Real estate projects in financial difficulty: Part 3
This article originally appeared on The Lawyer’s Daily website published by LexisNexis Canada Inc.
A real estate developer deals with a number of different parties, including the developer’s trades, the local municipality, secured lender(s), purchasers and in the case of a residential development, Tarion Warranty Corporation (Tarion). When a developer is insolvent and a court-appointed officer (CAO) takes possession of the property, the CAO addresses the various interests of the developer’s stakeholders as it works to maximize realizations from the project.
Scenario 1 – Project is incomplete
Where a project is incomplete at the time a CAO is appointed, the CAO prepares projections to determine whether realizations will be maximized if the CAO completes the project. If projected costs to complete exceed expected realizations from existing pre-sales and any unsold units not subject to a sale agreement, the CAO may consider whether the additional revenue to be derived from the CAO terminating existing pre-sales and re-selling the units at market value will result in realizations that exceed costs to complete. If neither of these scenarios is profitable or practical, the CAO’s only option may be to sell the project on an “as is, where is” basis, which may only benefit the project’s secured lenders and lien claimants.
Scenario 2 – Project is complete or will be completed
Where a project is complete or is completed by a CAO, the stakeholders in the project will have various and possibly, competing interests. In order to commence selling units, the CAO must address all of the conditions imposed by the local municipality to register and/or approve the project. If there are liens registered against the project, the CAO must obtain a court order that removes the liens from title. The CAO will then set aside from the sales proceeds a “reserve” that can be used to satisfy the lien claims if they are determined to be valid.
If the CAO is at a stage where proceeds from sales are being collected, each stakeholder’s inclination is that their interests come first and that the CAO should prioritize their claims over others. Secured lenders and lien claimants want to be paid in priority to each other; secured lenders want to ensure that realizations are maximized and costs are controlled to minimize any shortfall they may experience; residents will make claims regarding deficiencies and expect them to be rectified or settled; Tarion wants to ensure that warranted deficiencies are addressed; and the municipality and federal government want to ensure that property and sales taxes are paid. The positions of stakeholders are addressed by the CAO.
Secured lenders and lien claimants
The CAO retains legal counsel and obtains an opinion on the validity and enforceability of the claims of both secured creditors and lien claimants. A court order that sets out a priority resolution mechanism to establish who is to be paid first will be sought. The CAO’s mandate includes reviewing supporting documentation from lien claimants to confirm the reasonability of the claims and the amount claimed as a statutory holdback. The CAO’s report to the court includes the CAO’s position on the claims, and the court will issue an order setting out the claims’ respective priority. The secured creditors and lien claimants are then paid from sales proceeds collected by the CAO.
Purchasers and Tarion
Purchasers want claimed deficiencies rectified and purchasers of residential units will rely on Tarion to ensure deficiencies are addressed in a timely fashion. The deficiencies the CAO typically focuses on are those that deal with life-safety or other hazards and, in the case of residential units, Tarion-warranted deficiencies. It is usually more cost-effective for the CAO to engage a general contractor to address the deficiencies than to have the municipality or Tarion, if applicable, rectify them. Residential purchasers typically make claims for unwarranted deficiencies. Tarion may conduct a formal conciliation in which it attends on site and inspects each claimed deficiency to determine whether or not it is warranted. For warranted items, Tarion will provide reasonable time for the CAO to either rectify the deficiencies or settle with the purchaser(s).
Municipality and government
The CAO needs to ensure that it sets aside sufficient sales proceeds to pay property and sales taxes incurred during its appointment, so that the CAO is not held personally liable for their payment. There may also be statutory liabilities that were incurred by the developer prior to the CAO’s appointment, the disposition of which may have to be considered by the CAO.
Each stakeholder of an insolvent developer has its own interests and objectives. The CAO must act impartially and be seen to approach issues and requests objectively in order that all stakeholders are treated in an even-handed and fair manner.