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Development projects and commitment letters: Be wary of what you bargain for

When development deals are financed through commitment letters, both lenders and developers would...

When development deals are financed through commitment letters, both lenders and developers would be wise to pay close attention to the risks they are assuming. A case that recently appeared before the Ontario Court of Appeal demonstrates the potential fallout for both sides if the deal ultimately goes sideways.

In Marshallzehr Group Inc. v. Ideal (BC) Developments Inc., Ideal (BC) Developments Inc. (Ideal), an Ontario-based development company entered into a project finance deal with MarshallZehr Group Inc. (MZ) for a residential development. A commitment letter was executed in November, 2018, which contained the following terms:

    1. MZ intended to syndicate the loan and lend Ideal $15.2 million for the development;
    2. the loan was for a 13-month term and would act as a first mortgage land loan for Ideal’s development of the project;
    3. the funds for the project were to consist of the loan plus $5.9 million in equity;
    4. the closing date for the loan was scheduled for December 5, 2018; and
    5. 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.

The commitment letter also contained a provision which gave MZ the right to unilaterally cancel the commitment at its sole discretion, without notice to Ideal, before any funds were advanced.

Parties reach an impasse

By December 17, 2018, MZ informed Ideal that the syndicated lenders were advancing funds toward the loan. In accordance with the terms of the commitment letter, MZ advanced the funds from the syndicated lenders to its lawyers, which would be held in trust pending Ideal’s satisfaction of the initial funding conditions.

One of the initial funding conditions was for Ideal to obtain a standstill and postponement of a mortgage that existed on title for the project properties. The parties reached an impasse on the length of the standstill period for the mortgage. Specifically, Ideal wanted the standstill period to last 90 days and MZ insisted that it should be for the entire period of its loan.

The parties could not resolve this issue and, as a result, the loan never closed and MZ did not advance any funds to Ideal. On January 23, 2019, MZ sent Ideal a letter which terminated the commitment letter on the basis that the initial funding conditions were not met. Ideal pushed back and took the position that MZ could not simply terminate the commitment letter without giving notice and affording them a chance to cure the default.

MZ sued Ideal and sought payment of $553,899.48 for various fees and expenses in connection with the commitment letter. Ideal counter-claimed for damages caused by MZ’s alleged wrongful termination of the commitment.

The court decision, and an appeal

The court did not accept Ideal’s position.

Given that MZ had a unilateral termination right, it did not have to provide Ideal with notice or a chance to cure the default. Judgment was therefore granted in favour of MZ and it was awarded $508,071.09 in damages, representing $101,958.82 in standby interest, $60,112.27 in expenses, including legal fees, document review, and planning advice and a “lender’s fee” of $346,000.

Ideal appealed the decision on the basis that MZ wrongfully terminated the commitment letter by failing to give notice and affording them a chance to cure the default. Ideal also took issue with the amount that MZ was awarded.

The Court of Appeal agreed that MZ was entitled to terminate the agreement, given that it had a unilateral termination right in the commitment letter before funds were advanced. MZ had not advanced any to Ideal and it was therefore permitted to terminate the commitment letter and was not required to provide notice or the opportunity to cure the default.

However, it was held that MZ was not entitled to the lender’s fee after the commitment letter was terminated. The commitment letter stated that the amount of the lender’s fee was to be deducted from the funds initially advanced to Ideal.

MZ was therefore not entitled to the lender’s fees until the funds were advanced to Ideal, which never happened. As such, MZ’s damages award was reduced by the amount of the lender’s fee.

This decision presents interesting lessons to both sides of the bargain when commitment letters are concerned.

In particular, if there is a unilateral termination right in the pre-funding period, developers should be aware of the risks that they are assuming, given that a small impasse between the parties could result in the lender pulling the plug. 

Lenders, on the other hand, should also be aware of inherent risks in cancelling a deal before funds are advanced, or they could find themselves being short-changed on their fees. 

Both parties could benefit from keeping these factors in mind before a commitment letter is signed.

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