Risk, its existence and its management in Commercial Lending preoccupies the minds of both Lenders and Borrowers. Both are risk averse. However, each group sees risk through a different lens, or more appropriately different sides of the same coin. Banking has become a process of employing polices and procedures to manage risk in a complex financial marketplace. Banks manage liquidity, credit and exchange rate risks. Borrowers (Corporations) can see risk as an obstacle, real or imagined, to obtaining the funding they need to acquire a business asset and earn business cash flows; or refinance a corporate asset in order to liquidate equity for investment or the retirement of a high interest debt. In this series of articles on risk I am going to discuss the four major areas of risk that must be identified, investigated and explained to all parties during the mortgage origination process. This first article is dedicated to the “The Corporate Structure and Share Capital”.
It is the responsibility of the Commercial Mortgage Broker to support both the lender and the borrower by clearly telling the story of the risk associated with the mortgage application. The mortgage origination process is the tool a mortgage broker uses to identify, investigate and explain the existing risk factors. The process does not remove the risk – but once identified – it does eliminate the negative effect of undisclosed risk on the closing of the mortgage. The skeleton of the Corporation consists of the following:
- Corporate Profile and the Articles of Incorporation
- Shareholder’s Agreement
- Corporate / Business Timeline
The corporate profile and the Articles of Incorporation are documents that defines:
- the type of legal entity, it’s date of incorporation
- registered office
- Directors and Officers
- Share Structure, Types (Classes) and Characteristics
- and, Filing History
These documents define the share capital system of the corporation. The corporation’s share capital is generally made up of shares (units). These shares may be organized into groups or classes. Within a class, each share is equal to every other share; the number of shares determines the owners interest in the company. Each share has certain rights and privileges as outlined in the Articles of Incorporation. Common shares represent residual ownership and Preferred shares have preferential rights such as a claim on earnings and assets (upon dissolution of the company). The important point here is that common shareholders control the corporation management through voting rights attached to the common shares, and are the folks “in play” during the financing process.
When it comes to a mortgage origination this is important stuff. The broker will review these documents and determine if the company can legally enter into a lending agreement with the lender. A company that does not have a current filing with ISC is not a registered entity does not have authority to do so. Additionally, the broker will review the share structure. This review will identify those shareholders that have residual ownership (common shares), define who must sign a proportional guarantee and be identified under Canadian Anti-Money Laundering Law.
THIS IS WHERE THE RISK MAY PRESENT for the borrower (Corporation), as all shareholders may not agree to sign a proportional guarantee. It is important to note that there are a lot of good reasons for a shareholder not to do so; and each shareholder should be advised to seek quality, independent legal advice in these matters. If a broker is aware that there are objections in this group the matter must be referred back to the Board of Directors and the Corporation’s Management for resolution.
Just one part of the story in the mortgage origination process!
My next article in this series will focus on Informed Consent and Commercial Mortgage Origination.
Randell Toporowski is an Accountant in private practice and an Associate Mortgage Broker with DLC Powerhouse Mortgages in Regina, SK. He can be contacted at 306-541-5438.