to rely on a mortgage signed by the registered title holder regardless of whether a beneficiary exists behind the legal title.
The difficulty with this is that the Know Your Client rules in the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (Canada) require many lenders to conduct due diligence on their borrowers including a determination as to whether an account is held on behalf of a third party. As outlined above, any account held by a nominee would be held in trust for the beneficial owner and therefore disclosed to the lender, thereby giving them actual notice not only of the beneficial interest, but also of the restrictions imposed on the nominee when dealing with the subject property pursuant to the nominee agreement.
Lenders will often also want security from the beneficiary to capture rents or other benefits arising from ownership of the mortgaged property.
Prudent lenders and their solicitors will take steps to ensure that the enforceability of their security is properly authorized by the beneficial owner. Such steps may include (i) a review of the nominee agreement; (ii) delivery of a resolution or other direction from the beneficial owner authorizing and directing the nominee to enter into the mortgage transaction; (iii) addressing the beneficial interest in the various security documents granted to the lender in exchange for advancing funds. Alternatively, an opinion from counsel to the borrower may address some or all of these issues.
In many circumstances the interest of the beneficiary is addressed directly in the relevant security document. For example, the beneficial owner may guarantee or indemnify the lender for the obligations of the nominee borrower under the loan. Some solicitors advocate naming the beneficiary as a borrower and not guarantor because of additional protections afforded guarantors in some jurisdictions. However, a properly drafted guarantee should grant equivalent protection to a lender while permitting flexibility in structuring loans – which can be important to borrowers who structure their holdings for reasons such as tax planning or creditor protection.
Security agreements can and often do include the beneficiary alongside the nominee, either in the same or in a standalone agreement.
Since the use of nominee is intended to keep the beneficiary off the title record to a property, it is often either not possible or not desirable to reference them in a mortgage or other land charge. Instead, a beneficial owner’s agreement (a “BOA”) from the nominee and beneficiary is an off title agreement to charge the beneficial owners interest in the subject property.
A well drafted BOA will do the following:
- Confirm the relationship between the nominee and the beneficial owner;
- Authorize the nominee to enter the mortgage and other charges of land (if applicable);
- Confirm that the beneficial interest in the property is subordinate or postponed to the mortgage and other security and confirm that there are no existing liens on the beneficial owner’s interest in the property; and
- Restrict transfer of the beneficial interest.
The use of nominee companies is a common occurrence when structuring real property ownership and should not be ignored whether disclosed through the Know Your Client rules or otherwise. As outlined above, there are straight forward and effective solutions for managing a lender’s risk in these circumstances.