The Application for Substitution of Security (art. 2731 C.C.Q.): Strict and Specific Parameters

By: Gabriel Di Genova

A legal hypothec, commonly referred to as a “contractor’s lien”, is a powerful tool to protect the interests of a contractor (or any unpaid creditor) that contributed to — or participated in — the construction or renovation of an immovable. This protection can extend to a sub-contractor, architect, engineer or supplier of construction materials. The publication of a legal hypothec against title is generally a cost-effective way to protect the monetary interests of such a party, ensuring payment in priority, insofar as the relevant procedural publication modalities are respected (namely, as detailed at art. 2726 and 2727 C.C.Q.).

Evidently, having a legal hypothec published against title comes with a myriad of inconveniences and undesirable consequences for the property owner, which can persist up until final judgment on the claim, or until such time that the debt is extinguished to the complete satisfaction of the creditor. It can, for example, cause a lender to recall a loan, prevent an owner from obtaining financing and complicate the sale process.

A way to avoid or mitigate such inconveniences pending a final judgment is the regime for substitution of security as detailed at 2731 C.C.Q., which allows for interim radiation of the registration against title. However, in Construction Tecta inc. c. Keita, 2021 QCCQ 7539, the Court recently reiterated the established principle that an order authorizing the substitution of security in virtue of 2731 C.C.Q. will not be automatically granted, and will only be available in specific circumstances, when all conditions are clearly met.

There are four cumulative criteria to obtain such an order:

1. The application can only be made by the owner of the property;
2. Such an application can never concern a debt claimed by the state or legal person established in the public interest (e.g.: a municipality, providers of utilities like Hydro-Québec);
3. The post-radiation protection of the hypothecary creditor must be ensured; AND
4. The owner of the immovable must demonstrate, by a balance of probability, that the hypothec causes prejudice.

In Construction Tecta Inc., the Court analyzed the relationship between the third and fourth criteria in detail:

[24] Enfin, le préjudice nécessaire pour donner ouverture à une substitution de garantie doit être « sérieux et réel », par opposition à un préjudice seulement éventuel. Il ne suffit pas que le propriétaire préfère tout simplement avoir un titre libre de charge. Il doit démontrer de façon prépondérante que l’inscription de l’hypothèque légale lui cause un préjudice. Le fait de ne pouvoir obtenir un financement hypothécaire additionnel pour terminer les travaux ou de ne pouvoir négocier une marge de crédit sont des motifs suffisants pour donner ouverture à une demande en substitution de garantie. (underlining added)

While the Court concluded that the prejudice suffered by the owner of the property met the fourth criteria, the third criteria was not satisfied:

[49] La demande en substitution de garantie est rejetée. Ses allégations ne démontrent de manière prépondérante que les défendeurs remplissent toutes les conditions nécessaires pour pouvoir substituer l’hypothèque légale de Tecta. Notamment, la demande n’est pas appuyée d’une déclaration sous serment et ne précise pas de manière satisfaisante la nature de la garantie offerte, ses conditions d’encaissement ou son terme. Enfin, le montant est insuffisant. (underlining added)

More specifically, the Court was not convinced that the interests of the hypothecary creditor would be sufficiently protected if it authorized the substitution. Justice Thibaudeau reiterated that any substitution must place the creditor in manifestly the same position as it is before the radiation and leave sufficient security to cover capital, interest, additional indemnity, judicial and extra-judicial fees. Not only was the capital amount proposed insufficient to cover the alleged debt, in addition the Court noted that the procedural aspects of such an application were not respected. For example, the applicant didn’t bother supporting its demand with an affidavit. More so, the application did not provide a specific plan for the substitution, it merely suggested the applicants were willing to provide security in the form of funds in trust or deposit with a financial institution or deposit at Court, but didn’t identify the specific modalities for deposit nor the identity of the financial institution nor the terms for the deposit. In other words, it is necessary to submit to the Court a concrete plan for the security, not simply list options and impose the burden on the Court to select one, all the while without any evidence that any such options are feasible.

One reason the legislature established a high threshold to authorize substitution of security is that liquid funds remain more vulnerable than a published real right over a property. For example, in the event of the debtor’s insolvency, without an irrevocable movable hypothec in favour of the creditor, funds in a lawyer’s trust account can be made available to the mass of creditors. This is not true of an immovable asset afflicted with a legitimate real right: the hypothecary creditor can appropriate the available funds in priority from the eventual sale of the property.

In reality, the process to substitute security can have advantages for both debtor and creditor. For example, it can allow a debtor to optimize an asset, all the while simplifying the debt collection process for a creditor. However, in order to “unlock” the positive attributes of this mechanism, Construction Tecta Inc. reminds us that the application process cannot be taken for granted.