There is a mechanism under the Bankruptcy and Insolvency Act (“BIA”) where a Trustee in Bankruptcy, with the Courts permission, can sell property of the bankrupt that is the subject of a security interest, and the Court can order that the security be cancelled and the property sold free and clear.
A lender that holds a mortgage on real property as security for its loan is a secured creditor. There are very few circumstances in which its security can be lost. One of those circumstances, and one that is not commonly known, arises under the BIA.
The BIA provides that where a Trustee who has knowledge of property that may be subject to a “security” (which includes a mortgage) can serve notice on the secured lender to file with the Trustee proof of their security. Where the secured lender does not file a proof of security within 30 the Trustee may with the permission of the Court sell any property that was subject to the security free and clear of that security (emphasis mine). So if a borrower becomes bankrupt, the Trustee can mail or fax a notice to a mortgage lender and if a proof of the mortgage security is not filed within 30 days, the mortgage may be lost.
Mortgage lenders should be aware of these sections of the BIA and be diligent in filing their claim with the Trustee when they receive notice of a bankruptcy.Any lender that receives a notice a notice of bankruptcy should immediately contact the Trustee and either file a proof of claim and proof of security or seek legal advice.Failure to do so can result in a loss of the mortgage and the loan becoming unsecured.