In the spring of this year the Ontario Superior Court of Justice provided guidance with respect to a lender’s discretion to refuse advances under a credit facility, as well as when a credit agreement might be considered varied or altered by the conduct of the parties. In XPG v. Royal Bank of Canada (“XPG”), the Court found that in providing advances to XPG, a partnership (the “Borrower”) that was operating outside of its covenants and had borrowed in excess of the ratio provided for in the credit agreement, the Royal Bank of Canada (the “Bank”) was granting indulgences and had not varied or superseded the terms of the credit agreement by its conduct. Further, the Court stressed that there is an important distinction between the requirement to provide reasonable notice before demanding a loan and the requirement to provide reasonable notice before refusing an advance. In the former instance there is always be a requirement to provide reasonable notice. In the latter instance the Court will not read in a reasonable notice requirement where it runs contrary to the express terms of the agreement and the reasonable expectations of the parties.
The Borrower, an Ontario partnership, bought and sold grain and other agricultural products as its primary business. Often buying and selling on futures contracts, the Borrower had an extensive hedging program to protect against averse market fluctuations.
In September of 2007, facing a cash flow crisis amid an unprecedented rise in the price of wheat that had caused the Borrower to draw funds in excess of the terms of the existing facilities, the Bank offered increased credit facilities in the form of a $19MM revolving demand facility and a $5MM revolving term facility. The demand facility was subject to a borrowing limit ratio, as well as a clause providing that the Bank could exercise its discretion to cancel or restrict the availability to undrawn portions. The terms of the agreement further provided that the Borrower was not to make any purchase or purchase contracts until the term facility was repaid in full. The Borrower was also subject to extensive reporting requirements.
The Borrower continued to make purchase contracts despite the terms of the credit agreement and the pressure of the Bank. Nonetheless, with the sympathy of certain representatives of the Bank, the Bank continued to advance funds to satisfy, among other things, an ever increasing amount of margin calls during what appeared to be a never ending rise is the price of wheat.
An amendment the facilities in October of 2007 increased the size of the facilities but failed to satisfy the needs of the Borrower. The situation carried on much the same as before. The facilities were quickly overdrawn and the Borrower remained offside a number of covenants. In December of 2007, the Bank issued a first forbearance letter setting out conditions under which a demand would be withheld. The letter was never signed as received and in any event, the Court found that although the Bank was within its right to issue a forbearance letter, the conditions were unreasonable. A subsequent cash flow projection showed an increasingly grim picture – the Borrower would continue to purchase grain and continue borrowing in excess of the facility.
Evidence was led, and the court accepted that around this time the Bank communicated to the Borrower that no cheques would be bounced unless the loan limit hit $33MM, a figure well in excess of the agreement on its face, and further in excess of the borrowing ratio in the agreement. The Borrower relied on this evidence in an attempt to demonstrate that the Bank had, in effect, agreed to a course of dealing whereby the Borrower could utilize funds up to $33MM, despite the facts that these funds were not available under the loan margin formula.
Suffice to say that this state of affairs continued on for several months. Indeed, the term facility matured on December 31, 2007, yet the Bank did not make a demand or enforce its security. An informal protocol developed between the Borrower and the Bank whereby each morning the Borrower informed the Bank of outstanding cheques and the amount of any margin calls that were payable. Advances continued to be made despite the increasingly tenuous situation.
The account was moved to the Special Loans department in mid-February of 2008, amidst attempts by the Borrower to secure alternative financing arrangements. On February 25, 2008 the Borrower was under the “unofficial” limit of $33MM, but remained well overdrawn under the terms of the credit agreement. Faced with a margin payment of $1.6MM, the Borrower sought an advance and the Bank refused. The Borrower was faced with few options but to liquidate its hedging positions.
The timing could not have been worse. Only two days later the price of wheat began to fall. With its hedges unwound, an opportunity to make up some of the cash it had previously lost on its hedges was missed. Only two days later, the Bank, realizing its mistake with the benefit of hindsight, then advanced a further $6MM to the Borrower to re-hedge . A later arrangement prevented a demand from being issued, but the Borrower eventually sued for damages relating to, among other things, the Bank’s refusal to make an advance for the margin call.
Position of the Parties
The Borrower asserted that, under the terms of the credit agreement, RBC was required to provide reasonable notice if it was not going to advance funds for a margin call. In the alternative, the Borrower argued that the requirement for reasonable notice arose out of the course of dealing between the parties during the crisis. However, the Borrower maintained that it was not advancing an argument based on the concept of detrimental reliance.
The Bank argued that the relationship between the parties continued to be governed by the terms of the credit agreement and that no notice for refusing advances were required. The Bank maintained that advances made in the face of defaults and expiry of the loan terms were good faith indulgences.
Ruling of the Court
Despite the fact that, in certain circumstances, oral agreements and the conduct of parties may prevent a court from enforcing the terms of a written contract, even in the face of a clause expressly providing otherwise, the Court found in this instance that the loan agreements between the Bank and the Borrower continued to govern the relationship between the parties. In reaching this conclusion, the Court highlighted that, among other things, i) the Borrower never suggested that the agreement no longer applied; ii) the Bank continued to report internally on how overdrawn the facilities were; iii) internal approvals were still sought for advances, and; iv) despite the fact that one facility had matured, no demand was made, the other had yet to mature, and there was nothing in the agreement that specified that the agreements would cease to govern the relationship amongst the parties at a certain date.
The Court stressed that the granting of indulgences did not preclude the Bank from insisting compliance with the terms of the agreement and that similarly, the fact that the parties acted inconsistent with the strict terms of the agreement does not automatically lead to the presumption that the parties are no longer bound by the terms of the contract. A case put forth by the Borrower wherein the court sided with the Borrower in somewhat similar circumstances was distinguished on the basis that the alternate course of dealing had persisted for more than three years.
The above finding led to a consideration of whether the Bank was entitled to refuse an advance and whether it was contractually obliged to provide reasonable notice if it did so. Given that the Borrower was in an overdraft position and that the contract governed the relationship between the parties, the Court held that there was no requirement to make further advances and stressed that such refusal should not be considered an exercise of the Bank’s discretion, but rather a refusal to an already delinquent debtor.
Despite finding that the refusal was not required to be made pursuant to a discretion clause, the Court nonetheless considered whether reasonable notice would have been required under the discretion clause and found that no notice was required. Refusing to read in a requirement of reasonable notice, the Court noted that the parties were sophisticated and that the Borrower’s argument that it had a reasonable expectation that it could rely on further advances to continually be made when one facility was matured yet unpaid, and the other was extensively overdrawn was misguided. Importantly, the Court noted that such an expectation may be reasonable where during the currency of the loan the debtor is in compliance with all terms of the agreement.
This ruling provides some helpful guidance for lenders in similar circumstances to those described above. In particular, lenders who continue to make advances to delinquent debtors may take some comfort in the Court’s pronouncements on the importance of the written agreement and the reasonable expectations of a debtor in such circumstances. In particular, the case illustrates that compliance with internal procedures and formalities when granting indulgences may contribute to a finding that, despite operating outside of the formal agreement, the terms formal agreement nonetheless still govern. Despite this, lenders should still operate with considerable caution when providing indulgences to delinquent borrowers and should continually remind borrowers that the terms of the agreement still govern.
The Court’s commentary around notice requirements is helpful in some regards, while contributing to a degree of uncertainty on others. In particular, the Court’s pronouncement that a bank may be required to provide reasonable notice for refusing to make an advance when the borrower is in compliance with the terms of the agreement casts some doubt on whether a clause expressly allowing the lender to exercise discretion in this regard would be strictly upheld. Despite this, it appears to be clear that reasonable notice will not be read into a discretionary refusal to provide an advance when the borrower is in breach of covenants or has overdrawn on the facilities.