Update on Demand Obligations 

publication 

Summer 2010 - (InBrief Summer 2010)

InBrief Summer 2010

Shortly after Ontario's Limitations Act 2002 (the "Act") came into force in January of 2004, we wrote a Banking and Project Finance Brief to describe the impact the Act would have on the financial services community, including its application to demand obligations. This article provides an update of the Act as it relates to demand obligations, resulting from both changes to the Act and case law.

The Limitations

Generally speaking, the holder of a debt obligation governed by Ontario law must make a claim against the debtor within two years from the date when the creditor becomes entitled to sue. With a demand obligation, when does that entitlement arise?

The jurisprudence under previous Ontario limitations legislation provided that demand obligations evidenced by demand promissory notes created an obligation to pay from the time the note was created.

That position was reiterated in the 2006 decision in Hare v. Hare (" Hare "), in which the Ontario Court of Appeal upheld the decision of the motions judge that the action was statute-barred by the limitation period of six years under the former Limitations Act . The Hare case confirmed previous jurisprudence that the limitation period in respect of demand promissory notes runs from the later of (i) the date on which the loan is made, and (ii) the date of the last interest or principal payment under the note.

However, subsequent amendments to the Act have had an impact on its application to demand obligations. One such general amendment is contained in Section 22(5) of the Act, which provides that, in respect of business agreements, the basic limitation periods under the Act may be varied or extended by an agreement made on or after October 19, 2006. This provision gives business parties the ability to provide for longer limitation periods than those set out in the Act.

More specific to demand obligations, Sections 5(3) and 5(4) were added in 2008. Section 5(3) provides that "the date on which injury, loss or damage occurs in relation to a demand obligation is the first day on which there is a failure to perform the obligation, once a demand for the performance is made ." [Italics added.] And by virtue of Section 5(4), this new provision applies with retroactive effect to all demand obligations created on or after January 1, 2004 (i.e., the date on which the Act initially came into force).

What if There's No Demand?

It is, therefore, clear that Section 5(3) of the Act reversed the established law in the area as enunciated in the Hare decision. What is less clear is whether or not the ultimate limitation period provided for in the Act serves its intended purpose of providing certainty insofar as demand promissory notes are concerned.

Section 15(2) of the Act provides for a 15-year ultimate limitation period, which period starts on the "date on which the act or omission on which the claim is based took place." However, Section 15(6)(c) provides that for demand obligations, such date is the "first date on which there is a failure to perform the obligation, once a demand for the performance is made ." [Italics added.] What if demand is never made on a demand note? Based on the language in the Act, neither the basic two-year limitation period nor the ultimate 15-year limitation period would commence, and so the obligation would continue indefinitely. Is this the intention of the legislation or an inadvertent loophole? Only time will tell.

How Are Demand Guarantees Treated?

What about demand guarantees that provide that the guarantor is obligated to pay upon receipt of demand from the lender, as opposed to the occurrence of another event (e.g., default by the borrower)? The established caselaw in respect of third-party collateral obligations given to secure the obligation of the primary debtor is that formal demand is a condition precedent to that obligation. This is different from the jurisprudence that applied prior to Section 5(3) regarding demand notes, discussed above. In the recent Ontario Court of Appeal decision in Bank of Nova Scotia v. Williamson (" Williamson "), the court addressed the issue of commencement of the limitation period on a demand guarantee.

In the Williamson case, demand on the borrower was made October 20, 2004 and on the same date, the bank sent the guarantor a letter advising that demand had been made on the borrower and that "if payment of our demand is not made as required, we will take steps to recover payment from you." The Bank made formal demand on the guarantor on June 12, 2007, and not having received payment, commenced an action against the guarantor on July 7, 2007.

In arguing that the bank should be statute-barred, the guarantor stated that the two-year limitation period should run from the date on which the bank knew that the Borrower could not pay the debt or, alternatively, from October 20, 2004, the date of the first letter to the guarantor, which it argued was a demand for payment. The court referenced the established caselaw regarding demand guarantees; but stated, in any event, that by virtue of Section 5(3), the two-year limitation period regarding the guarantee did not commence until formal demand was made in the June 12, 2007 letter. (The court held that the October 20, 2004 letter to the guarantor was "sent merely to advise the guarantor" that if the principal debtor did not pay, the Bank would look to the guarantor).

Interestingly, the guarantor did raise the issue discussed above regarding the potential for indefinite liability under a demand guarantee. The court responded that the ultimate 15-year limitation period in Section 15 of the Act would ensure the "liability will not be indefinite." The only conclusion to be drawn from this statement is that in respect of a demand guarantee, the date of demand referred to in Section 15(6)(c) must be the date on which payment is demanded from the borrower. Otherwise, the period could, in fact, be indefinite since the lender could simply postpone or refrain from making demand on the guarantor, thereby not triggering the commencement of the ultimate limitation period.

Some Final Thoughts

The last several years have seen certain amendments to the Act and some related caselaw that have both changed the direction and clarified the application of the Act as it relates to demand obligations. However, some questions still remain and may not be fully answered until either further amendments to the Act are made or additional litigation ensues. Clearly, there will have to be further updates.

This article appeared in the Lang Michener LLP InBrief Summer 2010.