General Litigation - Case Study
Case Name: Braut v. Stec
Between
John Braut, appellant (plaintiff), and
Adam Stec, respondent (defendant)
[2005] B.C.J. No. 2318
2005 BCCA 521
Vancouver Registry No. CA030377
British Columbia Court of Appeal
Vancouver, British Columbia
Donald, Braidwood and Hall JJ.A.
Heard: September 28, 2005.
Judgment: October 31, 2005.
(31 paras.)
Contracts Consensus, lack of Unconscionable transactions Unequal bargaining positions Appeal from decision of the Supreme Court reported at [2002] B.C.J. No. 2527 finding that a written agreement was unconscionable dismissed There was inequality in the bargaining power of the parties and the agreement was unfair.
Appeal by the plaintiff, Braut, from the order declaring a written agreement between Braut and the defendant, Stec, unconscionable, and refusing to enforce the agreement. Braut was the owner of three residential rental properties. Stec was interested in real estate investments. Braut and Stec met to discuss an equity sharing arrangement regarding Braut's properties. Braut argued that the parties had reached an oral agreement in which Stec agreed to buy the properties and look after them with financing to be arranged by Braut. Braut and Stec would then share in any gains that would be realized upon the later sale of the properties. Stec denied any agreement had been reached before the sale of the properties to Stec. At the time of the purchases, Stec was impecunious. He falsely represented his income to mortgage lenders in order to obtain financing and Braut arranged for the remaining funds to be advanced to Stec to enable the purchases by Stec. After the transfers were complete, Braut presented the equity sharing agreement to Stec, who refused to sign it. The agreement imposed significant obligations upon Stec and required that he bear all of the risks related to the property. The properties were subsequently sold, according to Braut, at a profit greater than that asserted by Stec. The trial judge found that the bargain between the parties was unconscionable.
HELD: Appeal dismissed. There was an inequality in the bargaining power of the parties and the agreement was substantially unfair to Stec. The presumption of fraud had been raised, and Braut failed to demonstrate that the equity sharing agreement was fair and reasonable. Stec was coerced by Braut into signing the agreement. The trial judge did not err in holding that the clean hands doctrine was no bar to granting relief to Stec.
Counsel:
R.D. Gibbens and C.S. Flerlage: Counsel for the Appellant
W. Kosteckyj and S.S. Parhar: Counsel for the Respondent
The judgment of the Court was delivered by
1. HALL J.A.: This is an appeal from an order of Kirkpatrick J. (as she then was) pronounced November 7, 2002. The trial judgment can be found at [2002] B.C.J. No. 2527 (S.C.). The trial judge held that a written agreement between the appellant and the respondent was unconscionable and she refused to enforce it.
2 . In the year 1986, the appellant, Mr. Braut [Braut], was the owner of three residential rental properties located in East Vancouver. Braut had been dealing in real estate for several years prior to this time. He was a member of a local real estate club which met at intervals. At one such meeting he met the respondent, Mr. Stec [Stec], who was interested in real estate investments. This meeting between Stec and Braut occurred sometime in the Summer or Fall of 1986. Braut was desirous of making some arrangement with regard to his revenue properties because he wanted to return to his native Yugoslavia to assist his ailing father. Apparently, his first thought was to get someone to manage his properties in his absence but, having become acquainted with the concept of "equity sharing" through a real estate course, he said that he decided that perhaps he could make an arrangement with someone to enter into such an arrangement on his properties.
3. Both the appellant and the respondent testified that there was some discussion between them in the Fall of 1986 about the concept of equity sharing as it applied to the properties then owned by Braut. Braut testified that the parties had an oral agreement whereby Stec would buy the properties and look after them with financing to be arranged by Braut and that Braut and Stec would share in any gains that might be realized upon later sale of the properties. Stec testified that although the concept had been discussed in general terms between himself and Braut, no agreement of the sort suggested by Braut had been reached between the two men before the properties were sold by Braut to Stec in early 1987.
4. It is common ground between the parties that in December 1986 Braut had arranged for appraisals to be made of the properties and he and Stec thereafter entered into interim agreements for the sale from Braut to Stec of the three properties at a total price of about $9,000 in excess of the appraised value of the three properties. The transactions closed at the beginning of April 1987 and Stec became the registered owner of the properties.
5. When Braut and Stec initially discussed the question of sale of the properties by Braut to Stec, a major stumbling block to the proposed transaction was that Stec was impecunious. He had a small equity interest in his residential property in Surrey (the down payment for which had been advanced by his mother-in-law), his employment was somewhat sporadic and his yearly income was in the range of $10,000. Bearing in mind that the total purchase price for the three properties aggregated about $450,000, it seemed unlikely on the face of matters that Stec would be able to purchase these properties from Braut. Stec acknowledged in his evidence that it was "somewhat of a miracle" that he had been able to purchase these properties. How that result came to be achieved was as follows.
6. Braut engineered an arrangement whereby Stec falsely alleged to a mortgage lender that he was in receipt of an income in excess of $50,000 a year and, given his income and the projected cash flow of the properties, this lender was persuaded to provide, in two cases, 75% financing and in another case involving CHMC an even higher ratio of financing. This stratagem had the effect of satisfying a substantial portion of the purchase price to be paid to Braut for the three properties but there still remained a shortfall of over $100,000. Given the financial circumstances of Stec, this gap had to be bridged in some fashion. The methodology used to resolve this problem consisted in the vendor, Braut, persuading his then fiancιe, Ms. Roadburg [Roadburg], who apparently had access to family funds, to advance the requisite additional funding by way of second charges. The sum of $106,000 was needed to make up the total purchase price for the properties and this sum was advanced by Roadburg. The face amount of these charges aggregated about $116,000, representing a $10,000 bonus, a not uncommon arrangement in this sort of mortgage lending. It was also said that Braut stood to gain an additional $10,000 on sale of the properties. Stec thus became the registered owner of these properties, the sale of which had been financed to the extent of 100% by the efforts of Braut.
7 . A day or so after the registration of the transfers of the properties to Stec, Braut presented the aforementioned written agreement to Stec and requested Stec to sign it. It is to be noted that Braut presented the agreement to Stec after the transfer of the properties was complete and he was entitled to the sale proceeds. Stec testified that he was reluctant to sign the document and Braut testified that he wanted Stec to have some independent legal advice before signing it. Braut clearly wanted Stec to sign this document, but Stec had a great reluctance to sign.
8. In the course of her reasons for judgment, the trial judge said this concerning the credibility of the two men, Braut and Stec at para. 3:
Credibility is a central issue in this case. Both Braut and Stec were evasive witnesses. Certain of their evidence was implausible. Some was downright unbelievable. Neither man impressed me as having an appreciation of the oath each had sworn to tell the truth. This most regrettable state of affairs makes the determination of the case more than usually difficult.
9. Given her findings about the credibility of the parties, it becomes important in this case to look to documents, to the surrounding circumstances and to the evidence of other witnesses to endeavour to ascertain the true situation between the parties at the time in April 1987 when the agreement was signed. The trial judge was required to consider these other sources of evidence in order to decide the case.
10. It is clear that on the 3rd of April 1987, Braut and Stec attended at the office of a Mr. Crosby [Crosby], a Vancouver solicitor. Crosby was engaged to give legal advice to Stec concerning the agreement that Braut had had drafted by another lawyer and which document he wished Stec to then sign. Crosby testified at the trial that he had not been made aware of the circumstance that Stec had become the registered owner of the properties as a result of the 100% financing arranged by Braut, nor was he aware of any of the background relating to the transactions. His advice to Stec was unequivocal: "Don't sign this agreement". Crosby testified that he gave Stec this advice because he could see no advantage in Stec, who was by then the registered owner of the three properties, signing this agreement which imposed a great many obligations upon Stec including an obligation to share profits with Braut from future sales of the properties. Crosby testified that it became apparent to him in his interview with Stec that Stec seemed to have no informed understanding about the nature and meaning of the agreement.
11. After the meeting with Crosby, there were further discussions between Stec and Braut. Stec in his evidence asserted that Braut had put a gun to his head and demanded that he sign the document. The trial judge rejected this evidence as unworthy of belief. But there was no question that Braut did put considerable pressure on Stec to sign the document. He acknowledged that he had threatened to expose the false statements Stec had made to the mortgage company about his income to get the mortgages and further, there was no doubt that Braut made it clear to Stec that he had the capacity to persuade Roadburg to call the demand mortgages if Stec did not sign the proffered agreement. It is obvious that there was some discussion between the two men as to terms of the agreement because one of the terms concerning the methodology of future appraisal of the properties was changed and this change was initialled by the two men. Stec ultimately signed the agreement before a notary in the month of April 1987.
12. The agreement included terms that imposed considerable obligations upon Stec but no obligations upon Braut and required Stec to bear all of the risks related to the property but imposed no risks upon Braut. The agreement required Stec to expend considerable work and labour on the properties and to obtain the consent of Braut to any expenditures on the property other than relatively minor ones. Stec was required to share in any income and ultimate gains from sales of the properties, but if losses ensued by reason of maintenance or other causes, Braut was not required to bear any share of such losses. Stec was required to give notice to Braut if he intended to sell any property and Braut had an option of first refusal to buy any property proposed to be sold. Braut was to receive half of the profits from the enterprise, but profits were defined in such a way that certain expenses or possible mortgage penalties would not be taken account of in calculating such profit. This term was clearly very favourable to Braut. This provision generated a controversy in this case in that according to Braut, when the properties were sold, the profits were considerably greater than what was asserted by Stec to be the total profit after calculating all expenses and sums that had to be paid out in satisfaction of mortgage charges and penalties.
13. Stec took over the properties and managed everything relating to them after April of 1987. Although Braut from time to time urged Stec to make certain changes to the properties or rental arrangements, Stec does not appear to have adopted these suggestions or demands. The evidence indicates that Stec was having difficulty in keeping the properties in a positive revenue situation and he was unable to fully service the Roadburg mortgages. In 1989 he undertook to sell one of the properties without the participation of Braut and Braut moved to legally encumber the properties so they could not be sold. Ultimately, however, all three properties were sold after a considerable delay.
14. In this lawsuit, Braut seeks to obtain an order for payment of a share in the profits pursuant to the terms of the agreement. There is disagreement between the parties as to what the actual sale profit was, although it is clear there was a significant profit, largely because of appreciating real estate prices in Vancouver during the relevant time.
15. This case manifests a tension between different well-established legal principles. The first is that courts will normally enforce bargains entered into between competent contracting parties. The Latin maxim pacta sunt servanda reflects this legal principle which is a cornerstone of the rule of law. Failure to enforce contractual arrangements would be highly disadvantageous to commerce. But there is another long-standing principle: the courts will refuse to enforce a bargain that is extorted by duress or that is found to be unconscionable. It is this latter principle that the trial judge invoked in refusing to enforce the agreement that was signed by these parties in April 1987.
16. In Harry v. Kreutziger (1978), 95 D.L.R. (3d) 231, 9 B.C.L.R. 166 (C.A.) [Harry], a decision of this Court relied upon by the trial judge, McIntyre J.A. said this:
The principles upon which a Court will interfere with a concluded transaction and nullify it upon the ground that it is unconscionable have found frequent expression. An early Canadian case is Waters v. Donnelly (1884), 9 O.R. 391. The leading pronouncement on the subject in British Columbia is to be found in Morrison v. Coast Finance Ltd. et al. (1965), 55 D.L.R. (2d) 710 at p. 713, 54 W.W.R. 257 at p. 259, where Davey J.A., speaking for himself and Bull J.A., said:
The equitable principles relating to undue influence and relief against unconscionable bargains are closely related, but the doctrines are separate and distinct. The finding here against undue influence does not conclude the question whether the appellant is entitled to relief against an unconscionable transaction. A plea of undue influence attacks the sufficiency of consent; a plea that a bargain is unconscionable invokes relief against an unfair advantage gained by an unconscientious use of power by a stronger party against a weaker. On such a claim the material ingredients are proof of inequality in the position of the parties arising out of the ignorance, need or distress of the weaker, which left him in the power of the stronger, and proof of substantial unfairness of the bargain obtained by the stronger. On proof of those circumstances, it creates a presumption of fraud which the stronger must repel by proving that the bargain was fair, just and reasonable: Earl of Aylesford v. Morris (1873), L.R. 8 Ch. 484, per Lord Selborne, L.C., at p. 491; or perhaps by showing that no advantage was taken: see Harrison v. Guest (1855), 6 De G.M. & G. 424 at p. 438, 43 E.R. 1298; affirmed (1860), 8 H.L.C. 481 at pp. 492-3, 11 E.R. 517. In Fry v. Lane (1888), 40 Ch. D. 312, Kay J., accurately stated the modern scope and application of the principle, and discussed the earlier authorities upon which it rests. At p. 322 he said:
The result of the decisions is that where a purchase is made from a poor and ignorant man at a considerable undervalue, the vendor having no independent advice, a Court of Equity will set aside the transaction.
This will be done even in the case of property in possession, and a fortiori if the interest is reversionary.
The circumstances of poverty and ignorance of the vendor, and absence of independent advice, throw upon the purchaser, when the transaction is impeached, the onus of proving, in Lord Selborne's words, that the purchase was 'fair, just, and reasonable.'
This case has been followed in such cases as Knupp v. Bell et al. (1966), 58 D.L.R. (2d) 466 [affd 67 D.L.R. (2d) 256 (Sask. C.A.)], and Marshall v. Canada Permanent Trust Co. (1968), 69 D.L.R. (2d) 260, and it was cited with approval by Lord Denning, M.R., in Lloyd's Bank Ltd. v. Bundy, [1974] 3 All E.R. 757 at p. 764, which case discusses the applicable principles.
From these authorities this rule emerges. Where a claim is made that a bargain is unconscionable, it must be shown for success that there was inequality in the position of the parties due to the ignorance, need or distress of the weaker, which would leave him in the power of the stronger, coupled with proof of substantial unfairness in the bargain. When this has been shown a presumption of fraud is raised and the stronger must show, in order to preserve his bargain, that it was fair and reasonable.
17. The agreement between the parties here imposed all of the obligations to maintain and successfully rent the properties upon Stec, made him responsible for any shortfalls or operating losses, and imposed no obligations upon Braut. The agreement expressly provided that Braut would not be deemed a partner in the venture and that he would have no responsibility for operating losses. He bore no risks, as the trial judge found, but he did stand to gain an equal share of profit as defined in the agreement from any increased value of the properties when the properties came to be sold. Braut also had a potential right to receive a portion of operating profits and he had a right of first refusal to purchase any of the properties. Braut thus had a possibility of good fortune, but no possibility of misfortune should rental income be insufficient to service debt or should the property market decline.
18 . The trial judge also found that a material inequality existed in knowledge and bargaining power between the parties. Braut was better educated, more conversant with business, and more familiar with the English language. The judge found that he was able to impose his will upon the reluctant Stec to get him to sign a highly disadvantageous agreement. The judge said this, commencing at para. 75:
There can be no doubt that there was an inequality in bargaining power between Braut and Stec. It is abundantly clear that Stec was clueless as to the meaning and effect of the equity sharing agreement. That is made amply clear by the evidence of Mr. Crosby as well as the evidence of Mr. Streuger who testified in the plaintiff's case that Stec did not understand formal language, including correspondence from his lawyer. Not only was Stec ignorant about the meaning of the agreement, I also conclude that Braut's threats to expose Stec if he refused to sign the agreement generated genuine distress for Stec.
In addition, as Mr. Crosby testified and which is amply demonstrated by the terms of the equity sharing agreement itself, there was substantial unfairness to Stec in the bargain. All of the risk was upon Stec. Braut, who risked nothing, stood to gain one half of all of the net income and capital profits from the properties.
In my view, a presumption of fraud has been raised against Braut. According to the authorities, the burden is upon Braut to demonstrate that the equity sharing agreement was fair and reasonable. I find that he has failed to do so.
19. The situation in April of 1987, when this agreement was executed by the parties, was that Braut had sold his properties at full if not slightly in excess of full value to Stec. Stec was liable on the first and second mortgages that were together equivalent to the then full value of the properties. Stec, altogether aside from any provisions in the agreement, was obligated to keep the properties in good condition in order to obtain sufficient rental income to service these highly indebted properties. In a word, he was highly "leveraged" and if, as proved to be the case, the cash flow did not suffice to service all financial obligations, Stec would be in a position where he might have to liquidate some or all of the properties at a loss. While over the long term, real estate is likely to appreciate in urban areas, there are always fluctuations dependent on general economic conditions, interest rates and the like.
20. On a risk reward analysis, in April 1987, Braut was fully paid out on the properties at market value, had no ongoing obligations and had only the possibility of gain if the properties generated excess cash or could ultimately be sold at a profit. Stec bore all of the risks of possible loss and had to look after the properties, but under the terms of the agreement could only be entitled to receive part of the profits on sale.
21. The appellant submitted that it was an extraordinary advantage for Stec, a man without assets, to be enabled to become owner of these properties with the likelihood of capital gain, which did in fact occur. However, that is much easier to observe in hindsight than was the situation in April 1987. As noted above, all the risks and obligations rested on the shoulders of Stec and no risk at all relative to the properties was to be borne by Braut.
22. If this agreement had been structured as a true "equity-sharing" agreement with risks and rewards to be shared by both parties, the submissions of the appellant would have considerable force. The casting of all of the burdens on Stec under this agreement, having regard to the relative knowledge and business acumen of these parties, resulted in what the judge found to be an unconscionable agreement. This sort of finding has about it a strong factual element. An appellate court is required to show considerable deference to such a finding on the part of a trial judge, Housen v. Nikolaisen, [2002] 2 S.C.R. 235, 2002 SCC 33.
23. Many cases, such as Waters v. Donnelly (1884), 9 O.R. 391 (Div. Ct.) [Waters] and Marshall v. Canada Permanent Trust Co. (1968), 69 D.L.R. (2d) 260 (Alta. S.C. (T.D.)), disclose situations where property was sold by an improvident individual to a more astute individual at a considerable undervalue. A case often cited that was referred to in Harry is Earl of Aylesford v. Morris (1873), L.R. 8 Ch. 484, which concerned a transaction involving a loan at a high interest rate to a reckless young nobleman who in effect was mortgaging his expectation of inheritance. On appeal from a judgment significantly adjusting downward the interest rate, Lord Selborne, L.C. said that equity refused to enforce such bargains because they were tinged with fraud. He said (at 490-491):
Fraud does not here mean deceit or circumvention; it means an unconscientious use of the power arising out of these circumstances and conditions; and when the relative position of the parties is such as prima facie to raise this presumption, the transaction cannot stand unless the person claiming the benefit of it is able to repel the presumption by contrary evidence, proving it to be in point of fact fair, just, and reasonable.
24. In Waters (at 401), Chancellor Boyd, citing an Irish case, Slator v. Nolan (1876), Ir. R. 11 Eq. 386, stated:
... where parties were not on equal terms, the party who gets a benefit cannot hold it without proving that everything has been right and fair and reasonable on his part.
25 . In the instant case, the appellant argues that Braut was giving the impecunious Stec an opportunity, which eventuated, to make money on real property. However, as the trial judge concluded, there is no doubt that Braut was able to persuade Stec into signing an agreement that had no risk for Braut and all risk for Stec. Braut uttered threats to Stec to help persuade him to sign this agreement. When it was entered into, Braut had already received in excess of full value for the property sold to Stec. The judge found that Braut was able to impose his will on the weaker party, Stec, to get him to enter into the improvident equity-sharing agreement. This case is perhaps a more subtle example of imposition than one of a sale of property at gross undervalue, but there can be no doubt that Stec was coerced by Braut into signing an agreement wholly favourable to Braut and wholly unfavourable to Stec. As the categories of negligence are never closed, so too the categories of unconscionability are never closed.
26. Given the circumstances, the sale of Braut's properties for full value and this highly disadvantageous agreement imposed by threats on Stec, a relatively unsophisticated person with a limited knowledge of English, I consider that there was a sound basis in the evidence for the trial judge to find that this was a unconscionable bargain.
27. The appellant submits, however, that even if this finding of the judge is sustainable as regards unconscionability, relief should be denied to the respondent Stec on account of laches, acquiescence, and a lack of "clean hands" on the part of this respondent. While at least two years passed before Stec sought to market one of the properties without seeking consent from Braut as stipulated in the agreement, the evidence does not disclose that Stec in any material way adhered to the terms of the agreement prior to this time. He simply managed the properties as he was bound to do in his own interest to try to keep the debts serviced. His action in marketing one property was not an acquiescence in the agreement, but the ignoring or rejection of it. There was no occasion in practical terms until the attempted disposition of this property in 1989 for Stec to do anything concerning the agreement, so it is difficult to see how the equitable doctrine of laches could have any application here.
28. As regards the "clean hands" doctrine sought to be invoked by the appellant, it was observed by the Court in City of Toronto v. Polai, [1970] 1 O.R. 483, (1969) 8 D.L.R. (3d) 689 (C.A.), that this principle must not be applied too widely. It was observed that:
The misconduct charged against the plaintiff as a ground for invoking the maxim against him must relate directly to the very transaction concerning which the complaint is made, and not merely to the general morals or conduct of the person seeking relief; or as is indicated by the reporter's note in the old case of Jones v. Lenthal (1669) 1 Chan. Cas. 154, 22 E.R. 739: ". . . that the iniquity [sic] must be done to the defendant himself."
29. In that old case, the plaintiff had given a false answer in a previous proceeding, a situation somewhat analogous to the finding here that Stec was not a credible witness. Stec joined with Braut in deceiving the mortgage company as to his income in order to obtain first mortgages on the properties and he was found by the trial judge to be not a truthful witness. These are marks against his conduct and his character, but these acts are not directly connected to the agreement at issue in these proceedings. I consider the trial judge made no error in holding that the "clean hands" doctrine was no bar to granting the relief sought by the respondent, namely to be protected from the enforcement of the agreement, the relief sought by Braut in this lawsuit.
30. While a court must exercise caution in finding an agreement unconscionable lest a contracting party be enabled to too easily escape from an unwanted contractual obligation, there are cases, of which this one is an example, where the equitable jurisdiction of the court can be successfully invoked to protect the weak or disadvantaged from the enforcement of unconscionable bargains. This was an unconscionable transaction when it was entered into and the accidental circumstance that Stec did ultimately realize a profit on the sale of the properties does not rescue this agreement from being categorized as unenforceable for unconscionability.
31. I am in agreement with the result reached in this case by Kirkpatrick J. (as she then was) and I would dismiss this appeal. I would not interfere with the disposition of costs in the trial court, but I consider the respondent should be entitled to costs on the usual scale in this Court.
HALL J.A.
DONALD J.A.: I agree.
BRAIDWOOD J.A.: I agree.
QL UPDATE: 20051101
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