When a mortgage brokerage misappropriates client funds, can its insurer deny coverage because the money was held in trust rather than secured by a mortgage? A recent Ontario Court of Appeal decision examines this distinction and the role of mandatory insurance requirements in interpreting insurance policies.
In 2069586 Ontario Inc. v. Sovereign General Insurance Company, the Court considered whether an errors and omissions insurance policy covered losses arising from a mortgage brokerage’s fraudulent misappropriation of nearly $460,000. The insurer argued that the policy’s fraud endorsement did not apply because the stolen money constituted trust funds rather than mortgage funds.
The Court rejected that interpretation, finding that funds held in trust can also qualify as mortgage funds when provided in connection with a proposed mortgage transaction.
In 2016, a businessman and two related corporations (the “Borrowers”) sought approximately $6.75 million in financing to purchase a student housing development property. They engaged a licensed mortgage brokerage (the “Brokerage”), which introduced them to a potential lender.
As a condition of obtaining financing, the Borrowers were required to provide US$350,000, equivalent to $459,975 CAD. Under the agreement, the Brokerage would hold the money in trust and return it without deductions after 19 days.
However, the financing never proceeded. The Borrowers discovered that the Brokerage’s principal had withdrawn most of the money. They commenced civil fraud litigation against the Brokerage, its principal, and others, obtaining a default judgment. After partially recovering their losses, $353,520.92 remained unpaid.
The Borrowers sought recovery of the outstanding amount through the Brokerage’s errors and omissions insurer (the “Insurer”). As a licensed Ontario mortgage brokerage, the Brokerage was required under the Mortgage Brokerages, Lenders and Administrators Act, 2006 and Ontario Regulation 188/08 to maintain errors and omissions insurance with extended fraud coverage. The regulations establish minimum coverage of $500,000 per occurrence and $1 million across a 365-day period.
Although the policy generally excluded losses arising from dishonest conduct and the mishandling of funds, a specific endorsement provided coverage where an insured became legally liable to a third party for a failure to “advance or secure mortgage funds” resulting from mortgage fraud.
The Insurer argued that this endorsement did not apply because the Borrowers’ money was held in trust rather than secured by a mortgage. The lower court accepted that interpretation, granted summary judgment dismissing the claim against the Insurer, and awarded costs against the Borrowers.
The Borrowers appealed, arguing that the lower court had interpreted the endorsement too narrowly. The Ontario Court of Appeal determined that the terms “trust funds” and “mortgage funds” were not mutually exclusive. While mortgage funds describe money connected to mortgage-related activities, trust funds describe the legal arrangement under which money is held.
Importantly, Ontario’s regulatory framework requires mortgage brokerages to hold certain money received through their regulated activities in trust. The Court found that money does not lose its mortgage-related character simply because it must be held in trust. Since the Borrowers provided the funds specifically to obtain financing, the misappropriated money qualified as mortgage funds under the endorsement.
The Court also considered the regulatory environment in which the insurance policy was issued. Unlike optional insurance arrangements, the Brokerage’s policy existed to satisfy mandatory licensing requirements. Ontario’s regulatory framework required coverage for certain fraudulent conduct and established minimum insurance protections for members of the public dealing with mortgage brokerages.
The Court determined that insurance policies must be interpreted in their legal and commercial context. Where contractual language reasonably permits an interpretation consistent with applicable regulatory requirements, that interpretation is preferred over one that creates a conflict. However, regulatory requirements do not permit courts to rewrite otherwise unambiguous policy terms.
Another central issue concerned the meaning of “secure” within the endorsement. The Insurer maintained that the provision applied only to money already secured by a mortgage. However, the Court found that the word could describe both protecting money from loss and obtaining mortgage financing.
The Brokerage failed to safeguard the Borrowers’ funds when its principal misappropriated them. The contemplated financing was also never secured. The Court concluded that these circumstances fell within the endorsement’s wording, which was not restricted to existing mortgage proceeds or registered mortgages.
The Court further considered established principles of insurance contract interpretation, including commercial reasonableness and the reasonable expectations of the parties.
Under the Insurer’s proposed interpretation, funds would be excluded from fraud coverage precisely because they were held in trust, even though Ontario’s regulatory framework required that arrangement. The Court found that this would substantially undermine the endorsement’s intended protection.
The Court also addressed contra proferentem, under which unresolved ambiguity in insurance contracts may be interpreted against the insurer. Although the Court found the endorsement unambiguous when properly interpreted, it concluded that this principle would reinforce the same outcome if ambiguity remained.
The Court emphasized that its interpretation did not establish unlimited insurance coverage for every fraudulent act committed by a mortgage broker. Coverage still requires a sufficient connection between the fraud and a failure to advance or secure funds associated with regulated mortgage activities.
Because the material facts were largely undisputed, the Court determined that the matter could be resolved through summary judgment without a trial.
The appeal was allowed, and the lower court’s judgment was overturned. The Court declared that the Insurer was liable to indemnify the Borrowers for the outstanding $353,520.92, together with applicable interest. It also reversed the previous costs order against the Borrowers.
The decision illustrates how contractual language, regulatory obligations, and the commercial purpose of a transaction interact when courts interpret insurance coverage. For parties involved in mortgage fraud disputes and commercial real estate litigation, it clarifies that money held in trust may retain its mortgage-related character before financing is finalized.
The ruling also highlights the potential importance of insurance coverage in asset recovery proceedings when parties responsible for financial misconduct cannot satisfy a judgment.
Ultimately, 2069586 Ontario Inc. v. Sovereign General Insurance Company confirms that mandatory regulatory requirements form part of the context for interpreting insurance contracts. Whether coverage applies depends on the policy’s language, the nature of the transaction, and the connection between the insured conduct and the resulting loss.
The civil fraud litigation lawyers at Milosevic & Associates represent businesses, investors, lenders, and individuals in complex mortgage fraud, financial misconduct, commercial real estate, and insurance-related disputes. We assist clients with fraud claims, recovery of misappropriated funds, disputed commercial transactions, and litigation involving significant financial losses.
Our firm provides representation in Ontario civil and commercial litigation, including trials, summary judgment motions, appeals, and judgment enforcement proceedings. Contact Milosevic & Associates at 416-916-1387 or reach us online to discuss your legal matter with our team.
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