Edward D. (Ned) Brown
Some sale and purchase and acquisition financing transactions may be challenged, in whole or in part, on the basis of outright fraud or physical duress. Other transactions may not involve elements which rise to the level (legally speaking) of fraud or duress, but nevertheless impose a harsh burden on one of the parties involved (typically, a buyer or a borrower). Such transactions may be challenged on the basis that they are unconscionable, given the underlying/surrounding circumstances. In particular, where a "business" creditor is sophisticated and experienced (in the sense of having conducted previous substantial commercial activity) and the debtor is in a vulnerable position, the arrangement between the parties may be successfully challenged by the debtor. This is particularly so where the creditor has "business experience" (as described above), and the debtor is an individual person who is under financial stress, has little or no "business experience", is elderly, infirm, doesn't understand the language of his or her immediate community, or is just plain naïve.
The Judge in the Quick Auto Lease case (referred to below) quoted another Judge in an earlier (Prince Edward Island Supreme Court) case who stated that "…it can be safely said that, in the mind of the borrower, the cost of his loan is usually always excessive." In applying the law related to unconscionable transactions (summarized below), a Court must distinguish between those cases where one of the parties to a transaction is unequal in bargaining power and/or vulnerable and has made a bargain which, only in hindsight, or only in view of the party's subsequently changed circumstances, is - or appears to be - onerous to that party, and, those cases in which, essentially from the outset, elements of the transaction are "manifestly" inequitable, regardless of the vulnerability or the inequality of one of the parties.
As to what is "manifestly" inequitable, the legal system has - literally going back hundreds of years - established certain criteria for Courts to relieve certain persons - including certain businesspersons - from their obligations under improvident commitments. The relevant law is:
- in part, case or "judge-made" law and dates back at least 500 years to the development of the concepts of "equity". In particular, vulnerable persons may be relieved of their obligations or restored to their original positions (ie, prior to when they committed to an improvident or were "unfairly" deprived of their property or rights); and
- in part, statutory enactments which have provided - and continue to provide - for relief to certain persons in certain situations, for example, the relatively modern statutes dealing consumer protection and unconscionability.
A couple of recent Manitoba Court of Queen's Bench cases are illustrative of the current approach taken by the Courts in dealing with unconscionable - or allegedly unconscionable - transactions.
The Quick Auto Lease Inc. and Hogue case (judgement, July 19, 2018, hereinafter, the "Quick Auto Case"), and the Conceicao and Richard Boon case (judgement, May 3, 2018, hereinafter, the "Boon Case") deal, respectively, with a secured credit sale of an automobile and a refinancing loan made with respect to and secured by a mortgage on a residential property. Both cases cite and refer to legislation other than the Unconscionable Transactions Relief Act, C.C.S.M. C U20 ("UTRA"), but it is UTRA with which this paper is primarily concerned.
The Quick Auto Case
The defendants acquired a 2001 automobile from the plaintiffs with 85,000 kilometers on it in August of 2004 by way of a financing lease transaction utilizing the plaintiff's standard form of lease with option to purchase. The "cash price" of the vehicle was $18,273.00 with total lease payments of $32,488.30 payable over five years. The implicit interest rate in the financing transaction was 29.9% per annum, but this rose to 36% per annum compounded daily in the event of a default. The total amount payable was augmented by the value of a trade-in resulting in a total outlay of $37,912.30. The defendants defaulted in their payments due and in consequence thereof, the plaintiff obtained a judgement (by default) in September of 2006 for a total outstanding balance of $20,234.00 with post-judgement interest set at 36% per annum. In July of 2010, the automobile was returned to the plaintiff who subsequently disposed of same. With the 10-year limitation on enforcing the judgement claim approaching, the plaintiff re-sued the defendants on the default judgement in September of 2016. In the current action, the plaintiff claimed $19,292.46 as at September 16, 2016, plus 36% per annum on that amount thereafter (which the Court estimated at approximately $12,700.00).
Having considered the evidence, the Court came to the following conclusions:
- The Manitoba Consumer Protection Act. Notwithstanding that the creditor took back the leased automobile, the "seize or sue" provisions in the legislation which terminate a creditor's right to sue for a deficiency where the goods are taken back by the creditor did not assist the defendants. This was because in substance, the agreement between the parties was a "lease", not a "credit agreement" (as defined by The Consumer Protection Act). However, as lessors of consumer goods are nevertheless required to provide statutorily detailed information concerning the leasing transaction to lessees, the plaintiff's failure to provide proper disclosure (the Court noted many failures to follow the statutory disclosure requirements) entitled the defendants to require that a reduced rate of interest be applied to their indebtedness.
- UTRA. The Court pointed out that Section 2 of UTRA entitles the Court to relieve a debtor where the Court concludes, taking into account (i) the risk, and (ii) all of the circumstances at the time that the credit transaction was agreed to, that either the cost of the loan is excessive, or that the transaction is harsh or unconscionable. Clearly, "excessive cost" is something different from "harsh or unconscionable", although presumably, the circumstances of any particular impugned transaction may lead to the conclusion that both elements of Section 2 are made out. Dealing with the burden of proof, and quoting from an earlier UTRA case involving Quick Auto, the Court observed that firstly, the debtor must establish both that the parties are in an unequal bargaining position and that the bargain is improvident, and then, secondly, if that is made out, the creditor must show that the agreement entered into by the parties was "fair, just and reasonable in the circumstances". The Court had no difficulty in holding that the lease arrangement in the Quick Auto Case was unconscionable. In so holding, the Court referred to the following elements of the arrangement and the parties' situations:
- the lease agreement was described by the creditor as a "simple and easy-to-read (document)", but in fact, the document was anything but simple and easy-to-read. It was lengthy with "dense provisions printed single-spaced in an exceedingly small font". It was complicated, difficult to read and definitely not presented in "plain language".
- although the agreement contained an option to purchase in favour of the lessee, there was no proper specification of how the option price was to be determined.
- the lessee was required to insure the financed vehicle and to do so "in the form of a Mortgage Endorsement (Broad Form SPE 23 or equivalent)…", this was not explained and no such form was included by way of a schedule or otherwise defined.
- the agreement was in a form which entitled and enabled the creditor to fill in certain blank spaces in the lease, including the "lease commencement date" and the due date for lease rental payments.
- the lease contained a provision that stated that "the doctrine of fundamental breach shall have no application to this lease".
- the agreement provided that notwithstanding any failure to perform on the part of the creditor, the lessee was not entitled to terminate and was not entitled to reduce or set-off claims for its loss(es) against the rental payments due.
- the lease required the debtor to indemnify the lessee against any losses or claims suffered by the creditor notwithstanding that the same were the result of the creditor's own "negligence or fault or otherwise".
- the lease provided for payment of what was described as "liquidated damages and not a penalty" in the event of the lessee's default, with "elements that (were) sweeping in breadth".
- there may have been a breach of Section 4 of the Canada Interest Act, in that the default interest rate of "36% per annum calculated and compounded daily", was not equivalent to an annual percentage rate of 36% per annum, and was in fact something closer to 44% per annum.
- the pre-default interest rate specified (29.9% per annum) was very much higher than the prevailing interest rates at the time the bargain was made.
It is interesting to note that the creditor did not provide evidence to the effect that the high interest rate was justified by the risk involved. "Reading between the lines", one can reasonably assume that the lessees/defendants were likely high risk borrowers, so that an interest rate in excess of "prevailing interest rates" might have been justified. However, the fact that the contracted rates (both before and after default) were very much higher than the prevailing rates and the other (above-noted) elements of the transaction may well have convinced the Court to invalidate the arrangement in any event.
It is also interesting to note that the creditor took the position that the Court should not review the circumstances of the original deal because the current action involved the creditor suing on an early obtained judgment. In other words, the pre-existing judgment should be taken as a fait accompli, and was something that should not be reopened. The Court acknowledged that it might have been preferable for the defendants to have attempted to set aside the original (2006) judgment, but their failure to do so in this case did not "inevitably mean that the lease agreement and the circumstances of the parties in entering into same should not or cannot be examined". "If the agreement underlying the default judgment upon which a further judgment is claimed runs afoul of legislation, or on the whole is unconscionable, or is based on an excessive interest rate, then it would be fundamentally unfair and unjust for the court to aid the offending party to exact further charges from the other".
The Boon Case
The plaintiff was in financial difficulties, in particular, with respect to her bank debt secured by a mortgage on her residence. She did not read English, had been a widow for approximately one year, she did not understand the meaning/effect of the documents the defendants asked her to sign, and she additionally alleged that "not all of the signatures purporting to be hers (were hers)" on the defendants' documents. At the time that the plaintiff initially dealt with the defendants, the residence had a value of approximately $88,000.00, the outstanding balance on the bank mortgage was approximately $27,000.00 and the overdue payments (with interest, etc. then due to the bank approximated $4,800.00).
The defendants approached the plaintiff, stating that they understood she was in financial difficulties and could lose her home, and that they (the defendants) could assist her if she entered into an arrangement. That arrangement involved the defendants paying off the mortgage arrears in exchange for the plaintiff making monthly payments of $200.00 until she had paid a total of $5,000.00. The defendant Boon came to the plaintiff's house and had her sign a number of documents, although the plaintiff alleged (and there appeared no evidence to contradict this) that some of the documents were signed "in blank", with the information to be filled in subsequently, presumably by the defendants. In fact, as the Court concluded, "The documents…do not coincide (with the plaintiff's) contention that she needed only to pay $200.00 per month until $5,000.00 was paid". In fact, what she bound herself to were:
- a sale and purchase agreement whereby she agreed to sell her property to the defendants for $28,000.00 "by cash and assumption of existing mortgage by bringing it current";
- a standard form residential tenancy agreement for a term of one-year wherein the plaintiff was obliged to pay the defendants $559.00 per month, together with utilities, insurance and taxes;
- an option agreement which provided the plaintiff with an option to buy the property from the defendants (in one year) by paying $559.00 per month (presumably the tenancy payments) plus $1,250.00 plus her assuming the mortgage balance then existing; and
- a transfer of land in favour of the corporate defendant showing a consideration of $28,000.00, but with an affidavit of value stating the property's value to be $88,000.00.
Shortly after signing these documents, the defendants registered a caveat against the title giving notice of the corporate defendant's interest pursuant to the purchase and sale agreement and registered the transfer of land at the Land Titles Office. Additionally, the defendants paid out the current bank indebtedness mortgage arrears (approximately $4,800.00).
The plaintiff made one payment of $200.00 to the defendants, but then stopped making further monthly payments "after receiving a telephone call from an unidentified woman who told her that Mr. Boon was in trouble". However subsequently, she paid further mortgage debt arrears (approximately $8,400.00) to her bank and eventually made sufficient payments to fully repay the mortgage secured debt.
Although the plaintiff pleaded both fraud and unconscionability, the Court determined that it would not be appropriate to decide the matter based on fraud without a full blown trial being held (where more detailed and better evidence could be called by both sides etc.). However, the Court held that its hearing of the matter could and should deal with the alleged unconscionability of the transaction(s). That involved a consideration of the case in relation to the UTRA, and in doing so, the Court determined the following:
- Reiterating what the Court said in the Quick Auto Case, UTRA requires that before a Court may relieve a debtor of his/her/its obligations previously undertaken, the Debtor must establish both that there was an inequality between the parties plus that the transaction committed to was improvident. When the Debtor so establishes these matters, the burden passes to the creditor who is then required to "show that a contract freely entered into by the parties was fair, just and reasonable in the circumstances (the underlining here is by the writer for emphasis purposes)".
- On the basis of the facts above-noted, the parties were clearly in an unequal bargaining position, and, the bargain was clearly improvident, from the plaintiff's point of view.
- The various documents referred to above were "structured to give to the defendants a stronger enforcement mechanism than would otherwise exist if a conventional real property mortgage had been used". Perhaps the most egregious example of this is the taking (and submitting for registration) of a transfer of land covering the plaintiff's property, thus attempting to do an "end-around" the statutory scheme for security realization found in The Real Property Act).
- The fact that the defendants got the plaintiff to sign what is commonly called a "waiver of ILA" (ie, a waiver of independent legal advice), together with an acknowledgment by the plaintiff that she understood the meaning and effect of the documents, was useless to the defendants given the unequal position of the parties and the (strongly) improvident nature of the dealings between them. The defendants should have ensured that the plaintiff did in fact get independent legal advice.
A question may arise as to what Court would have held if the plaintiff had actually obtained independent legal advice, and notwithstanding provision of such advice (which if given by any lawyer with a minimum of comprehension of the realities of the situation would have almost certainly resulted in a recommendation to the plaintiff to not proceed), the plaintiff went ahead with the transaction, in any event, whether out of desperation or otherwise? Arguably, a Court might have still held the transaction(s) to be unconscionable under UTRA on the basis that they were improvident (and extremely so), although the inequality between the parties might have been considered to have been materially removed by virtue of the provision of the independent legal advice.
Some take away thoughts concerning the Quick Auto Case and the Boon Case:
- Some critics of the current economic system will almost certainly take the position that most credit transactions between businesses and individuals are "unconscionable". To such critics, there is no such thing as a "reputable" financial institution, unless it is a government owned/controlled entity. Unfortunately, this point of view overlooks the fact that most "reputable" financial institutions (typically chartered banks and credit unions) are rigorously regulated in various ways at various government levels (legislative and administrative) with a view towards protecting consumer interests. The more likely occurring dangers for debtors/potential debtors arise out of dealings with less "reputable"/less regulated credit providers. Such operators will sometimes ignore the statutory restraints intended to protect consumers, acting, no doubt, on the assumption that when, after the fact, debtors find themselves in an untenable financial position, they will not challenge their creditors due to lack of business acumen, a low sense of self-worth and an unwillingness or inability to find the financial resources necessary to engage the legal system to assist them. These types of credit providers generally do not have much regard for their own "reputations".
- While the Quick Auto Case and the Boon Case are illustrative of clearly inequitable bargains committed to by clearly vulnerable persons, they are extreme examples of unconscionability. The task for a lawyer engaged to review a proposed credit transaction on behalf of a proposed debtor - and this would also apply to at least some "small" businesspersons under UTRA - is to ascertain the "circumstances" of the client(s) engaging her/him and then additionally to review the terms of the proposed credit/transaction documents to determine if they appear to be excessively one-sided. Provision of independent legal advice, if done properly, usually involves a substantial expenditure of time and effort for which the engaged lawyer is not likely to be adequately compensated. Most such review engagements will not be as clearly inequitable as those found in the Quick Auto Case and the Boon Case.